Commercial Real Estate Sector Experiences Rising Stress as Delinquencies on Multifamily Mortgages Increase

Commercial Real Estate Sector Under Pressure

The commercial real estate sector is facing increased stress with a rising number of delinquencies on multifamily mortgages. In April, around 8.6% of commercial real estate loans bundled into collateralized loan obligations (CLOs) were distressed, matching the record high set in January, as per Bloomberg, citing data from analytics firm CRED iQ.

Impact of Covid Era and Surging Borrowing Rates

These loans, bundled into CRE CLOs, were combined with funds from individual investors to acquire multifamily housing during the Covid era. However, a surge in borrowing rates took many by surprise. A significant chunk of these deteriorating loans had floating-rate interest rates, which put a massive strain on landlords' cash flows, reduced the market value of the properties, and wiped out equity in numerous investments.

CRE CLO Issuers Scramble to Prevent Defaults

With $78.5 billion of CRE CLO loans outstanding according to data provider Trepp, many CRE CLO issuers are scrambling to find ways to prevent a wave of bad loans from defaulting or risk losing the fees they collect on the securities.

Increasing Buyouts of Delinquent Loans

Recent estimates from JPMorgan indicate that lenders purchased $520 million of delinquent loans in the first quarter of this year. Lenders have been increasing the number of buyouts over the last four quarters due to the rise in bad loans in a period of elevated rates.

Surprise at Lenders' Ability to Purchase Bad Debt

JPMorgan strategist Chong Sin expressed surprise at lenders' ability to obtain warehouse lines to purchase bad debt, given tightening credit conditions. "The reason these managers are engaged in buyouts is to limit delinquencies," Sin said, adding, "The wild card here is, how long will financing costs remain low enough for them to do that?"

Expectation of Continued Buyouts

Anuj Jain, an analyst at Barclays Plc, expects buyouts to continue as distress increases across the CRE CLO space. "If the outlook for the Fed shifts materially to hikes or no rate cuts for a while, that might lead to a sharp increase in delinquencies, which can stifle issuers' ability to buy out loans," Jain said.

Increased Distress in Multifamily Assets

Those blows helped increase multifamily assets classed as distressed to almost $10 billion at the end of March, a 33% rise since the end of September, according to data compiled by MSCI Real Assets.

Fed Leaves Interest Rates Unchanged

Last Wednesday, the Fed left interest rates unchanged at around 550bps as inflation data reaccelerates and economic growth tilts to the downside, stoking stagflation fears.

Increased Shorting of CRE CLO Issuer Arbor Realty Trust Inc.

Meanwhile, bears are piling in on CRE CLO issuer Arbor Realty Trust Inc., with 40.3% of the float short, equivalent to 73 million shares short. "The multifamily CRE CLO market was not prepared for rate volatility," said Fraser Perring, the founder of Viceroy Research, which has placed bear bets against Arbor, adding, "The result is significant distress."

The Longer the Fed Delays Rate Cuts, the Worse the CRE Mess Will Get

The longer the Fed delays rate cuts, the worse the CRE mess will get.

This article brings to light the current distress in the commercial real estate sector, particularly in the multifamily mortgage space. The implications of this situation are far-reaching and could potentially impact the broader economy. What are your thoughts on this matter? Feel free to share this article with your friends and engage in a discussion. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.