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.

June Rate Survey

Thinking about the future of multi-housing

I spent much of last week at the National Multi-Housing council’s Strategies Update and Finance Conference and Board Meeting.  This was a group of about 300 industry professionals, owners, sale brokers, mortgage bankers and lenders who listened to a number of panel discussions about the industry and its future.  There was a lot of discussion about a number of topics, too much for me to recount.    For me the highlights were a discussion on capital markets (lending) and the last panel discussing the future of Freddie/Fannie and housing policy.

The discussion on capital markets did not reveal any new information, but confirmed many of my opinions.  1) Lending on multifamily is still strong, supported by Freddie/Fannie/Hud, but with some smaller banks and life companies also participating. 2) The lending pie is much smaller than in the past with many loans or borrowers not fitting today’s underwriting criteria. 3) More lenders are entering the market, but on their own terms.  Life companies are aggressive on lower leveraged class A/B deals in top markets, conduits will do multifamily, but at much higher rates than Freddie/Fannie and only on larger deals. 4) Everyone is looking to buy deals, but very few are finding deals that work.  5) There is no consensus on the future rest rates, but everyone recognizes today’s rates are low and if they had deals to finance they would.

The most interesting part of the discussion was how everyone is keenly interested in how CMBS will look when the market comes back.  There have been some CMBS deals and the pro’s expect there to be many more this year.  There is strong appetite for the securities so as long as the lenders can find product they can do loans.   But the interesting thing was how all the other lenders in the room were keenly interested in whatever the CMBS professionals said and were actively asking questions.  Clearly they see the potential/possibility for CMBS to drive the market again.   Everyone is hoping this time it will be more controlled and with wiser underwriting.

The other hot topic at this session and running through other sessions was how to deal with many of the problem loans/properties.   Everyone recognizes that over the next few years more and more loans will mature with properties that can’t be refinanced.   There will need to be new capital for these properties either through new equity or lender write-downs.   It sounds like there is equity for recapitalizing the properties in top markets, but lenders will probably have to take the hit in many weak markets.

As for the Freddie/Fannie discussion it was a knock down brawl between the speakers who represented the right and left spectrum of the debate.    There was consensus around a few items 1) nothing can be done about the agency lenders now, because we need them. 2) The solution is not just looking at Freddie/Fannie, but the total way our housing system works.  3) Multifamily is just an afterthought the issues will be made on single family and multi will just go along for the ride.  Beyond that there was significant disagreement about whether Freddie and Fannie helped create the problems and if they should be part of the solution.  From an audience perspective I think it was unanimous that if this discussion represents the two sides in Washington that it will be quite a while till anything changes.   Given Freddie and Fannie are supporting the apartment lending business today waiting a few years to make a change may not be too bad.