UPDATED, Aug. 23, 2023, 10:14 a.m.: Veritas Investments, a prominent multifamily landlord in San Francisco, is seeing red flag indicators on two loans tied to a portfolio in Southern California.
San Francisco-based Veritas is not making enough income from 11 of its apartment complexes in Los Angeles County to meet its monthly debt payments, as rising rates have ballooned debt costs, according to Morningstar data.
“We intend to extend the loans,” a Veritas spokesperson said.
Since interest rates have shot up since last June, many commercial real estate firms that used floating-rate loans to buy properties can’t raise net income fast enough to meet their bigger debt payments.
Multifamily, once thought to be more insulated from distress given steep rent growth in 2021, has now come under fire, with more borrowers scrambling to meet ballooning payments.
Veritas is one multifamily owner with experience in the painful reality of rising rates. In January, the landlord defaulted on $1 billion in loans tied to 95 rent-controlled properties in San Francisco. Currently, the firm is awaiting the results of a debt auction for loans, backed by a total 2,452 units in two portfolios. As TRD reported in May, Veritas planned to bring in new financial partners to buy back its own debt.
In Los Angeles, the 11 Veritas-owned properties are tied to two loans with a value of $114.2 million, originated by MF1 Capital, a debt fund favored by multifamily syndicators, and then packaged into collateralized loan obligations, or CLOs.
Veritas scored both loans in 2021, according to a Morningstar report.
MF1 originally gave out a $49.3 million loan, which is backed by nine properties — eight in the city of Los Angeles and one in West Hollywood — and a $5.4 million loan. Both had a provision to allow Veritas to tap more funding to buy properties in the future; in total, Veritas could draw on $200 million.
And Veritas took up the offer. The second loan now totals $59.8 million and is backed by two apartment complexes — 12707 Mitchell Avenue in L.A. and 33 Eastwind Street in Marina del Rey — which Veritas purchased for $8.1 million in 2021, records show. The loan proceeds were to go towards acquisitions and capital improvements.
Both loans carry rate caps — 4.55 percent on the first and 4.8 percent on the second, according to Morningstar. But when the loans mature in December, Veritas will have to secure a new one if it chooses to refinance the properties.
The dark omen hovering over the SoCal portfolio is a metric called debt service coverage ratio. If a property is reeling in enough cash to meet its debt payments, the loan has a debt service coverage ratio of 1.
In December, the debt service coverage ratio on the first loan backed by nine buildings was 0.56, meaning cash flow was far below the threshold needed to service its debt, according to Morningstar. The ratio on the second loan was 0.89.
“Improvements are ongoing at these assets and our ability to extend the loans are not tied to the properties’ DSCR,” a Veritas spokesperson added.
According to a Morningstar report, MF1 required Veritas to always keep a minimum debt service coverage ratio of 1 on both loans. It’s unclear if MF1 has reported an event of default or has instituted some sort of waiver.
There are two ways to raise the ratio. First, the Federal Reserve could lower interest rates, which would bring down debt payments. Or second, the landlord has to boost income by raising rents at the property.
But that’s a challenge in L.A. The average monthly rent for a one-bedroom in Los Angeles is currently $2,402, a roughly 2 percent decrease from a year ago, according to Zumper.
This story has been updated to include a statement from a Veritas spokesperson and clarifications.