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CRE Finance World, Autumn 2012

Privatizing Fannie and Freddie’s Multifamily Business Cultural trends identified by the JCHS that will support demand for while single-family stayed on track. In 1991, the multifamily multifamily properties include: portfolio comprised 5.7% (by principal balance) of Freddie’s total portfolio, but accounted for 30.2% of all charge-offs. •The recent financial crisis and the related “homeowner distress,” although apparently abating, has left a bad taste in the mouths “The strong outlook for the What accounted for the of many homeowners and potential homeowners. multifamily sector adds value to multifamily portfolio’s the GSE portfolio, which makes poor performance •Lenders, whether private or public, developed a bad taste for it attractive to the private sector during that period? mortgage products geared to affordability and premised on rising and increases the likelihood The simple answer is collateral values rather than ability to pay. Put another way, it of creating viable options to a bubble, although in seems fair to conclude that, at least for a time, the idea that government control.” this case a commercial “everyone should own their own home” has been diminished. real estate bubble centered around •Young adults are attracted to apartments as a “green” alternative 1981–1986 rather to single-family detached housing. Multifamily projects are more than a single-family bubble such as preceded the 2008 crisis. compact, and likely place fewer aggregate (although more The bubble was created by changes in tax laws and underwriting concentrated) demands on infrastructure such as water, sewer deficiencies. Accelerated depreciation schedules that were introduced and roads, reduce the use of travel by auto, and allow for certain in 1981 and 1984 encouraged developers to take advantage of populations such as the elderly to enjoy more concentrated health write-offs. Then tax reform passed in 1986, and returned depreciation and social services. to the straight-line method, adversely affecting property values. What’s more, appraisals relied on pro-forma increases in operating Regardless of any cultural aspects which may drive a shift away income, inflating property values. from homeownership, the demographics seem persuasive. The result is that it is hard to see any reason why there would not be Certainly, one of the main considerations which is likely to arise a strong demand for multifamily housing in the U.S. over the near in the upcoming discussion regarding the privatization of the GSE and intermediate term — at least for so long as the “echo boomers” multifamily business is the observation that the multifamily business are reaching the age of forming independent households. has survived the latest financial crisis without experiencing material losses, and has actually made money. The obvious conclusion is Fannie and Freddie’s Experience in Multifamily that Fannie and Freddie have “nailed” multifamily, and that the One of the principal differences between the GSEs’ single-family platform consequently must have value that can be monetized via and multifamily business is the wide divergence between the a privatization. performance of the two products. From January 2008 through the third quarter of 2011, the two GSEs lost a combined $208 billion However, history provides a basis for skepticism as to the proposition on their single-family business while their multifamily business that surviving the most recent financing crisis suggests that a made a $7 billion profit, according to the FHFA. What accounts for business model will survive all future financial crises. It may be this difference between GSE multifamily and single-family loans? especially useful to consider that one of the major difficulties faced by the GSEs’ multifamily business in the late 1980s and early The short answer is underwriting. The GSEs developed and applied 1990s was not of their own making: it was a fairly abrupt change a rigorous definition of what constitutes a “prime” multifamily loan, in tax laws (although poor appraisals and bad underwriting made and generally abided by those criteria with respect to their multi- a contribution as well). family portfolios. Given the strength of the collateral, the guaranty fees charged by the GSEs on the securitized multifamily portfolio The Guaranty Fee Debate more than cover the losses, and the business is profitable. The way a credit guarantee business makes money is by charging risk premiums which generate more than enough income to cover However, the GSEs’ multifamily business has not always looked losses. Thus the essential trick to making money in such a business so rosy: the 1991–1995 period was almost the reverse of the is to price correctly those premiums. 2008–2012 experience, insofar as multifamily performed poorly CRE Finance World Autumn 2012 14


CRE Finance World, Autumn 2012
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