Scotsman Guide - July 2012 Commercial Edition

By Adrian Hartman
Director
Love Funding

5 Insider Tips for HUD Deals
Be prepared for a rigorous underwriting process

Tight credit conditions recently have prompted scores of mul- tifamily 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 under writing process and ensure a smooth transaction.

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 ap-
plication process, because HUD’s Mul-
tifamily Accelerated Processing (MAP)
and LEAN offices will revisit property
performance during the processing
required mortgage-credit investigation
and related paper work.

set aside enough time to respond to information requests.

3. provide full disclosure

There is no such thing as too much information when it comes to compiling a bulletproof application. Lenders can’t help you and your client 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.

It is far better to communicate issues like low credit scores, defaults, title challenges, pending judgments or suits, and

“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.”

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.

environmental concerns to the lender than to try to hide them. When they inevitably surface in the submission process, it can hurt the deal.

5. 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.

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

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 paper work 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

4. 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
• • •
Inexperienced or ill-informed market
participants have made the HUD pro-
cess seem unnecessarily complicated.
It doesn’t have to be. Every transaction
has twists and turns, and not every con-
tingency is known going in. But when the
right team is in place, these hiccups are
just part of the process and can be man-
aged easily. Knowing what to expect is
half the battle; the rest is up to us. •

Adrian Hartman is a 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 served on numerous loan committees, acted as mentor to under writers and assisted in expanding the depth of the under writing team. Reach him at ahartman@lovefunding.com or (314) 512-8736.