The multifamily divisions of Fannie Mae and Freddie Mac are off to a slow start this year as the government-sponsored enterprises (GSEs), their network of lending partners and multifamily borrowers contend with rising interest rates.
Fannie Mae’s volume of new multifamily business totaled $10.2 billion in the first quarter of 2023, which is a 36 percent decrease from the same period a year earlier when the agency closed $16 billion. Freddie Mac closed $6 billion in new multifamily business in the first quarter, a year-over-year decrease of 60 percent.
Seasoned agency lending professionals all point to elevated borrowing costs as the primary reason for the two agencies closing less business thus far in 2023.
“The rapid increase in rates across the board has really been a shock to the industry,” says Vic Clark, senior managing director and head of conventional multifamily production at Lument.
At its May meeting, the Federal Open Markets Committee raised the federal funds rate to a target range of 5 to 5.25 percent. The fed funds rate is the interest rate that U.S. banks charge each other to lend funds overnight. This time a year ago, the short-term benchmark rate was at a range of 0.75 percent to 1 percent.
When the fed funds rate increases, it can spur a rise in interest rates on a variety of consumer products, ranging from credit cards to mortgages, and it can impact other rates in the economy as well.
For example, the Secured Overnight Financing Rate (SOFR) rose from 0.78 percent a year ago to 5.05 percent as of this writing. SOFR is often used as the benchmark rate for short-term, variable-rate loans like construction or bridge financing. So, a borrower could be looking at an 8 percent all-in rate today versus a 3.75 percent all-in rate a year ago for an adjustable-rate loan, assuming the spreads remained consistent at approximately 300 basis points over SOFR.
The hike has been less dramatic for the U.S. 10-year Treasury yield, a benchmark for permanent, fixed-rate financing in commercial real estate. The 10-year yield stood at 3.82 percent in late May, an increase of slightly more than 100 basis points from a year earlier. The yield peaked in fall 2022 at north of 4.2 percent, the highest level since the Great Recession hit in fall 2008.
Consequently, the all-in rate for a 10-year, fixed-rate loan for refinancing an apartment community today could be closer to 7 percent versus 6 percent a year ago, assuming a 300-basis-point spread above the 10-year Treasury yield.
Clark says that the U.S. multifamily sector is stuck in a period of limbo because of the rate hikes, though other inflationary factors are also impacting the industry. These include elevated costs for property taxes, labor and construction materials, as well as ballooning insurance premiums that Clark says have tripled in some instances due to inflation, natural disasters and insurers hitting pause or exiting certain markets.
“For the first time in 12 years, our industry is really getting hit from all sides,” says Clark. “It is truly a rough patch in the road, and it’s not just one thing. All expenses are up, and the market has not adjusted quickly enough to allow for deals to really underwrite the way we’re used to.”
“Deals are harder to pencil out,” adds Dan Brendes, senior vice president and head of GSE lending at Berkadia. “And for those deals that we do see, we are doing more sizing, quoting, requoting and advising. There is definitely more churn.”
The Mortgage Bankers Association (MBA), which works with the GSEs and the Federal Housing Finance Agency (FHFA) to set the agencies’ annual multifamily lending caps, forecasted an 11 percent drop year-over-year in multifamily loan originations in 2023 due to higher borrowing costs. Sources interviewed for this article confirm that this figure is on target based on current levels of origination activity.
As agency lenders and borrowers navigate current market conditions, the number of available capital sources is winnowing. This year can already lay claim to the high-water mark for bank failures in terms of total assets, according to the Federal Deposit Insurance Corp. (FDIC). The failures of Silicon Valley Bank, First Republic Bank and Signature Bank have collectively totaled $548.5 billion in total assets, which is more than 2008 and 2009 combined when 165 banks failed, affecting more than $544 billion in total assets.
“Banks are putting fewer dollars out into commercial real estate and multifamily,” says Brendes. “The amount of liquidity in the market is changing.”
The convergence of higher interest rates and fewer active capital sources has created a “liquidity predicament” of sorts that, according to Geri Borger Urgo, head of production at NewPoint Real Estate Capital, benefits the agencies. On the one hand, acquisition activity has slowed down significantly, and deals are more challenging to convert. On the other hand, the agencies are performing their role of providing “counter-cyclical liquidity.”
