It may seem like a good time to get apartment buildings.
For many owners it is. Rents have skyrocketed in recent years due to housing shortages across much of the country and a period of high inflation.
However, a growing number of rental properties, especially in the South and South West, are experiencing financial distress. Only a few have stopped paying on their mortgages, but analysts worry that up to 20 percent of all apartment loans could be at risk of default.
Although rents rose during the pandemic, the rise has stalled in recent months. In many areas of the country, rents are starting to fall. Interest rates, raised by the Federal Reserve to fight inflation, have made mortgages much more expensive for building owners. And while homes remain scarce in many places, developers may have built too many higher-end apartments in cities that are no longer attracting as many renters as in 2021 and 2022, such as Houston and Tampa, Florida.
These problems have not yet turned into a crisis because most owners of apartment buildings, known in the real estate industry as multifamily properties, have not fallen behind on their loan payments.
Only 1.7 percent of multifamily loans are at least 30 days past due, compared with about 7 percent of office loans and about 6 percent of hotel and retail loans, according to the Commercial Real Estate Finance Council, an industry association whose members include lenders and investors.
But many industry groups, rating agencies and research firms worry that many more home loans could go sour. Multifamily loans make up the majority of loans recently added to watch lists compiled by industry experts.
“Multifamily doesn’t come and punch you in the nose right now, but it’s on everyone’s radar,” said Lisa Pendergast, executive director at the real estate board.
Apartment loan concerns add to a host of problems facing commercial real estate. Older office buildings are suffering due to the shift to working from home. Hotels are hurting because people are taking less business trips. Malls have been losing ground to online shopping for years.
The issues facing apartment buildings are varied. In some cases, owners struggle to fill units and generate enough income. In others, apartments are full of paying tenants, but landlords can’t raise rents fast enough to find cash to cover mounting loan payments.
As a result, nearly one in five multifamily loans are now at risk of default, according to a list maintained by data provider CRED iQ.
Analysts are most concerned about the roughly one-third of multifamily mortgages issued at variable rates. Unlike typical fixed-rate mortgages, these loans required increasing payments as interest rates have risen over the past two years.
ZMR Capital bought the Reserve, a 982-unit building in Brandon, Florida, near Tampa, in early 2022. The property’s mortgage was packaged into bonds sold to investors. The property is more than 80 percent occupied, but interest payments have increased more than 50 percent, or more than $6 million. As a result, the building’s owner was unable to repay the mortgage, which was due in April, according to CRED iQ’s analysis of loan servicing documents. ZMR Capital declined to comment.
OWC 182 Holdings, the owner of Oaks of Westchase in Houston, a 182-unit garden-style apartment property comprised of 15 two-story buildings, has defaulted on its mortgage payments since April, largely as a result of high costs interest. according to CRED iQ. Representatives for OWC 182 could not be reached for comment.
“Rising interest rates are causing the cost of servicing the debt on these properties to increase,” said Mike Haas, CEO of CRED iQ.
But even borrowers who secured a fixed-rate mortgage can struggle when they have to refinance their mortgages with loans that carry much higher interest rates. About $250 billion in multifamily loans will mature this year, according to the Mortgage Bankers Association.
“With interest rates much higher and rents starting to decline on average nationally, if you need to refinance a loan, then you’re refinancing in a more expensive environment,” said Mark Silverman, partner and leader of the CMBS Special Servicer group at law firm of Locke Lorde. “It’s harder to make these buildings profitable.”
While debt and office loan challenges are focused on buildings in major cities, particularly in the Northeast and West Coast, multifamily concerns are more concentrated in the Sun Belt.
As people increasingly moved to the South and Southwest during the pandemic, developers built apartment complexes to meet the expected demand. However, in recent months, according to real estate analysts, the number of people moving into these areas has dropped sharply.
In 19 major Sun Belt cities — including Miami, Atlanta, Phoenix and Austin, Texas — 120,000 new apartment units became available in 2019 and were absorbed by 110,000 renters, according to CoStar Group. Last year, these markets had 216,000 new units, but demand slowed to 95,000 renters.
Additionally, as construction and labor costs rose during the pandemic, developers built more luxury apartment buildings, hoping to attract renters who could pay more. Now, prices and rents for those buildings are falling, CoStar analysts say.
“Developers just got away with so much,” said Jay Lybik, national director of multifamily analytics at CoStar Group. “Everyone thought the demand we saw in 2021 would be the way it was going.”
That could be a big problem for investors like Tides Equities, a Los Angeles-based real estate investment firm that’s betting big on multifamily properties in the Sun Belt. Just a few years ago, Tides Equities owned about $2 billion worth of apartment buildings. That number quickly rose to $6.5 billion. Now, as rents and prices for those apartments drop, the company is struggling to pay off loans and cover operating expenses, according to CRED iQ.
Tides Equities executives did not respond to requests for comment.
All that said, apartment buildings are likely to have a stronger financial footing than offices, for example. That’s because multifamily units can be financed by borrowing from the government-backed mortgage giants Fannie Mae and Freddie Mac, which Congress created to make housing more affordable.
“If the regional banks and the big investment banks decide they’re not going to make multifamily loans, then Fannie and Freddie will just have more of the business,” said Lonnie Hendry, chief product officer for Trepp, a data firm commercial real estate. . “It’s failsafe that other asset classes just don’t have.”
Additionally, while offices are being hit by a major shift in working patterns, people still need places to live, which should support the multifamily sector in the long term, Mr. Hendry said.
Even so, some industry experts say they expect a wave of foreclosures in the apartment industry, compounding problems in the commercial real estate industry.
“There’s a lot of really strong multifamily assets,” said Locke Lorde’s Mr. Silverman, “but there’s going to be collateral damage, and I don’t think it’s going to be small.”
