As published in Scotsman Guide's Commercial Edition, July 2012.
Tight credit conditions recently have prompted scores of multifamily and health-care property owners and developers to flock to loan-insurance programs offered by the U.S. Department of Housing and Urban Development’s (HUD’s) Federal Housing Administration (FHA). In the fiscal year that ended this past September, the agency issued $15.7 billion in these loan commitments, an increase from $14.4 billion in fiscal year 2010.
For commercial mortgage brokers and their clients, there are plenty of reasons to like FHA lending programs. Because FHA loans are backed by the federal government, their interest rates are highly competitive. They also are nonrecourse, which means that in the case of a default, the lender only can pursue the collateral put up to get the loan; the government must make up the difference. HUD’s programs also allow for fixed, long-term financing, as much as 40 years for new construction and 35 years for refinancing.
But applying for a HUD loan is a completely different animal than working with a conventional or private lender, and the process can rattle even the most seasoned owner or developer. That is where the knowledge and experience of a commercial mortgage broker can come into play.
HUD has maintained a stellar record on its multifamily and health-care loans because of the intense scrutiny they give to each and every loan application. It is critical to submit nearly flawless loan packages. Incomplete applications or careless mistakes can lead to costly processing delays and might even scuttle a transaction.
Here are five points that can help HUD newcomers navigate the rigorous underwriting process and ensure a smooth transaction.
1. Stabilize performance
Your clients should recognize the importance of achieving stable operations before submitting loan applications. The value used for lending is primarily based on how much net operating income the project is pulling in relative to its market capitalization rate — what the industry calls the “income approach.” Submitting an application while the project has not yet reached its operating potential in terms of achieving market rents or stabilizing expenses will result in a lower market value and reduced loan proceeds.
For example, consider a recently purchased multifamily property that is operating at 87 percent occupancy. When HUD sees that the local market is achieving 97 percent occupancy, the only conclusion it can draw is that poor management is to blame. In addition, a property that is not performing at its potential can and will receive increased scrutiny from the lender and from HUD. Correcting any issues and restoring occupancy levels to market norms, therefore, is far more important than rushing an application.
It also is important to maintain stable operations throughout the application process, because HUD’s Multifamily Accelerated Processing (MAP) and LEAN offices will revisit property performance during the processing review of the lender’s underwriting. Commercial mortgage brokers should advise property owners or operators not to make any sudden changes to the development after the application is filed. If operating changes are inevitable, it is crucial to communicate those changes to the lender as soon as they are known, so they can work with you and your client to present a plan for mitigating them before HUD offers its own recommendations.
2. Define the principals
Identifying the mortgagor, management agent and operator (if any) at engagement is vital for expediting the underwriting and processing of any transaction. The lender’s processing team cannot produce the required paperwork without the proper articles of organization and operating agreement (in the case of a limited liability company), making it an important early step to get right.
Turning in paperwork without confirming the entity structure can result in needless duplication and delays. Although it is reasonable that these parties may not be firm in pre-application — for instance, on a new construction deal — the sooner this information is provided, the sooner the underwriting team can begin the required mortgage-credit investigation and related paperwork.
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