Picture this: Billions of dollars sitting in funds specifically designed to capitalize on market distress, with fund managers checking their phones daily for news of the next wave of foreclosures and fire sales. The problem? The distress never came.
Starting in 2021 and accelerating through 2022, $7.5 billion in distressed real estate funds were raised in 2021, dropping to $1.9 billion through Q3 2022—hundreds of funds launched in preparation for the next great financial crisis. Veteran investors dusted off their 2008 playbooks, expecting a repeat performance. Today, many of those funds have been closed with little to no activity, their investors left wondering what happened to the promised opportunities.
The fundamental insight that even some sophisticated investors missed? Financial markets are highly adaptable. They are not infallible, but when they make mistakes, they generally learn from them and adapt to prevent past mistakes from repeating themselves. This adaptability—not market perfection—explains why the expected wave of distressed assets never materialized.
The Learning Curve: From 2008 to 2018
To understand today’s market dynamics, we must first examine what regulated financial institutions learned during the 2009-2013 crisis. When the national economy softened and loans began to default, nearly 500 banks failed, including Washington Mutual with $300 billion in assets, eventually costing the Deposit Insurance Fund approximately $69 billion. FDIC banks, HUD, CMBS markets, and Fannie and Freddie all pushed nonperforming debt into the markets quickly to liquidate problem assets and write off losses.
This desire to move past a difficult time quickly cost these institutions billions of dollars. Foreclosure proceedings jumped from 1.3 million properties in 2007 to 2.3 million in 2008, with an estimated $10 to 15 trillion in lost GDP. The lesson learned was clear: be more conservative when markets heat up.
Starting in 2018, regulated financial markets began implementing these hard-learned lessons, increasing lending standards, lowering LTV ratios, and becoming much more selective in their lending practices. This conservative behavior created an opening in the debt markets—excess demand beyond the conservative supply—and Wall Street filled it with large and aggressive debt funds.
Wall Street Fills the Void (2018-2021)
The capital was there, and the demand was enormous. These debt funds fueled the multifamily markets to levels never seen before, eliminating risk-adjusted cap rates in the process. In many cases, the same low cap rate was applied to Class A, B, and C properties without adjusting for the risk and age of the assets being purchased, driven by the prevailing wisdom that “what goes up, must go up further.”
The volume and velocity of the multifamily markets between 2018 and 2021 was historic. Not only did it bring new, inexperienced players into the market, it drove up prices to unprecedented heights for old and often obsolete multifamily assets. Most importantly, it created a solid foundation for new supply—in some cases, too much too soon.
While this was happening, disciplined investors recognized the signs. The difference between deploying capital to meet timelines versus walking away from deals that don’t meet rigorous standards became the critical distinction that would determine who survived the coming adjustment.
The “Extend and Pretend” Masterstroke
The balloon was created, but it has yet to pop. Why? Because the debt funds watched what the regulated financial institutions did during the global financial crisis, and they adapted. When distress came due to rising interest rates and expanding cap rates, values fell and distress began—but Wall Street decided to take a wait-and-see approach versus aggressively enforcing lender rights.
Research shows that banks “extended-and-pretended” their impaired CRE mortgages in the post-pandemic period to avoid writing off their capital, with 41% of loans maturing showing this strategy. Making the strategic decision to give borrowers future hope versus foreclosing immediately, borrowers continued to oversee assets and make some level of payments when possible while markets healed.
The lenders understood that with patience, rates would stabilize, housing absorption would equalize, and values would rise again. So the old lending strategy of “pretend and extend” was widely implemented across commercial real estate lending, affecting a massive volume of debt.
The story hasn’t been fully written, but so far, this strategy has worked. Multifamily markets have been absorbing new supply at a record pace, with 440,000 apartment units completed in 2023 (a 36-year high) and another 670,000 scheduled for 2024. Interest rates have begun stabilizing and may soon fall, and cap rates have settled into historic norms versus rising to fear levels that fuel market crashes.
The Fundamental Reset
The most interesting part of this new market cycle is that we still do not know how it ends almost 4 years later. The Class B and C assets that benefited from the extend-and-pretend strategy are now 4 years older. Multifamily completions rose 22.1% in 2023 to 438,500 units—the highest number since 1987, with approximately 508,000 units expected to complete in 2025. Many of those apartments have sold at values much lower than the sales prices paid in 2020 and 2021 for Class B and C assets that are much older and in many cases located in older markets than the new supply being delivered.
