Is The Distressed Opportunity Over?

Good morning,

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Mid-December comments by FED Chairman Jerome Powell sent the equity markets higher as investors interpreted his words to mean there would be rate cuts in 2024. Powell noted that the FED is getting close to the point when unemployment and inflation have equal priority in monetary calculations. Higher rates curb inflation and lower rates curb unemployment; this is a very delicate balance to strike. The CPI stubbornly remains above 3% while the labor market (except government hiring) is struggling

.Some investors have asked if a FED pivot to lower rates in 2024 will bail out troubled apartment owners and put an end to the distressed investment opportunity. To answer this question, you must first understand what is causing the distress and then determine if lower rates will solve the problem.

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Causes of current distress in multi-family:

1. Inability to refinance – Investors that opted for floating-rate debt are in a difficult position. Fixed rates are probably double what they initially were paying, valuations have declined, and banks are lending less and requiring more equity in the deals.
2. NOI under pressure – Rent growth has stagnated and, in some regions, fallen as a surge in new supply comes to market. Operating costs have surged, especially with insurance, taxes, and labor.
3. Tenant delinquency – In general, many renters are tapped out, financially. Wage growth has not kept up with inflation, and many are falling behind with their rent. Vacancy is also increasing as net absorption isn't keeping up with new development.

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Lower rates will certainly help some distressed investors refinance, but not all. Access to capital will be more difficult and, in many cases, investors will have to bring an equity infusion to the closing to meet debt service coverage ratios and lower loan-to-value ratios. Some investors will not be able to raise the additional capital and will be forced to sell. Lower rates will not solve the falling NOI problem. Investors who overpaid for assets and budgeted unrealistic rent growth and expense assumptions will run out of cash and be forced into a distressed sale. Tenant delinquency will continue to be a challenge for years to come. As Torsten Slok, Chief Economist for Apollo Global Management, cautioned after the FED's pivot, lower rates could spur demand and reignite inflation. Inflation will continue to dog average tenants until wage growth catches up.

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We at CREE Capital believe the environment for investing in distressed assets will remain attractive for the next few years. Some operators are waiting for a "Hail Mary" to bail them out, but a few rate cuts will not save them. Between now and 2025, $1.5T of CRE debt needs to be refinanced, and this will force some to realize they need to cut their losses and sell. We will continue to evaluate deals and look for opportunities like Regatta, our current investment opportunity in San Antonio. If you would like to learn more about this investment opportunity, schedule a call below.

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