Multifamily Distress: Spotlight on Troubled Markets
The multifamily sector's distress potential stirs debate. A new Trepp report now indicates that location could be the key factor.
Good morning. Opinions are mixed on whether multifamily is the next shoe to drop. According to Trepp, a property’s location matters most in the equation. The CLO market is set for a major $20B reset. Meanwhile, generative artificial intelligence may transform the way CRE professionals do business and ultimately increase their bottom line.
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Multifamily Distress is Coming, Depending Where You Look
Opinions are mixed on whether multifamily is the next shoe to drop. But according to Trepp, a property’s location matters most in the equation.
Location is key: Given the distress in other sectors, multifamily has looked mostly unscathed this year. Yet many major metros are showing signs of distress. Of the top 25 U.S. MSAs, San Francisco saw the most delinquencies at 2.69% — attributable to the Veritas Multifamily Portfolio, accounting for $447M in securitized CMBS debt, or 81% of the region's delinquent balance. New York is second at 1.01%, followed by Pittsburgh (0.82%), Philadelphia (0.70%), and Houston (0.62%).
Focus on the metrics: A Debt Service Coverage Ration (DSCR) of 1 means there's enough cash to service the debt. Lenders typically want at least 1.2 for a 20% cushion. If DSCR is under 1, the property isn't able to cover its debt payments and could likely default. A sub-1 DSCR is also location dependent. In San Fran, 12.98% of properties were unable to cover their debt payments. Dallas, Houston, and San Antonio 9.15%, 9.03%, and 7.59% of properties also had DSCRs below 1.
The problem with Houston: Houston's lack of zoning regulation makes it a difficult area for multifamily. Although delinquency hasn't hit concerning levels in the still-growing Sun Belt city, DSCR and occupancy rates are nonetheless concerning. The Houston market tends to follow oil and gas trends, so its multifamily market is underperforming seasonally.
➥ THE TAKEAWAY
Mixed feelings: Experts don't agree on whether multifamily will be the next CRE sector to fall. With many properties unable to meet their debt obligations, distress seems inevitable. But when? While buyers and sellers continue to find themselves at a standstill over price, one thing is clear — there's a lot of dry powder out there if the price is right.
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SIGNS OF A REVIVAL
Impending $20BCLO Market Reset Marks Major Thaw in Global Finance
The rising popularity of a specific refinancing transaction in the $1.3 trillion collateralized loan obligations market signals a recovering industry, suggesting easing worries over rampant inflation and potential recession.
Refinancing versus Reset: In refinancing, equity holders call CLOs and reissue them via cheaper debt, which may reduce bondholder payouts but enhance equity returns. On the other hand, a reset entails refinancing the CLO and extending the debt's maturity. Historically, they've accounted for up to a third of annual issuance, as per Bloomberg's data. However, last year's severe credit conditions almost halted these deals. Now, they're bouncing back.
Recent resets: Recently, Credit Suisse Asset Management and Oak Hill Advisors have reset liabilities for CLOs initially issued in the latter half of 2022. This reset enables CLOs to effectively slash their borrowing costs, leaving more cash for the equity portion – the riskiest and highest returning segment of the structure – after paying other note holders. Bank of America Corp. projects that approximately $20 billion worth of additional CLOs, issued when funding costs peaked, could undergo a similar reset in the following months.
Credit spreads: CSAM's original transaction had priced the AAA-rated tranche at 2.25%, while the reset came at 1.85%. Some managers priced AAA bonds at spreads as wide as 2.6% last year. But more reset deals will also add supply to a market that's struggled to attract enough investors. U.S. banks, once the biggest buyers of AAA tranches, have mostly stayed on the sidelines in recent months amid a decline in deposits and expectations for increased capital requirements.
➥ THE TAKEAWAY
Improving conditions: The resurgence of resets underscores the recent betterment in credit conditions. While the majority of CLOs might not find it advantageous to reset, the CLOs issued in the second half of 2022, now eligible to be called, present a perfect reset opportunity. Over 70 deals were concluded during this period, with over half pricing their AAA bonds at a spread exceeding 2%, compared to the current low of 1.75%.
Around the Web
📖 Read: Hessam Nadji, CEO of Marcus & Millichap, discusses the strategic approach that underpins his successful career, emphasizing specialization, building relationships, and focusing on long-term value.
🖥️ Watch: Greg Peters, co-CIO at PGIM Fixed Income, talks about the cracks he sees in CRE and why opportunities exist in emerging market bonds as inflation pressures subside.
