Multi-Family Still Solid, but Beware of Toxic CMBS Pockets

Multi-family has been the darling of the recovery, but it’s also one of the worst performing property types in terms of delinquencies for Fitch-rated CMBS. But the good news is that most of the toxic assets are contained in small pockets – ones that can be avoided.

Last month, Commercial Property Executive examined the idea that the time is right for buying, selling and refinancing in the multi-family sector. Buoyed by high-profile transactions and a landlord-favored market climate — as well as pent-up capital that’s been looking for a release — experts at CBRE Capital Markets and Marcus & Millichap Real Estate Investment Services Inc. saw 2012 as the time that things would be turning around and the money would again flow.

However, new data from Fitch Ratings suggests that there is an interesting contradiction in multi-family performance: While the sector has been the darling of the recovery, it’s also one of the worst performing property types in terms of delinquencies for Fitch-rated CMBS. But the good news is that most of the toxic assets are contained in small pockets – ones that can be avoided.

Multi-family loans amount to $54.9 billion in fixed-rate multi-borrower CMBS rated by the agency, making up 14 percent of the total rated CMBS portfolio. Using the standard definition that counts any loan 60 or more days delinquent, the multi-family delinquency rate across the whole country was 14.4 percent at the end of 2011 but dropped to 12.8 percent at the end of January 2012. Huxley Somerville, a managing director at Fitch and one of the report’s authors, suggested that the problem isn’t the market in general, but specific cities and outliers that are bringing down the aggregate multi-family CMBS market.

“There are specific markets that are performing far worse than average,” Somerville told Commercial Property Executive. “New York is one of those markets.” While the city has a high delinquency rate — 56.7 percent, the second-highest in the country — the reality is that just four loans, totaling $3.6 billion, are skewing the results. Those four properties, which were all originated in 2007 based on the expectation that they would be converted from rent-controlled units to market-price rents, bore the brunt of the financial crisis and haven’t been able to perform. Remove those four problems from the equation and New York’s delinquency rate drops to 3.4 percent.

“Otherwise, New York is performing well,” Somerville said. “It’s well underwritten with the proper rents in place.”

That process is repeated in other markets around the country as well. Nevada is sitting at a delinquency rate of 32.6 percent but, as Somerville explained, “when you say Nevada, you really mean Las Vegas.” Vegas was hit hard by the recession, full of developments, rental properties and apartments that proved unsustainable in the full force of the economic compression. Kansas is another problem area. “You would expect Kansas to be stable,” he said, “but it’s 16 percent delinquent.”

“The biggest surprise was the variance,” he said. “You’re always told that geographic diversity across loans makes for a more stable portfolio, and now that’s not the case.”

Another confounding factor, Somerville said, was that many of the CMBS holders are individuals, not companies. “They’re not REITs,” he said. “They’re typically smaller ventures, so it’s more difficult to understand what’s going on at the borrower level.”

So while multi-family looks like it will certainly continue as the darling property type for 2012, it’s important to look at the individual markets, especially when evaluating investments on the CMBS side.