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Financing the Apartment Market in Volatile Times

Multifamily SVP Mike MayA year ago, almost all signs about apartment markets were uniformly bad. Today, conditions are more mixed. That's progress. But we're not out of the woods yet. And that reality informs our business direction right now.

What's changed for the better?

  • Property values, which had collapsed by 20 percent or more during the economic crisis, have begun to firm up.
  • Vacancy rates, which had climbed to the highest levels in half a century, have come off their peaks.
  • Rents, the principal source of income for property owners, have stabilized and begun to increase in markets with stronger local economies.
  • Private sources of mortgage funding – which made a mass exodus from the market in 2008 and have been absent ever since – are slowly reentering the market.

These are all positive developments. But a full recovery is still a ways away.

For one thing, many financial institutions are still conserving capital to cope with high delinquency rates: more than 400 basis points for loans held by banks and more than 1,000 basis points for multifamily loans in commercial mortgage-backed securities. (By contrast, Freddie Mac has a delinquency rate of just 28 basis points.)

Also, the firming up in property values might reflect a bear market rally where supply is artificially low. Apartment owners with underwater loans are avoiding valuation losses by holding onto their properties. And we have yet to see significant new construction. Both developments have combined to limit the supply of marketable properties.

But the biggest obstacle to a full recovery is continued high unemployment. The simple fact is, lasting improvement in apartment market conditions can come only from strong job growth. Higher incomes and household formations are essential to a lasting recovery. But neither is achievable when the unemployment rate is 9.6 percent.

To use a football analogy, the multifamily market recovery is around mid-field, with another 50 yards still to go. Conditions certainly are better than a year ago. And local markets with stronger economies are performing quite well. But overall, job growth must go up and loan delinquencies go down for the broader market to fully recover.

For these very reasons, Freddie Mac is approaching the multifamily market with prudence. As a business, we recognize that market risk is still very much present. And so we're maintaining the kinds of credit terms that make sense in volatile markets.

We're looking for sound loan-to-value percentages and debt-to-coverage ratios (80 maximum and 1.25 minimum, respectively, on most loans); realistic forecasts of net operating incomes; and proven property owners with strong balance sheets and local market experience. For deals that meet our credit requirements, we have plenty of available funds for multifamily loans. Otherwise, we're willing to take a pass, even if that means missing out on some attractive deals on the leading edge of a lasting recovery.

After all, during the housing and credit boom, we didn't agree with the market's view on risk, and so we consciously reduced our multifamily market share. As a result, our multifamily business has avoided the worst of the bust and instead has been able to finance what is for us a record share of loans during the current economic crisis. Since the beginning of 2008, when the crisis first emerged, we have purchased roughly $45 billion in multifamily loans that have housed more than 700,000 families.

Apartment markets are moving into a transition stage of a recovery in the making. But our economists say it might take a while to get there, and there will be setbacks along the way. That's one key reason why we remain cautious in how we are deploying our capital.

* Mike May left his position as executive vice president of Freddie Mac's Multifamily Division in July 2011.


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