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HUD Launches its 223(f)/Low Income Housing Tax Credit Pilot Program

Housing Client Alert

Authors: Scott E. Fireison, Christine Waldmann Carmody and Sheldon L. Schreiberg

2/13/2012

By release of Housing Notice H2012-1 and Mortgagee Letter 2012-1, HUD officially introduced its new and important pilot program for streamlined application and processing of FHA-insured mortgage loans for LIHTC projects. FHA insurance products, in both design and administration, have oftentimes been avoided, or discounted by industry participants, for their apparent ill fit with timing and underwriting demands of the LIHTC program. The substantial rehabilitation costs present in LIHTC redevelopment generally triggered a requirement that HUD’s 221(d)(4) loan program be used; while that program can be commended for many advantages over other loan products available in the market, its long application/processing timeframes and associated costs have never been subjects of praise. The far simpler (some might say efficient) 223(f) program could rarely be used effectively for LIHTC development, given lower rehabilitation cost limits; we have seen 223(f)/LIHTC projects move forward rarely, and always with a bit of “wink and nod” among participants.

The LIHTC Pilot, however, presents a new model, for eligible projects, by which FHA’s 223(f) program is modified to serve as a “distinct application platform and separate processing track” specifically targeted for use with the housing credit. The Pilot’s intended targets include subsidized properties, stabilized projects unable to obtain permanent financing, and older LIHTC projects that have come round for redevelopment/re-syndication with new credits. Eligible projects may be processed by eligible mortgagees as a 223(f) under the Pilot’s streamlined procedures.

The Pilot will initially be limited to transactions processed by certain HUD offices. Nevertheless, the Notice and Mortgagee Letter restate several important HUD preservation initiatives, and this new model for FHA/LIHTC transactions, if successful, can readily be seen as a path toward efficient and effective preservation/redevelopment.

We discuss, below, several elements of the Pilot program we believe to be of interest to those industry participants involved in or planning FHA and LIHTC transactions.

Targeted Transactions

The Pilot’s 223(f) financing will be targeted toward three classes of projects/transactions:

  • acquisition and/or refinancing with rehabilitation of properties with at least 90 percent of units subsidized with project-based Section 8. Projects with Rent Supp, RAP and project-based vouchers (PBVs), even if meeting the 90 percent threshold, do not qualify
  • permanent financing of newly developed/rehabilitated and stabilized projects. Under the Pilot, the “three-year rule” waiver extension for 223(f) loans will remain available. Description of three-year-rule waiver provisions were most recently included in Mortgagee Letter 2011-13 and Housing Notice 2011-06. Under the Pilot, however, borrowers need not demonstrate that they have sought and failed to obtain alternative permanent financing
  • permanent and moderate rehabilitation financing for older stabilized LIHTC projects that are being redeveloped and resyndicated. For these purposes, “stabilized” will mean that the project has had 85 percent or greater occupancy for the previous 12 months.

Rehabilitation Limits/Requirements

The Pilot’s 223(f) financing will permit significantly higher rehabilitation expenditures than traditional 223(f) program loans. Transactions involving rehabilitation may include up to $40,000 per unit hard costs. For these redevelopment projects, however, several controls present in the 221(d)(4) program will be required for Pilot 223(f) processing, including (i) engagement of an architect for CNA and repair work oversight, (ii) engagement of a general contractor, and (iii) monthly inspections and lender control of draws.

Davis Bacon. Davis Bacon wage rates will not apply if rehabilitation costs in excess of the amount permitted by the standard (non-Pilot) 223(f) program are paid from LIHTC equity. As some might imagine, we have seen 223(f) loans close on LIHTC transactions in prior years, meeting this requirement by establishing a base-223(f) underwriting, with subsequent non-critical repairs covered by additional equity brought in through the LIHTC. These have, however, been “non-standard” transactions, and the Pilot’s recognition of the model is welcome – although limited to the Pilot.

Tenant Relocation During Construction. Redevelopment must occur with tenants in place. Temporary relocation for unit-specific repairs is foreseen, but expected to last a few days, and may not exceed two weeks.

