What's at stake for the apartment industry with the November election soon upon us and the 113th Congress getting to work in January? Given the paucity of even lip service that President Obama and Republican Mitt Romney have paid to the housing crisis along the campaign trail, it's a pretty tough prognostication. But industry advocates targeting key decision makers in both parties are off ering some insight—ranging from sobering to encouraging.
A variety of issues will face the Congress—should it choose to act on them— among them government-sponsored enterprise (GSE) reform; tax reform, including the low-income housing tax credit (LIHTC); various federal subsidy programs; and several capital-markets regulations, such as those involving commercial mortgage-backed securities (CMBS).
While it's doubtful either party will have a sufficient Senate majority to ramrod through truly controversial legislation, wide-ranging tax-related reforms will no doubt “all be on the table,” observes Michael Berman, immediate past chairman of the Mortgage Bankers Association and former president and CEO of CWCapital.
All of which creates quite a diplomacy challenge for the industry's chief lobbying body, the Joint Legislative Program of the National Multi Housing Council (NMHC) and the National Apartment Association (NAA). Indeed, NMHC president Doug Bibby must delicately garner support for industry positions from one party aiming to cut subsidies that help the sector, and from the other party likely to tax more of its high earners' profits. “Each of these approaches presents its own issues for the apartment sector, and our response is to adapt as best we can either way,” Bibby explains.
If Romney wins and the GOP retains control of at least one congressional body, Bibby's job will become tougher. After all, public-sector participation clearly benefits the apartment sector but runs counter to prevailing Republican philosophy. “There's a group of people who don't like having the government in the housing business and want to cut back on this kind of funding,” Bibby acknowledges.
Berman puts it more bluntly: “If they're willing to go after Medicare and Medicaid, it's hard to believe they'd support Sec. 8 and LIHTC.”
Then again, greater Republican control would reduce the likelihood that apartment moguls would get soaked by higher taxes. As veteran multifamily investment manager Jerry Fink is quick to point out, Romney earned his fortune in private equity and hence seems far less likely than a Democrat to push for treatment of carried interest as ordinary income rather than capital gains. “That's probably why he doesn't want to show his tax returns,” quips Fink, managing partner of Irvine, Calif.–based Bascom Group.
Fink and his co-principals fear that a switch to ordinary-income rates for what real estate investors refer to as “promoted interest” would essentially double their tax obligations.
“It's the single biggest potential threat to our profitability going forward,” Fink says, adding that a lame-duck Obama presidency could become “the worst nightmare” for entrepreneurs relying on promote-centric income.
But if free-market fanatics are ultimately able to reduce Sec. 8 rental-assistance allocations, the impact could be “disastrous” for low- and moderate-income residents especially, and for their landlords in the noncoastal markets where demand for marketrate units remains relatively soft, Fink says. The same scenario follows for would-be developers in secondary and tertiary markets if Sec. 221(d)(4) and related Federal Housing Administration (FHA) mortgage insurance programs are diminished.
Below is a look in more detail at some of the most pressing industry issues on the plate this coming term.
The latter part of the next congressional term will likely witness contentious debates over the long-term fates of Fannie Mae and Freddie Mac. Industry insiders eagerly anticipate a spinning out of the two GSEs' multifamily finance operations into private businesses—hopefully with some public credit enhancement of apartment-backed mortgage securities.
While experts generally agree that Democrats are more likely than their GOP counterparts to support a spin-off of the GSEs' critical (and highly profitable) multifamily programs, they're not holding their breaths anticipating that Congress will take meaningful action on GSE reform. When GSE legislation is addressed, Berman expects the “fragile” single-family sector, rather than the multifamily operations that continue generating federal revenues, to dominate the focus. “So as desirable as a multifamily spin-off of some sort may be, it seems unlikely in the near term,” Berman says.
Bibby notes that the NMHC/NAA Joint Legislative Program (JLP) isn't advocating that any specific structure underlie the ultimate fate of Fannie's and Freddie's multifamily divisions, but the JLP does continue to lobby for a “separate solution” from singlefamily activities. Bibby is also concerned about any near-term eff orts to eliminate explicit federal backing of GSE multifamily securities issues, for fear of “spooking” the investor marketplace.
Berman, meanwhile, supports the notion that credit and interest-rate risk in the multifamily sector ultimately needs to be transferred to the private sector. He further recommends that at least the senior-most mortgage securities classes be creditenhanced by a clearly stated federal guarantee, to maintain liquidity throughout economic and real estate cycles.
But Berman suspects the laissez faire–leaning likes of Financial Services Committee vice chairman Jeb Hensarling (R-Texas) and Capital Markets Subcommittee chairman Scott Garrett (R-N.J.) are unlikely to support public guarantees. Nor, in turn, would a full Republican-controlled House. Yet, eliminating the government guarantee would constrict the supply of rental housing, Berman laments. “And that's bad news, from a public policy perspective.”
