After the first wave of COVID receded, buying a multifamily rental seemed like one of the best bets a person could make. Prices were high, sure, but interest rates were low, and it seemed that with a little savvy you could raise rents forever. (Not to mention that those high real-estate prices pretty much guaranteed steady demand that would keep rents up — all those would-be buyers priced out of the sales market.) But depending on when and what you bought and the debt you used to finance it, the tides have turned.
Next month, $4.5 billion in loans will mature, which means that many property owners will have to refinance their existing loans when interest rates are high and lenders are skittish about making new loans. But this is just a sliver of what’s coming due in the next four years: Between 2023 and 2027, $980.7 billion in multifamily debt will come due, an amount that dwarfs commercial-office debt. Of course, unlike offices, there’s no lack of demand for apartments. But what does that huge wall of debt actually mean for these building owners and their renters? Is it a looming crisis? And if so, for whom?
To make sense of how landlords got here and what might happen next, we talked to Manus Clancy, a senior managing director at Trepp, a commercial real estate data firm, to find out what’s going on.
Okay, so what’s happening?
There are three things happening all at once. Interest rates are considerably higher now than in early 2022. That means property values have fallen and borrowers/landlords are learning that their property is not generating enough cash to qualify for a loan that will retire the existing debt. Certain property types have become toxic, particularly offices. It is hard to predict what demand for office space will be in the future so lenders are very hesitant to make office loans, making the repayment of existing debt impossible. And because of the bank runs that took out SVB, Signature Bank, and First Republic, banks are much more cautious about making loans than pre-March 2023. All of this is constraining landlords’ ability to refinance.
And why is it all coming to a head for multifamily building owners?
Prices for multifamily really shot up in 2021, early 2022. A lot of buyers came in and paid really high prices for these assets. They were expecting rent growth to continue for eight to ten years for as far as the eye could see. They used floating-rate debt to finance this. They’re now faced with serious headwinds. There’s not a lot of default happening right now but the concern is that there will be.
Can you talk us through what floating-rate debt is?
When borrowers take out a new loan, they can lock in a fixed rate — in 2021, that often meant rates in the 3 to 4 percent range for apartment loans [which was low]. Or they can take out a floating-rate loan. Floating-rate loans have an interest rate that is based upon an index plus a margin and the loans reset every month. In 2021 and early 2022, the rates on these loans were very low and so borrowers flocked to them. When rates started to go up in 2022, borrowing costs shot up, erasing all or much of the free cash flow on these newly purchased properties.
And now back to those headwinds.
If you took out floating-rate debt, your cost of debt has probably doubled from 4 to 8 percent, and that’s eating away at your profits. And the level of rent growth is not what they were expecting now that the COVID rent boom is over. We’re seeing much higher costs: insurance, utility, and labor. And if their strategy was that they’d come in, slap a couple of cans of paint on the place, sell it for 15 percent more, the market isn’t there anymore. For a lot of buyers, they’ll have buyer’s remorse. Why did I buy during the peak of the market? The other buyers, the costs will eat up their profits, and they’ll end up defaulting on their loans.
When you say the COVID rent boom is over, it might not feel over for tenants who are still paying rents that are 25 percent higher than they were in 2019. Rents have stopped rising, but they’re not dropping either. But that’s not enough to offset these interest-rate hikes?
Sometimes people think that when inflation levels off, it means a return to previous levels. That is not the case. If rent on an apartment increased from $2,000 per month to $2,500 per month, rarely will that rent go back down to $2,000. But for landlords, the interest-rate hikes and the cost of operation increases have more than offset those rent increases.
So were these bad bets?
It was this narrative that a lot of people believed in — that rates were never going to go up, that the Fed would never do what it did. You could look back and say they were pennywise and pound foolish and they should have known, but plenty of people were doing it.
So what’s going on in New York, specifically?
In New York you’re talking about three separate markets, two of which are problematic and one of which is great.
Let’s start with the problems.
The first is the rent-stabilized and rent-controlled market. Those properties are selling at enormous discounts compared to what they were a few years ago. Rent growth is capped and costs are increasing. The permissible rent hikes have been so low and for a while, that didn’t matter as much, but now with inflation so high, expenses are exploding. Owners are losing ground.
Local Law 97 is also introducing new costs.
Local Law 97 is really going to hammer property owners, if you’re a property owner where you’re going to be capped with 30 percent rent hikes and facing enormous fines for not replacing your HVAC.
What’s the second market?
This one is very opaque, the $10 million and up market, where you’re selling stuff on billionaire’s row. This isn’t rental, but you’re seeing developers saying stuff like there just aren’t as many billionaires as we thought there were. There are a lot of developers sitting on properties that are only 30 percent occupied. It’ll work out fine, but it’s challenged.
And the third —
The non-stabilized market is where things are going gangbusters. Rents are at an all-time high, renters’ costs have kept pace with inflation. Demand is terrific. By and large, New York City market-rate properties have done great. It’s a great place to be. Values have gone up. In some ways it defies logic: Why do people want to be here if they’re only in the office Tuesday, Wednesday, Thursday? But they do.
So landlords are actually doing alright here, it seems.
In the city, landlords of market-rate apartments are probably feeling very good.
What happened to Blackstone, then? Before they sold this summer, they were in danger of defaulting on a $270 million loan backed by 11 New York apartment buildings where apartments rented for an average of $3,700 a month.
I think that Blackstone made the mistake where they bought into the floating-rate debt issue, and their debt went up and up and up, and it’s eating away at their profits. Had they locked it in at 3.5 percent, I don’t think they’d be having those issues.
Rents have started to plateau now. Will that cause problems for the owners of market-rate buildings in New York?
It depends on the loan. The cost of living in New York has gone up sharply, food, student loans are kicking back in, everything is up. There is a level at which people can’t surpass in terms of percentage of their income.
So in terms of impacts at the ground level — how will the average tenant feel this?
Nationally, I think rent hikes in excess of 10 percent are a thing of the past. Rents have leveled off and in some markets have decreased modestly. Over the last year, tech firms and banks have slowed their hiring. There have been layoffs. But because the apartment market in New York City is so constrained, it is very unlikely we’ll see rents coming down in any meaningful way.