Act Now to Wean Multifamily Lending Off GSE Support

Ninth in a series.

Somewhat overshadowed by events in the single-family residential mortgage market have been Fannie Mae and Freddie Mac's multifamily finance programs. In anticipation of GSE reform, policymakers should consider shaping the Dodd-Frank risk retention requirements in a way that brings private investment back into the multifamily mortgage business. A short window of opportunity exists to accomplish this now.

Fannie Mae's and Freddie Mac's multifamily financing activities have long been touted as consistently successful and highly profitable programs, even during the recent years of unprecedented losses that thrust the government-sponsored enterprises into government conservatorship. The agencies today hold or guarantee nearly $400 billion in multifamily debt, with $62.6 billion originated in 2012. Yet their respective delinquency rates have remained under 1%. Industry players argue that for multifamily lending to continue in its current capacity, agency reform must keep the federal backstop in place.

Profitability, however, is not a strong argument to keep these programs going if such lending doesn't truly require a federal subsidy to survive. In allowing each multifamily mortgage to take on an explicit federal guarantee, there is an untold cost to taxpayers. Much of the profit from this subsidy, however, ends up in the hands of the correspondent mortgage bankers, which typically earn 150-350 basis points on each loan they originate—a very handsome profit at the expense of taxpayers.

Even as capital has returned to commercial real estate, the private sector has had difficulty competing against the agencies and their subsidized interest rates for multifamily. Fannie and Freddie's combined market share is now roughly 60%—about double what it was before the credit crunch. For private capital to find its way to multifamily, it must pursue riskier loans that fall outside the parameters of the GSE programs, such as construction financing or properties that have yet to achieve stabilized rental incomes.

Industry pros such as Tom White of SeaChange Consulting Group and Charlie Wilkins of Compass Group have made other arguments for privatization as well. Without the federal subsidy, they argue, multifamily financing terms would more accurately reflect the risk of lending. Bubbles created by cheap debt that typically lead to overbuilding would be circumvented, and the moral hazard of risks taken under the assumption of socialized loss would be avoided.

Furthermore, debt for multifamily properties provided by the agencies does nothing to enhance affordability for renters, as the industry has never proven any connection between multifamily interest rates and the rents that tenants actually pay. If policymakers observe a need for more affordability in rental housing, increasing the amount of tax credits available for low income housing tax credit development would be a more effective way of achieving that goal.

If a catastrophic liquidity shortage in the future arises, the government can always step in to provide assistance by loosening restrictions on the Federal Housing Administration's multifamily mortgage program or through targeted quantitative easing whereby the Fed would purchase either individual multifamily MBS or bifurcated multifamily CMBS. Some argue that even those measures wouldn't be necessary, as history has already shown that private investment is strong enough to fill the gap if Fannie Mae and Freddie Mac quit the multifamily market. The LIHTC sector serves as such a model—it survived the flight of the GSEs when the two agencies stopped buying affordable housing tax credits in 2008. And when CMBS issuance froze in 2008, a similar scene played out with commercial properties: portfolio lenders and life insurers stepped up to provide capital and fill the space left vacant by conduits.