During the pandemic era, big money
investors poured billions of dollars into
buying up apartment buildings with the
expectation that rents would continue to
rise. However, these optimistic projections
have not come to fruition, leaving landlords
facing significant losses as rents remain flat
and expenses continue to increase.
While offices have been going through a
significant shift as more employees work
remotely, apartment buildings have
experienced strong demand from tenants.
But for investors who paid top dollar for
assets that relied on substantial rent
increases and low interest rates to achieve
profitability, fault lines have emerged.
These optimistic projections became
increasingly necessary in the booming
markets of 2021 and 2022 when investors
were hungry for apartment-building
acquisitions, driving up competition and
prices. During these years, investors
purchased unprecedented sums of $355.5
billion and $299.2 billion worth of
apartment buildings, according to MSCI, far
surpassing the previous record of $194
billion in multifamily sales in 2019.
In the hypercompetitive market, investors
needed to make ambitious predictions
about how they could grow rents and
control expenses to win deals. However, as
Will Mathews, a multifamily-investment-
sales broker at Colliers explains, "What
they've found is that rents have plateaued
or even declined in some markets, and
expenses have skyrocketed."
The situation could worsen as more
mortgages expire at properties where fix-
and-flip strategies have stalled, leading to a
growing number of defaults. This situation
highlights the risks of making overly
optimistic projections when investing in real
estate, particularly during periods of
intense market competition.
Collateralized loan obligations look shaky:
Amid the pandemic era, some of the most
speculative investment deals were made by
placing mortgages into a riskier segment of
the securitized-loan market known as
commercial-real-estate collateralized loan
obligations or CRE CLOs. These loans are
typically spread over two to three years,
with floating interest rates that surge as the
Federal Reserve increases its benchmark
rate. They also involve higher leverage
levels, covering a larger percentage of an
asset's purchase price.
Although CRE CLO delinquency rates have
remained low, there are growing concerns
that they will increase. Alan Todd, the head
of commercial-mortgage-backed-securities
strategy at BofA Global Research, explains
that "it's early, but it's going to become a
bigger story, especially if interest rates
remain high and lending standards remain
tight."
There are already signs of stress in the
market. A recent analysis by Trepp found
that 71.9% of multifamily properties
financed with CRE CLOs in Washington DC
didn't generate enough rent to cover their
debts. Some of the factors contributing to
this situation include remote-work policies
among federal government offices, which
have weakened the local rental market by
allowing workers to migrate and work from
afar.
Falling property prices have further
compounded the problems for investors,
with apartment-building prices falling by an
estimated 8.7% on average year over year,
according to MSCI. In April, Green Street
estimated that prices had declined by 21%
from a year ago.
As short-term debts come due, they may be
challenging to refinance with
commensurately sized loans today due to
falling values, higher interest rates, and
lender caution. This could force landlords to
pay the difference out of pocket, which
could amount to millions of dollars they
may not have.
Overall, the risks associated with CRE CLOs
and the broader multifamily real estate
market underscore the importance of
caution and risk management in investment
decisions.
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