“Multifamily borrowers are very lucky to have liquidity from Freddie Mac and Fannie Mae, and while other options are limited, the agencies have proven to be excellent partners through this period,” says Borger Urgo. “We still see some optionality for borrowers from life companies and, to a limited degree, banks.”
“The banking turmoil has curtailed debt capital, which has provided more inflows to the agencies,” adds Jeff Erxleben, president of debt and equity at Northmarq.
Property sales plummet
Though agencies are available sources of capital, acquisition financing activity has declined sharply because the volume of multifamily investment sales cratered in the first quarter of 2023. According to CoStar Group, investors generated $14 billion in multifamily acquisitions the first three months of the year, a 74 percent decline from first-quarter 2022.
The multifamily industry is no different than other asset classes in that buyers and sellers are in a period of price discovery as values are proving to be a moving target. Matt Rocco, president of Colliers Mortgage, says that a wide bid-ask spread between buyers and sellers is a natural byproduct of massive swings in interest rates.
“When the interest rate in [some] commercial mortgages more than doubles in less than 12 months, there has to be a recalibration both in value of the asset as well as interest from investors,” says Rocco, who leads Colliers Mortgage’s agency business from its Charlotte office.
Clark of Lument estimates that 20 to 25 percent of Fannie Mae and Freddie Mac’s multifamily lending activity is for acquisitions thus far this year. The remainder comprises refinancing activity. While refinancing activity accounts for the majority of the agencies’ multifamily business, sources say that the attractive rates in late 2021 and early 2022 caused a flurry of refinancing activity, leaving behind a dearth of potential deal flow.
“Much of the product in the multifamily space the past couple of years that could have been refinanced, particularly on a longer-term basis, was refinanced on a longer-term basis,” says Rocco. “So instead, what we’re facing today is closing in on some [loan] maturities. We don’t expect a lot of those maturities to come until later this year, throughout 2024 and early 2025. Those would be highly correlated to some of the new deliveries in near-term stabilization of assets.”
To Rocco’s point, CoStar Group is reporting that 2023 represents the 40-year high in terms of expected multifamily deliveries in the United States (531,000 new units nationwide). Additionally, supply has outpaced demand for the past six quarters, including first-quarter 2023 when deliveries (109,000 units) were more than double net absorption (+42,000).
Lenders are monitoring this expected wave of construction loan maturities stemming from recent deliveries to see how owners will approach their bridge financing decisions. Rocco expects legacy multifamily investors and developers to remain in the fray and not sell, but points out that some sponsors could exit the space altogether.
“We’ll see if what I call ‘core’ real estate investors remain invested in real estate,” says Rocco. “But those that were just investing in real estate over the past few years because it was a higher yield play will rotate out of the sector to alternative assets. There will be a reckoning.”
Although investment sales volume is down and refinancings are more selective, Borger Urgo of NewPoint says that she has observed an uptick in borrower requests for broker opinions of value (BOVs). This process gives borrowers an up-to-date opinion on how much a property is potentially worth on the open market.
“Borrowers are trying to figure out the right timing to re-enter the market and most efficient opportunities within their portfolios,” says Borger Urgo. “More owners are going to the various shops and asking for these BOVs now, which could foreshadow increased investment sales activity in the second half of 2023.”
But she adds that an uptick in BOVs does not always translate into increased sales activity. Sometimes sponsors request BOVs to maintain working relationships with investment sales professionals. At other times, borrowers just have an innate curiosity on how interest rates are impacting cap rates.
Clark says that while refinancings are accounting for the bulk of recent deal activity, his conversations with Fannie Mae and Freddie Mac coupled with the rise in BOVs suggests the ratio of sales versus refinancings may be changing soon.
“In calls with both agencies in the past 24 hours, both said they are just now seeing a slight uptick in sales volume versus refinancings,” says Clark.
Underwriting trends
Up until 2022, several years of historically low interest rates enabled borrowers to have their pick of underwriting options depending on the quality of the underlying assets, as well as borrower preferences for the length of the loan, fixed versus floating interest rate and prepayment flexibility.
