Change in the air

With the February 11 release of the Obama Administration's white paper, Reforming America's Housing Finance Market, it is official-the two giant government-sponsored agencies Fannie Mae and Freddie Mac will no longer exist in their present form.


What is yet unclear is what will replace them.

The GSEs are blamed in large part for the single-family finance bubble that led to the current economic downturn, and the country’s leaders believe GSE reform is necessary to prevent another meltdown. The purpose of GSE reform is to end the taxpayer-funded bailout and shift the burden of loss to the private market.

The GSEs currently guarantee around $5 trillion in mortgages and are the nation’s largest source of takeout financing for apartment transactions. They were seized by the Bush Administration in 2008 and have been held in conservatorship ever since. They have posted $240 billion in losses, received more than $151 billion in aid and have returned about $17 billion in dividends to the government.

The plans
The white paper offers three plans for phasing out Fannie Mae and Freddie Mac in their present form. Each one restricts federal credit to varying degrees.

One option restricts it entirely and limits the government’s guarantee to the Federal Housing Authority, the United States Department of Agriculture-Rural Development, and the Department of Veterans Affairs for a small group of borrowers. Another offers a government guarantee only in case of emergencies.

The National Multi Housing Council and other housing groups, doubting an emergency-only guarantee could be ramped up quickly enough to respond to a crisis, favor a third option that replaces the GSEs with private companies that would provide guarantees for mortgage backed securities with a government back-stop at all times.

“Option Three still restricts federal credit -they didn’t define it specifically-but there are very clear clues that if they were to extend federal credit to the market under Option Three, it would be on defined terms. For example, it could be on affordability dimensions and it will be paid for so that the taxpayer is protected,” said National Multi Housing Council President Doug Bibby.

The good news for multifamily
Apartment owners, investors and rental industry organizations concerned about the impact any wind-down of Fannie and Freddie will have on their business found encouragement in the administration’s explicit recognition of the importance of rental housing in any GSE reform action and housing policy going forward.

Housing Secretary Shaun Donovan reiterated the administration’s overarching messages in early March.

“One is that homeownership is incredibly important as a steppingstone to the middle class for a great many families, and we will continue to find sustainable ways to support it. But, we also recognize we need a more balanced housing policy in this country and

a key part of that is we have focused too little on multifamily,” he said.

Such support for rental housing is unprecedented, especially from a Democratic administration. The apartment industry’s cries for a balanced housing policy have largely been ignored by previous administrations that promoted homeownership as the American Dream, at almost all costs, for the past 70 years.

However, while the importance of rental housing is mentioned throughout Obama’s 32-page proposal, multihousing groups hope the administration isn’t just paying lip service.

The white paper stops short of offering a clear-cut plan of support for multifamily financing programs, especially on the market-rate side, in its three wind-down scenarios for Fannie Mae and Freddie Mac.

Donovan said that defining the government’s role in multifamily financing today is a bit like putting the cart before the horse.

“Before a clear direction on the GSEs’ role in multifamily is established, a decision must to be made on a replacement for Fannie Mae and Freddie Mac and what the government’s role will be in guaranteeing mortgages,” he said in early March.

Tackle rental housing first
Meanwhile, the National Housing Conference Center for Housing Policy (NHC), a nonprofit group, urges the Treasury Department to address multihousing finance first and separately from singlefamily to ensure renters have an adequate supply of multifamily properties with affordable rents.

Demographics alone support the need to tackle apartment finance as a leading and separate issue of housing reform. According to Recap Real Estate Advisors, apartments currently house more than 15 million households, and number of publications have even dubbed the U.S. a renter nation.

More figures: a 78-million cohort of echo boomers is just beginning to enter the housing markets, primarily as renters, and another 78 million baby boomers are beginning to downsize and are most likely to rent after moving. Because of these demographic changes, one housing expert estimates that half of all new homes built between 2005 and 2030 will have to be rental units.

“You have a tremendous tailwind of demand, but at the same time we are not producing multifamily housing right now,” said Bibby.

