Across the United States, the multifamily real estate industry is facing a reckoning driven by its overreliance on floating-rate debt during a period of ultra-low interest rates. As the Federal Reserve has aggressively hiked its benchmark rate over the past year to combat inflation, that adjustable debt has become an albatross for apartment developers and investors.
"The U.S. multifamily sector gorged on floating-rate leverage and now they're paying the price," said Josh Lipstone, a managing director at Green Street Advisors. "We're seeing liquidity crises, forced property sales at discounts, and a spike in demand for asset managers and workout specialists."
During the pandemic era of easy money, floating-rate construction loans with teaser rates around 2-3% became the norm for funding new apartment projects. Investors also feasted on bridge acquisitions financed with floating debt, betting on rapidly rising rental rates.
However, as the Fed has raised its benchmark rate by nearly 5 percentage points over the past 15 months, that adjustable mortgage debt has ballooned to levels that are crushing pro forma underwriting. Many new developments no longer pencil out at double-digit permanent loan rates.
"Developers that started multifamily projects in 2021 underwrote to 4% construction loans and 5% permanent debt, tops," said Dori Blakeley, a partner at architecture firm KRSS. "Now they're staring down 8-10% permanent loan rates that demolish their projections and return expectations."
Acquisition bridgers are also stuck in a vise, with lower rent growth projections coupled with higher debt service costs upending their business plans. An influx of discounted property sales and recapitalizations by distressed owners is anticipated, creating opportunities for cash buyers.
"We're being inundated with listings from floating-rate bridge borrowers that can't refi out of their loans at the rates they underwrote," said Dan Woodward, a senior vice president at mortgage bank Berkadia. "There will be a lot of forced equity recycling before this blows over."
Perhaps even more perilously, many floating-rate multifamily loans originated just a few years ago are now facing prohibitive new terms upon their resets or maturities. Thousands of properties across the country could be facing delinquencies, foreclosures or onerous loan extensions if borrowers can't refinance.
"Special servicers are going to have their hands full with multifamily maturities hitting a debt service wall," said CJ Reed, executive managing director at Hospitality Investors Trust. "The volume of workouts and restructurings in the space will be staggering."
This tsunami of distress has caused a spike in demand for experienced multifamily asset managers who can navigate these challenging situations. Trimont Real Estate Advisors, one of the nation's largest asset management firms, has seen its inbound inquiries double over the past year.
"We've hired dozens of new asset managers and workout specialists," said Desiree Douglas, Trimont's director of business development. "Property owners devastated by rising floating rates badly need our capabilities to restructure their debt and maximize asset values."
The options range from full-scale property renovations aimed at pushing rental rates, to expense management squeezes and negotiated loan modifications to ease debt service burdens. For properties too far underwater, opportunistic asset managers are being brought in to manage a controlled sales or recapitalization process.
"Asset management execution is make-or-break when you're staring down a looming mortgage default," said Mike Heisterkamp, chief investment officer at Lantian Development. "Through smart asset management, there's still a pathway to minimize losses and bring these properties back to stabilization in most cases."
For many in the multifamily industry, the current conditions mark a harsh wake-up call about the risks of excessive floating-rate leverage. While interest rates may eventually pivot back down, the impact on valuations, developments and investor returns is likely to linger for years to come.
"This was a necessary reset to curb the frothiness across multifamily," said Green Street's Lipstone. "But you have to feel for owners and developers that were simply practicing the widely accepted lending approach and now find themselves underwater. Skilled asset managers will be their lifeline."