On February 21, the U.S. Department of Housing and Urban Development (HUD) issued Housing Notice 2019-03 announcing the 221(d)4 / Low-income Housing Tax Credit (LIHTC) Pilot Program. The notice establishes an expedited review process, with the goal of issuing a firm commitment in 30 days and then close in another 60 days. If achieved, HUD will become the capital source for new construction or substantial rehab tax credit projects.
What projects qualify?
Either 9 percent new construction or 9percent/4 percent substantial rehab projects qualify, but 90 percent or more of the project must be income-restricted. New construction projects must have rents at least 10 percent below market. Substantial rehab projects must have a Section 8 contract covering 90 percent or more of the property. The maximum loan-to-cost (LTC) ratio is 65 percent for new construction projects and 75 percent for substantial rehab projects. Loan amounts may not exceed $25 million on any one project.
Environmental reviews always seem to be a significant hurdle in processing insured loans. Routine environmental issues, such as lead-based paint, asbestos-containing material and radon mitigation, are acceptable if they can be addressed with established mechanisms like operations and maintenance plans or mechanical venting. Projects where environmental remediation occurs during construction and requires a No Further Action (NFA) letter are not eligible. Other environmental issues, such as elevated noise levels, historic structures or wetlands, will be processed under HUD’s conventional review process. Proposed projects will be presented at a concept meeting with HUD staff to confirm eligibility for expedited review.
Projects with more than 200 units will not qualify due to the more extensive environmental review performed on larger projects; nor will 4 percent new construction and projects that have extensive demolition involving gut rehabs, or adaptive re-use projects. Rental Assistance Demonstration (RAD) projects and those involving New Market Tax Credits or Historic Tax Credits are also ineligible for the pilot.
Projects that are straightforward, proposed by highly experienced LIHTC developers, with no unusual environmental issues are most appropriate for the expedited review.
How will HUD issue a firm commitment in 30 days?
HUD will rely on lenders for their due diligence and limit the HUD underwriting review similar to 223(a)7 loans. HUD underwriters will their review on the following programmatic and regulatory issues:
- Active Partners Performance System (APPS)/Previous Participation
- Affirmative Fair Housing Marketing Plan
- Market acceptability
- Clean environmental conditions
- Accessibility, fair housing, and lead-based paint safety
- Management capacity
A long-standing source of frustration for lenders and borrowers has been not knowing the status of HUD’s review or when a closing can be scheduled. In the pilot, a Designated Pilot Underwriter (DPU) will be assigned to every application and hold a kick-off call with the lender and HUD counsel after receiving the application. Target dates for issuing the firm commitment and closing will be discussed. Draft-closing documents may also be submitted with the application to expedite the closing process.
HUD has also designated a single point of contact at headquarters to assist with previous participation clearance, prepayment approvals and Section 8 renewals. Once the firm commitment has been issued, HUD will schedule a pre-closing conference call with the lender’s finance team to discuss closing issues and reiterate the desired closing date. Such coordination will greatly reduce lender and borrower anxiety and should facilitate a much smoother closing process, particularly for locking in the interest rate.
HUD is also modifying some of its construction period processes. HUD will continue to approve the first and last draws at initial and final Endorsement. However, lenders will be permitted to approve change orders and release funds from the working capital and initial operating deficit escrows. HUD also recognizes that the industry often utilizes the AIA G702/703 forms to monitor construction costs. HUD will allow these forms to be used so long as the owner, architect and contractor still sign HUD Forms 92248 and 2328 (but without the numbers).
What’s the catch?
There are a couple of issues which may initially limit its success. As with any new program, there is always some transition period in which HUD staff (and lenders) will have to work through to ensure smooth coordination. This could take some time. Then, there is the issue of continued pressure on staffing levels. Not every HUD office will be able to offer the pilot. The agency will review each office’s work flows and staffing to determine eligibility. Work share may be required. The notice also states that each project is to be submitted to a national loan committee, which could impact timing. Notice 2019-03 also states that total loan volume may not exceed $250 million in any federal fiscal year.
The notice also outlines a standard review process for 4 percent or 9 percent substantial rehab projects without Section 8 undergoing a re-syndication. HUD is targeting issuance of a firm commitment within 60 days and closing within another 60 days for these projects—roughly the same as the current conventional process. Acquisitions of existing properties that require substantial rehabilitation are not eligible for either the expedited or standard pilot programs, but would continue to be processed under the conventional 221(d)4 program.
HUD should be commended for its efforts to make the insured loan more compatible with LIHTC projects. HUD’s previous efforts with the 223(f) LIHTC pilot have significantly increased its volume such that in 2018, over $3.2 billion of insured loans financed LIHTC projects, nearly a third of HUD’s total volume. It took a while to get there, but HUD staff consistently worked with the affordable housing industry to refine its processes. Whether the 221(d)4 pilot will be as successful as the 223(f) pilot depends on keeping the dialogue open and sharing best practices among all participants.
Tony Love is a senior vice president at Bellwether Enterprise Real Estate Capital LLC.