The only sure thing when it comes to the future of our nation’s housing finance system is that the solution will take awhile to come to fruition.
The National Multi Housing Council (NMHC) believes it will take five to seven years to move from today’s uncertainty to the full enactment of specific legislation. But multifamily borrowers shouldn’t get lulled into complacency by that long timeline.
“If I’m a multifamily owner or developer, I need to plan for what happens if Freddie and Fannie aren’t there,” says John Cannon, executive vice president with Horsham, Pa.-based Berkadia Commercial Mortgage. “If you remove them from the equation, who’s going to replace them? What kind of debt do you put on your property? Who’s going to be there to refinance it?”
There are basically three major legislative paths being explored in Congress: a fully private model; a fully private market with an “emergency” government guarantee for periods of crisis; and a market with an “always-on” government guarantee for select portions of the industry.
Each option has big ramifications, especially given that the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac account for roughly two-thirds of the multifamily debt market today. In other words, borrowers who don't start preparing now to live in a world with no GSEs, or at best, a market with more limited GSE participation, will be left behind. What does that preparation look like? It can take many forms, from cultivating additional lender relationships, to focusing on long-term debt, to underwriting exit strategies more conservatively. Here are four tips to remember
If the first or second option is enacted, then the private market—banks, life insurance companies, and conduit lenders—will absolutely dominate the multifamily lending arena. So borrowers should start striking up more relationships with more capital sources today. “They should be cultivating their bank, insurance company, and CMBS relationships, absolutely. That’s the only way they could be protected,” says Shekar Narasimhan, managing partner at Washington, D.C.-based Beekman Advisors. “Whether they borrow from them or not, they should be cultivating them now, learning the ropes, and understanding what the implications are if the GSEs were to go away.”
Like many multifamily borrowers, Lincoln Property Co. has grown increasingly dependent on the GSEs. The company had about 10 percent of its outstanding permanent debt with the agencies in 2000. But by the end of last year, agency permanent loans accounted for nearly 80 percent of their debt portfolio. “As an industry, we have to be prepared to have a significant downsizing in that source of financing,” says Brian Austin, vice president of finance for Dallas-based Lincoln. “We all have to do a better job of rounding out the table to make sure you’re talking to everybody.”
Many large borrowers are doing just that. Take Behringer Harvard, which has been one of the biggest multifamily buyers in the country, closing about $2 billion in acquisitions since 2008. The company has borrowed about $850 million in mortgage financing since the fourth quarter of 2008, and made a conscious decision to diversify. Even though few capital sources have been as active as the GSEs since 2008, half of that $850 million was done through banks and life insurance companies.
Borrowers should cast a wide net as they diversify. The appetite that a life insurance company has for multifamily deals is a fickle thing, for instance, driven as much by the attractiveness of alternative investments as it is by the desirability of the multifamily sector itself. “You’ll need a lot of relationships, because you never know who’s going to be the hot lender at a given time,” Cannon says.
#2: Go Long.
Many industry veterans believe that interest rates will rise regardless of which option is enacted. “The cost of capital is going up no matter what model gets implemented,” says Mitch Kiffe, co-head of origination for Los Angeles-based CB Richard Ellis Capital Markets. “It’s not just GSE reform, but financial reform in general, and risk-based capital rules, that will have an impact.”
Behringer Harvard, for one, has made a conscious decision to favor only long-term debt—seven to 10 years—to mitigate the interest rate risk presented by the upcoming new world order. And the company’s prudence in taking a long-term view can sometimes be painful, given today’s rates for shorter-term floating-rate mortgages.
“I’m going more long-term in thinking. That interest rate risk is moving forward, with the potential elimination or reduction of impact of the GSEs, is a huge risk to me,” says Mark Alfieri, executive vice president and chief operating officer of Addison, Texas-based Behringer Harvard. “We’re more about long-term, fixed-rate thinking today than probably we should be, given where adjustable rate financing is today.”
#3: Underwrite Exit Strategies Conservatively.
Even if the third option, the always-on guarantee, is enacted, it will still have ramifications on the upper end of the asset class spectrum. As life insurance companies grow more aggressive in pursuit of Class A luxury deals, the GSEs are becoming a shrinking presence in that space. And less competition ultimately means higher interest rates. “I sense the GSEs are pulling away from the Class A market,” Cannon says.
Last year, Berkadia originated a loan for large, institutional quality property on Manhattan’s Upper East Side, and the GSEs competed aggressively for the deal. Recently, Berkadia was looking to originate debt for a similar property in Manhattan, and the GSEs turned it down. “If you’re an owner or developer of Class A real estate, you’ve got to keep that in the back of your mind,” Cannon says. “What if Fannie and Freddie did pull away from Class A? What’s that going to mean to you from a cap rate perspective. Or from an exit strategy perspective?”
Under such a scenario, the cap rate disparity between Class A and Class C assets may begin to flatten a bit. The fear is that, while life insurance companies will step in to the void, their rates will certainly not be as low as they are now. A lot of developers have been bailed out the past few years by the availability of Fannie and Freddie permanent takeouts. But in a fully or mostly private market, you can’t rely on low-rate permanent financing always being there. So owners should be prepared for higher rates, and model a worst-case scenario when underwriting exit strategies.
#4: Shout From the Rooftops.
Sometimes, the best defense is a good offense. Many in the multifamily industry fear that the single-family sector—which accounts for 95 percent of the GSEs’ businesses—will hijack the debate in Congress, leaving the apartment industry as an afterthought.
That's why operators emphasize the importance of supporting industry associations such as the NMHC and its legislative partner the National Apartment Association, which are working diligently to get the multifamily industry a seat at the table. In fact, the importance of this effort can’t be overstated. After all, the multifamily divisions are the only real surviving success stories at the GSEs—they’re profitable, feature delinquency rates of less than 1 percent, and provide liquidity through good times and bad, helping to prop up values in times of crisis.
“You’ve got to stay actively involved in things like NMHC and NAA. You’ve got to shout from the rooftops that multifamily is different from single-family,” Austin says. “I think some people get it now, but there may be a new Congress in 2012, so you’ve got to keep supporting and keep shouting that we are different from single-family.”