CRE CLO Issuance Is Down Limiting Multifamily Finance Options

At a time when the industry is worried about changes in traditional bank CRE lending, other forms of financing understandably get extra attention. One is CRE collateralized loan obligations, or CLOs, whose issuance, according to Trepp, has outpaced the conduit CMBS market in 2021 and 2022.

Making them popular are a “flexible structure, relative basis attractiveness, higher relative yield, and floating rate structure,” says the firm. But while tracking CRE CLO issuance, where usually the instruments were favored by investors, 2023 has brought a “dip” in issuance.

CRE CLOs offer higher yields because of greater risks: lower debt-service coverage ratios and higher loan-to-value ratios, meaning more leverage and less room for problems in net cash flow. Not unsurprising to Trepp, as the loans in CRE CLOs are typically shorter-term forms of financing like bridge loans, mezzanine loans, and B-notes.

The increased uncertainty and risk are why CRE CLO managers favor multifamily, with typically “low delinquency rates and steady lease rollovers,” creating more dependable rents and an overall safer profile.

The preference shows in that 69.3% of nearly $79 billion in outstanding CRE CLOs are backed by multifamily properties. Loans are often written as three-year term bridge loans with optional extensions should they meet performance goals.

Of $54.7 billion in outstanding multifamily CRE CLOs, 85% comes due within the next two years. At that point, lenders and borrowers have to agree on one of three actions: extend the loan, refinance into a new loan, or pay the balance. If payment is the option and the borrower doesn’t have, or is unwilling to provide, the necessary capital, then either both parties modify the loan or there’s a default.

However, while the multifamily market road high through much of the pandemic, the combination of increased operational expenses, higher interest rates, increased insurance, inflated building replacement costs, and softening of the apartment rental market have had an effect. Many owners lack the cash to pay back loans.

Even if refinancing seems possible, there’s probably a demand for an interest rate cap. And the costs of those are currently crushing many CRE deals.

That’s a problem according to Trepp because 16% of the CRE CLOs are backed by multifamily properties built between 2019 and 2022. Of those, many of the properties have two appraised values: the value at origination with in-place rents and an “as-stabilized” value, which assumes that value-added modifications and rehabs occur, and that the property gets leased up.

If the owner-operator doesn’t get the occupancy and rent growth they had projected at a time when expectations were running high, the property doesn’t hit as-stabilized.

Greater stress makes it less likely that CLO deals will go through.