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FHA Aligns with Tax Credits

By Jerry Ascierto

FHA Aligns with Tax Credits By Jerry Ascierto The Federal Housing Administration (FHA) has made sweeping changes to its multifamily programs to make them work better with low-income housing tax credits (LIHTCs).

Some changes were made through internal processes, and others were required by the Housing and Economic Recovery Act of 2008.

In the past, most tax credit developers wouldn't use FHA mortgage insurance since the FHA's requirements were outdated and in stark contrast to the needs of LIHTC developers. But Mortgagee Letter 2008-19 streamlines requirements for LIHTC developments using the Secs. 221(d)(4), 220, and 231 programs.

The biggest barrier for tax credit developers was an FHA requirement that 100 percent of a project's equity be deposited in cash before the closing of the construction loan. This requirement severely limited a tax credit investor's cash flow, forcing many to take out a bridge loan just to fund the escrow. Most conventional financing requires a much smaller percentage of the equity upfront, allowing the rest to be paid as development progresses.

One effect was that tax credit investors would pay less for credits used by an FHA-insured development, since they couldn't phase in the equity contribution over time. The end result was less equity for a project—on average about 5 cents less per tax credit dollar compared to a more conventionally financed LIHTC development, estimates the Mortgage Bankers Association (MBA).

"We took a serious look at the 100 percent tax-credit-equity escrow situation," said John Garvin, deputy assistant director for multifamily and senior advisor at the Department of Housing and Urban Development (HUD), at a recent congressional hearing. "No one wanted to put 100 percent of the equity up front."

Mortgagee Letter 2008-19 reduces that requirement to just 20 percent, allowing developers to pay the remainder over the development period, meaning no escrow is required. If the initial equity installment is less than 20 percent, deals can still get done, but a recommendation to close the deal must be approved by HUD headquarters.

"That was a big change, and it really improves the tax credit pricing," said Cheryl Malloy, the MBA's senior vice president of multifamily and governance. "The other big changes were centered on improving the FHA's timing."

Speeding it up

One change aimed at speeding up deal cycle times allows developers to defer submission of final plans and specifications. Developers can now submit schematics with their application instead.

And borrowers will get some relief from the FHA's notorious 2530 system, also known as the Active Partners Performance System (APPS). The system requires deal participants to disclose and certify past performance in multifamily mortgage insurance programs. This is meant to give the agency an outline of their history of meeting financial and legal obligations.

APPS clearance had to be obtained prior to the FHA's issuance of a firm commitment. But the process was often slow, frustrating borrowers who were applying for tax credits from state agencies. The new regulations give borrowers the ability to condition the firm commitment upon APPS approval, meaning they have more timing flexibility on the deal.

"The state housing agencies had to have a commitment during their process of allocating the tax credits, but the FHA couldn't come out with a commitment that quickly," said Malloy. "This should really help developers hit that timeframe."

The new regulations also require each HUD field office to have a LIHTC coordinator who will work with local allocation agencies and train HUD staff on the program to ensure consistency among offices. With these changes, "I think the development community will turn back to FHA," Garvin said.

Housing bill

The Housing and Economic Recovery Act of 2008 also includes several provisions aimed at helping the FHA work better with LIHTCs. The biggest change: The legislation mandates a six-month pilot program for processing applications of tax credit developments seeking FHA-insured mortgages.

Under the pilot program, HUD would designate a "chief underwriter" at each field office to review applications. Previously, HUD did a detailed, multi-step review, where separate HUD staffers would review a different part of each application. One appraiser, one architect, and one market study specialist would review the applicable part of each application, for instance.

Because the original appraisers and architects on the application were already pre-approved by HUD, many felt this process was redundant. The move to a chief underwriter aligns HUD's practices with those of private industry. If the pilot program is a success, it could be expanded to include any type of multifamily development (and if it's a failure, HUD has the right to go back to its old system).

The other changes enacted by the housing legislation are likewise process-related. Previously, LIHTC properties using FHA mortgage insurance were subjected to two separate, but identical, annual inspections. One inspection was done by the state housing agency, and HUD's Real Estate Assessment Center (REAC) conducted the other. The act basically takes REAC out of the process and allows HUD to accept the state agency's inspection.

In the same vein, the act streamlines the FHA's subsidy layering review, a process meant to ensure that no development received more federal or state subsidies than it needed. But since most state housing agencies already review proposed tax credit deals to make sure they are not receiving more tax credits than needed, this process too was deemed redundant by many in the industry. The act allows HUD to accept the state agency's review.

The act also streamlines cost certification requirements. In the past, the developer had to certify all project costs at the end of construction, to show that the amount of debt didn't go over the statutory loan-to-value ratio. But this requirement didn't make sense for tax credit deals.

"On a tax credit deal, where tax credits are usually covering 40 to 50 percent of the cost, or more, there's almost no way you're ever going to have a mortgage higher than the cost of the project," said Malloy. "So it's an unnecessary thing."