The article below is reprinted with permission from The Capital Issue, a quarterly newsletter published by Lancaster Pollard.
During the first half of October 2013, the U.S. federal government partially shut down for the lack of a continuing resolution to fund government operations. Only functions that were deemed essential were allowed to operate.
For the U.S. Department of Housing and Urban Development that meant working with an "extremely limited" staff to only conduct closings of projects with firm commitments prior to Sept. 30. When the government fully reopened getting back up to speed to review the backlog of applications put on hold was a challenge.
In recent months, however, HUD, and more specifically the Office of Healthcare Programs, has regained the underwriting momentum lost as a result of the government shutdown. Despite the fact that the respective queues have started to shrink and more resources have been allocated to all deal types, owners and operators are still faced with timing constraints that may be problematic. For construction loans, such as the Federal Housing Administration Sec. 232/241(a) program, this has been a particular issue.
This supplemental loan is available to existing FHA-insured healthcare facilities to fund repairs, additions, improvements and major movable equipment. As with all FHA-insured mortgages, a Sec. 241(a) loan is nonrecourse, providing a low, fixed interest rate for a term and amortization of up to 40 years. One of the benefits of using the program is enhanced cash flow debt capacity for the provider.
Commencing construction prior to firm commitment
In an effort to help alleviate some of these constraints, OHP continues to honor requests for commencement of construction prior to issuance of a firm commitment for Sec. 241(a) loans as outlined in the first of this series on the program, "Facility Improvement: Using FHA Sec. 241(a) to Stay Competitive." This early start of construction process is more commonly referred to as an "early start."
While not every request will be approved, circumstances, such as a pending certificate of need, the weather's impact on the construction timeline or losing residents due to a lack of care options, would be examples of compelling reasons for OHP to approve a request. Although an approval should in no way be construed as OHP's approval of the overall financing of the project, it is an important step for many borrowers dealing with timing constraints such as those listed above. It is also important to note that HUD has issued guidance stating that if an early start is requested and approved, an FHA Sec. 241(a) firm application will only be allowed to be submitted as a single-stage application.
When considering such a request, communication with your lender and OHP is incredibly important and cannot be overstated. Communication regarding complex construction projects can make the process run incredibly smooth or make it painful, either of which can leave a lasting impression.
Project in point
In recent months, an Ohio senior living provider and client of Lancaster Pollard's closed on a Sec. 241(a) loan, which included a request for, and subsequent approval of, an early start of construction for an addition to a skilled nursing and assisted living facility. For this particular project, the provider was faced with a pending CON expiration date as well as winter weather considerations, which made early start of construction critical to management’s goal of maintaining their market position as the provider of choice and meeting the growing demand in the market.
It was key to appropriately size a development budget and loan that both the lender and borrower were comfortable with and felt represented an ideal candidate for approval under the Sec. 241(a) program. This due diligence included the standard OHP required appraisal, market study and environmental reporting. Additionally, the hiring of a third-party architectural plan and cost reviewer was of particular importance to the early start process, ensuring that any worked completed was done in accordance with HUD requirements. Because of the provider's timing constraints, the early start request was not only for site and foundation work, but also to construct the actual building (the "bricks and sticks"). Thus the scope of the due diligence for the early start process emphasized not just the architectural plan and cost review, but also the architect and general contractor.
Once all parties were comfortable with the development plan, including the architectural drawings and project cost estimates, the request was sent to OHP for an early start in accordance with the required checklist. The checklist, which can be found on HUD's portal, requires up to 12 exhibits, including an executed construction contract for all work contemplated under the early start program and a request to begin construction prior to initial endorsement for mortgage insurance. Both these documents are important: They reiterate the need to have a general contractor selected and to be working with the third-party architectural plan and cost reviewer to ensure that all parties are comfortable with executing a construction contract that will reflect a work scope and terms that are acceptable to OHP; and they reinforce the borrower’s understanding that any work completed is done entirely at its financial risk and that approval of an early start should in no way be construed as OHP approving the project for mortgage insurance.
Concurrent with the assembly, submission and approval of the early start request, Lancaster Pollard and the borrower continued to assemble and ultimately submit the firm application. The additional due diligence previously completed for the early start request, coupled with no changes to the organizational structure since the Sec. 232/223(f) loan was put in place (the last HUD application in this case), allowed for a smooth application process. In other words, borrowers considering an early start request should not necessarily view the due diligence required by the process as additional work, but rather as what would have to be completed even if an early start was not contemplated. If the borrower had an organizational change, such as a new owner or operator, it would add an additional layer of HUD review.
Through a loan by the parent organization the borrower was able to commence and complete construction and lease-up the additional units while the project waited in the OHP queue. Upon being assigned for underwriting, Lancaster Pollard was able to work closely with OHP to review the request and ultimately received a firm commitment. Based upon a number of factors, including the strong operating history of the property and the quick lease-up of the additional units, the borrower was not required to post an initial operating deficit, working capital escrow or debt service reserve, one or more of which are common for such projects.
Upon receipt of the firm commitment, the borrower, Lancaster Pollard and OHP were able to work quickly to accommodate a closing that ultimately paid back the parent organization 90% of eligible costs, the maximum allowed under the Sec. 241(a) program. Further, because the construction was complete, there would be no need for the loan to consider a more typical construction period and draw schedule. Instead, the vast majority of the mortgageable costs were funded on the closing draw request. This short and heavily front-loaded draw schedule ultimately allowed for the interest rate on the loan to be more reflective of that which a borrower would achieve on a refinance, as opposed to a typical construction loan, in this case representing a rate reduction of approximately 60 basis points.
When circumstances allow, the early start process for Sec. 241(a) loans can be an incredibly valuable tool for providers that currently have a Sec. 232 loan and are looking to quickly improve their facility, either through an expansion or renovation. After all, the purpose of the program is to help senior living providers to stay competitive in their markets.
Robert Baxter is a vice president and underwriter with Lancaster Pollard in Columbus. He may be reached at rbaxter@lancasterpollard.com.
Kass Matt is a senior vice president with Lancaster Pollard. He is regional manager for the Eastern Great Lakes Region and is based out of the firm’s Columbus office. He may be reached at kmatt@lancasterpollard.com.