MultiFamily Market Outlook - September 30, 2009

FHA Multifamily Financing Update: What’s There, and How to Use It

As capital in the traditional lending markets dried up due to Wall Street’s collapse, developers have increasingly turned to Federal Housing Administration (FHA) insured mortgage programs administered by the Department of Housing and Urban Development (HUD) to finance new multifamily construction projects and refinance existing properties.

During HUD’s FY 2008, FHA endorsed 647 multifamily loans for insurance, totaling $3.7 billion, of which 78 involved tax credits. 

HUD’s insurance programs have been used by borrowers since 1937, and provide excellent terms, including 40-year amortizations, DSCR as low as 1.05x, and loan to value up to 90% (or 95% for a nonprofit sponsor) on new construction or rehabilitation, and 85% on a refinancing. Despite the benefits of these mortgages, the process can be daunting and overwhelming for the uninitiated. A full understanding of the process and the potential pitfalls will help you get the most out of FHA financing and ensure that your project’s objectives and timeframes are met.

To secure financing through FHA mortgage insurance programs, borrowers must engage an approved FHA mortgagee to process the application at the appropriate HUD office and provide the loan, which HUD will endorse for insurance at closing. All mortgage applications are processed at regional Hubs throughout the country (except for the Section 232 LEAN process, which covers housing for the frail elderly, those in need of supportive services, which will be discussed separately).

Outside of LEAN, each application has two potential paths, TAP or MAP. TAP stands for “Traditional Application Processing” while MAP means “Multifamily Accelerated Processing.” As its name suggests, the MAP program was instituted in 2001 to establish national standards for mortgage insurance and promote faster processing, making the timing of FHA financing more competitive with conventional sources of financing in the marketplace.

The most-utilized programs, including the Section 221(d)(4) program for new construction/major rehabilitation projects, and the Section 223(f) program used for refinance or acquisition loans, are approved for processing under MAP. However, many programs are only allowed to be processed using TAP.  To process an application under MAP, the mortgagee must be designated as an approved MAP lender.  A list of all approved MAP lenders is available at www.hud.gov. 

HUD provided numbers for the last 12 months for initial endorsements for the Section 221(d)(4) and  223(f) programs, as well as for their 12-month totals. During the earlier part of last  year — the first six to eight months — activity was very slow because there was some uncertainty in the rate environment. When the market fell, FHA rates took a hit and things slowed down considerably. Those rates eventually came back and business has picked up. The offices are now swamped and 2009/2010 should see a huge jump in activity.

Another popular program is the Section 232 LEAN process, used for constructing or refinancing health care facilities. Again, a mortgagee must be designated as an approved LEAN lender. While Section 232 and Section 232/223(f) are longstanding FHA programs, the LEAN process is a newer development, initiated in 2008, and still is evolving. (The program is named after the Toyota Corporation’s model of lean management.)

The LEAN process, which is administered by the Office of Insured Health Care Facilities at HUD, has a two-step process that is heavily front-loaded so that once the commitment is issued, the project is ready to close. This requires the mortgagor and mortgagee to work closely on not only underwriting issues but also due diligence and legal review, as they are now part of the application process. All applications under the LEAN process are reviewed through the Office of Insured Health Care Facilities,  although the closing still occurs at the field office, often by mail instead of in person as is still customary in other HUD program closings.

How Can Multifamily Builders/Developers Use these Programs?

The process of financing a project is different for FHA-insured mortgages than other types of financing, and involves steps that take the timing and approval of the loan out of the hands of the lender.  The programs take the following steps:

1) The borrower engages the mortgagee to process an application for mortgage insurance with FHA. This typically requires the borrower to deposit funds with the lender sufficient to cover completing the application the HUD application fee. Third-party reports typically run anywhere between $20,000 to $50,000, depending on the project. The application fee depends on the size of the mortgage, and is calculated by multiplying the requested mortgage amount by 0.3%.

2) The mortgagee completes the application with significant input from the borrower and qualified third-party vendors, who may provide a market study, an appraisal, an engineering analysis and an environmental phase I, depending on the type of project. Applications typically consist of more than 40 exhibits, including standardized HUD forms that must be completed fully and accurately. The application process typically takes between 45 and 60 days, but may take longer depending on varying factors.

