Editor’s Letter

APARTMENT FINANCE TODAY • JANUARY 2008

Looking at the Big Picture

By Andre Shashaty

As I was reporting on the capital markets outlook for this issue, I realized just how hard it is to get a realistic picture of capital availability and real estate valuations in the year ahead.

Logic dictates that apartments stand apart from the troubled home sales and lending business. Like a mansion high on the hill, we should not be affected by the financial floodwaters around us. Multifamily borrowers are nothing like overstretched homebuyers who can’t make their next loan payment. Demand is strong and growing, and rents are healthy.

In the normal course of economic events, you would expect capital providers to just sober up and promise not to drink so much at the next party. After all, they still need someplace to put their money and earn a decent return.

So there is a strong argument to be made that the current dip in liquidity and the uptick in capitalization rates for some deals is, in fact, the long-awaited buying opportunity, a chance to get back on the train leading to the glorious world of longterm income growth and price appreciation.

If the availability and cost of capital for apartments settles down and it remains relatively easy to get a solid deal done on good terms in 2008, it will be a testament to the resiliency of the capital markets and the appeal of apartments.

But it’s not quite that easy. Remember, everyone downplayed the very existence of a housing bubble just two years ago. Then, when the first subprime mortgages started going bad, they downplayed the impact of that. Then, even after capital began withdrawing from commercial mortgagebacked securities, they said things would bounce back by year’s end.

The reality has always been worse than the forecast.

The other argument for optimism is that the current capital market turmoil comes at a time when apartments are nowhere near as vulnerable as they were in the early 1990s, when there was massive overbuilding and lenders had good reason to fear lending on multifamily deals.

Of course, this situation is not the same. But that fact alone does not guarantee that the multifamily industry won’t face serious problems of a different nature.

Some say the home mortgage market crisis is good news, since it prevents the loss of good tenants to homeownership, but the fact is, it will only delay those losses.

The subprime crisis will end sometime in 2009, and reduced home prices and a new round of “creative” financing will start luring your tenants back to the open houses and homes-for-sale listings. Politicians will jump on this bandwagon with a vengeance, and may even enact new programs to help more people buy homes.

As Wharton real estate professor Peter Linneman put it, “The challenge is for apartment guys to understand that the strong demand due to reduced ownership propensities is a transitory phenomenon, not a paradigm shift.”

Meanwhile, there is a broad consensus that the economy will slow in 2008, hurting job growth and household formation. There could be a recession in 2008, but according to Linneman, it’s more likely in 2009 or 2010.

In other words, it’s not a question of whether the economy is getting softer, but how soft it will get over what time period. And declines in occupancy and flat or negative rental income growth will not do much to enhance the value of your properties or attract financing.

That’s why our readers need to look beyond the immediate crisis and keep their eye on the big picture, with a strategy that focuses on building long-term value that can withstand a volatile economy. A key part of that plan should focus on how to keep good tenants happy long after the home sale market revives.