Not all real estate tainted by crisis

Real Estate Weekly, Nov 26, 2008 by Daniel Geiger

Gloom and doom surrounds the city's sales market for commercial real estate as the credit crunch has made Manhattan office buildings extremely difficult to finance and the slumping economy their vacancies much harder to fill.

Sales activity in recent months has come close to a standstill after reaching record levels before the tumult began to take effect in the summer of 2007.

The Metropolitan Transportation Authority recently said that mortgage recording and transfer taxes, both of which are triggered when properties are sold, have plummeted and thrust the transit agency's already troubled financial position into even worse shape.

But some brokers have begun to draw a distinction that not all segments of the city's real estate sales market have been tainted by the crisis. Sources say that real estate funds that had invested in portfolios of apartment buildings with institutional capital from investors such as pensions and insurance firms are beginning to sell off assets.

Sources identify two motives for the activity. Amid falling residential rental rates, some funds have begun to see their investment projections crumble. Rather than hold the assets and continue to manage them with the promise of little, if any, returns, the owners are liquidating instead.

Others simply want to raise cash because they see buying opportunities in the months and years ahead on expectations that real estate prices could drop sharply as a result of the upheaval in the capital markets and the problems in the economy.

Whatever their reasons, many of the firms going into the market are finding eager bidders and respectable prices at a time when the prevailing opinion among many real estate experts is that sellers should postpone dispositions until better times. One strategy helping sellers divest themselves of assets is to take the exact opposite approach they used in buying them. Bob Knakal, a co-founder and chairman of the real estate services firm and sales brokerage Massey Knakal, said that real estate operators investing institutional money as a general rule had sought to purchase large portfolios of apartment buildings in order to be maximally efficient in allocating the capital.

Selling such portfolios now has become difficult with the credit crunch. Breaking the portfolios down to individual property sales opens the assets up to the much wider pool of buyers capable of doing smaller deals that are also far easier to finance.

"That's a reversal of what the trend was," Knakal said. "Up until about a year and half ago you wanted to put as big a package together as you possibly could because then an operator could get institutional capital interested, because institutional capital says 'look why am I going to waste time working on a $5-$10 million deal when 1 can spend the time working on a $200 million deal so 1 can put out a lot more money?'"

"Today it's the opposite. The financing is available for the smaller transactions and pricing for the smaller sized properties is consequently much better."

Knakal said that the real estate fund the Praedium Group had tried to sell a portfolio of 50 apartment buildings located around the city. It received a handful of offers but in the end, buyers were unwilling to shell out what the company had felt they were worth.

In September, Knakal put a team together that worked through the night to value the bunch. He gave the firm his projection, which was considerably higher than the offers the firm had received, and suggested breaking the portfolio up into individual sales.

"The offers had been disappointing and you could draw a conclusion in that," Knakal said. "The fact is it's very difficult to get financing for such large transactions today and that probably affected the price. By breaking the portfolio up, there is additional value because smaller properties are selling at higher prices."

Praedium contracted Knakal to sell 13 of the properties. Using his approach, Knakal now has five under contract to sell and said he is close to arranging deals for four of the others.

In recent weeks Westbrook Real Estate Partners, another real estate investment firm that allocates institutional capital into real estate, tapped Knakal to handle a 17 apartment building portfolio located on the Lower East Side. "We definitely suggested selling the properties as one-offs would maximize their aggregate consideration," Knakal said.

Knakal didn't want to speculate what was prompting both firms to sell but said that they were profiting on most if not all of the sales. Adding to the companys' profits is that a sizeable portion of the properties in both portfolios had been bought five or more years ago, when prices had been far lower than the peak levels seen leading up to and just before the credit crunch.