Posts Tagged 'FHA/HUD'

HUD issues new multifamily rules, finally.

Earlier this month HUD finally issued their new multifamily rules.  These were previewed at the CFEF/MBA meeting earlier this year and have been much disused since.  The full announcement can be found on the web at HUD Mortgage Letter 2010-21.   The announcement covers a number of HUD programs and outlines different rules for affordable properties and market rate properties.  However, today I will discuss some of the more important changes as it relates to owners of market rate properties. 

For owners of market rate properties HUD has been a major refinance lender in the last two years and a major construction lender for longer than that.  These new changes do not affect some of the most desirable attributes of the HUD programs like their long term fully amortizing nature and relatively low rates.  However, it does affect the underwriting criteria and particularly the leverage that is available on HUD deals. 

From my perspective the three most important changes are 1) new ratio levels on maximum LTV, minimum DSCR levels; 2) required occupancy levels and 3) the process.  In addition there are numerous other changes including an increased focus on the borrower, their tax returns and financial position; an increase in working capital reserves for new construction deals and the ability for HUD to revisit certain items such as the level of replacement reserves over the life of the HUD loan.   

Many borrowers went to HUD for a loan because of their high loan proceeds.  HUD could offer an 85% LTV on a purchase or refinance 223 (f) and 90% on new construction D (4).    For market rate properties that is over.  The level is now 83.3% LTV or both refinance and new construction.  When you take into account that HUD loans usually have higher costs than conventional loans, I believe the net proceeds are now on par with more conventional lenders.    The DSCR requirements have also been tightened to 1.20x.   This is still slightly more aggressive than most conventional lenders who require a 1.25x, but only slightly so.

For purchase or refinance properties HUD was one lender who was not overly focused on current and historical vacancy.  HUD would look at deals that were just stabilized or even experiencing a stabilized occupancy at an unusually low level.   They did have 85% occupancy rules, but these could be worked with and modified by exception.   HUD is now very focused on occupancy.  The new rules state that the property needs 85% minimum physical occupancy and “projects must demonstrate a pattern of stable occupancy i.e. average occupancy… for a period of 6 months prior to submission of the firm commitment application and through” the process.   This is a sea change and will eliminate many projects from the program.  Additionally HUD is now using a 7% minimum vacancy in its underwriting which is more conservative than many conventional lenders.

The process changes are very interesting.  In the past it was common to have a pre-application meeting with HUD on new construction projects.  It seems HUD likes this process and is now requiring it on construction deals and is recommending it on refinances.   I think this is very wise and should help reduce the HUD timelines as they only see deals in final application that they really like.   However, l this will require more from the borrower up front who will now have to put together a package before knowing if it fits the HUD program.  This also makes it more important to deal with a HUD lender who has experience with the local office you are using.   If there is a pre-application meeting then it’s better to be with someone who knows the people in the local office vs. an out of town HUD lender who fly’s in for the meeting.    By the way, expect to pay for that flight and other costs before you go under application.   In line with that HUD has also initiated a 15 BPS fee for pre-app construction deals that will not be refunded if HUD does not accept the deal. 

As with any new thing there is an implementation process that means these rules are not yet in effect.  However, HUD offices have started to look at all new deals through the glasses of these rules.   As for real implementation that will start with 223 (f) deals whose final application are being submitted to HUD after September 6 (60 days after the letter) or D (4) deals whose outstanding invitation is less than 120 days from submission. 

For borrower who do not fit these new rules, but want a HUD deal I think you have missed your mark.  If you are already under application you might get in under the wire, but it will be tight.  Also, HUD is clear in the letter that if you submit a full application package under the old rules and it is not complete and correct they will return it to the lender and if it’s after the new rules have gone into effect the package will have to be redone under the new rules.

