🏗️ What the Construction Lull Means for the Apartment Sector

This year sees a marked decline in new apartment constructions, attributed to elevated interest rates, reduced rents, and overbuilding worries in select regions.

🏗️ What the Construction Lull Means for the Apartment Sector

This year sees a marked decline in new apartment constructions, attributed to elevated interest rates, reduced rents, and overbuilding worries in select regions.

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Good morning. Apartment construction is declining due to higher interest rates and falling rents. CMBS and CLO issuance have pretty much collapsed in recent months. Meanwhile, US office properties may face a prolonged drought before bouncing back, according to Bloomberg.

Today’s issue is brought to you by Terrydale Capitalproviding specialized financing options for commercial investment properties.

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Market Snapshot

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*Data as of 10/02/2023 market close.


Higher Rates and Falling Rents Spark a Decline in New Apartment Developments

Higher interest rates, falling rents contribute to decline in building starts


Construction of new apartments has experienced a significant decline this year due to higher interest rates, declining rents, and concerns about overbuilding in some areas.

By the numbers: According to the Census Bureau, apartment building starts fell by 41% in August, compared to the same month the previous year, reaching a seasonally adjusted annual rate of 334K units. This decline, only seen once since the subprime housing crisis, is expected to result in approximately two years of reduced building, as Greg Willett, first vice president at Institutional Property Advisors, predicted.

US apt construction starts

Construction pause: The market is expecting a surge in rental building openings for the next two years, the highest since the 1980s. This influx of new supply has caused apartment vacancies to rise and rent growth to flatten or decline in several areas. As a result, apartment builders are pausing construction in order to assess the profitability of their projects compared to safer investments, as well as to evaluate the impact of existing buildings in the market.

Completed new construction apartments

Financing freeze: The cost and scarcity of construction financing have become significant obstacles for builders. Banks, now holding increased reserves to support troubled property loans, are lending less frequently and tightening standards. Interest rates for construction loans have doubled, climbing from 4–8%. This financing crunch has made it difficult for developers to raise equity from investors uncertain about the future value of completed projects.

Regional impacts: The decline in multifamily starts is most evident in areas that experienced substantial construction during the pandemic. Denver, for example, saw a 66% drop in starts for new apartments in 2Q23 compared to the quarterly average since 2021. This drop in new construction is attributed to stagnant asking rents and the uncertain potential for rent inflation before completion. Additionally, developers in the Dallas metro area have scaled back in untested neighborhoods.


Slowly slowing down: The future of apartment buildings heavily depends on interest rate fluctuations. If rates stabilize or fall more in coming quarters, developers and lenders will likely gain confidence and resume stalled construction plans. Another factor favoring the apartment building market is the continuous increase in the price of for-sale homes. This rising affordability gap should drive demand towards rentals for the foreseeable future.


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Turbulence in CMBS and CLOs Triggers Concerns in Commercial Real Estate Financing

Hits to CMBS and CLOs Are Bad News for Commercial Real Estate Financing


Commercial lending has dwindled since last spring's regional banking crisis, and while alternative lenders and life insurance companies cautiously fill the void, the markets for CMBS and CLOs have sharply plummeted.

Declining issuance: CMBS and CLO issuance has dramatically decreased, with private label CMBS and CLO issuance dropping by over two-thirds in the past year, according to the CRE Finance Council. Private label CMBS and CLO issuance fell from $92.3B to $30.7B in September 2023 YoY. Conduit CMBS issuance is down 27%, while SASB CMBS issuance has declined by a massive 73%.

Rising defaults: CMBS defaults are escalating, reaching 4.25% in August after a previous 2020 peak of 10.31%, with maturity defaults being particularly prevalent. According to Moody's Matthew Halpern, term defaults remain rare. Moreover, the CLO market has starkly contracted, seeing a fall in CRE CLO issuance of 83%—from $28.9 billion to $4.8 billion from 2022 to 2023. Deryk Meherik of Moody's notes only nine CLO transactions, averaging $500 million to $600 million, have reached the national market this year.

Treading water: The 30-day average SOFR rate has increased from 2.28–5.31% YoY leading to decreased interest in floating-rate debt. Investors who heavily invested in floating-rate debt from 2018–2022 now face difficulties due to high rates. The increase in the 10-year Treasury rate, from 3.71 to 4.64%, has also impacted the CMBS market, forcing borrowers to pay higher loan coupons to justify the new cost of capital. Negotiated extensions for loans coming due are becoming more common as borrowers are unwilling to take out new loans.

Silver lining: Despite the challenges, borrowers are still drawn to CMBS originations due to pricing advantages and the potential for higher loan-to-value ratios. Lenders are offering modified A-B note structures with loan extensions, where portions of the loan are modified, restructured, and extended. This approach brings in new equity partners and attracts borrowers with longer timelines. Lenders are recognizing the need for compromise and are granting maturity extensions, subordinations, and interest rate relief to borrowers.


