Apartments in downtown Phoenix.Getty
Major investors pumped billions into buying homes during the pandemic era.
The deals were often based on the assumption that rents would continue to rise.
But rents are stagnant and spending is rising, leaving landlords suffering big losses.
While offices have undergone a paradigm shift as more workers do their work remotely, apartment buildings are experiencing robust demand from tenants.
But fault lines have emerged for investors who have paid top dollar for assets that have depended on significant rent increases and persistently low interest rates for profitability.
That kind of bullish forecasting became all the more necessary in the booming markets of 2021 and 2022, as investors grew voraciously for residential property acquisitions, boosting competition and prices. During those years, investors bought $355.5 billion and $299.2 billion in multifamily home sales, according to MSCI — unprecedented sums that far surpassed the previous record $194 billion in multifamily home sales set in 2019 .
“To strike a deal in this highly competitive market, investors had to make ambitious predictions about how to increase rents and control spending,” said Will Mathews, a multifamily investment sales agent at Colliers. “What they found is that rents have plateaued or even fallen in some markets and spending has skyrocketed.”
The problems could explode as more mortgages expire in properties where fix-and-flip strategies have faltered, causing a growing number of them to default.
Secured loan commitments look shaky
Some of the most speculative investment deals have been made with mortgages shoveled into a riskier part of the securitized loan market known as Commercial-Real-Estate Collateralized Loan Obligations, or CRE CLOs. These loans generally lasted for two or three years, had variable interest rates that rose sharply when the Federal Reserve raised its benchmark interest rate, and featured higher leverage that covered a larger portion of an asset’s purchase price.
The story goes on
CRE CLO’s crime rates have been low, but observers expect an increase.
“It’s early days, but it will be a bigger story, especially if interest rates remain high and lending standards are tight,” said Alan Todd, head of commercial mortgage-backed securities strategy at BofA Global Research. “At the moment the water is in the pot, the heating is on, but we’ll wait and see when it boils.”
Stress signals are present. A Trepp analysis found that in Washington DC, for example, 71.9% of multifamily homes financed with CRE CLOs were not earning enough rent to cover their debt. Trepp attributed some of the pain in that pool of bad loans, which totals about $1 billion, to the remote work policies of federal agencies — the city’s dominant tenant base — which have allowed workers to churn and work remotely to work, thereby weakening the local rental market.
Falling real estate prices have compounded the problems for investors. MSCI estimated in February that apartment home prices had fallen an average of 8.7% year over year. In April, Green Street estimated they were down 21% year over year.
When this short-term debt matures, it will be difficult to exchange it for adequate amounts of credit today due to falling values, higher interest rates and the caution of lenders.
That could force landlords to throw in millions of dollars to pay the difference — cash they may not have.
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