Distress for big and small owners in NYC

How owners of different sizes will feel their own brand of distress

Concerns around office distress may be overshadowed by cracks beginning to appear in the multifamily sector. Interest rate risk will be the leading driver of this distress, but lower collection rates and longer housing court processing times will play a strong role in the distress that mom & pops face as well.

The plight of the large players

A&E Real Estate refinanced a 31-building portfolio covering some 3,500 apartments in June 2021, at the height of low interest rates. The company secured $506 million in debt funding from JP Morgan Chase with a 2.4% floating rate loan with a 3-year term. Then two things happened: rent growth slowed and interest rates flew up. According to the Real Deal, A&E’s debt coverage ratio is hovering south of 1:1, indicating that the loan payments are greater than the net income from apartments backed by the mortgage. The new legislation that will de-facto bar the combination of apartments to raise rents will certainly not help. It’s expected that A&E will use one of its two loan extensions to delay having to refinance. Still, doing so will require the firm to check certain boxes so that JP Morgan feels comfortable extending the loan now that banks at large are applying more scrutiny to borrowers in the wake of bank collapses. A&E’s loan was placed on a special servicer list by Morningstar a few weeks ago.

Other NY multifamily assets under special servicing

• Blackstone’s 11 building multifamily portfolio loan portfolio - $271M

• A&R Kalimian Realty’s 43-story luxury Lincoln Center building - $250M

• Chetrit Group’s Park Hill city 640 unit twin properties in Jamaica Queens - $225M

To complete refinance transactions, some investors are opting for capital calls to successfully meet lender requirements. Brokers and sponsors have shared anecdotes about this. Lenders such as Seth Weissman’s Urban Standard Capital and Adam Sabella’s Stoney Clove Capital are raising funds to provide flexible “rescue capital,” for operators who will not meet bank refinance standards, but still want to hold their properties. These lenders might offer short, three-to-five-year fixed rate debt to keep properties afloat. Is this kicking the can down the road? If rent stabilized buildings continue to be rent stabilized and interest rates continue to be high, it might be. It’s unlikely that the value of these properties will change in a positive way from today’s status quo in the foreseeable future.

Tenant protections and smaller landlords

Landlord properties have fared better since the heights of covid, when ~25% of tenants in NYC did not pay their rent, but owners still have collection challenges. Tenant protections have evolved in NYC over the years. Former Mayor de Blasio implemented various tenant protection organizations and initiatives. Amongst them was the Right to Counsel (RTC), implemented in 2017, which grants tenants the right to free legal counsel during evictions if they fall under certain income levels. In the Bronx, long known as the poorest of the five NYC boroughs, resources are uneven. Fewer than 10% of tenants have legal representation. Landlords use counsel 90% of the time. According to the Office of Civil Justice, 78% of tenants in NYCHA housing that were facing eviction and used legal representation were allowed to stay in their homes (however that is defined) during the July 1^st, 2021 - June 30^th, 2022 period. Additional data shows that the number of evictions carried out in NYC overall from 2013 to 2019 were down 41%. On top of that, in Connecticut a study showed that close to 80% of tenants with attorneys were able to avoid eviction when they sought that, and 70% that wanted a month or more grace period of free rent were able to obtain it.

These numbers might be inspiring, but fewer evictions, in of itself, is not an objective good. Reducing the number of unjust, unmerited eviction is a good thing. Increasing the number of tenants who can use anti-eviction sentiment to thwart eviction and ignore their lease agreements is not good. When you sum up all the months of free rent that were afforded in the Connecticut study with tenant move outs, how much lost rent does that make up, forever lost to housing providers? Anecdotally, from speaking to owners of smaller properties, that number is large.

This is especially important when looking at owner occupied properties that are fewer than 5 units in size. Properties like these are often not owned by investors, but more by families and mom & pops. This can be observed in the table below in Queens, where 59% of the legal service cases for Queens evictions were for tenants living in unregulated properties (not subject to rent controls). Given the lower density in Queens, and that rent stabilized buildings are typically 6 units or more in size, we can take it to mean that these evictions are happening in 2-5 family homes. Landlords like this will not have the reserves to withstand months of non-payment by tenants. The differences in incomes between these landlords and their tenants may be small. The time for evictions to be processed in the NYC courts is estimated at 12-24 months. For some owners, that lost rent can create a real problem in their finances, wellbeing, or even their retirement. These owners of small multifamily may be less worried about floating rate debt that resets at upcoming maturity, and more concerned about the ongoing difficulty in removing non-paying tenants.

How does this relate to the NY multifamily market in the second half of 2023?

Distress is anticipated to set into the market in 2H 2023, and I think that lower collections / tenant arrears will play a hand in exacerbating the distress. According to The Real Deal, $8bn of NYC multifamily loans matured in October and November of this year. Low interest, interest only, and floating rate loans will have to be refinanced and many experienced investors will not be able to “take out” their existing debt with a new, larger loan. Small owners with fewer tenants may find that their challenge comes down to relationships. Making sure they are aligned with their tenants and on good terms so as to avoid going to the housing courts and they keep collecting their rents.

Sources: The Real Deal, Universal Access to Legal Services report 2022, Bloomberg City Lab