AMLI Residential Properties Trust's recent purchase of two apartment communities in Atlanta and Dallas caused a stir in investment circles. Competing apartment buyers and investment advisers were not only impressed with the properties, but also AMLI's partner in the acquisitions. The Chicago-based REIT teamed up with BPMT, a Dutch metal workers' pension fund, to acquire the communities - the first purchases in a $165 million venture AMLI plans with its new institutional partner.

"We're still looking for more apartment assets to buy in joint venture with the Dutch," says AMLI president and co-CEO Allan J. Sweet. "We're putting our money alongside theirs to buy properties. They are taking advantage of our expertise, and we are benefiting from their strong source of capital. It's a strategy we think makes a lot of sense in the multifamily business."

For their part, investors seem to agree. Institutional property buyers and their advisers are again embracing the U.S. apartment market, making a wide variety of deals ranging from direct acquisitions to joint ventures with REITs, private investors or developers. Institutional investors pumped several billion dollars into the multifamily housing sector in 1999, and market watchers predict more funds will be committed in the year ahead.

"The trend really started 12 to 14 months ago, but didn't come into play until the second half of 1999," says Steve Pumper, executive vice president of Dallas-based Transwestern Commercial Services. "I think it will continue until we see some improvement in the REIT stock prices. Most of the REITs don't have liquidity and are doing a lot of these joint ventures with institutional players. It's a way for REITs to stay in the game."

The attractiveness of apartments grows In their annual Emerging Trends report, New York-based PricewaterhouseCoopers and Atlanta-based Lend Lease Real Estate Investments Inc. give apartments high marks. Half of the reports' sources say they would buy apartments in the year ahead; only downtown office space had a higher recommendation rate in the survey. "Apartments have rebounded," the report says. "They are the biggest mover among the property categories. Worries about new construction have abated, and investors signal renewed confidence in the sector's staying power as well as its excellent cash flow returns."

While in the past institutional buyers like pension funds and life insurance companies have been fickle suitors of the multifamily business, analysts agree that, in the current environment, their marriage seems appropriate. "Out of all the property types right now, multifamily is the most liquid investment category," says John Lyons, executive managing director of New York-based Granite Partners, an investment bank. "Rental income and values of multifamily product have increased in every quarter since 1995, and the fundamentals remain very positive for this category. Plus, a lot of institutions like the multifamily sector because it is an inflationary hedge investment. And people are concerned about the prospects of inflation in the near future."

Such positives now outweigh the traditional concerns institutional investors have had with the apartment market, including the ability of developers to quickly overbuild in many cities and relatively short-term leases. Lyons estimates that in 1999, institutional players - both domestic and international - accounted for more than a third of the U.S. apartment investments, second only to private buyers. REITs, which a few years ago dominated the apartment-acquisition picture but now are cut off from raising equity in the securities markets, made only about 25% of the purchases in 1999, Lyons adds.

"The institutions, for the most part, are only buying at the high end," Lyons says, estimating that in 1999, pension funds paid an average of $90,000 per apartment unit. Private investors and REITs shelled out an average of $57,000 and $49,000 per unit, respectively, he adds.

Furthermore, according to the National Association of Real Estate Investment Trusts (NAREIT), the total annual return on apartments owned by REITs through November 1999 was 5.95%. That compares with -4.36% for offices, -0.85% for industrial properties and -11.32% for shopping centers.

Unlike REITs and many private buyers, pension funds often need a savvy strategic partner in their purchases. "Institutions have the capital, but they don't necessarily have the expertise," says Lyons.

Institutional advisers are scrambling to put together apartment deals while there are still opportunities in the market. Most institutions believe that they have room to grow their multifamily investment portfolios, which have lagged in size compared to other income property sectors. "We start the millennium with institutions significantly underweighted in multifamily, and with some great statistics that indicate that, over the long term, multifamily has significantly outperformed the other markets," says Vincent J. Costantini, a member of Lend Lease Real Estate Investments' multifamily investment group.

According to the National Council of Real Estate Investment Fiduciaries, apartments have earned an average annual return of 8.7% during the past decade, compared to just 5.5% for other assets. That statistic can overcome some perceived downsides to apartments. "There has been the perception that multifamily is a very management-intensive business and that there was a boom-bust cycle," says Constantini. "But the real story is starting to be told. There has been a rebirth in interest institutionally in multifamily properties."

