Executive Q&A: Takeouts, Investment Sales to Fuel Mortgage Market
While apartment fundamentals are strong, there are likely to be fewer refinancings in 2019 because many borrowers refinanced last year, according to PGIM Real Estate Finance's Mike McRoberts.
Following the Mortgage Bankers CREF conference, CPE interviewed Mike McRoberts, managing director & head of agency originations for PGIM Real Estate Finance. We asked him about PGIM’s market outlook, his forecast for the future of the GSEs and the prospects for business growth in a relatively stable originations market.
As we can tell from the attendance at MBA, debt is a hot investment product right now. How is PGIM responding to the increased competition?
From a multifamily perspective, the agencies were somewhat flat in 2018, doing about $143 billion combined, and life companies were up just a bit. It’s the debt funds that are the new entrants and doing a lot more. With this increased capital in the space, spreads contracted significantly, and the funds competed mainly with our bridge lending program. For PGIM, we look at high quality, lower risk transactions, and our pipeline picked up significantly in 2018. We did over $5.2 billion through the agencies, which is a record for us and a dramatic increase over 2017.
How did PGIM manage to grow the business when the market size was relatively the same?
We were tracking a very large bulge of maturities to come in 2019, and with the yield curve flattening, the prepayment costs came down. Several of our borrowers decided to refinance early since the increase in short-term rates reduced yield-maintenance costs incurred with prepayments. We were able to lock interest rates forward in 2018 with closings this year.
We also strategically increased our originations staff throughout the year, which combined with the market forces, helped to push our numbers up.
What does PGIM forecast for its multifamily financing business in 2019?
We see 2019 pretty much as business as usual. A popular topic at MBA CREF this year was the idea that the market doesn’t drop but plateaus, which is a possibility. We don’t see significant declines coming, though eventually things are going to start slowing. The MBA is estimating $315 billion in multifamily financing in 2019, and we think it could be a bit higher. There were a record number of sale transactions in 2018, up 8 percent, and there’s still a lot of capital on the sidelines that managers need to invest, which will ultimately need financing. There are more than 600,000 units under construction, and those properties will need long-term permanent financing. Overall, the market is strong, multifamily fundamentals have held up well, and there is a lot of interest in the sector. However, if I had to point out one headwind, it would be that we don’t see a lot of refinancing coming in 2019, as many borrowers brought it forward last year and 2009 was not an especially active year.
PGIM participates in the affordable housing market through its Fannie and Freddie activity. What else is the company doing to increase the affordable housing supply?
There is a real lack of affordable housing with most developers not doing new construction for social responsibility purposes and lower-income residents. On the equity side, we have a social impact group looking to make investments there. And from a debt perspective, we utilize workforce housing programs from Fannie and Freddie. Through these programs, we are able to offer borrowers discounts in pricing since those segments don’t count against the cap, and we see that as an important driver for 2019.
How does PGIM encourage sustainability and green building?
We are always socially and environmentally conscious, and that starts with our parent company, Prudential Financial, and where we invest on their behalf. That mentality seeps across our capital sources and of course into our agency lending programs. Fannie and Freddie have green programs, and the FHFA tightened up their requirements, raising the bar on what constitutes green. They made changes to their green initiatives requirements to now require 30 percent cost savings vs. 25 percent previously, which some think will constrain green lending activity. We don’t think it will be as impactful as others though, and we expect to be active. Sustainability is one of our leading conversation points. Sustainability impacts all our stakeholders―the tenants, our borrowers and the agencies.
Agency lending is your specialty. What do you think about the potential privatization of the agencies? How would that advance or disrupt the multifamily lending market?
We think there are two paths to housing finance reform. The first is the legislative path, where for 10 years, we’ve needed someone to propose legislation and get it signed into law. There hasn’t been any real traction on any proposals from that side. The second is on the administrative side, where there’s an argument that the FHFA director and treasury secretary have expansive powers to make adjustments to the agencies and get them to the other side of conservatorship. However, even if there’s any adjustments from the administration, at the end of the day the federal government has to be involved to allow for a federal government explicit guarantee on the securities issued, which will need to be passed by legislation.
What is PGIM’s overall outlook for the multifamily market?
We are very positive on the performance of multifamily. Vacancy rates are still under 5 percent, even though they ticked up a bit with all these recent deliveries. We are still seeing rental growth in most markets. There’s high demand, good fundamentals driving household formation, Millennials leaving the basement, Baby Boomers downsizing, and job growth is healthy and still coming. We’ve seen a record number of deliveries, but they are getting absorbed. One headwind we had seen was a lack of income growth, which could hurt rental growth potential, but over the last couple of quarters, we have seen even that drive up.
For originations, as I mentioned, we saw the overall multifamily mortgage market come in at $315 billion last year, and we expect to see at least that again with construction loans needing takeouts, record sales and dry powder looking to buy. For the interest rate environment, last year saw a spike and volatility, which moved spreads out. But since the 4th quarter, we have seen 10-year Treasury yields fall from 3.25 percent to 2.65 percent, and that spike in spreads has settled down. People thought the window for locking interest rates below 4 percent was gone, but here we are back at historically low levels, which overall makes the market feel pretty good.