high yield, passive income
Appetite for Non Freddie Mac and Fannie Mae Bonds is Increasing
October 12, 2021
3 min read

With the residential real estate housing market continuing to exhibit strong underlying fundamentals and price appreciation, the competition to offer buyers alternative mortgage financing options is also increasing. Mortgage originations and loan packaging is increasingly taking place outside of the real estate financing industry’s two behemoths – Fannie Mae and Freddie Mac.

As we have discussed in the past, large Wall Street investors are increasingly entering the residential real estate market – most often in the form of rental property owners. However, given the strong demand, Wall Street is also increasingly entering the loan financing and pooling market. As recently reported in the Wall Street Journal, “Wall Street is diving back into the business of turning home loans into bonds, injecting new competition into a market long dominated by government-backed mortgage giants Fannie Mae and Freddie Mac. The so-called private-label mortgage market—in which financial firms serve the middleman role of creating giant pools of loans and selling them to investors—had more than $42 billion of issuance in the second quarter. That is the most since the pandemic started and almost the most for any quarter since the last financial crisis, according to Inside Mortgage Finance, an industry research firm.”[1]

As most investors no doubt will remember, turning home mortgage loans into bonds was big business leading up to the financial crisis of 2008/09. Therefore, on the surface, this development may lead to some consternation on the part of real estate investors. However, as we have discussed in past posts, the current residential real estate market is different than the one prior to the housing crisis. Unlike in that crisis, today inventories of new and used homes for sale continue to remain at near-historic levels. While builders are working to catch up to the demand, the gap between buyers needing a home and sellers entering the market is still quite wide. Add in the fact that millennials are entering the home-buying market in record numbers, and this heightened demand for housing stock could potentially remain for years.

The strength in both the economy and the housing market continue to push home prices higher, creating greater levels of equity for homeowners. Many of these homeowners are looking to turn that equity into second homes and investment properties. In general, these buyers have greater levels of equity, stronger balance sheets, and higher credit ratings than prior to the housing crisis in 2008. However, even with these strong fundamentals, Fannie Mae and Freddie Mac have actively stepped away from issuing loans to these segments of the market. This has caused gaps in financing access and has added to further demand for lending options. As reported in the article, “There also has been more supply of new [private label] loans, partly because Fannie and Freddie have curtailed some business. Earlier this year, they capped their purchases of mortgages tied to second homes and investment properties. That has made it tougher for lenders to sell these loans to the government-backed giants. Instead, many lenders are selling them to Wall Street firms or creating their own mortgage bonds instead.”1

As the saying goes, “nature abhors a vacuum”. Apparently, that goes for Wall Street as well. As Fannie and Freddie have created a vacuum in the second home and investment property segments – Wall Street has stepped in. However, the segment is also attracting a whole new ecosystem of real estate firms and real estate focused funds.

The potential for further inflation and higher interest rates continues to make the news. However, from a historical perspective, interest rates remain at very low levels. While this is good news for borrowers, investors and savers continue to find it challenging to find investments with attractive income yields. Given the strong fundamentals of the real estate markets, many investors are beginning to turn to these new mortgage products. From the story, “As it has become more liquid in recent months, the private-label market has piqued the interest of more money managers, who are searching for yield in an era of rock-bottom rates. Private-label securities typically offer higher yields than those issued by Fannie and Freddie since they don’t come with a government guarantee that investors get paid.”1  Our Aloha LTD Income Fund is a prime example of an investment that fills a void for high yield, passive income seeking investors.

The money management industry is always looking to create new and innovative ways to match investors and borrowers. These ‘private-label’ mortgage markets are just one more example of this. However, make no mistake, Fannie Mae and Freddie Mac are, and most likely always will be, the dominant player in the home mortgage finance market. From the story, “This market still made up a mere 4% of all mortgage bonds issued last quarter. Fannie Mae and Freddie Mac, which issue bonds that come with a federal guarantee that investors will get paid, remain the industry’s dominant players.”1 However, if the residential real estate market continues on its current run – don’t be surprised to see large Wall Street investment firms continue to find ways to participate.

[1] “New Appetite for Mortgage Bonds That Sidestep Fannie and Freddie” by Ben Eisen, Wall Street Journal, 8.23.2021

Steve Sapourn
Steve Sapourn

Steve Sapourn is an active real estate investor, Aloha Capital’s co-founder, and portfolio manager. At Aloha, Steve has overseen more than 1300 real estate investor loans in 35 states. He has managed alternative investments in a variety of asset classes for over 25 years. He has deep experience in designing low-risk portfolios that reliably outperform benchmarks. Over his career, Steve has served as portfolio manager for a Fund of Funds, where he analyzed hundreds of alternative investment strategies. In addition, he has developed and implemented quantitative trading strategies in the futures, stock, and volatility markets. Steve’s long and diverse career benefits Aloha’s investors.