Looking at these changes HUD is getting more mainstream with respect to market rate deals.   This should reduce their workload on this type of deal and focus more of their time on “affordable” deals which better fit the “mission” of HUD.     Deals that were marginal will no longer get in front of HUD and they will only see construction deals they really want to do.  For borrowers who do use HUD it should reduce processing timeframes to more reasonable levels.  This won’t happen right away and I see things slowing down from the last flurry of business under the old rules.  However, by next year things should be back on track and timeframes should be down. 

For many borrowers who have started to do HUD deals as the rest of the market tightened, the game is no longer as lucrative as it was.   It’s still pretty good with very low rates and long term fixed rate financing.    However, HUD is no longer the clear choice for most borrowers.  Anyone financing an apartment deal needs to look at HUD, Fannie, Freddie and maybe even banks or life companies.   The best lender for each deal depends on its location and structure.   Talk to an experienced lending professional and shop more than one lender before you decide who the best lender is for you and your property.

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May Apartment Rate Survey

Below are the results of this month’s rate survey.   Despite the drop in long term treasuries multifamily interest rates have only dropped slightly.   Banks have maintained their rates in the 6% ± range and Agency lenders have modulated their spreads as treasury rates move due to a number of factors including an increase in debt risk premiums.   This makes us feel more comfortable that rates will stay low for the near future.  We expect that as long as the 10 year treasury keeps under 4% multifamily rates will be stable.

 

HUD Update

I just heard some feedback from a recent HUD Lenders Conference.  The big issue was the proposed underwriting changes that have kicked around since late January. The word is that HUD lenders will receive information sometime near the end of June. No word for the actual changes, but it’s expected to be in line what was previously discussed (HUD discusses changes in their program). They did indicate that they would give at least 60 days notice before instituting the new rules and would grandfather deals already in process. If you have a deal that fits HUD, now is the time to get it in, before the new rules go into effect.

One other interesting thing that I hear was about HUD timing. We are all hearing terrible stories about how long it is taking to process a loan. Evidently HUD gave out some data which shows that nationwide average processing time for 223 (f) deals has stayed relatively flat. Processing times for deals once they get to HUD were about 4 months for a commitment and another 2-3 months for a closing during 2008 and 2009. In 2010 times actually dropped some to just over 3 months for a commitment and 2 months to close. Remember this does not include the processing time in the lenders shop before getting the package to HUD. My surprise in these numbers is not the 2010 data which shows 5 months from submission to close, but the 2008 data. Maybe my recollection is wrong, but it feels like things have slowed down not speeded up. Either way the current data does fit my expectations of total timing of 6-9 months. It typically takes about 2 months to submit a package to HUD, 3-4 to get a commitment and 1-3 to close. Of course this depends on the office and lender you deal with.

The difference between 30/360 and actual/360 and why should you care?

Do you know how your lender calculates your monthly payment ad amortization schedule.   Its not as simple as you think.   In fact your lender may be calculating your payment differently than you expect or know.

A few years ago there was a lot of talk about payment methodology. People were talking about 30/360 payments, actual/360, actual/365 and all sorts of different methods to calculate your monthly payment.   From my perspective these various payment methods were just ways for lenders and brokers to hide the real deal and fool borrowers.  Today you don’t hear much about this issue, but its still an issue and one you need to understand in order to property evaluate your loan options.

For most of the 20th century, all lenders used a 30/360 calculation in determining your monthly payment.  They assumed every month had 30 days and each year had 360 days. This allowed for easy calculation of interest rates and amortization schedules. A 30/360 calculation is listed on standard loan constant charts and used by your calculator or computer in determining mortgage payments.

During the mid 1990’s the Wall Street lenders started using actual/360 or actual/365 payments in mortgages.  These are methodologies used in some other debt instruments sold on wall street.  These methodologies call for the borrower to pay interest for the actual number of days in a month. This effectively means that you are paying interest for 5 or 6 (on a leap year) additional days a year.  By doing this a lender can quote you a lower spread and rate on a transaction but actually collect the same or a greater amount of interest each year.    

