Wolf in Sheep's Clothing?
I am reading the Behringer Harvard Multifamily REIT I 10-K, and it is an interesting read, to say the least. Before I get too far into this post, here is an excerpt from the Behringer Harvard website on the REIT's objectives:

Behringer Harvard Multifamily REIT I, Inc. is a real estate investment trust created to primarily acquire a portfolio of high-quality multifamily communities, including conventional multifamily assets, such as mid-rise, high-rise, and garden-style properties; age-restricted residences (typically requiring tenants to be 55 or older); and student housing.

Behringer Harvard Multifamily REIT I, Inc. is for investors seeking:

• Capital preservation
• Capital appreciation
• Current cash distributions
• Attractive total returns
• Portfolio diversification
• A mid-term holding period

• REIT Strategies–The REIT will focus on acquiring a blended portfolio consisting of core, stabilized, income-generating assets; assets for repositioning, renovation, or redevelopment to core status; and development assets for stabilization to core asset status. Development investments may include making an equity investment in the project or making a mezzanine construction loan with a right to acquire equity in the project.

Reading the above information you'd think that the REIT would acquire quality apartment complexes that generate enough cash flow to allow the REIT to pay distributions to investors. But the last sentence needs to be read carefully because it appears to be the key sentence: Development investments may include making an equity investment in the project or making a mezzanine construction loan with a right to acquire equity in the project.

Multifamily has made ten apartment investments and nine are developments. Here is how the 10-K describes the investments:

We have made ten separate investments in multifamily BHMP CO-JVs. Nine of the properites are in development projects and one is an operating property. As of December 31, 2008, the BHMP CO-JVs have made ten mezzanine loans related to the development projects and seven equity investments in Property Entities, with equity purchase options for all Property Entities.

That is a lot of development, and a lot of projects that are not generating rental income. The properties are in Texas, Virginia, Colorado, Maryland, Nevada and Florida. The mezzanine loans look like they have options to convert to an equity position in the project entities. The mezzanine loans look like they are at interest rates of 9.5% to 10%, with maturities before the end of 2012. (These seem like low interest rates. A mezzanine loan could generate interest income of 10% to 20% or more, and involve points of an additional 2% to 4%. Maybe the REIT took a lower interest rate due to its equity option.)

All the REIT's investments appear to be with an affiliated entities. One development is in Florida and two are around Las Vegas.

This is a complex deal. The affiliated transactions, European money partner and third party developers add to its complexity. It is going to take me several posts to wade through it all, but I wanted to get the analysis started.

A couple of final points. I am not sure where the cash flow is coming from and whether all the mezzanine debt is paying current income (v. deferred interest). I would not be surprised if some of the loans reserve interest payments for a certain period. The REIT is developing properties in a tough environment, especially in markets like South Florida and Las Vegas. There are legacy issues, too, as most of the REIT's projects were started (and budgeted) before 2008. This is an area for investigation as the values may have changed.

The REIT is not coming close to covering its dividend. It was 6.5% and only covered 58% by FFO according to the 10-k, but for some reason the dividend was raised to 7.0%.

More posts will be coming over the next few days.