Paradigm shift: Amid the decline in the CLO market, a paradigm shift has occurred, with multifamily properties becoming the preferred asset class. Around 80% of CLO loan compositions are comprised of multifamily properties, as they provide certainty of outcome with waves of renters and more affordable interest rate caps. However, the CLO market still faces difficulties, and there is a limited supply of investors. Bond buyers are waiting for the stabilization of the SOFR before investing more capital in this space.


📖 Read: Amtrak, which you probably don’t spend a lot of time thinking about, is about to make some big moves, with plans to double ridership by 2040 thanks to a $1 trillion infrastructure law passed in 2021.

▶️ Watch: M&G Real Estate and Nuveen's 40 Leadenhall is officially the largest office building in London. Set to be completed this year, it’s 70% preleased and emphasizes high-quality amenities.

🎧 Listen: In this episode of Odd Lots, Julia Coronado, founder & CEO of Macro Policy Perspectives, thinks that despite rapid rate hikes by the Fed, the true impact has yet to be felt, particularly in credit and other debt-dependent sectors.


Bloomberg Survey Says US Office Faces Big Dip, Rebound Expected After Collapse

MLIV Pulse: What is your outlook for the US office market?

Source: Bloomberg

Bloomberg’s latest Markets Live Pulse survey reveals that the US office market is poised for a substantial crash, with CRE prices expected to decline until 2H24 or longer.

Behind the numbers: About two-thirds of the 919 respondents anticipate a rebound only after a severe collapse, suggesting a challenging road ahead for the sector. This downturn poses a threat to approximately $1.5T of CRE debt due before the end of 2025, making refinancing a daunting task. Additionally, the Fed's aggressive tightening only makes things worse by impacting lending capacity and buyer confidence.

US Office Faces Big Dip, Rebound Expected After Collapse

Lender challenges: Financial institutions looking to reduce their exposure to the struggling CRE market are facing limited options. The lack of enthusiastic buyers who believe the market has bottomed contributes to the prevailing difficulties. Smaller regional banks, which hold around 30% of office building debt, are also stressed, leading to reduced lending capacity due to shrinking deposits.

US CRE Prices Expected to Keep Sliding

Long-term impact: The effects of higher rates on the US CRE market can take years to fully materialize. Many office investors have long-term fixed-rate financing in place, and tenants often have long-term leases. Research by Moody's predicts that it will take until 2027 for current leases to expire and reveal lower revenue, potentially resulting in a 10% dip compared to the present.


Challenging office outlook: The slow reckoning of CRE in response to changing rates, particularly in the distressed office sector, suggests a prolonged recovery process. US office is anticipated to face a crash, with prices in decline until 2024 or later. However, despite potential major loan losses and distress in the office segment, experts believe that the overall stability of the market is not under immediate threat.


  • Throwing out landlords: The US Supreme Court refused to hear a case challenging NY's Rent Stabilization Law, leaving tenant protections intact.

  • Building hope: Hugh Frater, former CEO of Fannie Mae (FNMA), believes a preconstructed housing system can help close the affordability gap in the US.

  • Capital conundrum: Blackstone's $67B real estate fund (BREIT) experienced a decline in withdrawal requests as investors sought to pull out $2.1B in September.

  • The building tide: Distressed offices may be on the rise, with an increase in defaults, foreclosures, and credit downgrades, indicating a potential wave of distress in the market.

  • Redfin drops NAR: Redfin (RDFN) is calling on 1,800 realtors to cancel their memberships with NAR, citing grievances including a harassment scandal.

  • Nostalgia: Toys R Us plans to open 24 new flagship stores, expand to airports and cruise ships, and increase its global footprint by over 50%.

  • From desks to dwellings: Office conversions in the US are set to double this year, with 100 projects scheduled; 48% of the conversions are for multifamily projects.

  • Checking in: Marriott International (MAR) has signed more than 2,000 long-term contracts for luxury and midscale hotels, with 547K rooms in the pipeline for future expansions.

  • Turning the tables: Tighter monetary policy is reducing housing demand, cooling mortgage applications and new home construction, but presenting opportunities for private funds.

  • Follow the lawyers: CoStar (CSGP) is suing the founder of Homesnap, Guy Wolcott, alleging he used proprietary trade secrets to develop a copycat data-transfer platform.

  • Student loan pause ends: The end of the federal student loan payment moratorium will result in 40M Americans facing new monthly payments very soon.


Change in weight by property sector

Source: Nareit

Nareit analyzes the quarterly investment holdings of the top 27 actively managed real estate investment funds specializing in REIT investments to understand professional investor sentiment. In Q2 2023, data centers experienced a substantial quarterly increase, rising by 3.6%. Meanwhile, self-storage may have flown too close to the sun, down around -3.6% YoY.

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