New apartment construction had been crippled by the credit freeze, making it impossible, until recently, for developers to move forward on new ground-up projects. The two to three-year timeline required to deliver new product started this year won’t be soon enough for the newly formed households that need them now and in the years to come.

“We had completions of around 127,000 units for 2010 and the starts were below that and to meet this demand we need to be in the 300,000-plus range per year and we are nowhere near it,” said Bibby.

To the delight of apartment REITs and private developers, owners and operators, the apartment shortage and increased demand has led to higher rents and occupancies.

Apartment market fundamentals are expected to strengthen further as down payments and single-family mortgage insurance costs increase with GSE reform, persuading would-be homebuyers to remain renters even longer.

The one dark cloud on the horizon for REITs would be the absence of GSE financing for multifamily, which, according to Moody’s Investor Services, would require apartment REITs to lower their current level of leverage, which would then affect their ratings.

A tale of two markets
Donovan agrees with multifamily groups that a federally backed secondary market and the availability of long-term, fixed-rate mortgages for multifamily is absolutely critical to the sector’s health and ability to meet growing demand for rental housing. And, he is quick to point out that multifamily finance was in no way responsible for the Great Recession.

“If you look at the multifamily books of the GSEs, they performed well, even through the crisis. A second point that many folks often miss is that, because of the nature of multifamily finance, there are reasons why a guarantee can be important to multifamily, but may not even apply to single-family. And, because of that, one of the things we say first of all-and these are a couple of key principles in the white paper-is that FHA needs to continue to enhance what it does in multifamily,” he said.

He notes the need for improved FHA processes and a greater FHA focus on mixed-use transactions, revitalization of downtown areas, transit-oriented development and underserved markets.

“For instance, we particularly focus on small multifamily as an area where there is a lack of capital and, beyond that, also have to recognize that, disproportionately, lowincome people are renters and that while a strong support of multifamily finance is critical, it’s not enough, because just a low interest rate on a safe long-term loan isn’t going to help a family making $10,000 a year be able to afford decent rental housing.

“Whatever of the three options (proposed for the GSEs) ends up being put into place, we need to ensure there is a dedicated source of funding for not only down payments for those who want to get access to homeownership, but also a dedicated source of funding for rental housing to ensure we have a supply and that low-income folks have access to that housing,” Donovan said.

Multifamily experts, however, are unsure that the future of market-rate rental housing is best served by relying on an expanded FHA in the absence of the GSEs.

Some like Mark Zandi, chief economist at Moody’s Analytics, see as a more viable solution replacing Fannie and Freddie with five to ten privately owned but federally chartered entities to issue mortgage-backed securities that would be explicitly backed by the government for a fee.

Recap Real Estate Advisors noted, in a report commissioned by the NHC, that providing long-term, fixed-rate mortgage debt for multifamily properties that can be packaged in MBS and sold to capital markets should be a core loan product for the GSEs or their successors.

The Recap report also said it finds value in seeking to continue many other of the successful multifamily functions played by Fannie Mae and Freddie Mac.

The NMHC points out that because the GSE’s multifamily programs did not contribute to the housing meltdown or put taxpayers at risk, they could serve as a model for a reconfigured housing finance system.

“We have two incredibly successful business models out there for the multifamily books of business that Fannie and Freddie do. Fannie Mae has the delegated underwriting (DUS) where their lenders are in the first loss position. They have skin in the game and it really colors the kind of underwriting they do and the fact that they have 60 basis points of serious delinquencies speaks very highly of that.

“On the other hand, Freddie Mac has a life insurance model with prior approval and very serious careful underwriting of the assets and, as of the third quarter of last year, had 28 basis points of serious delinquency. When you look at the CMBS issuances that are out there right now, they are close to ten percent serious delinquencies, so if you average the two GSEs, Fannie and Freddie, the CMBS serious delinquencies are 20 times the level of losses.

“So what we say is, you have incredibly successful business models out there that have demonstrated their ability to perform almost perfectly in a tough environment and they have been incredibly successful at producing workforce housing,” said Bibby.

