Talk About Déjà Vu.

When Ranieri Real Estate Partners closed its acquisition of Deutsche Bank Berkshire Mortgage earlier this year, a familiar face orchestrated the deal.

Jon Vaccaro led Deutsche Bank’s Commercial Real Estate group from 1997 to 2010, building it into a powerhouse of multifamily finance. One of the biggest splashes during his tenure was the acquisition of Berkshire Mortgage, a prolific agency lender and a strong complement to the bank’s lending operations.

In April 2010, Vaccaro left Deutsche and co-­founded Uniondale, N.Y.–based Ranieri Partners with Lewis Ranieri, often credited as ­the ­father of commercial mortgage-backed securities (CMBS). And 18 months later, there was Vaccaro, acquiring the same agency lending business, for the second time.

Vaccaro is a CMBS trailblazer himself. From 1986 to 1992, he led Citigroup’s Real Estate Capital Markets division, developing its CMBS operations into one of the nation’s largest. Yet, for all his background, ­Vaccaro knows the private sector can’t be the only option.

“A world without Fannie Mae and Freddie Mac is a theory,” he says, “and is not viable.”

Together, the government-sponsored enterprises (GSEs) own more than half the market for new permanent multifamily debt, a level of dominance that hasn’t changed much since they were commandeered by the government in September 2008.

The GSEs were there when the industry needed them most, providing liquidity as the private sector—banks, life insurance companies, and conduit lenders—licked its wounds. This countercyclical liquidity became the silver lining of conservatorship. But the longer the GSEs’ future remains uncertain, the more important the private sector ­becomes.

And private-sector lenders are slowly, cautiously coming back to life, even as Fannie and Freddie slowly grow more cautious.

“The growth in rents is starting to taper off a little. Cap rates are fairly low,” says Vaccaro. “The agencies are now thinking they need to be a little more restrictive in their underwriting. They’re just starting to do that, while others are starting to be more aggressive.”

A Post-GSE World?

When Vaccaro started his career at Citigroup, the apartment world was dominated by banks, thrifts, and life insurance companies. And to some, it’s just a matter of time before the private sector again becomes ­dominant.

“It might not be as fluid for a period of time, change will come slowly, but the private sector will be able to make up the slack,” says Walt Smith, CEO of Dallas-based Riverstone Residential. “When the markets froze up, the GSEs were the only answer just because we hadn’t developed any other model. But the next time it happens, the private sector could be there.”

During the downturn, every borrower had the agencies on speed-dial. After all, if it hadn’t been for the GSEs, cap rates would’ve risen dramatically, and values would’ve plunged, much as they did in every other commercial real estate sector. Yet, the GSEs provided a safety net, minimizing the free fall.

Even well-heeled public REITs leaned heavily on Fannie and Freddie during the downturn. Rochester, N.Y.–based Home Properties, for instance, has always been a heavy Fannie Mae borrower, doubly so when the public markets freeze up. But according to its CEO, the GSEs’ demise isn’t cause for too much alarm.

“Let’s say the GSEs are gone—so what? I believe it will cost us only another 25 to 35 basis points to exist,” says Ed Pettinella. “Banks would kill to get our portfolio, and life companies, too, so I really think it’s going to be a nonevent.”

Still, the private sector’s ability to ramp up will be challenged by a more vigorous regulatory environment. Dodd-Frank will likely alter the way CMBS loans are originated and sold, and Basel III regulations await the banking sector.

Like Home Properties, Highlands Ranch, Colo.–based UDR has its fair share of GSE loans. In 2009, the REIT took out a $200 million line of credit with Fannie Mae, and a year before that, UDR and Fannie partnered on a joint venture valued at $650 million. According to Tom Toomey, UDR’s CEO, apartment firms will just have to adjust to a more cautious capital environment should the GSEs be eliminated.

“The cost of debt is going to rise and start drifting back to its long-term average,” says Toomey. “And this low-levered model that we think is temporary might be more permanent—you’ve got to get used to the 50 to 65 percent leverage model.”

Life Lines

Once upon a time, life companies dominated multifamily finance. And the way they’ve been behaving, you’d think they’ve turned back the clock.

Firms like Prudential, Northwestern Mutual, New York Life, and MetLife have stepped up to compete with Fannie and Freddie by trying to be less conservative in their underwriting, such as by offering more flexible prepayment penalties. And some life companies compete on development deals by using construction-to-permanent loans as a way to capture more long-term business.

Yet, the traditionally conservative sector continues to target only the best of the best, cherry-picking the most desirable deals. “Life companies are very disciplined investors; they tend not to get caught up in the market,” says Mitchell Kiffe, senior managing director at New York–based CBRE Capital Markets. “And they weathered the downturn very well.”

The CMBS story, however, is the opposite. The sector suffered the downturn terribly, a result of the undisciplined underwriting that characterized the boom years and served as a chief cause of the Great Recession. In September, CMBS multifamily delinquencies fell below 10 percent (compared with less than 1 percent for the agencies and life companies). And as the legacy portion of the industry starts to heal, the pace of originations is accelerating. Interest rates for CMBS loans fell throughout 2012, in a range that made traditional agency borrowers take notice.

Vic Clark, managing director at New York–based Centerline Capital Group, says conduits are winning more and more deals that fall out of the agencies’ credit box. He recently quoted a series of loans with Fannie and Freddie that went to CMBS—even though the interest rate was higher—because of the underwriting flexibility the conduit lenders offered.

“They had complications that resulted in heartburn for [the agencies], including fractured condos. There was a complicated ground lease on one of the properties; there was a huge military component on one of them,” says Clark. “I won’t say agencies won’t ever do those deals, but they make it complicated.” After closing a CMBS deal at the end of September, Centerline had five others in process, Clark says.

Many industry watchers wonder if the next incarnation of Fannie and Freddie will have access to a government guarantee. But to Clark, it’s not much of an issue given the agencies’ increasing reliance on securitized lending. Nearly every Fannie Mae loan is made through its mortgage-backed securities program, while Freddie Mac has its Capital Markets ­Execution program.

“I think Freddie Mac is prepared to walk away from the government guarantee because they’re basically a securitized lender,” says Clark. “They have a three-year-plus history, and they’ve been successful. With or without the guarantee, they’re going to be ­successful.”

Imbalance Sheet

The CMBS industry’s return is a work in progress. And for all the talk of life companies, they still only muster about 10 percent market share, combined, in their biggest years. Like life companies, banks are also balance-sheet lenders, and balance sheets can only stretch so far.

Yet, even banks, a traditionally conservative sector, went a little crazy during the boom years. Ranieri Partners has a fund that invests in distressed commercial real estate loans, and 45 percent of the defaulted loans it buys from banks are multifamily.

To Vaccaro, all this talk of the private sector’s firepower is about more than just quantity, it’s qualitative, too. Even if there is enough firepower, is the private sector, on the whole, of the same caliber as the GSEs?

“Many of the replacement lenders to Fannie Mae and Freddie Mac lack the experience of carefully managed underwriting,” Vaccaro says. “We could be creating a credit problem that currently doesn’t exist.”