No federal guaranty for multifamily
And other ideas for multifamily housing finance reform

Article Highlights

  • There is strong evidence that a federal guaranty is not necessary in order to produce a smoothly functioning multifamily debt market.

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  • In the United States, the debt markets for industrial, retail, office and hotel properties function smoothly and efficiently, with no federal guaranties.

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Executive Summary

No Federal Guaranties in Multifamily. Period. Everyone now agrees that it was a bad idea to have an implicit federal guaranty for the multifamily activities of Fannie Mae and Freddie Mac. The public debate is now focused on the question of whether there should be explicit federal guarantees for at least some multifamily loans, in at least some market conditions. We believe that (other than FHA and Ginnie Mae, which we discuss below) there should not be any federal guarantees in the multifamily sphere, and we believe that there should be no exceptions to this principle.

Federal Guaranties Are Not Necessary. There is strong evidence that a federal guaranty is not necessary in order to produce a smoothly functioning multifamily debt market.

  • A review of other countries’ real estate finance markets indicates that, in the absence of government guaranties, capital flows smoothly and efficiently to real estate.
  • In the United States, the debt markets for industrial, retail, office and hotel properties function smoothly and efficiently, with no federal guaranties.
  • If, in some future financial crisis, the government determined that it needed to provide capital to the multifamily sector, the Treasury could simply purchase multifamily mortgage-backed securities at their fair market value.

We acknowledge that, because of the recent market-distorting presence of Fannie Mae and Freddie Mac, the United States’ multifamily debt markets are dominated by the federal government in one way or another. We also acknowledge that it will take time to return to a fully private multifamily debt capital market. But there is no reason to believe that it is essential to have a government-dominated multifamily debt market.

Even if Federal Guaranties Were Necessary, They Are Bad Policy.
Not only are federal guaranties unnecessary, they are also bad from a policy standpoint. The main reasons include:

  • A federal guaranty will drive out private competitors, in exactly the way that Fannie Mae and Freddie Mac drove private competitors out of the prime multifamily loan market, slowly but steadily over the last twenty years. Some of those competitors left the business entirely, and others moved into the below-prime market (which subsequently collapsed as a result of unsound lending). This is why multifamily is so dependent on federal lenders at the moment.
  • If there is a federal guaranty, the temptation for both the legislative and executive branches to intervene -- to drive down underwriting standards in the name of ‘affordability’ – will prove irresistible, placing us in danger of future housing finance crises. Because the recent GSE multifamily programs were created in reaction to past failures and because meeting multifamily affordable housing goals did not require loosened underwriting, the GSE multifamily programs were largely insulated from these sorts of interventions. It is unlikely any program with an explicit federal guaranty would experience the same insulation.
  • If there is a guaranty, then as a matter of economic and political necessity, the guaranty will be priced well below its value.
  • Even if the guaranty has a relatively low risk to taxpayers in the context of high quality (‘prime’) multifamily loans, the normal course of politics will result in the extension of the guaranty to more risky loans.
  • Despite claims to the contrary from the industry, there is no connection between multifamily mortgage interest rates and the rents that tenants actually pay. It is important to remember that these are loans to businesses. The interest rate and other loan terms affect the profits of these businesses, but local market conditions (not the owner’s costs) determine the rents that tenants pay.
  •  A federal guaranty will result in a mis-allocation of credit, with the multifamily sector receiving more credit than it should, relative to other borrowing sectors.


The Downside Risk of Federal Guaranties is Unacceptable. When there is a credit crisis regarding private debt, there is a problem of liquidity, in which government needs to provide temporary additional liquidity until the crisis is past. When there is a credit crisis regarding government-guaranteed debt, there is a problem of solvency, in which government needs to absorb the losses as well as provide additional liquidity. Said differently, when a government guaranty is provided, no matter how carefully the guaranty is structured, there is a material risk that the guaranty will lead to a future crisis of solvency. Taxpayers should accept the risk of a crisis of solvency only when the government guaranty has very powerful advantages. In the case of multifamily debt, the advantages (to taxpayers) of a government guaranty are negligible or non-existent, which leads us firmly to the conclusion that a government guaranty should not be provided.

Federal Guaranties Are Not Desirable for the Multifamily Business. Even if federal guaranties were necessary, and even if they could be provided prudently, we believe that federal guaranties are bad for the multifamily business in the long run. This is because a guaranty will result in a government-dominated multifamily debt market, which exposes the industry to periodic capital crises when (not if) government changes its policy stance.

Below-Prime Multifamily Loans Are High Risk Loans Not Suitable for Retail Investors. A salient lesson from the recent housing finance crisis is that the retail securitization process is inappropriate for below-prime mortgage loans. One reason is that the retail securitization of below-prime loans – no matter how well regulated – will allow lenders to transfer the risk of those loans to others, thereby undercutting market discipline. Also, the recent housing finance crisis also demonstrated, beyond any doubt, that below-prime mortgage loans (whether single family or multifamily) cannot be accurately evaluated by rating agencies or retail investors. We believe that below-prime loans should be made – in multifamily as well as in single-family -- but only by private lenders with their own capital at risk. We also believe that many below-prime loans should be securitized, but we believe that the resulting CMBS should not be allowed to be sold to retail investors.

Defining Prime Multifamily Loans, Suitable for Retail Investors. We propose that retail securitization should be allowed for only two categories of multifamily loans: what we call ‘prime tier one’ multifamily mortgage loans, and what we call ‘prime tier two’ multifamily mortgage loans. The ‘prime tier one’ category mirrors the bulk of multifamily loans made by the GSEs over the last fifteen years. The ‘prime tier two’ category allows for limited departure from ‘prime tier one’ requirements, recognizing the diversity of the multifamily portfolio and the diversity of America’s real estate markets, but the added risk as a result of each departure from ‘prime tier one’ requirements must be offset by added strength in some other key dimension of the loan (for example, if the property size is smaller than required for ‘prime tier one’ status, the debt service coverage ratio would have to be higher and/or the loan-to-value ratio would have to be lower).

