Across the country, there are countless struggling neighborhoods in need of renewal and also a tremendous demand for affordable rental housing, but it typically takes government incentives to spur a real estate investor to do these projects. Fortunately, there are government programs on the books that can entice investors to build affordable apartments. Unfortunately, some of these programs are underused.
One option for financing multifamily-housing projects in urban development areas is the so-called Section 220 urban-renewal mortgage through the U.S. Department of Housing and Urban Development (HUD). Urban-renewal mortgages have been around for some time, but only 41 of these loans have been originated since 2009, or an average of four loans per year, according to HUD. Many commercial mortgage brokers and their borrower clients are unaware of the program, so they miss out on an opportunity to fund potentially profitable projects that also serve a public good.
It is a good time, however, for mortgage brokers to learn more about Section 220 loans. Neighborhood revitalization remains a major topic across the country. HUD also recently took specific actions to spur more investments via its multifamily programs, including the Section 220 loan. The agency announced this year that it will provide two paths for investors to obtain a Section 220 loan for a project that qualifies for HUD’s low-income housing tax-credit program, which has traditionally been the primary tool used to attract real estate investors in underserved areas. This program allows investors to claim credits on their federal tax returns for investments in affordable apartments.
The commercial mortgage broker who learns more about urban-renewal mortgages — and other obscure mortgage products that tend to get little attention from other brokers — stands to gain a competitive advantage over his or her rivals. They also are likely to get more referrals in the future.
“ Section 220 loans have both commercial and residential loan features and are, in essence, a hybrid of a commercial and residential loan. ”
Section 220 explained
A major hurdle facing affordable multifamily mortgages are the less-favorable loan terms that typically come with a commercial mortgage. The Section 220 option enables a multifamily construction or rehabilitation loan in an urban-renewal area to be treated more like a residential loan that is insurable by HUD. The government insures against losses due to mortgage defaults, thereby making these loans far less risky for lenders. Lenders will then offer more competitive interest rates and better terms.
HUD’s goal is to attract private real estate investors toward revitalization projects. Absent the government’s backing, these projects would be viewed as too risky and unprofitable. The Section 220 program is available for properties with two or more units in urban-renewal areas, in neighborhoods where there has been significant code enforcement and in areas targeted for urban development. The urban-renewal mortgage is an excellent example of how the federal government is attempting to use national policy to improve individual neighborhoods throughout the U.S.
Section 220 loans have both commercial and residential loan features and are, in essence, a hybrid of a commercial and residential loan. Like a commercial loan, HUD’s urban-renewal mortgages cater to real estate investors but, unlike most multifamily loans, also allow for the owner to occupy the property — a feature that is typically found only in residential lending. Underwriters of multifamily loans usually decline to allow these properties to be owner occupied because it makes the foreclosure process more difficult.
Section 220 loans are less common than the agency’s Section 221 loan program, which provides construction and permanent financing for multifamily projects. The Section 220 program, however, can be more suitable for high-density urban areas than Section 221 because a greater percentage of the building can be used for commercial purposes. Section 220, for example, may be a better fit for a mixed-use building that has retail and office space on the lower floors and apartments on the upper floors. The Section 220 program limits the amount of nonresidential space to 25% of the gross square footage and 30% of the gross revenue, according to HUD.
These loans provide surety and stability for the borrower, as well as flexibility for the lender. The mortgages have exceptionally long terms, extending for as long as 40 years or 75% of the estimated economic life of the project, whichever is less. Maximum available loan amounts are calculated for each county and lenders may reduce the maximum to fit their own lending guidelines.
Other factors suggest there could be more demand for Section 220 loans. Successful multifamily investors hunt for ways to get the most for their mortgage buck, while also looking for investments that generate substantial positive cash flow. Redevelopment projects in renewal areas tend to have low purchase prices, enabling the investor to complete a project at a lower cost using a smaller mortgage.
Many real estate investors want to achieve a public good with their investment. Real estate investing can be tied to a philanthropic cause, fulfilling a community need and improving the economic condition of an area. The banking industry doesn’t have a reputation for being champions of social change, but commercial mortgage brokers have a chance to do their part by offering neighborhood-revitalization mortgages.
Collaborative community redevelopment projects have popped up across the U.S. These projects are stimulating less-fortunate areas with new education services, employment opportunities and housing options. They’re not a quick fix. Community initiatives are generally drawn out over decades, but give these areas a chance for success. Several cities have started urban-renewal efforts that should provide an opportunity to use Section 220 financing.
Detroit’s Strategic Neighborhood Fund has drawn considerable corporate sponsorship to boost development in the city. JPMorgan Chase, for example, recently contributed a $10 million long-term loan and $5 million for philanthropic efforts, with the money targeting commercial corridors across 10 neighborhoods, according to the Detroit Free Press.
Atlantic City, New Jersey, adopted the state’s Neighborhood Revitalization Tax Credit program to stimulate the Ducktown district. Massive tax breaks were packaged to business owners and landlords. The city and county then agreed to reallocate 60% of taxes collected in the area to invest into resources and infrastructure needs.
Section 220 loans come with special challenges, however. You will need to have a conversation with the borrower about expectations. These projects can take extra time to complete and the developer will have to meet certain standards to protect the tenants. Section 220 landlords are expected to provide functionally sound structures, operational utilities and fair rental prices, while being dedicated to remedying hazardous living conditions.
There is one last word about Section 220 mortgages: Discovering these hidden funding sources can be a way to stand apart from rival originators. The Section 220 urban-renewal mortgage from HUD can give investors a low-entry price point, as well as a chance to improve a community.
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Helping to finance mortgages in revitalization areas isn’t for everyone, but presenting your extensive knowledge of options could solidify client relationships. Commercial mortgage brokers can play a small but impactful role in neighborhood revitalization by offering loans designed to improve struggling American neighborhoods.