Panelists Concerned Over Fannie, Freddie's Future

(Mark Your Calendars: RealShare Apartments 2011, October 20 in Los Angeles).

SAN FRANCISCO-With Congress focused on reducing the US debt ceiling, the future of the GSEs—which finance the lion’s share of multifamily project—is in jeopardy. During a capital markets discussion at PCBC last week, panelists expressed their growing concern over the future of Fannie and Freddie. On the flip side, panelists were primarily bullish on the prospects for investing in the multifamily sector over the short and long term.

“We are seeing more players (financiers) come to the marketplace,” said Marshall DeWolfe, director of loan production for Intervest, “which has created more competition.” He said that life insurance companies and conduits, for instance, are more active in the multifamily space right now. DeWolfe noted that delinquency rates for multifamily are low compared to other property sectors, making apartments a more financeable product. In fact, DeWolfe’s firm is increasingly comfortable to “going down low” on debt coverage ratios in this environment because of the strength of the West Coast apartment sector.

However, as some inexperienced financiers enter the debt markets, Paul Lewis, a vice president with Fannie Mae, warned that these players lack the “credit discipline” to properly finance projects. Underwriting is still relatively stringent, but as these financiers—who jumped on the multifamily bandwagon to turn a quick profit—that discipline could easily disappear, leading the industry down a dangerous path, Lewis said. Or in the words of the capital markets moderator, ALM Real Estate Media Group’s Michael Desiato, “My concern is that we (as an industry) won’t learn our lesson” from the Great Recession.

“Fannie and Freddie were created to provide liquidity to the market,” said Lewis. “More than $32 billion in multifamily financing was financed this past year by Fannie and Freddie. The GSEs have better “segmented our data on a quarterly basis. At the end of the day, it better explains the health and profitability of the multifamily sector,” he said.

As the multifamily market improves nationwide, a number of “amateurs” are getting into the construction business that don’t understand the entitlement, construction and development process, noted Sharon Dworkin Bell, senior vice president of the National Association of Home Builders.

Bell also warned that cutting funding for the Department of Urban Housing and Development could be dangerous for multifamily finance professionals, especially those using the Sec. 221 (d)4 program, which provides financing for buildings with SRO units.

In spite of the uncertain future of the GSEs and continued capital markets shifts, the multifamily investment sector remains healthy. Class-A cap rate recompression has been “profound,” in many primary western markets, said Hessam Nadji, managing director, research and advisory services at Marcus & Millichap Real Estate Investment Services. In a few rare cases, some multifamily assets have even traded below a 4% cap rate, panelists noted.

Institutional investors that were able to acquire top-tier properties in primary metro locations captured the “low-hanging fruit” and are now reaping the benefits, said Nadji. Properties in secondary markets are also gaining traction now, although cap rates for these assets remain higher, and tertiary market are still being avoided by most investors.

One panelist warned of too much upward pressure on pricing, especially for top-tier assets. “Pricing is like a giant helium balloon that’s been over-inflated and is on its way to Death Valley where the air temperature is 185 degrees,” said Steve Steppe, executive managing director of Stockbridge Real Estate. Cap rates, which he said dropped below 4% in some prime locations, are too low to turn a profit. “You can’t buy real estate at this low of a yield and expect to make money.”

Michael Schall, president and CEO of Essex Property Trust, advised that investors should seek out properties with cap rates at 5% or 6% to earn higher returns, which is what’s occurring in the major primary markets in the West.

Stanford Jones, executive vice president of Institutional Property Advisors, said that as the class-A market continues to thrive, investors will begin to move down the quality chain in search of yield. For instance, he explained, “We are seeing the reemergence of funds in the market, including endowment funds.”

Private investors need to look at value-added, opportunistic deals, added Geoffrey Stack, managing director and principal of Sares-Regis Group. “You’re not going to compete with REITs, or big institutions.” Instead, he advised seeking class B and C assets in high-demand urban locations that have issues, such as management problems, are old or are in need of rehabilitation. “There are a number of different things you can do with older apartment properties to enhance value and increase cash flow.”