The risk of defaults at a growing number of apartment buildings is on the rise as owners with floating-rate debt struggle to make payments.

Collateralized loan obligations, or CLOs, are mortgages packaged into bonds that are sold to investors. A vast majority of the CLOs issued over the past two years have been tied to apartments, according to Trepp data reported by The Wall Street Journal.

Owners are drawn to CLOs because they have shorter terms and allow borrowers to take on more debt than a bank loan. But rising interest rates, coupled with a slowdown in rent growth and higher expenses, have hamstrung profits, and CLO holders may not be making enough money to cover their debt.

“The market has really changed for these people,” Selina Parelskin, CEO of Beacon Default Management, told the WSJ.

BMC Capital, a Dallas-based lender and mortgage banker that specializes in apartment financing, is scrambling to find solutions for clients with multifamily debt set to expire this year. Even owners of high-performing properties are falling short of the proceeds needed to refinance, President and CEO Keith Van Arsdale told Bisnow.

“We’re unfortunately going to see a lot more of that,” Van Arsdale said.

Dallas-area based Applesway Investment Group lost ownership of four complexes in March after stopping payments on about $229M worth of loans, some of which were securitized through CLOs. At least one landlord in downtown Los Angeles was forced to sell a portfolio of apartments after missing CLO payments, per the WSJ.

More than 40% of the $88B of securitized debt is at risk of default, according to Trepp, and CLOs comprise the majority of the at-risk loans. About 1.4% of commercial real estate CLOs were delinquent as of the end of April, but stakeholders worry that could quickly change as exposure to rising interest rates pressures borrowers.

The pain may be most acute in the Sun Belt, where investors rushed to capitalize on soaring rent growth in 2021. That frenzy of activity has since died down, and many markets are now seeing rent growth either plateau or decline.

In Dallas-Fort Worth, rent growth landed at close to 19% in 2021, far outpacing its historical yearly average of 6%, according to Apartmentdata.com. As of the end of April, rental rate growth had averaged 0.3% over the past 12 months, which Senior Director Bruce McClenny said signals a normalization of demand.

"2023 is shaping up to be a flat year, which I think would be a win,” he said.