FHFA Slowdown May Spur Multifamily Resurgence in Conduit CMBS

CRE Finance World, Winter 2014

FHFA Slowdown May Spur Multifamily Resurgence in Conduit CMBS he Federal Housing Finance Agency (FHFA), the conservator and regulator of Fannie Mae (Fannie) & Freddie Mac (Freddie), has begun to implement strategies to reduce its multifamily footprint. As a result, we expect a gradual decline in Fannie and Freddie’s securitized market share, which could eventually revert to levels not seen since before the run-up to the CMBS market peak. The percentage breakdown of multifamily loans funded as a component of the new issue structured finance market has oscillated between CMBS conduit deals and transactions backed by Government Sponsored Enterprises (GSEs), with the GSEs ramping up production when the private label market was frozen1. At the peak of the market in 2007, the conduit market’s share of the $36 billion securitized multifamily loan market was more than 78%2. As the financial markets spiraled, that trend reversed and the GSEs became the primary source of multifamily loan production, dominating securitized new issues with more than 95% market share between 2009 and 2013, which is depicted in Chart 1. Chart 1 Multifamily Loans as a Percentage of the New Issuance Market3,4 Sources: Bloomberg, CMA, Fannie Mae During the recession and in its aftermath, all segments of the commercial real estate (CRE) market were unsettled. However, the collapse of the residential market, spurred by foreclosures and unemployment, provided a boon to the multifamily sector. By Q2 2011, the national vacancy rate per REIS dropped below its 10-year average of 5.9%5 and continued its decline to a 10-year low of 4.2% in Q3 2013. As vacancy rates fell and rental rates rose, a broad spectrum of investors migrated into the multifamily sector. The investors included REITs and smaller operators, which were lured by solid fundamentals and plentiful credit, thanks to the GSEs. According to the Mortgage Bankers Association (MBA), in 2009, Fannie and Freddie expanded their guarantee to 85% of multifamily production. However, the GSE’s expansion, and in turn domination of the multifamily market, was somewhat at odds with CRE Finance World Winter 2014 46 the clamoring in Washington to shrink the GSEs, which have yet to emerge from the conservatorship they entered in September 2008 after years of failed reform attempts. As such, policymakers tasked with cleaning up the aftermath of the housing crisis are focused on reform and the return to a market dominated by private capital. Earlier this year, to commence the move to non-government sponsored entities, Fannie and Freddie’s regulators reduced the amount of the Agencies’ multifamily activity by 10%, a combined reduction of more than $6 billion. Subsequently, the FHFA directed its focus solely on the multifamily market, seeking input as to how to reduce Fannie and Freddie’s presence in the sector and contract their multifamily activity throughout 2014. Various alternative strategies have been proposed, which include limiting loan terms and imposing tighter underwriting standards. Implementation of these proposed strategies would impede many loans from qualifying under GSE origination guidelines. The tightening of credit standards will reduce their competitiveness, permitting the private sector (insurers, banks and conduit lenders) to seize a greater portion of market share. The private sector has already begun to increase its market share. According to the Mortgage Bankers Association, as of September 30th, origination volumes for Fannie and Freddie were down on a quarter-over-quarter and a year-over-year basis by 37% and 40%, respectively. At the same time, the percentage of multifamily loans in CMBS fixed-rate conduit transactions increased 105% yearover year, albeit from a small base. The dollar volume of loans in conduit transactions year-to-date was just $5.0 billion, more than 87% lower than the 2007 market peak. As the private sector looks to recapture market share, credit fundamentals are on their side, despite the lagging economy. Vacancy rates have declined sharply from their peak, but have since flattened out while effective rents at the national level continue to expand due to greater demand as homeownership continues to decline. As depicted in Chart 2, effective rents and vacancy rates hit all-time highs and lows this quarter, however the improvement in fundamentals has slowed. T Terri A. Magnani Senior Director Kroll Bond Rating Agency, Inc.


CRE Finance World, Winter 2014
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