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Real estate

Fannie Mae, Freddie Mac privatization would affect many real estate portfolios

James Martha said privatization could hurt liquidity, which the government provides.

A private Fannie Mae and Freddie Mac would impact investors' real estate portfolios — but to what degree depends on what the Trump administration means by "private," industry insiders say.

The idea of privatizing the Federal National Mortgage Association and Federal Home Loan Mortgage Corp. bubbled to the surface in June as part of a reorganization plan for the federal government proposed by the Office of Management and Budget. Few details were provided as to how Fannie Mae and Freddie Mac would go private, but the plan suggests lifting the U.S. conservatorship of the two entities, in place since 2008, but keeping a limited federal backstop or guarantee.

Under the plan, mortgage-backed securities issued by Fannie Mae, Freddie Mac and their competitors would have a federal guarantee only "in limited, exigent circumstances," the OMB plan states. Only Congress can privatize Fannie Mae and Freddie Mac, and no bills have been introduced that would do so.

Investors have much at stake. The largest 1,000 U.S. retirement plans had a combined $315.8 billion in real estate assets as of Sept. 30, Pensions & Investments' latest annual survey found. As of March 31, real estate managers had a record $266 billion in dry powder, according to data from London-based alternative investment research firm Preqin.

Some in the industry are concerned that privatization could lead to less available credit resulting in lower valuations in some real estate sectors. A private Fannie Mae and Freddie Mac also would limit the government's role in ensuring the liquidity of the housing markets, as well as in encouraging, through incentives, increases in housing for underserved market sectors and promoting resource-efficient housing.

A fully privatized Fannie Mae and Freddie Mac would diversify credit and create a new private market to replace the government agencies, said Michael Smith, Chicago-based partner at law firm Baker & McKenzie LLP. "There will be more companies that will be able to apply for government backing," Mr. Smith said.

Added Chuck Leitner, CEO of Berkshire Group: "In many ways these agencies have been moving pretty aggressively to independent life even before the current administration." The Boston-based firm borrows mainly from Freddie Mac for multifamily projects and also is an investor in Freddie Mac securities, he said.

Both Fannie Mae and Freddie Mac have been positioning themselves away from government conservatorship, creating markets in which they could still make money even without government ownership, Mr. Leitner said.

However, "the devil is in the details," he said. How the switch to a private ownership structure unfolds depends on whether it is a smooth transition without a big increase in the agencies' current cost of capital, changes to their current processes and procedures, or a loss of staff, he said.

"As an active borrower of agency debt and investor in the bond pools we think that the end to Fannie Mae and Freddie Mac's conservatorship and transition to an independent ownership structure is ultimately inevitable," Mr. Leitner said.

Deja vu

This is not the first time privatization has been proposed. Two competing bills in 2013 failed to gain traction in Congress, said Shekar Narasimhan, McLean, Va.-based managing partner of boutique investment bank and advisory firm Beekman Advisors Inc.

"It's the largest bond market in the world," Mr. Narasimhan said. "It's illogical that 10 years after the financial crisis, we have not done anything about the two largest financial institutions in the world."

Fannie Mae and Freddie Mac do a significant amount of lending in the housing markets, accounting for close to 80% of single-family and around 50% of multifamily mortgages, Mr. Narasimhan said.

The two entities also securitize the mortgages, which are backed by the full faith and credit of the federal government, he explained. They trade at a small discount to U.S. Treasuries. The OMB proposal would create a single platform that Fannie Mae, Freddie Mac and other private firms could access to securitize mortgages with a limited government guarantee, Mr. Narasimhan said. "Investors lives might get easier" with better pricing of these bonds because of the conformity in the market, he said.

However, right now, institutional investors also invest in subordinated debt of Fannie Mae and Freddie Mac, which also comes with a government guarantee. If the two entities become private, they would no longer have the implied or explicit government guarantee and their cost of debt would go up, Mr. Narasimhan said. Mortgages issued by Fannie Mae and Freddie Mac would also get more expensive, with analysts' estimates ranging from 25 basis points to 50 basis points. "The supply of paper will remain about the same under either model (private or government owned) ... pricing will change to the consumer," Mr. Narasimhan said.

The worry is that a less-regulated market with more entrants could result in less credit and lower property valuations, he said.

Ted Willcocks, Toronto-based global head of asset management, real estate, at Manulife Asset Management LLC, said his team is just beginning to analyze the impact of the administration's proposal.

"Our belief is that it will increase competition in the mortgage market, which will create positives and negatives," Mr. Willcocks said. "We will have to see how the (mortgage) rates will change."

Manulife has $17 billion in real estate assets, including $1.5 billion of multifamily properties.

Liquidity concerns

Privatizing Fannie Mae and Freddie Mac could remove the government role to ensure liquidity in the U.S. housing market, said James Martha, Hartford, Conn.-based managing director and head of multifamily at TH Real Estate, Nuveen's real estate investment management affiliate, speaking about the multifamily sector in an email.

"(The) government acts as a safety net in the event of a housing crisis," Mr. Martha said. "Through privatization of Fannie Mae and Freddie Mac, interest rates will likely rise, resulting in higher costs for housing and furthering the current housing affordability issue."

The government would also retain the risk, he said. "The federal government loses the economic control lever Fannie Mae and Freddie Mac provide without eliminating their role as a safety net in the event of another housing crisis similar to 2008," Mr. Martha said.

Privatization could have a negative impact on certain areas that are now being encouraged with government subsidies, such as affordable housing and energy and water efficiency, he noted.

"In the private model it is quite possible that the (government) pushing to create affordable housing might no longer exist," Mr. Narasimhan said. Although private lenders might continue to encourage affordable housing because it opens up a new market, he added.

Privatization could also have an impact on how limited partnership interests of real estate debt and equity funds trade on the real estate secondary markets, noted Laurence G. Allen, Rye Brook, N.Y.-based managing member of alternative investment secondary market broker NYPPEX LLC.

"We believe that secondary private market bids will decline modestly for LP interests in real estate credit funds without the implied U.S. government guaranty to FNMA/FHLMC," Mr. Allen said.

In the second quarter, NYPPEX data show lower repricing of limited partnership interests of real estate funds already has started. Secondary median bids declined 1.02% to a median bid price on the real estate secondary market of 82.79 as of June 30 from 83.65 as of Dec. 31.