Navigating Distress in the Class-B Multifamily Market

The multifamily market attracted a record-high global investment of more than $478BN in 2021, and it has continued to attract eyes and capital ever since.

However, just four years after its peak, the Class-B multifamily market is facing significant distress, creating a rare window of opportunity for strategic investors.

Understanding the Current Landscape

Class-B multifamily properties, which cater to middle-income renters, have historically been considered resilient and offer relative recession protection with stable demand. These assets have consistently outpaced the growth of other categories, benefiting from strong rent growth and low vacancy rates. However, the real estate market, as a whole, has faced substantial headwinds over the past year, including:

• Rapid interest rate hikes
• An increase in expenses, especially insurance and property tax
• Declining property values

These challenges have disrupted traditional strategies, placing some owners under severe capital and operational strain. In certain cases, inexperienced or under-capitalized sponsors are facing operational and financial distress, with some being forced to relinquish control and return properties to lenders – a sharp reversal after a decade of robust returns.

Factors Contributing to Distress in the Class-B Multifamily Market

These challenges are driven by a combination of financial, operational, and market dynamics. Many properties acquired during the 2021 market peak were financed with short-term, floating-rate debt. As interest rates have risen sharply, debt service costs have surged, placing considerable pressure on cash flow. This issue has been compounded by the failure of some borrowers to adequately hedge against interest rate risk using tools like interest rate caps.

Operationally, rising property taxes, insurance premiums, and maintenance expenses are adding to the burden, while increased competition from new supply in the Class-A segment is impacting occupancy rates and rental income. Additionally, oversupply concerns have limited short-term rent increases, further straining cash flow.

From a market perspective, overvaluation during the peak and aggressive lending practices have left some properties vulnerable to price corrections and financial distress. As a result, many owners are struggling to meet the restrictions of their current debt covenants, with some unable to manage the high debt load.

Opportunities for strategic investors

While the current market presents challenges, it also creates compelling opportunities for vertically integrated and experienced investment managers like Sentinel Peak Capital Partners, uniquely positioned to navigate the complexities of the Class-B multifamily sector and seize emerging trends.

Well-capitalized firms can acquire distressed assets at attractive prices and invest in necessary improvements, leveraging their financial resources to unlock value. Vertically integrated managers with in-house property management capabilities bring operational expertise, driving efficiencies that enhance occupancy rates and boost net operating income (NOI). Furthermore, experienced managers with deep local market knowledge can identify undervalued properties and execute effective turnaround strategies, while strong relationships with lenders provide access to off-market deals and favorable financing terms.

The market is also poised for a resurgence. Urban migration has returned to pre-pandemic levels, with renters moving back to cities and their outskirts, often prioritizing spacious, affordable luxury – a hallmark of Class-B properties. These assets are especially attractive to former Class-A renters seeking to cut costs amid the ongoing cost-of-living crisis.

Despite oversupply concerns in certain areas, the broader U.S. faces a persistent housing shortage. The National Multifamily Housing Council estimates that 4.3 million rental units will be needed over the next decade, underscoring the critical role of Class-B properties in meeting demand. As construction pipelines shrink due to capital constraints, strong renter demand is expected to reduce vacancy rates and support above-average rent growth by 2026. Regions like the Sun Belt remain particularly attractive, offering affordable living, robust job markets, and population growth, all of which continue to drive multifamily investment opportunities.

Opportunities for strategic investors

While rising interest rates, oversupply, and declining values shaped the multifamily market in 2024, investors are optimistic about 2025 as a rebound year, with unique investment opportunities poised to restore its status as the preferred asset class in commercial real estate.

With approximately $4.7 trillion in outstanding commercial real estate loans – $2.1 trillion of which are secured by multifamily properties – significant opportunities exist for those ready to deploy new capital or assume existing debt. This environment offers the potential for meaningful portfolio growth, particularly for investors equipped to navigate the complexities of distressed assets.

At Sentinel Peak Capital Partners, we have a deep understanding of the challenges and opportunities found within this market.

Our expertise in acquisitions, asset management, and property operations allows us to identify and acquire undervalued properties, implement value-add strategies, and improve financial performance. For a conversation about helping you navigate the multifamily market in 2025, please get in touch.