Multifamily apartment building on fire showing the crisis happening in 2024 where investor money is being burned up in bad deals.


Why It Could Get Worse Before It Gets Better

Multifamily apartment building on fire showing the crisis happening in 2024 where investor money is being burned up in bad deals.

Rule Number 1: Don’t lose money.
Rule Number 2: Don’t forget the first rule. And that’s all the rules there are.”

Warren Buffett Legendary Investor, CEO of Berkshire Hathaway

Executive Summary

History doesn’t repeat but it rhymes, and out of the last four real estate crashes it’s always the over-leveraged players that get washed out.  Real estate crashed in 2008 and then began a slow recovery to eventually a market that was on fire from 2018 through 2022.  Anyone with an Instagram account, or flipped a few houses or had been a Limited Partner in a few apartment buildings was suddenly multifamily genius.  

Several factors should be considered before investing in multifamily assets in the near future:

The Glory Days of Multifamily Are Over (For Now)

The period from 2012 to 2022 witnessed one of the greatest booms ever in multifamily investments, fueled by historically low interest rates that went even lower during the pandemic. Investors could ride the wave of inflating asset prices, enjoying easy profits and a seemingly endless stream of returns. However, those golden days are for now, firmly in the past.

From 2019 to 2023 the multifamily gurus and masterminds spread like wildfire throughout the once staid commercial real estate industry.  If you could buy a house you can buy an 800 unit apartment complex (or so the thinking went).  You could attend a multifamily investor conference every week of 2022 and a multifamily meetup almost everyday.  

The themes presenters and attendees all told themselves were also all the same: multifamily only goes up; value add multifamily is the closest thing to a sure thing you will find; we tested the rent growth with 4 units and go 10% increases which will extrapolate to the other 796 units in the apartment complex; this time it is different; FOMO in before you are priced out!

What is left over in 2024 is the new refrain “stay alive until 2025.”  Unfortunately, billions of dollars of investor equity has gone up in flames and will be wiped out in foreclosures, recapitalizations, distressed debt sales and sponsors walking away from the deals.  These numbers also don’t include the ponzi schemes and fraud perpetuated as investors reached for higher and much more riskier yields.

The Multifamily Debt Crisis

The looming multifamily debt maturity wall is a tidal wave of trouble for all multifamily property investors.  According to the Mortgage Bankers Association, there is nearly $2.7 trillion in Commercial Real Estate (CRE) debt maturing between 2023 to 2027.  That is more than the entire cryptocurrency market cap as of March 2024.  The next 12 months have the highest volume of maturing CRE loans with $210 billion of debt coming due in 2024 and $111 billion of debt coming due in 2025.  

This graphic depicts the average cost of expenses, including taxes, utilities and repairs/maintenance, per unit, comparing the northeast, southwest, west, southeast and midwest regions to the national average.

Multifamily (rental apartments) represent more than 35% of those maturing loans with $113 billion worth of debt needing to be refinanced or paid off within the next 24 months. For all the talk about the Office sector being dead it has less than half of the maturing loan problem ($46.6 billion) that is currently facing the Multifamily sector.  

Multifamily owners now face a maturing debt crisis characterized by rising interest rates, replacing once abundant and inexpensive debt costs with extremely high debt costs. Of the CRE loans scheduled to mature in 2024 and 2025, more than 40% have current interest rates below 5.00% and around 15% of maturing CRE loans in the next two years have an existing interest rate under 4.00%.  Many of those loans were 2 and 3 year interest only bridge loans on shaky deals with no margin for error when purchased for too high a price.   

For example, 38% of maturing multifamily loans have a Debt Service Coverage Ratio (DSCR) of less than 1.25X (The debt-service coverage ratio is a measure of the cash flow available to pay current debt obligations)  The Debt Service Coverage Ratio is calculated Net Operating Income divided by Debt Service (NOI/DS = DSCR).

35% of maturing multifamily loans had origination cap rates of lower than 4%.