Loan Amount, Underwriting and Rents (HAP Extensions)

The maximum loan amount under the Pilot will be $25 million. Additionally, commercial space/income is limited to 10 percent. Underwriting of Pilot 223(f) transactions will generally follow LTV, DSC and cost requirements of the standard 223(f) program. Given, however, its target toward Section 8 and resyndicating LIHTC transactions, some modified criteria are involved. In addition, some long-term preservation mandates are imposed.

For older LIHTC projects, undergoing resyndication/redevelopment, underwritten project Effective Gross Income cannot exceed 105 percent of historical, and post-rehab underwritten operating expenses cannot be less than 90 percent of historical. Section 8 projects will have their rents underwritten at HAP contract levels, and may, under conditions discussed below, have their income underwritten at post-rehab comparable rents. It must be noted, however, that unlike the 221(d)(4) program, which provides for a delay in debt amortization during construction, a 223(f) loan begins amortization immediately. As a result, Pilot 223(f)/LIHTC transactions underwritten on a Section 8 rent increase approval that is contingent on completion of rehabilitation, must include a Section 8 escrow to fund the difference between those underwritten post-rehab rents and the lower rents that will exist until completion occurs.

The Pilot program will also require a specific reserve for unsubsidized LIHTC projects. This reserve must be equal to at least six months of debt service, although credit will be given to any funded debt service reserve required at the partnership level.

LIHTC Rents. The Notice and Mortgagee Letter mandate that 90 percent of units must have occupancy and rent restrictions. Further, for projects with fewer than 90 percent subsidized units, developers must demonstrate that LIHTC rents are at least 10 percent below comparable market rents – for all unit types. Some clarification will be required concerning this limitation as projects move into preliminary evaluation for eligibility.

Section 8 HAP Contract Extensions and Rents. Owners with HAP Contracts must agree to a 20-year HAP Contract. As we have seen in cases of extension for post-Mark-to-Market project redevelopments, and in certain other contract extensions under specific circumstances, this 20-year contract extension may in fact include a commitment by the project owner for continued participation in Section 8 well beyond 20 years. Participants in the Pilot will agree to termination of the existing Section 8 contract, with immediate execution of the new HAP contract with a 20-year term. An exhibit will then be appended to the new HAP contract by which the owner will agree to renew that HAP contract following its 20-year term, for the number of years that remained under the terminated Section 8 contract at the time of its termination. This form of exhibit is now commonly called a “Preservation Exhibit.”

With regard to rents under the new 20-year HAP contract, the Notice and Mortgagee Letter recognize that rent increases to “post-rehab” market rents are available under Chapter 15 of the Section 8 Renewal Policy Guide and in certain other circumstances. Both the Notice and Mortgagee Letter also, however, recognize that these types of rent increases require time, separate application, and determination outside of production and Pilot processing staff. Owners and lenders are encouraged with underlined language to address rent increases prior to submission. While lenders may underwrite new expected subsidized rent levels, this tandem effort by owners and lenders requires great coordination, and the developer must have adequate facility with budget-based renewals and market determinations.

Lenders Must Pre-Qualify

Only MAP Lenders that have been pre-qualified may submit 223(f) applications under the Pilot. Upon issuance of guidance, soon forthcoming, lenders will have 30 days to submit their pre-qualification requests to HUD Headquarters. Requests must include detail of the lender’s experience with the following:

  • MAP/LIHTC and/or bond transactions, including performance
  • other GSE, state or federal loan experience underwriting with the LIHTC
  • Section 8 underwriting and Section 223(f) three-year rule waivers
  • MAP and LIHTC work in the HUD Hubs that will initially be handling Pilot projects (currently expected to include Los Angeles, Boston, Chicago and Detroit).