3) Once the application is complete, it is delivered by the lender, along with the HUD application fee, to the appropriate Multifamily Hub for MAP or TAP, or to the Office of Insured Health Care Facilities in the case of LEAN.

4) HUD reviews the application for completeness. This review typically takes five days. Once satisfied that all appropriate exhibits are in the application, HUD does an extensive review of all exhibits, asks questions, and often requests additional information. HUD has specific timeframes to review these packages — from 45 to 60 days depending on the deal — but those timeframes can be extended based on additional information requests and the timeliness of the responses. In other words, once the application has been submitted, there is no guarantee that the review will be completed in the expected timeframe, but the more complete and accurate the application, the more likely that the review will be timely. This review time also can vary depending on the HUD office conducting the review, which the sophisticated lender will be able to preview for the borrower.

5) If the review goes well, at the end of the review period, HUD issues a commitment to insure the loan. That commitment will lay out HUD’s requirements and the terms under which HUD will issue that commitment. 

6) At that point, your lender will likely issue its own commitment for the loan based on the HUD commitment (finally a commitment to lend you money!). You also will lock your rate with the lender, and the HUD commitment may need to be amended to reflect the new terms.

7) Both commitments will be signed by the lender and the borrower. They will be turned over to the lender’s counsel, who will then provide a closing checklist to the lender and borrower. The whole process of collecting and finalizing documentation begins anew. Within 20 to 45 days of the receipt of the commitment, you should be ready to close. Counsel submits closing packages, consisting of entire sets of all closing materials (title work, surveys if needed, opinions, organizational documents, draft loan documents and evidence of any special conditions) to the HUD office for review. Upon approval of all exhibits, the closing date is set. Often an in-person closing is conducted, where the Note is endorsed for insurance by HUD after an original title policy has been delivered to HUD.

As you can see, the process has many steps, and much of the review, timing and approval process lies outside the lender’s control. While the lender’s ability to package and underwrite the deal are of utmost importance, the ultimate decision on the financing lies with FHA and the individual field offices.

Avoiding Common Pitfalls:

Due to the complexity and number of steps involved, it is important to perform certain actions to ensure that the process is as smooth as possible. Some of  the most significant issues/pitfalls you may face during the application process are as follows:

1) Lender Selection and Underwriting Team
Selecting a lender is a key part to the process. Many lenders are capable of doing all types of transactions, while others have a special niche. You must understand your lender’s abilities as it relates to your specific transaction. The success of your deal also will depend on the strength of your underwriting team, which includes your lender, the appraiser, engineer and environmental consultant. These different groups all must have experience with HUD programs, understand HUD requirements and have an excellent reputation.
     It is the job of your lender to put this team together and to coordinate their work. Certain lenders also have developed strong relationships with certain field offices. Discuss with your lender the locations of the projects it has previously shepherded through the FHA application process and confirm its expertise with your type of project and the applicable HUD program.

2) Hands-On Approach/Coordination
The application materials can be overwhelming and daunting. Many lenders take the approach of delivering the necessary HUD documents and checklist to you and ask you to complete the needed information. While you will need to assist in compiling the necessary information, your lender should take control of the process. Get assistance in completing the forms. Have your lender physically sit down with you and “hold your hand” in the process. This will save on the back and forth between the lender and borrower, and will ensure that forms and materials are completed properly the first time.

3) Focus on the Hardest Parts First
Certain parts of the application take the longest to complete and need to be the focus in the early stages of the process. Most importantly, the third-party reports typically take between three and six weeks to complete, and the information gathered in them often drives the underwriting process.
     In addition, certain information in the appraisal depends on information from the engineering report and vice versa. These reports must be done concurrently to ensure the timeliness of each report. The findings of the environmental report also may require additional environmental research and reporting, which of course requires additional time and further delays the processing. Get the required funds for these reports to your lender early and get the reports under way first thing. Also be aware that some information can go “stale,” so be sure to ask your lender to carefully coordinate and stage the diligence process.