The industry consensus appears to be that a Republican leadership would be less likely to pursue higher rates for high-income investors and operators than would a Democratic leadership, particularly where carried interest is concerned.
In contrast to the unclear timetable for GSE action, the 113th Congress seems almost certain to take up tax-related issues as part of the great debate over the federal government's role and budget proceeds. And this will almost certainly include taxation-related proposals with meaningful implications for the multifamily sector, perhaps including interest deductibility, the LIHTC program, and other topics.
While Bibby acknowledges that many in the industry would welcome a simpler federal tax code with fewer deductions and credits— wouldn't we all?—the JLP's general position with respect to taxation rates is “stand pat.” The lobby opposes any increases in current federal income-tax rates for carried interest or partnership income and, of course, any changes to business-interest deductibility.
Bibby also echoes Fink in warning that larger liabilities on exiting investments would tend to hinder future activity as aff ected owners look for alternatives to selling. “This could be a very serious issue,” Bibby says.
Under a turn to the right, key programs supporting the multifamily sector—FHA mortgage insurance, Sec. 8 rental assistance, and even the LIHTC—could potentially see allocations reined in as Republicans look to cut spending and streamline revenues by targeting entitlements and tax expenditures.
After all, it's no secret that a lot of antigovernment, antitax Republicans demonstrate far more hostility than do Democrats toward public subsidies of apartment production and rental assistance, not to mention continued taxpayer guarantees of mortgage securities. And Romney's selection of Tea Party darling Paul Ryan, the Wisconsiner who chairs the House of Representatives' powerful Budget Committee, doesn't exactly diminish that perception.
The industry will likewise continue to educate legislators about just how important key federal programs are to apartment sector interests—and to low- and moderate-income Americans. In addition to permanent retention of the LIHTC program, this agenda includes continued funding of Sec. 8 programs, FHA insurance programs, and other initiatives that support production and help tenants pay rent.
While legislators should indeed dissect and fine-tune all these programs in pursuit of broader housing finance reform and longer-term budget balancing, “any tampering with or elimination of these programs in a vacuum could have a destabilizing eff ect on the market,” cautions NMHC spokesman Jim Lapides.
Illustrating the corresponding challenges amid so much antigovernment rhetoric among the Tea Party set, the fiscal year 2013 budget passed by the House entails less funding for projectbased assistance than the counterpart measure currently winding through the Senate and, in fact, represents a funding cut from the current fiscal year's budget. “That's cause for immediate alarm,” Bibby relates.
Late 2013 should see more serious eff orts to return liquidity to the semi-stalled CMBS arena, as lobbyists push regulators and legislators to at least temporarily ease risk-retention and other rules proposed as part of the Dodd–Frank Wall Street Reform and Consumer Protection Act. As NMHC vice president of capital markets David Cardwell stresses, the industry is pushing for rules that don't unduly boost securitization costs and that promote, rather than impede, liquidity to apartment properties via conduit lenders.
Several underwriting thresholds have been proposed that would exempt securitized mortgages from risk-retention requirements. But industry leaders prefer maximum appraised loan-to-value ratios of 70 percent to 75 percent rather than the proposed 55 percent to 60 percent, along with a minimum debt coverage ratio of 1.35x (based on historical in-place income) rather than the proposed 1.70x.
Cardwell also points out that these recommendations are more conservative than seen even with the GSEs' proven underwriting. The industry also prefers rules allowing for retained-risk positions to be reduced after three to five years if mortgages perform as underwritten and pass follow-up credit–rating agency reviews.
Another proposed requirement would include the escrowing of sales proceeds of the safest bond classes to be held as reserves against potential bondholder losses, which the JLP also opposes. Such a rule would tend to diminish CMBS issuance, since those proceeds are a significant component of how issuers earn their profits, Cardwell explains.
Bascom's Fink, for his part, acknowledges that during boom times, risk-retention requirements for CMBS issuers might make sense in terms of preventing bubble-esque loan underwriting. But he'd prefer that regulators lay off for maybe a couple of years and loosen restrictions on the sputtering marketplace rather than imposing more.
“A 2 or 5 percent risk-retention requirement might seem small, but when you're talking about so many billions in issuance, it makes for a very capital-intensive proposition,” Fink elaborates.
As for Berman, he agrees, to some extent. Sure, a longer-term structural revision including built-in risk-retention mechanisms would likely create a more stable CMBS marketplace. Nevertheless, he's willing to consider a Republican push to “dilute” risk-retention rules under Dodd–Frank for possibly a couple of years, which would help attract more capital back to the CMBS arena.
“But for long-term stability, we really need a better [structural] model,” Berman concludes.