Builders Tap HUD Dollars

SAN FRANCISCO, CA - Several Bay Area housing developers are turning to a little-used HUD program to jump-start stalled market-rate apartment construction after traditional financing dried up. San Francisco-based developers Menlo Capital Group, the Emerald Fund and Martin Building Group are all applying for Housing and Urban Development's Section 220, a program that insures loans for multifamily housing projects located in areas that are designated for redevelopment or revitalization. Under the program, the federal government essentially guarantees 40-year loans by providing Federal Housing Administration mortgage insurance to lenders.

The program, which only covers rental apartments and works for market-rate but not luxury housing also has a non-recourse provision, meaning that the developer does not have to put up personal property as collateral.

Thus far at least four projects are in the process of applying for Section 220 approval, including Emerald Fund's 308-unit 333 Harrison St. and Martin Building Group's two projects — 2235 Third St. and 178 Townsend St. — together totaling 275 apartments. The fourth applying for funds is Menlo Capital Group, which has a fully-entitled 50-unit project in Oakland.

The program has been used rarely in the Bay Area over the past two decades because capital has been so readily available and because the program includes statutory limitations restricting the loan amount that can be insured. In the Bay Area, Section 220 covers up to $227,000 in construction costs for a two bedroom, $185,000 for a one bedroom or $165,000 for a studio. Even with construction costs down an estimated 20 percent to 30 percent over the past year, the federally insured loans would only cover about 60 percent to 70 percent of project costs for a modest wood-frame apartment complex in San Francisco.

But with banks mostly out of the construction lending business, developers have no choice but to see if they can make Section 220 work, said Oz Erickson, president of the Emerald Fund, which was the last developer to take advantage of the program with the SoMa Residences a decade ago.

"Even though people say there is lending, the fact is, nobody is lending. The building trades are getting killed," said Erickson. "This is the program we are going after (for 333 Harrison St.) … We will just have to find another way of getting the rest of the cash." He added: "If you meet the federal requirements, they give you the money."

Menlo Capital Group may be the first Section 220 project out of the gate with Victory Place in Oakland, a 54-unit project on the corner of Jefferson and 15th streets, said Managing Director Karan Suri. Menlo Capital, a San Francisco-based family-owned merchant builder that has developed mostly in Silicon Valley, is about half way through the six-month HUD application project. He said the company started looking at the program after banks showed no interest in the project.

"They are politely saying we are not in the market unless you have $40 million in deposits. Which doesn't make sense when I'm looking for a $10 million loan. … So we have to be creative and find other ways of making our deals work."

Suri said he would like to see the federal government increase statutory limitations so that more Bay Area developers could take advantage.

"They discriminate against the Bay Area. So no developer in the Bay Area could ever use them. I can only do it in Oakland because the costs for me to build this have come down 30 percent. And I have to put down 40 percent equity."

Gary Alex, national director of FHA lending for Enterprise Community Investment Inc., which is the lender on Victory Place, said he has seen a 150 percent jump in developers applying for the HUD program because of the credit crunch.

"We have not seen anything like this since the early '90s," he said. "The pipeline is packed. You're going to see HUD's market share spike amazingly."

Even two years ago, he said, banks would have been "beating down the door to lend money to top-flight owner/operator developers like Menlo. … The playing field has changed dramatically. The phone is ringing off the hook."

HUD spokesman Larry Bush said he expects more Bay Area Section 220 applications this year than the agency has seen in years.

"Clearly there is more interest, and we expect applications to increase," said Bush. "It is a very good product, but has not fit well for the past 15 to 20 years." Suri said he expects to be under construction by September with a two-year build-out period.

"Our construction industry is in shambles and a lot of people need jobs. My subcontractors need jobs," he said. "And the stunning thing is that vacancy is actually pretty low in Oakland. I'm next to nice retail. I'm walking distance to City Center BART (and) one stop from the city. … People can hop on a train and get something that is priced 30 percent to 40 percent less."