To meet its clients' needs, Lend Lease is doing everything from direct acquisitions to partnerships with public companies. For example, in November 1999, Lend Lease formed a partnership with Palo Alto, Calif.-based Essex Property Trust Inc. to purchase more than 1,400 apartments in a $126.5 million deal. "We have done three major joint ventures like that in the last 18 months," says Costantini. "Lend Lease also has a number of large separate account investors looking for Class-A properties that are unleveraged. We have done probably $600 million in acquisitions on behalf of those types of clients."

Early last year, Lend Lease entered into joint venture with the San Diego-based ConAm Group, a private real estate investment and management firm, to acquire a 14-property apartment portfolio for $117.9 million. The portfolio, totaling 2,236 apartment units, includes properties located in Florida, North Carolina, Colorado and Arizona.

Lend Lease's activities in the multifamily sector grew dramatically with its purchase last fall of Boston-based Boston Financial Group LP. The acquisition increased Lend Lease's multifamily holdings to almost 100,000 apartment units. Lend Lease has also raised a co-mingled investment fund to purchase multifamily properties that need repositioning or remodeling.

Avoiding the lag time Atlanta developer Karlton Jackson of JMG Realty was looking for a source of equity to redevelop aging apartment properties in the Southeast and Southwest. He partnered with Chicago-based RREEF Funds in a venture that, so far, has done about $110 million in deals.

"We had been doing similar projects for ourselves and individual clients," says Jackson, whose company operates more than 20,000 apartment units. Undertaking such projects is a slow process, and a private company often loses out to larger public and institutional investors.

Jackson says JMG was negotiating to sell some assets to RREEF investors when the plan for the joint venture was hatched. To date, the JMG-RREEF partnership has made three acquisitions and has a fourth property under contract. One of the properties in the fund is the Stonebridge apartment community in north Atlanta. Built in the early 1970s, the project had more than 400 apartments when JMG acquired it. "It had been considered a Class-D property in an 'A' location," says Jackson. "We are spending almost $25,000 a unit to upgrade the existing property, and there was some adjacent land we also acquired where we will be building slightly less than 50 additional units."

The partnership has also done similar, albeit less extensive, rehabs in west Houston and north Dallas. "A pension-fund partner is a good vehicle for this because of the patience of the pension fund investor," says Jackson. "You need several years to season these properties and reposition them, so you want a partner that isn't wanting to sell as soon as the project is leased up." Also, by working in a venture fund with specific investment parameters, JMG avoids the lag time often required with institutional investments.

Gary Kachadurian, principal of RREEF Funds, says his firm's institutional investors prefer apartments in locations where there is not a lot of competition from new construction. And the company is willing to take the risk with under-performing properties that have up-side. "We are trying to get good visibility and a close-in site and a building that was built 10 or 15 years ago," he says.

Kachadurian estimates that RREEF Funds currently manages about 16,000 multifamily units for its clients, with a total value of more than $1.1 billion, a relatively small piece of RREEF's $12 billion portfolio. But RREEF's multifamily holdings are growing. "Most of our clients are still very interested in keeping up their allocations with apartments," says Kachadurian. "The fact of the product is it that it's difficult to do large transactions because of the deal size."

It's also getting harder to pick investments because of the potential for overbuilding in many U.S. metropolitan markets, Kachadurian adds. "Pricing has reached replacement costs in many of the markets, and in many submarkets that have seen a lot of construction, owners are giving free rent. You have to be a lot more selective today than a few years ago."

A good balance Robert Plumb, managing director of separate account acquisitions for Boston-based AEW Capital Management, says he's still looking for multifamily acquisitions for his clients in Boston, New York, Chicago, San Francisco and Washington, D.C. "The markets we are bearish on are those without any supply restraints that are mainly in the Southeast and the Southwest", he says, adding that if he proposes an apartment investment opportunity in hot markets like Atlanta or Houston, "it probably won't get through my committee.

