Multifamily Market Approaches ‘Hydrogen-Bomb Scenario’ As CMBS Loans Come Due
Despite high occupancy and rent growth, some are warning of an incoming “Red October” for owners of multifamily properties due to the nature of financing for the asset class.
Multifamily landlords face a “hydrogen-bomb scenario,” Peter Sotoloff, a former managing partner at Mack Real Estate Credit Strategies and former head of U.S. originations at The Blackstone Group, per his LinkedIn profile, told The Wall Street Journal.
The situation is largely credited to an increase in interest rates and borrowing costs set to hit the industry harder than most.
Morningstar in a paper released last month said multifamily is the largest real estate category, comprising 18.5% of market value — office makes up 15.5% of market value — and warned that real estate loans in the sector are looking “especially wobbly.”
While rising interest rates affect all asset classes, Morningstar cited three reasons they pack a particular punch for multifamily developers and landlords.
First, a significant chunk of property developers took out loans in 2021 to finance construction and redevelop existing stock when rates were low.
Second, multifamily residential financing interest rates are effectively reset after a much shorter time frame than single-family mortgages, typically within two to three years. That means many multifamily property developers “are just now about to enter the gauntlet of higher rates,” the paper says.
Lastly, more than half of the cash borrowed by property developers to create today's housing stock was provided by small and midsized regional banks. Regional banks used to be the largest source of capital for commercial real estate borrowers, but they have largely pulled back after the crisis brought on by the collapse of Silicon Valley Bank.
The combination of those factors means an “$8B tsunami of multifamily commercial mortgage-backed securities” should come due in the second half of this year, with some in real estate predicting a “Red October,” according to Morningstar.
A growing number of landlords already face the consequences of rising interest rates.
In Houston, one borrower that tried to entice investors with "high yielding multifamily investment opportunities" in March lost a multifamily portfolio valued at $229M through foreclosure. The borrower, Applesway Investment Group, bought the four properties between August 2021 and April 2022.
In February, a $271M Blackstone loan backed by 11 apartment buildings in Manhattan was sent to special servicing.
Unprecedented rent growth since the start of 2021 and historic levels of liquidity in capital markets pushed valuations to worrying heights, Bisnow reported in early 2022.
This created a bubble that made it hard to imagine soaring numbers in the multifamily industry could be sustained, Lorie Soares Lazarus, a commercial real estate attorney and partner at Stroock in Los Angeles, told Bisnow in April.
Apartment building values fell 14% for the year ending June 2023 after rising 25% the previous year, the WSJ reported, using CoStar data.
The multifamily market carries about twice the amount of debt as the office market — about $2T — the WSJ reported.
Zooming out, Trepp data shows that $980.7B in multifamily debt is set to come due between 2023 and 2027.
UPDATE, AUG. 7, 2:10 P.M. CT: This story has been updated to better reflect Peter Sotoloff’s past positions.
