Wall Street's Real Estate Bubble Bursts: Investors Left Reeling from Risky Loan-Fueled Bets

How One Investor Lost Everything in US Real Estate

Lynn Nathe, weary of the modest returns from her family's retirement account, took a daring leap in late 2021. She invested $200,000 with a company boasting 30% returns by purchasing US apartments, the hottest commodity in global real estate. Now, she says, most of that money is gone.

For Nathe, a business school graduate investing earnings from her husband's dentistry practice in Yakima, Washington, the loss is a personal catastrophe. Yet her story — a tale of social-media-fueled investing, Wall Street's securitization machine, and sharply rising interest rates — also serves as a cautionary chronicle of FOMO and easy money bursting yet another American real estate bubble.

The Real Estate Bubble Bursts

Concerns over US commercial property have justifiably focused on the office market, where more than $38 billion in buildings were in distress as of March, compared with about $10 billion for apartments, according to MSCI. However, multifamily buildings pose the greatest risk, with more than $56 billion worth of real estate in potential financial trouble. Unlike office buildings, mostly backed by major financial institutions, the unraveling here largely affects personal investors.

The Illusion of Safe Investments

Apartments were seen as a bulletproof investment, backed by basic human needs and the potential for high returns amid a persistent housing shortage. But financial firms seeking higher gains took on greater risks. Upstart landlords like Western Wealth Capital, where Nathe invested, specialized in speculative fix-and-flip deals, leveraging loans often packaged as securities and sold to institutional buyers.

This situation echoes the subprime mortgage boom that led to the 2008 financial crisis: a lending model based on packaging seemingly safe loans for borrowers with minimal track records and small down payments. When interest rates began to rise, values plummeted, causing chaos for landlords, debt funds, and investors like Nathe. She and four other investors who spoke with Bloomberg News reported losses in Western Wealth deals.

The Casino Effect in Real Estate

"When you're at a casino, you know you're gambling," said Aleksey Chernobelskiy, whose firm Centrio Capital Partners helps retail investors salvage investments in multifamily deals. "Here, people were gambling but didn't know it."

Western Wealth CEO Janet LePage, in an email response to questions, emphasized the company's comprehensive disclosures and commitment to transparency and regular communication with investors. She admitted that many firms, including hers, failed to anticipate the speed and magnitude of interest rate increases.

High Interest Rates Deepen Troubles

The issues in commercial real estate are intensifying as high interest rates persist and loans come due. Some major landlords are trying to avoid asset sales. Barry Sternlicht's Starwood Real Estate Income Trust, a vehicle for personal investors, recently tightened limits on shareholders' ability to withdraw money to preserve liquidity and avoid selling property in a declining market.

Apartment owners like Western Wealth, however, sometimes must sell buildings at steep losses to pay debt or escape cash crunches. Their turmoil is impacting the far corners of Wall Street, where the $80 billion market for commercial real estate collateralized loan obligations (CRE CLOs) is under unprecedented strain. Distress in CRE CLOs reached a record 8.6% in April, according to data provider CRED iQ, with new CLO creation down roughly 90% this year compared to 2022.

The Pandemic's Impact on Real Estate Investment

During the Covid-19 pandemic, Nathe shifted her retirement strategy, observing widespread wealth creation. Her family lived comfortably on her husband's earnings as a dentist, but after putting four children through medical school, their 401(k) wasn't enough.

At that time, the apartment industry was booming as investors capitalized on rock-bottom interest rates and soaring rents. In the fourth quarter of 2021, a record $166 billion worth of US apartment buildings changed hands, triple the pre-pandemic norm. Major players like Blackstone Inc., Guardian Life, and Canadian pension fund Caisse de Dép?t et Placement du Québec led the way.

The Rise of Real Estate Syndicators

Many high bids came from lesser-known real estate syndicators, who pool money from affluent individuals to buy properties. This allows investors to benefit from rising values and rents without dealing with renovations and financing headaches. Nathe was drawn in by crowd-sourced investments gaining traction in the financial landscape. As meme-stock buyers banded together to topple hedge funds and crypto enthusiasts drove Bitcoin's rise, everyday investors targeted real estate, leveraging technology to build empires of Airbnb vacation homes, self-storage facilities, and most of all, apartments.

The Influence of Wealth Influencers

Nathe followed wealth influencer Mir Jafer Ali Joffrey, nicknamed "Buck," a former cosmetic surgeon turned full-time investor. Joffrey hosted the Wealth Formula podcast, dedicated to personal finance and investing for an easier life. One guest was LePage, who began flipping houses in Phoenix after the financial crisis and formed Western Wealth Capital in 2014. The firm boasted average annualized returns of over 30% from 2014 to 2022.

Western Wealth focused on growing markets like Arizona and Texas, enhancing properties with 84 improvements to boost rents and sell at a profit. This value-add investing fit into Joffrey's "infinite returns model," emphasizing rapid capital recycling for maximum gains.

The Rise of CLOs: A Cousin of the Subprime Lending Bubble

CLOs, or collateralized loan obligations, are a type of financial product that's similar to the high-risk bonds that inflated the subprime lending bubble. And they're playing a significant role in the current real estate crisis.

The Bridge Loan Bubble

Bridge loans, which are used to carry buildings from purchase to rehab and finally sale, are too risky for many lenders. But CLOs have filled the gap, offering flexible terms and underwriting that factors in predicted after-renovation value. It's a perfect cocktail of a problem.

The Apartment Boom and Bust

The apartment boom was a bonanza for executives and nonbanks, but it's turned into a nightmare for many syndicators. With interest rates rising, rents flattening, and sales plummeting, the debt market is drying up, and sales of apartment buildings are down over 80%.

Delinquencies, Foreclosures, and Losses

Tides Equities, one of the largest syndicators, has over $200 million in delinquencies in its CRE CLO debt. Lenders are struggling, and short sellers are targeting companies like Arbor Realty Trust Inc. It's a sign of the fissures in the system, and it's reminiscent of the early days of the Great Recession.

Fissures in the System

Piskorski, a Columbia University professor, warns that syndicators may not threaten broader financial stability, but they expose fissures in the system. It's an early manifestation of risk, and it's a sign that things are starting to crack at the boundaries of the system.