What’s old is new again.
As traditional construction lenders continue to back away from the market, the search for construction capital is leading developers back into the arms of the Federal Housing Administration (FHA).
FHA lenders are reporting an unprecedented boom in demand; even the nation’s largest developers are now flocking to the agency to keep their construction pulses beating, according to panelists discussing construction financing trends at the recent Apartment Finance Today Conference.
“One of the greatest strengths of HUD—and one of its greatest weaknesses—is that it never changes,” said Dee McClure, a senior vice president in charge of CWCapital’s FHA business line. “Right now, that’s a great strength.”
While the FHA’s bread-and-butter business in the past has been small loans from small borrowers, the agency isn’t afraid of large executions. The average deal size that McClure processed in the past was about $20 million. But some recent deals for “household name” developers are stretching all the way up to $100 million, and one deal McClure closed this year featured a $226,000 per-unit loan amount.
The FHA’s programs offer unbeatable rates and terms. The FHA’s flagship construction-to-permanent loan program, Sec. 221(d)(4), is nonrecourse, offers a 1.11x debt service coverage ratio, and 40-year amortization after construction is complete.
Questions remain, however, about the agency’s ability to process all that business, as a typical FHA deal runs about six to nine months. The 53 FHA regional offices have 53 different personalities, and certainty of execution often hinges on the specific office with which you’re dealing.
Developer Alliance Residential Co. often tapped traditional construction financing sources such as banks in the past. But the company is taking a close look at the FHA’s programs, said Elizabeth Beckwith, Alliance’s director of capital markets.
“There are some tremendous advantages to their programs, and we’re looking very seriously at it at the moment, but the timeline is a challenge,” Beckwith said. “We don’t want to put all our eggs into one basket, so we’re also exploring a variety of nontraditional sources such as credit unions and hedge funds.”
Some FHA requirements can be a challenge, Beckwith says. First, if you’re developing anything taller than four stories, the FHA requires developers to pay the Davis-Bacon wage schedule, which ratchets up costs. The agency also requires a bonded general contractor. And the program is much more in tune with long-term holders: Merchant builders looking to sell in five years may run afoul of the Sec. 221(d)(4)’s prepayment penalties.
But it’s not entirely fair to say that traditional portfolio lenders are out of the game, according to Tammy Linden, a regional director with lender Bond Street Capital. While equity requirements are much higher now than in the past—30 percent equity or more is often asked now—some healthy regional banks are seizing the opportunity before them.
For developers trying to find a healthy bank these days, one tip is to look at which banks are giving back their TARP funds. TARP funds were distributed to many banks regardless of whether they needed them or not, as a sort of camouflage: The government didn’t want to single out only the weakest banks. Healthy banks are now giving the money back, a sort of badge of honor in today’s economy.
And not every FHA lender is equal. Beckwith and Linden advise borrowers to look at the experience of potential FHA lenders. Ask how many deals they’ve closed recently, and how long those deals took, before deciding which lender to use.