Because of the crisis in the credit markets, few industry leaders expect 2008’s residential rental buildings sales velocity to reach anywhere near last year’s record levels.

The only avenue to finance the purchase of rental properties, they say, is from balance sheet lenders and federal agency programs.

Adding insult to injury, many owners of rental properties who are contemplating the possibility of selling are in denial about the current credit market and the limitations on financing.

Last year was a completely different story — more like a fairy tale. More than $10 billion worth of residential rental properties was purchased by local and international investors, as buyers from Europe, the Middle East, and Canada joined the ranks of domestic investors who bought rental properties in the traditionally stable New York region.

“The residential rental market in Manhattan has experienced incredible growth over the past few years,” the president of Citi Habitats, Gary Malin, said. “Average rents increased 10.4% from 2005 to 2006 and 5.5% from 2006 to 2007; vacancy rates for Manhattan averaged at or below 1% for 2007 primarily due to the lack of rental inventory.

New York remains a renter-based city, with 75% of its overall housing stock comprised of rental properties. The development community has taken notice of these trends and we are seeing increases in rental development as new buildings are added to the developer’s portfolios.”

Looking ahead, Mr. Malin said the unknown factor is how much financing will be available to allow trading.

“All indications seem to point to greater availability for financing developments that are in the $100 million range, and consequently, expect interest in smaller projects with long-term value,” he said.

A senior broker at Besen Associates, Adelaide Polsinelli, said the market now is one “of contradictions. Lenders are tightening their loan commitments, yet interest rates are at all-time lows. Supply is tight, yet demand is down. Developers are sitting on the sidelines, yet the need for housing has never been greater. Fundamentals are strong, yet we are supposed to be in a recession.”

She added: “The contradictions continue in the investment sales market. Buyers are looking for discounts because everyone is saying we are in a down market,” Ms. Polsinelli added, noting that many sellers are “holding firm” because some buyers who recently sold properties and get a tax break by reinvesting are willing to pay a premium.

“I have a package of Bronx and Harlem properties where the seller is cognizant of the market and willing to take a reduced price to get the assets off his books, yet the buyers are few and far between for this type of product. I have a package of Upper East Side apartment buildings and the offers are coming in as high as 17 times the gross rents! In an uncertain market, the better locations still command a premium.”

The director of acquisitions at Taconic Investment Partners, Ari Shalom, said sellers “have not come down on their prices for rental properties. Nevertheless, we are only looking at investments which can allow our firm to obtain financing with debt service coverage of at least 1.0, with amortization. We are looking at a lot of properties, and keep bidding if the project makes economic sense.”

He added: “2008 is the year when investors are much more careful on the underwriting of a project. We won’t bid on a project unless we have adequate information to underwrite the project, with detailed operating statements and rent rolls.”

For some buyers, there is no price too high. The chairman of the Lightstone Group, David Lichtenstein, said, “There are New York City players that think the rest of the country is like Hicksville and will keep buying rental apartments at absurd prices. ‘To a thirsty man any beer looks good.'”

The president of Metropolitan Valuation Services, Steven Schleider, said multifamily investment sales velocity “has slowed since the summer, as purchasers are more selective in seeking opportunistic buys of under-managed portfolios in Upper Manhattan and the outer boroughs.”

The market for rent-controlled and -stabilized buildings is seen by many industry leaders as a safe haven.

The chairman and chief executive officer of Intervest National Bank, Lowell Danker, said rental rates “remain firm and properties subject to rent control and stabilization for the most part still have rents that are below market and have the potential for growth. Investors have always had a desire to own New York City multifamily and that interest continues today.”

The managing director and partner at Massey Knakal Realty Services, Shimon Shkury, said investors for rent-stabilized buildings “are for the most part unfazed by recent economic headlines. For stabilized buildings, the fundamentals simply haven’t changed: sub-market rents will provide significant and immediate turns as soon they become vacant. The Fed’s interest rate cuts give investors the flexibility to take on properties at low capitalization rates and high rent multiples.”

