The Not-So-Hidden Secret of Multifamily Distress

Multifamily distress has jumped 100 basis points between June and July, which CRED iQ called a “staggering” growth rate. At the end of the previous month, it sat at 8.4%, the fifth consecutive record high and up from 2.6% in January.

That’s the third highest stress level among property types, according to CRED iQ, and includes all multifamily-securitized CMBS financing. Office and retail were in worse shape, but there is something scary when deep problems appear in an asset class with natural ongoing demand and little to no room for tenants to walk away. It’s not as though there is a home-from-work option. The impending danger in multifamily raises questions about what would happen in a large downturn. Could lenders find buyers fast enough/? Operate the properties while waiting? What would the potential impact on society and the economy be?

Concerns about multifamily didn’t just start. The minutes from the January Federal Reserve’s Federal Open Market Committee indicated that the central bank called out multifamily and office as problematic. In May, the National Association of Home Builders saw declining confidence in the market. Skyrocketing operational expenses have put downward pressure on net operating income.

Multifamily’s distress level at the opening of 2024 was roughly at the same point the year before. It had grown to about 5.5% by October 2023 and, after some volatility, dropped back again. But the rise, as CRED iQ noted, has been rapid, showing roughly the same increase as office has done since November 2023.

MSCI data suggests that multifamily could represent a larger financial burden than office, as the Wall Street Journal reported. At the end of the second quarter, more than $40 billion in office loans were distressed. However, $80.95 billion in multifamily mortgages are at risk of distress — either because of falling occupancy rates or low debt-service coverage ratios — compared to $66.87 billion in office loans.

The Journal called CRE CLOs as “one of the rockiest corners” of financing and a “niche product that apartment flippers gorged on during the pandemic.” They pointed to data from CRED iQ.

The data came from a July report of the firm. The numbers represent the entire financing category, not multifamily alone. The distress rate of CRE CLOs rose to 10.3% in June 2024. That was a 60-basis-point increase from the previous month and included any loan that was 30 days delinquent, past maturity, or specially serviced.

What makes them dangerous is that they are floating-rate loans that have seen big declines in debt service coverage ratios. About 78.4% had an operating DSCR lower than the one listed in their underwriting, and 62% of all CRE CLOs had a DSCR below 1.00. Even factoring out current interest rates, which are likely higher than when the loan was first made, and 46.4% had net operating income below the underwriting assumptions.