Fannie Mae started off the year with a bang, producing $17.4 billion in multifamily financing in the first quarter, up about 38 percent compared to the first quarter of 2016. The quarterly total was also up 20 percent from its fourth-quarter 2016 production.
Compared to its counterpart, Freddie Mac had a slower start to the year, producing $12.7 billion in the first quarter, down about 28 percent from both first-quarter and fourth-quarter 2016.
Hilary Provinse, Fannie Mae’s senior vice president of customer engagement, says the driver of Fannie Mae’s hot start is the increased activity in its green product lines, which incentivize borrowers to perform energy and water efficiency improvements at their properties to qualify for financing with reduced interest rates.
“Fannie Mae is the market leader in green rehab financing,” says Provinse. “In 2016, we did $3.6 billion in green financing volume. In the first quarter of 2017 alone we did $5 billion.”
Hilary Provinse, Fannie Mae Multifamily
David Brickman, executive vice president of Freddie Mac’s multifamily business, says that Freddie Mac’s first-quarter production was more affected by the “pause” in the market in late 2016 and early 2017 than Fannie Mae.
“There was a little disruption in the fourth quarter of last year that resulted in the market taking a pause,” explains Brickman. “It was the twin effects of the election and the increase in interest rates. That is not a political statement; the election caused a pause among market participants who were waiting to get clarity in terms of fiscal, tax and regulatory policy. At the same time, rates ran up almost 100 basis points, and that provided borrowers an economic justification to pause and stop and see where things might settle.”
Brickman also says that Freddie Mac didn’t experience the same amount of carryover in loan closings from the fourth quarter that it tallied in previous years. “Every year there’s some degree of carryover. It was lighter this year,” according to Brickman.
David Brickman, Freddie Mac Multifamily
Fannie Mae, on the other hand, had about $2 billion in carryover from the fourth quarter of 2016, according to Provinse.
Despite the dip in the first quarter, Brickman expects Freddie Mac to produce $60 billion in multifamily business in 2017, surpassing its 2016 total by about 5 percent.
“The inflows and activity that we see in the market indicate that [growth],” says Brickman. “Today we are seeing a lot more transactional activity in the second quarter that will ultimately result in originations in the third and fourth quarter, both in terms of refinancing and acquisition activity. That gives me the confidence to say that we will likely see growth in year-over-year production.”
Managing FHFA’s Cap
Pursuant to the lending cap set by the Federal Housing Finance Agency (FHFA) for 2017, about 62 percent of Fannie Mae’s first-quarter business counted toward the cap for market-rate apartment communities. Set at $36.5 billion for each, the FHFA established the cap as a means for Fannie Mae and Freddie Mac to serve as backstops for the multifamily finance market while not edging out private capital.
The remaining production by Fannie Mae — about 38 percent, including its Green Rewards product — was excluded from the FHFA cap. The percentage of loan volume excluded from the cap is up compared with last year when roughly one-third of the agency’s production was excluded from the cap.
“It’s not a policy of Fannie Mae to push up our percentage of uncapped business, but clearly the FHFA through its volume cap regulatory regime has incentivized us to create more liquidity in certain product areas,” says Provinse.
Also included in FHFA’s cap exclusions are targeted affordable housing whereby rents are restricted and/or receive government subsidies. Small multifamily properties that feature five to 50 units, manufactured housing, seniors housing, affordable properties in high- to very high-cost markets and properties in rural areas are also excluded.
Having already produced $10.8 billion of financing that counts toward the cap, some lenders opine that Fannie Mae will need to be more selective in its capped business for the remainder of the year.
“There’s a slight concern when you extrapolate what Fannie Mae did in the first quarter, but I don’t foresee any problems with it managing to the cap,” says Mike McRoberts, managing director of PGIM Real Estate Finance’s conventional Fannie Mae and Freddie Mac business.