Donovan thinks a GSE-type model focused entirely on multifamily is an option worth considering, “Especially as we look at FHA, for FHA to be as effective as possible, making sure FHA can operate more efficiently and effectively and can have more flexibility to respond in the next crisis.

“One of the things we have certainly struggled with, and you see it on multifamily and FHA now, our market share has quintupled on the multifamily side through this crisis and scaling up quickly to be able to respond to that market demand and ensure that financing remains available in a crisis is an essential part of FHA’s mission. Yet, many of the ways that, for example, our personnel, our technology, our contracting is funded makes it very hard to respond quickly to that kind of crisis. So we thought and want to consider with Congress when we look at GSE reform whether it would be a good idea to have FHA become a different kind of entity, perhaps a government-owned corporation within HUD.

“And there could certainly be opportunity to think about consolidating some of the multifamily activities of the GSEs together with an entity like that. So that is certainly a direction that we will be considering and talking to Congress about. I think there are frankly some downsides to that, where if you don’t have risk management and other functions, securitization that are cut across the single-family and multifamily markets, you lose some economies of scale and may risk having the markets diverge in ways that might make multifamily financing less efficient and therefore more expensive.

“It’s a very important idea for us to look at, I think there are pros and cons to that and we need to consider them carefully with Congress as we go through this reform discussion,” he said.

Some Republicans and conservative think tanks were disappointed that Obama’s proposal did not go the distance to include a fully private model with no government guarantee.

Yet another camp proposes replacing the current securitization model of the GSEs with a U.S. covered bond market. Covered bonds, which are popular in Europe, are debt securities backed by cash flows from residential or commercial mortgages, but, unlike assets in the current securitization market, remain on the issuer’s balance sheet and give investors preferential claim on the cover pool in the event of default.

“We recognize that this current system where the government is financing 90 percent of the debt financing needs is just unsustainable. However let’s figure out the glide path. How do we get there? What has to happen? The Republicans have suggested we look at covered bonds as a possibility. We’re all for it, but we have to figure out how it can work in the U.S market and what kind of a role it really truly can play,” said Bibby.

The end game
Bibby sees Obama’s white paper as some guiding principles with some directional clues rather than a proposal.

“It was artfully done because it tacked to the right to get closer to where Republicans stand, but still lays out some different options. Yet it doesn’t take a position and, at this stage of the game, taking a position that Option One is the only position is impractical,” he said in early March, after meeting with Republican key staffers on the House Financial Services Committee.

“It is very clear they (Republicans) are going with Option One as the end game, but they understand, as does everyone else, that you can’t just wave a magic wand and have Option One be in effect,” he said. That is especially true for multifamily housing finance, he said.

“You must first have a restructured CMBS market. You have to have banks willing and capable of coming back in in a much bigger way. You have to have life companies increasing their appetite for multifamily above what it traditionally has been and you have to have other players come in and that doesn’t happen overnight. We have to wean ourselves off of federal credit. And I think Republicans recognize that the private sector is not ready.

“Every time we have had a dislocation, whether it was the Long Term Capital Management Crisis, the Russian Ruble Crisis, the recession of 2001 or the most current housing depression, private capital has headed for the hills, and you can’t have an efficiently functioning market when private capital can come and go on a whim. They have very definite investment preferences and performance metrics that drive their investment and when they can’t be met they leave. So we have to have a market where liquidity is available to the borrowers and developers across all cycles in all seasons and in all markets.

“We are very much in favor of robust private sector participation in housing finance, but private capital alone cannot meet 100 percent of the rental housing industry’s needs,” he said.

As predicted, the white paper sparked fiery congressional debates, a spate of hearings scheduled over the next few months and a number of other bills and proposals from diverse stakeholders.

Whatever plan for housing and GSE reform is ultimately decided on will take five, seven or even ten years to implement, said Bibby.

“During that transition we are going to need access to federal credit. And not just as a backstop where you have everybody in mothballs and then you dial them up when a crisis hits, which is totally impractical, but access to federal credit that the user pays for, which is defined in terms of how they want to extend that federal credit, but accessible to the market during this transition period. And that is our focus right now, because the debate on the end game is going to take some time and it is just starting right now,” he said.