Morningstar Credit rarely lingers on multifamily when sizing up CMBS risk. But a recent spike in troubled loans—concentrated in Texas—was enough to change that.
"Even with marginally higher delinquency rates recently, the sector doesn't move the overall CMBS needle the way that office and retail tend to," Morningstar wrote.
Yet May data told a different story. Of 24 multifamily loans transferred to special servicing that month, 10 were in Texas. Over the past year, 120 multifamily loans moved to special servicing, and 37 of them—30.8%—were tied to the state. Most of that activity is recent, with 29 of those Texas loans transferring in just the past six months.
The clustering appears striking, but Morningstar said the underlying causes are largely disconnected from geography, describing them as factors "only tangentially related" to location.
Instead, the distress traces back to borrower-specific issues. A significant bankruptcy involving sponsor Rao Polavarapu triggered at least five transfers, according to Morningstar. Another five loans fell short after failing to secure a tax exemption and missing required principal paydowns.
A separate pocket of stress centers on S2 Capital. Seven of the Texas loans are linked to the firm and its effort to shore up its REIT through a capital call. Without sufficient investor support, the firm indicated it may need to sell assets. Reports show S2 Capital raised $30.0 million of a targeted $70.0 million.
Morningstar's review of 13 S2 properties that have transferred to special servicing, including assets outside Texas, points to persistent performance issues. "It's notable that not a single reporting period across the 13 properties shows a net cash flow that meets or exceeds the original underwriting," it wrote. "While floating rate loans may implicitly contain some cash flow volatility, a review of other loans in these deals shows loans that are hitting underwritten figures."
Whether the Texas concentration reflects coincidence or something more structural remains an open question. Morningstar noted it could be a temporary surge or "if healthy population growth is pulling so much capital into the state that there were bound to be pitfalls."
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