These interest-only structures, fueled by the Federal Reserve’s monetary policies, may result in foreclosures as property values struggle to match the debt burden. 

Property Values are Falling (Higher Cap Rates)

Property values are in decline. The once-reliable multifamily assets are now in the middle of a downturn, with property values plummeting as fast as the historic FED interest rate hikes. 

There has been a staggering loss of up to $2.7 trillion in wealth due to a historical increase in cap rates and a sharp decline in asset values within the commercial real estate sector. The multifamily and office segments are at the forefront, experiencing estimated declines of 30% and 35% in asset value from peak to trough with even more substantial percentage drops in equity value. This downward trend is a significant red flag for investors.

Many multifamily sponsors will tell you that the looming debt defaults only represent approximately 3-4% of the total value of all multifamily properties in the United States. But, PRICES ARE SET AT THE MARGINS and price discovery is always the last sale. The comp for your refinancing, rescue capital and exit sale is the last sale recorded in the market.  

So, if you purchased an apartment building in 2021 with a 3 cap anticipating cap rate compression on a short-term, interest-only loan, the numbers won’t work.  There is lots of dry powder waiting to jump in and buy but cap rates have now moved much higher.  -financing.

This downward pressure on values also creates a vicious cycle for performing assets as higher interest rates push cap rates higher, unlike what many sponsors thought during the era of cap rate compression.

The United States, particularly in previously hot markets such as Austin, TX, and Fort Meyers, FL, now faces a daunting 3 to 5 years where multifamily values are expected to drop off.

This chart shows the 48% decline of the multifamily sector and 30% value decline of multifamily assets by year-end 2023, wiping out the equity in this sector.

By the end of 2023, all property values averaged a 22% decline since their recent peak, with the multifamily sector declining by 30% and wiping out the equity in this space. The United States, and especially in many previously hot markets, now face a 3 to 5 year chasm in which multifamily values drop off a cliff. 

For example, a shift in the 10-year rate from 2.2% to 4.75% would lead to a 150-basis-point rise in the average cap rate. As a result, an asset initially traded at a 4.5% cap rate now has a 6% cap rate, indicating approximately 25% value decrease. If asset prices drop 25%, it would ultimately destroy all of the equity in a 75% leveraged deal. The dynamics of the deal have changed and, for some, the only recourse involves injecting more capital or relinquishing ownership.

Considering prime Class A multifamily properties, the average annual rent growth projection for the first three years decreased from 4.5% in April 2022 to 2.4% in December 2023. Unleveraged target IRRs increased from 5.79% to 7.68%, and initial cap rates at 3.37%, and now rose to 5.06%. Exit cap rates have moved from 4.13% to 5.18%. The gap between going-in and exit cap rates originally at 76 basis points now dropped to 11.

Interest Rates Higher For Longer

Interest rates are rising with no end in sight. With interest rates on the rise, the cost of multifamily debt has shot up by 75% in just three years. This surge is creating a domino effect, exerting downward pressure on property values.

After a series of major adjustments to the federal funds rate in 2022, the Federal Reserve continued to hike up rates in 2023. The first hike took place in February, with a 25-basis-point increase, raising the target range to 4.50%–4.75%. Further 0.25% hikes happened in March and May, setting the target range for the federal funds rate at 5.00%–5.25%.

Over the last eighteen months, interest rates have continued to soar, posing a challenge for building owners who secured loans at lower rates. They are now confronted with refinancing at significantly higher rates ranging from 5-8%, inevitably lowering net revenue.  

Owners are also sweating over cap rates as they increase alongside interest rates in other assets, like 10-year treasuries. Buying a building with a 4% yield might not be a smart move when the 10-year treasury yield offers nearly the same return on investment. The United States Federal Reserve FOMC (Federal Open Market Committee) decided to raise interest rates to 5.25%–5.50% during July 2023, the 11th rate hike to combat down high inflation. Rates have remained steady so far.

Related Article: What Can You Do About Inflation To Protect Your Wealth?