The difference between actual/360 and actual/365 is the monthly payments not the overall yearly interest charge.  Both calculations charge you interest on the actual days in a month, but on the 30/365 loan your monthly payment is increased by the extra 5 (or 6) days of interest.  On an actual/360 loan the monthly payments are the same as on a 30/360 loan, but the amortization schedule is adjusted to account for the difference in interest.  Therefore, your balloon balance for an actual/360 loan would be slightly higher than for a 30/360 with the same payments. An actual/360 loan will have a balloon balance approximately 1% to 2% higher than a 30/360 loan with the same payment.

At current rates of about 6% the difference between an actual/360 or 365 loan and a 30/360 loan translates into about 8 Bps.  So in order to compare a 30/360 loan to actual/360 loan you should subtract 8 Bps or so from the 30/360 quote to put it in the same terms as an actual/360 or 365 quote. 

While the Wall Street conduit lenders started this trend, the Freddie Mac and Fannie Mae multifamily groups followed quickly behind.   Freddie and Fannie found they were losing deals to conduit lenders because of the quoted lower spread and its lower payment even thought he effective interest rate charge was the same or in some cases higher.  They started offering actual/360 loans in addition to 30/360 and today you can request a loan using either calculation.    Though the conduits are dead you still see most Freddie and Fannie quotes being offered as actual/360.    This is because it makes the rate sound better, lowers the monthly payment and makes it more likely the borrower will go ahead with the loan.   However this is not always te case so ask your lender what calculation method they are using.

While most Freddie and Fannie loans are being quoted as actual/360 this is not true of most other lenders.  FHA/HUD loans are quoted as 30/360 as are most life insurance company loans and almost all bank loans.   Therefore when comparing a Freddie or Fannie loan to a quote from another lender you must adjust for the payment methodology.

What’s the better methodology?  It really does not matter as long as you understand the difference.   Some people prefer actual/360 because it’s effectively a longer amortization schedule.  I personally prefer 30/360 because I can calculate the payment myself on my trusty HP 12c.  On an actual/360 loan I need an excel spreadsheet and still need to ask the lender for a printout of the actual payment and amortization schedule to make sure I am correct.   Whichever you prefer just remember to ask what payment methodology your lender is using so you can properly evaluate your loan quotes.

CMBS lending – Will it ever come back?

There as been a great deal of discussion about the future of CMBS and other types of securitized lending.  Will it ever come back? When will it come back? What will it look like when it does come back?   I have gotten a lot of questions about this since I wrote a blog posting on the Freddie Mac CME program.    Let’s get real, CMBS is not DEAD, but it is too early to know anything what the future will bring. 

 

Why am I so sure that CMBS is coming back?   Its simple, the capital markets are where the money is.    Lending has gotten too big to do it the old way with banks or insurance companies taking in money and then lending it out the back door.   And the ability for banks and insurance companies to get direct leverage from their own balance sheet is being limited not expanded.   Only through access to the capital markets will they be able to leverage their expertise and balance sheet to satisfy borrowing demand.   Once the general markets stabilize and there is confidence that the economy is strong, then CMBS will be back.  As long as the issuer can show they are really underwriting their loans and making “good” investment decisions the security investors will return.  They may require a higher interest rate, but they will return.

 

The most discussed issue relating to securitized lending is how to align the economic interests of the banks or originators and the security investors.  There have been many ideas discussed to accomplish this and its how CMBS was in the bad old days of the late 1990’s.  At that time the groups that originated the loans often bought the “B” or risky piece of the security so they made sure the loans were well underwritten and documented.  While its important to align the economic interests of the investors and originators (lenders) there are some legal issues that might be harder to overcome. 

