Prior to 2022, multifamily operators acquired properties throughout the United States at record low interest rates, creating a unique buying opportunity for owners and investors.
The formula was not limited to one geographic region; owners across the United States took advantage of low-interest floating-rate loans to acquire multifamily properties, added value through renovations and capital improvements, and raised rents. With interest rates at record lows, and even moderate levels, this formula worked. The revenue generated by the properties was more than sufficient to allow investors to cover their debt service obligations. However, over the past 18 months, rising interest rates have led to falling debt service coverage ratios, and the same investors who benefited from low-interest floating-rate loans now find themselves having to deal with substantially increased rates, increased supply, decreased valuations, and looming maturities.
Yet, when compared to the office market, both operators and lenders in multifamily are far less fearful. But why?
This is Not Office
First and foremost, commercial office owners are now being forced to confront the monumental question of what role physical office space will play going forward, especially in light of hybrid and remote work models. Both commercial office owners and lenders are less confident that in four to five years’ time, the underlying asset (e.g., an office building) will increase in value. Given this uncertainty, owners of office assets are significantly less inclined to add additional equity into the asset, which is needed in most circumstances to consummate a loan extension or similar workout. Owners of multifamily assets, on the other hand, do not face this issue.
Second, many consider multifamily assets to be far more “recession-proof” — people will always need somewhere to live. Indeed, even lenders facing potential defaults are choosing to see the problem as an owner/operator problem, not an underlying asset problem. Arbor Realty Trust’s Ivan Kaufman recently said, “when you see stress in the [multifamily] portfolio like we’re seeing, it’s a fact that the sponsors are not executing along their plan.” Kaufman made good on that statement when Arbor Realty Trust recently foreclosed on 3,200 Houston apartments and then made a loan to the new owner of the same portfolio.
That bullish attitude is not unfounded. Yes, defaults by some multifamily owners who thought they would get by on low rates alone are inevitable (debt service coverage ratios under 1.0 may simply be too difficult for most potential refinance-lenders to work with), but data and industry sentiment hint at a strong multifamily market, not one completely torpedoed by rising rates. The Mortgage Bankers Association forecasts that multifamily mortgage originations in 2024 will total $452 billion, up significantly from the estimated figure of $299 billion for 2023 and close to the $480 billion originated in 2022. The dip in 2023 originations can likely be attributed to a few different factors: high interest rates; the increased cost of obtaining an interest rate cap, which is usually a lender requirement for floating rate loans; and the overall slowdown in the housing market, which itself can be contributed to rising interest rates and the resultant difficulty in accurately determining property values.
S&P Global Ratings expects high interest rates and inflated housing prices to lead some would-be home buyers to rent instead, thus bolstering a rental market they believe will remain strong. This, in turn will lead to multifamily loan performance remaining strong and reliable. Some industry executives see these factors contributing to growth, especially in gateway markets like New York, where BHI recently provided a $92 million construction loan for a multifamily development in Inwood and MF1 Capital recently refinanced a multifamily project in Harlem for $68.5 million.
The one variable which could undoubtedly upend the positive outlook for 2024 is a decision by the Federal Reserve to maintain elevated interest rates to combat inflation. Many of the 2024 figures optimistically assume a stabilization and lowering of rates in 2024 as inflation is tamed and the fears of a recession fade.
Oversupply and Under Demand?
Some argue that there is an oversupply and under-demand of multifamily in the United States. CBRE Group, Inc. has predicted that the completion of more than 716,000 new multifamily housing units over the next two years “will push the sector’s overall vacancy rate above equilibrium from 4.6% to a peak of 5.2% by year-end.” Some are worried that the confluence of record-high supply, coupled with declining demand, will cause vacancy rate issues for the multifamily sector. Conversely, CBRE and others contend that an additional 2.3 million new units will be needed throughout the United States over the next decade, and that the supply/demand imbalance will correct itself in the near term.
Unlike the office market, multifamily appears to be an asset class ripe with opportunity for lenders over the upcoming year. We will continue to monitor the multifamily market (particularly the vacancy rate concern) and provide an additional update in the coming months.
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