Apartment Finance Today

SPECIAL FOCUS

CFOs SHARE STRATEGIES

Setting a New Course

APARTMENT FINANCE TODAY • September 2008

CFOs share the creative debt and equity strategies that keep their pipelines moving during a credit crunch.

BY JERRY ASCIERTO

For most of its nearly 20-year history, Laramar Group never considered acquiring a failed condominium deal. But in the last year, the company has purchased three such deals in the Tampa and Boca Raton areas of Florida, as the condo industry’s gloom presents new opportunities for multifamily developers.

“It’s a whole new level of acquisition for us,” said Scott Shanaberger, chief financial officer (CFO) of Laramar Group, a Colorado-based developer and operator of more than 20,000 units. “We get the property at a significant discount, many times at 50 or 60 cents on the dollar from what the whole capital stack was originally.”

Laramar came up with a unique financing strategy to realize those discounts: Become the creditor. Laramar will acquire the existing mortgage from the senior lender and negotiate with the mezzanine lender, equity provider, and current owner to complete the foreclosure process.

There are a couple of advantages to this strategy. First, the deal is not marketed, so there’s no competitionfor the asset. Second, since many banks are suffering from the current real estate market and have no interest in becoming apartment operators, they are motivated sellers.

“They’ll do whatever they can to get nonperforming loans off their balance sheet,” said Shanaberger.

Laramar will offer some money to the original deal’s equity players and mezzanine lenders—entities that would otherwise have to walk away from the deal with nothing to show for it. It’s basically “stand down” money, a way of ensuring the stakeholders don’t interfere in the foreclosure process, Shanaberger said.

Laramar’s creative approach mirrors a growing trend in the multifamily industry.

As the debt and equity markets become increasingly conservative, developers are finding unique ways to boost liquidity while capitalizing on distressed markets. As construction financing in particular gets harder to find, many companies are unearthing other sources to fund development.

These creative acts of balance sheet re-engineering can involve reallocating a stabilized community’s income, raising more equity by selling older assets, or clearing balance sheets of debt to increase lines of credit in anticipation of future growth.

Balance sheet re-engineering

Home Properties has also taken advantage of the condo industry’s gloom to expand in one of its key markets, the Washington, D.C., suburbs.

Earlier this year, Home acquired a site in Silver Spring, Md., for $13.2 million, a discount for the desirable area. The site was initially being developed for a condominium tower, but the project’s developer, Centex Homes, couldn’t make the deal pencil out.

The planned 247-unit mixed-use tower will cost $74 million to develop. With a dearth of available and affordable construction debt on the market, Home Properties is taking a different path to fund its Silver Spring project and the rest of its development pipeline.

“We’re not even contemplating any construction-specific financing,” said David Gardner, CFO of Home Properties, a publicly traded real estate investment trust (REIT) that owns nearly 37,000 units. “As long as we can do it in another area of our balance sheet, we will.”

The company needed about $75 million for development in 2008 and next year will need about $140 million. To fund that activity, the company will sometimes put new debt on a debt-less property, use cash flow from the rest of its portfolio, or tap its credit line.

The company also employs a refinancing strategy that clears its balance sheet of properties encumbered by debt. Through amortization and property appreciation, a typical 10- year loan will have a loan-to-value (LTV) ratio of around 35 percent at the end of its maturity. If Home has two such loans maturing at the same time, it will refinance one mortgage back up to 75 percent LTV, take the funds from that refinance, and pay off the other property.

“I can take an existing property with a mortgage on it that has a low LTV and place a second mortgage on that,” said Gardner. “I can pull down some funds from that second mortgage but keep that other property free and clear.”

That strategy is especially favored as Home ramps up its development pipeline for next year. Since 2006, Home has made a concerted effort to re-engineer its balance sheet by raising the amount of debt-less properties in its portfolio. By having more unencumbered properties in its portfolio, the company can raise its line of credit to fund more development.

Home had 11 percent of its portfolio unencumbered in 2006, 18 per-cent in 2007, and plans to raise that figure to 21 percent by year-end.

Currently, the company has a $140 million line of credit, but plans to double that soon.

Rate-locking and floating

Mid-America Apartment Communities also plans to fund an aggressive pipeline to capitalize on the down market. In the first half, the company raised about $80 million in new common equity to pay down some of its existing debt and plans to raise another $20 million in the second half.

Mid-America sees opportunities in some currently distressed markets, such as Phoenix, which has suffered from overbuilding.

