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May. 6, 2013

GSE Pullback

By Keat Foong, Executive Editor 

What will be the effects on the multifamily sector if Fannie Mae and Freddie Mac reduce their financing levels by 10 percent? Will multifamily property values fall? Will it become more difficult for borrowers to obtain financing? The answer may depend on the type of multifamily property in question.

On March 4, the GSEs’ regulator—the Federal Housing Finance Agency (FHFA)—released its plan to reduce Fannie and Freddie’s “new multifamily business relative to 2012 by at least 10 percent by tightening underwriting, adjusting pricing and limiting product offerings.” Under FHFA’s scorecard, this goal received a substantial weight of 50 percent. FHFA’s directive is, in fact, consistent with one of the three goals announced in 2012 under its Strategic Plan for Enterprise Conservatorships—to “contract Fannie Mae and Freddie Mac’s dominant presence in the marketplace.”

That FHFA has now announced a concrete goal that seems to indicate the government is serious about reducing the financing volumes of Fannie and Freddie. Perhaps the industry has been lulled into a sense of security until now. “Until recently, many market participants believed the multifamily businesses would emerge relatively unscathed from conservatorship,” says Fitch in a statement. “The recent goal contradicts the notion and reaffirms that the multifamily sector could be negatively affected by the far-reaching strategic and structural changes regarding the GSEs.”

“It is never a good thing to have less capital supplied to the market,” observes Lauren Spiegel, partner at the law firm of Manatt, Phelps & Phillips. Spiegel says that a 10 percent reduction could be significant. Indeed, the National Multi Housing Council (NMHC) questioned the need for such a volume cap. “Fannie and Freddie have already reduced their share of the multifamily mortgage market from 90 percent during the peak of the financial crisis to just 45 percent today,” it stated. NMHC said that “an artificial limit in multifamily lending” by the GSEs could harm the industry’s ability to meet the growing demand for rentals.

David Cardwell, NMHC vice president of capital markets, affirms that the industry would like to see, ultimately, the private sector take on a larger role in the multifamily capital markets. At the same time, he questions how that 10 percent figure and the directives were arrived at, as well as the timing of the new restrictions. The Dodd-Frank rules on risk-based capital requirements have not been released, and those rules could have an effect on the recovering CMBS financing, he adds. “Our preference would have been to let [the capital markets] settle down and become more normalized” before the reductions are dictated, he says.

All the same, Cardwell and many sources are eager at this point to say that the possible impact on apartment values is minimal. Based on both agencies’ combined financing of $63.3 billion last year, the 10 percent cut translates into a $6.33 billion reduction in capital inflows from Fannie and Freddie. Given that the Mortgage Bankers Association projects 2013 multifamily originations volume will total about $100 billion, $6.33 billion may represent 6.33 percent of the estimated total multifamily loan originations. “I do not know that will have a transactional impact,” says Cardwell.

William E. Hughes and John Sebree of Marcus & Millichap suggest that overall, the currently active capital markets should be able to step in to fill the gap left by reduced financing from the GSEs. “There should be very little, if any, impact on values,” says Hughes, who is senior vice president and managing director of Marcus & Millichap Capital Corp.

“There are enough capital sources to take up the slack,” says Sebree, national director of National Multi Housing Group of Marcus & Millichap Real Estate Investment Services. “With other lenders loosening up as much as they are, there are enough alternatives at this point to pick up the slack.”

If there are any effects on property values, some believe the secondary and tertiary markets will be the ones to be affected, rather than the primary markets. “It would not even be a blip on the radar screen in the primary markets,” says David Rifkind, principal and managing director of George Smith Partners. In fact, Rifkind says that debt sources that are focused on agency financing in the primary, gateway apartment markets tell him that they expect to execute the same, if not an even greater, volume of financing in 2013. On the other hand, “[the reduction in Fannie Mae and Freddie Mac financing], I think, will make some difference” on the investment sales markets in the secondary and tertiary markets, since markets on the fringe may be where the financing cutbacks will be seen, says Rifkind.

From the multifamily financing standpoint, no effects of the mandate have been seen so far. The GSEs have not provided any directives to their approved lenders as to the specifics about whether or by how much pricing will be increased and underwriting tightened, or which or how products will be curtailed. “It is important to note the regulator is not directing Fannie and Freddie as to how to achieve that [10 percent] goal,” says William T. Hyman, senior managing director of Centerline Capital Group, which is both a Fannie Mae and Freddie Mac approved lender, in addition to providing CMBS financing. “It is left to Fannie Mae and Freddie Mac’s discretion to use the range of tools at their disposal throughout the year.” Hyman says the GSEs have briefed their lenders, and although they have not given specific mandates at this point, they have said they will not be emphasizing just any one of those tools.