Multifamily debt costs are up 75% in three years. All these interest only loans that were taken out by inexperienced sponsors to try to make the deals work are now coming due.

This graph depicts the rising interest rates set by the federal reserve from May 2022 through January 2024, showing the interest rate rising from just above 1% to over 5% in that time. This over 400% increase in the interest rate is creating a downward pressure on multifamily values, which decreased the performance of these assets and their returns.

Just above 1% to 5% is a 400% increase and going back to 2020 interest rates were almost zero.  So deals completed between August 2020 and May 2022 all were at some of the lowest interest rates on record.

With interest rates now up, this is creating downward pressure on multifamily values, which also creates downward pressure on performing assets. Higher interest rates caused upward pressure on cap rates when so many sponsors bought on the assumption of cap rate compression. From this, there is now downward pressure on values, forming a vicious downward cycle for any properties and eroding the returns once promised.

Higher Vacancy Rates

Vacancy rates are growing. A flood of new apartments entering the market has led to increased vacancy rates. Vacancy rates have escalated to a new 10-year high at 7.4%, almost a 1% (0.9%) year over year increase from last year. Simultaneously, rent growth is slamming on the brakes at a 10-year low with only a 0.6% increase compared to 3.9% the preceding year.

Despite the ongoing expansion in many growth sectors, certain markets are experiencing a decline. Notably, Austin, TX, as well as Fort Myers and Ocala, FL, are witnessing substantial decreases in rental rates, with declines exceeding 5% year-over-year.

Landlord pricing is closely tied to occupancy rates, allowing for a close estimation of rent growth expectations based on existing and approaching changes in vacancy rates. However, historical trends are broken when certain conditions align, typically emerging when vacancy levels approach critical thresholds.

For example, rental rates saw a significant increase for Sun Belt apartments during 2020–2022 as an influx of more wealthy migrants went to more affordable markets from coastal markets.

CBRE estimates that approximately 900,000 multifamily units are currently under construction and anticipates 440,000 units brought into the market in 2024. Among the 69 markets monitored by CBRE, 17 expect deliveries to surpass 7% of their stock in 2024, with five markets anticipating deliveries exceeding 10%.

More new rental apartments are coming to the market than at any time since the 1980s, and one reason is a proliferation of bigger and taller multifamily buildings, reported the Wall Street Journal.

Bad tenants are being pushed into lower-grade buildings, causing a headache for property managers, while good tenants are opting for higher-quality properties.

Higher Operating Expenses

Rising vacancies and escalating expenses are transforming the multifamily market into a challenging environment for property managers and investors alike. Operating costs for multifamily properties have skyrocketed, with a massive 75% increase in just three years, putting a strain on the profitability of these investments. 

Nationally, multifamily property operating expenses surged by 13% from 2020 to 2022, with only two markets showing slight decreases. In the 12-month period ending in June 2023, multifamily property expenses increased by an average of 9.3%, marking a substantial rise compared to the previous year’s 5.7% increase, according to Yardi Matrix data.

85% of U.S. multifamily properties are facing higher operating costs, ranging from a 5.0%–14.9% increase, due to inflation, a tight labor market, rising energy costs, and supply-chain disruptions.

Insurance costs, with an 18.8% average rise, are a major cost driver for apartment owners, followed by repairs and maintenance (14.2%), administrative (11.8%), and utilities and payroll (both 7.8%). Taxes, surprisingly, only increased by 5.9%. This surge translated to an $838 per unit increase in net operating income nationally for the year ending June 2023, increasing expenses by nearly $100 per unit.

Related Article: How To Utilize Commercial Real Estate For Taxes

Record deliveries of new apartment complexes in 2023-25 have contributed to a 51% surge, increasing vacancies and tenant segregation based on property grades. As previously stated, quality renters are shifting up to discounted higher-grade properties, leaving lower-grade buildings and their property managers with problematic tenants moving in and more trouble to deal with. Labor costs are expected to rise 5-6%, particularly for property management roles who may now face more difficult tenants.

