CMBS Specialist Predicts Three-Year Cycle of Increasing Multifamily Distress

Multifamily special servicing rates hit 5.71% in August, according to Trepp. That’s still lower than the office rate of 11.91%, but it’s still a nearly nine-year high. The new transfer balance to special servicing was 16%.

All numbers, but that doesn’t say where things are going. To get a more comprehensive sense, Mark Silverman, Locke Lord partner, and CMBS special servicer team leader offered some insight. “Between 2013 and 2017, there was a lot of lending and a lot of folks took advantage,” he told GlobeSt.com. “It’s distressing. It’s a significant number. The main concern we have on the multifamily side is poor timing.”

Interest rates, leverage, and non-recourse made it hard to refuse in that pre-pandemic window. Then inflation rose, the Federal Reserve drove up interest rates to slow the economy, and many multifamily owners got closer to a maturity date. And that’s without increased overall costs of repairs, maintenance, insurance, and utilities.

“It’s a big airball if you don’t have the reserves or funds,” Silverman says. “How do you increase your money in if you can’t massively increase rents? I think that’s a tough pill to swallow if you have a higher dollar amount than you had previously. The shocking data headline is in the early part of the year, multifamily distress was 2.6%. Some have it at 11%.”

Where will things go? “I think it gets worse before it gets better,” Silverman said. “My view on office is slightly different. People are going to take some pain, take some losses, and then move on. Multifamily can be a lot harder to solve. There are different rules and requirements for foreclosing on multifamily assets.” And no one wants to kick tenants out of their homes. Atop everything else, it’s terrible PR.

It’s a matter of resetting the basis and reestablishing your rents so you have the right mix of tenants and the right rents for properties,” he said. “Is there room to increase rents, or do you need to decrease rents and decrease amenities? Do you shift [the property] into a government program or shift it out of a government program?”

The biggest problem he sees is borrowers who bury their heads in the sand and lose communication with the lenders. “Once you get up to maturity or shortly before maturity may be too late to come up with creative solutions,” said Silverman.

To avoid special servicing, borrowers should begin considering their options at least a couple of years before a maturity date. “The ability to refinance something at maturity is looking particularly slim,” he notes.

Silverman thinks that “sophisticated multifamily owners” will find solutions, but they tend to have more resources to bring to bear. “I don’t see how you solve that problem if you’re a single owner of a single multifamily property and you don’t want to put in more capital, or may not have more capital.”

That is when a non-recourse option looks awfully attractive. But borrowers have to understand that there are usually carve-outs in loans and lenders are skilled at identifying and using them. Property damage, a bankruptcy filing, comingling funds that violates the special purpose entity provisions of the loan documents, or failure to provide financial information.

Silverman sees this as the early parts of a three-year cycle where there will be more distress and higher special servicing rates.