…Out like a Lion?
Some multifamily owners and investors in DFW face a significant challenge in the multifamily real estate market. With $1.9 billion of multifamily mortgage debt to mature in 2023, DFW is second only to New York City at $2.3 billion. The number of commercial properties in DFW on the CMBS watch list for financial distress has grown by more than 30% since the start of the year, with multifamily projects driving the increase, accounting for 113 of the 450 commercial properties on the watch list.
The main issue is the unprecedented rise in interest rates, especially for investors with floating-rate debt. Owners with rate caps may be forced to sell their properties when loans mature due to ballooning expenses. Many of those properties may need more equity than the loan proceeds required to refinance—the rising costs of insurance, taxes, utilities, material, and labor compound the issue.
Over the last decade, lenders continuously increased the amounts they were willing to refinance, resulting in higher capital returns for investors. As real estate values decline, lenders become more conservative, and loan-to-value ratios on new loans are likely lower than the current loan, compounding the issue. Although the lender may agree to an extension, the borrower will likely need to pay down a portion of the loan to win their approval.
Owners and investors may need to write checks to refinance – turning capital returns into capital calls. This path will require significant equity capital if refinancing must be topped off to lower the loan-to-value ratio or cover higher DSCRs. With uncertainty in banks, refinancing debt is becoming more problematic, and owners may have to inject more cash, sell, or let it default.
While a few trades are still happening, buyers are surprised that many sellers are stubbornly holding on to unrealistic prices (even at the risk of default) or, worse yet, are already upside down and can’t afford to sell. Owners unwilling to accept today’s lower prices and new debt costs have led to a considerable spread, resulting in a 74% sales decline so far in 2023. However, we may see more inventory coming to market in the 3rd and 4th quarters in the form of distressed sales.
Despite these challenges, it’s not all bad news: Longer-term prospects are still very strong. Multifamily in DFW is still a vital asset class in one of the most investor-friendly regions of the country. Population growth, high residential mortgage rates, low cost of living, high quality of life, availability of land, economic diversification, and a business-friendly state government have made the Metroplex one of the most resilient in the U.S. during downturns. If investors approach the market rationally, there is still room for growth and success in the multifamily space.
Author: Jay Lohmann