Yardi notes a sustained trend of insurance hikes, potentially due to increased weather volatility. Apartment owners in hurricane-prone regions face considerable challenges, although tax relief, as seen in Texas, could moderate costs.

This graphic depicts the average cost of expenses, including taxes, utilities and repairs/maintenance, per unit, comparing the northeast, southwest, west, southeast and midwest regions to the national average.

Expense growth is most pronounced in rapid-growth regions, with the Southeast leading at 11.0% and the Southwest at 10.3%. Tampa, Orlando, the Inland Empire, and Miami are just some of the large metropolitan areas seeing major increases.

Multifamily property owners are dealing with stagnant rent growth, increased vacancies, and competitive leasing markets.

Value Add Multifamily Profits Have Proved Illusory

Value-add capital expenditures that were once promising have failed to deliver the expected returns. Now, some of the best returns in recent years have been found in high safety, core-plus properties with steady cash flow, challenging the notion that promises for high multiples in the future and high IRRs are superior to continuous stable cash flow.

The formula sold over and over again at multifamily masterminds and conferences is start a podcast, write an ebook lead magnet, educate your tribe of investors on the benefits of value-add multifamily, GP on more doors, get rich and quit your nine to five grind of a day job.  For many aspiring GPs and many limited partner investors this has turned from a daydream into a nightmare.

Executing property management turnarounds and overseeing construction projects are not brain surgery but are complex tasks.  It has not helped that disrupted supply chains from government lockdowns from Covid have spiked the costs of building materials and labor shortages have added to increased the costs

Ranking of returns with the net IRR and equity multiple by the real estate strategy employed since inception for LA County employees depicted in a pie chart for the collective percent of investments in each strategy and in a table with the Net IRR and Equity multiple. Core strategy (77.0% of investments) had a net IRR of 7.9% and equity multiple of 1.41x; Debt strategy (1.3% of investments) had a net IRR of 8.7% and equity multiple of 1.28x; Opportunistic strategy (15.6% of investments) had a net IRR of 5.2% and equity multiple of 1.23x; and Value-add strategy (6.1% of investments) had a net IRR of -3.7% and equity multiple of 0.85x.

These same returns are repeated over and over again with pension funds and private equity, demonstrating over and over again that pushing for the extra risk most of the time does not give you the rewards. 

Value add is supposed to add Alpha returns to boost your portfolio.  Instead for Los Angeles county, it is dragging down returns.  This has been a similar scenario across the board with pension funds and average investors. 

Related Article: Can You Buy A Cup Of Coffee With That High IRR?

Inexperienced Sponsors Washed Out

The multifamily meltdown was worsened by the influx of sponsors lacking real estate expertise who presented themselves as adept “asset managers” who could steward capital for investors. Factors such as “get rich fast” podcasts and Instagram accounts and now even TikTok exacerbated the rise of these inexperienced sponsors.

 the JOBS Act, increased media coverage of real estate, and prevalence of social media platforms While the entry of newcomers into the real estate investment arena is not inherently problematic, issues arise when they downplay the risks and convince investors there isn’t anything to worry about.

Many inexperienced sponsors took excessive risks and persuaded others to follow suit, leading to significant financial losses. Lack of experience in asset management and the failure to predict potential challenges played a pivotal role in the multifamily meltdown. Entrusting capital to sponsors who downplay risks and lack the necessary expertise can result in poor decision-making, ultimately jeopardizing the success and stability of real estate investments.

The other issue was that Internet multi family grows sold $10-$50,000 mastermind’s where are you learned anyone could buy multifamily with little or no experience experience, and all you had to do was round up enough investors to pay the down payment and get somebody else to sign on your subsidize Fannie Mae loan.

Those deals in those properties going to be the first that get washed out because these inexperienced sponsors who sold themselves as knowledgeable about “underwriting“ and “asset management“ do now not know how to deal with the myriad problems, overwhelming them

And most, unfortunately, the investors who trusted the sponsors with their capital, retirement savings, and hard earned money will suffer the most. 