“We’ve been getting ready to take advantage of what we think is going to be an improved investment environment,” said Simon Wadsworth, CFO of Mid-America, a publicly traded REIT that operates more than 41,000 units in Southeast and South Central markets. “There are some good opportunities for contrarian buyers. We can come to the party with a big balance sheet, without any contingent financing, and make a quick deal.”

The company closed on a Phoenix deal in July, a 312-unit property called the Edge at Lyon’s Gate, which was built in 2007 and 85 percent leased up. Mid-America paid $113,000 per unit for the property, which is “probably 30 percent below what it might have sold for 18 months ago,” said Wadsworth.

Earlier this year, Mid-America rate-locked $100 million in debt in anticipation of a rising interest rate environment. Part of the debt will finance the company’s acquisitions this year. By striking when rates were low, the company achieved an overall interest rate of around 5 percent, saving at least 30 basis points compared to today’s rates, Wadsworth estimates.

The company keeps about 20 percent of its debt floating-rate as a hedge against downturns. When the economy hits a recession and the Federal Reserve drops interest rates, Mid-America can take advantage oflow floating interest rates. “And when the economy improves and our revenues improve, the Fed raises interest rates, and we can absorb it because our revenues are stronger,” said Wadsworth.

Poised to strike

Camden Property Trust is active in some markets that have been impacted by overbuilding and job loss, such as Phoenix and Tampa, Fla. Since the company’s assets are held for an average of about 12 to 14 years, it sees past the current downturn to an expected longterm surge of population and job growth in those markets.

But the company is holding off on two Florida deals, one in Tampa and another in Orlando, watching the markets closely to see how deep the regional recession will be.

“If they do recover soon due to limited new supply and you have the capital today to invest, 2010- 2011 might be a great time to have some new product hitting the market,” said Dennis Steen, CFO of Camden, a publicly traded REIT that operates nearly 70,000 units nationwide.

If and when that recovery happens, Camden is poised to strike quickly. The company has a $600 million revolving line of credit among some 19 banks that it uses to fund construction activities.

The company has a conservatively structured balance sheet—split down the middle between debt and equity. The debt side of its balance sheet is 82 percent unsecured debt, mainly composed of unsecured bonds.

With eight projects in various stages of construction and with such a low percentage of secured debt, the company is looking for some new permanent financing from Fannie Mae and Freddie Mac.

Since the company is flush with equity, its permanent loans would only go to 60 percent LTV, allowing it to get 10-year loans in the mid- to high-5 percent range.

Equity in the driver’s seat

The current credit crunch has led to some creative financing solutions.

More sellers are arranging debt in advance of finding a buyer for large portfolio transactions, to ensure that the transaction can be funded in today’s tight debt market. And sometimes sellers are helping to procure debt for buyers in other ways.

Colonial Properties Trust helped facilitate its sale of a Memphis, Tenn., apartment community last quarter by providing a loan for the buyer. The buyer had its equity all lined up, but procuring Fannie Mae or Freddie Mac financing was taking too long. So the company contributed a 70 percent LTV loan, which was later taken out by agency debt arranged by the buyer.

“The equity was ready to close, so we went ahead and put a conservative loan in place,” said Weston Andress, CFO and president of Colonial Properties Trust, a publicly traded REIT that operates more than 39,000 units throughout the Sunbelt.

Colonial prefers to finance its development activity through corporate equity and its line of credit, eschewing secured loans. The company last year expanded the size and lengthened the term of a $675 million unsecured line of credit extended through a syndicate of banks led by Wachovia and Bank of America.

“It’s given us the flexibility to finance our operations and development without having to go out, in this kind of an environment, and get construction loans or other secured loans,” said Andress.

As many capital sources grow more conservative, companies with ample equity at their disposal have an edge. And should the dearth of liquidity on the market continue, equity-rich players will hold an even greater advantage going forward. “There is a chance that over the next couple of years the market could be driven more by equity buyers,” said Andress.

Laramar can also afford to be aggressive in today’s market. Though the company’s current equity fund of $350 million is about 70 percent committed, Laramar plans to raise between $500 million and $600 million for a second fund soon.

“A lot of players used to rely on higher leverage, and they can’t get them now, so they’re bowing out of the marketplace,” said Shanaberger. “It’s definitely creating opportunities for us in terms of deals that perhaps in an up market we would not have gotten.”

For some companies, that lack of available leverage is the crux of their current problems, forcing them to consider other ways of funding their development activities. And for some companies, like Laramar, that lack of leverage is an opportunity.