evolution of securitization in multifamily mortgage markets and its effect on lending rates, The

Journal of Real Estate Research, The, Apr-Jun 2003 by Nothaft, Frank E, Freund, James L

Abstract Loan purchase and securitization by Freddie Mac, Fannie Mae and private-label commercial mortgage-backed securities (CMBS) grew rapidly during the 1990s and accounted for more than one-half of the net growth in multifamily debt over the decade. By facilitating the integration of the multifamily mortgage market into the broader capital markets, securitization helped to create new sources of credit as some traditional portfolio investors-savings institutions and life insurers-reduced their share of loan holdings. A model of commercial mortgage rates at life insurers, expressed relative to a comparable-term Treasury yield, was estimated over a twenty-two-year period. The parameter estimates supported an option-based pricing model of rate determination; proxies for CMBS activity showed no significant effect.

A wide variety of financial markets have been characterized by the growth in securitization during the past twenty years as numerous advantages accrue from holding financial assets in securitized rather than whole loan form. Risk-based capital rules, the flexibility to tailor cash flows and risks to the preferences of specific investors, liquidity and access to new groups of investors are some of the reasons for the growth of securitization.

Securitization developed first with single-family mortgage loans but was slow in coming to multifamily and nonresidential mortgage markets. During the 1970s, Ginnie Mae guaranteed multifamily mortgage-backed securities backed by FHA-insured project loans and Fannie Mae purchased FHA-insured multifamily loans for its retained portfolio. Freddie Mac introduced the first secondary market plan for conventional multifamily loans in the early 1970s and commingled a limited volume of multifamily loans with single-family loans in its Mortgage Participation Certificates (multifamily made up no more than 5% of the dollar volume of a pool). secondary market sales remained small and less than 1% of conventional multifamily mortgage debt had been securitized by the end of 1979.

Both Fannie Mae (in 1983) and Freddie Mac (in 1984) began to issue mortgage pass-through securities backed exclusively by multifamily loans. However, their efforts were muted when the market softened in the late 1980s and early 1990s, resulting in credit losses. By the end of 1989, 13% of multifamily debt was held in portfolios by Freddie Mac and Fannie Mae or had been securitized, compared with 41% of single-family debt. The limited scope of those early efforts reflected the nature of the underlying multifamily loans: mortgage contracts were not standardized, the collateral rental properties were heterogeneous and the geographic concentration of properties made multifamily lending a more risky undertaking.

Multifamily loans were included in the pioneering efforts of the Resolution Trust Corporation in securitizing mortgages collateralized by income-producing properties in the early 1990s. An important change took place in the mid-1990s, as secondary market activity involving multifamily mortgages picked up sharply. The growth was spurred by Freddie Mac and Fannie Mae and by the issuance of private-label, commercial mortgage-backed securities (CMBS), which included a substantial volume of multifamily debt. By the end of 1999, 33% of multifamily debt had been securitized or was held in the retained portfolios of Freddie Mac and Fannie Mae, compared with 60% of single-family debt.

A good deal of literature exists on the effects of securitization in the single-family mortgage market. Securitization has facilitated the integration of the single-family mortgage market into the broader capital markets and thereby reduced the severity of business cycle troughs, and has led to lower mortgage rates.1 The effect of securitization on commercial mortgage markets has received less attention. Several efforts have studied commercial mortgages as a whole. For instance, Haney, Epley and Liano (1997) examined the integration of the income-property mortgage market with the overall capital markets. They concluded that Treasury yields led commercial mortgage market yields during the 1980s, but more recently the yields moved virtually in tandem. Sa-Aadu, Shilling and Wang (2000) modeled yields for income-property mortgages as a whole and concluded that the emergence of securitization during the 1990s was a "market-integrating force" between commercial mortgage markets and broader capital markets. More recently, Maris and Segal (2002) studied the determinants of CMBS spreads. However, these studies did not examine multifamily mortgage markets except as an embedded component of the larger commercial mortgage market.

This article examines the determinants of multifamily mortgage rates-general market forces, risk factors specific to multifamily and securitization-with an aim of identifying whether effects relating to broader commercial mortgage markets also hold for multifamily mortgages. An overview of particular developments in multifamily markets is presented to provide an understanding of the environment in which this development took place. The article also discusses the institutional reasons for the rapid emergence of private-label securitization as well as the post-1998 slowdown in securitization. Finally, the determinants of multifamily-to-Treasury yield spreads are modeled to explore the effects of securitization on multifamily mortgage rates.