Investors in multifamily homes may want to consider leveraging the considerable incentives and benefits offered by 221d4 loans. Offered through the U.S. Department of Housing and Urban Development (HUD), and formally known as HUD Section 221d4, this program provides Federal Housing Administration (FHA) backing through approved lenders.
Perhaps the longest-term form of financing for fixed-rate construction and substantial rehabilitation (43 years with a three-year construction period), these kinds of HUD multifamily loans are available for newly built or substantially rehabilitated multifamily rental or cooperative housing or single-room occupancy (SRO) projects for moderate-income families, elderly, and the disabled.
There are no income limits for residents in a multifamily property funded by these loans, at least none imposed by the 221d4 program. And there's no maximum limit on the size of the loans.
These are not necessarily low-income housing loans
As one approved lender, ADROC Capital, says, "FHA/HUD commercial loan programs are often incorrectly associated with low-income housing. Indeed, (this) HUD loan program is a strong option for affordable and subsidized projects, many of which already benefit from other HUD subsidy programs. However, traditionally, the majority of projects financed under this program have been unrestricted market-rate multifamily projects, including Class A apartment complexes."
HUD says eligible borrowers for 221d4-insured loans include public, profit-motivated sponsors, limited distribution, nonprofit cooperatives, builder-sellers, investor-sponsors, and general mortgagors.
The minimum loan is for $4 million, and obtaining a 221d4 loan is more costly and cumbersome than a conventional loan, but they carry substantial benefits, in addition to the very long life of the note. Here are just a few:
- Nonrecourse: Investors and developers don't have to personally guarantee the loans.
- High loan-to-value ratio: Properties with 90% or more low-income units can get up to 90% LTV, meaning only 10% down. Market-rate properties can get 85% LTV, and properties meeting affordable housing criteria can get 87% LTV loans. Freddie Mac and Fannie Mae typically offer only 70% to 75% for fully amortizing, fixed-rate loans, while commercial mortgage-backed securities (CMBS) loans typically only go up to 80% LTV.
- LIHTC eligibility: Investors and developers can use tax incentives from the Low Income Housing Tax Credit (LIHTC) program with 221d4 loans, if the property qualifies.
- BSPRA eligibility: Builder Sponsor Profit Risk Allowance (BSPRA) rules allow the general contractor to defer taxable profits by using it as equity in the down payment and closing process for a 221d4 loan.
A lengthy, detailed process for approval
HUD loans are essentially asset-based -- thus the nonrecourse rule -- and the agency has an elaborate process for approving and funding 221d4 loans through its Multifamily Accelerated Processing (MAP) rules.
Working with a MAP-approved lender, the project sponsor begins by submitting required exhibits, which are then reviewed by HUD. If that passes initial muster, the sponsor is then eligible to submit a full underwriting package.
HUD says, "The application is then reviewed to determine whether the proposed loan is an acceptable risk. Considerations include market need, zoning, architectural merits, capabilities of the borrower, availability of community resources, etc. If the proposed project meets program requirements, the local Multifamily Hub or Program Center issues a commitment to the lender for mortgage insurance."
Here's a full checklist for the HUD process.
Commercial, retail space, substantial rehab rules, and mortgage insurance
Of interest to commercial real estate investors, retail space can be included in the projects but are limited to 25% of the net rentable area and 15% of underwritten effective gross income (EGI), although up to 30% of underwritten EGI is permitted in urban renewal areas.
There also are rules around qualifying as a substantial rehabilitation, primarily that the cost of repairs, replacements, and improvements to the existing property must exceed, a) the greater of 15% of the replacement cost of the property after completion of all work or $6,500 per unit adjusted by the local HUD office for high cost percentage in that area, or b) the replacement of two or more buildings, regardless of the cost.
Property mortgage insurance also is required, paid at closing for each year of construction and then every year after that. The mortgage insurance premium depends on the type of property. Currently, according to the Hud.Loans advisory firm, it's 65 basis points for market rate properties, 45 basis points for Section 8 or new money LIHTC properties, and 70 basis points for Section 220 urban renewal projects that are not Section 8 or LIHTC.
The long processing and closing times and substantial mortgage insurance and other costs, substantial escrow commitment, auditing, inspections and owner distribution requirements -- as well as rules around qualifying working capital and providing affordable properties -- that come along with 221d4 loans can make them prohibitive for smaller developments. But it's an attractive option if it's a fit for private investors and nonprofits with the resources to pursue these kinds of projects.