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.”
Lost in the shuffle
Whenever change comes to the GSEs, it will likely focus on the single-family side of the equation, since apartment loans account for only a small fraction, just 5% to 6% of the total loan portfolios of both Fannie Mae and Freddie Mac.
For now, industry groups including the Mortgage Bankers Association (MBA) and the National Multi Housing Council (NMHC) can only hope to inform policy leaders and lawmakers about the importance of the apartment sector as a vital thread in the overall American housing fabric.
“Frankly, not many members of Congress truly understand what multifamily housing is all about,” says Doug Bibby, president of the NMHC.
“In this environment when single-family housing caused great stress in the system, we are more often than not an afterthought,” adds Bibby. “It’s important for us to testify and be heard and have people understand how important multifamily housing is to the entire system.”
Peter Donovan, senior managing director of the capital markets group at CB Richard Ellis in Boston and chairman of the NMHC, agrees. “The needs of the single-family residential market and how Congress chooses to address that issue, for better or worse, are really going to dictate what happens with Fannie and Freddie. Multi-housing will be along for the ride in some fashion.”
Pent-up demand
One of the strongest arguments for including the multifamily sector in congressional discussions is a potential dramatic shift in demographics, which favors increased rental demand.
The largest generation of children under the age of 20 in the history of the U.S. will be entering the housing market in the next few years, according to the U.S. Census Bureau, and the number of seniors who can no longer maintain a house will grow dramatically.
“We have a huge group of echo boomers coming through that are not going to be able to put zero money down on a home,” says Donovan of CB Richard Ellis.
On the supply side, multifamily developers have dramatically slowed construction of new units. According to the Commerce Department, new multifamily starts fell 58% to 92,000 units in 2009, the lowest in 40 years. Starts in 2010 are predicted to be even lower.
According to Michael Berman, president of CWCapital, a DUS lender, there will be 400,000 to 500,000 new renter households every year for the next five years coming into the market.
“That tells me there is a very good demand side, and the supply is constrained for the next few years. For the next five years, multifamily is a great place to be. I don’t know why anybody is paying attention to anything else.”
Low delinquencies
Certainly both the MBA and NMHC are paying a lot of attention to the rising loan delinquencies at both Fannie Mae and Freddie Mac.
However, their underwriting on multifamily loans has remained conservative, stemming the kinds of losses now seen for their single-family portfolios and multifamily loans held in CMBS pools.
Less than 1%, 0.63% to be exact, of Fannie Mae’s multifamily portfolio is seriously delinquent as of the fourth quarter of 2009. For Freddie Mac, the number is even smaller, 0.12%.
On the other hand, bank loan delinquencies on multifamily mortgages hit 3.8% while CMBS delinquencies reached an all-time high in February at 6.72%, according to New York-based researcher Trepp LLC.
The story on the single-family loan side is decidedly different. Fannie Mae reports that in December 2009, delinquencies on loans in its single-family portfolio increased to 5.38%, up sharply from 2.42% in December 2008.
This news comes on the heels of a $16.3 billion loss for Fannie Mae in the fourth quarter. The GSE is seeking an additional $15.3 billion in aid from the U.S. Treasury to stay solvent. Freddie Mac recorded a $21.6 billion loss in 2009.
In early March, Standard & Poor’s said it expects losses at both GSEs to increase through 2010.
Still, the GSEs appear to be the only game in town when it comes to apartment financing. “My concern is that right now I don’t see a viable and substantial alternative source of capital that can play the role of Fannie and Freddie on the multifamily side,” says Donovan.
Instead, he believes the GSEs are successfully carrying out their mandate — maintaining liquidity at a reasonable cost to the market. “That’s the irony of all this. On the multifamily side they are doing exactly what they were designed to do,” says Donovan.
Congressional focus is coming at a time when the multifamily industry is showing signs of recovery, especially when it comes to Class-A properties in core markets.
That activity jibes with a recent survey of investors by PricewaterhouseCoopers and Korpacz, which revealed that real estate fundamentals in the apartment sector are expected to recover faster than other property segments.
With a national vacancy rate hovering around 8%, according to researcher Reis, apartment owners are banking on job growth to push values higher.
“From a credit performance standpoint, multifamily has performed relatively well in good times and bad compared to other property types,” says Bassin with PNC.
With Congressional hearings expected to run through the summer of 2010, and the passage of health care reform measures now in the rearview mirror, reforming Fannie Mae and Freddie Mac will come into sharper focus.
Advocates for reserving multifamily’s seat at the table will continue to face major challenges. “Everybody is so focused on what the GSEs did wrong, but try to focus on what they did right,” says Quinn.
“We need roughly 35% of Americans to have access to high-quality affordable multifamily communities,” points out Quinn, “and the GSEs are there to ensure we have that.”
Swimming against a stream of proposals
Since the U.S. government placed Fannie Mae and Freddie Mac into conservatorship in September 2009, an endless stream of reform proposals has surfaced, including total privatization, some combination of public/private ownership, and even complete dissolution. The list grows almost daily.
Leading the commercial real estate industry’s charge for Fannie and Freddie reforms are the Mortgage Bankers Association (MBA) and the National Multi Housing Council (NMHC).
Both groups testified before Congress on March 23, but each approaches reform differently. The MBA represents both single-family residential and multifamily constituencies, while the NMHC focuses exclusively on the apartment industry.
In October 2008, the MBA formed its Council on Ensuring Mortgage Liquidity, which released a specific set of proposals in September 2008. The centerpiece of the recommendations includes a new line of mortgage-backed securities.
Each security would have two components: (1) a loan guarantee provided by a privately owned, government-chartered and regulated mortgage credit-guarantor entity (MCGE); (2) a guarantee from the federal government on the securities, also called a “wrap.”
A similar guarantee is already used for securities issued by the Government National Mortgage Association, also known as Ginnie Mae.
The MBA also recommends preserving Fannie Mae and Freddie Mac’s infrastructure, including their technology, human capital, standard documents and relationships, to be used as the foundation for one or more MCGEs.
“The MBA goals are all about creating a sustainable liquid market,” says Michael Berman, president of CWCapital and chairman of the MBA’s council. “We took a very practical approach to it.”
Berman says the council is still working on a business model and transition plan to move to a new world of MCGEs.
The MBA also favors a “good bank, bad bank” approach to separating the performing and non-performing loans in the portfolios of GSEs into separate entities.
The NMHC proposals include:
• making multifamily lending programs a priority;
• preserving the ability of the GSEs to offer both portfolio lending and securitized lending programs;
• exempting multifamily loans from GSE mortgage portfolio limits through Dec. 31, 2012, or until a new secondary market structure for multifamily loans is operational.
Fannie and Freddie are required to shrink their $1 trillion mortgage portfolios to $250 billion by 2020.