Arbor Realty loans funded a Sunbelt apartment boom. Many of its borrowers are now struggling with higher interest rates.
By Konrad Putzier
Feb. 15, 2024 5:30 am ET
Arbor Realty Trust's CLO delinquency rate
Arbor Realty Trust rose from its roots on Long Island, N.Y., to become a property-finance powerhouse. As a major lender to Sunbelt apartment buyers, it helped fuel a speculative real estate frenzy in 2021 and early 2022.
That boom ended when interest rates shot up, imperiling borrowers’ ability to make payments on Arbor’s loans that were often repackaged into bonds and sold to investors. Now, the company is contending with a wave of property owners struggling to pay interest on their floating-rate debt.
Borrowers of a quarter of Arbor’s securitized debt were late on debt payments as of mid-January, according to the data company CRED iQ, which analyzed figures from the bonds’ trustee. Borrowers of around 9% of the debt were 30 or more days late.
Most borrowers who were late on January payments eventually paid, an Arbor spokesman said, and he said 5.8% of Arbor’s securitized debt payments are still not current on January payments.
Often, borrowers are able to catch up on payments or cut deals with lenders to lower interest payments for a while. Still, the large number of late payments in January shows the strain on borrowers and the growing risk of losses for lenders.
As of January 2023, borrowers of 0.4% of Arbor’s mortgage bonds, so-called collateralized loan obligations, were delinquent 30 days or more, according to CRED iQ. That share was up more than 20-fold in January of this year as higher rates squeezed investors.
The spokesman said the share of Arbor loans that were delinquent on January payments and delinquent for 30 days or longer was 4.6% as of Feb. 13.
Arbor mortgages backing apartment properties in Columbia, S.C., Gainesville, Fla., and San Antonio are among those that went delinquent over the past year. Arbor’s spokesman declined to address specific loans, but said “collections and performance have continued to improve.”
The company sits at the center of what a growing number of analysts say is one of commercial real estate’s biggest trouble spots: floating-rate apartment loans.
“Multifamily could be the next shoe to drop,” said Jade Rahmani, a real-estate stock analyst at KBW.
Investors raced to cash in on surging population and economic growth in Sunbelt cities, buying aging apartment buildings at high prices with floating-rate loans that were cheap at the time. Many of these loans were issued by nonbank lenders like Arbor and repackaged into bonds called collateralized loan obligations, or CLOs. Then, interest rates surged and rent growth slowed.
Now, many borrowers are struggling to pay their debt or renew the hedges they purchased to protect against rising interest rates. Many of these hedges are now expiring. Renewing them at much higher rates is tightening the financial pressure on Arbor’s clients.
Arbor isn’t the only property CLO lender facing challenges. These CLOs are often made up of so-called bridge loans that typically fund renovation or construction projects. Others have also seen a rise in delinquencies, and California-based Money360 recently laid off loan originators and is considering selling loans to raise cash.
“Commercial bridge loans have been especially vulnerable because these properties are going through transition and repositioning by design,” said Brett Koelliker, Money360’s co-founder.
The vast majority of late payments on CLO loans haven’t led to foreclosure. Still, the large number of late payments shows the strain on borrowers and the growing risk of losses for lenders.
Arbor sells most of the mortgage bonds it creates to investors, but generally keeps the riskiest 20% on its books. That means it is on the hook for losses before other bondholders if a borrower defaults.
Arbor also allows owners to put up less equity than many other lenders. The company generally lends around 80% of a building’s purchase price, renovation costs and other expenses, its lawyers said. That means the lender has less of a buffer than many banks, which often lend a much lower share to real-estate investors.
Arbor is scheduled to report fourth-quarter earnings on Friday.
During a previous earnings call in October, Arbor’s chief executive, Ivan Kaufman, said that “the next two or three quarters will be the most challenging part of this cycle.” He added that the company has been preparing for this for two years and has around $1 billion in cash.
“Given the value of our collateral and the recourse provisions in our lending documents, Arbor is well positioned, if necessary, to take back assets and optimize shareholder value,” Kaufman said in a recent statement to The Wall Street Journal.
Brokers and landlords say Arbor stands out because of its size. It is one of the largest publicly traded companies focused on floating-rate multifamily lending. The real-estate investment trust is one of the country’s most-shorted companies, according to MarketWatch.
Arbor has also attracted attention because it frequently issued high-leverage loans for risky projects and to borrowers who have owned properties before but in some cases have little experience running vast portfolios of rental apartments.
Lawyers for Arbor said that “sponsors of Arbor’s loans are typically experienced real-estate developers.”
Many of Arbor’s borrowers are so-called syndicators that pool money from small investors to buy apartment portfolios with lots of floating-rate debt, renovate the units and boost rents in the hope of selling the property for a big profit after a few years.
Last year one of Arbor’s borrowers, Jay Gajavelli, defaulted on loans backed by more than 3,000 Houston-area apartments in one of this cycle’s largest busts. Gajavelli, a former IT worker with only a few years of real-estate experience, had raised millions from small investors and relied on floating-rate loans to fund his purchases.
Gajavelli didn’t respond to a request for comment.
Arbor sold the properties in a foreclosure sale. The company recorded no loss on the sale, according to its lawyers. But Arbor still has a loan against the property. And as more borrowers at other properties miss payments the risk of losses rises.
Some borrowers have held on because they bought hedges against higher rates. But these hedges are coming due. Of more than 4,500 interest-rate caps sold to commercial real-estate firms in 2021, 65% have already expired as of Feb. 8, and 92% are scheduled to expire before the end of this year, according to the financial risk management firm Chatham Financial, which arranged these caps. In most cases interest rates shoot up by a lot when caps expire.
As hedges expire, floating-rate lenders will see more losses, said Rahmani, the analyst. “They’re living on borrowed time,” he said.
On average, buildings with Arbor CLO loans only made enough money to cover around 60% of debt payments as of the latest reporting date in 2023, absent hedges, according to CRED iQ data.
The spokesman for Arbor said hedges, interest rate reserves and guarantees are a “critical part of Arbor’s lending practices.”
Borrowers can buy new hedges at their old interest rates, but these are now much more expensive. A three-year interest rate hedge for a $100 million mortgage that caps debt payments once the benchmark short-term rate hits 2% cost $51,000 in January 2021, according to Chatham. Today, it costs around $5.4 million—a 100-fold increase.
Not all of Arbor’s loans are repackaged into bonds. The company held $12.9 billion in loans on its balance sheet as of October, up from $3.9 billion in fall 2019, according to its public filings.
Kaufman co-founded his first mortgage business in 1983 while still a law-school student. He started off as a single-family mortgage lender in the New York area and later pivoted to multifamily loans. He launched Arbor’s predecessor in 1995 and took the company public in 2004.
Write to Konrad Putzier at konrad.putzier@wsj.com