SLOW AND STEADY WINS the race, according to Aesop, and nowhere is that more evident than the Federal Housing Administration (FHA).
Throughout the credit crisis, the agency has emerged as a key source of capital for new construction and refinancings, offering unbeatable rates and terms. But the drawbacks of engaging with the FHA—more stringent documentation standards and longer processing times, for instance—can sometimes outweigh the benefits.
“One of the greatest strengths of HUD—and one of its greatest weaknesses—is that it never changes,” says Dee McClure, a senior vice president in charge of Needham, Mass.- based CWCapital's FHA business line. “Right now, that's a great strength.”
For new construction capital, the FHA is the only game in town. And its flagship 221(d)(4) program, which blends a construction and permanent loan, offers outstanding terms. The program is nonrecourse and offers a 1.11x debt service coverage ratio (DSCR) and 40-year amortization after construction is complete. All-in rates for the program (including the mortgage insurance premium) were at around 7.1 percent in mid-June. Meanwhile, many lenders report a big rise in refis through the FHA. The 223(f ) program also offers impressive terms—some of which are better than what's currently being offered by government-sponsored enterprises Fannie Mae and Freddie Mac.
As a result, many large development firms are turning to the agency for the first time, causing the average size of an FHA loan to balloon. McClure, who covers some stillthriving markets in the Mid-Atlantic, has seen her average deal size go from $18 million to between $45 million and $50 million in the last year. Across the nation, the average deal size of a 221(d)(4) loan was around $15 million in May, up from $10 million a year ago. And the average 223(f ) deal hit $5.5 million in May, up from $4 million a year ago.
“Historically speaking, your typical HUD borrowers were the small to mid-sized owners,” McClure says. “But now, the heavy-hitters—the household names—are moving forward with HUD.”
McClure's region is a bit atypical in that many Mid-Atlantic markets still have strong job growth. But other areas of the country, where employment is constricting, are not seeing the same rise in demand for FHA's Sec. 221(d)(4) program.
Ultimately, however, even considering the downsides of the FHA offerings—such as the agency's bureaucratic approach to loan processing—the administration is loaded up with more business than it seemingly may be able to handle.
The great debt terms are an obvious benefit to working with the FHA. But the tidal wave of loan requests trying to capitalize on those terms is reportedly overwhelming many FHA field offices. This may add time to the agency's already lengthy processing cycle. Most refis through FHA take about four months, compared to about two months for the GSEs, lenders report. Sec. 221(d)(4) deals can take closer to eight months.
“It will be interesting to [see] how effi ciently and quickly they process this new business,” says Will Baker, a vice president at Bethesda, Md.-based Walker & Dunlop.
Still, the FHA may get deals done a little more quickly these days, especially since the agency segmented all of its health care applications to the LEAN program, freeing up staff to focus on multifamily applications. And while the FHA's staffing levels are historically low, the administration was recently given approval to hire 70 multifamily staffers—65 for field offices.
Even with an amped-up staff , the FHA's bureaucratic process could pose additional problems. Many smaller, market-rate borrowers aren't prepared for the rigorous documentation the FHA requires. “A lot of them are not used to the upfront due diligence,” says Robyn Cunningham, a vice president at St. Louis-based Love Funding. “With HUD, they have a bigger checklist to do upfront, and it can be a roadblock to somebody that hasn't done it before.”
In addition, despite the demand, the agency is getting more conservative on new construction loans. “Construction loans through any source [are] more difficult to complete, and the FHA is no exception,” says Jeff Patton, a senior vice president with Charlotte, N.C.-based Grandbridge Real Estate Capital. “Their economists are worried about the overall market trends.”
While the agency is taking a closer look at feasibility now, other roadblocks apply. The per-unit cost limits—which range from $108,545 to $257,405 for a two-bedroom unit in a non-elevator building for the Sec. 221(d)(4) program, for instance— can make deals in high-cost areas impossible to do. The FHA's rule that developers pay Davis- Bacon wages, which requires builders of federally-assisted construction deals to pay the local prevailing wages and benefits, can also cause headaches in major metro areas.
Rule Change is Changing
Refis, on the other hand, seem to be having more luck in terms of the FHA's flexibility with the program. For instance, when it comes to cash-out refis, unlike the GSEs, the FHA won't constrain underwriting based on what market the deal is located in. “As long as the property is producing and stabilized, you're allowed an 80 percent LTV,” Cunningham says.
And back in February, the FHA issued a rule change easing restrictions on the 223(f ) program, causing much ado in the industry. The change allowed borrowers to refinance a property that was built or rehabbed within the past three years. In the past, the FHA would not insure a loan for a property built or rehabbed in the three years prior to the application date.
Since the rule change was announced, a few glitches have come to light. Borrowers need to have their certificates of occupancy issued as of July 31, 2008, so anything that wasn't operating by then needs to get a waiver. That waiver had to be sent to FHA headquarters, further delaying the deal.
The bigger problem, however, was that borrowers had to apply for the waiver at the same time as filing a firm application. The application fee and related charges, which run around $25,000, are nonrefundable. But at a recent meeting between a Mortgage Bankers Association (MBA) steering committee and FHA officials, the agency said it would consider entertaining a waiver request prior to receiving an application. While this verbal acknowledgement was good to hear, most FHA lenders don't believe it until they see it in writing.
The FHA has also become more in tune with its lenders. “Some of the more proactive offices are reaching out to the lenders and getting good information, so they can manage their staff accordingly, which is incredibly important,” McClure says.