The default on a $450 million loan by one of San Francisco’s biggest apartment landlords could be a sign of things to come as debt taken out at historically low interest rates begins to mature, according to market analysts and multifamily agents.
The delinquent loan, backed by 62 rent-controlled apartment buildings, shows that there’s a “chink in the armor” of commercial mortgage-backed securitized loans for multifamily assets, according to Manus Clancy at Trepp. He said multifamily has been a “really, really strong performer,” with rents rising in markets across the country and very few defaults until now.
“This is an outlier,” he said of the Veritas default, adding that unlike the Shorenstein Properties $400 million default on the Twitter building, “This I think took people by surprise.”
Melissa Che at Fitch Ratings agreed that the pandemic had boosted apartment returns overall as rents have gone up and the ability to purchase a home in many markets has gone down. But she said that this year, looking at a maturing loan backed by apartment buildings, is not dissimilar from a maturing loan backed by an office building.
“All property sectors across commercial real estate with maturing loans are going to face some level of refinance stress because interest rates have shot up so quickly in such a short amount of time,” Che said.
In a recent report, the ratings firm said that refinancing risk was high for the estimated $26.5 billion in CMBS loans maturing by the end of 2023 as the average gross interest rate at the time these loans were issued was 4.75 percent and the current market interest rate is about 2 points higher. Multifamily makes up nearly 22 percent of this year’s maturing loans and the bulk consist of Freddie Mac loans, which had an even lower average interest rate at issuance — just below 4 percent.
Fitch estimates that about a quarter of 2023’s maturing loans will not be able to meet loan-to-value or debt service coverage ratio parameters to refinance without a significant infusion of capital from the borrower, growth in net operating income or a combination of the two.
Che said she was not particularly concerned about the Veritas loan because the debt per unit is low and cash flow is above “stressed levels.” It also appeared from loan documents that even with higher vacancy rates, the portfolio was bringing in more rental income than when the loan was issued in November 2020, which meant the business plan to renovate the rent-controlled units on turnover and rent them at market rates was working.
“I think there might be a lot of noise in terms of the transfer to special servicing and the borrower defaulting at maturity,” she said. “They’re just likely discussing options and what types of workouts are suitable.”
In a statement, Veritas said that it remained committed to San Francisco and that it would “continue to operate and manage the properties as normal while its partner, who has decision-making authority, continues discussions with the lender about resolving the loan impasse to something acceptable to the parties.”
Ramon Kochavi of Marcus & Millichap said that Veritas was essentially too big to fail. He couldn’t see a scenario where its lenders would foreclose on the 62 apartment buildings rather than working out a new deal with capital partner Baupost, in part because other large, institutionally-backed owners in the city will likely face similar refinancing issues in the near future.
“There’s more where that came from,” he said. “There was an expectation of rent growth that happened across the U.S., but it didn’t happen here. The buildings just can’t carry the notes.”
Foreclosing and then flooding the multifamily market with properties for sale doesn’t serve anyone, Kochavi said. The market has come to a near-standstill recently as major buyers pull back and sellers aren’t willing to accept lower values,
“It’s a game of chicken now,” Kochavi said. “The bank doesn’t want it. The sponsor doesn’t want it to happen. It’s just the question of who takes the haircut.”