A few weeks before Thanksgiving last year, the Federal Housing Finance Agency (FHFA) made sweeping changes to Fannie Mae and Freddie Mac’s multifamily business pursuits for 2021. The FHFA revised the previous structure that capped loan production at $200 billion combined for both government-sponsored enterprises (GSEs). And unlike most years, that cap was spread across five quarters spanning from the beginning of fourth-quarter 2019 to the end of 2020.
For 2021, the FHFA is once again using the traditional four-quarter time frame but is now directing the agencies to produce $140 billion in multifamily loans combined ($70 billion apiece), which is lower than $159 billion in loans closed by the GSEs and their lending partners last year: $76 billion for Fannie Mae and $83 billion for Freddie Mac.
The FHFA is again doing away with its long list of exclusions for loans on properties that don’t count toward the cap. In the past, the agencies had no limits to finance certain multifamily categories, including communities with five to 50 units, seniors housing, rural properties and manufactured housing.
The FHFA is maintaining its directive for the agencies to finance properties deemed as “mission-driven affordable housing” — or those affordable to households earning 80 percent or less of the area median income (AMI) — but it’s upping the minimum requirement.
Affordable housing, which is defined as housing costs not exceeding 30 percent of a household’s monthly income, now must comprise at least 50 percent of the GSEs’ overall multifamily business, a sizable increase from the 37.5 percent requirement for FHFA’s previous cap.
“It has always been the goal of Fannie Mae and Freddie Mac to allow for more affordable housing production throughout the country,” says Vic Clark, senior managing director and head of conventional multifamily production at Lument. “It is nice to see that affordability is now the major emphasis, because that is how the money should be spent. It provides the most social benefit across the country, and it is what the agencies were established to do.”
The FHFA is also raising the threshold that the GSEs need to provide for units affordable to households earning 60 percent or less of AMI. The new goal is for at least 20 percent of all Fannie Mae and Freddie Mac multifamily loans to fall within this bucket.
For example, if the GSEs are looking to finance a property in the Atlanta metro statistical area where the AMI is currently $86,200, to meet the 60 percent AMI goal, rents at the property should not exceed $906 per month for a studio apartment, $970 for a one-bedroom unit or $1,164 for a two-bedroom unit.
The FHFA’s intensified approach on affordability is helping provide more capital to this particular segment of the multifamily sector as renters are becoming increasingly burdened by housing costs. Debby Jenkins, executive vice president and head of multifamily at Freddie Mac, says the COVID-19 pandemic put the national affordable housing crisis more in the spotlight, though the issue goes back much further than March 2020.
“The pandemic pushed millions of American families to their breaking point, and many were already on the brink before anyone had ever heard of COVID-19,” says Jenkins. “The country faces an affordable housing crisis, and Freddie Mac has been working to address this issue for years. FHFA’s 2021 cap requirements certainly upped the ante, but we’re all-in on our mission and hope to surpass the new requirements.”
For its part, Fannie Mae recently introduced a new loan product that will help lower borrowing costs for owners of naturally occurring affordable housing (NOAH). The new Sponsored-Initiated Affordability (SIA) incentives are lowering mortgage payments for borrowers that agree to preserve or create at least 20 percent of units at a property affordable to renters earning 80 percent of AMI over the life of the loan, as well as agreeing to not have monthly rental rates exceed 30 percent of AMI.
“These incentives are aimed to help address the shortage of affordable rental housing in America at a time when rent growth is outpacing wages,” says Charles Ostroff, senior vice president and chief credit officer of Fannie Mae’s multifamily business. “Keep in mind that nearly half of the families and individuals renting their home spend more than 30 percent of their income on rent, and this share continues to rise.”
Tucker Knight, senior managing director and head of Texas originations at Berkadia, says that the incentives are meant to keep affordability at the property level for the duration of the financing and reward borrowers with an average savings of up to 30 basis points on their all-in coupon. However, Knight says the SIA incentives haven’t gained much traction yet among borrowers.
“This business is a herd mentality, and no one wants to be the first one out, so it’s had a slow start because there is some uncertainty,” says Knight.
Don King, executive vice president of Walker & Dunlop’s multifamily division, says the SIA incentives are similar to Fannie Mae’s green financing products in that they will likely prove popular in the long term, but that borrowers need time to warm up to the program.
“There are a lot of similarities between green and SIA,” says King. “It’s a great idea and it will work, but right now SIA is in the discovery phase.”
Agency activity thus far
Fannie Mae’s multifamily production in the first quarter of 2021 was $22 billion, an increase of more than 50 percent compared with its first-quarter 2020 volume of $14.1 billion. Through the first five months of this year, the agency’s multifamily loan volume totaled $28 billion, which represents 40 percent of its annual cap and is a 7 percent increase from the first five months of production in 2020.
Ostroff says that Fannie Mae’s production is put under a microscope on a regular basis to ensure that the agency is meeting FHFA requirements and that it remains a reliable source of liquidity for multifamily borrowers, even amid a pandemic-induced recession.
