As Fannie Mae and Freddie Mac go, so goes the U.S. apartment market. Together the two government-sponsored enterprises (GSEs) now provide 80% to 90% of the mortgages financing apartment sales.

The problem is that they are losing money — taxpayer dollars to be exact — hand over fist thanks to their portfolios of defaulting single-family housing loans. By the end of 2009, the U.S. government had already pumped more than $125 billion into the two entities to keep them solvent.

“Both sides of the aisle in Washington understand that the current situation is unsustainable in the long run, particularly with the losses that they are incurring,” says Sam Chandan, global chief economist and executive vice president at Real Capital Analytics, a real estate research firm based in New York.

This taxpayer burden has made the GSEs a prime target for government reform, and a raft of proposals from key advocacy groups in the multifamily industry have been posited (see sidebar).

Experts agree that whatever happens to the GSEs will have an enormous impact on the recovery and long-term health of the nation’s apartment sector.

The GSEs, including Ginnie Mae, held $363 billion in multifamily loans in their own portfolios at the end of 2009, according to the Mortgage Bankers Association. That accounts for 11% of outstanding commercial/multifamily mortgages, or 40% of the total multifamily debt outstanding. The next largest debt holder is commercial banks with $210 billion in mortgages, or 23% of the market.

Apartment sales nationally totaled just $8 billion in 2009, a fraction of the whopping $80 billion in 2007, according to Chicago-based Moran and Co., a brokerage firm that tracks apartment sales of $15 million or more.

“Ninety percent of those transactions were financed with Freddie Mac and Fannie Mae,” says Tom Moran, chairman of Moran and Co. “Because of that liquidity source, apartments are available to trade, which is not true of the other property types.”

In fact, bidding has become fierce in core coastal markets like Washington, D.C., due to relatively few quality properties coming to market and an oversupply of buyers.

Bidding on one Class-A apartment property in Los Angeles has been heated, attracting 100 signed confidentiality agreements, 40 tours and 30 bidders, according to Moran. “They’re bidding on what they believe the income will be over the next 12 months.”

Peter Evans, a regional partner at Moran who worked for Freddie Mac from 1997 to 1999, has a unique perspective. “People forget that in 1998 with the collapse of the Russian ruble and the credit crisis, they [the GSEs] were the only ones in the market the next day providing liquidity.

“After 9/11, they were there,” adds Evans. “People forget that Freddie and Fannie have stood in very tough markets as a beacon and as a support level for the market as a whole.”

Running on borrowed time

The two entities have worked well for 70 years, says Kieran Quinn, vice chairman at Walker & Dunlop, one of the largest Fannie Mae, Freddie Mac and HUD lenders in the country. “They helped us create the best secondary market to finance residential real estate in the world. Do you blow that up?”

Still, to most observers it is no longer a question of if the GSEs will be reformed, but when. The situation became so dire that in September 2008 both Fannie Mae and Freddie Mac were placed into conservatorship.

They are now 80% owned by the U.S. government. And they continue to bleed the U.S. Treasury dry. There is mounting pressure for reform on Capitol Hill. Congressmen Darrell Issa (R-Calif.) and Jim Jordan (R-Ohio) are two of the staunchest critics of the GSEs.

In early March, the duo called for Congressional hearings into why the Obama administration has not come up with a detailed plan for restructuring the entities.

Also in March, Rep. Jeb Hensarling, (R-Texas) unveiled legislation that would privatize Fannie Mae and Freddie Mac over the next five years.

Even a few industry insiders have their doubts about the long-term role of the GSEs. “In other industrialized economies, a residential mortgage market can function well even in the absence of very large government-sponsored enterprises,” says Chandan.

Protectors of the GSEs

But the onus for action has been blunted of late. On Dec. 24, 2009, U.S. Treasury Secretary Timothy Geithner lifted the $200 billion cap on federal aid to both Fannie Mae and Freddie Mac through 2012.

Then in late February, Geithner testified that no plan for reforming Fannie Mae and Freddie Mac would be announced until at least 2011. “We want to make sure that we are proposing these changes at a time when we have a little bit more distance from the worst housing crisis in generations,” Geithner said.

On March 16, Senate Democrats, led by Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, unveiled a 1,336-page bill that proposed the most sweeping reforms of the financial services industry since the Great Depression. Conspicuously absent were specific reforms for Fannie Mae and Freddie Mac.

The House of Representatives version of the bill, led by Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, also does not address reforms for the GSEs.

The delay in deciding what to do with the GSEs could have its benefits. “In the shorter to intermediate term, the longer this [delay] goes on, the more time there is for the capital markets to heal in other respects,” says Scott Bassin, executive vice president at Pittsburgh-based PNC Real Estate.

PNC became one of Fannie Mae’s preferred Delegated Underwriting and Servicing (DUS) lenders after acquiring ARCS Commercial Mortgage in July 2007.

“To the extent the agencies can remain active and relatively unchanged for the next two to three years, there is a good chance that alternative forms of capital could become available to the market,” says Bassin.

Quinn agrees. “Nothing is going to get done between now and the November elections, and I’m kind of OK with that because every month we go by we’re getting closer to a true housing recovery.”