Michael McRoberts, vice president and head of multifamily sales and production for Freddie Mac, began his presentation at today’s “The Future of Commercial Real Estate Lending” conference call from New York-based Macquarie Capital (USA) with a look back.
In January 2009, rents and occupancies were falling with no bottom in sight. The transaction market stalled with life insurance companies and banks waiting on the sidelines and the CMBS market frozen. Cap rates were climbing in even the best markets. Freddie had $1 billion in loans on its critical watch list and its delinquency ratio was five basis points. All in all, things looked bad.
“In the fourth quarter of 2008, there were widespread fears throughout our industry and the investor community that our capital market dinner plate may have vanished,” says Jerry Korn, vice president of mortgage finance at Rochester, N.Y.-based Home Properties. “It appeared that every lender was hiding in the hills, except for the GSEs.”
Now, of course, occupancies are firming up and McRoberts expects rent growth at the end of 2010 and into 2011. Freddie is seeing a strong transaction pace and its Capital Market Execution Program, in its infancy in early 2009, is its dominant execution today. But unlike January 2009, Freddie is no longer the only game in town. “For commercial mortgage loans, there’s been a marked improvement in competition in the past six months. It’s coming from insurance companies and banks—both U.S. and foreign,” says Julia Lawler, senior vice president and chief investment officer of Des Moines, Iowa-based Principal Financial Group (PFG).
McRoberts estimates the life insurance companies secure about $5 billion to $6 billion of the $45 billion in permanent, non-recourse debt financing in 2010. “The life insurance companies are definitely back,” he says. “They’re lending on multifamily. They’re absolutely a viable competitor to us today.”
CMBS is also coming back, though McRoberts doesn’t view it as a credible threat yet from a pricing and leverage perspective. Todd Everett, managing director and head of real estate investments at PFG, expects about $10 billion in CMBS activity this year but says interest will be muted. “Until we have that [confidence in the financial regulation bill], we’ll see securitization conduits and shops that are in the business being a little more conservative,” Everett says. “They don’t want to build up big warehouse positions until they have the transparency and know what the exact requirements will be.”
Jerry Korn, vice president of mortgage finance at Rochester, N.Y.-based Home Properties, says he’s received a lot more calls from commercial banks telling him they’re back in business. “Their attitude has changed, and they’re becoming more aggressive,” he says.
Of course, not everyone is a REIT like Home. Many banks and insurers prefer Class A assets and borrowers, but even McRoberts was questioned about his lending preferences. “The market consolidated so there are less of the smaller players than there used to be,” he says. “We don’t have a real strong preference to go big just because it’s big. We look at the whole totality of the transaction [including location, quality, and sponsorship].”
While mostly all of McRoberts indicators are looking vastly better than 2009, a major problem still remains. Freddie’s watch list, like that of many other lenders, has ballooned up to $5 billion for its $100 billion portfolio. Its delinquency rate has risen to 24 basis points. “We expect that to increase,” McRoberts said.
Ultimately, McRoberts thinks a number of factors will determine how many more apartment owners fall into trouble. “There’s kind of a race to the finish here,” he says. “We’re watching cap rates; we’re watching interest rates; and we’re watching property performance. And how all of those sync up is going to really determine what kind of problems we really experience.”
With 10-year treasuries as low as 2.93 percent, Everett is seeing interest provide an escape for some upside down borrowers. “We’re seeing people who are wrong-sized on their loan now have a window of opportunity to get a lower interest rate and minimize their yield maintenance or exit fee, but they need to write a check,” he says. “Some of these players are saying, ‘We may not see this interest rate environment again for a long time. Let’s take advantage of it.’ Clearly, that’s driving a big part of our business today.”
But McRoberts expects others to throw in the towel this year. “Some of these owners will get fatigued and not have the capital to continue to make up a negative cash flow situation,” he says. “We expect that, at some point, there’s going to be a give up time.”
In fact, with a private equity amassed to buy deals, Freddie may make some opportunistic plays in the future. “We’ve thought about maybe doing some portfolio management for some assets that clearly look like they’re troubled and may be slipping into default, and then selling those loans or foreclosing quickly and selling those assets to take advantage of what appears to be a massive amount of capital looking to buy multifamily real estate today,” McRoberts says.