Multifamily can no longer be seen as a safe bet

Masked by the sector darling’s significant growth over the past four years, many miscalculations are now coming to a head.

Multifamily has been one of the most favored sectors in private real estate for over a decade. It has been the most popular sector-specific strategy by total capital raised in all but one of the past 10 years, according to PERE data.

But multifamily’s reputation as a safe investment bet – based on the premise that housing has the most resilient demand of any property type – is being called into question amid emerging distress in the sector, as PERE examines in this month’s cover story.

Managers developed one speculative apartment project after another in 2021 and 2022, assuming cheap debt and robust rent growth would continue. Those assumptions did not pan out, and firms are now having to sell those assets at significant losses amid a glut of supply in the market.

Indeed, in a PERE podcast interview due out next week, Brian Thies, a director with the North American banks team at Fitch Ratings, noted the asset class has “flown under the radar a bit” because of the significant growth the sector has seen over the past four years. Thies’ colleague and team head Christopher Wolfe added that such growth “is probably masking what’s underneath.”

What Wolf is alluding to is the elevated refinancing risks for US multifamily loans coming due over the next few years, as highlighted in a February report from Fitch Ratings. The ratings agency noted that base rates have increased by 525 basis points since 2014 – when many of this year’s maturing loans were originated or underwritten – reducing debt service coverage ratios and making it more challenging for borrowers to refinance some maturing multifamily loans.

This is particularly the case for mortgages backed by properties under rent control or rent stabilization measures. In areas where rent stabilization policies are in place, borrowers are less able to pass on cost increases to tenants and thus face a higher risk of default. Examples include New York City, which passed a series of tenant-friendly laws in 2019, as well as other cities that have rent control regulations, including those in California and New Jersey.

Meanwhile, the commercial property price index for apartment buildings in the US has fallen by approximately 27 percent over the past two years, according to data from Fitch and Green Street.

Return expectations reflect the troubles unfolding in multifamily. Total returns for US apartments are forecast to be -1.7 percent in 2024 – the second lowest after office, with a -6.3 percent projected return – according to industry body Pension Real Estate Association’s Q1 2024 Consensus Forecast Survey. Moreover, multifamily is also forecast to be the second-worst performer in 2025, 2026 and the five-year period spanning 2024 to 2028, the survey showed.

Such a dismal forecast does not mean that managers are opting out of multifamily, however. Crow Holdings Capital, for example, has a target allocation of 35 percent to the sector in its latest fund, but is likely to pause residential purchases until next year.

What has changed, however, is market participants are now approaching multifamily investing with greater caution than they did just two years ago. At least for now, it spells the end of the industry’s reputation as a safe bet.