Borrowers also had a wealth of options with the category of lender they preferred, including banks, agencies, life insurance companies and debt funds. Accounting for the underlying benchmark rate and the spread by the lender and mortgage broker, deals were executed at very attractive leverage points and all-in rates.
“Every deal works at 3 percent interest,” Borger Urgo points out.
Now with more expensive debt and fewer lending options, borrowers are picking and choosing their spots. Unsurprisingly, agency lending professionals are discovering that borrowers are asking to lock in fixed interest rates to mitigate the risk of even higher debt costs via floating interest rates.
“Historically, agency lending was roughly 60/40 fixed to floating. Based on the activity we are currently seeing, now that ratio is probably 90/10 or even 95/5,” says Borger Urgo. “The vast majority of borrowers are seeking fixed-rate debt.”
Clark of Lument says that borrowers are continuing to ask for longer interest-only payment periods and extended amortization schedules. Fannie Mae and Freddie Mac offer an attractive 35-year amortization option, but Clark says the GSEs are selective on who receives it. He adds that he’s heard that fewer 35-year amortizations will be offered in the future and that the product could even be discontinued or shelved until values and market conditions stabilize.
“What we’re hearing from both agencies is they are giving 35-year amortization for now, but it really must meet the mission and workforce housing goal parameters to qualify,” says Clark, referring to the agencies’ affordable housing goals.
According to the FHFA, 50 percent of the GSEs’ multifamily business must be for properties meeting an outlined affordability threshold, typically with units income-restricted at or below 80 percent of the area median income (AMI).
“The coveted 35-year amortization will most likely become more and more difficult to obtain if mission goals are not met by a given deal. That is going to continue to be prevalent as we move into the rest of this year,” Clark continues. “Borrowers with mission-rich deals will be best positioned to receive the 35-year amortization but interested borrowers should consider acting now.”
One commonality that agency mortgage lenders are seeing is that in addition to fixed interest rates, borrowers want shorter terms and flexible prepayment options. Thus, a five-year, fixed-rate loan with structured prepayment penalties is gaining traction with both agencies.
“That’s a popular choice because borrowers want to have as little maturity risk as possible and get the most creative financing,” says Erxleben. “The market by and large has been looking for stability as it relates to rates and as it relates to capital structure.”
Borger Urgo adds that today’s market has the highest volume of five-year, fixed-rate deals that she’s witnessed in her career, which includes leading Freddie Mac’s Northeast and Southeast multifamily divisions.
“Both agencies have financed a lot more five-year, fixed-rate debt than they have historically,” says Borger Urgo. “It used to be about 5 to 10 percent of agency business. It is probably closer to a third right now.”
Robust outlook
Although the pace of loan closings for the agencies has been slow to start the year, their lending partners expect deal velocity to accelerate the remainder of the year. The GSEs historically meet their lending cap, which the FHFA set at $75 billion a piece for 2023, a slight decrease from the $78 billion goal in 2022.
Clark says that right now, Fannie Mae and Freddie Mac are working through a backlog of deals, which is encouraging as investment sales volume remains stymied.
“Both Fannie Mae and Freddie Mac are in the $4.5 billion to $8 billion range in quoted business a week,” says Clark, referring to loan estimates that the agencies have issued.
“Some of that figure is requoted business as those loans work through their issues, but the volume is huge,” adds Clark. “Both agencies will likely meet their annual budget without a problem.”
While they are giants in the multifamily lending space, Fannie Mae and Freddie Mac aren’t the only game in town. Everyone is in a waiting game because of volatility in the capital markets, as well as uncertainty surrounding the near-term outlook for the U.S. economy, but those on the sidelines are “ready to pounce,” says Borger Urgo.
The good news is that the multifamily industry’s long-term outlook remains strong as housing represents a basic human need, say sources interviewed for this article. They also emphasize that the same capital cost hurdles are affecting single-family homeownership. Erxleben says the biggest silver lining is that the GSEs will continue to provide options for borrowers, whatever their needs and goals may be.
“There is still capital to spend,” says Erxleben. “Both agencies are going to provide liquidity throughout no matter how the rest of the year unfolds, which is a good thing.”
— John Nelson
The article was originally published in the June 2023 issues of Heartland Real Estate Business, Northeast Real Estate Business, Southeast Real Estate Business, Texas Real Estate Business and Western Real Estate Business.