There has been a fundamental shift in interest rates, cap rates, and risk-adjusted return expectations. What fueled the multifamily markets up to new heights in 2021 no longer exists and might not return entirely for several reasons:
- Interest Rates: Rates rose from effectively 0% in March 2022 to 5.25%-5.5% by July 2023, and will likely settle closer to 4% for the 10-year versus the 1-2% during the market run-up
- Cap Rates: Cap rates have stabilized around 5.8% for multifamily properties, with risk adjustments now properly applied to Class B and C assets
- Supply: This unprecedented construction boom continues with deliveries expected to decline from the 2024 peak but remain elevated at approximately 508,000 units in 2025, with more units coming in subsequent years before declining significantly
- Rent Growth: Rent increases have moderated to just 1.7% annually in 2025, with some sources showing growth as low as 1.0% year-over-year, and with inflation, we’re finding that we can only push rents so far until residents push back
- Underwriting: Lending has implemented lessons from the past in how multifamily is underwritten
Gone are the days of the liberal use of “below replacement cost” to justify below-market cap rates applied to 20-30-year-old assets to justify aggressive sales prices. No matter how markets adjust and grow, 2+2 will never equal 5 again—or at least not for a very long time.
The Coming Market Unlock
The good news is that we’re back to strong underwriting fundamentals for well-located and well-financed multifamily assets. The challenging news is there are billions of dollars of unrealized losses looming on the equity side of the capital stack from these debt fund transactions, waiting to be realized.
The debt fund strategy of extending enforcement of lender rights has been highly valuable. Rather than experiencing 30-50% losses like financial markets did in 2009-2013, debt funds will likely exit with either full payoffs or relatively minor losses—materially more stable than what could have been the final result.
The critical insight that very few people are discussing: If debt funds simply get their money back or lose a small amount of their investment, equity players will have lost most or all of their investment. This reality is coming to the markets, but few sponsors are sharing this fact with their investors. Instead, they’re hoping for a miracle that will likely never come.
Navigating the New Landscape
The next few years will be meaningful for those investors seeking distressed opportunities. While debt funds were taking a wait-and-see approach, markets have continued trading portfolios of high-quality assets and new deliveries. However, after four years of watching the multifamily market remain locked for meaningful transactions, the time is approaching when debt funds’ collection days will arrive, with $2 trillion in commercial real estate debt coming due over the next three years. The national number of BOVs being requested and projects being discussed for marketing is growing—only waiting for the right time to exit.
Once the market opens up for these long-overdue transactions, sponsors will face a stark choice: write large checks to refinance (selling a story of growth to investors who would rather believe it than accept that their initial investment is gone) or tell investors that market changes have resulted in permanent losses.
For sophisticated investors, this environment creates significant opportunities—but only for those who understand the fundamental principles that ensure long-term stability and value:
First, you can never be forced to sell real estate at the wrong time. Conservative structures and patient capital become competitive advantages when others face maturity pressures.
Second, you make your money on the purchase. Buying an older asset, over value, simply because of aggressive underwriting is a death sentence to most multifamily investing over the long term.
The strategic opportunity: While debt funds were taking a wait-and-see approach, markets have continued trading portfolios of high-quality assets and new deliveries. However, after four years of waiting and watching the multifamily market remain locked for meaningful transactions, the time is coming when the debt funds’ collection period will arrive.
This environment favors investors who maintained discipline during the euphoric period and can now deploy capital without deployment pressure. Deals that don’t require everything to work perfectly become increasingly valuable as market participants discover that perfect execution is rarely achievable.
Conclusion: Patient Capital’s Advantage
Real estate remains an exceptional investment, but the lessons from this cycle reinforce timeless fundamentals. The debt fund evolution demonstrates that while markets adapt and learn, the basic principles of successful real estate investing remain unchanged.
Debt is a valuable tool for investing in real estate, but like any tool, if misused, it can be dangerous and create harm for the user. The difference between those who thrive and those who merely survive in the coming market environment will be determined by their adherence to disciplined fundamentals and their ability to remain patient when others are forced to act.
For investors positioned with conservative structures and patient capital, the next phase of this market cycle may present some of the most compelling opportunities in decades. The key is being ready when the market unlocks—and having the relationships and network access to identify truly exceptional situations rather than settling for anything that meets minimal criteria.
Deals that don’t require everything to work perfectly become increasingly valuable as market participants discover that perfect execution is rarely achievable. The extend-and-pretend strategy bought time, but time has limits. As those limits approach, the investors who maintained their standards while others abandoned them will find themselves in an enviable position.
If you’re seeking a partner positioned to capitalize on the coming market unlock—one who never compromised on underwriting standards during the euphoric period and maintains the patient capital advantage when debt fund collection days arrive—we’d welcome a conversation about the opportunities ahead. Contact our team to discuss how PEM’s conservative approach positions us for the next phase of this unprecedented market cycle.
Paul Mashni is the Founder and CEO of Professional Equity Management (PEM), a vertically integrated real estate investment firm specializing in multifamily properties. With over 30 years of experience and more than 25,000 apartment units acquired, Paul has successfully navigated five downturns while maintaining an average IRR of 20%+ since inception. His investment philosophy is guided by the principle that it’s “better to sell a year too early than a day too late.” His background in accounting and finance, along with his law degree from Wayne State University, informs PEM’s disciplined approach to investments. Paul holds a Bachelor of Science in Accounting and an MBA in Finance from Michigan State University.