“We look at the numbers very closely on a weekly basis. This has always been a big focus for us, and it continues to be during 2021,” says Ostroff. “We manage the pipelines together with our lender partners and we continue to work with lenders to make the process more seamless and efficient. We are confident we can adapt our business to manage to the new cap.”
Freddie Mac didn’t come right out of the starting gate as hot as Fannie Mae, but it too has posted year-over-year production gains. Freddie Mac and its Optigo lender network closed $14 billion in the first quarter, a sizable gain from the $10 billion production in first-quarter 2020. Through May, Freddie Mac has produced $22.4 billion in new multifamily loans, a 5.5 percent increase from the first five months of 2020.
Even though the agencies aim to close less loans overall this year, Jenkins says that there are plenty of capital sources available for borrowers as other lender categories win business.
“We have seen an uptick in engagement in the debt space from life companies, debt funds, CMBS and others,” says Jenkins. “It’s driven by investor demand for the asset class, which is performing well compared to other commercial real estate [sectors].”
“Banks are getting aggressive, and bridge lenders continue to pop up every day,” adds Clark. “There are many lenders out there.”
The agencies aren’t merely acting as bystanders. Instead, they are continuing to push the limits on new multifamily mortgages, which in recent weeks has begun to include higher-end properties that fall well outside the affordable housing scope.
Faron Thompson, regional managing director of NorthMarq, says one positive result from FHFA’s new cap structure is that the GSEs discovered through the first half of 2021 that they can be aggressive in pricing for affordable housing while still giving attractive terms for borrowers of market-rate properties.
“Fannie Mae and Freddie Mac recently determined that the 50 percent production requirement [for affordable loans] is nowhere near the hurdle they thought it might be,” says Thompson. “That doesn’t mean they’re going to finance luxury apartments, but we’re not going to see them reserve their best pricing for communities that are deeply affordable. We’re seeing their best pricing come across a variety of product, whereas at the first of the year it might not have been priced to win.”
Both agencies are comfortably hitting their goals and are showing a greater willingness to go outside the box and bid on deals that aren’t in those buckets, according to King.
“Part of that is a portfolio management play as borrowers want to have some mix of all product types for a well-rounded portfolio,” says King. “It is important [for the agencies] to finance some nicer Class A assets, and we’re seeing that now.”
Economy favors multifamily
The U.S. gross domestic product grew at an annualized rate of 6.4 percent in the first quarter, aided by stimulus checks issued at the beginning of the year that gave consumers more discretionary income. Additionally, total nonfarm payroll employment rose by 559,000 in May, according to the U.S. Bureau of Labor Statistics, and the unemployment rate fell to 5.8 percent, its lowest level since the start of the pandemic.
As the U.S. economy recovers, Ostroff of Fannie Mae says the nation’s apartment market stands to benefit.
“The improvement in the economy and gains in the job market bode well for multifamily,” emphasizes Ostroff.
However, inflation is starting to rear its ugly head as the Consumer Price Index rose in May by 5 percent year-over-year, which is a faster pace of annual growth than at any point since August 2008, according to the U.S. Department of Labor. As the prices of consumer goods elevate, Clark says some borrowers are nervous about what that could mean down the line for their mortgage payments.
“If you’re out there buying, living and eating out, we’re all seeing higher prices,” says Clark. “The more sophisticated borrowers are seeing this as an opportunity to lock in their fixed-rate debt for 10- or 12-year terms. That’s just the smart thing to do right now.”
Berkadia’s Knight says the improving economy is directly benefitting the U.S. multifamily sector at the property level as landlords are still able to push rents, which bottomed out last summer. Yardi Matrix data shows that rental rates for the U.S. apartment market were up 0.8 percent in May 2021, which is the highest monthly increase since June 2015. The $1,428 average rate is also up 2.5 percent year-over-year but remains slightly below pre-pandemic levels.
“I don’t know if I’ve ever seen rent appreciation like we’ve seen in the past three months, and you can attribute that to things like rent affordability, government assistance and renters getting jobs and returning to the office,” says Knight. “It is robust out there to say the least. I would say that rent appreciation in secondary markets is the highest that it’s ever been.”
Multifamily is one of the few property types that is performing well during the COVID-19 pandemic, though it did suffer some setbacks in 2020. According to Moody’s Analytics, effective rental rates fell by 2.9 percent over the course of last year, and both asking and effective rents declined by about 0.2 percent year-over-year in the first quarter of 2021. Moody’s Analytics is forecasting both asking and effective rents to end the year at 2 percent growth as the New York City-based firm posits that the worst of the pandemic is in the past for the U.S. apartment sector.
As such, new and existing investors are targeting all levels of the multifamily sector as a safe haven for their capital.
“Sales are as active as I can ever recall. The supply of multifamily sales can’t keep up with demand,” says Knight. “We continue to see the continued addition of more and more growth of crowdfund buyers and new syndicators that we’ve never seen before purchase assets. It’s a whole new world.”
