Article originally posted on CoStar on March 1, 2024

Multiple measures show increased delinquency rates in commercial real estate collateralized loan obligations, better known as CRE CLOs.

While office property leads with the highest proportion of distressed loans, multifamily real estate shows the greatest distress by dollar amount with about $1.4 billion in distressed funds, according to an analysis by CoStar News. That’s nearly half of all delinquent loans and an outstanding balance more than 6.5 times larger than office.

Increases in the amount of CRE CLO distress highlight the challenges posed to lenders and borrowers taking advantage of then historically cheap financing following the pandemic, only to have their floating-rate loans balloon. They now face those loans coming due in a time of muted property performance, including declining rents, higher operating costs and increased insurance premiums.

CRE CLOs are pools of short-term, often floating-rate, loans made mainly by nonbank lenders. The loans are typically originated on newly built properties or those going through a transition to reach stabilized cash flow. They pose risks to investors who can buy into portions of the pooled loans when those properties run into financial trouble.

According to CoStar News analysis of Morningstar data, 6.2%, or $3.33 billion in CRE CLO loans are either delinquent or have matured without being paid off. Delinquency rates almost doubled over 2023, rising more than 280 basis points. CRE CLO loans made in 2019 before the pandemic show a 19.5% distress rate, equivalent to $471 million, while 11.7% of 2020 deals valued at $264 million are distressed. Newer loans are faring better with 5.7% of 2021 loans and 5.5% of 2022 loans under distress.

Of the total $52 billion in outstanding CRE CLO loans analyzed by CoStar News, 78% are backed by multifamily properties. The property type also accounts for almost half of all distressed loans with $1.39 billion of the total $2.75 billion in delinquent loans, similar to findings of other analysts.

High lending rates have made holding debt more costly. The New York Federal Reserve reports that the SOFR, or Secured Overnight Financing Rate, a benchmark for derivatives and loans, ran near zero from late March 2020 until May 2022. The rate is now 5.31%.

An additional report released Tuesday from KBRA showed loans originated before 2023 had a 5.4% distressed rate, which the credit-rating firm defined as a loan that is either delinquent or in special servicing, up from just 1.4% at the end of 2022. Echoing other reports, KBRA said the worst-performing loans were originated in 2020 and prior, though it noted that the older-vintage loans had been paid down by 48.9%, increasing the subordination levels.

The KBRA report also indicates that higher interest rates have played an outsized role in creating delinquent loans, particularly at multifamily and office properties that it said make up more than 80% of outstanding loans. While office loans continue to suffer from demand shifts, the report noted multifamily has been experiencing slowing or negative rent growth, and higher operating and insurance costs. These dynamics have led to a number of deals not meeting their interest obligations in recent months.

Issuers of CRE CLO debt with the largest outstanding balances, according to CoStar News’ analysis, are MF1 REIT, Arbor Realty Trust, Benefit Street Partners, Bridge Investment Group, LoanCore, Ready Capital, Rialto Capital and Acre Commercial Mortgage. Among those, Arbor and LoanCore showed distress levels above the 6.2% across all CRE CLO loans. LoanCore showed an 8.7% rate of distress totaling nearly $305 million in delinquent or unpaid matured loans, while Arbor’s distress level was more than twice that of all CRE CLO loans at 12.6% of its outstanding balance, or $543.5 million.

CoStar News reached out to Arbor and LoanCore for comment but did not immediately hear back.

Both CoStar News’ analysis of Morningstar data and the report from KBRA showed that while the office sector is experiencing the highest rates of distress, multifamily makes up the largest loan delinquencies by dollar amount.

KBRA said multifamily makes up nearly 70% of the principal balance of CRE CLO loans, while office is a “distant second” at 13.3%. According to CoStar News’ analysis, more than $52 billion in loans are outstanding. Of that amount, 78% originated in multifamily. And while the distress rate among offices is nearly five times larger than multifamily at 15.5%, because of multifamily’s outsized portion to the total loan amount, its total amount of distressed dollars has reached close to $1.4 billion compared to nearly $972 million in distressed office dollars.

Of the nearly $1.4 billion in multifamily distress, Arbor’s book of delinquent or unpaid matured loans accounts for almost 40% at roughly $544 million. All but one of Arbor’s loans are backed by multifamily, with the additional property in the full-service hotel space. Its largest loan more than 30 days delinquent is valued at $51.4 million on the 302-unit Amara Apartments in Phoenix. CoStar data shows the building now carries a 22% vacancy rate, almost triple the rate of nearby apartments, while asking rents have declined nearly 10% year-over-year, compared to a 1.8% decline in rents over the same time across the Phoenix market.

Arbor has come under fire recently from a number of critics and short sellers concerned about distress on the company’s books. The company downplayed the amount of distress during its fourth quarter earnings call — estimates of which ran as high as 26.6% in January and 16.5% in December — as cherry picking point-in-time statistics that do not “contain the full picture or represent the industry’s focus,” according to Arbor’s CEO, Ivan Kaufmann.

Short seller Viceroy Research, a critic of Arbor, has said the company systematically misrepresents the quality of its loans, pointing to company data that shows more than half of Arbor’s multifamily loan book as of the fourth quarter of 2023 was rated “special mention,” indicating a potential deterioration of creditworthiness, or worse. Since the last quarter of 2021, loans with a “pass” risk rating have declined from 61.3% of Arbors’ multifamily book to just 1.7% in the final quarter of 2023, according to a Viceroy analysis of Arbor data.

Of Arbor’s total delinquencies, $366.5 million is less than 30 days delinquent, meaning there is a chance that those loans will be paid off soon, according to CoStar News analysis. But Arbor has indicated that the company and the industry at large is in a period of “peak stress,” according to Kaufmann, and expects the next two quarters to be particularly challenging.

Bond-rating firm Fitch expects delinquencies in the apartment sector to rise to 1.3% by November 2024, up from 0.62% in the same month in 2023, and up to 1.5% in November 2025. Freddie Mac also reported increased delinquencies in its January 2024 volume summary, with total multifamily delinquencies rising to 0.44% up from 0.28% in December 2023, and from 0.12% in January 2023.