Landmark Links August 14th – Temptation


Every now and then one comes across an idea so dreadful that it’s almost as if the people behind it have run out of ideas and are simply throwing shit up against the wall in a desperate attempt to find something that sticks, consequences be damned.  This crossed my mind last week as I read about a hair-brained program from Freddie Mac to offer cheap(er) mezz loans in exchange for rent caps (h/t Dave Kidder).  From Erika Morphy of Globe Street (emphasis mine):

Freddie Mac has launched a new mezzanine loan pilot for multifamily borrowers that provides favorable pricing and additional debt capital in exchange for keeping the majority of rents in the property at levels affordable to low- and moderate-income families.
The mezz loan provides the borrower an additional 10% of the loan amount for up to 90% LTV at a below-market interest rate. Currently mezz debt is pricing above 9% so the program will provide financing under that rate, according to Amanda Nunnink, senior director of Production and Sales at Freddie Mac Multifamily. The larger the loan — and hence the more units that will have fixed rents — the more aggressive the pricing will be, she said.

The average loan size will likely range from $2 million to $3 million.
The point of the program is to make it worth the while of property owners not to raise workforce housing rents, Nunnink told “This program allows the property owner to achieve the same returns via the workforce housing mezz loan as they would through a standard rent increase.”

The program has safeguards to ensure that the property owner doesn’t raise the rates after securing the financing including a penalty of 5% of the mezz loan amount for noncompliance.

Before going into some of the myriad of issues with such a program, I want to be clear: affordable housing is a catastrophe in many parts of the US right now.  Development of rental product is booming but nearly all of it is high end due to the increasing costs of land, construction and regulations/fees.  Older, more affordable product is increasingly scarce as very little gets built and some buildings are bought up by developers who provide much-needed capital improvements and repairs of deferred maintenance but seek higher rents in return.  All this while the low end is clearly where the most demand exists as we sit today.  The result is a new push for rent control in expensive markets despite it’s abysmal track record in reducing housing costs for all but a very lucky few.

Freddie Mac has apparently seen the affordability crisis and come up with a program that allows for developers to “opt in” to a rent control agreement dictated by their financing agreements rather than by statute in order to get out in front of the issue.  There are a bunch of reasons that this program as currently constituted is a terrible idea but here are a few:

  1. Cost Inflation– what happens under this program if a re-assessment triggers a large tax increase or utility rates spike?  What happens if the local jurisdiction changes the rules for on-site managers, causing an increased cost burden?  Under this program, it appears as if the owner is SOL.
  2. Maintenance – Programs like this seem destined to lead to buildings that fall into disrepair as there are huge disincentive for landlords to invest in buildings since they can’t benefit from that investment.  Also, there is a massive incentive for landlords to skimp on reserves since it is one of the few places that they can effectively control (or at least defer costs), all to the detriment of tenants.
  3. Risk Versus Return – Multi Family yields are incredibly low today in expensive markets, meaning that the upside available to an owner largely comes via rent appreciation since cap rates are highly unlikely to compress further.  By taking advantage of this program, a landlord still takes on all of the risk of the market turning but reaps none of the upside of the market improving.  That becomes incredibly risky when leverage is as high as 90%.
  4. Cost of Capital – It’s not clear to me that the cost of capital is all that good.  The Low Income Tax Credit program that is currently utilized for much of the development of affordable housing has incredibly low-cost financing through Community Development Authority bonds that can provide leverage into the 80% range.  The cost of this debt can often be well into the very low single digits.  Add in the sale of Low Income Tax Credits and developer equity can be as low as 10% (maybe even less) of the stack with all other financing coming at an incredibly at a very low cost.  In contrast, this mezz loan program will be substantially more expensive and sit behind conventional debt – which is substantially more expensive than bond financing or using tax credit sales to finance a large chunk of equity.  Part of the reason that LITC deals work is that the cost of the financing is low enough to offset the risks laid out above.  That does not appear to be the case here unless of course the mezzanine financing is cheaper than the senior financing which would be insane on the part of the issuer who ultimately has to securitize it and sell.

The Low Income Tax Credit program is far from ideal in that it involves a complicated structure that can take a long time to put together with a credit valuation that fluctuates based upon tax policy.  However, its a lot better than rent control and it’s certainly a whole lot better than this.  Some landlords may be tempted to use the new Freddie program in an attempt to fix their cost of capital at a low level.  However, it will be to their own determent when costs increasing operating and maintenance costs eventually eat into their bottom lines without the ability to increase rent.  And how about Freddie Mac rolling out a product that blatantly encourages a buildup in deferred maintenance on their collateral, all while increasing leverage?  When it comes to market affordability, there is simply no substitute for making it easier for developers to build more units where they are needed the most.  The Freddie program doesn’t do that and is instead a band-aid that tries to treat a symptom rather than the disease (not enough affordable units getting built) itself, all while increasing risk in the system.  This will likely end in tears – don’t say that you haven’t been warned.


Carved Up: By the numbers, Turkey’s ongoing financial debacle/ lira devaluation rivals the that of the Thai baht back in the mid 1990s.

Everything Old is New Again: The political business cycle is making a comeback, according to Merrill Lynch.

Seller’s Market: The amount of investment capital looking to buy private businesses has reached an insane level.

Under Pressure: Online competition like Goldman’s Marcus platform is forcing banks to finally increase deposit rates.


Changing of the Guard: Singapore has overtaken China as the top foreign investor in US commercial real estate in 2018.

Push Back: Spurred by residents, some cities are considering levying vacancy taxes on landlords who leave prime street level retail vacant for years waiting for a tenant willing to pay high rents.

Synergy: Co-working business are finding growth potential at local malls.


Fragmented: Low manufacturing profit margins, regional issues, scale and non-transferability of innovation make the notion of an Amazon of housing difficult.

Slowing: Redfin’s stock plunged 22% last week when it’s CEO gave guidance that suggested a significant slowdown in sales volumeSee Also: Spiking prices, rising rates and sluggish starts have led to less housing sales.  However, these same factors make it likely that inventory will stay low, meaning price increases will stall out but values will probably not fall much.

Off Target: Rents in expensive cities are falling for the wealthy but rising for the poor and middle class thanks to a large amount of new high end apartments coming online and almost no new low-end product.


The Most Important Thing You’ll Read Today: Why booze is the secret to humanity’s success (seriously).

Misplaced Blame: The sorry state of the taxi industry in NYC is not about ride sharing but rather a system where the city’s focus on the short-term well-being of a small group of workers at the expense of the rest of the public.

Chart of the Day

Our developer and builder clients are reporting that it’s become nearly impossible to accurately underwrite construction costs.  This is why:

Source: The Daily Shot


Sign of the Times: Clip-on man buns are now officially a thing because Millennials.

Chip ‘n Dales: A drunk man performed a strip tease for a couple eating dinner at a Japanese steakhouse because Florida.  No word as to whether or not sausage was on the menu that evening.

Kids These Days: According to the Smoking Gun, young people are increasingly treating their mug shot sessions as if they were going to be posted on Instagram.  Perhaps this is why.

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