This may seem like a great time to own apartment buildings.
For many landlords, it is. Rents have skyrocketed in recent years due to a housing shortage in much of the country and high inflation.
But a growing number of rental property owners, particularly in the South and South West, are in financial difficulty. Only a few have stopped repaying their mortgages, but analysts fear that up to 20% of all loans on apartment buildings are at risk of default.
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, raised higher by the Federal Reserve to fight inflation, have made mortgages much more expensive for building owners. And while housing remains scarce in many places, developers may have built too many high-end apartments in cities that aren’t attracting as many renters as they did in 2021 and 2022, such as Houston and Tampa, Florida.
Those problems have not yet turned into a crisis because most owners of apartment buildings, known in the real estate industry as multifamily properties, have not fallen behind on their loan payments.
According to the Commercial Real Estate Finance Council, an industry association whose members include lenders and investors, only 1.7% of multifamily loans are at least 30 days delinquent, compared with about 7% of office loans and about 6% of hotel and retail loans.
But many industry groups, ratings agencies and research firms worry that many more mortgages could be in trouble. Multifamily loans make up the majority of the new loans added to industry watch lists.
“Multifamily isn’t hitting you in the face right now, but it’s on everyone’s radar,” said Lisa Pendergast, executive director of the real estate council.
The mortgage concerns add to a litany of problems facing the commercial real estate industry. Older office buildings are suffering from the shift to remote work. Hotels are suffering because people are taking fewer business trips. Shopping malls have been losing ground for years to online shopping.
Apartment buildings face a variety of challenges. In some cases, landlords are struggling to fill units and generate enough income. In others, apartments are filled with paying tenants, but landlords can’t raise rents fast enough to raise the money needed to cover rising mortgage 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 most concerned about the roughly third of multifamily mortgages that were issued with variable interest rates. Unlike traditional fixed-rate mortgages, these loans have required increasingly higher payments as interest rates have climbed over the past two years.
ZMR Capital bought the Reserve, a 982-unit complex 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% occupied, but interest payments have increased by more than 50%, or more than $6 million. As a result, the building’s owner has been 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, owner of Oaks of Westchase in Houston, a 182-unit garden-style apartment complex consisting of 15 two-story buildings, has not made payments on its mortgage since April, largely because of high interest rates, according to CRED iQ. Representatives for OWC 182 could not be reached for comment.
“Rising rates are driving up debt service costs on these properties,” said Mike Haas, managing director of CRED iQ.
But even borrowers who have fixed-rate loans can face challenges when they have to refinance their loans with much higher interest rates. About $250 billion worth of multifamily loans will come due this year, according to the Mortgage Bankers Association.
“With interest rates much higher and rents starting to come down on average nationally, if you have to refinance a loan, you’re doing it in a more expensive environment,” said Mark Silverman, partner and head of the CMBS Special Servicer group at law firm Locke Lorde. “It’s harder to make these buildings profitable.”
While office debt and loan concerns are concentrated in big-city buildings, particularly in the Northeast and the West Coast, concerns about multifamily buildings 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 expected demand. But in recent months, real estate analysts say, the number of people moving to those areas has declined sharply.
In 19 major Sun Belt cities, including Miami, Atlanta, Phoenix and Austin, Texas, 120,000 new apartments became available in 2019 and were occupied by 110,000 renters, according to CoStar Group. Last year, those markets had 216,000 new units, but demand has slowed to 95,000 renters.
Additionally, as construction and labor costs have risen during the pandemic, developers have built more luxury apartment buildings, hoping to attract renters who could pay more. Now, prices and rents for those buildings are falling, according to CoStar analysts.
“Developers have simply gone overboard,” said Jay Lybik, national director of multifamily analytics at CoStar Group. “Everyone thought the demand we saw in 2021 was going to continue.”
That could be a big problem for investors like Tides Equities, a Los Angeles-based real estate investment trust that has 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 ballooned to $6.5 billion. Now, as rents and prices for those apartments plummet, the company is struggling to repay its loans and cover operating expenses, according to CRED iQ.
Executives at Tides Equities did not respond to requests for comment.
That said, apartment buildings are likely to be financially sounder than, say, office buildings. That’s because multifamily buildings can be financed with loans from government-backed mortgage giants Fannie Mae and Freddie Mac, which Congress created to make housing more affordable.
“If regional banks and big investment banks decide to stop lending to households, Fannie Mae and Freddie Mac are simply going to get a bigger share of the market,” said Lonnie Hendry, chief product officer at Trepp, a commercial real estate data firm. “That’s a safety net that other asset classes just don’t have.”
Additionally, even as offices are impacted by a major shift in work patterns, people still need places to live, which should support the multifamily sector in the long term, Hendry said.
Still, some industry experts expect a wave of defaults in the apartment sector, which would exacerbate problems across the commercial real estate sector.
“There are a lot of really strong multifamily assets,” said Locke Lorde’s Silverman, “but there will be collateral damage, and I don’t think it will be small.”
