The slump in commercial real estate has spread to apartment buildings, which were the sector’s top performers in 2021 when rental rates surged with demand as soaring home prices froze more households out of home ownership.

Rents followed home prices into the stratosphere, rising 20 percent or more in the most sought-after locations.

Investors bid up prices of existing properties and backed construction of new blocks of flats, assuming that rents would rise indefinitely.

They didn’t.

Instead, more renters took in roommates to share costs while others moved back in with parents or other family members, a trend we reported in “Apartment Rent Increases Slow Their Pace” (9 Aug 2022). 

As a result, rents are rising more slowly and, in some markets, have begun to reverse.

Many investors who bought into the sector during the peak in 2021 and early 2022 took advantage of adjustable-rate mortgages, only to see their monthly payments steadily rise as the U.S. Federal Reserve increased its benchmark interest rate over the past 12 months.

Also, the banking industry has suddenly grown more cautious in general, becoming more picky about the deals it finances and then often at premium rates.

Applesway Investment Group borrowed $230 million to buy four apartment complexes in the Houston area. The loan’s interest rate has more than doubled, growing from 3.4 percent originally to 8 percent this month, data firm Trepp reported.

With rental rate increases slowing or going negative, a growing number of investors no longer have the cash to keep up payments, The Wall Street Journal noted.

Arbor Realty Trust, Applesway’s lender, foreclosed on the Houston properties.

Veritas, a private equity firm, defaulted on a $450-million loan against rent-controlled apartments in San Francisco; private equity giant Blackstone Group is renegotiating loans on a portfolio of New York City apartment loans, the WSJ noted.

Now property owners are less able to escape their loans by selling their apartment buildings.

Sales of apartment buildings fetched $14 billion in this year’s first quarter, 74 percent less than the first quarter of 2022, research service CoStar Group said.

Properties that did sell averaged prices 8.7 percent below those a year earlier, according to the MSCI Real Assets index. 

Among publicly traded landlords, the decline was 20 percent, data firm Green Street reported.

TREND FORECAST: The drop in dollar volume represents the sharpest annual decline since the first quarter of 2009 when the Great Recession was still near its depth. The fall marks the largest annual dive since 2012, except for 2020’s first quarter when the COVID War effectively shut down the market.

A bad situation will get worse as many of these investments are backed by floating loans whose borrowing costs rise as interest rates move higher.  

As an investment, apartment buildings – and commercial real estate in general will not recover until—or if—inflation stabilizes and the U.S. Federal Reserve begins to cut its base interest rate. And it should be noted that the deeper interest rates fall, so too will the value of the dollar which means inflation will stay high.