A client recently asked us, “Why would I want to finance my seniors housing community today and lock a high rate for the next 35 years?” Hearing that question, we carefully laid out the reasons why this client should consider financing his projects through the HUD Lean program today.
The reasons apply to many owners of seniors housing, and we have presented them below.
Like all federal agencies, HUD’s fiscal year runs from Oct. 1 through Sept. 30. From Fiscal Year 2010 through Fiscal Year 2022, the HUD 232 or “Lean program,” as it is more commonly known, has financed on average $3.75 billion worth of seniors housing loans. This volume was made up of new construction loans, acquisition loans and refinance loans.
The Lean program has been an important part of seniors housing financing for more than 20 years. Originally, seniors housing loans were processed through various multifamily field offices under either the TAP (Traditional Application Processing) model or the better-known MAP (Multifamily Accelerated Processing) model.
In 2008, HUD made the strategic decision to create the Lean program, which was loosely based on Toyota’s Lean manufacturing model. While HUD’s MAP program had cut down on some of the processing time for loan applications as compared to the older TAP program, a team of HUD professionals from all levels and professional disciplines believed they could improve on seniors housing and healthcare loan execution by incorporating Lean principles.
The Lean model faced challenges in the first few years of its inception which included the credit crunch of 2008 through 2010, but the pioneers of the Lean program persevered and ultimately created the program that exists today. The Lean program finances skilled nursing, assisted living and memory care communities, as well as independent living (up to 25% of the overall units).
From 2018 to 2022, we have seen Lean rates locked in the 2.50% to 4.00% range. For a new generation of HUD borrowers and lenders, those rates have become the norm. However, the database of HUD Active Insured Mortgages shows Lean loans closed in the early 2000s with rates ranging from 5.00% to 7.50% or higher. Currently rates are around 5.65%, including the .65% Mortgage Insurance Premium (“MIP”) that HUD receives in exchange for its non-recourse loan guaranty.
Even in today’s interest rate climate, we are at the lower end of this historical range. Compared to other seniors housing loan products in the market today, it is still a low rate. HUD borrowers can obtain leverage up to 80% of value as compared to other loan products that top off at 65% of value or even less.
There are a few other benefits to the HUD LEAN product which include:
• A 35-year term and amortization period;
• Non-recourse except for standard “bad act” carve-outs; and
• Flexible prepayment schedules.
Yes, we said two words that are not normally spoken in the same sentence, HUD and flexible. Unlike other loan products, HUD offers a declining pre-payment penalty, with the standard schedule starting at 10% and declining by 1% each year. At the end of year 10 the loan is fully pre-payable at par.
A borrower may ask, “What if I want to sell my community in year six?” HUD is flexible in these cases and allows borrowers and their lenders to structure pre-payment penalties that better suit their needs. In exchange for a slightly higher rate, a borrower can obtain a pre-payment penalty that might include five years of pre-payment penalty at 10%, followed by five years of pre-payment penalties at 1% and open after year 10. This is just one flexible option HUD allows to accommodate future sales, and other permutations are possible.
So back to the client’s question: Why would a borrower want to finance a community with HUD Lean today? To begin with, timing. Throughout the past five years if you asked how long the queue was, we would answer 30 to 40 projects. As of late February, the HUD Lean queue sits at only 15 deals!
That is one of the shortest queues since Lean’s inception. If Lean assigns an average of four loans per week for underwriting, that is a queue wait time of only one month – much shorter compared to wait times of up to a year in the early days of Lean processing. Having said that, as rates eventually settle lower, the queue and wait time will expand.
Many borrowers’ main concern with HUD today is locking in a higher interest rate for a long period of time. HUD has programs to mitigate these concerns. HUD offers the Lean 223(a)(7) refinance and the Interest Rate Reduction (IRR) modification programs to give borrowers the opportunity to lower their interest rates in a streamlined fashion.
The 223(a)(7) refinance loan can be processed by any Lean-approved lender, while the IRR loan modification must be processed by the current HUD lender. Both are quick and easy tools to reduce the interest rate. And with the 223(a)(7) program, borrowers may even be able to extend the term of their loans, borrow additional funds for improvements and refinance additional existing debt.
Recently, Lean adopted the Green MIP program. This program allows borrowers to lower HUD’s MIP rate to just 0.25% annually, a decrease of 0.40% on a 223(f) refinance and more than 0.50% on a new construction transaction. This program applies to borrowers who have already achieved a HUD-approved green standard for their community and borrowers who intend to implement energy-saving measures to achieve a green certification.
For borrowers who intend to implement these measures, HUD will allow you to refinance your community and include the cost of these measures in the loan amount. You have 12 months post-closing to implement those changes, but your reduced MIP starts at loan closing. While there are costs associated with achieving the Green MIP, the significant reduction in annual MIP cost should provide a very short payback on the investment. This is not only a win for HUD borrowers through lower rates but a win for the environment, too.
However, like most loan programs and lenders across our industry during this time, Lean underwriting standards have tightened. On top of expecting an experienced owner and operator, Lean requires a strong trailing-12 income statement that supports the loan amount at 1.45 times debt service coverage or above. If you meet these requirements, HUD may be a great option for you and your next project. Today might be the day to begin the HUD process with an experienced HUD Lean lender.
Christopher Fenton and Corley Audorff are senior vice presidents focusing on seniors housing at Colliers Mortgage.