Consider Market Approaches Instead of Regulatory Approaches. When we recommend breaking multifamily loans into prime and below prime categories, we do not necessarily envision a regulatory approach. Better would be an approach that utilized the rating agencies (with appropriate reforms to prevent a repeat of the mid 2000s disaster when the rating agencies served the Wall Street originators instead of investors). Another market alternative would be to require private mortgage insurance for multifamily loans.

The GSEs Should Continue to Guaranty Steadily Declining Amounts of Multifamily Loans During the Transition to a Fully Private Market. The multifamily origination activities of Fannie Mae and Freddie Mac should be wound down, but over a reasonable period of time, to allow the new multifamily finance system time to evolve. We recommend a five year period, with the total volume of GSE multifamily lending being on a declining glide path over that period.

The GSE Multifamily Portfolios Should Be Managed In Place Rather Than Sold.
We believe that the GSE multifamily portfolios should not be sold (the existing risk sharing and servicing arrangements would be difficult or impossible to accommodate in a sale transaction). We provide several options for the management of this book of business, during and after the transition to a fully private market.

FHA and Ginnie Mae Should Focus on Below-Prime Loans. We believe that FHA and Ginnie Mae are good examples of transparent government initiatives in the below-prime segment of the multifamily lending business. Each FHA loan product, and the Ginnie Mae guaranty, involve fees to the borrower that, when carefully evaluated on a net present value basis, are sufficient to cover the risk to taxpayers. The FHA structure also allows for FHA to guaranty loans for which the fees do not cover the risk to the government, but only if Congress appropriates funds in advance to cover the net risk to taxpayers. We think that this governance approach, laid down in the Federal Credit Reform Act of 1990, is a good one.

That said, we think that FHA should be restricted to the below-prime portion of the multifamily lending universe. This has the following implications for the FHA multifamily product line:

  • The Section 221(d) construction-permanent loan product would continue, because construction loans are below-prime by definition.
  • The Section 223(a)(7) refinance product (for loans that already have FHA mortgage insurance) would continue; this is a defensive asset management tool that lowers risk for both the borrower and FHA.
  • The Section 223(f) refinance product (for loans that do not have FHA mortgage insurance) would be restricted to non-prime areas (i.e., locations that do not pass the ‘stable market area’ test that we discuss in Section 6).


The Existing Government-Assisted Apartment Stock. Because market rate multifamily rental housing is inherently not affordable for many low-income households, we believe that any conversation about multifamily must also include a conversation about affordability. Currently, in the United States, we have roughly four million multifamily units that have received significant governmental investments to promote affordability.2 In addition, roughly 1.5 million low-income tenants receive portable (“tenant based” or “voucher”) governmental assistance that pays part of their rent.In summary, the federal government is currently providing rental subsidies on a large scale. Reasonable and knowledgeable people differ about how many households should be subsidized, whether the subsidies should be attached to projects or be portable, and who should be eligible, but there can be no doubt that the need is significant. Similarly, there is no reason to expect this to change in the future. Accordingly, what to do about the existing stock of government-assisted multifamily properties is an extremely important question.

From having spent our careers developing and attempting to sustain existing subsidized multifamily properties, we know that the United States needs a more systematic and principled approach for deciding whether, and if so how, to preserve existing government assisted multifamily properties that serve low-income tenants. We will mention some key points now:

  • Too often, when multifamily properties are built specifically for low-income use, the theoretical benefits of the project-based approach –location in a neighborhood in which potential tenants want to live, long-term physically sound housing, at rents that remain affordable long-term – are not realized. Instead, locations often are below average or worse, initial subsidies are inadequate to support sound physical condition, and initial affordability evaporates when it becomes necessary to increase rents.
  • Properties initially intended as workforce housing are converted to concentrated-poverty housing. In the process, the rents that tenants actually pay are reduced, while rents that are paid by government are increased substantially. Sometimes, the low rents paid by tenants act as bribes, to stay in housing that is unsafe, ill-maintained, and undesirable.
  • All housing deteriorates (physically) over time unless reinvestment is both careful and intensive. Subsidized housing programs – including the Low Income Housing Tax Credit – have systematically under-invested in properties over time. Assisted properties that are preserved must be structured with reserves that are adequate to fund 100% of anticipated major repairs and major systems replacements for a significant period of time such as 20 years. State allocating agencies should strengthen their LIHTC underwriting requirements so that LIHTC properties will be physically and financially viable through the extended affordability period.
  • All housing deteriorates (from a marketing / desirability standpoint) over time.Older properties tend to have bedrooms that are too small, kitchens that are inadequate, and not enough bathrooms. These are problems that are prohibitively expense to remedy. Similarly, many older properties no longer fit into the neighborhood architecturally. Once a property reaches an age of 30-40 years, it is likely that it is obsolete in this sense and should not be preserved as government-assisted housing.
  • At origination (for new government-assisted properties) or at the time of refinancing or contract renewal (for existing government-assisted properties), we favor structuring the finances of government-assisted properties, so that they are viable long-term at or below local neighborhood market rents. Once that is accomplished, it is possible to make more use of tenant-based assistance rather than project-based assistance. In that situation, we think that tenant-based assistance has very powerful advantages and that there should be a presumption in favor of utilizing tenant-based assistance.


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