With conventional construction lenders reluctant to fund new apartment projects and take-out mortgage lenders sticking with conservative leverage levels, many market-rate developers are gravitating toward the program known as “(d)(4).”

Known formally as Sec. 221(d)(4), it is the Federal Housing Administration's (FHA) multifamily mortgage insurance program helping for-profit developers secure both construction and permanent financing covering 90 percent of the projected replacement cost of a development or substantial rehabilitation project.

And in meaningful contrast to construction facilities offered by commercial banks, (d)(4) doesn't require any personal “recourse” repayment guarantees from borrowers.

While (d)(4) isn't the best fit for many high-cost projects, the dramatic decline of Wall Street's securitized conduit lending is pushing a lot of market-rate developers into the program, which the Department of Housing and Urban Development (HUD) oversees.

“Frankly, there are so few conventional alternatives out there today, interest in (d)(4) is as strong as we've seen in recent years,” says Karl Reinlein, executive vice president overseeing HUD/FHA lending at Capmark Finance.

Hardly 18 months ago, the availability of high-leverage take-out mortgages from conduit lenders made construction lenders comfortable funding 90 percent or more of expected production costs. Now, most commercial banks are shying away from commercial construction lending altogether, Reinlein says. And those that will consider apartments are typically keeping loan-to-cost (LTC) ratios below 60 percent —and requiring personal repayment guarantees, he adds.

So, the ability to secure 90 percent LTC leverage and also lock in a permanent mortgage rate for up to a 40-year term is making (d)(4) an attractive alternative, Reinlein says. “I don't know anyone else doing construction/forward commitments these days.”

Yet, (d)(4) isn't necessarily compatible with projects in some high-cost locations. HUD places per-apartment limits on insured mortgage dollars allowed, and construction contractors must comply with federal “prevailing-wage” designations. And then there's HUD's notoriously cumbersome processing of FHA insurance applications.

But for developers whose projects pencil out despite those limitations— and who are able to document financial viability within the program's 1.11x debt-coverage constraint—(d)(4) can be an effective alternative.

The high-leverage, locked-in long-term rate, and non-recourse features are particularly meaningful in today's environment.

“There's a reason it's 5 p.m., and I haven't finished half my day's workload,” says Dee McClure, senior vice president at CWCapital. She was referring to the considerable boom in (d)(4) inquiries and applications that approved HUD lenders, in particular, have seen over the past year.

The surge in applications should culminate in hefty increases in closings in coming months. Statistics from HUD are already demonstrating a bump in (d)(4)-related activity— (d)(4) insurance commitments were up nearly 57 percent during the first four months of the current fiscal year. From October to January, FHA committed to insuring more than $476 million in (d)(4) loans, compared with a bit more than $304 million in the year-earlier period.

The (d)(4) program accounted for 43 percent of Capmark's November and December applications for HUD financings, Reinlein says.

In January, Capmark funded a $25 million (d)(4) loan for American Community Properties Trust's 184-unit Gleneagles Apartments in St. Charles, Md., with a coupon rate of 6.9 percent.

Likewise, due in great part to conventional construction lenders' reduced LTC levels, developer inquiries about (d)(4) are up sevenfold or more at PNC in recent weeks, estimates Tom Booher, executive vice president at PNC MultiFamily Capital.

PNC MultiFamily in January financed Miller Development Co.'s 496-unit Farmgate Apartments in Herriman, Utah, through a $48.9 million (d)(4) loan at 6.68 percent.

All-in rates

PNC has been originating (d)(4) deals at coupon rates mostly in the 6.5 to 6.75 percent vicinity in early 2009, Booher says.

Despite general upward movement in the 10-year Treasury yield index against which (d)(4) rates are quoted, narrowing credit spreads through mid-February helped push coupons down 25 to 30 basis points (bps) since New Year's Day, he adds.

The annual (d)(4) mortgage insurance premium comes to 45 bps, or less than one-half of 1 percent of the outstanding principal balance. Generally speaking, total fees to close (d)(4) deals (including FHA's 30-bp application fee) will amount to 2 to 2.5 percent of loan proceeds, Reinlein says.

And the FHA can be more flexible than many borrowers expect. For instance, HUD officials are open to amortization periods of less than 40 years. They'd also consider proposals about alternatives to standard (d)(4) prepayment fee schedules, which are already considered more attractive than the yield-maintenance and defeasance seen with conduit lenders, Fannie Mae, and Freddie Mac.


The flexibility appears to reflect HUD's efforts to reduce bureaucratic impediments and streamline application processing. Yet a couple of cost-related issues—namely statutory mortgage limits and prevailing-wage requirements—remain the biggest impediments to even more transactions.

The so-called “stat limits,” which haven't been adjusted upward except for general inflationary purposes since fiscal 2001, are overdue for an overhaul, experts agree. Developers pursuing projects in costly parts of the nation may need additional subsidies beyond (d)(4)-insured mortgages, which due to the limits may not reach 90 percent of cost, Reinlein says.

The impact of prevailing-wage requirements for labor on federally assisted construction projects (as detailed under the Davis-Bacon Act) can be another hurdle. Prevailing-wage requirements tend to be most challenging for developers in areas where cost differentials between non-union and unionized labor are sharpest.

The better news is that prevailing wages pencil more readily as construction materials costs fall, as has been the case in recent months, McClure says.

Meanwhile, HUD appears to be making progress resolving long processing times. “They may be the only game in town” for some projects today, “but the flip side is (d)(4) deals can be cumbersome,” Reinlein acknowledges.

But working through a lender approved for FHA's streamlined multifamily accelerated processing (MAP) can save considerable time and effort, as experienced MAP lenders can quickly prepare forms, order third-party reports, and handle the “heavy lifting,” as Reinlein puts it.