“There have been a number of new groups come in through various vehicles to buy multifamily,” adds Thompson of NorthMarq. “It’s also the same cast of characters, but it’s expanding because there is new formation of capital out there. There is so much pent-up demand for new groups of capital to get into real estate.”
Some of the economic tailwinds helping boost the multifamily sector include the widespread implementation of the COVID-19 vaccines, which Jenkins believes is the key to a full recovery for the U.S. economy. King of Walker & Dunlop says that the job market is a direct beneficiary as public health concerns wane and states fully reopen their economies.
“The vaccines will help the economy fill [non-office] jobs that were hard to do during the pandemic,” says King.
The federal government’s aggressive approach in getting stimulus funds and expanded unemployment assistance into the hands of renters has proven instrumental for multifamily owners. Lument’s Clark says that there was so much uncertainty in the industry a year ago that his firm was holding conference calls with clients in preparation of only receiving 20 to 30 percent of renter payments.
“Stimulus money saved the market and allowed our borrowers to weather the pandemic. It was a once-in-a-lifetime situation that turned out about as well as we could have hoped for,” says Clark.
Jenkins says that more relief is coming for renters struggling to make ends meet, which is especially important given that the eviction moratorium established by the Centers for Disease Control and Prevention is set to expire at the end of July.
“The federal government has allotted nearly $50 billion, including $25 billion in the American Rescue Plan, to rental assistance,” says Jenkins. “Those funds will be essential.” President Joe Biden signed the $1.9 trillion economic stimulus bill into law in March.
Borrower behavior changes
A year ago, many multifamily borrowers eschewed new acquisitions in favor of refinancing their existing communities for a multitude of reasons, including the record low interest rate environment, uncertainty with rent collections due to COVID-19 and disruptions in site tours as part of the due diligence process. Also, fewer debt options were available a year ago as many lenders took a wait-and-see approach amid the economic fallout stemming from the pandemic.
Today, U.S. multifamily investment sales are showing signs of returning to pre-pandemic levels. In the first quarter of 2021, apartment sales totaled $35.5 billion, which is down 12 percent year-over-year, according to data from Real Capital Analytics (RCA). Fourth-quarter 2020 sales though were basically even with fourth-quarter 2019 ($56.7 billion).
Ostroff says Fannie Mae experienced similar trends in the agency’s loan volume the past few quarters.
“Last year we saw a demand to refinance multifamily mortgages when U.S. Treasury rates declined,” says Ostroff, referring to when the 10-year Treasury yield oscillated between 0.5 percent and 0.8 percent last summer. “More recently, we have seen an increase in demand to finance purchases of multifamily properties. We believe 2021 will continue to be a more traditional mix between refinancing and acquisition loans.”
Clark says that the market for value-add investors is becoming aggressive as many companies are seeking higher yields. Borrowers are using financing from the agencies to target acquisitions in urban and suburban settings that provide short-term upside when it comes time to sell.
“Right now is a great time to sell, and buyers are in an upgrade mode where they can trade their older vintage properties and replace them with communities built in the 1980s or 1990s,” says Clark.
Over the course of the past few years, the agencies and their lending partners have been preparing for the transition away from LIBOR (London Interbank Offered Rate) as a benchmark rate for their mortgages to SOFR (Secured Overnight Financing Rate). While there was some trepidation when the move was fully made, agency lenders agree that it’s been more or less a non-event.
“Fannie Mae and Freddie Mac are the most prominent capital sources using SOFR in their floating-rate products,” says Thompson. “But the indices are indifferent to them, their economics and profitability are all in the spreads, so it has nothing to do with the underlying index.”
When it comes down to choosing the best underwriting structure for their mortgages, borrowers are increasingly selecting floating-rate financing because it gives them maximum flexibility. About 52 percent of Freddie Mac’s multifamily business through May was structured with a floating interest rate.
“A key trend out of the first quarter that should not go unrecognized was the substantial market demand for floating-rate debt,” says Jenkins. “That has come more in line with our traditional book as we adjusted to be more competitive in [fixed-rate financing].”
Even so, a large percentage of borrowers are locking in their 10- to 12-year loans with fixed interest rates to take any risk off the table. Knight says that Berkadia’s agency loans year-to-date have been about 60/40 in favor of fixed interest rates, and only 7 percent of Fannie Mae’s loans year-to-date are financed with floating rates.
For the remainder of the year, agency lenders anticipate Fannie Mae and Freddie Mac to be aggressive in closing their fair share of multifamily business. Whether or not borrowers go with agency debt or loans from other capital sources, the multifamily sector appears to be a relatively safe property sector in which to invest.
“I’m seeing a full return of activity by both younger borrowers and mature, sophisticated borrowers that have lived through multiple lending cycles,” says Clark. “Everyone believes it’s a good time to be in multifamily.”
— John Nelson