A&E Real Estate’s struggles with a $600 million multifamily loan came to a head last month.
The debt was supposed to be repaid in June. To extend its maturity date, the New York landlord needed an expensive new rate cap, according to Morningstar Credit.
Making matters worse, the 31-building portfolio, which is heavily rent-regulated, had been bleeding for over a year. Its value had fallen so much that the loan-to-value ratio had soared to 200 percent from the original 71 percent.
A&E, led by Douglas Eisenberg, kept making payments on the expired debt but didn’t buy the rate cap and didn’t extend the loan, thus rendering it delinquent, according to Trepp and Morningstar.
An A&E spokesperson said the firm had “remained current on all payments since the loan’s inception.” The firm is working to get an extension “in light of improving conditions in the capital markets,” the spokesperson added.
The loan’s expiration helped push the national delinquency rate for CMBS multifamily loans to a three-year high, according to Trepp. It was the first time in recent months that an asset class other than office jacked up the overall rate.
Until now, the distress in securitized multifamily loans has been in the Sun Belt, where investors tapped short-term, floating-rate debt to buy and renovate apartment complexes. Then rates rose, rent growth flatlined, money for renovations ran out and delinquencies mounted.
“It’s fair to say there’s a significant amount of that,” Trepp’s Lonnie Hendry said on a recent webinar.
A&E’s situation is a different beast — a case of rent-regulated distress bubbling up in CMBS, and a sign of a wider trend.
The A&E portfolio in question is 85 percent rent-regulated and comprises buildings in Upper Manhattan, the Bronx and parts of Queens. Valuations of rent-stabilized properties have fallen by as much as 60 percent as expenses outstripped revenues, which were stunted by the state’s 2019 rent law. But some of those A&E units are subject to regulatory agreements, not permanent rent stabilization.
Some units also have preferential rents, which are below the legal maximum but can be raised to the legal rate when a tenant vacates, if the market will bear it.
Other units have capped rents because of tax abatements such as J-51, which allows landlords to return them to market-rate after 12 years with advance notice to tenants.
But the bottom line is A&E isn’t getting market-rate rents on many of the units and the increases allowed by the Rent Guidelines Board nearly always lag inflation.
A&E is hardly alone among rent-regulated borrowers with CMBS debt problems. The delinquency rate among rent-stabilized buildings in Manhattan as of February was 6 percent, compared to less than 1 percent for market-rate properties, which have enjoyed a record rise in rents, according to data from Trepp.
Declining valuations have likely played a role. Trepp examined 37 Manhattan rent-regulated properties reappraised in the past two years and found 32 had lost value, driving the average loan-to-value ratio up to 110 percent — that is, underwater.
The good news for investors who own that CMBS debt is that rent-regulated borrowers make up a small share of the market in commercial mortgage-backed securities.
But that could be changing.
“I wouldn’t say [CMBS] was a common execution — until recently,” said Matthew Dzbanek, a director of capital services at brokerage Ariel Property Advisors.
The broker said more rent-stabilized owners, both big and small, have turned to CMBS as agencies and banks have either retreated or, in the case of Signature Bank, collapsed.
CMBS loans have advantages. They are interest-only, whereas banks and agencies often demand principal and interest payments. A smaller monthly payment means sponsors can borrow more yet stay above the typically required 1.25 debt service coverage ratio.
But buildings need to be financially healthy to tap CMBS markets, Dzabanek said. Many rent-stabilized owners with traditional loans are not in a position to do so.
Most CMBS loans are fixed-rate and long-term. (A&E’s floating-rate, short-term loan is an outlier.) It remains to be seen if the rent-regulated borrowers taking out CMBS loans can pay them off when they mature in five or 10 years.
Those borrowers believe if rates drop enough by then, they will be in good shape to refinance.
“People are putting five-year money on it and hoping that in a handful of years we’ll be in a much better place,” Dzbanek said.
But many owners of heavily rent-stabilized buildings say their trajectory is unsustainable.
“As long as expenses keep rising faster than revenue,” said one who has faced widespread distress, “the terminal value of these buildings is 0.”
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