The FHFA has shown in the recent past that it is willing to adjust the cap to adapt to changing market conditions. Last year the conservator revised the cap twice: once in May from $31 billion to $35 billion and again in August to its current cap of $36.5 billion. The FHFA meets every quarter with Fannie Mae, Freddie Mac and the Mortgage Bankers Association (MBA) to review the multifamily finance market’s size and its need for liquidity.
“We’re not worried about being able to provide liquidity or exceeding our volume cap,” says Provinse. Last year both Fannie Mae and Freddie Mac’s capped business ended slightly below the FHFA cap.
Fannie Mae’s Delegated Underwriting and Servicing (DUS) partners are adapting to the cap exclusion environment, winning business in segments of the apartment market where they may not have participated in previous years.
“PGIM’s approach to the business has adjusted somewhat over the past year or two, and we’re making a bigger push to get into the middle market,” says McRoberts, referring to 10- to 30-year-old assets in suburban or secondary markets. “PGIM has a lot of institutional relationships, so the company had a lot of Class A assets that were in our wheelhouse, but we’ve expanded pretty dramatically into the middle market, which has been a strategic push for us.”
In the first quarter, nearly 46 percent of Freddie Mac’s production was excluded from the cap, well above its 35.8 percent cap exclusion rate in 2016. Brickman says the agency is embracing the cap exclusions so far this year.
“Freddie Mac is certainly continuing to lean into uncapped business, which is the objective of the regime,” says Brickman. “We’re also seeing success in some of the newer uncapped areas that are contributing to the more significant change in the percentage of uncapped. Notably, these include our suite of green programs that are doing extremely well, and that’s probably the source of our biggest stream of uncapped business.”
Freddie Mac’s Small Balance Loan program is another significant contributor to its uncapped production. Brickman expects the program to see a 50 percent increase on a year-over-year basis. Freddie Mac’s lenders are also seeing a jump in their small balance financing.
“RED Capital Market’s Fannie Mae loan production was up a little bit year-over-year, and our Freddie Mac Small Balance Loan business was up 50 percent over the prior year,” says James Croft, chairman and CEO of RED Capital Markets. Croft also points out that Freddie Mac has picked up the pace for its capped business in the second quarter.
“What we’ve seen so far in the second quarter is Freddie Mac coming back with more competitive pricing to capture that capped business going forward,” says Croft.
Low Interest Rates Persist
Underpinning Fannie Mae’s strong first quarter and Freddie Mac’s rebound in the second quarter is the continued attractive interest rate environment for borrowers. After a run-up in November following the presidential election, the 10-year Treasury yield has held steady the past few months. The rate settled at 2.25 percent on Monday, May 22, up from 1.83 percent a year earlier but still well below the Federal Reserve’s long-term average of above 6 percent.
“Interest rates for multifamily loans remain at low levels when compared with historical averages,” says Ed Hussey, senior vice president and head of multifamily production for Pillar Financial, a division of SunTrust Bank. “Movement in the Treasury has made borrowers recalculate their yield requirements and adjust their financing strategies. In some cases, the Treasury movement was the impetus for companies to make a decision to refinance or acquire, where before they might have been on the fence about whether or not to act.”
John Powell Jr., executive vice president and director of agency production at Bellwether Enterprise, adds that the tightening spreads over the course of the year have helped to absorb the 10-year Treasury yield’s increase from last year.
“While the 10-year Treasury yield has gone up approximately 50 basis points over the past year, loan spreads have tightened modestly, underscoring the strong demand by investors for Fannie Mae and Freddie Mac transactions,” says Powell. “Tighter spreads have helped reduce the impact of increased Treasury yields, and given the pace of multifamily lending activity, it is clear that the market has absorbed the rate increase.”
In March the Federal Reserve increased the federal funds rate, the overnight interest rate at which banks and credit unions lend to each other, by 25 basis points to a range of 0.75 percent to 1 percent. The Fed has indicated it will likely raise the rate two more times this year, which Brickman expects to be well-received by multifamily borrowers.
