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Exploring Greater Access to FHA Mortgage Insurance for Small Rental Investors

Front Cover of Examination of Alternative FHA Mortgage Insurance Programs for Financing Single-Family Rental and Small Multifamily Rental Properties

During the recent financial crisis, the Federal Housing Administration’s (FHA’s) mortgage insurance program ensured mortgage credit access for qualified single-family owner-occupants and for investors in large multifamily rental properties. FHA’s active mortgage insurance programs did not, however, provide similar support for single-family (1–4 units) rental property or small multifamily (5–49 units) rental housing property investors, despite the fact that single-family and small multifamily rental properties constitute 87 percent of all rental units in the United States. As the nation’s foreclosure crisis spread and many communities experienced unparalleled numbers of vacant, neglected, and abandoned properties, some recommended that FHA expand its insurance programs to single-family and small multifamily rental properties to help preserve the supply of affordable housing. FHA provided mortgage insurance for single-family rental properties until a spate of defaults in the 1980s and 1990s led Congress and FHA to close Section 203(b) and 203(k) programs to rental property investors. Today, under the auspices of the Section 203(b) program, FHA insures mortgages made by qualified lenders to people purchasing or refinancing a primary residence and Section 203(k) insures mortgages covering the purchase or refinancing and rehabilitation of a principal residence.

HUD recently released a commissioned study that examined options for making FHA’s mortgage insurance programs available to single-family rental property investors and more attractive to small-multifamily rental property investors. Rental housing market participants such as the government-sponsored enterprises (GSEs), small banks (portfolio lenders), hard money lenders, and equity lenders were surveyed, and data were collected from reviews of the literature, underwriting guidelines, loan performance records, a survey of rental property owners, and other sources.

Single-Family Rentals

Single-family rental properties (1–4 units) make up more than half of all rentals in the United States. Most of these properties have “mom-and-pop” owners who use them for supplemental income. Since 2010, investors have increased their demand for single-family rental properties, especially institutional investors making cash purchases. The main sources of financing for cash-poor investors are the GSEs, Fannie Mae and Freddie Mac, who charge investors a fee for loans. Reinstating the Section 203(k) program for rental property investors, which had been available to single-family rental property investors through 1996, might encourage investors to purchase and rehabilitate more properties in distressed neighborhoods, stabilizing property values and increasing the supply of affordable rentals. A distinction is made here between long-term, community-anchored rental property investors versus strictly profit driven, predatory investors who do not live in the community and have few incentives to maintain their properties. Long-term investors tend to have good credit scores and are less likely to have second liens. Investors surveyed for this study stated they would increase their market activity if lenders lowered interest rates and eliminated loan restrictions. Many said they would raise their downpayments if they could finance more properties.

The authors suggest that modification of Section 203(k) could allow investors to participate, while also simplifying and streamlining procedures for both lenders and investors. In evaluating the financing options proposed by those who were interviewed for this study, the authors attempted to balance investor needs, lender needs, and apparent financing gaps. The authors recommended three options to help “mom-and-pop” investors obtain financing to allow them to compete with cash investors.  Features of the three recommended options include:

  • Fast-track underwriting for borrowers who make a downpayment of 50 percent or more.
  • Streamlined refinancing.
  • Refinancing of an investment property purchased with cash within six-months as a purchase.

These features would allow investor-borrowers to leverage their funds and use short-term financing to acquire a property as quickly as a cash investor and convert to permanent financing later.

Small Multifamily Properties

Small rental properties make up a majority of U.S. multifamily rentals and are more likely than larger multifamily properties to serve low-income renters. These properties are less likely than larger multifamily properties to have a mortgage, and those that do tend to have loans with higher adjustable rates and shorter terms. These findings suggest that small multifamily properties lack access to reasonable financing and could be lost to the housing stock as a result.

In fact, the literature confirms the existence of a financing gap for small multifamily properties despite some provisions of GSEs, FHA, and community banks that might be helpful to small borrowers. Financing has proven more expensive for small multifamily properties, both as a percentage of the loan and on a per-unit basis because multifamily lending and insurance programs require the same due diligence and underwriting procedures for both small and large multifamily properties so that small multifamily properties incur the same fixed costs as large multifamily properties but spread over a smaller number of units and smaller loans. The authors of this study suggest that revisions to FHA’s multifamily program could resolve some of the problems that have created financing gaps, including high origination and servicing costs, lengthy loan approval times, the lack of a secondary market for small multifamily loans, the lack of available financing for rehabilitating these properties, and insufficient underwriting flexibility.

New Program Impact

If FHA were to make its insurance programs available to investors in single-family rental properties and more attractive to investors in small multifamily rental properties, further study of the impact of these changes on various aspects of the rental market, such as the supply of rental housing, rents, foreclosure inventories, first-time and owner-occupant buyers, conventional lending, and housing prices, would no doubt be beneficial. This study suggests, however, that if investors could participate in FHA programs, the result could be new investment that not only protects and preserves the existing rental housing stock but also speeds the conversion of distressed properties to rental units, which could help stabilize housing markets in turmoil. The authors note that economic conditions remain an important predictor for default risk, although that risk can be mitigated by appropriate loan features and underwriting guidelines, which FHA has improved during the past two decades.