Operating in the shadow of Freddie Mac's business as America's second-largest guarantor of home loans, the company's unit serving apartment landlords is booming as borrowers take advantage of looser lending terms.
The mortgage company underwrote $21.2 billion of debt on apartment buildings in the second half of 2014, triple the total in the first six months. The surge meant the McLean, Va.-based lender almost surpassed the larger Fannie Mae last year to become the biggest provider of U.S. apartment financing, following changes by the agency that oversees both companies.
Mel Watt, who took over as director of the Federal Housing Finance Agency last year, is rolling back policies aimed at shrinking the government-controlled finance companies, letting Freddie Mac push into segments of multifamily lending that had been off limits. That's helping bolster demand for apartment buildings, already the hottest part of the commercial real estate market, as values rise to a point of possible overinflation.
"Rents have been growing at a significantly faster clip than wages," said Sam Chandan, president of Chandan Economics. "The outlook for rental growth is more measured than what we've seen over the last couple of years."
Apartment values have been rising steadily since 2010, according to the indexes compiled by Moody's Investors Service and Real Capital Analytics Inc. Multifamily buildings in large cities such as New York and San Francisco have had the biggest gains in the real estate recovery, with prices 40% higher than the record reached in November 2007, during the last boom. Those higher values will be tested when the central bank raises interest rates, a more likely prospect in 2015 after a strong jobs report this month.
While prices for the best apartment buildings in the highest-demand markets may be due for a correction, there's still room for growth among properties outside the top tier, said David Brickman, head of multifamily operations at Freddie Mac.
"Nobody is building Class B properties," Brickman said in a phone interview. "Vacancies continue to be very low."
Both Freddie Mac and Fannie Mae boosted apartment lending during the latter half of 2014 after Watt eased restrictions on that part of their businesses, according to real estate research firm Green Street Advisors. The FHFA capped their multifamily lending at $30 billion each last year — a $4 billion increase for Freddie Mac — after telling the companies to shrink the business in 2013.
Watt succeeded Edward DeMarco, who made cutting the size of the companies a priority while he was director, a role he assumed when the FHFA was created in July 2008. Freddie Mac and Fannie Mae were seized and taken into U.S. conservatorship in September 2008 as the companies buckled under the weight of souring home loans, requiring a $187.5 billion taxpayer bailout.
The surge in volume at the end of last year was due in large part to an unexpected drop in interest rates that pulled some borrowers off the sidelines, according to Jeff Hayward, head of multifamily operations at Fannie Mae.
The demand for loans was sluggish at the start of the year, and Fannie Mae and Freddie Mac didn't have a clear mandate from their regulator until May, according to Willy Walker, chief executive officer of Walker & Dunlop Inc. The new FHFA road map allows the lenders to exceed volume caps to serve affordable-housing needs, Walker said.
"That was really a great shot in the arm," said Walker, whose company is a lender in the multifamily programs at Fannie Mae and Freddie Mac, which rely on partnerships with banks and other financial institutions to acquire loans.
The shift in tone at the FHFA has been especially beneficial for Class B buildings, properties that are typically at least 20 years old and may need upgrades, Green Street analysts led by Dave Bragg wrote in a report last month. Ownership of such buildings varies widely, ranging from individuals to large institutions, according to Bragg.
Freddie Mac last year started a program catering to borrowers renovating their properties, Brickman said. The short-term loans are designed to facilitate improvements prior to investors taking on longer-term debt.
New FHFA rules last year also enabled Freddie Mac to finance manufactured-housing communities and form a group dedicated to originating small apartment loans, of $1 million to $5 million. The average size of a Freddie Mac multifamily mortgage is $15 million, and loans can be as large as $450 million.
Fannie Mae has been doing such lending, geared toward providing low-income housing, for several years.
Fannie Mae is losing ground as Freddie Mac expands its programs and offers borrowers more generous terms, such as allowing landlords to defer paying off principal. Freddie Mac's multifamily-loan volume exceeded Fannie Mae's by more than $2 billion in the fourth quarter.
For all of 2014, Fannie Mae retained a slim lead, completing $28.9 billion in apartment financing, compared with Freddie Mac's $28.3 billion. Combined, the two hold about $334 billion of outstanding multifamily debt, with Fannie Mae accounting for $198.4 billion as of Sept. 30.
By contrast, the companies hold more than $4 trillion of loans backed by homes occupied by their owners.
In their multifamily units, the two use different models to distribute the risk of borrowers defaulting. Fannie Mae shares in losses with the lenders it partners with, while Freddie Mac offloads losses to private investors. Fannie Mae's model leads to a more conservative approach to underwriting.
The larger lender isn't standing still. At the end of last year, Fannie Mae started funding borrowers with newly constructed properties that are still in the process of finding tenants for them. While buildings typically have to be least 90% occupied to qualify for funding from Fannie Mae, the new program allows for vacancy rates as high as 25%, said Hilary Provinse, a senior vice president at the company.
More than six years of near-zero interest rates engineered by the Federal Reserve have pushed all types of investors to take on more risk to generate higher returns. Fannie Mae and Freddie Mac have to get more aggressive to compete, and Freddie has been faster than Fannie to adapt, said Walker of Walker & Dunlop.
Still, the landscape remains relatively tame compared with the excess of the years leading up to the last property-market crash, Walker said.
"We're not doing loans with either agency that say the silly underwriting of 2006 and 2007 is coming back," he said.
The multifamily units at Fannie Mae and Freddie Mac, which have been growing steadily since 1994, emerged from the financial crisis relatively unscathed, compared with the arms that deal with individual homeowners. The companies' track record in the industry supports their continued growth, according to Bragg of Green Street.
"We don't necessarily think we're taking on more risk," said Brickman of Freddie Mac. "We're feeling more empowered to make good loans and not as concerned about staying in a lane."