If you are a passive investor, look for sponsors with experience in turnarounds and negotiating with lenders.

What Every Investor Should Know Before Making an Investment

If you are hesitating with an investment decision, you may want to reflect on your investing philosophy and criteria to identify what is most important to you. Everyone has different expectation when it comes to investing, but just ask yourself these questions to see if an investment aligns with what you are looking for:

  • How do projected returns compare with actual risks?
  • How can I lose money on this investment (and can anything be done to mitigate the loss)?
  • Will this investment help me get closer to my overall goal, even if the projected returns fall short?

There are more opportunities for cash flow and investments returns without the added risks that currently the multifamily sector is facing. Real Estate strategies that preserve your capital and create higher than average returns for 2024 and beyond include:

  • Single Tenant Triple Net (NNN) Properties
  • Commercial Real Estate Debt Funds
  • Single Family Sale/Leaseback Opportunity Funds
  • Positive Aspects Of Multifamily After 2025

The Triple Net Advantage: Stability in Unstable Times

Triple Net (NNN) properties, also known as net lease properties, are favored investments due to their ability to generate reliable cash flow throughout the lease duration while minimizing management responsibilities for investors. With the tenant paying not only the rent, real estate taxes, insurance AND the maintenance of the triple net property, the investor has minimal management responsibilities. 

Related Article: Beginner’s Guide to Triple Net Lease (NNN) Investing

A pure Triple Net property means that you, as the landlord, will have no expenses other than possibly hiring a property manager, bookkeeper and tax expert to keep track of finances and payment. But other than that, you’re going to have no expenses on a pure Net-Net-Net property. The consistent and predictable monthly cash flow over these long-term leases enhances the appeal, providing investors with a hassle-free, stable income stream that remains relatively unaffected by fluctuating expenses.

Additionally, the tax-efficient and tax-sheltered nature of net lease income, attributed to depreciation benefits, further enhances the attractiveness of these investments.

Investors in Triple Net leases also benefit from the association with well-known brand names. For instance, investors can own a property operated by a popular brand like Starbucks or Walgreens, enjoying the perks of investing in a brand-name tenant and receiving regular rents from the parent company. The association with reputable brands adds a layer of security and familiarity to the investment.

The long-term nature of Triple Net leases, coupled with their predictability and minimal management requirements, makes them a superior investment option for those seeking stable and secure returns in the commercial real estate market.

Triple net properties offer a haven of stability with no expense exposure. Despite the challenges in the multifamily sector, certain mitigating factors suggest that the U.S. has a structural housing shortage, potentially averting foreclosures as banks may choose to extend and pretend to avoid dropping capital.

CRE Debt Funds

Commercial real estate debt funds present several advantages for investors looking to capitalize on well-located properties at current, lower values. CRE debt funds offer an income stream generated through interest payments on the underlying real estate loans, offering a predictable cash flow. 

These funds typically invest across various real estate projects and property types, spreading risk geographically and across different sectors. This type of diversified portfolio helps investors manage risk, enhance returns, and navigate market fluctuations more effectively.

The professional management of commercial real estate debt funds, overseen by experienced professionals, enhances the overall risk management of the portfolio. 

Debt investments also generally have lower volatility, making them attractive for investors seeking stable income and wealth preservation. 

Investors also enjoy a senior position in the capital stack structure, providing a higher claim on cash flow and assets in case of default. Accessibility to the real estate market, without the complexities of direct property ownership, and the potential for liquidity add to the appeal. Just be aware of the associated risks with the fund and assess factors such as interest rate risk and credit risk.

Single Family Sale/Leaseback Opportunity Funds

Investing in Single Family Sale/Leaseback Opportunity Funds in real estate can offer several benefits to investors. Single family sale/leaseback arrangements typically involve long-term lease agreements, providing investors with a stable and predictable cash flow. 

