Where Inexperienced Multifamily Investors Rushed In, 'Generational Opportunities' Await

Throwing investment cash at the multifamily sector was sound logic in the early days of the pandemic: People might not be going out to shop, eat or work from an office, but they would always need a place to live.

Add in the appeal of low interest rates, and it's little wonder investors turned up in droves, taking out floating-rate loans for what had been easy, passive investments or pooling resources with others in syndications promising hefty returns without the headache of becoming hands-on landlords.

But when interest rates skyrocketed, growing exponentially faster than rental rates, distress seeped into the market. Now, a wave of defaults and foreclosures has begun — and is unlikely to end anytime soon.

That has some more experienced investors seeing fields of green and making moves to harvest it when the time is ripe.

“There's no shortage of capital that's wanting to invest in distressed commercial real estate assets,” said Greg Friedman, founder and CEO of Atlanta-based investment firm Peachtree Group, pointing to more than $250B of private equity capital set aside to invest in commercial real estate.

Fifty percent of that sum is allocated for multifamily, he said, despite the fact the sector only makes up roughly 35% of the commercial real estate ecosystem. 

“There's a ton of capital, several hundred billions of dollars worth of capital, just sitting on the sidelines, waiting to pounce,” said Gautam Goyal, CEO and co-founder of Houston-based private equity firm Three Pillars Capital Group.

The sector has already racked up more than $7.5B of outstanding distress nationally, with another $65.7B of potential distress on the way, according to third-quarter data from MSCI. Multifamily lags office, retail and hospitality in overall distress for now, but MSCI ranks the asset class highest for potential trouble down the line, accounting for almost a third of all at-risk properties.

With loans coming due, prices for apartments have dropped 12.8% from the third quarter of 2022 to the third quarter of 2023, MSCI reported. Meanwhile, deal volume has fallen more than 60% each quarter since Q4 2022.

All of that is likely to leave a mess for lenders and well-capitalized investors to clean up, experts in the sector told Bisnow. And much of the cleanup, in more ways than one, will come from private equity shops like Peachtree Group or Three Pillars, as well as from sovereign wealth funds and high net worth individuals. 

“People who believe in the area where the property is located and who are well-capitalized are probably sitting and waiting,” said Dan Berman, partner at New York-based law firm Kramer Levin. “There is probably going to be tremendous opportunity, like generational opportunities.”

A few deals are already happening. When Arbor Realty Trust foreclosed on a $229M, 3,200-unit portfolio of Class-B and lower Houston apartment buildings picked up by multifamily syndicate Applesway Investment Group when rates were low, Fundamental Partners stepped in. The firm, which touts an “opportunistic private investment strategy” of acquiring distressed or underperforming housing assets, bought the apartments via foreclosure in April for an undisclosed sum.

In September, a local Chicago investor picked up a 237-unit multifamily portfolio on the South Side for almost $12.3M in a foreclosure sale, well below the nearly $17.6M in loans owed on the 10 properties. 

Even major firms have been pushed to sell, like Blackstone's trade of a majority stake in 11 of its Manhattan multifamily properties to dodge foreclosure efforts from lenders. 

Many institutional buyers aren’t risking buying quite yet because they expect values to drop further, Berman said.

“I think everyone believes that prices will be lower nine months from now,” he said. “So why would they buy something now as opposed to just waiting?”

But a reckoning is coming, and those in the industry have said much of it could come from syndicators, which raised at least $115B from investors between 2020 and 2022, according to Securities and Exchange Commission filings, often investing using floating-rate loans initially secured at low rates.

Five major syndicators — Tides Equities, GVA Investments, Nitya Capital, ZMR Capital and Rise48 Equity — hold $3.6B in commercial collateralized loan obligations with maturities of 30 months or less, according to Trepp data reported by GlobeSt.

“I do expect to see more of those types of situations,” Friedman said. “I do expect that you’re going to see more foreclosures and more defaults as loans are maturing.” 

Owners who have floating-rate or maturing loans have limited options right now, Friedman said, as property values drop some assets' worth below their debt balances.

“Either you have to hand back the keys to the lender or you have to pay down debt in order to refinance that loan that's maturing,” he said. 

In at least one case, Three Pillars Capital stepped in before a loan maturity. Earlier this year, Three Pillars bought the 426-unit Chateaux Dijon Apartments in Houston in a deal that came a month before the complex’s loan was due, Goyal said. 

The transaction was a win-win, Goyal said, because it meant the previous owner wouldn't have a foreclosure on its record, which would harm its reputation with lenders, and Three Pillars didn’t have to compete against other buyers the lender might have marketed to, driving up the price.

“Equity was lost, but the reputation, at least from a securing debt perspective, is still intact,” Goyal said. “That's always preferred.”

But such deals don’t always materialize, Goyal said, citing one distressed Houston complex whose owners were trying to sell for $44M and rebuffed Three Pillars’ offer in the high $30M range. That complex is likely heading toward foreclosure, he said.

Sellers need to “get off their high horse,” Goyal added.

“It's not a good feeling, at the end of the day, whether it's the institutional seller or single-asset seller, to be able to sell an asset at a loss. But that's what we're seeing.”

Three Pillars’ transaction volume has been low this year. Chateaux Dijon was its only acquisition so far. But Goyal said competition is stiffening and large distressed asset funds are primed to buy many more assets.

Owner-operators will likely team up with capital providers to buy properties at a lower price, whether through foreclosure or after the lender takes possession, Berman said. 

Debra Morgan, managing director of the restructuring and dispute resolution practice at CohnReznick, helps owners and operators of distressed real estate navigate their debt. In the past two years, demand for her services has increased from about two cases a quarter to one a week, she said.

A large factor was new investors crowding into the space because it represented a natural first investment, akin to buying a house requiring a mortgage, insurance, utilities and the new responsibility of property upkeep.

“We've seen a lot of people join in the market who thought that this was an easy asset class to get into and an easy asset class to manage,” she said. 

Inexperienced investors also targeted multifamily due to high demand and cap rates that compressed for 15 or more years straight, outpacing inflationary growth, Friedman said.

“That lack of experience is going to have an impact on how certain ownership groups and operators across multifamily are going to be able to navigate and survive,” he said. 

Many of the groups experiencing distress right now did a terrible job of maintaining and renovating their properties, Goyal said, adding that “new paint is not a renovation.” 

Options are limited for investors who got in while times were good and are now underwater. New financing is difficult or even impossible to find. While lines are forming for distressed real estate, the reality is that property values haven't yet settled, and comparable purchases are lagging, Morgan said.

“We're still in a falling-knife environment,” she said. 

If values continue to drop in the next year and lenders pull the trigger on foreclosures, the bidding wars are on, Berman said.

“I think lenders have been waiting to actually push the foreclosure button, because the moment you do that, you then have your own internal valuation issues,” he said. “You're just waiting for someone else to go first. … Now, I’m hearing and seeing more velocity of foreclosures. I think that’s going to only increase for the foreseeable future.”