In the course of just a few years, the FHA has become the premier source of construction capital for market-rate developers. The agency processed more than $3.7 billion in new-construction or substantial-rehab multi family loans last year, more than double the amount issued in 2009, and more than triple the amount closed in 2008.

The question is: How long will that dynamic last?

According to the FHA, its appetite for market-rate deals is as strong as ever. Yet the agency has been placing more emphasis on aff ordable housing. After all, the organization changed its underwriting requirements last year to make them less friendly for market-rate developments—lowering the leverage levels and upping the debt service requirements—and those changes have begun to affect proceeds.

Despite this, “we haven't lost focus on what has been the traditional role of FHA, which is financing for the broad middle of rental housing,” says Carol Galante, deputy assistant secretary for multifamily housing at Washington, D.C.–based HUD. “The new underwriting standards weren't put in place because we don't want to do market-rate housing. It's just that, in this financial environment, we have to do it prudently."

Galante's emphasis on the “broad middle" wasn't an accident. Many of the newconstruction deals the FHA has closed over the past two years are Class A—just consider Englewood, Colo.–based Archstone's recent work. In December, the developer broke ground on a 389-unit, transit-oriented Class A development in Gaithersburg, Md., funded by an $89.9 million Sec. 221(d)(4) loan. Six months earlier, it broke ground on a 469-unit Class A development in Washington, D.C., with a $151 million FHA nonrecourse loan.

Could those deals get done today? Perhaps, though Galante says luxury deals aren't the agency's focus. Instead, as conventional construction lenders such as JPMorgan Chase and Wells Fargo grow more comfortable issuing debt from their balance sheets, it's likely that the industry will see the FHA's market share on the upper end of the class spectrum start to recede.

“The FHA is not going to turn away good deals, but they believe they shouldn't be the main provider of that kind of financing, especially on a nonrecourse basis,” says Phil Melton, a senior vice president at FHA lender Grandbridge Real Estate Capital, based in Charlotte, N.C. “They've stepped into the void the past couple of years because that's what was needed for the economy, but that's not a long-term thing."

Four New Principles

In addition to the new underwriting requirements, there are other changes under way that may make it a little more difficult for market-rate developers going forward. For instance, the FHA is now emphasizing four principles—sustainability, green development, urban, and affordable—in its Sec. 221(d)(4) program.

When the agency began broadcasting these principles, many lenders feared that it pointed to a greater shift—that a nongreen, suburban market-rate deal would now be dead in the water. But Galante says that's not true. Those four requirements are merely strategic goals for HUD—a management action plan, and not a prism through which all deals will be judged.

“It's not at all saying that FHA isn't interested in financing a plain-vanilla, two-story walk-up apartment in a suburban community,” Galante says. “It's our strategic goal to expand our business and make our products available to projects with those four principles. But if you don't have those four things, you're not going to be lower in priority for processing."

The FHA will also propose some rules this year regarding large loans, some of which it is already testing to lay the groundwork. The agency is concerned about the risks posed by larger transactions—in February, it had about 80 projects of more than $50 million in its pipeline.

One rule already in place that's affecting large loans is the 18-month absorption requirement for (d)(4) deals. In the past, developers had two years to stabilize. Many developers are now reconsidering the size of their projects in light of the new requirement, sometimes proposing two 150-unit phases instead of a single 300-unit deal, for instance.

Slower Processing

Further complicating the process for market-rate developers is the FHA's new National Loan Committee (NLC), which reviews deals from regional offices before giving them the final seal of approval, started last September. Through its first four months, the committee reviewed 41 applications, rejecting only one deal outright. Any market-rate (d)(4) deal that's more than 150 units—or more than $15 million—must go to the NLC.

Translation: It takes longer to close an FHA deal. This new, extra layer of review and approval has slowed the FHA's processing times, especially given the deluge of deals that have come its way in the past two years. Another concern expressed by lenders is that there's little predictability regarding the outcome when the NLC reviews a loan.

“The advent of the NLC process in September—and the field office's preparation of information required for submission to NLC—has certainly expanded HUD's processing time,” says Dee McClure, a senior vice president at Boston-based CWCapital. “As the NLC process continues to be refined, I anticipate that turnaround time will diminish."

An expanded mortgage credit review process has also slowed things down at the agency. Last year, the FHA expanded the definition of a principal to include anyone serving on a company's board, and that has proved to be somewhat intrusive.

Now, lenders have to gather Social Security numbers, run credit checks, and obtain Previous Participation clearance (known as the 2530 process) for every member of a company's board.

Despite these hurdles, McClure thinks the FHA will continue to be a viable player in the construction financing sector: “Projects in primary markets, which are larger in nature and address a distinct market need, are still achievable."


FHA rethinks its approach to rehabs.

LATER THIS YEAR, the FHA hopes to revamp its Sec. 223(f) program to allow for more significant levels of rehab on both market-rate and affordable deals. The program currently offers light-rehab dollars, and anyone looking to do more must go through the Sec. 221(d)(4) program, which is a more cumbersome, costly, and time-consuming process.

But the FHA is looking to scale up 223(f) to more closely mirror something like Freddie Mac's Mod Rehab program.

“The biggest groundwork we've done is some work around the legal aspects of how we define what's substantial rehab," says Carol Galante, deputy assistant secretary for multifamily housing at Washington, D.C.–based HUD. “What we've learned is, we have a lot more flexibility in how we define what goes into sub rehab versus what goes into a 223(f), so that's good news."