GSEs Regain Their Sea Legs Amid ‘Adjustment Period’

by Jeff Shaw

Loan originations for Fannie Mae and Freddie Mac moderate while they navigate the rising interest rate environment.

By John Nelson

Multifamily mortgage loan originations rose 57 percent in the first quarter on a year-over-year basis, according to the Mortgage Bankers Association (MBA), but Fannie Mae and Freddie Mac’s combined multifamily origination volume dipped during the same period.

Although Fannie Mae and Freddie Mac are still considered the premier capital sources for multifamily borrowers, sources say that the level of competition has increased as debt funds, banks, life insurance companies and lenders of commercial mortgage-backed securities (CMBS) are all active in the multifamily sector. 

What’s more, the sharp increase in inflation over the past year, the subsequent rise in interest rates and slowing economic growth have combined to make the near-term outlook for multifamily property valuations more challenging than at any other point in the past decade. Fannie Mae and Freddie Mac, commonly known as government-sponsored enterprises (GSEs), also tend to be risk-averse.

“We’re in the middle of this capital markets-driven adjustment period that has impacted how everyone is looking at commercial real estate,” says Jeffrey Erxleben, president of Northmarq’s Dallas office. “Rising interest rates are adjusting values — by how much is still being worked through.”

Steve Johnson, vice president of Freddie Mac’s multifamily small balance loan and targeted affordable sales and investments business lines, says that even though the Fed’s move to calm inflation has helped drive a run-up in the 10-year Treasury yield, the extremely competitive multifamily debt market has kept loan pricing in check. 

Even though the higher interest rates may have slowed the deal pipeline for the GSEs in the first quarter, the dominance of Fannie Mae and Freddie Mac in the multifamily lending sector can’t be overstated.  The agencies originated a combined $139.5 billion in 2021. To put that figure into context, it represented nearly a third of all U.S. multifamily lending in 2021, which the MBA estimates was a record-breaking $470 billion.

Shifting Interest Rate Climate

[Editor’s Note: This article was published in the June edition of several France Media publications, and the numbers below represent the most recent information as of press time.]

Interest rates have taken off this year in direct response to accelerating inflation, which hit a 40-year high in March when the Consumer Price Index increased 8.5 percent year-over-year. The Federal Reserve made the largest single-rate increase for the federal funds rate since 2000 at its May meeting, and the 10-year Treasury yield eclipsed the 3 percent mark for the first time since 2018, topping off at 3.12 percent on May 6. As of late May, the 10-year Treasury yield had retreated to 2.8 percent, up about 120 basis points since the start of the year. 

Equity markets are also in flux as the Dow Jones Industrial Average dropped for eight consecutive weeks before snapping its skid during the last full week of May. Meanwhile, the Nasdaq Composite Index and S&P 500 Index are down 23 percent and 13 percent year-to-date through May 27, respectively. 

Additionally, the Secured Overnight Financing Rate (SOFR), which the Federal Housing Finance Agency (FHFA) recently adopted to replace the London Interbank Offered Rate (LIBOR) for Fannie Mae and Freddie Mac loans, jumped from basically zero in March (0.05 percent) to 0.78 percent by late May.

Because interest rates have been relatively muted for the better part of the new millennium, many professionals working for lenders and financial intermediaries are experiencing rising interest rates for the first time. 

Dan Brendes, senior vice president and head of GSE lending at Berkadia, says that rising rates are breeding “a different set of anxieties” than those encountered the past two years amid the COVID-19 pandemic, and this extends to real estate buyers and sellers as well.

“Rising interest rates are forcing buyers and sellers to reset expectations,” says Brendes. “It creates a different kind of volatility, and it’s now starting to slow certain transactions as companies get into discovery mode, whether it’s on price or creditworthiness for the lender.”

Martin Fayer, senior managing director of NewPoint Real Estate Capital, says that the gap is closing between floating and fixed interest rates, which is giving multifamily borrowers pause as to how they want to finance their deals going forward.

“When you have a rate shock like this on both the floating- and fixed-rate sides, it usually has a tendency to at least put a pause on new acquisitions as the multifamily debt and equity market recalibrates,” says Fayer. “On the refinancing side, borrowers could want to refinance since they think rates will continue to go up, but on the flip side borrowers are saying rates are too high right now. It’s really hard to assess what’s going to happen right after a rate storm hits.”

In their attempt to nail down property values, lenders are figuring out how to leverage their underwriting to account for the interest rate volatility. Erxleben says that loan-to-value ratios for Fannie Mae and Freddie Mac loans have jumped from around the mid-50s at the beginning of the year to the low to mid-60s now as the agencies have become more aggressive. 

