Friday Letter The problem with Fannie and Freddie

The US multifamily sector has been bolstered thanks to liquidity from the mortgage insurers Fannie and Freddie. Impending reform of the government agencies though could prove painful for apartment borrowers and the sector.  

Multifamily Investors in the US could not have helped but notice this week that Freddie Mac, one of two US government agencies being used to prop up the country's housing market, was forced to bring out the begging bowl yet again.

After reporting losses of $6 billion in the second quarter alone, the government-sponsored enterprise (GSE) admitted it needed an additional $1.8 billion of federal aid to stay afloat, pushing the amount it has received from taxpayers to $63.1 billion since being taken over by the government almost two years ago.

Combined with its sister GSE, Fannie Mae, the two organizations have swallowed a massive $148.2 billion of bailout cash since September 2008. It's a situation that has made many politicians sit up and take notice, and one that multifamily Investors are also closely monitoring.

Established in the 1930s and 1970s respectively to provide liquidity to the US mortgage markets, Fannie and Freddie play an integral role not just in the availability of single family home mortgages, but are essential to the multifamily sector as well.

Indeed, over the past 12 months it has been to Fannie and Freddie that most multifamily investors have turned for credit. One might say Fannie and Freddie are the market, with liquidity all but squeezed out of the system. Where else could one go for a source of permanent debt financing but these GSEs? At the height of the crisis, according to many estimates, Fannie and Freddie accounted for between 80 percent and 90 percent of all multifamily debt issued.

Fannie and Freddie's mounting losses – and expectations their bailout could cost taxpayers as much as $400 billion – has prompted demands for reform. President Barack Obama this week announced plans for a public debate on the issue on 17 August, featuring speakers including mortgage investor Lewis Ranieri and Wharton School real estate professor Susan Wachter, with legislation planned for 2011.

For multifamily borrowers, calls for change could ultimately lead to worse pain.

The simple fact that financing for many multifamily deals has been made available through the GSEs, has meant the sector has performed relatively well in comparison to its commercial real estate brethren. A Jones Lang LaSalle survey of real estate Investors in November last year revealed the sector was expected to make a comeback in 2010 with financing from Fannie and Freddie credited for “bolstering viability” of the sector.

Almost nowhere else have multifamily borrowers been able to secure debt at rates as low as those secured through the GSEs. Real estate developer Behringer Harvard said in June it acquired $168m single asset loans and a $150m credit line through the latter half of 2009 through 28 May 2010 with weighted average interest rate of 4.7 percent and 2.4 percent respectively.

Critics of GSEs would like to see the government step back completely from running the companies, handing over full responsibility to the private sector. But with Fannie and Freddie accounting for $5 trillion of US home mortgages that is unlikely to happen.

What many do expect to see though is much greater scrutiny of Fannie and Freddie alongside guards against excessive risk-taking, such as increased capital reserves and limits on involvements in certain securitisations. That in turn will ensure heightened GSE underwriting standards, higher interest rates or shifts in guarantee levels.

For many multifamily investors it seems the sector is in a “heads you lose, tails you lose” situation.

Maintaining the status quo is not only unsustainable for the country (and budget deficit), but it is also encouraging Investors into the sector, helping to push up prices and drive down yields. Reforming the GSEs, however, could severely limit the liquidity that has proved critical to the success of the sector in the worst recession for s generation.

As Obama and US legislators attempt to tackle this thorny issue, you can be sure multifamily Investors will be watching the action extremely closely.