Wall Street Sees Promise in Multifamily Loans

Fannie Mae FNMA -2.61%and Freddie Mac FMCC -1.98%are finally getting some private-sector competition in the business of financing loans in the debt market, at least in multifamily housing.

Wall Street lenders are getting more aggressive bidding on multifamily loans to securitize in recent months, helped as the demand for their commercial mortgage-backed securities has cut their costs to the lowest in more than four years, getting closer to those of government-advantaged programs of Freddie Mac, Fannie Mae and the Federal Housing Administration.

Congress has urged private capital to take over as the primary source of funding for real estate, after the housing bust left taxpayers shouldering billions in losses from the single-family portfolios of Fannie Mae and Freddie Mac. With CMBS recovering faster than private residential mortgage bond issuance, that shift may be seen first in multifamily housing, analysts said.

“Multifamily loans lead the pack in terms of how aggressive the lenders will get” within commercial real estate, said Christopher Haynes, president of Broadacre Financial, which advises commercial real-estate borrowers.

The drive for more multifamily loans comes as CMBS lenders seek to regain a foothold in a sector of commercial real estate that has evaded them since the financial crisis. Multifamily loans made up just 6.6% of CMBS deals this year, down from the 10-year average of 19%, so any change to the “practical monopoly” of the agencies is significant, according to Harris Trifon, head of asset-backed and CMBS research at Deutsche Bank DBK.XE +2.18%.

CMBS lenders are capitalizing on a five-month rally in their bonds to regain multifamily share lost to the agencies. This is diversifying CMBS loan pools to the liking of rating firms and investors uneasy with concentrations in riskier real-estate sectors, like retail. CMBS lenders could see another $10 billion in multifamily if the agency market share is cut even a small amount, Mr. Trifon said.

The growth comes as CMBS risk premiums have dropped as low as 0.83 percentage point this month, from about 1.6 points at midyear. Tighter spreads let CMBS come closer to lending packages offered by Freddie Mac and Fannie Mae, whose similar bonds demand yield premiums of about 0.5 point.

“We’re seeing them nibble around the edges a bit more,” said Kimberly Johnson, Fannie Mae’s senior vice president for multifamily capital markets.

CMBS have a way to go before making a dent in the market share for multifamily debt. Led by portfolios and securitizations, agency and FHA multifamily debt outstanding grew by 2.6% in the third quarter to a record $368.9 billion, the Mortgage Bankers Association said. That tops an increase at banks and compares with a 3.2% decline in CMBS multifamily debt to $74.3 billion, the lowest in nearly eight years.

David Brickman, senior vice president of Freddie Mac’s multifamily program, said Fannie Mae, insurers and banks are still his main multifamily loan competitors. But CMBS lenders are finding areas where they can compete, especially where Freddie Mac is “not terribly aggressive,” Mr. Brickman said.

“If it was really in our strike zone, it would be hard to see where a loan would go to [CMBS lenders] over us or one of our primary competitors,” he said.

One area that could be favoring CMBS lenders may be interest-only loans, where Freddie Mac has been “tightening up,” he said. Fannie Mae has tightened its standards “a little,” including less access to interest-only loans, Ms. Johnson said.

In addition, there could be growth for CMBS lenders in student housing, a sector that can be a challenge to agency criteria, said Mr. Brickman. That may be panning out, as student housing made up nearly half of the $82 million of multifamily loans in a J.P. Morgan Chase JPM +0.90%$1.1 billion CMBS last week.