Rodrigo Lopez, president and CEO of DUS lender AmeriSphere, affirms that Fannie Mae “has indicated no drastic changes will be instituted, including underwriting guidelines and pricing.” And in fact, “we do not anticipate receiving additional underwriting guidance from Fannie Mae in the near future.” As to pricing, “changes will take place whenever market warrants such action in order to maintain competitive interest rates across all sources of capital,” says Lopez.

One word of advice for borrowers could be: get in line quick for financing. What Hyman can say is that one possible manifestation of the directive is that the GSEs could become less aggressive towards the end of the year as they reach their financing quota. “We tell our clients, depending on how the year plays out, that they could be sitting in the fourth quarter, and there is a risk that the GSEs will be less aggressive to do business,” says Hyman. The GSEs could become more selective, and financing terms later in the year may not be as attractive. Consequently, “we encourage our clients that if they should have financing needs in 2013, they should get in the queue to start the process earlier and not wait till the end of the year.”

The agencies will “remain competitive” sources of debt for strong businesses and strong borrowers, affirms Hyman. Hyman says that marginal-quality transactions—whether on account of weaker market locations, fewer secure sponsors or poor physical condition—may be the ones to be affected by the financing reduction. “We expect Fannie Mae will be less willing to grant waivers to [transactions] that it considers of marginal quality,” says Hyman. Where weaker applications may have obtained underwriting waivers in the past because Fannie Mae wanted to go after the business, borrowers may find that Fannie Mae is less willing to compete on granting waivers this time around. “The agency will become more selective on extending debt to properties on the margins,” says Hyman.

In any case, the 10 percent reduction in GSE financing volume does not make for huge consequences on the market provided other capital sources are now increasing their financing volumes. “It is important to put this news in context in terms of its implications,” says Hyman. He points out that if Fannie Mae provided about $33 billion in multifamily financing in 2012, the 10 percent reduction means the GSE will be executing about $30 billion this year. This figure hardly represents a big drop. Also, Hyman noted that if the GSEs’ market share falls below the current 45 percent, it is only moving closer to historical GSE market share averages. “Prior to the credit crunch, Fannie and Freddie throughout the ‘90s and until 2005 had about 35 percent of the multifamily market share. The GSEs’ market shares skyrocketed during the credit crunch and since then has been north of 50 or 60 percent,” says Hyman. “It is appropriate for the regulator to say a healthy real estate industry needs access to a variety of capital sources.”

And indeed, many sources say that the financing industry welcomes this announcement by the FHFA because it will create an opportunity for other debt capital sources—in particular, the conduits—who have been hungry for multifamily business to step up their activities. It may be a part of the regulator’s intention “to motivate players to think about market opportunities and to motivate market action,” says Spiegel.

According to Sebree, “if anything, it’s probably a good thing for the industry because it’s going to create more opportunities for conventional lenders and possibly even CMBS lenders to become just a little bit more aggressive in the marketplace.”

“Multifamily is still underrepresented in most CMBS pools, and there is a strong desire among CMBS players to execute more multifamily business,” observes Rifkind. Weaker transactions may still be left out in the cold by conduit financing, however. Rifkind says CMBS will step into the gap left by Fannie and Freddie for “good properties and sponsors.”

“We have always known Fannie and Freddie would be changing in a dramatic way in the near future,” says Brett Meringoff, vice president at WinnDevelopment. Meringoff comments that apartment owners may be preparing for this change in the same way they are preparing for the expected interest rate increases—by locking in long-term fixed rate loans at the historically low interest rates, where possible. “The uncertainty is always there,” he agrees, though he says there is no cause for alarm at this point until it is known how the agencies may be changing their lending practices.

There is no indication whether or by how much Fannie Mae and Freddie Mac financing will be further reduced in 2014 and subsequent years. FHFA may have established the 10 percent reduction goal in response to improved liquidity and market conditions. Conversely, if there should be a serious crisis in financing—for example, if conduits should leave the market once again due to a flareup of the European debt crisis—the FHFA may conceivably adjust its goal. “If there is a need for greater liquidity,” the regulator may change its policy, agrees Rifkin. “These policies are evolving. They are based on market conditions.”

Nevertheless, shrinking the agencies’ dominant footprint has been one of FHFA stated goals since 2012. With that in mind, perhaps it can be conjectured that given that private capital returns to the marketplace as predicted, the agencies will not be contributing to intensifying the magnitude of any apartment market booms outside of the hot markets.


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