Application Process

Stated processing and closing goals of the Pilot are within reason: (i) Firm Commitment within 60 to 90 days of application submission, and (ii) closing within 90-120 days from submission. The Pilot’s design to reduce processing time for 223(f)/LIHTC transactions largely involves reduction in redundant review and participation by HUD staff specifically knowledgeable in and experienced with LIHTC transactions. Indeed, its success will largely revolve around those individuals who will be charged with oversight and processing. Given the burdens placed on Hub and HUD Headquarters staff by the Notice and Mortgagee Letter, it seems that some initial queuing delays may occur unless applicants are extraordinarily rigorous in their submission/application packaging.

Dedicated Personnel (DU). Each Hub selected for the Pilot must designate one staff person to serve as the “Designated Underwriter” (DU) for Pilot projects. The DU must participate in a concept meeting with the lender to discuss qualification, proposed rehab and any Asset Management Approvals needed (i.e., HAP renewals, extensions, rent increases, other HUD-loan deferrals, 2530, etc.). The DU must then review the application (which will be submitted in single hard copy, but also electronically in editable format), and choose to reject for incompleteness or lack of qualification within five days. The DU is expected to complete the processing without need for delegation to other staff, other than for specifically complex or technical matters such as environmental review. This review by the DU is to include architectural, engineering, cost and mortgage credit review.

HUD architects are to be engaged for analysis of Fair Housing and accessibility if necessary. HUD architects also are to be engaged for review of any third-party appraisals and any Rent Comparability Study (RCS) – submitted in connection with rent increases – and the lender’s appraisal analysis, in limited cases, including (i) differences between RCS and appraisal or lender underwriting, and (ii) significant projected drops in operating expenses.

The DU also is required to perform at least one site visit, and to determine if repair work and reserve schedules are appropriate, and whether borrower’s management company has capacity to effectively manage the property. Finally, the DU must present an underwriting memorandum with Firm Commitment recommendation to the Hub Director and to the Hub loan committee for approval.

With nearly all underwriting and review duties resting on the individuals designated as DUs, it is plain to see that lenders with an early history of complete, comprehensive, well supported, coherent and fully consistent applications will serve themselves and their borrowers well. A by-product of Pilot participation may include greater demand by lenders for responsiveness and appropriateness/completeness of documentation from their borrowers. It is unlikely that any submissions that are less than complete will be treated as other than an opportunity to reject, as DUs get in their cars for another site visit, or prepare for lengthy committee reviews of their work and conclusions.

Headquarters Staffing. A “Designated Asset Management Point of Contact” (POC) will be designated in Headquarters for coordination and guidance of the Pilot. The POC will be called upon to assist in coordinating HQ and field office staff in all manner of synchronized reviews and approvals that will likely be required for the transactions. It is likely that Section 8 rent increases, 2530 flags, HUD-held loan deferrals, and many other matters will require some Headquarters review or waiver for multiple Pilot projects. In addition, Headquarters staff are expected to hold biweekly tracking calls with Hubs, issue guidance on specific transactions, and provide training to HUD field and lender staffs on Pilot program issues and policy. In the short run it does seems likely that the POC’s e-mail inbox will be full and their phone will be ringing off the hook.

Closing Process

Closing of Pilot loans will follow the MAP Guide process for 223(f) loans, with some important exceptions, including among them:

  • surveys can be waived by the DU for transactions involving refinancing of Section 202 and other HUD-held loans, or in which the current lender will also be the new lender and certifies that no material changes have occurred at the property
  • Plans and Specifications may be deferred, and submitted prior to closing, under guidance now generally applied from Mortgagee Letter 2010-26 and Mortgagee Letter 2008-19, as now incorporated into the November 2011 revised MAP Guide
  • title, survey and loan documents should be available for HUD review prior to Firm Commitment.

Having seen the FHA/LIHTC Pilot grow from conception, following enactment of the Housing Tax Credit Coordination Act, to some streamlining instruction included with MAP Guide revisions, and now into a notice of program implementation that is “effective immediately,” we look forward to its successes in 2012.

Scott E. Fireison, Christine Waldmann Carmody and Sheldon L. Schreiberg

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship. Internal Revenue Service rules require that we advise you that the tax advice, if any, contained in this publication was not intended or written to be used by you, and cannot be used by you, for the purposes of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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