 

You have probably heard the worries from lenders’ about the General Growth bankruptcy.  This is directly testing the issue of single asset entities.  In securitized lending each borrower is set up in a single asset entity so if it goes into default or bankruptcy the lender can cleanly foreclose on the property.   General Growth is a mall owner/operator which is the sole owner of a number of single asset entities.  These entities were set up for individual properties in order to accommodate the CMBS loans.   When General Growth went into bankruptcy it also took most of the individual single asset entities into bankruptcy.  They did this even though many of these properties were generating enough cash to pay their debt.  The concern of lenders is that the court might use cash flow and/or value from one entity to pay obligations of other entities.  In effect this would negate the benefit of single asset entities and make it harder for someone to lend on “just the real estate” and not the overall borrower.    How this will play out is still unclear, but this concern is buzzing around in the world of lenders.

 

Another, and from my perspective more worrisome, legal concern for securitization was recently highlighted in NY Times article Looking for the Lenders Little Helpers.   This showed how attorneys are claiming that the securities holders are really joint venture partners of the lender because the loans were created solely for the purpose of creating the securities.   This is an interesting approach and if it wins in court has the risk of putting the security holders and issuers in legal bed with the originator or lender.  This is effectively removing the holder in due course protection of a note holder and will mean the holder is liable for improper acts of the loan originator and could be responsible for statements, side agreements and promises of the loan originator.   This is a big deal.   From the article it sounds like courts are buying this argument for single family loans.  Whether this will fly on a commercial or multifamily deal is unknown, but its something we should keep watching.

 

If these legal issues do become the force of law it will drastically change the way securitized lending will occur.   It will also change how Freddie Mac, Fannie Mae and HUD financing occur since these lenders rely on the same legal standards.  However, these are issues that can be overcome.   Solving some of these issues may require new legislation or a different type of underwriting.  It may change how CMBS is originated or who does it and it will change what types of loans are available to the borrowing public.   However, I have herd it quoted that almost ½ of all lending in America was done on a securitized basis.  With the kind of money that generates we will find a way to save the baby and not throw it out with the bathwater.

HUD 223 (f) – Pros and Cons

 Borrowers who never considered FHA/HUD are now being told they need a FHA/HUD 223 (f) loan.  However, most borrowers, and brokers who are selling this product, don’t understand the issues relating to these loans.   The 223 (f) is FHA/HUD’s acquisition/refinance program for conventional apartment projects.  With limited sources for apartment financing today, this program is being pushed by most mortgage brokers and bankers as the way to refinance your apartment project.

To get a complete, but very dry, description of the program visit the HUD web site at http://www.hud.gov/offices/hsg/mfh/progdesc/purchrefi223f.cfm.   The summary of this program states that “Section 223(f) insures mortgage loans to facilitate the purchase or refinancing of existing multifamily rental housing.”  So first things first, this is not an FHA/HUD loan, because HUD does not lend money, FHA provides insurance on the loan allowing the lender to sell a security to fund the loan.  So while FHA/HUD underwrites and approves the loan they do not fund it.  It’s really the original conduit loan. 

FHA/HUD underwriting, loan terms and restrictions are not like conventional loans.  They look at the numbers differently and limit loans based on things other than just LTV and DSC.   Because of this you really need to deal with someone who has experience in HUD lending and knows how to process your loan.  There are many approved FHA/HUD lenders and a list can be found at the HUD web site.  Some lenders are just small shops and some are FHA/HUD departments of national or regional mortgage bankers.  As long as they are a lender who annually processes a large number of FHA/HUD multifamily loans you should be OK, but make sure they are active lenders because some approved lenders only dabble in multifamily lending and only do a few loans a year.   If you don’t know of a good FHA/HUD lender give me a call (847-421-2217).

So why is everyone pushing the 223 (f) loan.  There are two main reasons, first is that FHA/HUD is actively lending, unlike conduits and most life companies; second, and more importantly, it’s the leverage.  At a time when other lenders are cutting back on LTV levels and increasing DSC levels this program is still an 80%-85% LTV program (80% on cash out refinances and 85% on acquisitions or cash in refinances) with a minimum DSC of 1.175.   This is the only program today that can get borrowers even close to the leverage they were able to get a few years ago.  For many borrowers that is the most important factor given their loans are coming due and other lenders cannot get to their existing loan balance.

