Are There Likely to Be Many Distressed Multifamily Assets Coming to the Market in 2023?

Dear valued existing investors and future investors,

Welcome to this week's CPI Capital's news briefing. Our regular, weekly newsletter contains a mixture of updates, commentary, and information articles related to the lucrative world of passive real estate investment.

If you're already one of our subscribers, thank you. If you are not, I hope you'll find this article useful and will take this chance to sign up to our newsletter so that you can keep up-to-date with all you need to know about syndicated real estate investments!

Download and read our FREE e-book: 25 Fundamental questions to ask a Syndication Sponsor before making your investment

This week we ask a topical question recently raised by a number of investors: Are there likely to be many distressed multifamily assets coming to the market in 2023? So, I thought I'd take a closer look at this topic which has important bearings on current investors' market sentiment.

The Overall Commercial Real Estate (CRE) Market

The CRE market has been affected to different degrees by a series of events over the last 2-3 years. In fact, CRE investment sales have been trending down for some time, with higher interest rates, amongst other things, creating uncertainty about the future direction of property values. For example, in the fourth quarter 2022, overall investment sales volume in the US fell 62% compared to the prior year to $138.9 billion.

With the realistic possibility for a recession starting in 2023 causing further unease for already committed real estate investors, other investors are wondering whether a number of distressed multifamily assets will be coming to the market, thereby creating investment opportunities.

Multifamily Market: A Broad Overview

Before we look further into the potential for distressed assets, it's important to understand the state of the multifamily market and how it reacts especially in a recessionary phase. In general, the multifamily market stayed relatively stable throughout the pandemic, in this rising interest rate environment, and even when a major recession is now being forecast. Demand for rental properties has remained strong and rent growth has stayed robust throughout these up and down markets.

However, there are two trends worth noting which may have some impact on the multifamily market in the coming months.

The first is the so-called “urban exodus” which saw many renters leaving dense urban areas in favor of suburban and rural locations during the pandemic. This trend has slowed down somewhat of late.

Additionally, eviction moratoriums put in place during the pandemic have prevented renters from being evicted for non-payment of rent. This has helped keep rental vacancy rates low. But this could lead to a backlog of evictions once the moratoriums expires.

On the other hand, a key demand driver for multifamily and/or BTR-SFR (built-to-rent and single family rental) accommodations, namely those marketed toward retirees, show no sign of abating.

So, will there be many distressed or other multifamily assets coming to the market?

The short answer is that it is difficult to say for sure. While there are certainly some factors that could contribute to distressed assets hitting the market and affecting values and cap rates, there are also several factors which could help prevent this from happening.

Some key factors causing multifamily properties to become available (note: not all distressed sellers) include:

• The eviction backlog: as touched upon above, once eviction moratoriums expire, landlords may find themselves with a backlog of unpaid rent and no way to recover those losses. This could lead to distressed properties hitting the market as landlords try to recoup their losses by selling their properties;
• Expiration of government relief programs: a number of renters and landlords were able to stay afloat during the pandemic thanks to government relief programs, such as with stimulus cheques and rental assistance. However, these programs are not sustainable in the long term and once they expire some landlords and renters may find themselves unable to pay their bills. This could lead to distressed properties hitting the market as landlords try to relieve their financial burden;
• Loans maturing: some sellers will need to sell because their loans are maturing. They financed with highly-leveraged floating rate debt and so are experiencing distress with larger interest payments. Such borrowers will likely be the first group of sellers;
• End of fund life: others will sell because they are at the end of the fund's life. They're in a position to not make as much money should they have sold in 2021 or early 2022, but still enough to achieve their targeted returns.

In fact, the entities most motivated to make deals or transact are groups which in 2021 financed with floating-rate bridge loans at 80% or more leverage, with interest rate caps at 2.5%. Whether such a transaction is a sale or a refinancing it regardless also requires additional capital vis-a-vis preferred equity or mezzanine in the form of a cash-in refinance. Those groups will also be highly motivated to make deals.

On the buy side, a lot of capital is patiently waiting on the sidelines for opportunities to hit the market at their required target pricing levels. As motivated sellers begin to sell that will set the market precedent for pricing and cap rates.

Why some multifamily and/or BTR assets may not come to market

Firstly, the strong demand for rental properties has persisted throughout the pandemic even as interest rates have risen (making buying properties less affordable) and even in the face of the latest tremors of the recent banking crisis with SVB, Signature Bank, and other institutions circling the drain. Even if some landlords are struggling financially, there may be other investors willing to step in and purchase their properties. Additionally, the still relatively low-interest-rate environment could make it easier for landlords to refinance their properties and avoid foreclosure.

Furthermore, distressed assets do not necessarily have to hit the market. Some landlords may be able to work out deals with their lenders or sell their properties off-market rather than going through a public sale. This could help prevent distressed properties from flooding the market and driving down prices.

SIGN UP HERE to receive our investment offerings

Even for an experienced investor and multifamily syndicator such as CPI Capital, it is difficult to predict with certainty whether many distressed multifamily assets will hit the market in the coming months. While there are certainly some factors which could contribute to this, such as those mentioned above, eviction backlogs, and the expiration of government relief programs, there are also countervailing factors that could help prevent it, such as strong demand for rental properties and higher interest rates which depreciates asset prices and further discourage buyers from stepping forward.

In reality, the multifamily and/or BTR-SFR market has remained relatively stable over the last 3-4 years, and it's likely that it will continue to do so in the coming months and years. In any event, CPI Capital is well positioned to take advantage of any attractively priced distressed deals which come to market as we remain confident that multifamily will continue to yield attractive returns for our passive investors.

Yours sincerely,

August Biniaz, COO, Co-Founder CPI Capital

Signup here to receive our investment offerings