Investing in single family sale/leaseback opportunity funds offers investors diversification in their real estate portfolios beyond traditional residential or commercial properties, which can mitigate risk and reduce the impact of market fluctuations on overall investment performance.

Sale/leaseback arrangements often involve established homeowners who are looking to unlock equity in their properties while retaining occupancy that lowers the risk of tenant turnover and vacancy compared to traditional rental properties, as the homeowner typically has a vested interest in maintaining the property.

Single family sale/leaseback opportunities combine rental income and potential property appreciation that can yield competitive returns for investors, especially in markets where demand for single family rental properties is strong.

These funds can also serve as a hedge against inflation. As the cost of living increases, rental income and property values may rise, helping investors preserve the purchasing power of their investment capital over time. Like other real estate investments, single family sale/leaseback opportunity funds may offer various tax benefits to investors, including deductions for depreciation, property taxes, and mortgage interest, which increases the overall after-tax returns for investors.

Investing in these opportunity funds often provides access to professional management teams with expertise in identifying, acquiring, and managing the single family sale/leaseback properties, which provides investors with a different stream of passive income that requires little to no work on their part.

Sale/leaseback arrangements can benefit homeowners by providing them with liquidity while allowing them to remain in their homes, appealing to investors who prioritize responsible investing and community development.

Overall, investing in Single Family Sale/Leaseback Opportunity Funds in real estate can offer investors a compelling combination of stable income, diversification, potential for capital appreciation, and tax benefits.

Related Article: The Different Ways Of Financing Commercial Real Estate

Safeguarding Your Investments

Multifamily does still have good factors for investing, including depreciation and financing through Federal National Mortgage Association (FNMA), Housing and Urban Development (HUD), Government National Mortgage Association (GNMA), and Freddie Mac/Federal Home Loan Mortgage Corporation (FHLMC). 

The US is in an ongoing battle with the Housing Affordability crisis, as well, as the market continues to be under-supplied in low and middle income housing, which could see relief by building more multifamily properties that serve those tenants.

As multifamily investments face an uncertain future, astute investors are diversifying and seeking refuge in stable alternatives. The key lies in informed decision-making, cautious risk management, and a strategic shift toward investments that weather economic storms. 

For investors seeking safer havens, the following steps are recommended:

Avoid Rescue Financing. Investors should be cautious with rescue financing and recapitalization deals, which may cram down existing investors and lead to potential equity wipeouts. Instead, consider focusing on distressed debt and aligning with experienced sponsors for passive investors. Resist the temptation of rescue financing and recapitalization. Instead, consider buying distressed debt directly from lenders at a discount.

Look for Experienced Sponsors. Passive investors should seek sponsors with a track record in turnarounds and negotiating with lenders. Experience matters in navigating the complexities of the current market.

Explore Alternative Investments. While waiting for the multifamily market to recover, consider exploring NNN properties with credit-worthy tenants and debt funds capitalizing on well-located properties at current, lower values.

Remember, wealth is about assets that earn while you sleep, and now is the time to prioritize stability over speculative gains.

For more information contact: 

Michael Flight

Co-Founder & Chief Strategy Officer of Invest On Main

CEO & Co-Founder of Liberty Real Estate Fund

Co-Founder of Blockchain Real Estate Summit

Michael Flight was named the Godfather of Blockchain Real Estate by Forbes Crypto.  Michael achieved that distinction by co-founding Liberty Real Estate Fund, the World’s First Net Lease Security Token Fund, creating the Blockchain Real Estate Summit. More recently co-founding Invest On Main ( the Real Estate & Alternative Asset marketplace of the future and AcceleratedLaw a faster, cheaper way to create and tokenize securities offerings! 

Michael is a real estate entrepreneur and real estate tokenization pioneer who is an expert in retail real estate investment, redevelopment and real estate on the blockchain.  He started his commercial real estate career in 1985, and then co-founded Concordia Realty Corporation in 1990, which continues to partner with some of the world’s most well-known banks, insurance companies, hedge funds and institutional investors in many successful investments.

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