Why a multifamily foreclosure tsunami is unlikely



Distressed debt buyers will have some opportunity to pick up multifamily loans in the aftermath of the pandemic, but given the strong market for rental housing, a large wave of foreclosures is unlikely, observers generally agree.

Until now, most of the distressed debt funds for commercial mortgages raised early in the pandemic have remained on the sidelines because few packages have come to market. When multifamily forbearance programs end, the spigot could open, but only so much.

The clouds on the horizon
There are a few pessimistic signs for the market. A full recovery for the multifamily market, to 2019 levels, could take longer than past recoveries, a report from Fitch Ratings noted.

“Rents in urban markets typically rebound within a year or two after bottoming, as renters seek to capitalize on concessions and discounts, but the uneven nature of reopening cities could delay the post-lockdown recovery,” Fitch said. “Changing demographics in the key renter cohort and outmigration trends that favor suburban and/or sunbelt markets over selected coastal gateway cities are persistent headwinds that will delay a full recovery of prior peak cash flows for coastal, urban landlords, including selected multifamily REITs.”

Location is key. Occupancy at suburban properties are at or above 2019 levels but lagging at urban locales, the report found. “Suburban rents are on pace to overtake prior peak levels in 2021, perhaps as early as the second quarter in some markets, based on monthly observations,” Fitch continued. “Urban rents have recovered at least half of coronavirus-induced declines, but remain 5%-15% below 2019 peaks, according to monthly observations.”

Given that rents are the driver of debt service coverage for multifamily mortgages, that could be a key sign of possible trouble brewing in a market that so far has not seen anywhere near the delinquency levels reported for retail and lodging properties since the pandemic started. The government-sponsored enterprises are believed to be the investor on nearly half of the multifamily loans outstanding.

Yet, while most are expecting an increase in distressed loan activity, it is because rents are strong that some servicers and others involved with such lending are positive that a multifamily foreclosure tsunami isn’t coming.

Another delay to the end of forbearances
Simultaneous announcements from Fannie Mae and Freddie Mac that extended the deadlines on their respective forbearance programs for these properties to Sept. 30 from June 30 served as a stopgap for multifamily loan foreclosures over the summer.

At the end of April, Freddie Mac had 1,154 forborne securitized multifamily loans, representing about 2.1% of the total securitized unpaid principal balance.

Approximately 1.3% of Fannie Mae’s multifamily book as of March 31 had received a forbearance plan during the pandemic. But just 0.2% with an unpaid principal balance of $917 million was still in an active plan at the end of the first quarter.

When this does all shake out, there is a higher risk for foreclosures for the multifamily segment versus single-family, at least on paper, said Daren Blomquist, vice president of market economics at Auction.com.

There are several layers of risk with multifamily, the first being that fewer of those properties have federally-backed mortgages. Those are accompanied by eviction moratoriums for renters — a court decision in Texas against the Centers for Disease Control and Prevention eviction moratorium notwithstanding. The moratoriums can affect landlord’s ability to collect rents, making it difficult not to dip into reserves to pay their mortgage loan.

There are federal government programs in place to provide rental relief, but the tenant has to apply for them.

“In talking to some landlords out there, with the eviction moratorium in place, tenants are less motivated to apply for the rental relief, because they have an eviction moratorium that’s protecting them,” Blomquist said.

But overall, compared with other property types, multifamily has held up very well when it comes to late payments. In May, 1.8% of these borrowers missed their payment, compared with 20% for lodging and 9.5% of retail properties, according to the Mortgage Bankers Association.

“The inherent risk factors could certainly spell problems for that sector going forward, particularly depending on how the combination of forbearance, foreclosure moratorium and eviction moratorium are handled,” Blomquist said.

While the first quarter saw an increase in scheduled sales on Auction.com for multifamily properties compared with the fourth quarter of 2020, the actual number of properties that end up getting to the point of sale were very low, Blomquist noted. “That would indicate there are more of these properties getting into trouble, or these loans getting into trouble, but fewer are making it to the auction.”

Given the moratoriums, a year-over-year comparison for both multifamily and single-family scheduled auctions showed a significant drop off.

In the first quarter, there were 30% fewer multifamily foreclosure auctions than in the same period of 2020. And far fewer were even completed, just 10% of those scheduled, versus 22% in the first quarter of 2020.

But compared to the quarter before the pandemic, single-family property auctions going to completion had a similar percentage with the most recent period. While there were 36% fewer auctions scheduled year-over-year, 20% were completed in this year’s first quarter compared with 24% in the first quarter last year.

Knock-on effects of the single-family inventory squeeze
Ever since the pandemic’s onset, Rick Sharga, executive vice president at RealtyTrac, has been bullish on the outcome for real estate.

“I don’t see a foreclosure tsunami in any real estate category coming out of the pandemic, because of market dynamics, and then candidly because of all the intervention we’ve seen from the government and the industry,” Sharga said.

He doesn’t see multifamily as being vulnerable because of the high demand for those units from people who are being shut out of the single-family home purchase market.

“The young adult cohort of the millennials are actively looking to become homeowners, but there’s just not enough homes,” Sharga said. Rather than going back to their parent’s house, “they’re going to look for somewhere to live and in a lot of cases are going to be renters.”

