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This Seems Odd…

February 21, 2008

The Real Estate Journal is reporting that the largest landlord in San Francisco is putting apartment properties up for sale, and raising some questions:

After five years as the most aggressive buyer of apartment buildings in San Francisco, the Lembi family has — for now — become the city’s biggest seller.

The 18 buildings up for sale are a pittance of the family’s 307-building holding in one of the country’s hottest rental markets. But the listings have aroused speculation about this most-watched but little-understood local empire: Is the move portfolio-shaping to take advantage of a run-up in prices that the Lembis largely created or is it a sign they are overextended?

“We’re not under any pressure to sell,” said Walter Lembi, managing director of Lembi Group. He said the closely held group, whose main units are Skyline Realty Inc. and CitiApartments Inc., is seeking to take profits on buildings that it “successfully turned around, fixed up and earned higher rents.”

But Mr. Lembi acknowledged that the tight commercial-mortgage market has crimped the group’s ability to fund acquisitions and refinance highly leveraged properties.

“We’ve been through many tough markets before, and from a financing standpoint, this is one of the toughest,” he said. “All the lenders I have are working with us, giving us extensions on loans that are coming due.” He said the discussions involve refinancing, not restructuring, loans that are due “in a year or two” as the group looks to “reduce short-term debt.” Mr. Lembi declined to comment on the amount or composition of the group’s debt and whether rental income covers debt obligations.

That’s… interesting.

As the article itself mentions, San Francisco is projected to be the most attractive market for multifamily in the nation, with rents expected to increase 7.4% in 2008.  And that fits in with the conventional wisdom about rents in a tough residential housing market.

Lost amidst all the doom and gloom about the sub-prime meltdown and its impact on the residential housing market, with stories of homeowners just walking away from their over-levered homes, etc. is the fact that people have to live somewhere.  If people can’t buy a house, or walk away from the one they already own, they still have to hang their hat somewhere.  That means a recovery in the rental market, as demand for rental units increase.

So one would think that 2008, 2009, and possibly beyond would be a great time to be in multifamily rental properties.

Why is Lembi group selling now?

If it’s simply the case of one company facing cashflow issues and needing to sell some buildings to deal with it, then no big deal.  If the Lembi Group is just acting in concert with their investment plan, and this is the time to maximize portfolio gains by selling the properties, then no big deal.  If it’s indicative of something else in the underlying economy, that the Lembi group sees as the largest landlord in San Fran but others do not, then possibly a big deal.

One possible clue is the notion of domestic outflow.  Michael Barone wrote in middle of 2007 that San Francisco experienced a domestic outflow of 10% between 2000 and 2006 (with an immigrant inflow of 7%, for a net loss of 3% of the population).  That’s a lot of people to lose in six years’ time.  If the San Francisco market has been experiencing net outflow — particularly of higher-income tech industry workers — then that could explain why smart multifamily operators want to cash out some gains now, even as the home sales market goes into the tank.

Fewer renters = lower rent.  The iron law of economics.

This story bears some watching.


2 Comments leave one →
  1. ernest permalink
    July 22, 2008 1:57 pm

    I think you missed the most important reason of all- the debt market. Do not underestimate what Lembi says.

    “We’ve been through many tough markets before, and from a financing standpoint, this is one of the toughest,” he said. “All the lenders I have are working with us, giving us extensions on loans that are coming due.”

    He was only able to pay aggressive values for properties due to some very favorable debt that provided high leverage at a low cost. With the credit markets collapsing lenders are unwilling to do that today. After all, all commercial debt is eventually securitized and sold to investors. Are investors excited about buying asset backed securities today?

    As a consequence, bank are tightening up and refusing to provide leverage. On top of that, they are highly scrutinizing appraisals. Apartment brokers in Southern California are already experiencing this as values for apartments are falling, even as rents rise (or stay stable) and occupancy remains solid.

    Commercial real estate had its own version of the “sub-prime” loan. With it now gone the only consequence is falling real estate values- just like homes.

  2. July 22, 2008 2:57 pm

    ernest –

    I don’t think I’m missing that — it’s the most obvious explanation. And as I’ve said, if this is just “normal course of business” stuff, then all is well.

    The thing about that is, however, 7.4% expected increase in rent.

    Presumably, a 7.4% increase in rent for a large multi-family operator translates to far stronger cashflows that can be used to service debt. Selling assets that are expected to increase in value by that much, in the middle of a market where homeownership is going to decline, makes me wonder, that’s all.

    Raising capital to make further investments makes sense, but selling multi-family assets that are going to generate 7.4% more cashflow in 2008 to fund new purchase/development sounds… I don’t know… suspicious?


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