How the GSEs Are Proving Vital Once Again
Entering 2023 with $150 billion for multifamily funding, Fannie and Freddie are providing capital when others retreat.
Midway through 2022, regulators began scrutinizing the extent to which banks were exposed to commercial real estate loans amid the rising interest environment, sending many big bank lenders in particular to the sidelines for the balance of the year. Now, with the recent spate of bank collapses bringing regulatory attention to the massive amount of property loans at smaller banks, those lenders, too, are likely to pull back.
In the multifamily sector, the decline in credit availability from banks and other lenders spooked by growing economic uncertainty is expected to generate more business for Fannie Mae and Freddie Mac. The mission of the two government-sponsored enterprises is to provide a liquidity backstop, and it’s a role that they have fulfilled in periods of financial disruption—most recently during the early days of the COVID-19 lockdowns.
This time is no different, observers said.
“Lenders have a herd mentality—when there’s a lack of bank liquidity, everybody becomes cautious,” said Tucker Knight, senior managing director in Berkadia’s mortgage banking division. “There are going to be a lot of people clamoring for Fannie and Freddie money.”
Given the severe slowdown in transaction in the second half of 2022 that continued into 2023, however, business for all lenders is fading. Multifamily investment sales totaled $4.8 billion in February, a whopping 76 percent drop from the year before, according to MSCI Real Assets, a New York-based commercial real estate researcher tracking deals of $2.5 million or more.
Anticipating a continued slowdown in originations this year, the Federal Housing Finance Agency announced in November that the multifamily loan purchase caps for Fannie Mae and Freddie Mac would be $75 billion each, a slight reduction from $78 billion the prior year.
“There is a ton of liquidity for multifamily assets, but given the turmoil and the volatility in the capital markets right now, capital is still sitting on the sidelines,” said Brandon Harris, managing partner & co-founder of BlackBear Capital Partners in Basking Ridge, N.J. “Cap rates just haven’t moved as much as people initially thought they would.”
Indeed, the average apartment cap rate nationwide fell below 5 percent in 2021 and remained there since, according to MSCI Real Assets. While the average cap rate ticked up 40 basis points to 4.7 percent at the end 2022 from earlier in the year, it remained at 4.7 percent as of February 2023, even as apartment prices fell 8.7 percent from a year earlier, the same source reported.
Despite uncertainties surrounding credit, buyers and lenders can still find value in the market, said Kyle Draeger, senior managing director with CBRE Multifamily in Boston. “Overall, the tailwinds for multifamily are still pretty good,” he said. “If you’re making a permanent loan today, you’re basing it on values that have already reset. So, there’s not a lot of concern on that front.”
The agencies have largely maintained the same underwriting metrics that have been in place for the past several months, although they have increased their loan price spreads over the 10-Year Treasury yield by about 20 basis points, said Knight, who is based in Houston.
That widening equates to spreads of between 160 basis points and 220 basis points, depending on the amount of proceeds, asset, market and sponsor. It also diminished the benefits of the roughly 60-basis-point drop in the benchmark yield to around 3.4 percent in March.
While the GSEs will still finance 75 to 80 percent of an asset’s value for the right deal, that amount of leverage has effectively vanished amid a 10-Year bond yield that remains around 100 basis points higher than where it was a year ago—and roughly 200 basis points higher than at the end of 2021—coupled with apartment cap rates that have barely budged. In 2022, the agency loan-to-value ratio dropped to 61.2 percent from 66.3 percent a year earlier, MSCI Real Assets said.
“I haven’t seen an apartment deal size beyond 65 percent LTV since last March,” Knight stated. “The bottom line is that many deals aren’t penciling out financially like they did a year ago because of the rise in interest rates.”
Still, because the agencies remain flexible and focused on strong sponsors and market fundamentals, they are finding ways to finance even challenging deals. In March, for example, Berkadia secured $110 million in Freddie Mac acquisition financing for the Angelene, a 179-unit apartment complex in West Hollywood in Los Angeles. The project had an unpaid rent backlog of about $870,000 after evictions were prohibited during the pandemic, Knight pointed out. But Berkadia and the buyer was able to illustrate that a new management approach would improve conditions.
“There’s not a lot of blue sky right now,” Knight explained. “But Freddie leaned in and did the deal because of their granular knowledge of the neighborhood and the sponsor.”
With historic rent increases over the last few years and sky-high home prices, the agencies in particular are seeking deals with an affordable component, whether it is part of an affordable program, such as low-income housing tax credits, or is simply naturally occurring affordability. For 2023, the FHFA maintained the provision that at least 50 percent of GSE apartment business must be on mission-driven affordable housing. It also created a new category of affordability that emphasizes workforce housing to support residents who live close to employers, schools and hospitals.
This emphasis in some cases can improve pricing in riskier small markets and even so-called “pre-review” markets, said Zach Lutwak-Fitzgerald, managing director with BlackBear Capital in Chicago. Typically, the GSEs constrain LTV and bump up debt service coverage requirements in pre-review markets, he said, which may have a single economic driver, like energy, or have a preponderance of agency-backed loans in the area already.
Late last year, for example, Lutwak-Fitzgerald was seeking financing for a 142-unit multifamily property in the pre-review market of Corpus Christi, Texas. Initially, the amount of proceeds was going to be limited to around 62 percent LTV. But because BlackBear was able to demonstrate that the project’s rental rates were affordable for residents earning 80 percent of the area median income, it was able to bump up LTV to 65 percent by increasing amortization to 35 years. The final 10-year fixed-rate financing package included five years of interest-only payments, debt service coverage of 1.3x and an interest rate of 5.35 percent.
“Fannie and Freddie are willing to lend nationwide in all markets of varying size, and they’re not pulling back from secondary and tertiary markets,” said Lutwak-Fitzgerald, who is head of the Midwest region for BlackBear Capital. “And when deals in some of the smaller markets have an affordability component to them, that’s very beneficial to the agencies, and they are actively going after them.”