Freddie Mac’s Michael Case on the agency’s multifamily mission

At a time when housing units are undersupplied with an estimated 4 million unit nationwide shortage, Freddie Mac is sharpening its sights further on creating and preserving affordable spaces to tackle the ever-present demand.

Even though the Federal Housing Finance Agency has nominally cut its lending cap for Freddie Mac to $75 billion for 2023, the scope and appetite for financing new activity has not diminished for the government-sponsored enterprise.

Michael Case, vice president, multifamily capital markets and loan pricing, maintains a pulse on the front-end origination and production lines and a broad view across the division’s back-end securitization group and is one of the key leaders within Freddie Mac’s multifamily division. Since Case started running the pricing desk in 2017, Freddie Mac’s output has doubled in size and he and his team now price an estimated 5,000 different loans in a given year.

Freddie Mac generally tries to average close to 18-20 percent of the full multifamily mortgage market with its total volume – which is managed in conjunction with the FHFA. In 2014, Case notes Freddie Mac’s volume was a little over $28 billion and nearly 10 years later it has almost tripled in size to keep pace with how fast the multifamily industry has been growing.

Case got his start in commercial real estate at Bank of America in 2002, where he spent 10 years with the Charlotte-based bank working at both its headquarters and New York office focusing on commercial mortgage-backed securities  initially before spending a few years in investment banking. In 2013, he moved to Invesco where he helped the Dallas-based real estate investment manager launch its commercial real estate debt fund – now managed by Charlie Rose – and led the origination and investment arm for the vehicle.

At present, Case’s oversight at Freddie Mac has him looking at where bonds are executing, talking to investors and the agency’s capital markets team and then piecing that together with how the agency can competitively source new mortgages. “I come up with our daily breakeven based on where I think the bonds are going to execute and I turn that into front-end loan prices for everything we do,” he says, noting the end result is a workflow that ensures the agency is hitting its mission goals, volume targets, profitability targets and risk metrics on each opportunity.

All-in on affordability

Core to Freddie Mac’s commercial lending output is the focus on affordable multifamily assets.

“Affordable is our ‘North Star.’ Everything we do starts with that at the top of the food chain,” Case says. “Volume is still an important driver, but affordability, profitability and risk management are our priorities.”

Put simply, Case says the agency is trying to continue to grow the business but not at any risk of safety and soundness to the wider mission.

Per FHFA requirements, Freddie has to reach a number of goals to qualify its commercial real estate lending efforts toward said wider mission, including three primary fixtures spanning very low income goals, low income goals and low income goals on small properties with five to 50 units under management. “Those are the three that we are constantly trying to make sure we are meeting our goal and the requirements for,” he says. “We have to be at least 50 percent mission and 61 percent of our units have to be at or below 80 percent of the area median income.”

Agency lending units at PGIM Real Estate and Capital One among other commercial real estate financiers have helped move toward those goals, especially in recent years as volume output has grown.

Mike McRoberts, head of agency lending with PGIM Real Estate and chairman of the Newark, New Jersey-based manager’s agency platform, says Freddie Mac has been critical to its own success which currently has the firm ranked as the sixth highest producing multifamily lender for the agency.

“Our clients need access to all sources of multifamily capital,” McRoberts says. “Without Freddie, we would not be as effective for clients in providing them with all debt options to address their needs.”

Phyllis Klein, senior vice-president, head of agency production at McLean, Virginia-based Capital One, says the agency has played a significant role for the bank, especially on larger transactions and portfolio purchases by tapping into programs such as Green Advantage and Lease-Up Loan offered by Freddie Mac.

“Last year in particular, we drove significant volume through Freddie Mac’s index lock program and variable rate program,” Klein says. “These programs enabled us to lock in quickly and meet time constraints for our clients, making these Freddie products valuable to our customers and our business.”

Capital One notably ranked as the fourth top Freddie Mac originator by volume in 2022 with its $6 billion of output.

Tapping into TACs

One of Freddie Mac’s newer ways of spurring creation of more affordable multifamily units is Tenant Advance Commitments, or TAC, notably used by Comunidad Partners at the end of January.

