Apartments Could Be the Next Real Estate Business to Struggle

An apartment complex in Houston, April 21, 2022. (Christopher Lee/The New York Times)
An apartment complex in Houston, April 21, 2022. (Christopher Lee/The New York Times)

It might seem like a great time to own apartment buildings.

For many landlords, it is. Rents have soared in recent years because of housing shortages across much of the country and a bout of severe inflation.

But a growing number of rental properties, especially in the South and the Southwest, are in financial distress. Only some have stopped making payments on their mortgages, but analysts worry that as many as 20% of all loans on apartment properties could be at risk of default.

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Although rents surged during the pandemic, the rise has stalled in recent months. In many parts of the country, rents are starting to fall. Interest rates, ratcheted higher by the Federal Reserve to combat 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 they were in 2021 and 2022, like Houston and Tampa, Florida.

These problems haven’t yet turned into a crisis, because most owners of apartment buildings, known in the real estate industry as multifamily properties, haven’t fallen behind on loan payments.

Only 1.7% of multifamily loans are at least 30 days delinquent, compared with roughly 7% of office loans and around 6% 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 are worried that many more apartment loans could become distressed. Multifamily loans make up a majority of loans newly added to watch lists compiled by industry experts.

“Multifamily is not coming up and punching you in the nose right now, but it’s on everyone’s radar,” said Lisa Pendergast, executive director at the real estate council.

The worries about apartment loans add to a litany of problems facing commercial real estate. Older office buildings are suffering because of the shift to working from home. Hotels are hurting because people are taking fewer business trips. Malls have been losing ground for years to online shopping.

The issues facing apartment buildings are varied. In some cases, owners are struggling to fill units and generate enough income. In others, the apartments are full of paying tenants, but owners cannot raise rents fast enough to come up with the cash to cover rising loan payments.

As a result, almost 1 in 5 multifamily loans is now at risk of becoming delinquent, according to a list maintained by the data provider CRED iQ.

Analysts are most worried about the roughly one-third of multifamily mortgages that were issued with floating interest rates. Unlike typical, fixed-rate mortgages, these loans have required rising payments as interest rates have climbed in the last two years.

ZMR Capital bought the Reserve, a 982-unit building in Brandon, Florida, near Tampa, at the beginning of 2022. The mortgage on the property was packaged into bonds sold to investors. The property is more than 80% occupied, but interest payments have gone up more than 50%, or more than $6 million. As a result, the building’s owner was unable to repay the mortgage, which came 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 consisting of 15 two-story buildings, has failed to make payments on its mortgage since April, largely as a result of steep interest costs, according to CRED iQ. Representatives of OWC 182 could not be reached for comment.

“The spike in rates is causing the debt service costs on these properties to surge,” said Mike Haas, the CEO of CRED iQ.

But even borrowers that secured a fixed-rate mortgage may struggle when they have to refinance their mortgages with loans that carry much higher interest rates. Roughly $250 billion worth of multifamily loans will come due this year, according to the Mortgage Bankers Association.

“With interest rates much higher and rents beginning to decline on average nationwide, if you need to refinance a loan, then you are refinancing into a more expensive environment,” said Mark Silverman, a partner and leader of the CMBS Special Servicer group at the law firm Locke Lord. “It’s harder to make these buildings profitable.”

Whereas the debt and loan challenges for offices are focused on buildings in large cities, particularly in the Northeast and on the West Coast, the concerns around multifamily are more concentrated in the Sun Belt.

As people increasingly moved to the South and the Southwest during the pandemic, developers built apartment complexes to meet expected demand. But in recent months, real estate analysts said, the number of people moving to those regions has fallen sharply.

In 19 major cities of the Sun Belt — 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, those markets had 216,000 new units, but demand slowed to 95,000 renters.

In addition, 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, analysts at CoStar say.

“The developers just got so far out of hand,” said Jay Lybik, national director of multifamily analytics at CoStar Group. “Everybody thought the demand we saw in 2021 was going to be the way it was going to be going forward.”

That could be a big problem for investors like Tides Equities, a real estate investment firm based in Los Angeles that bet big on multifamily properties in the Sun Belt. Just a few years ago, Tides Equities owned about $2 billion worth of apartment buildings. That figure quickly grew to $6.5 billion. Now, as rents and prices for those apartments fall, the firm is struggling to make loan payments and cover operating expenses, according to CRED iQ.

Executives at Tides Equities did not respond to requests for comment.

All that said, apartment buildings are likely to be on stronger financial footing than offices, for instance. That’s because multifamily units can be financed by lending from the government-backed mortgage giants Fannie Mae and Freddie Mac, which Congress created to make housing more affordable.

“If regional banks and large investment banks decide they’re not going to be making multifamily loans, then Fannie and Freddie will simply get more of the business,” said Lonnie Hendry, the chief product officer for Trepp, a commercial real estate data firm. “It’s a fail-safe that the other asset classes simply do not have.”

Moreover, while offices are being hit by a major shift in work patterns, people still need places to live, which ought to support the multifamily sector over the longer term, Hendry said.

Even so, some industry experts say they expect a wave of defaults in the apartment business, intensifying problems across the commercial real estate industry.

“There are a lot of really strong multifamily assets,” said Silverman of Locke Lord, “but there is going to be collateral damage, and I don’t think it will be small.”

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