Shidler Group wasn’t about to miss out on South Florida’s multifamily bonanza.
In 2021, amid an influx of out-of-state residents creating unprecedented apartment demand and the biggest rent hikes nationwide, Shidler bought the 433-unit Sealofts at Boynton Village for $153 million. The complex of 20 white and sky blue buildings tucked in suburban Boynton Beach is over 90 percent occupied and lists monthly rents from about $2,000 to nearly $3,800. Surely, Sealofts ought to be a worry- free investment.
Except not exactly. From mid-2022 to mid-2023, property repair and maintenance costs rose 22 percent, insurance skyrocketed 62 percent and payroll and other expenses increased 12 percent, according to research firm Morningstar Credit.
The squeeze Shidler is feeling from the Federal Reserve’s 11 aggressive interest rate hikes since 2022 isn’t clear. Morningstar Credit shows its debt service coverage ratio, a measure of an owner’s ability to meet debt obligations, dropped last summer to 0.75, or below the DSCR breakeven threshold of 1. The Honolulu-based firm, led by Hawaii’s formerly richest person, Jay Shidler, didn’t return requests for comment, including if it has an interest rate cap or other hedge against elevated rates. Shidler took out a $79 million floating-rate loan in 2021, when the federal funds rate was near zero. Now, it’s over 5 percent.
Shidler is not alone. Across South Florida, investors swooped in on the boom of 2021 and 2022, paying peak prices for apartments, believing that record rent hikes and demand would shield against debt woes. Yet, now even well-leased complexes are facing increasing costs, lowering cash flow and potentially putting the kibosh on dreams of a windfall.
“South Florida’s demand and rent dynamic are the best in the country, period,” said David Lynd, CEO of apartments developer and investor The Lynd Group. “But that has nothing to do with interest rates, insurance rates and costs. There’s no hiding from them anywhere, no matter what market you are in.”
Compounding the problems are inflation, which has prompted rent delinquencies, and a hefty development pipeline that’s slightly tempered demand, prompted concessions and led rents to plateau or slightly decline in some submarkets, according to experts.
“We definitely saw that groups that purchased in 2021 and 2022 are having this sort of day of reckoning right now,” said Alex Horn of Miami-based lender BridgeInvest. “They bought at low cap rates with the projection of ever-increasing rents, and all of the sudden that has flipped.”
Gut (Renovation) Pains
The Fruchthandler family’s New York-based FBE Limited joined the South Florida investment party in 2022, buying the 316-unit Sheffield Apartments in southwest Miami-Dade County for $36.5 million.
The plan: a major renovation and expansion of 26 new units, according to an application to Miami-Dade County, financed by an $85 million floating-rate loan from MF1 Capital. During the post-2020 multifamily boom, debt fund MF1 issued short-term loans, many of which hinged on the ability of borrowers to raise cash flow through value-add plans. Now, the Sheffield loan is “watchlisted,” according to Morningstar Credit, meaning that even though FBE is meeting debt obligations, the servicer is keeping an eye on the property’s performance due to a drop in cash flow and a lower DSCR.
The property, which had month-to-month leases, was emptied last year to allow for renovations and expansion. That led net operating income to drop to a negative $791,900 in the first three quarters of last year, though FBE has been appropriately using its reserves to meet debt obligations, according to Morningstar Credit.
Miami-Dade approved the project, but construction has not started, records show. Whether FBE completes its value-add plan and has enough of a hedge against rising interest rates remains to be seen. The company didn’t return requests for comment.
Experts pointed to these types of plays as most exposed to trouble. The strategies lead to reduced cash flow due to vacancies during renovations and hinge on completing the work before short-term debt matures. (The Sheffield loan matures in January and has one six-month and two one-year extension options, Morningstar Credit shows.)
“They make you a loan with a target you would be able to raise rents high enough. If you don’t get through enough renovations … you didn’t create the value that you told the old lender you would create,” Lynd said, speaking generally about value-add plays. “So the property isn’t worth what we thought it would be worth at the end of the loan.”