The Austin, Texas-based real estate investment manager secured a $400 million TAC through Freddie Mac to create and preserve affordability in an estimated 4,000 to 5,000 housing units over the coming quarters, starting with a $21 million loan to finance and renovate a 176-unit apartment complex in Austin.

“The chronic lack of capital being invested into workforce and affordable housing threatens the existence of these properties, which ultimately negatively affects the diverse tapestry of residents who reside in these communities,” says Debby Jenkins, CEO and partner of Comunidad’s new impact credit platform Comunidad Credit Capital.

Comunidad was the first company to use the structure in 2021, which requires financiers to self-impose rent restrictions running concurrent to the loan terms and provide social impact services to residents of the assets.

Comunidad-backed social services through its TAC have included after-school programs, virtual healthcare services and credit and wealth-building programs to bolster the existing resident base with tangible benefits.  

“Over the last year and a half, we have been really focused on tenant advancement and credit building for renters and what we want it to look like,” Case says. “Now we are actually going out and doing it.”

Since Freddie launched the credit building program in late 2021, more than 150,000 families have enrolled in the program and over 21,000 renters have established credit scores for the first time. The agency recently opened applications for additional rent-reporting vendors to apply and be part of the initiative.

Upward, outward

Growth and innovation is as important as creating affordable multifamily housing and workforce housing preservation for Freddie Mac.

“We are working on building out and growing our footprint in areas such as preservation. That is when we work with borrowers to take a property that is not affordable and have them restrict rents such that they are, and in exchange for that, we work with them on ways to incentivize them. That might be pricing or credit or various terms and we’ve got a goal of doing a certain number of units that way this year,” Case says. “That is not something we had a few years ago, but it is something that we have worked to build out.”

In tandem, Freddie Mac is directing more effort toward forward loans which help finance construction of new properties as one means of improving supply. “We do not do construction lending, but we will agree to take that construction loan out upon stabilization, which in turn makes it easier for the borrower to get the construction financing at an affordable rate in the first place. So indirectly, we are helping with the supply constraints there,” he adds.

Klein says rate volatility has created a challenging environment for multifamily lending opportunities, especially with the market constantly moving which can cause a disparity in proceeds and present obstacles throughout the closing process.

“The greatest opportunity comes from deals that need immediate refinancing and acquisitions,” Klein says. “Despite these challenges, I believe this is a great time to be an agency lender given Fannie Mae and Freddie Mac are providing the bulk of the liquidity in the market today.”

She notes agency lending continues to be an attractive option to borrowers given the agencies’ consistent underwriting standards, loan terms and interest rates.

Cooling under pressure

Akin to every other commercial real estate debt provider in the market, the agency has seen mortgage market activity cool as a result of rising interest rates.

“Right now, a lot of borrowers are in this gridlock,” Case says. “Either people don’t want to sell at higher cap rates or they are afraid to do a transaction because the financing rates may go up before they can get their transaction closed.”

Two themes have emerged from the agency’s standpoint early in 2023. The first is a migration toward shorter-term, fixed-rate loans and a gravitation away from floating-rate demand given where SOFR is at.

“We have started to do a lot more five-year, fixed-rate loans due to market demand,” Case says. “Last year, I could probably count on my hands the number of five-year deals we have done, and this year it has become a significant portion of the business that we are doing – due to economic concerns.”

The agency has moved and expanded into the fixed-rate lending market in accordance with demand at a time when borrowers are comfortable taking the floating-rate risk off the table, though notably are not locking into a full 10-year deal in the event rates do come down.

The second theme from Freddie’s perspective has been willingness from borrowers to pay up for pre-payment flexibility. “A lot of loans are looking for us to now quote instead of being full-term defeasance or yield maintenance, they will pay a premium to get the last one, two or three years open as prepayable in those back-end years.”

McRoberts says the landscape is a difficult and transitory environment at the moment. Cap rates have not adjusted to account for the rapid rise of interest rates, he explains, which results in negative leverage in most cases that makes it tough for deals to pencil.

“The sweet spot seems to be the five-year fixed rate product with flexible prepay,” he says. “That gives borrowers debt service certainty with no interest rate cap requirement and a bridge to a time where interest rates will hopefully be lower.”

