Debt doldrums set to alter investor profile.

The freeze in the securitized debt market has allowed almost $300 billion of unsold mortgage backed securities to accumulate, according to analysts and written reports.

Real estate experts say that the large surplus--which now sits on the balance sheets of the lenders that originated the loans--will slow the return of a market that had become, in essence, the most abundant and inexpensive source of financing for real estate acquisitions and recapitalizations.

While the dramatic pullback in capital would seem likely to cause a decline in the value of assets because it will almost certainly push up the costs of financing, investment sales experts have expressed differing opinions on the impact it will have on prices in Manhattan, where office buildings have seemed to appreciate unceasingly in recent years.

One factor that experts say will insulate real estate values in the city is the diverse pool of investors that have been attracted to Manhattan for its reputation as a global hub of business and its historically strong rental market, which in recent years has risen to record levels in areas like midtown.

"New York has been such an extraordinary market because it attracts so much capital from so many different players," said Yoron Cohen, a leading investment sales broker in Manhattan with the real estate services firm, Cushman & Wakefield. "If the financing situation gets tighter and affects the competitiveness of a certain group of investors, the city has been the kind of place where there are others who will still be able to pay the prices that we have been seeing."

Wealthy foreign buyers have been active in the city using very little leverage or by drawing from capital sources unaffected by the turmoil in the U.S. debt markets. Istithmar for instance, the investment fund through which the Dubai government channels its oil wealth, has been an active buyer in Manhattan and has scooped up buildings such as 230 and 280 Park Avenue for premium prices, paying predominantly with cash.

Cohen mentioned that institutional investors, such as REITs, pension funds and insurance companies, have invested heavily in Manhattan properties as well and typically use modest amounts of financing to do so, meaning that the capital crunch will have a minimal impact on the amounts that they are able to pay.

"From my perspective, REITs have been disadvantaged because of the discipline that we maintain in terms of being extremely low or moderately leveraged entities," Mitchell Hersh, president and CEO of the New Jersey based REIT, Mack-Cali, said in an interview with Real Estate Weekly's website, rew-online.com, last week.

"The leveraged buyer has had a distinct advantage because of the ability to employ 100%, if not more, leverage on a project with LIBOR based financing that's very attractive and [they] haven't had much skin in the game. It has pushed pricing further and made it very difficult for us to play."

Many experts agree that highly leveraged buyers, which have become one of the most active groups in the city's investment sales market, are likely to be the hardest hit by the unavailability of capital. The willingness of lenders to provide large loans at low interest rates meant that these investors could tackle high-priced acquisitions with favorable financing. These types of investors can still get cash, according to those familiar with the capital market, but there is a caveat.

"There's access to money," Howard Michaels, chairman and CEO of the real estate investment banking firm, the Carlton Group, said. "I've done the financing for $2 billion worth of transactions in the last two months."

But Michaels says that most of that money now comes from balance sheet lenders and in the form of mezzanine and equity loans. All three, but especially the latter two, make the debt significantly more expensive than it would have been just a few months ago. That cost, of course, is minimized for buyers who use lower leverage. Lenders are also willing to give borrowers who use moderate financing more favorable conditions because there is less risk for a smaller loan.

Highly leveraged buyers won't necessarily be back in business when the securitized debt market does reemerge either. It is almost a certainty that loan originators will abide by stricter underwriting standards in the wake of the debt crisis, requiring lower loan to value ratios and higher interest rates in order to compensate for the perception of heightened risk in the sector.

Unable to borrow as much and as cheaply, highly leveraged buyers, as a general rule, will simply not be able to pay as much for real estate assets. Many anticipate that this will have the effect of thinning the ranks of bidders who participate in real estate auctions, thereby decreasing their competitiveness in a way that will slow or put a hold on the pattern of appreciation that has gripped the market for years.

"The market has been on an upward movement, but it's cyclical," Robert Lapidus, a principal and founder of the commercial real estate investment and management firm, L&L Acquisitions, said. "There's no-one smart enough out there to be able to predict exactly what's going to happen, but there's the feeling that the market is taking a breath fight now."

Highly leverage buyers are also considered among those most prone to financial hardship now that once abundant sources of capital have dried up. The reason for this is because high leverage in today's heated market has usually pushed a building's net cash flow into the minus category, a situation in which the building's rents can't cover the payments necessary to service its sizeable debt. Investors are then under pressure to improve rents to boost the building's income to the point where it can pay its mortgage or utilize continued appreciation to sell at a profit.

The continued strength of Manhattan's rental market may very well make sense of even highly leveraged and high-priced transactions, despite the fact that investors--once they improve an asset's cash flow--may now have a harder time trading in aggressive financing structures for cheaper capital because of the way the debt crisis has made it harder to recapitalize.

Buyers whose investment strategies count on deriving profits from continued appreciation are particularly at risk.

In recent months, The Blackstone Group employed and popularized an investment strategy for its record $36 billion acquisition of the REIT, Equity Office Properties, in which it used tremendous leverage on a short term basis so that it could quickly dismantle and sell large chunks of the portfolio at rates higher that what it paid per square foot.

Reaping this type of quick arbitrage by breaking up the company's nationally located collection of properties and unloading it piecemeal allowed the firm to effectively lower the price it paid for the real estate it did decide to keep and consequently swap money-hemorrhaging loans for more attractive financing.

Investors likely would find it difficult now to emulate Blackstone's success because the roiling debt market has slowed the necessary momentum of appreciation on which such a strategy depends.