Only a year ago, the apartment market was still celebrating its good health and the good fortune of stability and support from lenders Fannie Mae and Freddie Mac. Now Fannie and Freddie face an uncertain future and the humbled status of federal conservatorship, while apartment transactions have plunged 81% year-over-year through May, according to New York-based research firm Real Capital Analytics (RCA).

The $2 billion in apartment sales registered in the first quarter of 2009 was the lowest since the firm started tracking sales in 2001, says RCA senior analyst Jessica Ruderman. In the same period of 2008, more than three times that amount was recorded, $7 billion. That, in turn, was dwarfed by $19 billion in sales in the first quarter of 2007, the peak year for sales.

Still, Ruderman sees flashes of light following the dark news of the first quarter's dismal performance. “The pace of decline is slowing and investment trends are stabilizing,” she says. Analysts are encouraged by a number of large deals that proceeded to contract in the second quarter.

In Dublin, Calif., for example, the Waterford Place Apartments went under contract May 29 for $80 million. In the second quarter, apartment sales totaling $702 million were placed under contract across the country, says Ruderman. From late May through June, seven deals of $40 million or more went to contract or closed, compared with just one deal of that size that closed earlier in May. If the deals close, it will signal movement in the marketplace and a willingness by banks to lend, Ruderman notes.

Trading stocks for apartments

Zach Shipps, a broker and equity manager at The Oakley Group in Birmingham, Ala., sold an 11-acre parcel of land in June for development at just under $1 million. Shipps is marketing the 60-unit Autumn Brook Apartments for $2.8 million. “What we're seeing is a lot of smaller properties trade, 120 units or less. They seem to be fairly attractive to people pulling out of the stock market.”

Some investors who suffered deep stock losses switched to the multifamily market, encouraged by Birmingham's large student population as a steady source of renters, notes Shipps. But he estimates that sales volume is off 45% from last year in his market. Buyers are bypassing skittish banks to arrange creative financing such as second mortgages from sellers. With loan-to-value ratios at 75%, buyers who do snag bank loans have to rustle up a 25% down payment, the broker says.

Birmingham banks at times underwrite small deals of $1 million or less, while Fannie and Freddie still approve some larger loans. But the credit crisis is undeniably wreaking havoc. “We're seeing notes coming up that can't get refinanced. That's the major thing right now,” says Shipps.

In larger markets, deals are also stalled. In Manhattan, where $1.3 billion in apartment properties traded from January through late June 2008, sales dropped to a tortoise-like pace this year, with just $381 million in sales recorded through June 26, according to RCA. By late June of 2008, three cities had rung up sales of more than $1 billion. This year, not one has hit the $400 million mark.

It's not over yet

Cities like New York and San Francisco have been stung by rent declines, says Victor Calanog, director of research at New York-based Reis. Effective rents fell 1.1% in the first quarter and they are expected to drop 1.8% for the year. The nation is on course for the largest decline in effective rents since Reis began tracking annual data in 1980, says Calanog.

Vacancies rose in 73 of 79 primary metro areas in the first quarter, driving the national vacancy rate up 120 basis points from the first quarter of 2008 to 7.2% in the first quarter of 2009. The trend shows that occupancy is deteriorating faster than it did last year, says Calanog. Still, investors who recently bought multifamily properties may have a sound investment, he says, if they relied on equity in financing and have stable tenants.

Operators who clocked fast profits through quick resales in 2006 or 2007 should forget that strategy. “You're not going to be flipping that building for triple the price two years from now,” Calanog warns. New investors need to conduct due diligence, he says, examining rent rolls to determine when leases expire, for instance.

Although Calanog predicts that the apartment market will begin to recover in 2010, he cautions that there won't be a quick end to the industry's economic problems. “If you look at the glass half full, we're in the middle of a tsunami of a recession. Things are tough.”