It might seem like a good time to own apartment buildings.
For many landlords, it is. Rents have skyrocketed in recent years due to a housing shortage across much of the country and a bout of severe inflation.
However, an increasing number of rental properties, especially in the South and Southwest, are in financial difficulty. Only a few have defaulted on their mortgages, but analysts fear that as many as 20 percent of all loans for apartment properties could be at risk of default.
While rents rose during the pandemic, the increase has stalled in recent months. In many parts of the country, rents are starting to decline. Interest rates, which the Federal Reserve raised to combat inflation, have made mortgages much more expensive for building owners. And while housing remains scarce in many places, developers may have built too many luxury apartments in cities that are no longer attracting as many renters as they did in 2021 and 2022, such as Houston and Tampa, Florida.
These problems have not yet become a crisis, because most owners of apartment buildings, known in the real estate industry as multifamily properties, have not defaulted on their loan payments.
Only 1.7 percent of multifamily loans are at least 30 days delinquent, compared with about 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.
However, many industry groups, rating agencies and research firms are concerned that many more apartment loans could be affected. Multifamily loans make up the majority of loans recently added to watch lists compiled by industry experts.
“Multifamily buildings are not something that is on everyone’s radar right now, but they are on everyone’s radar,” said Lisa Pendergast, executive director of the real estate council.
Concerns about apartment loans add to a litany of problems facing the commercial real estate sector. Older office buildings are suffering because of the transition 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 problems facing apartment buildings are diverse. In some cases, landlords are struggling to fill units and generate enough revenue. In others, apartments are full of paying tenants, but landlords can’t raise rents fast enough to come up with the cash needed to cover rising loan payments.
As a result, nearly one in five multifamily loans is now at risk of going delinquent, according to a list maintained by data provider CRED iQ.
Analysts are more concerned about the fact that about one-third of multifamily mortgages were issued with variable interest rates. Unlike typical mortgages with fixed interest rates, these loans have required increasingly larger payments as interest rates have risen over the past two years.
ZMR Capital purchased Reserve, a 982-unit building in Brandon, Florida, near Tampa, in early 2022. The property’s mortgage was included in bonds sold to investors. The property is more than 80 percent occupied, but interest payments have risen more than 50 percent, or more than $6 million. As a result, the building’s owner was unable to pay the mortgage, which was due in April, according to CRED iQ’s analysis of loan servicing documents. ZMR Capital declined to comment.
OWC 182 Holdings, which owns Oaks of Westchase in Houston, a 182-unit garden-style apartment property consisting of 15 two-story buildings, has been unable to make its mortgage payments since April, largely as a result of high interest costs, according to CRED iQ. Representatives for OWC 182 could not be reached for comment.
“Rising rates are causing debt service costs on these properties to skyrocket,” said Mike Haas, CEO of CRED iQ.
But even borrowers who took out a fixed-rate mortgage may run into trouble when they have to refinance their mortgages with loans that have 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 need to refinance a loan, then you’re refinancing into a more expensive environment,” said Mark Silverman, a partner and leader of the CMBS Special Servicer group at the law firm Locke Lorde. “It’s harder to make these buildings profitable.”
While office debt and lending challenges are concentrated in big-city buildings, particularly in the Northeast and West Coast, concerns around 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 anticipated demand. But in recent months, real estate analysts said, the number of people moving to 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, which were snapped up by 110,000 renters, according to CoStar Group. Last year, those markets had 216,000 new units, but demand slowed to 95,000 renters.
And as construction and labor costs rose during the pandemic, developers built more luxury apartment buildings in hopes of attracting tenants who could pay more. Now, prices and rents for those buildings are falling, CoStar analysts say.
“Developers just got out of control,” said Jay Lybik, national director of multifamily analytics at CoStar Group. “Everyone thought the demand we saw in 2021 would be the same demand going forward.”
This could be a big problem for investors like Tides Equities, a Los Angeles-based real estate investment firm 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 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.
Tides Equities executives did not respond to requests for comment.
That said, apartment buildings are likely to be in stronger financial shape than offices, for example, because multifamily units can be financed with loans from 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 do multifamily lending, Fannie and Freddie will simply get a bigger share of the business,” said Lonnie Hendry, chief product officer at Trepp, a commercial real estate data firm. “It’s a safety net that the other asset classes just don’t have.”
Additionally, while offices are being affected by a major shift in working patterns, people still need places to live, which should support the multifamily sector in the long term, Hendry said.
Still, some industry experts say they expect a wave of defaults in the apartment business, which would intensify 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.”
