Department of Housing and Urban Development (HUD) multifamily projects are some of the most cautiously vetted in the commercial real estate industry. Their fixed-rate, fully-amortized, non-recourse loans offer some of the lowest interest rates in the business, but are underwritten twice – by HUD and the specific lender of interest. As a result, there are usually only a handful of defaults per year. Even so, HUD has been searching for ways to streamline its underwriting process to reduce waste and inefficiency by eliminating unnecessary paperwork while still providing a higher level of underwriting detail, including environmental and physical property assessments, and higher quality reports (which further lower the risk of default).
In 2012, HUD began formulating the idea to align industry best practices in an effort to streamline, and standardize Capital Needs Assessments (CNAs). The ultimate goal was to ensure that their portfolio of projects was reflective of their overarching mission, as well as functionally sound and financially secure assets. The CNA e-Tool is the product of those efforts, and is now the required reporting template for all Federal Housing Administration-insured loans under the HUD Multifamily Accelerated Process (MAP) 223(f) program, as well as Housing Assistance Payments (HAP), Transfer of Physical Assessments (TPA) and Rental Assistance Demonstration (RAD) transactions, with the United States Department of Agriculture (USDA) Rural Development program to follow suit in the near future.
Implementation of the e-Tool was mandatory November 1, 2017 for 223(f) and 221(d)(4) financing, and February 1, 2018 for all the rest. Six short months removed from the CNA e-Tool going live, and HUD due diligence is truly forever changed. While there has been resistance to change, and a lot of growing pains, the fact of the matter is that the machine is still going strong, deals are progressing, and firm commitments are being issued.
HUD sees itself as the last line of defense to enforce compliance to federal laws and stricter standards for borrowing. To administer this, they have often gone against the industry grain, yet the FHA lending world continues to adapt well to dramatic changes. A few notable examples:
- Implementing 37-year cost tables (now 20), which were much more protracted than the industry-standard 10+2 (i.e. 12-year) tables. Who could possibly predict what a property will need in 30+ years? We sure did try!
- Mandatory compliance with the Americans with Disabilities Act (ADA), the Federal Fair Housing Act (FFHA), and Section504/Uniform Federal Accessibility Standards (UFAS)
- Intrusive testing that initially resulted in additional site assessment cost and extended project timelines
- Green Mortgage Insurance Premiums – Fannie Mae and Freddie Mac eventually followed suit, but HUD initially offered lower premiums but requires meticulous reporting (e.g., data for tenant paid utilities, for example)
And the list goes on. Yet somehow, even in the face of technical and bureaucratic requirements, HUD’s portfolio has continued to grow, while their risk exposure and default rates have shrunk. With expanding green lending incentives and affordable housing shortages, multifamily is a robust and growing sector for developers, and if a future economic downturn happens, it will only grow in value. Currently, we are seeing high volume in new construction and refinances/acquisitions as a result of the overwhelming demand for affordable, efficient housing.
The CNA e-Tool is representative of HUD’s progression in commercial real estate, an industry that is generally averse to change and slow to adopt technology. It may not be a cutting edge, web based, app driven, iPad-reliant platform (yet), but compared to other paper-driven lending standards and report formats, what the e-Tool is trying to accomplish really is transformative.
If you’re a lender or developer who will be working on HUD deals, you will invariably have to use the e-Tool and should keep some best practices in mind to streamline your transactions as much as possible.
One, the new e-Tool represents a whole new program and process, so expect for familiarity and utility to be initial obstacles. Not surprisingly, this has caused some frustration among multifamily development stakeholders. Consider interfacing with a knowledgeable, experienced HUD lender and third party consultant to help ensure compliance is met.
Two, the e-Tool does revert to some stringent underwriting standards that have the potential to delay or hinder deals – formulas for minimum deposits are stricter, for instance. Every HUD deal has become more detailed from beginning to end and the level of detail/expected repairs have expanded. Consequently, this requires deeper understanding of the client and lender needs, what’s allowed/required with regards to Critical/Non-Critical Repairs and Reserves for Replacement, and how that will ultimately impact the transaction.
Finally, all stakeholders must understand that the timing and prices have changed. Be prepared and be patient. HUD deals have never been volume-driven, and these new requirements will protract them even more. Work through, not on a deal to ensure ultimate success and receipt of a Firm Commitment.
In the coming weeks and months, the Mortgage Bankers Association will be gathering key industry thought leaders to help HUD enhance the technical capabilities and usability of the e-Tool, and that’s a good thing. Additionally, as more and more lenders and third parties find new ways to collaborate and coordinate on deals (that are frankly not getting any less complicated), the growing pains will eventually start to subside, and we can all breathe a sigh of relief as the latest industry challenge is conquered, until the next one emerges to challenge us and remind us that rust doesn’t sleep.