After the U.S. housing crash, the apartment-lending units of Freddie Mac and Fannie Mae (FNMA) were among the few money making sources for these lenders. During the 2008 credit crisis, these two lenders were seized by the government. Those interested in eliminating the two fed lenders are now promoting a solution to solve the problem of the reckless lending system that caused the collapse of the U.S. housing market. Some lawmakers see the solution in the organization of companies with multifamily operations that would share the risks with investors.
Lawmakers have proposed a legislation system for the creation of a government-backed re-insurer of mortgage bonds. Based on this system, the private investors would bear losses on the first 10% of capital. This model closely imitates the multifamily lending operations used by Freddie Mac and Fannie Mae, where investors have to assume a risk on the mortgages originated by them.
The problem with the residential mortgage business at Fannie Mae and Freddie Mac was that lenders sold the debt and did not take any risk in the mortgage performance. Without direct risk, increasingly hazardous loans were made. The skyrocketing defaults on sub-prime loans were the boom of the collapse, with over $2 trillion lost by financial institutions worldwide. This was followed by the $187.5 billion taxpayer bailout of Fannie Mae and Freddie Mac.
The residential units of Fannie Mae and Freddie Mac were the most affected by the financial crisis. It was the divisions in charge of lending to apartment landlords who remained almost unaffected by the blow. The better underwriting saved the parties involved. Given the success of the two government-owned mortgage firms, in this market sector, specialists can better understand how the same system may apply to the large real-estate market sector.
Why does the multifamily lending work so well? The explanation resides in the fact that the lender assumes the risk of losses. Under the circumstances, lenders are now paying a lot more attention to the deals they make. A new lender is created by the Johnson-Crapo bill: the Federal Mortgage Insurance Corp. When this new lending corporation will begin its activity, Fannie Mae and Freddie Mac will take a serious blow. However, measures will be taken to prevent spikes in borrowing costs and other market disruptions.
Who dominates the market?
Although the residential divisions of companies are huge in comparison with their multifamily counterparts, Fannie Mae and Freddie Mac remain the dominant market players in financing apartment acquisitions.
During the recession, when lots of banks and lenders retreated, the investors that continued to support the market were Fannie Mae and Freddie Mac. According to the Mortgage Bankers Association, the two companies accounted for 85% of the multifamily mortgages originated by financial organizations in 2009.
At the harsh times of the financial crisis, Fannie Mae and Freddie Mac, with government support, continued to provide convenient mortgages to apartment owners. There were no capital availability problems for the multifamily sector. And it was the guarantee from the government that made this possible. Since there were no gaps in the cash flow for multifamily, this market segment had a faster recovery (despite slower gains) as compared to other commercial properties.
In January 2014, the value for apartment buildings was 6.4% higher than the pre-crash peak, according to Moody’s/RCA Commercial Property Price Index. For all types of real estate, values are 11.9% now below peak levels.
As lenders are taking their places back in the market, Fannie Mae and Freddie Mac no longer cover the biggest share of the market. According to the Mortgage Bankers Association, the two-government owned lenders accounted for 38% ($47 billion) of the multifamily loans originated in 2013 by financial institutions.
Fannie Mae and Freddie Mac aimed at making mortgages more affordable for low- and moderate-income potential homeowners. The declared objective of the companies is to increase the level of ownership. Fannie Mae was founded in 1938, resulting from the real estate crash during the Great Depression. Freddie Mac on the other hand was created in 1970 for the expansion of the secondary mortgage market.
The U.S. government seized the two entities in 2008, and since then they gained $202.9 billion for the Treasury in the form of dividends. The multifamily divisions of the companies received a much smaller blow. Although affected by the economic collapse, their losses were not that big. A comparison for the single-family portfolio and the multifamily holdings is illustrative in this respect.
In 2011, McLean, Virginia-based Freddie Mac lost $10 billion on its single-family portfolio and recorded a $1.3 billion profit on its multifamily sector. The same year, Fannie Mae lost $24 billion on its single-family mortgages, while it earned $644 million from its apartment division.
The multifamily divisions owe their better situation to more than just cheap funding and stringent underwriting. As compared to other types of commercial properties, the value of apartment properties held up better. The small impact on this market sector is due to the increase in the rental demand triggered by foreclosures and the falling of home values.
The expanding business presence
A 2012 study conducted by U.S. Government Accountability Office showed that the market dominance of Fannie Mae and Freddie Mac in rental housing or multifamily building business began in 1994. The range of multifamily mortgages from Fannie Mae and Freddie Mac is very large: from $150,000 to $500 million.
A wide range of properties are financed by these two companies. As it results from the documents distributed to investors, in November 2013, Freddie Mac had a bond offering that included a $31 million mortgage on Westdale Hills, an apartment complex in Eules, Texas. An assisted living facility in Fresno California was also part of the deal with a $246 million mortgage.
According to a February report from Fannie Mae, there are about $908 mortgages for multifamily buildings in the U.S. 36% of this amount is accounted for by the government-backed companies. Last year, Fannie Mae financed $28.8 billion in multifamily loans, whereas Freddie Mac purchased $25.9 billion of the debt.
Bundling loans into securities!
Freddie Mac and Fannie Mae convert the loans into bonds that are then sold to investors, based on the agreement that the U.S. Treasury backs the securities. This ‘transformation’ process allows the government lenders to borrow in better conditions. In turn, they can pass on these convenient interest rates to apartment landlords and homeowners.
The market depends on the risk-sharing programs of the multifamily sector to carry on. All the companies that originate apartment mortgages in compliance with the Delegated Underwriting and Servicing program (DUS) share in losses with Fannie Mae. The riskiest parts of bond offerings (15% of the deal) are sold by Freddie Mac to private investors
Apartment mortgages have not been subject to serious defaults and losses in the government-backed market segment. The competitive landscape bears the negative impact of subsidized lending. Lenders who cannot compete with the low rates available with Fannie Mae and Freddie Mac may inflate values and take on more risk.
Saturation already defines certain segments of the multifamily market, particularly there, where banks compete with agency lenders directly and take on higher risks. The underwriting standards are therefore expanding. The high demand for apartment buildings in areas like San Francisco or New York could be easily met by private lenders.
The competition on large segments of the multifamily market is incredibly tough. The need for government financing still remains. When lenders retreated from the market in the aftermath of the financial crisis, lots of landlords may not have found financial aid. Banks did not stay on the market when the things went ugly. It was government programs that threw the rescue line.