In the first quarter of 2022, Fannie Mae originated $16 billion in multifamily loans, down 25 percent from $21.5 billion originated in the first quarter of 2021. Charles Ostroff, Fannie Mae’s multifamily chief credit officer and senior vice president, says that the agency picked up the pace slightly in April and closed $6.3 billion in that month alone.

Multifamily loan production at Freddie Mac totaled $15 billion in the first quarter, up from $14 billion in the same period a year ago. Still, that figure pales in comparison to the $25 billion in loan production achieved by Freddie Mac in the fourth quarter of 2021. (Data for Freddie Mac’s multifamily loan production for April 2022 was not disclosed.)

Sources say that multifamily borrowers are increasingly utilizing Fannie Mae and Freddie Mac products to finance recapitalizations, as well as value-add investments and acquisitions whereby the buyer assumes an existing agency loan and adds a mezzanine agency loan.

T.J. Edwards, chief production officer of Walker & Dunlop’s multifamily finance group, says one of the biggest driving factors in new loan activity is maturing loans. Most agency loans are underwritten with seven- to 10-year terms, which coincides with the multifamily sector’s bull market following the Great Recession.

“Those loan maturities are either going to lead to new refinance business or investment sales, and hopefully whatever company is buying those properties may see agencies as an option for the financing, especially in this environment,” says Edwards. “It almost plays into the favor of the agencies when the markets get choppy because what [the agencies] deliver to their sponsors is certainty of execution.” 

FHFA Increases the Cap

As in years past, the FHFA, which is the regulator and conservator of Fannie Mae and Freddie Mac, has issued a lending cap for the agencies. For the second straight year, the FHFA is not tracking loan categories that for years were excluded from the cap, such as green loans or loans for properties with 50 or fewer units. The FHFA raised the cap from $70 billion apiece last year to $78 billion this year, which is giving the agencies more room to operate.

“The increase to our multifamily volume cap will continue to strengthen our ability to provide liquidity and stability in the multifamily mortgage market,” says Fannie Mae’s Ostroff.

“[Freddie Mac] is continuing to thoughtfully deploy capital throughout the multifamily market while remaining within the $78 billion FHFA-set cap,” adds Freddie Mac’s Johnson. 

“Borrowers have a wide array of debt capital sources to choose from, and that has driven a preference for shorter duration loans with underwriting that supports higher proceeds,” says Johnson.

Brendes says that the agencies aren’t winning as many deals as the multifamily sector is accustomed to.

“The agencies don’t have the command that they had several years back. Fannie Mae and Freddie Mac are equally challenged to win these deals,” says Brendes. “There is plenty of activity, but the win rate for the agencies is not as high as it has been. They are both working to get to that run rate that gets them to $78 billion, but there are some challenges with getting there.” 

In years past, the agencies have started strongly out of the gate and sometimes throttled down in the middle quarters, while other years the agencies have started slow and rebounded to post strong second halves. Edwards expects that Fannie Mae and Freddie Mac will be “smartly aggressive” for the remainder of the year as they look to exhaust their full cap.

“They want to compete; they both have a $78 billion cap that they have to use up for 2022,” says Edwards. “Freddie Mac and Fannie Mae want to get as close as possible, but they want to be profitable, and they want to serve their mission of affordable housing.”

“They continue to provide liquidity at all times, and in times of transition they have made smart adjustments to their underwriting to make the liquidity continue to flow,” adds Erxleben. “Their numbers look way off compared to their relative cap that they have, but you’ll see that number climb back up and continue to accelerate throughout the year. They are going to be the go-to lenders for the rest of 2022.”

In addition to the certainty of execution that the agencies provide, their partner lenders say that the diversity of existing loans is a clear differentiator for borrowers as well as for entities that are buying debt securities backed by Fannie Mae and Freddie Mac mortgages. Fayer of NewPoint says that the GSEs have extensive portfolios of loans that run the gamut in terms of markets, loan types and products served.

“They’re doing small loans with small sponsors and large loans with large sponsors. They’re doing deals in primary, secondary and tertiary markets, and they’re doing affordable, workforce and Class A properties,” says Fayer. “Because their portfolios are so large, it enables them not to have the concentration issues that a lot of other lenders do. They can play on deals and in markets that other lenders can’t. That’s probably their biggest advantage is how well-diversified their legacy portfolio is, which enables them a lot of latitude in terms of concentration risk going forward.”

‘Aggressive’ in Affordable Housing 

The primary differentiator between Fannie Mae and Freddie Mac and their competitors is their commitment to providing debt for affordable housing communities. 