4) 2530/APPS Approval
As part of every HUD application, the principals need to complete and file with HUD a form which cites all of the previous participation in HUD programs by the borrower and its principals. This can be done electronically through HUD’s APPS (Active Partners Performance System) or by a paper filing of HUD Form 2530. [Note that HUD has a strong preference for electronically filing through APPS.] Depending on the ownership structure and the total number of principals involved, this may require multiple filings. These filings detail previous financing and work history with HUD. All filings must be cleared through HUD central, which can be time-consuming.
     If there are issues on these forms, such as previous defaults or other blemishes, it will take additional time to clear the “flags” or may derail the process completely. Given the time considerations involved with approval of these forms, they should be dealt with early in the application process. Knowledgeable lenders and attorneys can be very helpful in correcting and resolving 2530 flags so that they do not preclude a borrower from FHA-insured financing.

5) Complete Applications
As mentioned above, a lender should take a “hands on” approach to the application. All application materials should be tackled as early in the process as possible. There is nothing worse than having all the third-party reports complete and having to wait on other materials which could have been finished previously in order to file your application.
     Note that for construction deals, all architectural drawings must be complete for the firm application. Efforts need to be made to ensure they are complete, or at the very least you need to understand that the application cannot be filed until they are complete. It does not help your cause to get an incomplete application into HUD as quickly as possible. HUD will not start the review process until the application is complete.

6) The Right Team
One of the most important aspects of ensuring a successful application process, and ultimate closing, is for the borrower and the lender to include on their teams individuals and entities with a thorough understanding of the HUD legal process and documentation requirements. Legal counsel for both parties, title agents, surveyors and all other providers who have HUD experience can make a significant difference in the ease and speed of the HUD processing. They will ensure that all the necessary documents addressing HUD requirements are included in the closing package, resulting in a more efficient review by the HUD housing specialists and closing attorney.

Conclusion:

While obtaining FHA insured financing may appear to be a daunting task, with some thoughtful planning and a team approach to the application process, it frequently proves to be the best financing option available. A savvy team will help identify the potential issues early in the application process and will be able to work quickly to resolve those problems and keep the process as streamlined as possible.

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Hugh Jeffers is Regional Director for FHA Lending with Great Lakes Financial Group.  He can be reached at 202-415-1862 or hjeffers@greatlakesfg.com.

Christine Waldmann Carmody is a partner in the Washington office of Pepper Hamilton LLP, concentrating in affordable housing matters. She can be reached at 202-220-1231 or waldmannc@pepperlaw.com.

Starts Show Some Improvement

In August, starts in buildings with five or more apartments bounced back to a seasonally adjusted annual rate of 115,000 units. This is up 35% from the revised July number (the rates for June and July were both revised upward by 5,000).  Although a 35% gain may seem large by some standards, it is fairly small relative to the size of the decline that hit the industry over the past two years. Even at 115,000, the five-plus starts rate is down 48% from August of 2008, and down 66% from August of 2007. Meanwhile, the rate of five-plus completions was down 12 %, but at 256,000 remains well above the starts rate. 

 As long as this condition persists, the number of units under construction will continue to decline. This is important from the standpoint of the overall economy, because it is the number of units under construction that determines the number of workers employed (estimates of 116 jobs per 100 rental apartments and 293 jobs per 100 multifamily condominiums were presented in the September 2008 Outlook). In order to reverse job loss, the five-plus starts rate would have to increase until it breaks above the rate of completions. Policymakers should bear this in mind when contemplating measures to support tax-credit production or revive the currently depressed markets for multifamily construction loans.

Rents Drop Once Again

In August, NAHB's real rent index dropped five tenths of a point to 111.6, giving back most of the ground it had gained since November of last year. While the overall CPI  increased at an annual rate of 5.5 % in August, the CPI's residential rent component actually declined for the second month in a row. Although the recent experience with  homeownership rates below 68%  would seem to favor rental markets, other trends explain why rental markets are showing signs of weakness. One such trend is the rising rate of unemployment, which has a tendency to depress the rate of household formations.  

