It might seem like a good time to buy an apartment complex.
For many landlords, that is true. Rents have risen dramatically in recent years due to housing shortages in much of the country and a period of severe inflation.
But a growing number of rental properties, particularly in the South and Southwest, are in financial distress. Only a few have stopped paying their mortgages, but analysts worry that as many as 20 percent of all loans on apartment complexes are at risk of default.
While rents soared during the pandemic, the increase has stalled in recent months. In many parts of the country, rents are beginning to fall. Interest rates, which the Federal Reserve has raised to combat inflation, have made mortgages much more expensive for homeowners. And while housing remains scarce in many places, developers may have built too many expensive apartments in cities that aren’t attracting as many renters as they did in 2021 and 2022, such as Houston and Tampa, Florida.
These problems have not yet developed into a crisis, because most owners of apartment buildings, also known in the real estate sector as multi-family properties, are not in arrears.
According to the Commercial Real Estate Finance Council, a trade association whose members include both lenders and investors, 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.
But many industry groups, ratings agencies and research firms worry that many more apartment loans could be in trouble. Multifamily loans make up a majority of the loans newly added to watch lists compiled by industry experts.
“Multifamily isn’t exactly a surprise right now, but it’s on everyone’s radar,” said Lisa Pendergast, director of the Realtors’ Council.
The apartment loan worries add to a long list of problems plaguing commercial real estate. Older office buildings are suffering from the shift to remote work. Hotels are suffering as people travel less for business. Shopping malls have been losing ground to online shopping for years.
The problems facing apartment buildings are varied. In some cases, owners struggle to fill units and generate enough income. In other cases, apartments are full of paying tenants, but owners can’t raise rents fast enough to find the money to cover rising loan payments.
As a result, nearly one in five multifamily loans is now at risk of default, according to a list maintained by data provider CRED iQ.
Analysts are most concerned about the roughly one-third of multifamily mortgages that were issued with variable rates. Unlike typical fixed-rate mortgages, these loans have required rising payments as interest rates have risen over the past two years.
ZMR Capital bought the Reserve, a 982-unit building in Brandon, Florida, near Tampa, in early 2022. The mortgage on the property was packaged into bonds that were sold to investors. The building is more than 80 percent occupied, but interest payments have risen by more than 50 percent, or more than $6 million. As a result, the building’s owner defaulted on the mortgage, which came due in April, according to CRED iQ analysis of loan service documents. ZMR Capital declined to comment.
OWC 182 Holdings, the owner of Oaks of Westchase in Houston, a 182-unit garden apartment complex consisting of 15 two-story buildings, has been unable to make mortgage payments since April, largely due to high interest charges, according to CRED iQ. Representatives for OWC 182 could not be reached for comment.
“The spike in interest rates is causing the cost of servicing these properties to skyrocket,” said Mike Haas, CEO of CRED iQ.
But even borrowers who have fixed-rate mortgages could find themselves in trouble if they have to refinance their mortgages with loans that carry much higher interest rates. About $250 billion in multifamily loans will come due this year, according to the Mortgage Bankers Association.
“Now that interest rates are much higher and rents are starting to come down nationally on average, you have to refinance a loan in a more expensive environment,” said Mark Silverman, partner and leader of the CMBS Special Servicer group at law firm Locke Lorde. “It’s harder to make these buildings profitable.”
While office debt and lending challenges are focused on buildings in large cities, particularly the Northeast and West Coast, concerns surrounding multifamily buildings are more concentrated in the Sun Belt.
As people moved to the South and Southwest during the pandemic, developers built apartment complexes to meet expected demand. But in recent months, the number of people moving to those regions has fallen sharply, real estate analysts said.
In 19 major Sun Belt cities — including Miami, Atlanta, Phoenix and Austin, Texas — 120,000 new apartments became available in 2019 and were taken 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.
What’s more, as construction and labor costs rose during the pandemic, developers built more luxury apartment buildings, hoping to attract renters who could afford more. Now, prices and rents for those buildings are falling, CoStar analysts say.
“Developers are so out of control,” said Jay Lybik, national director of multifamily analytics at CoStar Group. “Everyone thought the demand we saw in 2021 was going to be the way it was going to go.”
That 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 in apartment buildings. That amount quickly grew to $6.5 billion. As rents and prices for those apartments fall, the company 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 in a stronger financial position than, say, offices. That’s because multifamily units can be financed by loans from the government-backed mortgage giants Fannie Mae and Freddie Mac, which Congress created to make housing more affordable.
“If regional banks and large investment banks decide they’re not going to do multifamily lending anymore, Fannie and Freddie will just get more of the business,” said Lonnie Hendry, chief product officer for Trepp, a commercial real estate data firm. “It’s a failsafe that the other asset classes just don’t have.”
Furthermore, people still need places to live, while offices are facing a major shift in working patterns, Mr Hendry said, which should support the multifamily sector in the longer term.
Still, some industry experts expect a wave of defaults in the apartment sector, which will only exacerbate the problems in the commercial real estate sector.
“There are a lot of really strong multifamily assets,” said Locke Lorde’s Mr. Silverman, “but there will be collateral damage, and I don’t think it will be minor.”
