COVER STORY, MARCH 2007

FANNIE MAE: TIME IS RIGHT
Company modifies its multifamily approach.
Howard Smith

With $34.3 billion invested last year, there is no question that Fannie Mae is a force in multifamily financing. Growth from the company’s Delegated Underwriting and Servicing (DUS) program, however, remained flat at $15.8 billion from 2005 through 2006. With no growth last year from its marquee DUS program in an exploding multifamily market, why do some think that this is the year that Fannie Mae will once again be the market’s hot ticket?

A simple search of Fannie Mae press during the last 2 years will demonstrate the tumultuous period the company has weathered. To its credit, Fannie Mae used this period of change to modify its approach to the multifamily market. Appointed to the post in last year, Phil Weber is now at the helm of multifamily. Weber brought with him a clear focus and client-centric approach that is turning heads of both DUS lenders and borrowers alike. Other Fannie Mae leaders, such as David Worley, senior vice president, HCD Risk Management, are in the same client-centric camp.

One example, deal teams, may seem simple, but the impact on borrowers is significant. In the past, Fannie Mae might only need to occasionally review exceptions; but, in today’s competitive environment loan customization is the norm thus increasing the need for Fannie Mae review. Fannie Mae’s response to this market phenomenon has been to bring together deal teams of subject matter experts and empower them to support DUS lenders on their financing decisions to ensure quick response times. By leveraging deal team members from multifamily, credit, and pricing, Fannie Mae is able to strive for same-day approval of these out-of-the-box loans.

The deal team concept has also helped Fannie Mae’s transformation from a hands-off purchaser of loans to a relationship lender. In the past, the term borrower might be paperwork describing a key principal or single purpose entity. Under the new structure, Fannie Mae is spending significantly more time understanding borrowers and the stories behind their loans. Once again, this approach is designed to help the company to be more flexible and creative in its lending.

At the same time that Fannie Mae is focusing on the borrower, the company also recognizes the need to be a secondary marketer to its DUS lenders. Since the DUS lenders service the loans they close, continuing to empower the lenders is critical to maintaining the program’s primary differentiator.

To that end, Fannie Mae has continued to enhance the delegation to its lenders, now allowing DUS lenders to handle many waivers from the standard DUS guidelines. This is one of the behind the scenes efforts that benefits borrowers through faster responses, reduced paperwork and simply fewer cooks in the kitchen.

At the end of the day, however, loans are often won or lost on strength of product. There is little doubt that 2007 will continue to see Wall Street conduits differentiating on price and proceeds, taking debt service coverage to new lows and loan-to-value ratios to new highs. As long as the conduits can find buyers for the B-piece risk on these portfolios, this trend is unlikely to change. DUS lenders may go head-to-head, and even win, these price/proceed battles, but the sweet spot for Fannie Mae this year will be in specialty products and meeting borrower needs through the flexibility of their loan programs.

Specialty products such as credit facilities, seniors housing loans, and multifamily affordable housing loans traditionally have been a lay-up for Fannie Mae. Last year, the company did $2.7 billion in credit facilities, $2.2 billion in seniors housing, and $2.6 billion in Multifamily Affordable Housing (MAH) (financing for rent-restricted properties for people earning 60 percent or less of median income) in addition to bond enhancement and low-income housing equity investments.

For conventional multifamily loans, however, flexibility is the hallmark of Fannie Mae’s product suite. Time-tested components of the Fannie Mae suite include a streamlined refinancing process, supplemental loans, and multiple loan assumptions. Refinancing a Fannie Mae loan can be a simple process taking only days to complete and resulting in reduced payments or cash out equity.

Supplemental loans are a great tool for borrowers with increasing property values due to rehabilitation, renovation or rising real estate prices. A supplemental loan, essentially a second and/or third trust, is a simple way to release trapped equity without selling a property or refinancing subject to yield maintenance on the existing loan. In high growth markets, it is not uncommon to see a $10 million loan with a $3 million second after two years and another $3 million supplemental after year four.

Multiple loan assumptions are a device for borrowers who know they are not long-term holders. The new owner can benefit by assuming an attractive financing package during a period of rising interest rates, and the existing owner can use the assumption to create more value in a sale. A simple illustration can demonstrate this positive leverage concept:

Assume a property was purchased for $1 million on a first year net operating income (NOI) of $70,000, resulting in a 7 percent cap rate. If it is purchased for all cash, the cash on cash return in the first year is also 7 percent. Now assume an 80 percent loan-to-value Fannie Mae assumable loan on the property with 30-year amortization and a 5.50 percent interest rate. This would result in a loan of $800,000 and an equity investment of $200,000. These assumptions would give you an annual debt service of $54,508. Subtracting $54,508 from the same NOI of $70,000 leaves a cash flow after debt service of $15,492. Taking the $15,492 and dividing it by the equity investment of $200,000 leaves a new cash-on-cash return of 8 percent.

This example shows that the difference of 150 basis points of positive leverage between the 7 percent cap rate and the 5.50 percent interest rate results in a 100 basis point increase in first year cash on cash return. If the property were then sold subject to the mortgage, the seller would have the opportunity to realize this value through an increased sales price.

Last year, Fannie launched new products and features that provide even more financing flexibility. One of the most innovative new products is the portable loan, known in Fannie Mae parlance as Single Asset Substitution. Single Asset Substitution provides qualified borrowers with the ability to replace the original mortgaged property securing a DUS loan with another mortgaged property while keeping the existing DUS loan in place. This provides borrowers with greater flexibility to sell, exchange, and manage their multifamily assets while maintaining the terms of the original DUS loan.

At the recent MBA–CREF conference, Fannie Mae unveiled several other products in the works for this year. One of the more innovative new products, the Moderate Rehab product, will focus on fixed rate, long-term financing for multi-family assets requiring rehabilitation of $5,000 or more per unit. This product will be structured similar to the existing DUS Plus product by combining a DUS first mortgage with a Fannie Mae mezzanine loan. This new product will give borrowers the ability to fund mezzanine loan in draws and provides for more flexible pre-payment of the mezzanine loan using a Fannie Mae supplemental loan. Finally, the more aggressive underwriting parameters of this product will allow for sub-1.0x debt service coverage in some cases.

Just 2 years ago, industry people questioned whether Fannie Mae would even continue to exist in its present form. It appears that the company not only made it through, but came out in fighting shape ready to win multifamily business in this year.

Howard Smith is executive vice president and chief operating officer of Green Park Financial, a Fannie Mae DUS lender and the nation’s largest dedicated multifamily lender. Mr. Smith is also the vice chairman of the DUS Advisory Council and serves on the board of the Commercial Real Estate / Multifamily finance Board of Governors.


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