CMBS Delinquencies Vulnerable to Inflation, Particularly by Metro Area

According to Trepp, CMBS delinquencies, which had been on a decline until a June uptick, are back on their way down again.

“After a rare uptick in June 2022, the Trepp CMBS Delinquency Rate resumed its two-year-long decline in July 2022,” the firm writes. “The Trepp CMBS Delinquency Rate in July was 3.06%, a decrease of 14 basis points from June. Last month, the Trepp team asked rhetorically if market volatility, inflation, and higher interest rates, combined with an uptick in June’s delinquency rate represented an inflection point for the market. The July numbers reveal that it is still too early to know.”

That news is good, but inflation remains a potential danger, particularly by metro area. As Trepp noted in a recent research report, there are big geographic variations in rent growth for multifamily properties. “The average NOI growth for the top 10 Metros was 5.3% compared to -0.5% for the bottom 9 metros,” the report stated. “San Francisco, New York, and Washington D.C. had rent growth of less than 1.5% on average over the past 18-months. Average expense growth across the 19 metros outpaced revenue growth for 15 of the 19 metros. Low-rent properties significantly underperformed their high-rent counterparts within each MSA, with 14 metros seeing a YoY decline in NOI for low-rent properties on average.”

And there’s the rub. No matter how much price appreciation exists in the current overheated markets, properties within particular metros might find operating costs rising faster than rents and potentially tipping the entire investment into something that eventually started bleeding cash rather than offsetting inflation.

Having expenses rise faster than rents isn’t a complete statement. It might be that rents are so far ahead of expenses that it would take significant time for the difference to be erased. Or price appreciation could make for a strong return, if the owner is selling in the near future.