Homeowners pumped billions into apartment buildings during the pandemic. That effort can now go horribly wrong.

Homeowners pumped billions into apartment buildings during the pandemic.  That effort can now go horribly wrong.

Apartments in downtown Phoenix.Getty

  • Big money investors pumped billions into buying up apartment buildings during the pandemic.

  • The agreements were often based on the assumption that rents would continue to rise.

  • But rents are flatlining and expenses are rising, leaving landlords facing big losses.

While offices have gone through a paradigmatic shift as more workers do their jobs remotely, apartment buildings have experienced strong tenant demand.

But fault lines have emerged for investors who paid top dollar for assets that depended on significant rent increases and persistently low interest rates to achieve profitability.

Such optimistic projections became increasingly necessary in the booming markets of 2021[ads1] and 2022, when investors became ravenous for apartment acquisitions, increasing competition and prices. In those years, investors bought $355.5 billion and $299.2 billion in apartment buildings, according to MSCI — unprecedented sums that far surpassed the previous record of $194 billion in multifamily sales in 2019.

“To win a deal in the hyper-competitive market, investors needed to make ambitious predictions about how to raise rents and control expenses,” said Will Mathews, a mutual investment sales broker at Colliers. “What they’ve found is that rents have plateaued or even declined in some markets and spending has skyrocketed.”

The problems could mushroom as more mortgages expire on properties where fix-and-flip strategies have stalled, leading to a growing number going into default.

Collateralized loan obligations look unstable

Some of the most speculative investment deals were made with mortgages defaulted into a riskier segment of the securitized loan market known as commercial real estate collateralized loans, or CRE CLOs. These loans generally ran for two or three years, had floating rates that rose sharply when the Federal Reserve raised its benchmark interest rate, and had higher loan-to-value levels that covered a larger portion of an asset’s purchase price.

CRE CLO delinquency rates have been low, but observers expect an uptick.

“It’s early, but it’s going to be a bigger story, especially if interest rates stay high and lending standards are tight,” said Alan Todd, head of commercial mortgage-backed securities strategy at BofA Global Research. “Right now the water is in the kettle, the heat is on, but we are waiting to see when it will boil.”

There are signals of stress. A Trepp analysis found that in Washington DC, for example, 71.9% of multifamily properties financed with CRE CLOs did not earn enough rent to cover the debt. Trepp attributed some of the pain in that pool of troubled loans, which totals about $1 billion, to telecommuting policies among federal government offices — the dominant tenant base in the city — that have allowed workers to migrate and work from afar, weakening. the local rental market.

Falling property prices have compounded the problems for investors. MSCI estimated in February that house prices had fallen on average by around 8.7% year-on-year. In April, Green Street estimated they had fallen 21% from a year ago.

As these short-term debts mature, they will be difficult to exchange for loans of similar size today, due to falling values, higher interest rates and lender caution.

That could force landlords to shell out millions of dollars to pay the difference — cash they may not have.

Read the original article on Business Insider

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