The year-over-year change in households is a volatile series, but has been under a million since late last year. (Given the current size of the U.S. population, 1.4 million would be normal.) On the supply side, owners have had difficulty selling their homes at the desired prices, forcing property that would normally be part of the  owner-occupied housing stock into the rental market.

Based on seasonally adjusted Consumer Price Indices; U.S. Department of Labor, Bureau of Labor Statistics. The annual rates indicate what the %age change would be if the current monthly rate were sustained over a 12-month period. The real rent index is the CPI for rent of primary residence divided by the CPI for all items and scaled so that January 1995 is 100.

Positive Growth Indicates Economic Recovery Will Begin Soon

The contraction in economic output (real GDP) slowed considerably in the second quarter, and available data point toward resumption of positive growth in the third quarter of this year. It’s now likely that the official end to the “Great Recession” lies somewhere within the current quarter, although the decision about exact timing won’t be announced for some time. 

Systematic recovery of consumer spending is essential to sustainable economic expansion. Recent Federal Reserve data indicate key improvements to household balance sheets in the second quarter, a prerequisite to durable recovery of consumer spending. The Fed held monetary policy steady at the conclusion of the Sept. 22-23 Federal Open Market Committee meeting, maintaining the rock-bottom target for the federal funds rate and reinforcing targets for purchases of housing agency debt and MBS as well as Treasury securities. The Fed most likely will maintain a highly stimulative monetary policy as long as unemployment is high and inflation is low, a condition that’s likely to persist for nearly two years.

Federal Reserve management of the federal funds rate naturally will anchor the short end of the Treasury yield curve, keeping bill rates close to current levels for an extended period. The projected economic expansion, along with persistent concerns about the prospects for federal budget deficits down the line, will put some upward pressure on longer-term interest rates going forward, although containment of both core inflation and private sector inflation expectations will help hold long-term rates down. 

Maintenance of capital inflows from abroad is bound to remain a nagging issue, but NAHB does not expect those inflows to falter during the next few years. NAHB expects the Treasury yield curve to shift up and steepen to some degree between now and the end of 2011, with the 90-day bill rate up by about 50 basis points and the 10-year Treasury rate up by roughly a percentage point during that time span. These changes, if achieved, will keep both nominal and real Treasury rates in historically low ranges.

MFSI Hits Second Best Monthly Performance Ever

During the month of August, the MFSI rose by 288 points, its second-best monthly performance ever. With this monthly increase, the MFSI is now down slightly more than 32% over the past 12 months, and its 12-month performance has been negative for 24 of the past 25 months — its worst long-term performance ever. The August increase of slightly more than 16% returns the MFSI to a level last seen in late 2008—not even 12 momths ago.

Despite this most recent dramatic rise the MFSI still finds itself 1,787 points — or almost 47% — off its all-time high reached in January 2007. During the past month, the value of the S&P 500 with dividends reinvested jumped by slightly less than 4% and it now finds itself down slightly more than 18% over the past 12 months, the first time it has been in negative territory for 19 straight months year-over-year in well over six years. Because the MFSI increased by about 16% , or by more than four times as much as the S&P 500 during the month of August, the performance gap—or percentage difference—between the two indexes increased from 84% last month to 106%.

 
1 For initial article discussing the MFSI in detail see NAHB Multifamily Market Outlook, January 2002.
2  % difference is defined as (MFSI minus S&P 500 with dividends)/S&P 500 with dividends.

Since its cyclical low set in October 2002, the S&P 500 with dividends has increased by 44%, while the MFSI has increased by a slightly better 53% during the same 79-month time period. And the MFSI continues to dramatically outperform the S&P 500 over longer time periods, including the past 10, 11 and 12 years. Since December 1998, the MFSI has risen by 106% while the S&P 500 with dividends reinvested finds itself exactly where it began.

During the month of August the price-to-earnings ratio (P/E) of the MFSI rose and now stands at 13.98, while the dividend yield, defined as the total cash dividend payments divided by the current stock price, and which moves in the opposite direction, declined to 8.45%. The MFSI is an index of 18 publicly traded US headquartered firms, including 16 REITs, principally involved in multifamily ownership and management.