When the FHFA increased the cap to $78 billion, it also retained a directive for the agencies to have at least 50 percent of the units in their multifamily business meet the requirements to be “mission driven.” This guidance comprises loans on properties developed under the Low-Income Housing Tax Credit (LIHTC) or Section 8 programs, or those where a public housing authority (PHA) or a PHA affiliate is the borrower. 

The FHFA is also increasing the requirement that at least 25 percent of Fannie Mae and Freddie Mac’s multifamily business be for units affordable to residents earning 60 percent or less of area median income (AMI), which is an increase from the 20 percent requirement in 2021. (Loans that meet the 25 percent requirement also count toward the 50 percent requirement.)

“If you want to understand Freddie Mac and Fannie Mae and where their focus is, it’s first and foremost on affordable and workforce mission housing,” says Erxleben. “They’re very aggressive throughout that bandwidth.”

“In the first quarter and in the second quarter, we’ve seen Fannie Mae and Freddie Mac be laser-focused on the 60 percent AMI threshold, as well as the 80 percent AMI threshold,” adds Edwards of Walker & Dunlop. “They have to solve for the affordable component first because the last thing they want to do is be coming up close to the volume cap in the fourth quarter and not hit their affordable metric.”

Since 2015, Freddie Mac has provided more than $60 billion in debt capital for properties with apartments affordable to households earning 60 percent of AMI. Johnson says that nearly 95 percent of the agency’s multifamily lending finances units that are affordable to low- and middle-income households. 

Fannie Mae introduced a new pricing incentive in April called “Expanding Housing Choice” for apartment property owners in Texas and North Carolina that accepted vouchers through the HUD Housing Choice Voucher (HCV) program. To qualify, the properties must have a representative mix (or at least 20 percent) of units that are affordable at below the applicable HUD fair market rent.

“Borrowers see lower pricing, flexible loan terms and certainty of execution. They also see a steady stream of rent payments backed by HUD, and the voucher payments are directly deposited into their bank accounts,” says Ostroff. “Building owners benefit from an expanded renter base and they see less turnover in rent rolls because voucher holders stay nearly nine years on average.” 

One drawback to the HCV program is that voucher holders sometimes are unable to find landlords before their vouchers expire. Ostroff says that 30 percent of vouchers get returned unused, and then the renters end up homeless or living in areas with concentrated poverty. 

“Landlords in only 19 states are required by law to accept vouchers,” says Ostroff. 

Fannie Mae and Freddie Mac are primarily debt capital sources for the acquisition or refinancing of properties. But many industry insiders have long held the belief that the agencies would be welcome providers of construction financing when it comes to addressing the shortage of affordable housing. 

To that point, Johnson says Freddie Mac is addressing the supply side of the affordable housing equation head-on.

“We’ve focused on addressing supply with a record amount of equity investments in LIHTC properties while also driving the production of affordable forward commitments and cash preservation loans,” says Johnson. “The multifamily housing market is facing an affordability crisis as a result of inflation and a long-run supply shortage. The bottom line is that families are struggling with rents that rise faster than incomes, and Freddie Mac is a critical part of the solution.”

Some borrowers are using Freddie Mac’s tax-exempt loan (TEL) products to support new construction and rehabilitation projects. In December, So Others Might Eat (SOME), a nonprofit in Washington, D.C., used two Freddie Mac TEL products to finance 1515 North Capitol Apartments, a 15-story affordable housing tower underway in Washington, D.C. The project will add 136 affordable housing units to the local supply.

On Capitol Hill, the affordable housing shortage is taking center stage. The Biden administration recently unveiled its Housing Supply Action Plan, which would produce more housing over the next five years, with a strong focus on affordable housing units for both single-family homes and multifamily properties. 

Biden’s Housing Supply Action Plan is a series of incentives, reforms, legislation and financial vehicles that calls for the following:

  • increased funds to the LIHTC program; 
  • grants and HUD allocation for jurisdictions that have reformed zoning and land-use policies; 
  • direct investments to PHAs around the country;
  • funding to support the construction and rehabilitation of 10,000 HUD-assisted units in rural America. 
  • more accessible construction-to-permanent loans for multifamily developers that want to hold their properties for the long term.

Pursuant to the housing action plan, the administration is urging the Senate to pass the reconciliation bill (once part of the larger Build Back Better Bill), which the House of Representatives passed in November by a vote of 220 to 212.

In the meantime, Fannie Mae and Freddie Mac plan to aggressively finance mortgages for affordable housing. Whether or not each agency fulfills its $78 billion allotment this year, Brendes says that providing loans for the affordable housing sector remains the No. 1 priority for both agencies. 

“Volume is always important, but you can’t get to that volume number unless you’re doing a certain amount of mission business,” says Brendes. “It’s all about the affordable housing mission.”

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