It may seem like a good time to own apartment buildings.
For many owners, it is. Rents have risen in recent years due to a housing shortage in much of the country and a period of severe inflation.
But a growing number of rental properties, particularly in the South and Southwest, are struggling financially. Only a few have stopped making payments on their mortgages, but analysts worry that up to 20 percent of all home loans could be at risk of default.
Although rents rose during the pandemic, growth has stalled in recent months. In many parts of the country, rents have started to fall. Interest rates, pushed higher by the Federal Reserve to fight inflation, have made mortgages much more expensive for homeowners. And while homes remain scarce in many places, developers may have built many high-end apartments in cities that are no longer attracting as many renters as they were in 2021 and 2022, such as Houston and Tampa, Fla.
These problems have not yet turned into a crisis because most owners of the buildings, known in the real estate industry as multifamily properties, have not fallen behind on their loan payments.
Only 1.7 percent of multifamily loans are at least 30 days delinquent, compared with roughly 7 percent of office loans and about 6 percent 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 concerned that many more home loans could become difficult. Multifamily loans make up the majority of loans newly added to watch lists compiled by industry experts.
“Multifamily isn’t coming and hitting you in the nose right now, but it’s on everyone’s radar,” said Lisa Pendergast, executive director at the real estate council.
Concerns about condo loans add to the array of problems facing commercial real estate. Older office buildings are suffering due to the shift to work from home. Hotels are hurting because people are taking less business trips. Malls have been losing ground to online shopping for years.
The problems faced by residential buildings are different. In some cases, landlords are struggling to fill units and generate sufficient income. In others, apartments are full of paying tenants, but landlords can’t raise rents fast enough to find the money to cover rising loan payments.
As a result, nearly one in five multifamily loans is now at risk of becoming delinquent, according to a list maintained by data provider CRED iQ.
Analysts are more concerned about the roughly one-third of multifamily mortgages that are issued with variable interest rates. Unlike typical fixed-rate mortgages, these loans have required increased payments as interest rates have risen in the past two years.
ZMR Capital bought the Reserve, a 982-unit building in Brandon, Fla., near Tampa, in early 2022. The mortgage on the property was packaged into bonds sold to investors. The property is more than 80 percent occupied, but interest payments are up more than 50 percent, or over $6 million. As a result, the building’s owner was unable to pay off 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 the Oaks of Westchase in Houston, a 182-unit garden-style apartment complex comprised of 15 two-story buildings, has defaulted on its mortgage payments since April, largely as a result of high costs of interest. according to CRED iQ. Representatives of OWC 182 could not be reached for comment.
“Rising rates are causing the debt service costs on these properties to rise,” said Mike Haas, chief executive officer of CRED iQ.
But even borrowers who secured a fixed-rate mortgage can struggle when they have to refinance their mortgages with loans that have much higher interest rates. Roughly $250 billion in multifamily loans will come due this year, according to the Mortgage Bankers Association.
“With interest rates much higher and rents starting to fall on average nationwide, if you need to refinance a loan, then you’re refinancing in a more expensive environment,” said Mark Silverman, a partner and leader of group CMBS Special Servicer at. law firm Locke Lorde. “It’s harder to make these buildings profitable.”
While debt and office credit challenges are concentrated in buildings in big cities, particularly in the Northeast and West Coast, concerns about multifamily are more concentrated in the Sun Belt.
As people increasingly moved to the South and Southwest during the pandemic, developers built apartment complexes to meet the expected demand. But in recent months, real estate analysts say, the number of people moving into those regions has dropped sharply.
In 19 major Sun Belt cities — 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.
Additionally, as construction and labor costs rose during the pandemic, developers built more luxury apartment buildings, hoping to attract tenants who could pay more. Now, prices and rents for those buildings are falling, analysts at CoStar say.
“Developers just got out of hand,” said Jay Lybik, national director of multifamily analytics at CoStar Group. “Everybody thought the demand we saw in 2021 would be the way it was going forward.”
That could be a big problem for investors like Tides Equities, a Los Angeles-based real estate investment firm that’s betting 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 rose to $6.5 billion. Now, as rents and prices for those apartments drop, the firm is struggling to make loan payments and cover operating expenses, according to CRED iQ.
Tides Equities executives did not respond to requests for comment.
All that said, apartment buildings are likely to be on stronger financial footing than offices, for example. 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 the regional banks and the big investment banks decide they’re not going to make multifamily loans, then Fannie and Freddie are just going to take more of the business,” said Lonnie Hendry, chief product officer for Trepp, a commercial and real estate data. . “It has a fail-safe that other asset classes just don’t have.”
Furthermore, while offices are being hit by a major shift in working patterns, people still need places to live, which should support the multifamily sector in the longer term, Mr. Hendry said.
However, some industry experts say they expect a wave of failures in the apartment business, intensifying problems throughout the commercial real estate industry.
“There’s a lot of really strong multifamily assets,” said Mr. Locke Lorde’s Silverman, “but there will be collateral damage, and I don’t think it will be small.”