Finance: Trend Watch

By Keat Foong, Executive Editor

One major current in multifamily financing is the pullback in Fannie Mae and Freddie Mac financing, says Hugh Frater, CEO of Berkadia. Rather than being a development of little consequence, that trend could have some important implications for borrowers. It could, for one, portend greater general uncertainty in both capital availability and financing execution.

As the Fannie and Freddie footprint continues to be reduced by the regulators, CMBS and banks will be playing a much bigger role in multifamily financing, says Frater. “What will have to happen is that a lot more of the financing will have to go to CMBS,” he adds.

The loss of Fannie and Freddie financing could theoretically be adequately compensated for by CMBS and bank capital, even though, as Frater notes, maturing multifamily loans will more than double in the next three years.

To place the shrinkage in Fannie Mae and Freddie Mac’s footprint in perspective, Frater compares today’s level of agency financing to historical averages. He says that the agencies’ financing represented 85 percent of the multifamily marketplace in the past six years. However, in the nine years prior to that time, “if you go back to 2000, the GSEs never represented more than 47 percent of market share.” Their average market share was 30 percent, he notes.

Frater agrees, however, that in order for CMBS financing to adequately step up to the plate, CMBS issuers will have to extend their financings to smaller loans and to secondary and tertiary markets, which is already starting to happen. It will not be difficult for conduit lenders to ramp up the financing volume to the required amount if they add additional human capital, notes Frater, though in order for them to do so, they will have to be confident about the future business climate.

So what does a reduced Fannie/Freddie footprint mean for borrowers? “At minimum—uncertainty,” says Frater. Financing from the banks and from CMBS lenders can dry up more quickly than GSE financings. Bank financings are subject to regulatory and legislative pressures which can cause banks to retreat, says Frater. And CMBS financing is dependent on the capital markets which have been shown in the past few years to be vulnerable to overnight crises. By contrast, the most reliable source of financing has been shown to be the agencies, he suggests.

Execution terms may also be subject to greater fluctuations in a new world of financing that is dominated by CMBS. And there is also the perception that there may be more execution risks under CMBS, compared to Fannie Mae and Freddie, financing, adds Frater. The good news, though, is that conduits are prepared to advance more proceeds.

There are two other factors to watch out for in the world of multifamily financing, says Frater. One is the level of apartment supply. Generally, the most construction is taking place in markets with the strongest the employment growth—in markets such as Texas and the Northwest, says Frater. However, some lenders are already seeing cause for worry in some markets. For example, much new development has been seen in Florida, says Frater. On the other hand, there is still plenty of demand, and excess supply at this stage is just “something to keep an eye on,” says Frater.

Some players are also starting to worry about income growth. Rent increases in the apartment industry are such that eventually rents may get to the point where “the percentage of income that can comfortably be spent on rent hits a limit,” says Frater. When that happens, residents may trade up or go to the suburbs, or be forced to make other choices. At that point, “the ability to drive rents may decrease,” says Frater. In the past 12 years, rents have increased at a significantly higher rate than median income, Frater notes.

Increasing capital levels

Despite the agencies’ pullback, the capital market is still expanding overall—and that is another big trend currently in multifamily financing.

The Mortgage Bankers Association (MBA) is forecasting continued increases in overall debt financing for the commercial property sector in 2014. For 2013, MBA forecasted originations volume for commercial/multifamily properties to rise by 11 percent from a total of $244 billion in 2012. Through the first three quarters of last year, financing was up 14 percent—roughly matching the expectations, noted Jamie Woodwell, vice president in the Research and Economics group at MBA. At press time, MBA has not released specific figures for overall financing for this year, but there are indications that the upward trends seen in 2013 are “likely to continue to” 2014, says Woodwell.

The reasons for both greater volume of financing, and increased liquidity, are multiple: an improving overall economy, better real estate markets and fundamentals, low-interest rate environment directing capital to the relatively higher-yielding debt investments, not to mention greater lender confidence. “What we are seeing is strong appetite from lenders” being driven by improved real estate credit performance, returns and fundamentals, said Woodwell.

The increased interest rates and possible cutbacks on Fannie and Freddie notwithstanding, most of the major investor groups are projected to continue on track to increased financings in 2014. In the first three quarters of last year, financing volumes had already increased heftily, by 44 percent for CMBS financings, 22 percent for bank financings; and 19 percent for life company financings, according to MBA. (Indeed, in the second and third quarters of last year, life companies achieved the second highest levels of financings on record, Woodwell indicates.) The only exception to the uptrend last year lay in GSE financing, which declined by 3 percent in the first three quarters compared to the same period in 2012.

What about interest rates

Matthew Rocco, executive vice president and head of national production for Grandbridge Capital, is not overly concerned about impending interest rate increases, and is strongly optimistic about overall multifamily financing and market conditions.

“We are in a very good spot,” says Rocco. “The commercial real estate markets, and especially the multifamily and capital markets, have outperformed the broader economy.”

Also, Rocco points out that multifamily real estate has “enjoyed this recovery absent broader recovery in the economy, including in wages and employment levels.”

Multifamily remains the favored asset class for capital investors. As a result, there will be favorable market execution available for deserving multifamily assets throughout the country through 2014 and even 2015, says Rocco. The Fed is expected to tighten key interest rates in the first quarter, and throughout 2014 and 2015 and beyond, acknowledges Rocco.

However, in the near term at least, Rocco does not see Fed tightening to materially increase interest rates. “Overall coupon rates will remain very attractive throughout 2014,” he says.

Moreover, Rocco is of the opinion that there is some room in the apartment sector to take the rise in Treasury rates. Most markets have an ability to absorb another 50 basis-point bump in commercial mortgage interest rates without a corresponding increase in cap rates, he says, and there is not necessarily a one-to-one direct correlation between a rise in interest and cap rates.

As for the wave of maturing mortgages in 2015, Rocco believes the ability to refinance those loans stands on solid ground. He remains very optimistic regarding the next three years. One reason is that financing conditions may improve further as the fundamentals get even better. Rocco projects employment levels to start to rise on a more consistent basis, and he anticipates some wage growth, which will be favorable for the multifamily space. “Wage and employment growth will be where you will see owners’ ability to drive rents,” he says.

Also, household formation, which has been negative in the past few years, will start to recover as renters begin to move out of their shared living arrangements. These new households are more likely to be renters because the for-sale market is still moribund. If all else fails, agency and immigration reforms could prove to be positive developments for the apartment sector. Immigration reform, in particular, “will provide tremendous support for the rental marketplace.”

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