During the initial multifamily post-pandemic boom, many lenders bundled variable rate multifamily mortgages into instruments called Commercial Real Estate Collateralized Loan Obligations as an investment vehicle.
Unlike Commercial Mortgage Backed Securities, which are usually comprised of fixed-rate loans and, theoretically, less at risk from interest rate increases, CRE CLOs are a vehicle for borrowers in need of speculative financing not available from other sources.
Multifamily mortgage delinquencies have started to accelerate, however, and lenders are scrambling to prevent expanded damage to the market.
The total CRE CLO market stands at $79B worth of loans. Wall Street had financed investors who bought multifamily communities as value-add opportunities in the recent boom to renovate and raise rents. After the Federal Reserve began aggressively raising interest rates in an attempt to slow inflation in the overall economy, investors whose variable-rate loans were bundled into securities started missing or delaying payments.
In 2021, CRE CLO issuances increased 137% over 2019, hitting $45B. At the time, investors assumed a three-year loan duration would be enough to let them upgrade the properties they purchased and refinance their loans.
Now, however, the debt on which those securities are based is coming due. There is significantly reduced interest in the financing marketplace for real estate lending, overall monetary policy has tightened significantly, and other costs—such as insurance—have exploded.
Those complications and others led to multifamily assets identified as distressed to rise to nearly $10B by the end of March, which marks a 33% increase since September, according to MSCI Real Assets.
The CRE CLO market is now feeling the pinch, since the distress rate for loans bundled into those bonds went up 10% at the end of March, compared with just 1.7% last July.
If the share of bad loans gets too high, the issuers would be cut off from the fees they collect on CRE CLOs. To stop that from happening, those lenders have been buying them back in droves. In Q1 of this year, lenders bought up $520M in delinquent credit, a 210% year-over-year increase according to JPMorgan Chase & Company.
Complicating matters, some of the lenders that are currently buying defaulting loans are doing so with money borrowed on revolving credit lines. As loans continue to deteriorate in quality, they will have increased trouble accessing debt.
Some analysts have expressed surprise that it hasn’t happened already. JPMorgan’s Chong Sin said managers are engaging in buyouts to staunch delinquencies, but that is only possible if financing costs remain sufficiently low.
One factor keeping those rates low enough for the moment is that risk premiums, also known as spreads, have tightened significantly on CRE loans over the last six months. There is no way to predict if, or for how long, that will remain the case.
Barclays Plc strategist Anuj Jain expects buyouts to continue as distress continues to rise. That plan could run into trouble, however, if the Fed goes back to increasing interest rates or if it continues to hold off on cutting them.
Because of the volatility, short sellers looking to borrow stock, sell it and buy it back at a lower price are targeting lenders that used CRE CLOs. Because the issuers own the equity portion of the securities, they take the first hits when the loans go back.
Some providers are seeing short interest hitting record levels nearing 40%, and every new ripple continues to reverberate across the entire securitized multifamily debt marketplace. (Source)