The Times They Are A-Changin’

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Tony Petosa and Nick Bertino ​ - Wells Fargo Multifamily Capital

From both a global and national perspective, we are in the midst of witnessing major change unfold as President Trump takes over the reins from the Obama administration. It is undeniable that material shifts in policy are in the works, social and economic alike. Some of these will likely have an effect on the commercial real estate lending environment, including financing for manufactured home communities (MHCs). The Trump administration is already taking a new approach to banking regulations, which may at some point include working with Congress on the future of the government-sponsored entities (GSEs), Fannie Mae (FNMA) and Freddie Mac, both of which are active lenders to the MHC sector. More immediately, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank) is under review by the new administration in an effort to scale back regulations enacted during Obama’s presidency. And, as if we didn’t have enough change going on, many economists are predicting higher interest rates this year.

In 2016, FNMA and Freddie Mac continued to be reliable lending sources for multifamily and MHC properties while having remained in conservatorship since 2008. MHCs in 2016 were again excluded from the annual lending cap placed on the GSEs by their regulator, the Federal Housing Finance Agency (FHFA), and consequently MHC loans were generally priced with interest rate spreads well inside of those for conventional apartment properties. In December 2016, the FHFA announced that MHCs would continue to be excluded from the lending caps in 2017, which came as welcomed news to MHC property owners and lenders alike. Since Freddie Mac and FNMA will not have a limit on the volume of MHC loans they can originate this year, we anticipate they will continue to price MHC loans aggressively.

While we appear to be in a state of “business as usual” with the GSEs in the near term, there are talks of possible changes on the horizon. Some would like to see these entities be privatized, operating without any explicit or implicit government guarantee. Others would prefer a return to their previous state, out of conservatorship and with implicit government backing. The Mortgage Bankers Association (MBA) recently released a paper outlining its recommendation for reforming the GSEs “with the objective of ending the conservatorship of Fannie Mae and Freddie Mac and establishing a new, durable foundation for the secondary mortgage market.” Within the paper, the MBA points out that while the FHFA made progress in stabilizing the GSEs since the time of the financial crisis, they remain in conservatorship today without a clear path forward. The MBA’s vision for the future of the GSEs includes an explicit government guarantee along with one or more new entrants to compete with FNMA and Freddie Mac, collectively referred to in the MBA paper as “guarantors.” The purpose of the government guarantee would be to provide timely payment of principal and interest in the event a guarantor fails during a crisis, which the MBA argues is essential in providing institutional and international investors the confidence they would need to continue financing the U.S. housing market in both good times and bad. The guarantors would be chartered to purchase single family and multifamily loans from private- capital lenders, and the lenders would be required to share in the risk of the loans originated for purchase.

While the MBA proposal clearly calls for reforms, it also asserts that the existing multifamily lending platform provided by the GSEs should remain, with new options being permitted, and that a private lending market should be able to exist alongside a government- backed market. Regardless of what the end game might be for FNMA and Freddie Mac, it would appear that any changes would not be immediate due to the need for both Congress and the Trump administration to agree on a plan, as well as the size and complexity of the undertaking. In fact, the MBA proposes that a transition period should be expected to take place over several years.

By contrast, some immediate changes are already underway in the executive branch. President Trump’s position on Dodd-Frank is that it is currently limiting access to credit, and in the first weeks of taking office he signed an executive action designed to scale back this federal law, which was passed in 2010 in the aftermath of the Great Recession. Members of the new administration have argued that post-crisis financial regulations have forced banks to hoard capital and that we need to get banks back in the lending business again. However, steps to loosen regulations will likely face stiff resistance from consumer groups and the populist movement that led to their enactment. Trump’s executive orders are being fought in court, and the outcome of many of these remains to be seen.

Beyond the political landscape, there is a macroeconomic factor to take into consideration: interest rates. For a prolonged period of time, commercial real estate owners have reaped the benefits of a declining interest rate environment. Borrowers have been able to pull money out of their properties by refinancing while simultaneously locking in historically low interest rates on long term debt. On the acquisition side, investors have continually shown a willingness to pay low cap rates on a limited supply of properties for sale, particularly in the MHC sector, because of their ability to borrower at such low interest rates. If 2017 is the year interest rates reverse course and begin a steady climb, there is concern in the lending community that values will be negatively impacted. As a result, underwriters are closely tracking sale comps as well as using other stress and exist tests to account for higher rates in the future.

On the morning of Election Day (November 8, 2016), we saw the 10-year Treasury yield hovering around 1.80%. The following day, it increased to 1.95%, a material upward move within a 24-hour period. As we go to press, the 10-year Treasury is yielding just over 2.40%. While interest rate spreads have remained relatively stable during this time, this movement in the Treasury yield represents an increase of approximately 60 basis points in the all-in interest rate for a borrower on a 10-year loan. In other words, a borrower who began applying for a loan in early November assuming an interest rate of, say, 4.00%, would now be borrowing at 4.60%. On an acquisition, this much of an interest rate increase would not only have a material impact on an investor’s rate of return, but could also impact the loan amount that could be achieved due to minimum debt coverage ratio requirements set by most lenders. If borrowers can no longer achieve the high level of proceeds at the low interest rates they have become accustomed to, we could see cap rates begin to creep up for the first time in quite a while. However, given the continued lack of supply of MHC properties for sale, it could very well take some time before we see evidence of this.

In conclusion, while changes within the financing sector may be looming, we expect the lending environment will remain favorable for borrowers for the remainder of this year with interest rates that are still attractive by historical standards. While a restructuring of the GSEs may be forthcoming, we anticipate an orderly transition coordinated with current market participants. In the interim, MHCs continue to be a property type coveted by both the GSEs as well as conventional lenders due to their strong historical credit performance. It is our opinion that MHC borrowers will continue to see favorable lending parameters and pricing throughout 2017, if not beyond.

Tony Petosa, Nick Bertino, and Erik Edwards of Wells Fargo Multifamily Capital specialize in providing financing for MHCs through Fannie Mae, Freddie Mac, conduit, and balance sheet lending programs. For more information or for a copy of their ”Manufactured Home Community Financing Handbook,” please contact: Tony at (760) 438-2153 or tpetosa@wellsfargo.com; Nick at (760)438-2692 or nick.bertino@wellsfargo.com; Erik at (760) 918-2875 or erik.edwards@wellsfargo.com; or visit www.wellsfargo.com/mhc.

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