by William "Brad" Blash, Managing Partner at Crossbeam Capital
The real estate market’s distress has been amplified post-WeWork bankruptcy. However, as a student of the market for 30 years and having experienced multiple recessions, I have a unique perspective on the current circumstances in the multifamily (apartment) market.
This perspective is borne of the repetitive experience of over 250 individual transactions, each with its unique strategy and business plan, market, and time in the cycle, which all played themselves out over the investment period. This perspective has me thinking that while the storm is approaching, there are patches of blue sky ahead for the prudent investor.
The Fallout of High Valuations and Low Rates
To quote one of my favorite market sages at Newmark from their 11/20/2023 market letter:
"As we have discussed in the past and will discuss further below, Newmark Research estimates that $682 billion of apartment loans mature over the next 2+ years, and we believe a significant portion of them are troubled, which will put pressure on valuations as over-leveraged situations are resolved."
Let's unpack this.
Several deals were acquired at high valuations when interest rates were the lowest in 50 years. These deals qualified for more debt at record-low rates and pushed the ability to finance more of a purchase, which led to increasing valuations. The acquisitions made between 2019 and 2022 will suffer if they need to refinance or sell to a buyer using today's market rates. Owners of these assets have two choices: sell the deal and recoup what they can of your equity if your valuation is above the debt, or give the deal back to the bank if there is no equity remaining in the valuation.
How many of the $682 Billion assets are in trouble now?
According to CoStar, 294 apartment buildings are either 90 days late, have a maturity default (the loan matured, and they have not refinanced), are in foreclosure, or have been foreclosed on and are now owned by the bank, also known as Real Estate Owned (REO). This is a tiny fraction of the 345,000 apartment complexes tracked by CoStar, but it's the start of a trend.
We are seeing loan maturities will call the question more forcefully over the near term. CoStar added that 947 multifamily loans will mature in the next three months, 1,974 will mature in the next six months, and wait for it… 4,340 loans will mature within 12 months.
Experience tells us from previous market downturns that the gestation period of these deals as they make it through the foreclosure or deed in lieu process at a bank is 9-12 months from peak distress. This lines up nicely with our latest fund vehicle and its deployment period. Once the assets are REO, the banks are often anxious to move them off the books, so they run an efficient process to liquidate the assets as soon as possible. This means valuations will likely be lowered to move the assets quickly-- a time when a prudent investor can find value.
Tipping Point Turmoil
The multifamily wave of distress will be amplified by the immense distress coming to the office market driven by the recent $18 billion WeWork bankruptcy. In a recent conversation with a large firm specializing in the disposition of distressed and bank-owned properties, the word was out:
"WeWork is the tipping point that will drive faster resolutions in office, which will speed up the resolution of the remaining commercial asset classes."
We will see distress in various forms from overleveraged deals acquired at the market's peak. Then, what gives me any confidence in Multifamily Home’s future performance?
The Silver Lining
In the multifamily sector, optimism prevails against the uncertainty in the real estate market.
Where are the patches of blue sky in this sector?
Supply has been muted for years, and recent estimates show that the nation needs to build close to 4 million housing units to "catch up" to household formations since the GFC. In addition, the nation needs to build over 1 million units a year to "keep up" with new household formation. We are way behind these targets, and the tightening of credit will only exacerbate the problem from 2024 to 2025 when many new units will unlikely be built.
Demand is strong. Multifamily demand is a function of household formation and job creation. Unlike during the GFC, we are now close to full employment, with very low unemployment and significant labor participation gains over COVID-19. We are starting from a position of strength this time, and even if we see some deterioration, demand will remain strong.
Steep gains in single-family home pricing are pricing more Americans out of homeownership. According to Harvard's Joint Center for Housing, over 2.4 million households have been priced out due to price spikes over COVID-19. These folks will be long-term renters, which only bolsters demand.
The opportunity cycle to acquire overleveraged assets and not survive the current interest rate environment is upon us. It is early, but as the assets start to clear the market, there will be value opportunities for the prudent risk taker to lock in a low basis and drive asset performance over the hold period supported by solid fundamentals.
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About the Author
William “Brad” Blash is a Managing Partner at Crossbeam Capital. He is a national leader in transformative housing investments. He has experience across multiple real estate cycles, over $5 billion in invested capital, and 26 investment markets across the US.
About Crossbeam Capital
Crossbeam Capital is a private real estate firm focused on multifamily developments and strategic acquisitions. The firm comprises leaders with over 100 years of combined real estate experience and a promising record since 2010.