As some banks step away from construction lending, the Federal Housing Administration (FHA) is stepping into the gap, with competitive rates and faster processing times.
Federal officials are combining the offices that process FHA loans. That will cut down on the time it takes secure FHA loans and make the process much more consistent. However, FHA financing still takes a much longer time to close than other types of loans. Borrowers keep returning to FHA because of competitive interest rates and long loan terms.
“There are large developers who love the FHA program,” says Adam Roberts, FHA deputy chief underwriter for commercial real estate services firm JLL.
Many banks have sharply curtailed their construction lending on new apartment projects.
“There has been a material pullback on the banking community’s willingness to finance construction loans,” says Steve Wendel, FHA lending head of production in the capital markets group of real estate services firm CBRE. “The Federal Reserve is admonishing banks to not have such a focus on construction loans.”
But as banks step away from construction lending, FHA is still making loans to qualified projects.
FHA continues to lend in the range between $10 billion and $15 billion a year on apartment properties, as it has since the financial crisis. Prior to the crisis, it was lending about $5 billion a year for such properties, according to data from CBRE. “FHA is kind of counter-cyclical,” says Roberts. “When other lenders stepped out of the marketplace, FHA stepped in.”
The challenge with FHA loans has always been timing. They can simply take a very long time to arrange. Developers interested in FHA construction financing should start working with lenders early, as they prepare their market study and initial draft drawings.
At press time, FHA lenders offered construction borrowers long-term, fixed-rate financing with an interest-only period during construction, including 40-year loans with fixed interest rates of about 4.0 percent (plus mortgage insurance premiums of about 65 basis points). In comparison, banks are currently offering loans with interest rates floating at about 250 to 300 basis points over LIBOR, or about 3.5 percent.
HUD transformation speeds up FHA
The agency’s reorganization is making the time it takes to close an FHA loan shorter.
“There is going to be a lot more predictability,” says Stephanie McFadden, managing director of FHA lending for CBRE Capital Markets.
The parent agency of FHA, the federal Department of Housing and Urban Development (HUD), is also radically restructuring the field offices that handle its FHA loans. HUD’s Multifamily for Tomorrow Transformation will reduce the 52 separate offices that processed FHA loans as recently as 2014 to just 12 offices. HUD should be finished with the process by late 2016, and has already completed it in three of the five HUD regions of the country. The regions that remain include the Northwest and the West.
“The transformation drives a lot more consistency and streamlining,” says Jeff Patton, managing director for JLL.
HUD’s standard processing time to review an FHA loan application now takes 30 to 60 days. In the offices that have completed the transformation, HUD officials are now consistently meeting that standard. Previously they often ran 30 to 45 days behind.
Once HUD has reviewed a loan and given its firm commitment, borrowers can lock in an interest rate, usually 30 to 45 days before closing the loan.
FHA interest rates
The recent chaos in the bond markets has had less effect on FHA bonds.
“Spreads have been less volatile for FHA than for Fannie Mae and Freddie Mac,” says CBRE’s Wendel. “That’s because FHA is the only explicitly government-guaranteed loan product.”
As a result, for FHA bonds, the yield spread over Treasury bonds has not risen as much as for other mortgage bonds. Over the last four to six months, FHA spreads rose 25 to 30 basis points, compared to 40 to 50 basis points for Fannie Mae and Freddie Mac bonds and 75 basis points for CMBS, which have no government guarantee, implied or explicit.
The interest rates are typically lower for FHA loans by 15 to 20 basis points, though interest rates can be hard to compare since the loan terms are typically much longer than the seven-year and 10-year loans provided by other lenders. Just to compare, a conventional borrower might get an FHA 10-year loan with a fixed interest rate of 3.8 percent (or 4.0 percent including mortgage insurance), compared to 4.25 percent from Fannie Mae or Freddie Mac, as of late February, according to CBRE.
“FHA has a decided advantage,” says Wendel.
HUD also recently changed the rates for its FHA mortgage insurance premiums for properties that serve its mission. Premiums decreased 25 basis points for affordable housing properties, 25 basis points for sustainably developed properties and 35 basis points for mixed-income properties.
FHA has also revised its underwriting guidelines. The new Multifamily Accelerated Processing (MAP) guidelines for market-rate apartment properties allow loans that cover up to 85 percent of the value of a property (up from 83.3 percent previously), and debt service coverage ratios as low as 1.176x, instead of 1.20x. The new guidelines, announced in January, should take effect at the end of May.
“It opens the door to additional borrowers,” says Roberts.