Mortgage Giants Find a Bright Spot in Rental Financing

One of the last huge transactions involving a leveraged buyout of a public real estate company was last year’s $22.2 billion acquisition by Tishman Speyer and Lehman Brothers of Archstone-Smith, an apartment landlord with a national portfolio of nearly 88,000 luxury rental units.

But not long after the deal was announced, the credit markets stalled, and some analysts predicted that the transaction would never be completed because banks were no longer able to sell their loans on Wall Street.

Archstone Chelsea, New York, NY
Archstone Chelsea, New York, NY

The purchase did close in October, however, but only because the two now-beleaguered mortgage powerhouses — Fannie Mae and Freddie Mac — provided $8.9 billion of the financing.

In recent weeks, Fannie Mae and Freddie Mac have experienced painful losses stemming from the housing crisis; their shares have plummeted and an emergency bailout plan has been enacted in case either government-sponsored company fails.

But though financing for multifamily housing, including Archstone, as the national apartment company is now known, represents only a small portion of their multitrillion-dollar business, “it has been a rare bright spot for both of them,” said Richard C. Anderson, a senior real estate investment trust analyst at the financial services company BMO Capital Markets.

As a result, both Fannie Mae and Freddie Mac, though often associated exclusively with single-family housing, are rapidly increasing their multifamily portfolios.

“Multifamily started off as a bit player with us, but in recent years it has taken on more importance,” said Ken Bacon, an executive vice president at Fannie Mae. “Not everybody’s going to own their home.”

At the same time, the two mortgage finance giants have helped to make the rental apartment industry the strongest of the publicly traded real estate sectors by providing liquidity that is no longer available through commercial mortgage-backed securities, or C.M.B.S.’s. Neither Fannie Mae nor Freddie Mac issues mortgages; instead they buy loans from banks, freeing capital to make more loans.

From January through July, total returns for multifamily REITs rose 16.74 percent, while hotel REITs, for comparison, were down 27.85 percent, according to the National Association of Real Estate Investment Trusts, a trade group. “One reason that multifamily stocks have done better than other sectors is that they have a capital-raising advantage,” Mr. Anderson said.

Investors can no longer rely on the C.M.B.S. market — in which mortgages are pooled and sliced up according to degrees of risk and then sold to investors as bonds — because it is at a near standstill. Moody’s Investors Service reported that only $12 billion of the securities were issued during the first half of the year, a decline of 91 percent from the corresponding period last year.

The multifamily mortgage business at Fannie and Freddie dropped off significantly during the frenzied years of 2006-7. “They were more conservative than the Wall Streeters,” said David Tobin, a principal of Mission Capital Advisors, a loan-sale advisory company. “In ’06 and ’07, they were marginalized by the investment banks.”

During those heady times, lenders were routinely providing loans representing 90 percent or more of a property’s value, based on the expectation that rents would keep escalating at a rapid clip. “We figured if that’s what it took to compete, we were going to let them go,” said Mike May, a senior vice president at Freddie Mac.

Mr. Bacon said Fannie Mae also takes a conservative approach to multifamily financing. “We have a different business model in our multifamily business than we do on single-family homes,” he said.

That model was a reaction to the real estate slump in the early 1990s, when commercial buildings took the biggest hit. The ratio of the average loan to the property’s value in Fannie Mae’s multifamily portfolio is 67 percent.

But the freeze in securitized mortgages has created opportunities. Since June 2007, Fannie Mae’s multifamily loan portfolio has increased by 26 percent — to $163 billion from $129.5 billion. Freddie Mac, which has $63.8 billion in multifamily loans, bought $8.3 billion worth of new loans in the first half of this year, up from $5.5 billion a year earlier, a gain of 49 percent.

The two entities have about one-third of the outstanding multifamily debt, according to the Mortgage Bankers Association.

A lucrative business, with risks

“It’s a lucrative business for them, and they are doing a lot of it for that reason,” said Cheryl Malloy, a senior vice president at the association. Buried in the midst of last quarter’s hemorrhaging — the two mortgage giants reported losses totaling more than $3 billion — were modest earnings related to multifamily housing: $70 million for Fannie Mae and $118 million for Freddie Mac.

Douglas M. Bibby, president of the National Multi Housing Council, a trade group for large apartment companies, said Fannie and Freddie have also played an important part in fostering newer types of rental housing — for the elderly, students and the military.

Though both were created to focus mainly on housing for people with low or moderate incomes, their role is not limited to those segments of the market, as the Archstone deal shows.

Freddie Mac recently announced that it would provide $73.9 million in financing for rehabilitating Linden Plaza, a 1,527-unit income-restricted complex in Brooklyn. But it also agreed recently to buy a $78.3 million loan for a $100 million recapitalization deal for the Pegasus Apartments, a 322-unit luxury building in downtown Los Angeles.

Bolstering their claim that they seek to minimize risk is the low delinquency rate of their multifamily portfolios — 0.04 percent at Freddie Mac and 0.11 percent (up slightly from 0.09 percent in the first quarter) at Fannie Mae.

By contrast, multifamily loans packaged into commercial mortgage-backed securities have a delinquency rate of 1.278 percent — which still sounds low but is higher than any other property type, according to Realpoint L.L.C., a research company in Horsham, Pa.

Officials at Fannie Mae and Freddie Mac say they did not take on undue risk by helping to finance the highly leveraged acquisition by Tishman Speyer and Lehman Brothers of Archstone, the country’s largest apartment landlord (in terms of market and equity capitalization). The company has a well-regarded portfolio in desirable markets, mainly on the East and West Coasts.

But even though rents in Archstone buildings have risen by 5 percent, according to Lehman Brothers, the portfolio has lost value in the current downturn. While apartment REIT shares have risen recently, total returns have declined by 8.56 percent since the Archstone deal was announced.

Lehman Brothers and Tishman Speyer recently said they would take a 25 percent write-down on the investment.

As a private concern, Archstone has been scrambling to shed some of its portfolio to pay down its debt. The company has sold $2.3 billion in assets since the buyout, and has as much as $2 billion worth of properties on the market, said Robert M. White Jr., the president of Real Capital Analytics, a New York research company.

The sales price so far has averaged around $200,000 a square foot, $40,000 less than the average price paid by Tishman Speyer and its financial partner, he said. Archstone’s executives declined to comment.

But Mr. May of Freddie Mac said the agency is protected because its Archstone loans are senior debt, meaning that they would be the last to incur losses. “That deal, from a credit standpoint, was a solid deal for us,” he said. “If they are overleveraged, it won’t be the senior debt that suffers.”