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A Real-Estate Haven Turns Perilous With Roughly $1 Trillion Coming Due

Apartment buildings rose in value for years, but surging interest rates loom over sector’s property owners now. Apartments buildings, long considered a real-estate haven, are emerging as the next major trouble spot in the beleaguered commercial-property world. Investors bid up the prices of multifamily buildings for years, attracted by steadily rising rents and the prospect of outsize returns. Many took on too much debt, expecting they could raise rents fast enough to pay it down.

Unlike office buildings and malls, which have been hit hard by remote work and e-commerce, rental apartments have low vacancy rates. The apartment sector’s main problem isn’t a lack of demand – rents have soared since 2020 – it is interest rates.

The sudden surge in debt cost last year now threatens to wipe out many multifamily owners across the country. Apartment-building values fell 14% for the year ended in June after rising 25% the previous year, according to the data company Costar. That drop is roughly the same as the fall in office values.

Mortgage delinquencies in the multifamily category are low but increasing. Borrowing costs have doubled, rent growth is slowing and building expenses are rising. Data provider Trepp earlier this year identified one type of rental-apartment debt as accounting for a large share of the commercial mortgages at risk of default.

Apartment landlords face a “hydrogen-bomb scenario” said Peter Sotoloff, a veteran real estate finance executive and founding member of Blackstone’s property debt business. Outstanding multifamily mortgages more than doubled over the past decade to about $2 trillion, according to the Mortgage Bankers Association. That is nearly twice the amount of office debt, according to Trepp. The data provider adds the $980.7 billion in multifamily debt is set to come due between 2023 and 2027. Multifamily owners in Los Angeles, Houston, and San Francisco have defaulted on loans against thousands of apartments.

Apartment buildings have a reputation as a lower-risk commercial real estate investment. The have performed relatively well even at times of recession, including during the 2008-2009 financial crisis when the housing market crashed. People always need a place to live, and during times of crisis former homeowners would flood into the rental market.

Inflation also allowed landlords to raise rents higher than usual, which boosted the values of their buildings. Asking rents rose 25% over 18 months spanning 2021 to 2022, according to rentals website Apartment List. But few anticipated that interest rates could rise so quickly, pushing down building values and forcing landlords to refinance at much higher rates.

Houston-based Nitya Capital, owner of about $3 billion of multifamily buildings, notified investors in March that it was slashing profit expectations because of steeper interest rates. “We are essentially paying the higher mortgage costs instead of making cash distributions.”

Apartment landlords still have reason for optimism. Fannie Mae and Freddie Mac offer a reliable source of government-backed lending even as banks retreat. Most analysis expect housing shortages, and high rents, to persist. If interest rates come down, property prices could bounce back quickly. Multifamily owners with fixed-rate mortgages are better positioned to ride out any near-term turbulence.

Source: Wall Street Journal written by Konrad Putzier & Will Parker

Edited: Dan Campanella, CCIM

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