With the current focus primarily on office property loans, it is important not to overlook the mounting debt maturity within the multifamily sector in the coming years.
While multifamily assets have traditionally been regarded as relatively safe investments, recent instances of loan defaults on multifamily portfolios, such as the foreclosure of four properties totaling 3,200 units in Houston last month, have emerged as a cause for concern, according to a recent report in the National Observer.
According to Aaron Jodka, the director of National Capital-Markets Research at Colliers, the multifamily market is currently a fascinating test case. While rental growth has slowed compared to 18 months ago, many markets are still experiencing positive growth, and occupancy rates remain robust.
Taking a closer look at the apartment market, RealPage Inc. reports that national net absorption in Q1 2023 reached 19,243 units, with an occupancy rate of 94.7 percent in March. Although this represents a decline from the peak of 97.6 percent observed in February 2022, it aligns with the average seen in the decade preceding the pandemic. The effective asking rents for new apartment leases increased by 0.3 percent in Q1.
Despite the seemingly favorable conditions, buyers and sellers, including those in the multifamily sector, are currently at an impasse. Jodka notes that multifamily has been a favorite in the real estate investment world in recent years. From the early 2000s through the global financial crisis, and in the aftermath, multifamily drove around 24 percent of all investment sales activity. Between 2012 and 2020, that figure rose to 33 percent, and from 2020 to 2022, multifamily accounted for 43 percent of total investment.
Jodka explains that as investment flows continue to increase, more maturities are expected as a result of the higher volume. Specifically, borrowers who recently financed multifamily deals with short-term floating-rate debt, without anticipating a significant rise in interest rates, may face challenges with higher loan payments and potential issues when refinancing.
Moreover, a substantial number of multifamily loans are nearing maturity. The Mortgage Bankers Association estimates that there is approximately $2.6 trillion of loan maturities expected through 2027, with multifamily loans accounting for 38 percent of that total.
While experts tracking the commercial real estate market anticipate a higher level of distress in the multifamily sector in the coming months and years, they believe financing challenges will be more sporadic than widespread. Capital sources, both on the debt and equity side, are expected to provide funds for multifamily properties more readily than for other asset classes. Additionally, there remains a significant amount of uninvested capital waiting to enter the market.
Huxley Somerville, managing director at Fitch Ratings Inc., suggests that recent interest rate hikes, which could impact borrowers’ ability to refinance, may be partly offset by the substantial growth in rental rates that many apartment properties have experienced over the past decade. A considerable number of multifamily deals monitored by Fitch are backed by 10-year debt.
Although increased rental income could help counterbalance higher interest rates, apartment owners are currently facing elevated costs, particularly in insurance, Somerville adds.
The Sun Belt region, in particular, has witnessed a surge in apartment construction as developers and investors have pursued migration trends that accelerated during the pandemic. While markets like Miami continue to experience significant multifamily rent growth, many Southeastern and Southwestern metros have seen rent growth slow in recent quarters due to ongoing new construction.
RealPage reports that as of the end of March, national apartment construction reached its highest level in five decades, surpassing 1.02 million units.
However, geographic location may not be the decisive factor in determining which properties will encounter difficulties. Even two apartment properties situated across the street from each other, possessing similar fundamentals, could have different outcomes depending on the individual owner’s capacity to refinance, according to Somerville.
“Certainly there will be systemic risk from interest rates,” Somerville acknowledges in the report. “But at the end of the day, it really comes to idiosyncratic factors: what’s happened at that property, what’s the borrower been able to do, are they able to come out of pocket to pay down a maturing balance to make a refi easier — some borrowers will be able to do that, others won’t.”