It’s not just millennials that will be forming new households, it will be members of Gen Z as well looking for places of their own. And if they can’t buy a home, they will have to rent and that is good for multifamily housing, Sharga said.

The servicers’ point of view
The trio of servicers National Mortgage News spoke with are not forecasting a massive increase in multifamily delinquencies. Absent unexpected events such as a resurgence of the virus or an economic downturn, they do not predict major problems for the properties in their portfolios. Perhaps a small increase in delinquencies is likely as a consequence of the pandemic, but nothing massive.

“A year ago when the pandemic hit, we obviously had no idea what the future was going to hold; the floor underneath us opened up and the world was going to end,” said Tim Mazzetti, managing director, head of U.S. commercial real estate and asset management at SitusAMC. “Fast forward 12 months, and here we are a year later, the government has done an amazing job in terms of the Fed putting a lot of liquidity out there, the government putting a lot of extra money in people’s pockets in terms of direct payments — stimulus payments as well as additional checks for unemployment benefits.”

But even then, certain multifamily property types are likely to do better as the pandemic ends and the extra government support goes away. The top-end properties, what he termed Class A and Class B, are less likely to be affected than the Class C, whose tenants tend to work in the service sector and may have lost their jobs as their employers cut back or closed down entirely.

While commercial loan servicer Sabal saw an increase in the number of loans that are nonperforming, in special servicing, or some form of workout, compared with 2019, “we’re hovering right around that 1% rate, which is still an extremely low percentage of loans that are nonperforming,” said Vartan Derbedrossian, chief fulfillment and servicing officer.

More importantly, rent collections have so far remained steady and borrowers are able to meet, for the most part, their debt service coverage.

“If we look at the number of people that took forbearance and where they’re at today, about 50% of them have already paid back that forbearance, and that number continues to grow every single month,” Derbedrossian said. “If borrowers were not going to be able to make payments and if they were going to be struggling, you wouldn’t have such a high repayment of forbearance.”

Another mitigating factor are the low interest rates that have reduced costs for multifamily borrowers. Those were in place even before the pandemic began, as 10-year paper was in the mid-3% range for the last five or six years. “That picked up a lot of the pain,” explained Alan Wiener, group head of multifamily capital for Wells Fargo & Co.

“So even though rents were down, debt service [cost] was down as well,” said Wiener. “That’s helped a lot of owners.”

Like the other servicers, Wells Fargo has also seen a low amount of defaults in its multifamily mortgage servicing portfolio of over $100 billion.

“Yes, owners have taken it on the chin to some extent,” Wiener said. “But remember, at the same time they were going through this, the rates were extraordinarily low.”

Another good sign for the market is that CMBS loan underwriting is much stronger now than it was in years prior to the housing crisis of the late 2000s, he added. Many of the loans written in that era were overleveraged and so when the worst case scenario hit, they went into default.

Today, the credit quality is much better, so those loans aren’t experiencing any hiccups, said Weiner. “The bond buyers of the CMBS tranches understood the hits they took on the lower end last time and they were much more careful this time.”

For its struggling borrowers, Sabal has “various different workout options that could be deployed depending on what the borrower needs, so we’re not going to sit around and wait for anything,” explained Derbedrossian. “So that’s where special servicing comes in and that’s where asset management comes in where they can work with each individual borrower and try to understand kind of what that situation is.”

Foreclosure could be an outcome, but based on what he sees in Sabal’s portfolio, under current conditions it is highly unlikely there will be a huge amount.

Limited opportunity in distressed debt
There will be an opportunity for distressed debt buyers to act, said Kingsley Greenland, president and CEO at DebtX. But he pointed to the disparity in the default rate between retail (a troubled asset class even prior to the pandemic) and multifamily to show how limited it will be.

While those distressed debt buyers are clamoring for multifamily mortgages to purchase, the market will not be huge.

And a contributing factor might be the social implications associated with multifamily housing. Unlike the 2008 collapse, which fed the distressed assets market with properties of all types, this situation was caused by a pandemic, not greed, Greenland pointed out. As a result, “everybody’s trying to be pretty considerate to people, special servicers included,” he said.

While those workers in servicing operations that deal with problem loans are not exactly twiddling their thumbs, they’re not overworked either.

“I have to tell you right now my special servicing group is kind of slow, across all asset classes.” Mazzetti said. “A lot of the hospitality that didn’t blow up, they’ve been able to survive.”

But the fly in the ointment might be CMBS loans that are maturing, for which a borrower needs to refinance. The original mortgage was underwritten at a time the economy was stronger.

Today, lenders likely have tighter guidelines and as a result, borrowers “may have trouble refinancing, and I think that’s where we may see a slight uptick [in defaults], but as far as actual current performance, I’m just not seeing it,” Mazzetti said.

Every time a notice of default is filed, non-stop calls come in to Sabal, Derbedrossian said. “But just because there’s a lot of buyers out there, doesn’t mean that’s the best resolution for the investors,” he continued. “Just the fact that there’s a lot of buyers, that in itself speaks to [why] it’s not a dry market where you’re going to have to take an asset and dispose of it at a very low price.”

If anything, the high number of buyers is likely to drive the price of distressed assets up and provide better returns nd lower losses for investors.


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