In addition to the high level of leverage these loans also offer a longer term and amortization than conventional loans.   These are 35 year fully amortizing loans with the rate fixed for the full term.  The rates are very good, but the rate calculation is a little strange.  You have a fixed rate on the amortizing basis plus an additional mortgage insurance premium (MIP) which does not amortize.  Today the full rate is approximately 5.75%, including the MIP which is favorable when compared to other lenders.  Other positive factors of the loan are that it is a fully non-recourse loan and has a more borrower friendly step-down prepayment premium vs. a 10 year yield maintenance for most other long term lenders.  The 223 (f) is available in all markets compared to loans from some lenders who only like major markets and/or limit LTVs in certain markets. 

This sounds like a great loan, sign me up.  But before you sign on the dotted line there are a number of things you need to know about the loan.

The first thing that most people mention is that these loans have significant document requirements and the process is onerous.   This is a big issue when compared to traditional bank loans, but is not really that big when compared to other institutional loans.  Freddie, Fannie and other institutional lenders all have document requirements and in today’s environment even banks are getting document heavy.   While FHA/HUD is very specific on what they require and how the forms are completed that’s what you pay your lender for.  A good lender will help you manage the process and make it relatively easy.

 The second issues are the costs.  FHA/HUD loans cost more than conventional loans.  The fees are higher, the upfront reserves are higher and the costs of maintaining the loan are higher.  On a 223 (f) loan you pay a loan placement fee and a financing fee instead of the typical origination fee.  This can run up to 3½% of the loan amount, but is usually between 1 1/2% and 2%, combined (unless your loan is less than $2 million where higher fees are not unusual).  In addition to this FHA collects an application fee (30 Bps) and an inspection fee ($30 per unit).    Make sure you negotiate the placement fee, this is a competitive business and if you are paying more than 2% you are probably being overcharged.

 Next you must consider the reserves and escrows.  Like most loans, FHA/HUD loans require tax and insurance escrows, but HUD loans also require a replacement reserve and repair escrow.   At closing FHA/HUD requires a deposit for replacement of capital items during the loan term and monthly funding of the reserve account.  Initial funding is usually much higher than on conventional loans sometimes as high as $1,000 per unit.  You can get funds out of the account on a quarterly basis after submitting paid receipts for the work you have done.  In addition to replacement reserves you will be required to fund a repair escrow at closing for items that are identified in the engineering report as immediate repairs.

Some unique issues are the required audits and bi-annual limits on investor returns.  HUD requires all ownership entities to have an annual audit.  This usually adds about $2,500 to your annual operating costs.  While FHA/HUD does not limit the amount of return an investor can get on their investment they do limit the borrower to taking returns only twice a year, once after the audit and a second time after a certification signed by the borrower.  

Finally, the biggest issue on a 223 (f) loan is the timing.   To process and close the loan it takes 3-4 months, assuming there are no issues or problems.  Your rate is not locked until after a HUD commitment which makes the rate an unknown for most of the 3-4 months.  In a stable rate environment this is not a big issue, but today is not a stable environment.   I believe there is significant risk that the rate you eventually get will be higher than today’s rate.  The overall timing of the loan and of locking rate is a month or two longer than with Freddie or Fannie. 

On balance the FHA/HUD 223 (f) loan is a great loan.  It’s the best leverage with the lowest payment available today.  You may not like all the restriction, but these are not hard issues to live with.  Just make sure you know what you are getting into before you sign up for the loan.   Also, if you need leverage this is really your only option.

5-15-10 – Please note, HUD is changing some features of this program so everything n this article no longer applies.  Please visit our blog https://mfloan.wordpress.com/ and search on HUD to see information on changes to the program.


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