Short sellers are eyeing mortgage REITs with the expectation that, given refinancing troubles and expiring interest rate caps, 2024 is going to be a bad year for them.

Across the board, mortgage REITs have already lost about a third of their value since March 2022, when the Federal Reserve began raising interest rates. But all have also seen their shares on the rise amid growing confidence that meaningful rate cuts are coming soon, The Wall Street Journal reported.

But short seller Muddy Waters is betting against Blackstone Mortgage Trust, and Viceroy Research is waiting for Arbor Realty Trust to stumble, the WSJ reported.

“Short sellers’ bet on continued pain for lenders looks like a late but safe one,” the publication reported.

Arbor Realty was targeted earlier this year by a different short seller.

The short sellers anticipate that the short-lived nature of bridge loans will be one of the sparks that sets off the problem: Borrowers will have a hard time refinancing offices because their values have tanked, or they will be obligated to pony up equity to meet loan-to-value requirements from lenders.

If that is correct, it could affect sizable portions of the REITs’ portfolios.

“Almost 20% of Blackstone Mortgage Trust’s shares and 33% of Arbor Realty Trust’s are on loan, a proxy for short interest,” the WSJ reported.

Starwood Property Trust and Apollo CRE Finance, other mortgage REITs, have less than 10% on loan and haven’t received attention from short sellers.

Refinancing troubles could be a problem for offices, as office values have dropped by 35% since the beginning of the Fed’s rate-raising streak, according to Green Street data cited by the WSJ. Blackstone Mortgage REIT’s U.S. office borrowers make up 27% of its total loan book, the WSJ reported.

Apartment owners might have similar problems because “U.S. apartment values have tanked 30% as high debt costs burst bubbly prices,” the WSJ reported. More than 90% of Arbor’s loans are to multifamily residential landlords, according to the WSJ, citing Fitch Ratings.

By Viceroy’s analysis, debt service coverage ratios for properties in Arbor and Blackstone's portfolios have already dropped below 1, the benchmark that indicates the income generated from a property can cover its debt payments. The short sellers expect the expiration of interest rate caps, which have so far protected many borrowers from sky-high debt costs, to cause a rise in defaults.

Blackstone Mortgage called Muddy Waters' report outlining its reasoning for short selling “highly misleading” and said it “represents a fundamental misunderstanding of our senior secured lending business.”

The Fed has indicated that small interest rate cuts could be on the horizon in the coming year, and the gap between the rate cap ceiling and where rates are now is “hardly the sheer cliff that short sellers seem to expect,” according to the WSJ. However, the publication didn't debate that mortgage REITs will likely spend the next year sorting through “messy” loans.