"Yes, we want to make multifamily deals, but a lot of us who manage real estate for institutions are trying to be very careful right now given where we are in the cycle," says Plumb. "We are anticipating marginal weakening in the sector because of slowing job growth. And if the supply of new construction does not curtail, we will see flattening rents and more concessions in some cities."Even so, Plumb says investors feel that apartments provide a good balance to their other property holdings. Apartments are "fairly resistant to an economic slowdown - which we are anticipating," he says.

If higher interest rates cut into home sales, Plumb says that rental apartments will benefit from higher occupancy. "We also think demand for apartments will rise anyway over the next decade because of what we call 'the baby boomlets.' They are entering the job market and seeking housing."

Like other institutional advisers, AEW likes the joint-venture route of investing. In November 1999, AEW formed a partnership with Essex Property Trust to develop and acquire about $150 million in California apartments. Essex maintains a 20% stake in the venture and will provide management services. Each of the investments will be leveraged about 50%. AEW is also working with a development partner to do some infill urban multifamily projects in Manhattan and Boston, Plumb adds.

Finding that return in the multifamily market does not always work out. Dallas-based L&B Group has been sifting through the country's apartment markets for more than a year. But David Gleeson, the executive vice president who heads L&B's multifamily division, says he has not found many good buys.

"In spite of what everybody is saying about their enthusiasm for apartments, it is on a relative basis," he says. "My ability to raise my rents has declined almost every quarter for two years. I think that will continue because there are still just too many apartments coming on line. We are telling our clients that they need to lower their return expectations if they want to put money into apartments."

Some institutional market consultants also worry that the REIT sector's love affair with institutional investors will only last as long as public real estate company stocks remain depressed. Sweet says that, unlike some other REITs that have been cut off from raising money in the public market, his company always planned to partner with institutional and private investors.

The joint venture set up last summer with BPMT paired AMLI with one of Europe's leading pension funds. BPMT represents 37,000 companies and almost 330,000 workers in the Netherlands. The partnership with AMLI is the pension fund's first direct investment in the U.S. multifamily sector.

In 1999, the joint venture purchased AMLI at Windward Park, a 328-unit luxury apartment community in Alpharetta, Ga., and AMLI at Prestonwood Hills, a 272-unit luxury apartment community located in the Dallas suburb of Plano, Texas. "We have almost $900 million in joint ventures with partners - by far the largest volume of any REIT," says Sweet.

One of AMLI's partners is Chicago-based Heitman Financial. The two companies formed a $98.4 million venture last spring to develop three apartment complexes. Heitman represented a public pension fund in the joint venture.

"Our thought was [AMLI is] a great operator of properties, but more important our investors wanted to get access to certain property markets," says Richard Kateley, Heitman's managing director. "They are giving us access to development opportunities in markets like Dallas; Austin, Texas; Atlanta and Chicago.

Heitman sees an advantage to pairing its capital with apartment operators and developers. "This way we can be much more strategic," says Kateley. Heitman has done about $325 million in such joint ventures in the last five years. "We insist on seeing a significant equity contribution from our partners," he adds.

Expecting too much? Institutional investors also have to be prepared to deal with the downside of the multifamily market. "The key issues with these ventures is to make sure that you've prenegotiated the governance issues - who is going to make decisions and when," says Kateley.

Kateley agrees that some REITs may consider institutional investors as just the next source of capital to tap. "It will get overdone if people venture with companies that just need money momentarily," he says.

Likewise, institutional investors should not expect too much of the apartment market, says Kateley. "We're all looking for returns in the 13% to 15% range. It's tough at this going in the real estate markets to get those returns. Some investors might chose a marginal partner that promises too much."

Kateley is less worried about apartment overbuilding in this cycle. He points to tighter underwriting from lenders and the credit crunch in 1998 that put the brakes on a lot of speculative construction.

John Goodman, head of research for the National Multi Housing Council (NMHC) in Washington, D.C., says the influx of institutional investors broadens the capital base for the apartment industry. "It wouldn't be healthy for apartments to be totally dependent on public REITs or private investors for a source of equity," he says.

Goodman predicts that a flood of new institutional investors will actually help stabilize the U.S. multifamily market. "The capital that is available for the market is very discriminating capital," he says.

The appeal of apartment investments to institutional investors has grown for a number of reasons. However, investors should not to expect too much. If they do not, this relationship could provide a healthy diversification of the apartment market.