“Even if floating-rate debt is protected with hedges such as interest caps, many are expiring this year, and costs for renewals are surging. While a cap on a $125 million loan cost $50,000 in 2020, it’s now over $3 million,” said Liam Krahe, a commercial real estate attorney at Cohen Property Law Group who works with borrowers to restructure capital stacks.
Collateralized loan obligations totaling $633.8 million will mature this year in South Florida, and $1.3 billion next year, according to Trepp. CLOs are floating-rate debt generally used for value-add plays. Trepp shows that the majority of these loans have extension options, but experts say using them isn’t always easy.
“Lenders may require fees to use an extension, as long as a borrower is not in default of loan terms, or waive extension option fees if the borrower agrees to increase the DSCR,” Krahe said.
Some have a less gloomy outlook.
“Eventually, the development pipeline will slow, rents will catch up and so will value-add investors,” said broker Hampton Beebe of Newmark. “It’s not surprising to see a deal or two hit the watchlist because of the time they bought and how aggressive loans were. Landlords may be a little bit behind their expectations, but they will catch up.”
Counting Losses
Some, however, aren’t waiting to “catch up” and are cashing out at a loss. In the spring of 2022, investors Arvind Reddy and Krishna Persaud dropped $26.3 million on the 124-unit Amberstone Apartments in Pompano Beach and took out $21 million in floating-rate debt. Although they completed a $500,000 capital improvement, nearly fully leased the complex and had “better than expected” rent growth, they still sold at an 8 percent discount a year later.
“That’s sooner than their originally planned three- to five-year hold period,” Reddy said. “Higher interest and cap rates have suppressed property values, and if values continue to drop, selling the complex later would mean taking an even bigger loss, If the market picks up, any gains would be diminished by inflation. We just didn’t see, given where the market is going, as successful of an exit as we originally planned.”
The pain was more pronounced in Fort Lauderdale for Shidler, which sold the 276-unit Riverland Apartments for $84 million in March, marking a 22 percent discount from its purchase price a year prior. Shidler’s original strategy was to sell quickly, but as a ground lease. Interest rate hikes foiled that plan, according to Andrew Gordon of Boston-based Stratford Management, one of the buyers. While the industry expected more discounted sales in the past year, it hasn’t panned out so far.
“Instead, the transaction market has slowed down dramatically, and not many properties are transacting,” said Matt Scarola, head of investments at Integra Multifamily, a division of Miami-based Integra Investments.
“Tough Out There”
Indeed, lenders and borrowers are waiting for elevated costs and interest rates to drop and multifamily properties to regain value, experts say.
“It’s just sticker shock to both sides. People are literally not doing anything,” Lynd said.
The Fed is expected to make three rate cuts this year, though it postponed them at its March meeting due to stubborn inflation.
“Historically, other costs don’t return to previous levels, retrieving only about 15 percent off their high,” Lynd said.
Lynd expects this will be the case with costs associated with South Florida multifamily properties, except for insurance.
A study by Yardi Matrix showed commercial real estate insurance premiums were expected to go up 50 percent last year, with some properties experiencing a doubling of rates. At year-end, developers had 49,000 units in the pipeline across South Florida, slowing absorption and leading rents to flatline, a report from brokerage Lee & Associates shows. The Waller, Weeks and Johnson Rental Index shows Miami rents in January dropped 0.1 percent from December.
“The multifamily market’s downfall could be more pronounced in South Florida than elsewhere,” said Horn of BridgeInvest.
In-migration and record rents led investors to be more aggressive, taking out high-leveraged loans and betting on a rent windfall for longer than in other U.S. markets.
“The bigger fall now is that a lot of other markets started to cool down in 2020, but not South Florida,” Horn said. “It ultimately extended that curve further because there was continued growth in the market for the following two years. In some ways that made it worse.”
“It’s tough out there right now,” Lynd said, “and anybody who says it isn’t is lying.”
Source: The Real Deal
