Archives for 2023

The pattern of analyzing CRE loans of late has been shaking heads at the progress of maturing office properties and taking some solace in some other property types like office. But in what Moody’s Analytics CRE called an October surprise that had nothing to do with a political election, the tables turned. Office improved while multifamily weakened.

“In October, only $366 million of CMBS office debt reached its fully extended maturity date,” said the Moody’s report. “The payoff rate for October came in at 38.8%, the highest monthly rate since June. As a result, the year-to-date (YTD) payoff rate climbed slightly to 31.6%. Of the loans that have failed to pay off at maturity in 2023, just less than half have managed to secure formal extensions from special servicers.” There was also a maturing loan that was liquidated at a 55% loss.

On the other hand, for the second month running, multifamily saw a falling payoff rate to a much higher degree than the improvement in office. Although for most of the year the rate had easily topped 90%, in September it fell to 71.7%. October brought it further down to 48.8%. “Not only did more than half of the loans in October fail to payoff, the October maturity defaults of $303 million make up over half of the $600.3 million of loans that have failed to payoff all year,” they wrote.

In September, a portfolio of senior housing loans and two student housing loans were responsible for most of the maturity defaults. There was a similar pattern in October, with 94% of the maturity defaults coming from three groups. One of them was responsible for 55% of the defaults.

In looking at payoffs by debt yield and lease rollover, “The YTD payoff rate for loans with debt yield below 8% with limited lease roll was unchanged at 40.9%. No October loans met this criteria and no loans from prior months in this category paid off.” For loans with above 8% debt yield and significant leave rollover were up from 48.5% to 49.2%.

Ability to pay off mature loans followed a pattern Moody’s has seen during the entire year: the greater the loan, the lower a chance of a payoff. Although the year-to-date rate for loans under $10 million dropped a bit in October, the behavior left Moody’s reasonably assuming that financing a smaller property is easier than a large one, so dealing with maturity is easier with smaller loans.

Source: “Multifamily Maturities Weaken, While Office Improves“

To summarize Colliers’ Q3 capital markets snapshot is done by looking at one graphic. Their quarterly pricing forecast for office, industrial, multifamily, retail, and hospital is down, down, down, down, and down.

The company explained the overall results through a number of factors:

Although GDP growth in Q3 was an annualized 5.2% on revision, which should have sparked sales activity, transactions were down 50% year over year. Blame that on higher financing expenses and rising cap rates.

For the first time in years, CRE has competition for investment dollars. Risk-free rates like yields on Treasurys had been up significantly (though have been falling as of late, talking about uncertainty). Putting cash into a certificate of deposit for 5% is appealing. If you have capital, sit on the sidelines, collect your interest, and wait until markets have settled some. While watching cap rates rise as a result.

“This money’s geared toward the part of the market that needs it: value-add, opportunistic, and debt strategies,” they wrote. “Investors with the flexibility to play throughout the capital stack stand to benefit from the current market environment. Generational investment opportunities are expected to present themselves to those willing to make the bet.”

Here are some of the highlights by property type:

Multifamily — Volume in Q3 was down $30.1 billion with a -12.8% price change. Pre-pandemic, the category represented about 32% of volume. It’s unlikely to return to that level. Deals in the market are seeing cap rates nearing 6%. But home prices are still high, 30-year mortgage rates are in the 7s. It’s the least affordably time to own, so rentals have strength. Watch 30-year mortgage rates, development concentration, and assumable debt.

Office — Office-using employment is at all-time highs, but “debt maturities, slumping occupancies, and continued ambiguity with future office needs have most investors on the sidelines.” Falling occupancies reduce cash flow, pressuring values. Watch for loan sales, short sales, foreclosures, portfolio rebalancing, and continued interest in life sciences.

Industrial — What had been a market mainstay still has strength, just not turbocharging. Vacancies are rising as supply chains heal. Rent growth is slowing but still strong nationally, giving a potential option of buying a property, offering under-market rents in the short term, and raising them over time. Watch manufacturing rebound, port volume, and supply-side pressure.

Retail — Although out of favor compared to multifamily and industrial, it’s picking up attention from higher going-in cap rates and strong fundamentals. Retailers who survived the last 15 years have become stronger candidates. Watch job growth, union strikes, and the holiday sales season.

Hospitality — With higher travel, consumer spending, and job growth, hospitality should be faring better than it is. A high portion of loan maturities, capital needs for refreshing, tight labor market, and growing insurance expenses are headwinds. Watch new major hotel brands, mergers and acquisitions, and consumer spending.

Source: “CRE Pricing Forecast Is Down, Down, Down“

Long a darling of the commercial real estate industry, the rental housing market is showing warning signs, as slowing rent growth and demand, higher interest rates, and greater operational expenses test multifamily owners and developers.

The U.S. apartment market absorbed 90,827 units in the third quarter, according to RealPage Inc. While that’s an improvement from the negative absorption seen throughout 2022, the approximately 1 million apartments under construction nationally as of the third quarter is still outpacing demand and tempering rent growth in many markets.

As of the third quarter, rents nationally were up about 2% year-to-date, RealPage found, though the data-analytics firm predicts the year-end 2023 figure could come in below that amount.

That, on top of underwriting loan standards written during a different economy and multifamily market, will create financial headwinds for some owners in the coming quarters and years, especially for deals financed in the past two years with floating-rate debt. It’s likely to cause more lenders to pull back from the multifamily sector.

