Agency Lenders Foresee Yet Another Big Year
After three years of explosive growth in purchases of multi-family loans, Fannie Mae and Freddie Mac may temper their activity in 2018 — but not by much.
Many pros suspect that 2017 was the cyclical high-water mark for the mortgage agencies. “I think the expectation is things can’t get a whole lot better,” noted Brian Stoffers, global president of debt and structured finance for CBRE, one of the largest agency lenders.
That said, the favorable fundamentals driving the multi-family sector largely remain in place, and a slight pullback by the mortgage agencies would still represent a historically high level of activity. So agency lenders are expecting another big year.
“The skeptic in me says that higher interest rates could impede growth and that lending will be dialed back,” Stoffers said. “But the optimist in me says we’ll be at good levels this year.”
While final tallies aren’t yet available, Fannie and Freddie were on track to acquire more than $125 billion of multi-family loans last year, shattering the previous high of $112.1 billion set the year before and capping three years of growth that saw annual activity soar from $57.2 billion in 2014. That, in turn, led to unprecedented issuance of agency bonds. Freddie by itself set a company record by floating $68.1 billion of bonds, with 392 investors participating in its deals.
Last year’s surge of activity pushed agency lenders’ combined share of the multi-family origination market above the unofficial 40% maximum preferred by the Federal Housing Finance Agency, which oversees Fannie and Freddie. That was seen as the reason the regulator announced some steps in November aimed at tamping down their activity. The FHFA reduced the annual lending caps for Fannie and Freddie for the first time since the limits were established in 2013. The cap, which applies to most types of loans, was reduced to $35 billion for each agency in 2018, down from $36.5 billion last year.
More significantly, the regulator also tightened the definition of “green” loans, which fall outside of the caps and have become a major driver of agency activity. The loans offer property owners a pricing discount of roughly 10-25 bp in exchange for agreeing to improve water and electricity standards. Through the first nine months of last year, green loans accounted for a whopping 42% of Fannie’s overall purchases and 27% of Freddie’s.
“The amount of green business that’s getting done — I don’t think anybody foresaw how big that would become,” said Walker & Dunlop executive vice president Donald King, who oversees agency-lending activity for the firm.
Previously, borrowers had to agree to make changes that would cut annual water or electricity costs by 20% for Fannie loans or 15% for Freddie loans. The threshold now has been increased to 25% for both agencies.
Fannie and Freddie actively encouraged their lenders to offer green loans in 2017, which could have resulted in a one-time surge. “We did a lot of this business last year,” said Frank Lutz, a senior vice president at Berkadia Commercial Mortgage. “I would guess that even without the changes, the volume of green business might decline a little bit. Maybe we got all the low-hanging fruit this past year.”
Overall, the outlook for the multi-family sector remains favorable. Rental demand is strong, because the rising prices of single-family homes keep ownership out of reach for many renters. Plenty of domestic and foreign capital is available for purchases of apartment complexes, driving up values and the sizes of loans. A substantial amount of mortgages need to be refinanced. And interest rates, while trending up, still aren’t high enough to suppress borrowing demand.
David Brickman, Freddie’s executive vice president for multi-family business, said those factors appear to set the table for another strong year. “The health of the rental market and the mortgage market continue to be strong,” he said.
Contributing to agency originations is an increase in floating-rate loans, whose relatively short terms accelerate the pace of refinancings. Several agency pros said that floaters accounted for as much of half of Freddie’s total production in 2017 and for a significant portion of Fannie’s activity as well.
The increase is attributed to the larger presence of institutional owners. In past years, the sector was dominated by long-term holders that gravitated toward fixed-rate mortgages. But in recent years, property funds and other institutional buyers have accounted for a larger share of multi-family acquisitions. Those players often have shorter investment timeframes, aiming to make improvements and then cash out. Floating-rate debt gives them greater flexibility to prepay without penalties.
Agency reform isn’t at the forefront of lenders’ concerns now, but there’s a chance it could finally get some traction in 2018 after years of discussion. Committees in the Republican-controlled House and Senate are drafting measures that would remove Fannie and Freddie from the government conservatorship they were placed under in 2008 after suffering huge losses during the financial crisis. The early word is that the bills under consideration could retain the U.S. government’s guarantee on loans acquired by Fannie and Freddie — a provision agency lenders see as vital.