The Department of Housing and Urban Development (HUD) announced in late June it would revise a notice that eliminated developer fees for refinances of Section 202 Supportive Housing for the Elderly properties.
A May 30 Notice on Updated Requirements for Prepayment and Refinance of Section 202 Direct Loans said that no developer fee is allowed from the proceeds of an FHA-insured Section 223(f) refinance of Section 202 direct loans. On June 26, HUD released a statement to the effect it would revise the notice due to feedback received from lenders, including the reinstatement of the developer fee.
By and large, the notice was a compilation of prior guidance, several prior notices, several memos, and responses for frequently asked questions, says Nick Gesue, chief credit officer at Columbus, Ohio-based Lancaster Pollard. It also contained a couple surprises that were “completely unexpected” by many lenders and Section 202 owners, many of whom are not-for-profit.
“A big part of what HUD wants borrowers to do [as part of a refinance] is to update the buildings, as many were built in the ’70s and ’80s,” Gesue says. “As a way to incentive nonprofits, they allowed developer fees.”
The rules for developer fees changed from 15% of the repair amount Section 202 owners will spend on a property after refinancing to 15% of the amount of the prior financing a couple years ago, revised by HUD to match the Low Income Housing Tax Credit program. In the May 30 notice, HUD rewrote the instances of where a developer fee is allowable.
“[The change] eliminated the ability to get a developer fee [unless you were] using tax credits,” Gesue says. “The net result was, if you wanted to do a debt-only refinance, the developer fee was no longer allowable… It was immediately effective with no phasing in, and it caught everyone off guard.”
Lenders including Lancaster Pollard began rallying clients to express concern directly to HUD regarding the notice. HUD never gave any indication of motivations to eliminate the developer fee and did not respond to SHN’s request for such information, although according to Gesue some within the agency might have felt the fees were getting too large.
However, eliminating those fees resulted in its own issues, including the ability to afford repairs and updates to properties.
HUD programs require borrowers to put up cash escrows as a contingency reserve for development and many Section 202 owners don’t have a lot of cash, Gesue says. Often, the developer fee acts as the cash reserve until the work is done and protects against cost overruns.
A lender working with a Section 202 owner underwrites new loans to repay the property’s existing debt, cover the closing costs, and fund a certain amount of repairs and improvements to the project, including a developer fee. At the time of underwriting the loan, the property’s owner has to specify to the lender the scope of the planned improvements so that when the lender goes to HUD, it can be very specific as to the costs of the project and how much the loan needs to be.
If a loan was underwritten expecting $620,000 worth of work to be done on a property that ended up costing $650,000, then a portion of the owner’s $93,000 developer fee could be used to pay for the additional cost. Because developer fees are often used to cover the contingency escrow, their elimination cast uncertainty onto already-underwritten deals.
“We had to put a number of deals on hold and tread water with them until we knew what we could and couldn’t do, how we’d have to underwrite it, and the advice to give to clients,” Gesue says.
It’s not just about the money, he says: The changes would have made many deals either “infeasible or unpalatable.”
“It’s not so much people complaining about the lack of the developer fee itself—it’s been really really well-received, and it’s put to great use by a lot of nonprofits,” says Gesue. “It’s necessary to cover a HUD required contingency escrow, [and without the developer fee] many would otherwise not have the cash to do that.”
Had the rule remained, he predicts it would have caused a number of transactions to become “extremely” challenged in terms of feasibility. However, the fee was reinstated thanks in large part to collaborative efforts by Lancaster Pollard vice president Ryan Miles, chair of the Sect. 202 Working Group, and the MBA Multifamily FHA Committee.
“In the world of the government, this was a pretty big turnaround from issuance [in late May] to rescinding some of it [by June]. HUD probably hadn’t fully appreciated the use of the developer fee from a structural or incentive perspective,” Gesue speculated. “As soon as we laid out why it’s so important, they were really quick on the turnaround.”
Written by Alyssa Gerace