Stephen Buschbom, research director at Trepp Inc., during a webinar this week said the story around multifamily isn’t necessarily a straightforward one, but there’s increasing evidence of a disconnect between a property’s stabilization expectations at underwriting versus the reality now. That’s especially true of loans that originated after October 2021.

“If you entered the game later and you [had] a bias toward what rent growth will be [from] the past year or so, and that ends up in underwriting, you’re likely to underperform relative to what you thought you would get,” he said.

After the initial shutdowns and slowdown from the Covid-19 pandemic in early 2020, the multifamily market had a strong rebound in 2021 and into 2022. Low interest rates and high demand for apartments, not to mention what was frequently record rent growth, created a flurry of sales activity, with $335.3 billion in multifamily transactions completed nationally in 2021, according to CBRE Group Inc. By comparison, only about $29 billion in multifamily deals were completed in the third quarter of this year, CBRE found.

There is no evidence of widespread distress in multifamily yet, but the number of loans facing potential issues is rising. In October, the multifamily delinquency rate rose to 2.64%, up from 1.85% the month prior, according to Trepp.

Among the multifamily loans that have faced default recently, most are modifying terms, Buschbom said, a tactic he thinks more lenders will take as more multifamily loans face issues in the coming quarters and years.

“In many cases, they’re waiving or pretty dramatically altering the debt yield requirement,” he said.

By Trepp’s estimates, there’s been some $150 billion in commercial real estate collateralized loan obligation issuance, some 70% to 80% of which has gone to multifamily property types. While a short-term, floating-rate loan product, Buschbom said CLOs provide the ability to modify loans in ways that aren’t possible in, for example, commercial mortgage-backed securities pools, he said.

“There’s much more leeway to work with cash-strapped borrowers,” he said. “I’m hopeful we’ll see the modifications and flexibility ultimately pay off, and defaults and losses come in lower than what we would have thought … [but] it’s too early to tell.”

All eyes are on what the Federal Reserve will do with interest rates in 2024. It’s predicted by some economists and market watchers the Fed will move to lower interest rates next year, potentially at its May meeting. A recent Bankrate survey found 94% of economists believe the Fed could begin cutting interest rates next year.

One ripple effect if a rate cut were to happen could be that more households get off the sidelines — into owner-occupied housing and out of the rental market, Buschbom said.

“[That] could be detrimental to many of the assumptions of these [multifamily] loans,” he said, adding the nation’s housing-affordability issues have led many to believe rental demand will remain sticky in the short to medium term, therefore warranting higher rent increases baked into loan underwriting. “If that breaks because we have pent-up owner-occupied demand … that could really turn the business plan or underwriting assumptions on their head and prove very painful.”

Source: “Multifamily loans will face a critical test in 2024 and beyond“

After steady increases, demand for industrial and multifamily space appears to be slowing significantly. Lee & Associates’ 2023 Q3 North America Market Report shows US industrial net growth down 68% in comparative third quarters. The multifamily sector also felt a sharp increase in vacancies and the lowest rent growth on record.

Jeff Rinkov, CEO of the broker-owned real estate services firm, points to challenging economic times, supply chain recovery and cautious corporate behavior as key factors.

Industrial Space Remains Positive, Net Growth Down

“The economic environment, including interest rate increases, fluctuations in federal policy, and some credit tightening, is causing corporate America to respond slower and more measured in capital expenditures and their commitments to new and expanded space,” Rinkov said.

In addition to US net growth in industrial space decreasing from 94 million square feet to 29.9 million, year-to-date net absorption is 110.2 million square feet, down 62% from the same period, according to the report. Tenant expansion is at the slowest pace since 2012 and comes as a quarterly record of new inventory is set for delivery.

The report also found that construction starts have been dropping since last fall, with anxious developers concerned that higher interest rates may cause values of newly delivered projects to fall below replacement costs.

“I still think we will see continued growth within the industrial sector,” said Rinkov, and notes that the development pattern is in response to consumers pivoting more towards online shopping during and after the COVID pandemic. The pandemic also created significant supply chain issues that elongated the development cycle, he added.

Rinkov noted that port-centric markets continue to thrive with higher rental rates and outsized demand and won’t be as affected by development. The report found that Tampa, Jacksonville, Milwaukee and Detroit “bucked the national trend” with tightening availability rates year-to-date in 2023.

Multifamily Development Outpaces Demand

According to Lee & Associates, the surge of new apartments in the development pipeline continues to outpace demand, resulting in a sharp increase in vacancies (from 4.6% to 7% since mid-2021), and the lowest rent growth on record (10.9% to 0.9% over the last six quarters).

“Many cities experienced very high growth rates due to large migrations of people for jobs or COVID policies,” said Rinkov. He noted that while developers reacted quickly, absorption will still take more time.

Lee & Associates reported that more than one million multifamily units are under construction in the US, the most since the early 1970s. However, construction starts have fallen dramatically this year, a result of “higher interest rates, lower rents and overbuilding in several markets” it notes. Fewer than 160,000 units are forecast for completion in 2026 and an estimated 194,000 in 2027, compared to 440,000 and nearly 335,000 units projected in 2024 and 2025, respectively.

Uncertain Times, Optimism for the Future

Rinkov remains optimistic about the strength and resiliency of both sectors and expects them to settle and normalize.

“While we are seeing quite a bit of industrial product coming online right now, we will eventually absorb all of the space,” Rinkov said. “And multifamily markets, with higher vacancies because of construction deliveries, should resolve the issue in 12 to 18 months.”

Source: “Industrial and Multifamily Sectors Face Challenges, Slowdown“