How Rate Cap Costs Influence Multifamily Investment Decisions

Co-founder Frank Roessler explained that while the fund’s eight properties still generate enough cash to cover loan payments, the surging costs of rate caps have strained their finances. Rate caps, which protect against rising interest rates, were relatively inexpensive when Ashcroft borrowed in 2021, costing $513,000. Now, extending these rate caps has ballooned to $18.6 million.

Ashcroft’s pause on Class A distributions underscores the severity of their capital needs. Typically, Class A investors receive higher monthly returns than Class B investors. Roessler indicated this pause might extend through next year, but he assured investors that the properties remain operationally sound. The debt service coverage ratio (DSCR) is 1.28 across the fund’s assets, slightly above the threshold where loan servicers raise concerns.

Market-Wide Implications and Nuvo Capital’s Perspective

Ashcroft’s situation signals broader challenges for multifamily syndicators who relied on short-term, floating-rate loans during the high-demand period of 2021 and early 2022. Many of these borrowers purchased rate caps to mitigate the risk of rising rates. However, as these caps expire and costs rise, the financial strain becomes apparent.

Brian Underdahl of Nuvo Capital Partners discussed this issue on The Real Deal’s Deconstruct podcast. He noted that the Federal Reserve’s interest rate hikes have dramatically increased the cost of rate caps. This shift leaves many syndicators struggling to balance their finances, especially those who have not yet completed renovations to boost property revenues. Nuvo Capital, with its expertise in navigating distressed multifamily assets, observes similar trends. Thus, it is strategically positioning itself to assist syndicators facing these financial challenges.

Nuvo Capital Partners closely monitors these market developments. The firm leverages its experience to support distressed multifamily assets. Their approach includes providing gap capital and exploring preferred equity options to bridge financial gaps. This strategy ensures properties remain viable without forcing asset sales under unfavorable conditions. By focusing on long-term value creation and community resilience, Nuvo Capital positions itself well to navigate current market challenges.

Investor Assurance and Future Outlook

Despite these challenges, Roessler reassured investors that Ashcroft manages the situation without planning a capital call. The firm and its partners fund shortfalls and consider preferred equity to bridge financial gaps. They do not see selling the assets as a viable option since current market conditions would not yield sufficient returns to repay invested capital.

Roessler and co-founder Joe Fairless emphasized their alignment with investors by personally covering some of the rate cap costs. They already purchased a 12-month cap for a Jacksonville, Florida property for $1.4 million, a stark increase from the $27,500 cost for a 24-month cap in 2021.

While Ashcroft positions the pause on distributions as temporary, a recent blog post by John Casmon of Casmon Capital Group suggests that such pauses often indicate deeper financial issues that may take longer to resolve. These issues can stem from lower-than-expected rent collection or higher-than-anticipated debt service costs.

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