🎧 Listen: In this episode of The TreppWire Podcast, the team recaps 1H23 CMBS and discusses the busy holiday week for CRE with major headlines surrounding jobs, consumer spending, and Treasury yields.
From Transactions to Tenants: How AI Is Reshaping Commercial Real Estate
Artificial intelligence (AI) isn't going anywhere and holds the transformative power to drastically alter the way commercial real estate players conduct their operations and transactions.
Let's talk shop: The commercial real estate biz hasn't been the fastest to jump on the tech bandwagon. It's all about relationships here, right? But we're seeing a new kid on the block — artificial intelligence (AI). Some folks were skeptical at first, but we're now seeing how AI can amp up productivity, bring down costs, and really help professionals pencil more deals.
Not just a fad: So, AI isn't exactly fresh out of the box. It's been in the industry for a while, serving different industries. From retail chatbots to warehouse predictive models, it's made its mark. But the latest AI models, like OpenAI's ChatGPT, are stepping things up a notch. Especially in handling those pesky admin tasks.
What's in it for CRE? So, where is AI really showing its magic in commercial real estate? For starters, it's taking over repetitive administrative jobs, giving professionals more time to do what they do best. It's also supercharging marketing strategies and speeding up due diligence and demographic research. Plus, it's a whiz at crunching numbers, which can be a huge help in risk assessment and financial modeling.
No walk in the park, but worth the effort: Hopping on the AI train isn't a cakewalk. Firms have to figure out how to gather data effectively and overcome any hesitation about investing in shiny new tech. But the early birds are already seeing the benefits. The trick is to pinpoint the AI-powered tools that can really help streamline your operations. And don't forget: feedback from clients can give valuable insights on how to use AI effectively.
➥ THE TAKEAWAY
The bottom line: In a nutshell, AI is ready to give commercial real estate a major makeover. It's all about automating the grunt work, getting razor-sharp insights from data analysis, and giving your employees more time to build those all-important relationships. Companies ready to ride the AI wave could come out on top. And yes, some jobs might be on the line, but we'll also see new opportunities springing up in tech management and data analysis. Marking the start of an exciting new era in commercial real estate.
✍️ Daily Picks
Consumers get a break: Inflation in June hit its lowest annual rate in over two years, due to slowing cost increases and comparisons against a period when price hikes were at a 40-year peak.
Strategic shift: Sequoia Capital’s $16.4B wealth management arm is shifting its focus towards credit and real estate investments in anticipation of a potential split from its VC arm.
Bidding wars: Not sure how much to sell or buy for? Auction activity can provide valuable insights into pricing discovery when pricing remains uncertain.
Offloading industrial: Blackstone (BX) has listed a portfolio of 6 industrial properties in NYC and Long Island with major tenants, including FedEx and Harris/Edo Corp.
Downsizing: Smart lock startup Latch laid off 60% of its staff as part of a restructuring plan amidst financial troubles.
Insurers to the rescue: Insurance companies are back in the game with the tighter lending environment as borrowers look past banks for alternative financing.
Cautiously optimistic: CRE execs in San Fran have a cautiously optimistic outlook, anticipating moderate growth and favorable conditions while acknowledging headwinds.
Betting on office: Real estate firm LL Holding is placing a big bet on large office spaces in NYC’s Terminal Warehouse in West Chelsea.
Bargain shopping: Wealthier shoppers increasingly favor lower-cost stores like Target (TGT) and Ulta (ULTA) as they shift their shopping habits towards more value-oriented options.
Tax break: Since 1982, the permanent tax break enjoyed by Madison Square Garden has resulted in an estimated loss of nearly $1B for the city.
Political opposition: Developers are coming up with strategies to deal with political opposition to their proposed industrial projects.
Self-storage sale: Public Storage (PSA) just acquired Andover Street Self Storage, a 76,396 SF storage facility in Peabody, MA.
Game-changer: San Francisco could get up to $20B or more for affordable housing if a regional bond measure makes it on the 2024 ballot.
Senior housing success: The future of senior housing is bright as both cap rates and rents are expected to grow due to the growing aging population.
Retail forecast: Supply Chain News dives into how retail brands have adapted their operations during the past 2 years of rising costs, labor shortages, and market volatility.
Stopgap: Negotiations for a smaller version of the 421a property tax break are on hold due to a wage dispute between developers and construction unions.
📈 Chart of the Day
After a record-setting 2021 and 2022, multifamily sales volumes in Orlando have declined at the fastest rate across all sectors.
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