If you’re eager to see the Federal Housing Administration’s 203(k) rehab program reopened to investors, do you want the sobering news first or the good news?
OK, first the good news. In discussions I had last week with FHA officials, they confirmed that the agency has heard — and is sympathetic to — the pleas from Realtors, lenders, homebuilders, contractors and small investors to bring back 203(k), which has been closed to investors since the mid-1990s.
Not only does HUD agree that the program has great potential to help clear away some of the vacant and rundown REOs (bank-owned homes) that blight many urban neighborhoods around the country, they said, but the agency now ranks reopening 203(k) to investors as a high priority. That’s got to be gratifying news for the Realtors, rehabbers and mortgage bankers who’ve been pounding away on the subject for years.
Most recently, the Mortgage Bankers Association, headed by FHA’s immediate past commissioner, David Stevens, made a strong case to HUD two weeks ago for ending the moratorium, including detailed point-by-point recommendations on how the agency can safeguard against the scandals the program experienced in the past.
The National Association of Realtors has been actively lobbying FHA on the 203(k) issue for several years. In a letter earlier this year to HUD Secretary Shaun Donovan, NAR President Moe Veissi said widening eligibility in the program is crucial because investors are "able to access credit that is unavailable because of the current economic crisis." Investor activity will also create jobs, help stabilize property values in hard-hit communities and expand local tax bases.
HUD officials in the past typically have fended off inquiries about 203(k) by saying FHA is "studying" the issue, but have not publicly ranked revival of investor participation as a top priority of the agency.
Hopes ran especially high when Donovan took over at HUD in 2009 because he had direct knowledge of the neighborhood renovation potentials of the program, having served as New York City’s head of housing preservation and development for four years. Moreover, he was the first HUD secretary who had worked earlier in his career at FHA — so he knew the ropes.
But despite numerous entreaties, neither Donovan nor his FHA leaders — Stevens and current acting Commissioner Carol Galante — have signed off on a plan to let investors back in. The program, which involves combined financing for purchase and substantial rehabilitation of properties, has continued to be available for buyers who intend to live in the house after fixing it up.
FHA officials said last week that the poor performance of investors during the 1990s remains fresh in the institutional memory at HUD and has influenced the department’s go-slow approach on reopening the door.
Before FHA imposed a moratorium in 1996, federal auditors documented what they described as a pattern of widespread "waste, fraud and abuse" by investment groups, lenders and nonprofit agencies. The problems ranged from gross overvaluations of repairs, failures to make repairs with loan funds, fraudulent appraisals on home purchases, sequential deed-flips that inflated profits for speculators and other rip-offs that seriously endangered FHA’s insurance fund resources.
For example, auditors found one investment group in Georgia falsified settlement statements to indicate an average cost of $123,000 apiece for houses it purchased. But, in reality, the investors had paid only about $80,000 per house on average, and pocketed a $1.14 million profit that triggered $966,000 in losses to FHA’s general insurance fund.
In another case, Florida investors told FHA they paid $1.25 million for 52 houses to be renovated. In fact, the purchase was a quick-flip with fraudulently high appraisals. The investors actually had closed on the houses for just $715,000 hours earlier, netting a $533,000 profit — again endangering FHA’s insurance funds.
In many of the investor-related fraud cases, auditors said, "inside dealing" was involved, with settlement agents, appraisers, loan officers and realty agents making money illegally. Critics in Congress charged that the 203(k) program’s design flaws were part of the reason investors found it so easy to steal money from the government, especially FHA’s ceding administrative control to lenders to handle much of the application, underwriting and approval process.
In the MBA’s letter to HUD earlier this month, the group offered ways to remedy the 203(k) program’s design inadequacies. Among the recommendations:
- Restrict investor participation to essentially "moms and pops" who plan to have an ongoing stake in the property and post-rehab rental activities.
- Limit the number of properties per borrower to four single-family units. "Much of the waste, fraud and abuse to the program in the 1990s" was connected with investors "financing multiple (203(k)) properties," sometimes 20 or more units, MBA said.
- Charge higher risk-based premiums for 203(k) investor loans than on other FHA-insured products, something that was not done during the 1990s.
- Require qualified consultants to monitor the rehab of all 203(k) loans, including the standard and streamline versions of the program now used by individual buyers.
FHA officials I spoke with last week say the agency welcomes recommendations like these and takes them seriously in its efforts to reopen the program to investors.
However — and here comes the pail of cold water — HUD and FHA also have other high-priority efforts underway on the regulatory front. Prime examples: the long-awaited condominium certification rule changes that are now moving through departmental clearance and are expected to be issued soon. Also the note sale program FHA recently announced to move foreclosed properties off its books by selling the paper at discounts to investors is consuming significant time and energy by FHA’s personnel.
As a result of these and other projects, FHA is jammed and currently does not have a specific timeline for putting out proposals for a revised 203(k) program. Could the revisions come out before the November elections? Anytime this year? Not likely, I was told. How about 2013? Much higher probability.
Bottom line: HUD now confirms it is committed to a broadened 203(k) that will be open to investors rather than a continuation of the moratorium that’s been in place for 18 years. It’s going to happen — just not as quickly as a lot of people would like to see.