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What Would Warren Buffet Do? How to Leverage Multifamily Mortgage Maturity Defaults to Make Investments in Multifamily Properties

blog Jan 31, 2023
One hundred dollar bills folded into the shape of a house

Here’s the scenario. Everything’s on the way up. Prices. Occupancy. Rents. Investor Capital. All the right things are on the way down. Cap Rates. Expenses. Vacancies. Delinquencies. Multifamily investing has never looked better. 

Raising private money is easy. Everyone has it because the government has been giving it away like it isn't worth anything (Editor’s Note: Last statement to be read with sarcasm). So, investors are on a buying frenzy of historic proportions. Prices continue to rise, as do rents and dreams of massive paydays at the closing table; especially for those GPs who care more about acquisition fees than whether their syndication is a good deal or not. It feels like 2008 all over again.

And then cracks in the armor start to appear. The first of which is when the customer base (a/k/a tenants) start to wise up and say, ‘hey, we can’t afford to keep paying the next investor group a 9% preferred return like we have for the last three groups that bought this property. No más’.   

Then the economy starts to behave exactly like your Freshman Econ 101 professor told you it would. Too much cash in the economy causes a unique form of taxation that economists lovingly refer to as inflation.

Finally, the experts in our government use the one and only tool that they have at their disposal to control inflation and that is the raising of interest rates. How high, you might ask? No one really knows. But soon, those actions start to hit Main Street and life begins to change.

You might be wondering how the rise of interest rates impacts the valuation of a property when interest rates play no role in the three variables used to value multifamily assets. The fact is, rising interest rates have absolutely no impact on the valuation of a multifamily asset - unless you are buying or selling. In that case, you're in for a world of hurt.

The effects of interest rates on a multifamily financial statement appear below the Net Operating Income line. Therefore, they have no impact on the operation, but a massive impact on the cash-on-cash returns that investors need to earn to compete against other investments. If leverage is used and the cost of money for that leverage increases, the multifamily investor returns decrease, and multifamily becomes less attractive to your friends and family. If the high cost of capital becomes the new constant, then the only variable that can be modified is the purchase price of the property and, axiomatically, the only way investors get the returns they need is to buy low. But why would owners ever lower the price of their assets just because interest rates are on the rise? Why not just ride it out and weather the storm?

Why Don’t Owners Just Ride Out the Storm?

Some owners may not have a choice. The biggest problem that some owners are facing right now is timing. Their loans are coming due and they're finding themselves in a position where they have to refinance or sell at the same time that cap rates and interest rates are on the rise. This was never supposed to happen. Didn’t some blowhard multifamily guru say you could always overpay for multifamily because the prices would never go down? (That guy was obviously not in this business during the last crash. I had many properties that never came back in value. And he’s the expert?)

So, the note is coming due. Cap rates and interest rates are now on the rise. Vacancies are increasing and the cost of everything, including operating expenses is increasing due to inflation, ergo the net operating income is decreasing. Another perfect storm. With all these factors moving against you and the bank looking for their money, you have two options. Lower your sales price and hope that you can get out of the deal making full restitution to the bank, or default on the loan and take full advantage of its non-recourse language. What? You mean you signed personally for the loan? Well, look on the bright side — you'll never do that again.

What happens when the borrower defaults on their multifamily loan? This is where maturity defaults come into play. Understanding how these work and leveraging them properly can help you maximize your profits as a multifamily investor by helping you identify buying opportunities before the rest of the market does. Let's take a closer look at maturity defaults, how they work, and the opportunities they present for investors.

When a Borrower Defaults on Their Loan

Maturity defaults occur when the note comes due, the borrower fails to meet their loan obligations, and the lender calls for repayment of the entire balance. Sometimes, this is just a timing issue. Maybe the seller has the deal under contract but the buyer cannot close until after the note comes due. Usually in those circumstances, the lender will work with the seller and all parties win.

But what happens when the seller over-leveraged the asset, purchased the property at top dollar, used an interest-only mortgage and/or failed to complete a renovation, and now they find themselves in the unenviable position of being upside down on their deal?

In these cases, many lessons are about to be learned (the hard way), and many sleepless nights will be had by the GP as well as many of the limited partners. For the real investors buying value, not paying retail, and looking for deals at prices far below what they may have traded at just a few short years before, understanding maturity defaults is key to leveraging them to make Warren Buffet-level investments in multifamily properties. When a borrower defaults on their loan, it creates an opportunity for investors who are willing to buy out the debt at less than face value. This allows investors to own a property at a valuation below what the seller was probably offering the asset for before the bank got involved, and maybe even for pennies on the dollar.

The Benefits of Investing in Maturity Defaults

Investors benefit from investing in maturity defaults because they can purchase properties or even the mortgages at discounted rates, and then turn around and collect payments from borrowers or sell off assets associated with those mortgages later on down the road. In addition, because there is typically minimal competition when buying out these debts, investors have more leverage when negotiating prices because the sellers are now very motivated. Isn’t that the best type of seller?

For savvy investors looking for new opportunities in multifamily real estate, leveraging maturity defaults is an effective way to make profitable investments while minimizing risk exposure. By understanding how they work and being willing to take advantage of discounted rates offered by lenders, you can create reliable returns while diversifying your portfolio at the same time. So, if you're looking for a way to break into multifamily real estate investing without taking too much risk, consider taking a closer look at maturity defaults – it could pay off big!

Members of the MultifamilyOS™ System benefit from access to updates for all GSE and CMBS defaulted mortgages. To find out more, click here and speak to one of our staff today.

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