Now may seem like the perfect time to own an apartment.
For many landlords, that's true: A housing shortage in many parts of the country and severe inflation have caused rents to skyrocket in recent years.
But a growing number of rental property owners, particularly in the South and Southwest, are finding themselves in financial difficulty. While some have stopped making mortgage payments, analysts fear that up to 20% of all apartment loans are at risk of defaulting.
Rents soared during the pandemic but have stalled in recent months. Rents are starting to fall in many parts of the country. Interest rates raised by the Federal Reserve to fight inflation have made mortgages much more expensive for building owners. While housing is in short supply in many places, in cities like Houston and Tampa, Fla., that are no longer attracting as many renters as they will in 2021 and 2022, developers may have built too many luxury apartments.
These problems have not yet reached a crisis because most owners of the apartment buildings, known in the real estate industry as apartment complexes, have not missed their mortgage payments.
Just 1.7% of multifamily loans are 30 or more days past due, compared with about 7% of office loans and about 6% of hotel and retail loans, according to the Commercial Real Estate Finance Council, an industry group that represents lenders, investors and others.
But many industry groups, rating agencies and research firms are concerned that many more apartment loans could go bad. Most of the new loans added to a watch list compiled by industry experts are for multifamily housing.
“Multifamily housing hasn't come out of nowhere and hit you in the nose right now, but everyone is paying attention,” said Lisa Pendergast, executive director of the Real Estate Council.
The concerns about apartment loans add to a long list of problems facing commercial real estate: Older office buildings have been hurt by the shift to working from home, hotels have been hurt by reduced business travel and shopping malls have been struggling for years with online shopping.
The problems apartment complexes face are many: in some cases, owners are struggling to fill units and make enough money, while in other cases, apartments are full of paying tenants but owners can't raise rents fast enough to free up cash to cover mortgage payments.
As a result, nearly one in five multifamily loans are now at risk of defaulting, according to a list maintained by data provider CRED iQ.
What has analysts most worried are the roughly one-third of multifamily mortgages issued at adjustable rates. Unlike typical fixed-rate mortgages, these loans require higher payments as interest rates have risen over the past two years.
ZMR Capital bought The Reserve, a 982-unit complex in Brandon, Florida, near Tampa, in early 2022. The property's mortgage was packaged into a bond sold to investors. The property is more than 80% occupancy-free, but interest payments have increased by more than 50%, or $6 million. As a result, the building's owner was unable to pay a mortgage that came due in April, according to a CRED iQ analysis of loan servicing documents. ZMR Capital declined to comment.
OWC 182 Holdings, owner of Houston's Oaks of Westchase (182 garden-style apartments across 15 two-story buildings), has not been able to make mortgage payments since April, primarily due to rising interest rates, according to CRED iQ. Representatives for OWC 182 could not be reached for comment.
“Sudden increases in interest rates are causing debt servicing costs for these properties to skyrocket,” said Mike Haas, CEO of CRED iQ.
But even borrowers with fixed-rate mortgages could struggle if they have to refinance to loans with much higher rates. About $250 billion in multifamily loans are coming due this year, according to the Mortgage Bankers Association.
“Interest rates have gone up quite a bit across the country, and rents are starting to come down on average, so when they do have to refinance their loans, they're refinancing into a more costly environment,” said Mark Silverman, partner and leader of the CMBS special servicer group at law firm Locke Lord. “It's becoming more difficult to make these buildings profitable.”
Office debt and financing issues are concentrated in buildings in major cities, particularly in the Northeast and on the West Coast, while multifamily concerns are concentrated in the Sunbelt.
As more people moved to the South and Southwest during the pandemic, developers built apartment complexes to meet expected demand, but real estate analysts say the number of people moving to those areas has fallen sharply in recent months.
Nineteen major Sun Belt cities, including Miami, Atlanta, Phoenix and Austin, Texas, had 120,000 new apartments available in 2019 and absorbed 110,000 tenants, according to CoStar Group. Last year, those markets had 216,000 new apartments, but demand slowed to 95,000.
Additionally, as construction and labor costs rose during the pandemic, developers built more luxury apartments to attract tenants who could afford higher rents. Now, prices and rents for those apartments are falling, CoStar analysts said.
“Developers are overwhelmed,” said Jay Leibich, national director of multifamily analytics at CoStar Group. “Everybody assumed the demand we saw in 2021 was going to continue.”
That could spell trouble for investors like Tides Equities, a Los Angeles-based real estate investment firm with a large stake in Sunbelt apartment buildings. Just a few years ago, the apartment buildings Tides Equities owned were worth about $2 billion. That figure has quickly ballooned to $6.5 billion. Now, the company is struggling to make mortgage payments and cover operating costs as apartment rents and prices fall, according to CRED iQ.
Tides Equities executives did not respond to requests for comment.
That said, apartment buildings are likely to be on stronger financial footing than office buildings, for example, because they can be financed with loans from Fannie Mae and Freddie Mac, the government-backed mortgage giants created by Congress to make housing more affordable.
“If regional banks and big investment banks decide not to write multifamily loans, it just means Fannie Mae and Freddie Mac get more business,” said Ronnie Hendry, chief product officer at commercial real estate data firm Trepp Inc. “It's a safety net that other asset classes don't have.”
Moreover, while offices are experiencing major changes 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 expect a wave of defaults in the apartment business and deepen problems for the commercial real estate sector overall.
“There's a lot of very strong multifamily assets out there,” Locke Lord's Silverman said, “but there's going to be some collateral damage, and I think it's not going to be small.”
