Trouble on Horizon for Some Texas Multifamily Investors

Kenny Rogers put it best: a gambler needs to know when to hold ’em and when to fold ’em. In Texas, as multifamily CMBS loans mature amid slowed rent growth and higher interest rates, some investors are at the same fork in the road as “The Gambler”.

Many saw a bulletproof formula in the Texas Triangle in 2020 and 2021: asset values, rents and populations were booming, and debt to fund those expensive acquisitions was cheap. In 2021, average rent in Austin jumped 26 percent. That was then. In the last year, rents are down about 2 percent in Austin. Interest rates are up as apartment supply is increasing in major Texas cities at some of the fastest rates in the country, devaluing older and lower-quality apartments.

“That will crush rents,” said Scott Everett, CEO of Dallas-based multifamily firm S2 Capital, on a recent podcast.

That leaves many investors looking to refinance their debts facing more overhead on less-valuable property with a narrower path toward boosting income. The “extend and pretend” playbook is nothing new in real estate, and many multifamily investors who hold more expensive debt than they hoped to are now working out agreements with their lenders to kick the can down the road.

Others aren’t so lucky.

The special servicing rate of CMBS multifamily loans has more than doubled in the past year, hitting 3.26 percent in July. That’s still well below the overall CMBS special servicing rate of about 6.6, but it has steadily increased in the past year, unlike retail and lodging, whose rates have slowed.

In multifamily in particular, one cause for special servicing is particularly troubling to lenders: low debt service coverage ratios. A low DSCR isn’t always a sign of trouble, particularly for value-add multifamily properties. As owners renovate units and raise rents, there are inevitable declines in cash flow and occupancy. But as a loan approaches maturity and requires refinancing, a DSCR below 1 can be refinancing repellant.

TRD has compiled a list of multifamily CMBS loans in Texas flagged for low DSCR and set to mature by year’s end, according to data from Morningstar Credit. It’s important to note that almost every loan below has a maturity extension option that could kick the can back to 2026–however that usually involves clearing some sort of hurdle, potentially buying new rate caps or putting more equity into the deal.

It’s also important to consider that, even if the loans maturities are extended and renovations are completed before ultimate maturity, Texas metros are set to see a wave of new multifamily apartment delivery in the next few years. Dallas-Fort Worth has the largest pipeline of multifamily product in the country, with nearly 80,000 units under construction, according to a report from Berkadia. Austin and Houston also rank in the top 10.

Here’s the list:

All of the loans are adjustable-rate mortgages issued in 2021, with an average 3.3 percent interest rate. That’s well below the prevailing Secured Overnight Financing Rate of 5.3 percent. Based on that current estimate of prevailing rates, the following properties are already into their caps: The Place at 1825, Tides on Haverwood, Equinox on the Park, Verandas at City View and Park Lane & Biltmore Apartments.

UPDATE: Trailside Oaks Apartments has been refinanced, and its DSCR is at par, according to a spokesperson for the firm.