Multifamily’s Tough Times Will Be a Boon for Bargain Buyers

The multifamily fall from grace over the last couple of years was unexpected by most at the market’s pandemic highs. The increase in interest rates have hit hard, as have some other factors.

But according to Ralph Rosenberg, partner and global head of real estate at global investment firm KKR, problematic conditions should start tapering off after 2025, leaving strong possibilities for rent growth and opportunities to “buy high-quality properties below replacement cost while achieving attractive long-term yields.”

The factors confounding multifamily certainly start with interest rates. “Debt levels relative to equity are higher in multifamily than in some other segments, a loan maturity wall looms, and interest rate caps are expiring, putting many owners in the position of refinancing at a time when their properties are worth less than their acquisition basis and interest rates are much higher,” Rosenberg wrote.

He notes that multifamily is one of the most leveraged of CRE investments. That makes refinancing challenging. There is a loan maturity wall, reduced availability of financing, and high debt loads.

That’s only one part. As GlobeSt.com has previously reported, 2023 saw a record number of apartment unit deliveries added to inventory and 2024 is expected to top that by half again. These aren’t evenly distributed across the country, but the concentration in places even with high increases in population is still enough to depress prices, occupancy rates, and rent growth.

In addition, operational costs have increased. “Floating-rate interest payments rose faster than income from rent and fees,” the firm said. Falling valuations aided in negatively affecting debt service coverage ratios, making many properties fiscally unsustainable to the lender. Also, utilities and property taxes have continued to climb, adding to multifamily difficulties.

“Over $250 billion in multifamily loan debt matures in 2024 alone, and some owners will face a gap upon refinancing,” they wrote. “Likewise, as interest rate caps typically last for three years, many owners are looking at a sharp increase in the cost of debt.”

KKR expects a tough couple of years in a deleveraging cycle. Owners and investors who can hold on during this period face different conditions coming out. There is the chance of lower interest rates, although the degree and pace of any reductions are up in the air now. Demand for units will grow as the rising expenses and difficulty of continuation of building make it virtually impossible to keep pace with additional units. Currently, supply growth forecasts for many metropolitan areas are below the 2018-to-2022 five-year average, and that wasn’t adequate to satisfy market needs.

Buyers with sufficient resources will find many opportunities. “Consider what would happen to a multifamily property purchased in February 2024 at a 5.5% cap rate (a measure of the one-year yield on a property calculated by dividing NOI by asset value) with 50% leverage,” they wrote. “Assume that NOI grows at a 3% CAGR. As interest rates come down, it might be possible to sell at a cap rate of 5.0% five years later, in 2029. That equates to an internal rate of return of roughly 14.5% over five years, which is attractive for a historically stable, in-demand asset class.”