As an example, Case notes that in place of a traditional 10-year fixed deal, borrowers are now looking to have the back three years open on five-year loans and the agency is pricing them with straight, full-term lockout or, for a slight premium, borrowers will request the back-end to be fully pre-payable in the last two years.

Mission alignment stays atop the deal-making priority list for Freddie Mac as it navigates the present market challenges alongside the rest of the commercial real estate lending field.

The agency’s credit boxes have changed on the margins, though the credit policy is such that its design is intended to take a full-cycle approach. “When things are aggressive, when there are multiple people lending, we’re not loosening up our terms and likewise we’re not tightening them up; we are comfortable with where they are on a longer-term basis,” Case says.

He notes the agency has started to see a little more utilization of the 35-year Treasury versus the typical 30-year Treasury, though Freddie Mac does try to use it sparingly – specifically on very affordable deals or very low-leverage deals. “In general, I would not say our credit profile has changed materially,” Case adds.

Looking beyond its own activity, the agency is also seeing more talk and use of preferred equity in deals happening today. “A lot of our borrowers are looking for ways that they can creatively be an alternative lending source to help bridge the gap between how far the agencies can underwrite total proceeds,” Case says.

“As interest rates continue to go up, the amount we can lend on a certain asset gets constrained by the debt service coverage ratio and so you have got a void in terms of proceeds that the borrower wants and needs to make the deal work and where the agencies can size the loan to.”

Agency partners that include PGIM Real Estate and Capital One are not halting creativity in the business they are doing directly with Freddie Mac.

In addition to PGIM Real Estate’s equity investment program where the firm will continue investing directly into multifamily-focused funds, McRoberts says his team is focused on expanding its footprint in the big “A” affordable arena. “Stephanie Wiggins and Kelly Follain on my team are actively working to bring an expanded bridge lending capability, access to private placements, tax credit equity and other benefits to our affordable housing focused clients,” he says.

Klein says Capital One, atop its agency finance business, is continuously looking for strong bridge lending opportunities both on the transitional and lease-up fronts to tap into more multifamily lending lines this year.

As observed by Freddie Mac, this deeper exploration of gap financing has also led the agency’s borrowing partners to build funds or carve out lending ventures to become a preferred equity provider while debt markets are constrained.

Now, if borrowers take an agency loan with some preferred equity, Case says they can beat where the traditional commercial real estate debt funds are pricing to.

“The other thing I would say is a lot of borrowers – sophisticated borrowers who have traditionally been active – have been on the sidelines keeping some dry powder and trying to be in a position to take advantage of any sort of potential market distress that could occur,” Case says.

“I don’t think that’s our internal view, we’re not expecting market distress, but a lot of capital is on the sidelines waiting for opportunities to emerge in the back half of the year and are looking to deploy where it makes sense.”

FHFA cap calibration

While Freddie Mac and its associated government-sponsored enterprise Fannie Mae have seen multifamily loan purchase caps from the Federal Housing Finance Agency rise over 2022, macro uncertainties have slightly dented that trend in 2023.

In November 2022, the FHFA made a $3 billion cut to each agency’s volume caps from the $78 billion caps designated for each in 2022. In conjunction with the volume reductions, the parent agency’s affordable housing initiative saw some revisions too.

Under this year’s standards, the FHFA removed the requirement that 25 percent of Fannie and Freddie’s multifamily business be affordable at 60 percent of are median income or below to address inconsistencies with the parent agency’s housing goals regulation. Overall, at least 50 percent of Fannie and Freddie’s multifamily business must generally be mission-driven and Case notes 61 percent of the units have to be at or below 80 percent of the area median income.

FHFA also created a new category for the preservation of affordability in workforce housing to curry more lending momentum toward assets with rent or income limitations affordable at levels that meet market needs. “This is intended to support residents living closer to places of employment, hospitals and schools,” FHFA wrote in its November announcement.

Senior housing loans and loans for five- to 50-unit multifamily assets are also now filtered into the ‘Other Affordable’ category to streamline FHFA definitions. Loans to finance energy and water efficiency improvements with units affordable at or below 80 percent of AMI – up from 60 percent of AMI in 2022 – are now also considered mission-driven.