The chairman and chief executive officer at Eastern Consolidated, Peter Hauspurg, said: “In our shop residential rental properties are still in tremendous demand, and recent contracts still reflect sub-5 cap rate pricing. There is still plenty of debt financing, largely because at sub-5 caps limits such financing to 50% or 60% and the balance equity, of which there is still plenty.”

Still, Mr. Hauspurg said deals of more than $125 million seem to be “running snags.”

The co-founder and managing director at Madison Realty Capital, Josh Zegen, said: “I believe that there will be cap rate decompression of 50 to 150 basis points depending on location and property size in the New York metropolitan area in the next one to two years.

Fringe markets will obviously see greater cap rate expansion as these properties will see the least liquidity on a going-forward basis. Institutional buyers will still pay a premium for larger properties because they are able to achieve scale and operating efficiencies as well as having greater access to capital.”

He added: “Although there is more liquidity available for multifamily than almost any other asset class within the real estate sector today, the ongoing credit crisis has had a major impact on the overall leverage available for transactions.

“The current requirement by lenders of greater sponsor equity — sometimes upwards of 30% — and more stringent debt service coverage, have made the cost of financing multifamily real estate transactions significantly greater as compared to the last few years, when capital was much more abundant,” he said.

Some experts see bargains outside Manhattan. A partner in the real estate practice at Herrick, Feinstein LLP, Dennis Sughrue, said investors “can achieve higher returns purchasing rental properties in the outer boroughs. If you improve the properties, with capital repairs, you will do better than in Manhattan.”

The debt market is having significant a effect on the financing of residential rental apartments. A senior real estate partner at Wolff & Samson, Mitchell Berkey, said: “One bottom line here is — again, no surprise — the debt pool has shrunken and has gone away for residential ‘for-sale arena’ at least for the time being.” The administrative vice president and group manager at M&T Bank, Peter D’Arcy, said financing “for cash flowing properties is easily available from balance sheet lenders as well as the agencies at very attractive all in rates. While lending margins are up, all in rates are very favorable on a historical basis.”

He added: “Sales velocity seems to have slowed significantly in this area as more equity is needed as leverage on non-cash flowing levels has become much more expensive and hard to come by without strong recourse.”

Investors who purchased residential rental properties with hopes of converting them to condominiums are having difficulty in obtaining financing. Mr. Darcy said the buyer planning to convert a condo “is largely gone. These players were paying top dollar. Buyers now are back to long-term viability as a rental, which should have upward effect on cap rates, coupled with the fact that rental rates and future assumptions seem to have leveled off.”

The head of real estate at the Bank of Scotland, USA, John Gunter-Mohr, said the number of apartment deals his company is looking at “now exceeds condo deals for the first time in several years.”

“I am seeing a strong preference for rental apartments within the portfolio lender crowd, especially as condos have become a four letter word, as in ‘dead, gone, over,” Mr. Gunter-Mohr said. “As a construction and a reposition lender, we feel comfortable with the availability of takeout financing with Freddie and Fannie still active.

That being said, if these two had problems and stepped back from the market many deals would suffer, as refinancing costs would increase significantly. While we see no evidence of trouble with these federally supported lenders, it is hard to be bold enough to predict the impact of political and economic risks on their appetite.”

He added: “Generally the tougher residential mortgage standards have pushed a cohort of households out of the home ownership market into the rental pool. In addition, given uncertainty over house prices, potential buyers who can still qualify are waiting. Therefore demand for rental housing should hold up over the next year.”

A senior vice president at Banco Popular, Mark Noto, said: “Lately it has been like the ‘Revenge of the Balance Sheet Lender.’ We have been sucking wind for so long it was hurting. We were out priced or out-structured at every turn. We are active in the residential rental market with loans of up to 85% to loan-to-value on existing net operating income, providing earn outs and bridge financing, and competing on pricing utilizing LIBOR-based swaps.”

The combination of low interest rates, available financing from balance sheet lenders and federal funding sources, and limited availability of rental housing will continue to fuel the desire of investors to purchase rental properties in New York City.

Mr. Stoler, a contributing editor of The New York Sun, is a television and radio broadcaster and a senior principal at a real estate investment fund. He can be reached at mstoler@newyorkrealestatetv.com.