As the real estate market continues to grapple with the fallout from rising interest rates and economic uncertainty, a new area of concern is emerging: multifamily loans. While much of the focus has been on the struggles of the office sector, recent data indicates that the situation for apartment loans could become even more dire.
The Growing Distress in Multifamily Loans
A significant portion of apartment loans, particularly those associated with speculative investments made during the pandemic, are showing signs of distress. According to recent data from MSCI, more than $56.9 billion worth of apartment mortgages are at risk, surpassing the $50.9 billion of office loans currently in distress. This is a surprising development, given that apartments were seen as relatively safe investments compared to the struggling office sector.
The distress is particularly pronounced in a niche market segment: Commercial Real Estate Collateralized Loan Obligations (CRE CLOs). These floating-rate bridge loans were consistently used by value-add apartment flippers during the pandemic to purchase and renovate older properties, especially in the Sunbelt region. However, with interest rates now significantly higher and rental income not meeting expectations, many of these loans are in trouble.
Why Multifamily Loans Are in Jeopardy
The root of the problem lies in the optimistic assumptions made during the pandemic when CRE CLO issuance hit a record high in 2021. At that time, borrowing costs were exceptionally low, and property valuations were at their peak. Now, as these loans are maturing, many borrowers are finding that their properties are not generating the expected income and their property value has stagnated or declined. In fact, CRED iQ’s Chief Executive Officer Michael Haas recently provided an analysis suggesting that approximately 46% of CRE CLO loans are not producing the net operating income (NOI) that was anticipated during underwriting.
Compounding the issue is an oversupply of apartment units. Real estate services firm CBRE Group projects that 440,000 new units will be completed in 2024, which will likely push vacancy rates higher and keep rents flat in many markets. This oversupply, coupled with rising operating costs such as insurance, is putting additional pressure on landlords who are already struggling to cover their debt obligations.
The Road Ahead: A Mixed Outlook
Despite the growing distress, few apartment properties have gone into foreclosure so far. Lenders have been more flexible with apartment loans compared to office loans, possibly because they believe that rents will eventually rise if the loans can survive the current downturn. However, this strategy is risky, especially if a recession hits and consumer stress increases, leading to higher credit-card delinquencies and reduced rent payments.
In summary, while office loans have been the primary focus of concern in the real estate lending market, apartment loans are emerging as a significant risk. Investors should closely monitor developments in this sector and be prepared for potential challenges ahead.
