Multifamily borrowers are turning to Fannie Mae, Freddie Mac, and portfolio lenders after the subprime lending crisis cut deeply into commercial mortgage conduit originations through Wall Street. They are also looking at higher debt service payments and saying goodbye to the industry’s brief flirtation with interest-only, nonamortizing loans.
The problems in the home mortgage industry affected investors’ appetite for many forms of debt, including commercial mortgage-backed securities, leaving many Wall Street conduits with no way to make new loans.
Fannie Mae, Freddie Mac, and portfolio lenders (commercial banks and insurance companies) were relatively unaffected. However, as conduit loans became less and less available, they also became much more expensive. Fannie Mae and Freddie Mac both responded by increasing their loan rates by 15 to 30 basis points, depending on loan type. At press time, the 10-year Treasury was at 4.74 percent, and Fannie Mae loans were being priced at 6 percent to 6.4 percent.
At press time, conduit loans, to the extent they were available, were at about 200 basis points over Treasuries, while Fannie Mae and Freddie Mac were at about 160 to 170 basis points above Treasuries.
“The way we look at it, this is a correction back to normal,” said Michael D. Berman, president of CWCapital, describing higher pricing and tighter underwriting as a return to mortgage market conditions that prevailed just a few years ago, before lenders became ultra-aggressive.
The only question is timing. “It will normalize,” Berman said. “The one thing I believe in is global capital markets. So many investors all over the world want to invest in mortgagebacked debt, the market will re-establish itself—and it will be a good correction.”
But he added, no one can accurately predict how long it will take for markets to stabilize.
In mid-August, Federal Reserve policy makers slashed the central bank’s discount rate, the rate at which it makes overnight loans to banks, by 50 basis points.
The Fed’s action bolstered speculation that the central bank will lower its benchmark federal funds lending rate at or before its next meeting on Sept. 18.
“We still expect the credit restraint and the housing downturn to push the unemployment rate up by an amount that has generally coincided with monetary easing in the past," Goldman Sachs said in a research note.
Debt, Equity Financing Indexes Drop
The National Multi Housing Council’s (NMHC’s) July 2007 Quarterly Survey of Apartment Market Conditions found a dramatic worsening in debt financing availability. Eighty CEOs and other senior executives of apartment- related firms who serve on NMHC’s board of directors or advisory committee responded to the survey.
“Thanks to higher interest rates (compared to three months ago) and noticeably tighter underwriting by lenders, the Debt Financing Index dropped to 26, from 54 in April,” reported NMHC leaders. A reading above 50 indicates that, on balance, conditions are improving, and a reading below 50 indicates worsening conditions.
The Equity Financing Index dipped to 48, breaking a string of 15 straight quarters above 50. Still, more than two-thirds of the respondents indicated that conditions were unchanged, and 9 percent even said equity was more available than three months ago, a sign that equity for apartment investments is still relatively easy to get even as credit conditions tighten, according to NMHC leaders.
“While debt financing conditions took a turn for the worse, equity capital remains abundant,” said Mark Obrinsky, NMHC chief economist, in a statement. “This could lead to a shift in the composition of the investment market, however. If current conditions remain in place, highly leveraged private buyers may lose their place to the REITS and institutional investors who rely more heavily on equity financing.”
The Sales Volume Index was little changed at 39.
However, the tightening of debt markets is widely expected to result in some increase in capitalization rates in coming months.
However, the long-term economic outlook was very guarded at press time. The Mortgage Bankers Association stated that defaults on subprime home loans will not peak till the third quarter of 2008, and will stay near peak for a few quarters. That will probably mean continued weakness in the housing market, which could lead to recession and a decline in apartment occupancies and rents. For more information, visit www.nmhc.org.
Global Markets Struggle with Credit Crunch
The credit crunch brought on by the subprime mortgage meltdown hammered the AFT Index this session and sent it to the lowest reading since April 2004 at our session’s end on Aug. 15, 2007. The index lost 231.44 points, or 17.91 percent of its value, to close at 1,061.13. All index components lost ground this session, and the result was a shut-out: Declining issues won out over advancing issues by 16-to-0.
In the broader markets, no sectors remained unscathed. Worldwide equities tumbled at the end of our trading session and recovered briefly after the Fed injected cash into the system to stave off fears of a liquidity crisis. The first infusions gave Wall Street some stable ground but markets returned to volatility and ended sharply down after shares of Countrywide Financial, the largest U.S. mortgage lender, tanked on news that it is in trouble.
Wal-Mart and Home Depot added to economic worries after Wal-Mart said its profit will fall this year, and Home Depot said the soft housing market caused its quarterly profit to slip. After this session closed for the AFT Index, the Federal Reserve cut the discount rate, the rate it charges to make direct loans to banks, by 50 basis points, and economists expected a cut in the benchmark federal funds rate to follow.
“I think it’s more prudent to allow this correction to continue to unfold,” said Linda Duessel, market strategist at Federated Investors in Pittsburgh. “After all, we’re in the month of August and coming into September— historically, the weakest months of the year. The market has been in need of a correction.”
Associated Estates (AEC) lost the smallest dollar amount this session after the company reported funds from operations (FFO) of 24 cents per share in the quarter ended June 30, compared to FFO of a penny per share earned in the same quarter last year. Analysts polled by Reuters Estimates were expecting FFO of 26 cents per share. Net income applicable to common shares was $8.8 million for this quarter, versus $26.7 million a year earlier. AEC was off 2.71 points, or 18.10 percent, and closed at 12.26.
Despite reporting positive news, AvalonBay shares fell the most in dollar value this session, down 23.49 points, or 18.14 percent, ending at 106.01. AvalonBay announced that it will increase its share buyback program by $200 million, for a total of $300 million. A total of $50 million has been used so far to repurchase shares. AvalonBay also reported that its second quarter FFO increased to $94 million, or $1.17 per share, compared to $74.6 million, or 99 cents per share, in the year-earlier period. AvalonBay cited rising rents and falling vacancies. Analysts surveyed by Reuters Estimates were expecting $1.16 per share. Revenue was up 12.6 percent, to $203.5 million.
Archstone-Smith was the smallest percentage loser this session, off 4.15 points, or 6.95 percent. Archstone- Smith reported FFO of 45 cents per share, compared with 59 cents a year earlier. The company cited personnel costs and increased real estate taxes. Analysts polled by Thomson Financial were expecting FFO of 57 cents per share in the second quarter. ASN is being purchased by a private equity consortium including Tishman Speyer and Lehman Brothers. The deal is expected to conclude in October. Archstone-Smith ended at 55.57.
Colonial Properties was the top percentage loser, down 16.39 points, or 34.27 percent, to close at 31.44. Colonial Properties reported that second- quarter FFO fell to $20.2 million, or 35 cents per share, from $49.7 million, or 88 cents per share, a year earlier. Analysts polled by Thomson Financial were expecting FFO of 48 cents per share. CLP said the results were due to transaction and other charges.