It’s been a turbulent year for the multifamily industry, but not nearly as turbulent as it could’ve been.
Thanks to Freddie Mac and Fannie Mae, the multifamily industry was able to stave off the kind of collapses seen in other commercial real estate sectors. The companies comprised about 80 percent of all multifamily business over the past year, helping to keep values relatively stable by providing liquidity.
For its part, Freddie Mac has navigated the year well, keeping its delinquency rate at the lowest in the industry while churning out new business. Fifteen months after the company was placed into conservatorship, Mike May, senior vice president of Freddie Mac’s multifamily division, sits down with Apartment Finance Today's senior editor Jerry Ascierto to reflect on the past year and offer a glimpse of what he sees coming around the bend.
AFT: The fourth quarter is usually the industry’s busy season, but what are you seeing? How much is business off this year?
May: The fourth quarter is usually the quarter that we blow it out and come flying in, but that’s really not the case this year. It won’t be a peak quarter. In 2008, we did $24 billion, and we’re doing about $4 billion a quarter right now, so we’ll close the year in the $16 billion to $18 billion range. Early on in the year, there was a lot of REIT business. But as the REITs got more liquid, there was less need for secured financing, so that stuff has dropped off and we really don’t see it coming back for a while. The REITs tried to get liquid to prepare for all of those great deals that were going to show up, the deals that nobody seems to think are going to show up now.
AFT: Have you seen any indication that values are starting to inch back up?
May: Oh yeah, that’s certainly true. Cap rates have moved down over the last month or two and there are an awful lot of people chasing a good property in a good location. You hear stories of 30 or 40 bidders for a piece of property. And then, of course, the folks that raised capital and are sitting on it and waiting for the great deals, they see this, and they’re a little freaked out. If they don’t deploy the capital, what are they going to do? So that’s why you see so much action on the best properties. And then there’s a little bit of remorse when people lose it because they don’t know when the next one is going to show up.
AFT: Everyone thought 2009 would be the year of distress, but what happened? Will 2010 be the year we see more distressed assets hit the market?
May: The reason it didn’t happen is that there was liquidity provided by Freddie and Fannie. So people knew they could get financing, and sellers weren’t as fearful as they otherwise would’ve been. And a couple years out, the picture looks fairly positive in terms of supply. So liquidity and a positive picture in the midterm are the two things that have kept it from getting crazy. And also, there has been a delay in recognition of some of the issues, and that’s helped as well. Are there going to be great deals going forward? Actually I don’t see how that’s going to happen, unless everyone gives up hope for the future in terms of upside.
AFT: Do you expect 2010 to be another transitional year? Do you think we’ll see a return to stronger fundamentals by the end of the year?
May: Right now, the delinquencies and default rates are shocking, but they have a long way yet to go. At some point, the product has to come out—the delinquencies-to-losses is a pretty long trail—and so you’re going to start seeing losses flow next year. A lot of the CMBS structures will start burning through support bonds and starting to hit higher-rated bonds. We’re expecting another down year, a $15 billion or $16 billion year in 2010 for us.
AFT: Do you expect your delinquency rate to continue to climb next year?
May: It’s definitely going up; everyone’s is going up. People are hanging in there in terms of trying to make the property work; they’re waiting for unemployment to turn around. They see the positives in 2011 and 2012. But if rents keep falling and vacancies keep rising, at some point it’s just too hard to carry. And so I see that happening more and more, where the longer this goes on and people reach their tipping point, they start to walk away.
AFT: Is your schedule of maturing loans manageable for next year?
May: Over the next three years, I believe only 10 percent of our portfolio is going to mature. We’ve done a great job on that. We didn’t particularly like those shorter maturity loans: We priced them up; they were far more expensive than our 10-year. If people were price sensitive and didn’t care about the maturity schedule, they would’ve clearly picked a 10-year mortgage. We worked the book pretty heavily in '05, '06, and '07, so what we effectively did was roll the book out.
AFT: What gives you hope when you think about 2010?
May: We started the process of introducing the CME product to the market and this year we issued two securities, and they’ve gone off extremely well. So we feel pretty vindicated that we had the right strategy, and frankly that the stress in the market gave us the opportunity to craft a product that really works well. And so the more we issue, the more interest that will be generated, the stronger the bid will be and ultimately the better the pricing will be, which will flow ultimately to the front end.
AFT: Are you working on any new products or programs to roll out in 2010?
May: Next year for us is about continuing with our CME execution, to continue to expand CME. We’re going to do a pass-through securitization, which we don’t do right now. From a product standpoint, manufactured housing parks is something we haven’t done which I’m pretty sure we’ll get done next year.
AFT: What about migrating other product types into the CME program? Is that on the horizon?
May: Right now, we mostly just do conventional mortgage loans to place into our structured deals, but we want to expand that into all products. We want to do affordable, seniors, students, and the process we’re going through now is educating the B-piece buyers on the different products and see if folks are interested. Somewhere in the neighborhood of 20 percent of our business was financed through securitization this year, and I think that will be well north of 50 percent next year. But ultimately, it’s a question of what a borrower wants. There may be certain attributes that a borrower wants that really don’t make it that conducive for a sale through a CME, so that will be credit risk we continue to own completely. We’re going to have options for borrowers.
AFT: So the portfolio execution is still on the table for 2010, even though you have this government mandate to shrink the portfolio?
May: Absolutely. Prior to this year, pretty much close to 100 percent of our business was financed through debt, and we don’t need to finance that much through debt. So we moved 20 percent of it in a year to CME, and we think we can continue to make that movement. In some cases, we’ll finance it with a pass-through securitization. In some cases, it will be a senior sub-CME type and in some cases it will just be our portfolio.
AFT: Are you confident you’ll have a healthy portfolio capacity beyond 2010?
May: When you think about managing a limited resource, you’ll allocate it to whatever provides you with the best return, whatever gives you the highest mission value. And multifamily does that. We were the only profitable segment in the company. We’re the affordable housing engine for the company. So we’re going to get our fair allocation of the portfolio.
AFT: Congress is expected to take up the future of the GSEs next year, and there’s a lot of concern in the industry about whether there will be any disruption in liquidity. Are there any reassurances that 2010 will be business as usual?
May: I think 2010 will be business as usual. There is “duty to serve” language within the legislation that needs to be defined, and then there are actual multifamily-specific goals that will be established. So that will affect our business in terms of pursuing product that we currently don’t. I guess the biggest risk to business as usual is how bad do defaults get and when defaults become your sole focus, it’s like a tidal wave. It overtakes lenders, and it overtakes portfolios, where you focus all your attention on minimizing defaults as opposed to growing the business.
I think you’re going to be seeing increased defaults; these numbers that crank up every quarter are going to continue to rise. More and more of the industry’s time and attention is going to be focused on trying to work out these problem assets. There will be buyers that come back into the market, and the difference between buyers and sellers will begin to collapse, so there will be more transactions. And once transactions occur, people will have more confidence in value and that will start a positive trend. It’s going to be a tough year though. This next year will be pretty ugly from a default standpoint for the industry, and we won’t be spared.