Periods of market dislocation and the distress that it can bring create unique investment opportunities. And 2024 promises to have plenty of both distress and opportunities in private multifamily real estate. We enter this period with a clear perspective and approach to opportunities, armed with experience earned during the Global Financial Crisis (GFC). In this article, we’ll define the line between stressed and distressed real estate, identify what’s different in today’s market from the days of the GFC, and outline our competitive advantages in capitalizing on potentially distressed investments.
What are Stress and Distress in Real Estate?
It’s important to define these terms: Stress in private multifamily real estate is not uncommon in the current market environment—interest rate increases have made borrowing and refinancing difficult, especially as asset valuations fall; inflation, increasing operating costs and rent declines in 2023 have dented income. And lending conditions are tighter in the wake of Signature Bank and other failures. Generally healthy owners can experience stress in individual assets, usually in the form of a need for bridge financing or liquidity. In a stressed deal, the cause of the stress is clear, the risks are finite and quantifiable, and the solution is straightforward.
Distress is more complicated, going beyond a single asset and across an owner’s portfolio. Cash-flow, refinancing, management and income challenges could lead to delinquency and require serious restructuring. With more question marks, dollar signs—and risks—than answers, sometimes the only solution is to hand the keys over to the bank.
What we are seeing in the market at this point is stress. However, many loans that financed highly valued multifamily assets in 2021 and 2022 are coming due in 2024 and 2025 (see chart). Valuations are falling, and interest rate increases since those loans were originated mean it’s now more costly to refinance. At some point, we expect to see at least some distressed real estate assets on the market. That means assets becoming available at significantly below replacement costs; deal flow in multifamily loans at discounts; the use of positive leverage to fund purchases; and nontraditional capital solutions such as restructurings.
Multifamily Loan Maturities by Origination Period
Note: As of Oct. 24, 2023
Sources: MBA, Trepp, RCA, Newmark Research
What Are Our Investment Parameters During This Time?
While our Funds continue to focus strictly on the multifamily sector, the fundamental criteria for potential Fund investments include: the right vintage and location; the potential for growth; and quality physical real estate. For instance, an asset may require minor updates, be older but have solid returns, or be offered at a price that is a great investment.
We can raise capital for a distressed real estate Fund if this becomes appropriate. Whether that will happen depends on the types of opportunities that become available. At this point, it is more likely that complementary investments will be added to an existing Fund or that a sidecar will be created. We will not assume that the current amount of stress will inevitably lead to distress significant enough to merit a dedicated Fund. Our advantage is the number and quality of our investors, and our ability to be more agile on specific deals.
How Are We Able to Spot Opportunities? Our Experience in Distress
Origin Investments was created in 2007, just before the onset of the Global Financial Crisis (GFC). Our first two Funds, Growth Fund I and Growth Fund II, had portfolios of 11 and 17 properties, respectively. Fund I had a realized net IRR of 27.7%; Fund II’s hypothetical net IRR was 19.3% as of Sept. 30, 2023.1 These results reflect our early ability to provide liquidity and effective financial and operations management to quality assets that needed a boost. The assets included value-add office and retail to multifamily and industrial, dispersed across the U.S.
Examples of our results are in the chart below. Marquis Trace, in Roswell, Ga., was a well-located and well-performing—but mis-marketed—property in an area of anticipated growth that was a covered land deal. In that case, we executed a new business plan. Lux 24 was a partially built condo building project in Chicago that had been put on hold by the lender. We purchased the note, got financing and finished the construction, converting the condos into apartments.
Origin’s Competitive Advantages
In many ways, Origin is a different company than the startup that emerged from the crucible of the GFC. Today, we have more available capital, the ability to make significant and diverse investments in high-potential assets, and a bigger, deeper bench of expertise in acquisitions, development and investment management. We believe that 2024 will bring a period of dislocation in the market that will trigger generational opportunities for investment in quality assets. And we are ready for it in ways that we believe our competitors are not:
Stable management: The management team that created our first Funds amid the fallout of the GFC is managing our Funds today. Bank failures in early 2023 were unsettling, and we, along with everyone else, worried about how bad it would get. But we could picture and prepare for exactly how bad it could get because we had navigated much choppier waters early on. We know the industry is not immune to shocks, and more may come as outstanding loans face a reckoning, but we have been here before.
Key relationships: Origin’s history in the market, investment track record and reputation give it early access to deals through its growing network of multifamily owners and experts. Our expertise in key local markets connects us with reputable, dependable partners. Funds managed by Origin’s affiliate firm, Origin Credit Advisers, have earned the credentials to acquire Freddie Mac issued certificates in the primary rotation.
Disciplined risk management: Our adherence to clear-cut and conservative risk management requires discipline in all economic environments, including when distressed real estate is available. We regularly stress test our assets and real estate Funds. We treat leverage with respect and understands how it can be either an advantage or an agent of demise depending on the circumstances. Origin Funds are entering this period in solid financial shape, and leverage is our friend.
Data-driven, proprietary insights: We’ve been leveraging artificial intelligence for years in our quest to find high-potential pockets of growth. We weren’t satisfied with the quality of information from publicly available third-party resources, so an in-house team of data scientists developed and continues to refine a proprietary suite of machine-learning models, Multilytics℠. We use it to quickly and thoroughly analyze submarkets down to the property level, for due diligence, deal analysis and stress-testing. It’s an invaluable component of our market strategy.
Clear-eyed understanding of opportunity, risk and reward. As risk managers, the Origin team continues to set realistic expectations for how future investments could pan out: While Fund performance is up to us, the opportunities will depend largely on the level of distress in the market—something we can’t control. We anticipate relative outperformance, but we aren’t lowering our standards to do a deal or setting unrealistic expectations of sky-high rewards.
Adaptation to market shifts: Over the years, we have demonstrated the ability to adapt our investment strategy as market opportunities evolve. The last time we purchased an existing property was in 2020. We have moved from value-add acquisitions to core-plus, to development and preferred equity, depending on where the best relative risk-adjusted returns appear in the market. We remain agile by challenging and questioning our assumptions.
Ability to identify opportunities: We have a much more refined perspective on relative opportunities given our early experiences. Because we invest in different areas of the capital stack, we can consider opportunities from diverse perspectives. And key management team members live in our target markets across the U.S., building a strong network of relationships that bring opportunities others don’t access.
Current economic conditions don’t point to a repeat of the GFC, which was triggered in the U.S. by the collapse of the housing market and resolved through legislative measures including the Dodd-Frank Wall Street Reform and Consumer Protection Act. Multifamily market fundamentals are strong—the current influx of supply will not be enough to solve a chronic housing undersupply problem, rents are expected to recover and move into positive growth territory, and the multifamily sector is adapting to benefit from work-from-home trends adversely affecting other areas of commercial real estate. We see generational opportunities in the growing dislocation in the multifamily market, across senior debt, preferred and common equity, and we intend to pursue them.
- IRR is calculated based on a hypothetical liquidation of the Fund as of Sept. 30, 2023. Hypothetical performance doesn’t represent an actual investment and frequently has sharp differences from actual returns. Hypothetical returns are inclusive of appreciation and reinvestment of distributions and are net of fees.
