During a booming economy, programs offered by the U.S. Department of Housing and Urban Development (HUD) are just one of the many ways to finance apartments. HUD programs typically account for a small percentage of the annual multifamily mortgage market.
When lenders begin pulling out of the market in a downturn, however, HUD’s programs become an especially attractive option for apartment owners and developers. With the COVID-19 pandemic currently impacting all types of financing, it is important for commercial mortgage brokers to know that HUD is open for business and providing counter-cyclical relief.
The Federal Housing Administration (FHA), which is overseen by HUD, insures long-term, nonrecourse mortgages to owners of both market-rate and affordable multifamily properties, including independent senior communities. There also is a related program for health care facilities, ranging from assisted living to nursing homes. So, when are these programs best for your clients’ projects and how can you use them to the maximum effect?
FHA insures loans made by private lenders on apartment communities. This is similar to the mortgage insurance many folks use every day to finance their homes. Because the loans are insured by the U.S. government, the lender has much less risk, so the loans command low interest rates. And that’s the first advantage for the borrower — the lower rate allows your clients to borrow more with the same mortgage payment or borrow the same amount with a lower payment.
Since the federal government is insuring the loan, however, FHA loans have extensive underwriting requirements to ensure the agency isn’t taking undue risks. Your loan is processed, funded and serviced by a HUD-licensed lender that works with the agency to manage the application and approval process. The lender advocates for the best possible treatment allowed by the program’s regulations. The lender also arranges for the loan to be funded through the sale of Ginnie Mae mortgage-backed securities. These provide additional federal insurance to protect the end investors in the securities.
Borrowers pay an annual mortgage insurance premium (MIP) to compensate the government for the risk taken by providing the insurance. The costs vary depending on the program and property type. Even by including the MIP in the debt service, however, your client’s total cost of capital will still be quite low.
There are numerous types of HUD programs that fall under the umbrella of the Multifamily Accelerated Processing (MAP) guidelines. These are classified by the section of the National Housing Act that authorized them. Section 221(d)(4), Section 220 and Section 231 are three similar loan programs used for the new construction or the substantial rehabilitation of an apartment community. These programs combine a construction loan with a 40-year permanent mortgage. There is one application process for both components.
A big advantage of these programs is that a borrower can lock in an interest rate for the entire loan term before closing on the construction phase, so they have no interest rate risk during construction. Section 221(d)(4) is the standard program. Section 220 is used in urban redevelopment areas and opportunity zones, and allows more commercial space than the standard program. Section 231 is specifically for age-restricted communities in which everyone is 62 and older. For each of these programs, allow seven to 10 months to prepare the application, process it and close.
Other FHA programs are good options when refinancing. Section 223(f) is used for the acquisition or refinance of existing apartment communities. This program enables the borrower to cash out at a loan-to-value ratio of 80% or higher, and these loans have terms of up to 35 years. This program can accommodate considerable repairs and renovations, but there is a cap on the renovation costs that will vary by location. Allow six to eight months to apply, process and close through these programs.
Section 223(a)(7) is a streamlined refinance program for properties that already have an FHA-insured loan. The primary benefit is a reduction in the interest rate, although some borrowers may be able to reduce their ongoing MIP rate as well. The streamline program, however, doesn’t allow for cash out and permits only modest repairs. But since FHA has already insured a loan on the property, the underwriting is more limited and processing can be completed within three to four months.
FHA’s interest rate reduction loan allows the existing lender to modify an FHA loan to reduce the interest rate. This isn’t a refinance but a simple restructuring that may be helpful in certain situations. Processing is completed even more quickly than with a 223(a)(7) streamlined refinance.
Meanwhile, the Section 241(a) program is used to add an FHA-insured second mortgage to a property with an existing FHA loan for renovations and additions. This program is suited for FHA borrowers who already have low interest rates. The second mortgage allows the borrower to add a new phase to the development without refinancing. Loans are processed like a construction loan under Section 221(d)(4) and cash out is not allowed.
If you’re looking for long-term, nonrecourse financing with low interest rates and fairly generous loan sizes, going through the extensive HUD underwriting review can be well worth the effort.
Pros and cons
If you’re looking for long-term, nonrecourse financing with low interest rates and fairly generous loan sizes, going through the extensive HUD underwriting review can be well worth the effort. Each of these programs offer fixed-rate loans with no balloon payment at the end of the term, although prepayment penalties in the early years may discourage a borrower who wants to quickly flip a property. These penalties decline over time and are gone after 10 years.
Many affordable-housing developers use HUD loans in conjunction with the federal low-income housing tax credits program that encourages investments in affordable units. This program, however, requires a developer to set aside a certain number of affordable units. HUD’s loan programs also can stand alone without federal tax credits, should the developer want to avoid income and rent restrictions. So, using 221(d)(4) and 220 loans can be good choices for building market-rate, Class A communities in top-tier markets.
What are the biggest concerns that borrowers raise? With construction and rehabilitation projects, HUD requires developers to pay prevailing wages to workers under the Davis-Bacon Act. Timing is another issue. It can take some time to complete all of the necessary due-diligence and underwriting tasks, and prepare the application package for HUD. The agency also takes time to process and close the loans. Therefore, it’s helpful if you bring a lender into the transaction as early as possible. Acquisitions that must move quickly can use a bridge loan and follow up with a HUD refinance.
Finally, a few words should be said about the impact of the COVID-19 pandemic. HUD offices shifted to teleworking and senior leadership made it clear they were open for business. The staff continued to accept applications while processing and closing loans. As of late May 2020, as the country was beginning to reopen, senior staff continued to frequently revise their policies.
Naturally, this caused some hiccups for mortgage brokers and borrowers trying to complete deals. There have been some delays in closing new development projects because of construction delays. New loans are being protected with higher escrows when appropriate but are not overly penalized during what should be a temporary situation. Rehabilitation projects in which tenants remain in place have been especially challenging as HUD places resident safety above other priorities.
Overall, however, the agency has performed admirably during the health crisis. It also is clear that these loan programs will become critically important during this downturn to ensure that funding is available for worthy multifamily projects, and to help jumpstart the recovery. ●