In 2024, problematic apartment complexes could cause a significant increase in heartburn. The lion's share of the distress looms for value-add investors who took out variable-rate loans in the past few years but whose projects have fallen far short of financial projections. In many cases, investors overpaid for assets in anticipation of continued strong rent growth and historically low interest rates.
But the benchmark collateralized overnight lending rate has skyrocketed over the past two years from nearly zero to about 5.3 percent. Rising property taxes, construction costs and insurance premiums, as well as a surge in new supply and slow rent increases, are exacerbating the difficulties.
“There's going to be a lot of attention on the multifamily sector this year, with people wondering how much pain they're going to be in as expiration dates approach,” said Stephen Bushbom, research director. said. trep. “However, lenders have a lot of flexibility in how they restructure these loans, so the level of hardship will be highly case-specific.”
These warning signs related to troubled loans stand in contrast to some modestly encouraging signs that emerged regarding the large bond market earlier this year. NMHC's latest quarterly survey of apartment market conditions released in January shows that the financial industry is one of the few areas where sentiment is trending upward. 45% of respondents said debt has become more available, up from 0% in the October survey and the first improvement in 10 quarters.
A further 35% said there was no change in borrowing terms, and 14% said it was a worse time to find debt than last quarter. Chris Bruen, senior director of research at NMHC, said in a statement that the improved sentiment was due to lower 10-year Treasury yields and the potential for the Federal Reserve to cut interest rates several times this year.
kick the can
MSCI said the potential distress in the apartment industry approached $70 billion at the end of the third quarter of last year, or about 2.6% of the market, and is particularly concentrated in Brooklyn and Houston. Another important indicator, the current multifamily housing distress, represents a total of approximately $9 billion worth of assets.
Among other signs of concern, in August value-add investor Tides Equities and its lender MF1 reported extending maturities and modifying approximately $645 million in loans. genuine. This followed earlier reports that Tides had told investors that it would likely need investment from limited partners due to a lack of funding.
Other borrowers are following a similar path. In some cases, such as MF1 and Tides, the lender's exposure is so large that it has little choice but to work with the borrower, Bushbom said. He said to secure an extension, borrowers would need to take further steps, such as capping interest rates at 1.5% to 2.5% on loan balances and depositing new cash into interest reserve accounts. added.
libya capital Jeff Saladin, managing director of real estate at Private Debt Funds, reported that his firm is experiencing some stress in its portfolio. However, this is more in line with debt service ratios, which are tighter than expected, rather than loan payments being delayed. “If a borrower comes to us and likes the work we've done, we can work with them to get them across the finish line,” Saladin said. “That's what we're doing and we don't see any problem with those assets.”
Libya also sees opportunities to refinance troubled assets that may have mezzanine debt along with senior loans, but generally avoids such situations, he reported. “For obvious reasons, we don't want to take on anything difficult right now, especially if the property isn't generating enough income to support the loan,” Saladin said.
negative indicators
Although multifamily delinquency rates increased in 2023, they remained well below delinquency rates for other property types, excluding industrial properties, Trepp said. Still, Bushbom said multifamily mortgage debt, which consists of short-term floating rate debt to fund value-add transactions, paints an alarming picture. Still, some loan performance indicators paint a worrying picture.
Mr. Trepp recently compared the expected financial performance of CLOs issued by value-added multifamily syndicators to current performance at the time of stabilization, and found that between expected and actual metrics for occupancy, rents, and debt service coverage. I discovered that there was a big gap.
For example, the median monthly rent for properties with a stabilization date before mid-July 2024 was $1,013, compared to a projected $1,365. Meanwhile, the median debt service coverage ratio of 1.01 was half the expected rate. Real estate indicators with stabilization dates from mid-July 2024 onward showed similar problems, with debt service coverage averaging less than 1.0, for example.
Additionally, in certain regions, criticism of bank lending, which is characterized by concerns such as leverage, liquidity, and debt service coverage, makes multifamily default risks higher. About 25.7% of multifamily bank loans in the South Atlantic region were classified as critical, the highest of all regions, and 22.5% in Texas, Oklahoma, Arkansas and Louisiana, Trepp reported. has been criticized. Bushbom said a range of 5% to 15% of loans under criticism represents a more stable environment.
“Regulators have been pretty keen on allowing banks to reduce loans if they have some evidence that less than the full principal will be repaid,” he said. “Potentially, this is the new canary in the coal mine.”
rescue capital lady
As write-downs occur, pressure will increase on banks to take over troubled loans, Buschbom said. In anticipation of such events, “rescue capital” funds have emerged in recent months that seek to recapitalize struggling multifamily housing projects.
However, lender-initiated conflicts are severely hampering the infusion of new capital, co-founder Eric Brody reported, as well as bid-to-ask spreads that are preventing investment sales. Anax Real Estate Partners. The venture is putting preferred stock into unfinished multifamily housing projects ranging from $10 million to $250 million.
Mr. Brody said the risks associated with recapitalization transactions require caution. Unexpected surprises due to shoddy construction work and increased construction and insurance costs could weigh on expected returns, especially if investors were unable to secure a sufficiently deep discount when obtaining the original loan. He pointed out that there is.
In one example, Anax was competing to recapitalize a nearly completed multifamily project with ground floor retail. But after construction was halted for an extended period, commercial tenants pulled out of the project, its value declined, and lenders were left with the only remedy: foreclosure on their loans. “The perception of banks today is that the value of an asset is 100% of the outstanding loan, whether the project is under construction or just started, but the market requires that an investor take over a project by “This is a project that explains new financial realities,” Brody argued. “There's a game of chicken going on right now, and who gets spooked first – lenders or investors bringing new equity into the space – will play out in the first and second quarters of this year.”
Read the February 2024 issue of MHN.
