Rising Borrowing Costs & Distressed Multi-Family Properties

Blog May 2024

The first quarter of 2024 has witnessed a striking surge in loan delinquencies in the wake of rising inflation, creating a stressful environment for lenders and real estate investors. While the impact of market forces like high interest rates and inflation cannot be discounted, financing companies must regulate their effect with pragmatic and diligent lending practices. 

Water tight due diligence metrics safeguard lenders and their clients, preventing inexperienced investors from taking lofty risks they do not have the capacity to undertake.The case of Arbor Realty, a public company listed as ABR, is a prime example to understand how lack of due diligence can lead to a sharp increase in loan defaults. 

The real estate sector is abuzz with Arbor Realty’s disclosure of significant downgrades on their loan ratings brought on by a dramatic surge in loan defaults, mainly from distressed multi-family investment lending.

Borrowers Defaulting with Multi-Family Investments

Arbor is a popular choice for investors looking to develop and resell multi-family properties given their relatively relaxed financial requirements. Unlike most debt financing agencies that demand investors provide at least 30-40% equity to seal the deal, Arbor only requires 20% of equity. The company’s rise into a real estate financing powerhouse has inspired many, but the rapid expansion clearly came at the cost of inefficient loan handling as Arbor Realty failed to conduct thorough due diligence.

While Arbor is trying to spin its problems as a symptom of high interest rates, with a net increase of $155m in loan delinquencies, and 16% of loans having passed their due date, it’s clear there’s more to this crisis than just a “challenging” market environment!

As per Viceroy Research, Arbor have downgraded their loan ratings from pass to special mention – meaning credit challenged – from 60% to 1.7% pass – a staggering 97% decrease!

A vast majority of Arbor’s borrowers included multi-family developers working on turn-around projects. These developers aimed to renovate and improve the property and resell them for a sizable profit before the expiry deadline of the rate cap. One borrower, Jay Gajavelli, had taken out loans to invest in more than 7,000 units in the Houston residential market. Gajavelli didn’t come from a real estate background and the lack of experience led to a colossal mismanagement of the acquired portfolio. In 2023, Gajavelli went bankrupt and Arbor had to organize a foreclosure sale for the 7,000 units.  

This is just one example of the innumerable loan delinquencies cases Arbor is currently overwhelmed with. According to the company’s CEO, Ivan Kaufman, Arbor Realty is witnessing a “period of peak stress” and the rest of the year is bound to prove “challenging.”

Throughout the speculative real estate frenzy that lasted from 2021 to early 2022, Arbor emerged as the leading financing choice for Sunbelt housing investments. The relaxed borrowing terms made Arbor a favorable lender, but this rapid expansion came at the cost of inefficient loan handling. 

Despite Arbor’s efforts to camouflage the crisis and overshadow the startling figures, industry insiders are fully aware of the unmanageable volume of outstanding loans amassed by the company. Our findings are backed by a report from Banco Santander, claiming that Arbor’s volume of default loans is currently 2.5 times higher than the market average.

Our takeaway; the company has compromised thorough due diligence to prioritize short-term profitability at the expense of long-term stability. 

The Future of Interest Rates: Increase or Decrease?

With the FED maintaining there will still be three rate reductions this year, potentially reducing interest rates to 4.6%, pressure on borrowers may improve, but the outlook is far from certain.

Inflation is the strongest determinant of how interest rates will evolve. If inflation continues uncontrolled, then rate cuts aren’t a possibility. Given the rising cost of borrowing, we believe 2024 will witness a dramatic surge of distressed multi-family properties being listed in the market.

 The rising interest rates, curtailed revenue growth and excessive leverage will lead to an influx of distressed multi-family properties – a development that can allow the market to recover and create opportunities for those who prioritize strategic thinking. 

We’ve observed that most inexperienced investors will find themselves forced to sell as their cash flows dry up and loans inch toward delinquencies. Pragmatic investors can scan the market for an array of profitable assets with a high ROI potential as long as they rely on conservative fixed debt financing.

Setting reasonable assumptions about rental income growth lies at the crux of this strategy as most distressed investors have failed due to exaggerated assumptions and a disconnect from market realities.

Final Thoughts

Real estate is a field that demands patience and perseverance, and most importantly, the ability to overcome greed with calculated decision-making. We empower our clients with a straightforward investment approach grounded in transparency, equipping them with a wealth of resources to inspire confidence

Whether you’re looking to identify the best markets to invest, or seek to take advantage of high-potential properties that guarantee government-backed returns, GCG Real Estate is your ideal partner. Feel free to get in touch with our team and learn how we strive to benefit our investors and the communities we serve! 

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Any questions

What is affordable housing?

Affordable housing refers to housing units designed to be accessible to low- and moderate-income families, typically costing no more than 30% of their gross income.

The definition of “affordable” typically varies depending on location and income levels but generally encompasses rent or purchase prices that don’t exceed a certain percentage of a household’s income.

What is Section 8 housing in the US?

Section 8 is a federal rental assistance program in the US run by the Department of Housing and Urban Development (HUD) that helps low-income families and individuals afford decent and safe housing in the private market. 

The program provides eligible households housing choice vouchers that cover a portion of the rent directly to the landlord, with the tenant paying the remaining amount. Property owners who participate in Section 8 agree to rent units to qualified individuals and families at a rate approved by the program.

How can I invest in Section 8 housing?

There are several ways to invest in Section 8 housing:

  1. Direct ownership: You can purchase a property approved for Section 8 and rent it to a qualified tenant using a voucher and receive rent subsidized by the government.
  2. Real estate investment trusts (REITs): REITs pool investor funds to purchase and manage income-producing real estate, including affordable housing.
  3. Limited partnerships: Limited Liability Companies (LLCs) offer another option for investors to pool resources and invest in affordable housing projects.
What is the difference between multi-family and single-family properties?

Single-family property: This refers to a standalone house or unit designed for and rented to one household.

Multi-family property: This refers to a property containing multiple dwelling units, such as a duplex, apartment building, or condominium complex. Multi-family properties offer the potential for higher rental income but typically require different management strategies and considerations compared to single-family homes.

What is the difference between buying and flipping houses?

Buying and holding: This involves purchasing a property to keep it as a long-term investment, generating rental income and potentially appreciating in value over time.

Flipping: This involves buying a property, renovating it to increase its value, and then selling it quickly for a profit. This is a more hands-on strategy with higher risks and rewards compared to buying and holding.

How much do I need to start investing in affordable housing real estate?

The minimum investment required varies depending on the chosen method. Direct ownership typically requires a higher initial investment for the property purchase, and renovation up to Section 8 standards, while other options like REITs might have lower minimum investment amounts.

Do I need to be a US citizen to invest and own the property?

No, US citizenship is not a mandatory requirement for investing in affordable housing in the US. However, specific restrictions or regulations might apply depending on the investment method and your residency status.

It’s crucial to consult with a professional to understand the legal and tax implications for non-citizens.

Do I need to pay US tax as an overseas investor?

This depends on the type of investment, your residency status, and any applicable tax treaties between your home country and the US.

Consulting with a tax professional specializing in international investments is highly recommended.