During the pandemic, landlords invested billions into apartment buildings due to robust tenant demand, while offices underwent a paradigm shift with more employees working remotely.
However, fault lines are emerging for investors who paid top dollar for assets that relied on substantial rent increases and low-interest rates for profitability.
In 2021 and 2022, investors acquired an unprecedented $355.5 billion and $299.2 billion worth of apartment buildings respectively, as competition and prices surged.
To win in this hyper-competitive market, investors needed to make ambitious predictions of rent growth and control expenses. However, rents have plateaued or even declined in some markets, and expenses have risen, becoming problematic for investors.
As more mortgages expire, properties where fix-and-flip strategies have stalled will become problematic, and a growing number of them will be in default.
A growing concern is the speculative investment deals done with mortgages shoved into a riskier part of the securitized-loan market, known as commercial-real-estate collateralized loan obligations (CRE CLOs).
These loans, which generally stretched over two or three years, had floating interests that rose sharply as the Federal Reserve increased its benchmark rate and featured higher leverage levels that covered a larger portion of an asset’s purchase price.
CRE CLO delinquency rates are low, but observers expect them to increase if interest rates remain high and lending standards remain tight.
There are already signs of stress, with a Trepp analysis finding that 71.9% of multifamily properties financed with CRE CLOs in Washington DC didn’t earn enough rent to cover their debts.
A pool of troubled loans totaling around $1 billion has attributed some of the pain to remote work policies among federal government offices, which have allowed workers to migrate and work from afar, weakening the local rental market.
In addition, falling property prices have compounded the problem for investors. In February, MSCI estimated that apartment-building prices fell on average by about 8.7% year over year, with Green Street estimating a 21% decline from a year ago in April.
As short-term debts come due, swapping with commensurately sized loans today will be challenging due to falling values, higher interest rates, and lender caution.
Landlords may have to pour millions of dollars to pay the difference, which could be a significant financial burden.
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