Multifamily Distress: Why It’s Not the CRASH Everyone Predicted

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Michael Zuber (1:01)

Alrighty, folks, we have expected, frankly, a disaster in the multi-family real estate market. And we've seen some, there have been some creaks and some pains and some significant losses by folks like Brandon Turner, S2 Capital, and many others. But let's be clear, it's not the massive tsunami that we had expected. Now, one of two things are possible. One, we could still be a little bit early. And maybe with the rising 10-year and rising mortgage rates, something will prick that bubble and a wave will show up. Or this time might be different.

Banks turned out to be not the most aggressive lender at the top of the market. Could this new lender be potentially in the lend to own business? Or perhaps they just want to operate it till the cycle turns because they have patient capital.

So is this foreclosure wave that I had long been waiting for just not going to show up?

I don't know. Let's talk to Jonathan Twombly about it. How are you doing, buddy? Great. How are you, Michael? I'm doing well. This is a fun topic because you and I, years ago, turned $100 million property into 48 million with like two or three changes. We knew this was coming. Values are down 20, 30, and in some markets, 40 percent. But I think it's fair to say, other than some high-profile disasters, the wave, it's a trickle. It's not even a stream just yet. So what's what?

Jonathan Twombly (2:22)

Yeah. So everybody has been waiting for this huge wave of distress to hit the market and reset multifamily prices because deals just aren't happening right now. Everything is, sellers are holding on to their peak prices because they're trying to get their capital out. Buyers are like, no way, I'm not paying that, it ain't worth it. And usually when that happens, what you start to see is a bunch of foreclosures as people are unable to refinance their debt after five years.

So we're up at that five-year point now, almost at the end of 2026 So all of the 2021 vintage loans that were five-year notes have come to or about to come to this year. And we got a whole bunch more coming to next year.

Michael Zuber (3:07)

It's over a trillion dollars is what I've heard. It's just a massive.

Jonathan Twombly (3:09)

So there is a ton of debt that is just really going to struggle to refinance. So that would suggest like, hey, we're going to have a lot of foreclosures. And one of the things that I think I've overlooked in our conversations over the last couple of years, while we've been talking about this impending wave is, well, who were the lenders at the top of the market? And how are they potentially different?

So at the top of the market back in 2020, 21, 22, maybe even back into 2019, prices had gotten so frothy on multifamily that banks were basically priced out. They couldn't loan because they would require a 1.25x DSCR on property. Yeah, their covenants wouldn't allow it, yeah. And so what was happening was that the banks and Fannie and Freddie were coming in at very low leverage, which meant that investors had to come up with a lot of equity, and as you all know, when you got to come up with that much equity, your returns are lower, and all the operators are competing against each other to get capital, and to do so, they had to promise really high returns. So how did they square that circle? Well, they started going to debt funds. A lot of debt funds sprung up around this time to fill this gap where banks were basically priced out. And you could make an argument that if non-bank lending were not permitted, the bubble would have just run out of steam at that point.