Authored by: Adrian Hartman, Director at Love Funding
Strength in the multifamily sector is credited for luring some financial institutions back into commercial real estate lending. HUD lending is particularly appealing, attracting experienced lenders as well as some new players that lack experience with the agency’s stringent guidelines.
For today’s Strategic Brief for commercial real estate lenders, EDR Insight is fortunate to have guest author, Adrian Hartman, director of originations in Love Funding’s St. Louis office. In his previous position as Vice President and senior underwriter, he closed more than 30 multifamily and health care transactions with loan proceeds exceeding $200 million. Hartman has also served on numerous loan committees, acted as mentor to underwriters and assisted in expanding the depth of the underwriting team.
In this brief, Hartman outlines five key points that can help HUD newcomers as they go through the underwriting process. Interestingly, he highlights the dangers of borrowers attempting to downplay environmental concerns that could surface later and, ultimately, hurt the deal. To help you better navigate HUD’s rigorous requirements, and educate your borrowers, EDR Insight is pleased to share Hartman’s insider tips based on years of experience.
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.
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.
- Stabilize performance
Your borrowers 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 real estate lenders 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 to present a plan for mitigating them before HUD offers its own recommendations.
- 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.
- Provide full disclosure
There is no such thing as too much information when it comes to compiling a bulletproof application. Lenders can’t help borrowers address and overcome a problem if they don’t know about it. HUD’s processes are so thorough that you can be sure everything that needs to be known will be at some point.
Borrowers should be aware that it is far better to communicate issues like low credit scores, defaults, title challenges, pending judgments or suits, and environmental concerns to the lender than to try to hide them. When they inevitably surface in the submission process, it can hurt the deal.
- Set goals and communicate
The lender’s team should establish a timetable for borrowers that illustrates how the deal likely will progress provided that the borrower, underwriting team and all third parties are responsive throughout. Because of the number of parties involved, a slow response to the lender’s information request can result in delays in various parts of the application — from the appraisal and environmental study to the overall application assembly.Failure to promptly respond to HUD information requests almost always results in a delay in the application submission as the agency effectively “stops the clock” on application processing until they are addressed. In some cases, HUD may even return an application to the lender if they are unable to produce the required information because of a lack of response from the borrower or its principals.People have busy lives and your lender team should understand this. Communicate available times that work for you to manage routine updates and set aside enough time to respond to information requests.
- Find partners
Given the recent flurry of interest in HUD loans, it’s not only borrowers who are new to the agency’s application process. Lured by the increase in loan commitments, plenty of lenders have jumped on board with HUD in recent months, and few of them have extensive experience with its loan programs. A lender that is a jack of all trades may be good at providing lending options, but closing deals is what counts. Knowing what to expect from HUD to ensure borrowers are prepared in advance is critical for a smooth transaction, as is working with the right partners along the way. It is much better to find a third party that specializes in HUD loans than one that doesn’t but may be cheaper.The results can be tough to swallow when your partner tries to cut corners or isn’t prepared for the rigor which HUD brings to its processes. For instance, an engineering company might exaggerate estimates for the useful life of a building to lower a borrower’s reserve requirements, only to see the borrower blanch when HUD’s review increases those reserves based on its own analysis. Or a borrower risks having a property’s valuations reduced after submission when an appraisal company isn’t aware of ineligible sources of other income.HUD is familiar with the work of the most reputable companies, and when you partner with one of them, it tends to reduce questions that might otherwise arise. The more thorough your lender and involved third parties are, the quicker HUD will issue a firm commitment that is consistent with the original application.
Inexperienced or ill-informed market participants have made the HUD process seem unnecessarily complicated. It doesn’t have to be. Every transaction has twists and turns, and not every contingency is known going in. But when the right team is in place, these hiccups are just part of the process and can be managed easily. Knowing what to expect is half the battle; the rest is up to us.
NOTE TO READERS: This article originally appeared in Scotsman Guide’s Commercial Edition, July 2012, and is republished by EDR Insight with permission from the publisher and author.