“If interest rate increases are accompanied by growth in employment, wages and incomes, then the concern about higher rates is largely attenuated by the realization that it’s likely to be accompanied by higher rents going forward,” says Brickman. “So long as things increase in moderation and track largely with the macro economy, people are getting more comfortable that there won’t be any significant dislocation as a result of rate increases.”
What is already happening in the multifamily lending space as a result of increases in short-term rates, including LIBOR, is that borrowers are leaning more toward fixed-rate financing than floating-rate debt.
“There’s been a significant shift away from floating-rate loans into fixed-rate loans,” says Mitchell Kiffe, senior managing director and co-head of national production for CBRE’s Debt & Equity Finance Group. “It’s less attractive to put floating-rate debt on your asset, given where fixed interest rates are. Borrowers at this point in the cycle are thinking that maybe they will hold an asset for longer, and long-term rates are still pretty attractive. We have seen a shift for our clients to use a fixed-rate debt strategy.”
Multifamily Loan Pipeline
The MBA forecasts that total annual finance volume among all apartment lending sources will be roughly $267 billion in 2017. Freddie Mac’s outlook projects that total to reach $295 billion, driven by increasing property prices, a full construction pipeline, high number of maturities and continued low interest rates.
Already in 2017, lenders have more than enough multifamily loan originations to keep their shops busy. Bellwether Enterprise’s Powell says that the firm’s agency volume through the first week of May is up 300 percent from the same period a year ago, and its loans under application are up more than 100 percent during that same time frame. PGIM’s McRoberts also says his firm is “almost at capacity.”
“PGIM is doing a lot of business, and we’re almost at capacity with the amount of deals in preliminary processing and full underwriting,” says McRoberts. “Overall, our agency business is robust and has really accelerated over the past couple of months.”
The U.S. homeownership rate stood at 63.6 percent in the first quarter, about the same rate it was in the first quarter of 2016 and well below the 69 percent rate prior to the housing market crash. At the same time, the U.S. Census Bureau reports that single-family construction and home sales have risen steadily the past several years.
The sustained low homeownership rate shows that there’s still a robust demand for multifamily housing by renters, even if they are able to purchase a single-family home.
“We don’t see any indication that the homeownership rate will turn around,” says Freddie Mac’s Brickman. “We still have a significant cohort of millennials who have yet to form households. The prospect that some households may stop renting and buy homes is more than offset by the number of new millennials coming along. There seems to be a greater propensity among this group to rent.”
The median home price in 2016 was $316,200, up from $296,400 in 2015 and $282,800 in 2014, according to the U.S. Census Bureau. The increasing sales price of homes discourages the current renter cohort from buying a house, according to Brickman.
“We have a dearth of starter homes as most of single-family construction is for houses of more moderate- to middle-income homebuyers,” says Brickman. “That creates a significant headwind to increasing the homeownership rate.”
Through their various products, Fannie Mae and Freddie Mac anticipate focusing the rest of the year on preserving and stabilizing affordable housing. Fannie Mae recently rolled out the Moderate Rehab Supplemental Loan to preserve the country’s aging multifamily stock, and Provinse says there has already been significant interest in the program from borrowers.
“Fannie Mae wants to be smart and not jeopardize our underwriting standards, so once borrowers invest money into the property and then see rental rate improvements, we will allow the borrower to take an extra supplemental loan against that property to incentivize borrowers to make those upfront investments,” says Provinse.
Similarly, Freddie Mac is also pursuing ways to combat the affordable housing crisis in the country, which is exacerbated by steadily rising rents and a growing number of renters in need of affordable housing.
“Freddie Mac wants to be constructive in terms of doing what we can, given the very significant amount of capital that we are able to move,” says Brickman. “We want to find solutions in driving capital into the construction or preservation of affordable housing, not just financing existing properties. Over the course of the year, we hope to come out with a number of new products that will help serve in the development and rehabilitation of affordable properties.”
— By John Nelson, Editor of Southeast Real Estate Business. This article originally appeared in the June issues of Southeast Real Estate Business, Western Real Estate Business, Northeast Real Estate Business, Heartland Real Estate Business and Texas Real Estate Business.