- A virtual wall of maturities in which loans securing multifamily properties come due begins later in 2023 and will continue through 2025. Many of these loans were made at LTV’s (loan to value) as high as 80%, using floating rate loans, when cap rates were at their lowest (2021-2022). Rate caps have expired or are expiring imminently and the net operating income from the property is insufficient to support the debt service (i.e., the Debt Service Coverage Ratio, or DSCR, is below 1).
- As valuations have dropped, these loans cannot be refinanced. In some cases, sponsors will hand the keys to the bank.
- According to Trepp, $249 billion in multifamily loans will come due 2024 and 2025.
Figure 2: Multifamily Loan Maturities
Needless to say, the coming wave of maturities will create opportunities for astute investors. And, as we saw in Part I, timing will be key. Savvy investors will not wait until the absolute “bottom” of the market, for one simple reason: we have no way of knowing in real time when the bottom is occurring.
If we can’t know what the low point of market valuations is, how can we know when the water is right to dive in? Again, the key is to focus on fundamentals. It’s not a college test where the goal is to outscore your classmates by judging the bottom right to the day. Rather, the focus should be on whether buying a given asset at a particular price in this market will generate reasonable current income and long term appreciation. While fewer assets pass this test right now due to cost of debt capital, the sheer number of deals that will not be able to service their debt should bring more properties to market at lower prices such that even at today’s higher interest rates, investors will have the opportunity to buy excellent assets at favorable prices for the long term.
We have come close on several troubled deals of late, deals in which the property was selling for the amount of the loan or less. We would have been happy to acquire the assets at the price we were willing to pay but we were competing against exchange buyers or others with idiosyncratic reasons to pay more than we were. But the point is that we are seeing these troubled deals today
A point on the so-called “basis play”. Cap rates have come up significantly as one would expect given higher interest rates. Often a broker or other buyer will suggest a price is a good one for a building because it’s a “basis play”, meaning even though the projected cash flow and IRR aren’t incredible (on paper) due to high interest rates, the going in purchase price represents good value. We are circumspect in evaluating whether a particular price is a good basis play. Often, what is meant is that the price is simply higher than it was a year ago. While not irrelevant, that is highly relative, namely to a time when interest rates were lower and investors were chasing yield, and thus not dispositive to us. We prefer comparing price to replacement cost (the cost per unit to rebuild at today’s construction prices), as buying below the cost to rebuild is an objective measure of value. We are certainly starting to see deals that meet this more concrete test of current value.
Lastly, multifamily fundamentals are strong and should get much stronger. While there is a substantial amount of new construction hitting the market this year and next, due to higher interest rates and inflated construction costs, new starts are slowing dramatically which means that starting in 2025 and running through perhaps 2029 or 2030, multifamily demand should well outpace supply once again, with rental rates likely to rise as a result. With all of the question marks around office (namely persistent return to work rates hovering around 50%), investor capital is not likely to be deployed to that asset class as it has in the past. The shortage of rental housing nationally suggests multifamily will be the beneficiary of much of this equity capital
Bottom line, we are approaching a time of great opportunity for multifamily buyers. Whether it will be akin to that following the GFC, or the RTC during the early 1990’s remains to be seen, but our healthy balance sheets have positioned us, and our investors, to take advantage of what we believe will be a unique time to buy quality assets at excellent prices.