Apartment Debt Metrics Mostly Solid, But Gateway Metros Feeling Stress

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Most multifamily loans are prudently underwritten and are performing well, but cracks are starting to appear in properties in Gateway markets that were stable pre-COVID-19, according to an analysis of properties in Yardi Matrix’s database. 

The analysis—which encompassed more than 41,000 multifamily properties—found that the median debt-service coverage ratio (DSCR) for loans backed by multifamily properties as of August was more than 1.54, which means net income is about 54 percent more than the mortgage payments. The study also found that median loan-to-value (LTV) ratios for multifamily properties was in the low 70 percent range. 

That multifamily loans have a cushion against a downturn is not surprising, given how low default rates have been over the last decade. Pre-pandemic, all commercial loan delinquency rates were at decade-long lows, and multifamily has been the best performing property type. Delinquency for multifamily loans originated by Fannie Mae and Freddie Mac has been less than .01 percent since 2013, according to the Mortgage Bankers Association. 

Matrix’s analysis showed loans backed by apartments have seasoned well and generally have a strong cushion against default. However, the proportion of properties with weaker DSCR and LTV metrics has grown in Class A properties in Gateway metros. While there is no immediate distress evident, the performance of that segment bears watching.

Income Strong Relative to Payments 

The numbers are derived from analyzing the performance of properties in Yardi Matrix’s database. The estimated DSCR as reported by Matrix is defined by annual property income, divided by annual property debt service. Annual property income is calculated by subtracting per unit operating expenses from average annual revenue per unit and multiplying by the number of units. Annual property debt service is equal to annual principal and interest amortized on a 30-year equal payment calculation.     

Estimated DSCRs are relatively consistent across regions and market sizes. The median DSCR is 1.56 in Gateway markets, 1.50 in Secondary markets and 1.59 in Tertiary markets.

LTV as reported by Matrix is defined by the estimated current loan balance, divided by the current value. The estimated current loan balance is derived from the length of the remaining term, interest rate, and monthly payment based on a 30-year equal payment calculation. The current value is taken from the most recent sale. If no recent sales history is available, then a current value, and therefore an estimated LTV is unavailable.

Estimated LTVs are also relatively consistent across regions and market sizes, although larger markets had slightly lower ratios. The median LTV is 69 percent in Gateway markets, 73 percent in Secondary markets, and 74 percent in Tertiary markets.

Gateway Metros Feel COVID-19 Impact

One area that bears watching is loans on Class A properties in Gateway markets. The study found that just over a quarter (26 percent) of such properties had DSCRs of under 1.0 as of August, which means the net income is less than the mortgage payments. That’s about double the average for all properties in the study. The percentage of loans with a DSCR under 1.0 was 12.4 percent for Class B and C properties in Gateway areas, 12.5 percent for properties in Secondary markets and 11.4 percent in Tertiary markets. 

Data courtesy of Yardi Matrix

To be sure, a DSCR under 1.0 does not mean a property is in imminent danger of default. In some cases, low DSCR is temporary or due to a property being in a lease-up phase. And a property owner might not become delinquent even if there is a low DSCR level for many reasons, such as the owner wanting to maintain management fees, if property performance is expected to improve going forward, or if the owner wants to maintain a good credit record. 

Class A apartment properties in Gateway markets such as New York, Chicago and San Francisco have been the most severely impacted by COVID-19. Occupancy rates have plunged by 5 percentage points or more, dropping below 90 percent, and rents have taken a nosedive as people leave the most crowded and expensive urban areas. With service jobs disappearing, offices closed and many employees able to work from anywhere, and lifestyle attractions such as restaurants and theaters closed, some tenants are deciding that there is no reason to pay a premium to live in pricey urban submarkets.

The weak job market—the U.S. is down more than 10 million jobs pre-pandemic, and millions more have taken pay cuts—has increased renters’ cost consciousness. Another recent Yardi Matrix study found that the top 10 most expensive markets in the country have had the largest declines in rents since the start of the crisis, as renters look for less expensive living arrangements at a time of high unemployment. 

Class A multifamily in Gateway markets has been among the best performing segments of commercial real estate in recent years, so it’s too soon to count out the segment. Property owners are liable to ride out a dip in income with the hope that the downturn is temporary.

Paul Fiorilla is the Director of Research for Yardi Matrix. Ben Bruckner is a Senior Research Analyst for Yardi Matrix.