The crevices in the commercial real estate sector are expanding beyond offices, reaching into apartment complexes, with over $67 billion worth of housing potentially facing distress as borrowers grapple with repaying loans obtained during the peak of the pandemic. This poses significant challenges for lenders like Arbor Realty Trust Inc., specializing in packaging floating-rate loans into commercial real estate collateralized loan obligations (CLOs), a financing trend that surged in popularity during the pandemic’s peak.
Preliminary data compiled by Banco Santander SA indicates that the proportion of loans within Arbor’s CLOs failing to meet scheduled payments more than doubled in the fourth quarter. In December, approximately 16.5% of Arbor’s outstanding loans were past due, marking a 2.5-fold increase compared to the broader commercial real estate CLO market.
Mary Beth Fisher, a senior fixed income strategist at Santander, noted in a recent report that collateral performance in commercial real estate CLOs deteriorated throughout 2023, with stress and delinquency rates spiking notably in the final months of the year. Fisher anticipates this trend persisting until mid-2024.
Paul Elenio, Arbor Realty’s chief financial officer, stated that the company is currently in a quiet period ahead of releasing its year-end results later in February. Elenio affirmed the company’s commitment to transparent communication with investors and expressed anticipation for updating the public with the forthcoming earnings release.
Apartment building financiers faced challenges due to the sudden tightening of monetary policy, particularly as they frequently extend bridge loans with floating interest rates. Lenders like Arbor are particularly vulnerable to borrower defaults as they provide the equity portion of CLOs, thereby bearing the brunt of losses if loans go unpaid.
The resurgence of concerns surrounding commercial real estate intensified after New York Community Bancorp and Japan’s Aozora Bank Ltd. allocated additional funds to address deteriorating commercial property loans. Rising interest rates have led to declining property values, resulting in investors facing losses, akin to the impact of rising yields on bond prices.
The popularity of lending to apartment complexes and bundling these loans into CLOs soared amidst the Federal Reserve’s rapid response to pandemic-induced turmoil. However, as borrowing rates began to climb, the trend reversed. Factors such as new supply, stagnant revenue growth, and increased expenses exacerbated the situation, with the delinquency rate for multifamily commercial mortgage-backed securities projected to double this year, according to Fitch Ratings.
MSCI Real Assets estimates that over $20 billion worth of apartment complexes purchased in the past three years are potentially distressed, a figure that triples when including properties not recently transacted. Blackstone Inc. is considering further investments in multifamily assets despite emerging challenges, reflecting a long-term positive outlook.
Although the outlook for apartment complex rentals has improved in recent months as borrowing costs stabilize, Arbor, based in Uniondale, New York, has faced scrutiny from short sellers. Reports by entities such as Viceroy Research have raised concerns about Arbor’s exposure to distressed loans. As of Wednesday, short interest in Arbor stood at almost 31%, according to data from S&P Global.
Arbor had approximately $7.3 billion of outstanding collateralized loan obligations last year, constituting nearly half of its capital stack, as detailed in an investor presentation from May.
