Housing and Urban Development (HUD)

Yes, it is eligible for a refinance with a HUD-insured mortgage, per the 2020 MAP Guide, effective March 18, 2021.

FHA/HUD-insured programs do not offer supplemental loan programs like those offered by GSEs. However, there are a few options available to borrowers with HUD-insured loans: (1) a borrower with an existing HUD-insured loan may access HUD’s abbreviated refinance program, Section 223(a)(7). The main purpose of this program is to lower the interest rate on the existing loan and/or completed desired repairs to the property. (2) A borrower may pursue a note modification in an advantageous interest rate environment and lower the interest rate on the HUD-insured first mortgage if all other terms are kept the same. (3) A borrower may obtain a supplemental loan (pursuant to Section 241a) to fund major capital improvements or additions to an existing property.

Secondary financing is permitted under HUD’s programs but it is highly restrictive. Any subordinate debt must comply with certain requirements, most notably, the term of the note must at least be equal to the term of the HUD loan (35 or 40 years) and repayment is restricted to surplus cash (cash flow) only. HUD will allow a preferred equity arrangement if there are no prescribed cash flow payments and any changes to key principals cannot occur without HUD approval.

For insured loans less than $75 million, HUD does not have any specific financial requirements for a sponsor’s key principals and the recommendation is based on the judgement of the lender and its underwriting team. For loans, greater than $75 million, a sponsor’s key principals must have, in aggregate, a net worth equal to at least 20% of the loan amount and liquidity equal to at least 7.5% of the loan amount. This requirement may only be waived on affordable housing transactions.

HUD experience is not a requirement to be approved as a property owner, contractor or manager requesting a HUD insured loan. HUD does, however, require the property team to have experience in developing, owning or managing similar properties to the subject.

Generally, HUD does not permit an early start to the construction process and no work may take place on a site once the application process has begun. After receipt of a firm commitment, approval for an early start may be granted by HUD under certain conditions. Some work, such as clearing, grading, minor demolition, environmental remediation or other minor preliminary work may be permissible.

Generally speaking, the HUD underwriting process involves a higher degree of paperwork to complete the application. There are numerous HUD forms and certifications which are required for the borrower/sponsor, key principals, management agents, general contractors, etc. The overall scope of due diligence is similar to a GSE loan application. HUD’s guidelines and underwriting practices are more focused on risks associated with, environmental and fair housing/accessibility issues.

The Section 221(d)(4) program is considered a cost-based program with a maximum loan to cost of 85-90%. HUD underwriting guidelines only allow for a finite list of costs and exclude some costs that conventional developers may be used to including in their development budgets. The most common costs include: developers fee, contingency, lease-up reserve, marketing expenses, demolition and off-site improvements, but some of these items are considered in the HUD-required reserves which can be posted in either cash or letter of credit. While the program outlines a maximum loan to cost of 85%, it also allows for BSPRA, which can result in cash out when there is land equity.

An owner must provide annual audited financial statements to HUD for review within 90 days of the property’s fiscal year-end. This audit should contain a calculation of surplus cash (cash flow), which is the basis of cash distribution to ownership. Distributions can only be made upon audit review and approval twice per fiscal year. An owner must also comply with annual REAC (physical) property inspections. REAC scores are on a scale of 0 – 100, with below 60 considered to be failing. High scoring properties can obtain waivers of future inspections for a period of one or two years depending on the score.

A replacement reserve account is required to be maintained during the life of the loan. The replacement reserve account is structured according to a replacement schedule of the property’s capital items and withdrawals are typically made consistent with this model. HUD loan documents also require a PCNA Report every ten (10) years to measure the adequacy of the property’s replacement reserve account. If a property has qualified as Green/Energy Efficient and received a reduced MIP, HUD will require annual energy testing and compliance with a minimum Energy Star score of 75.

BSPRA stands for Builders/Sponsors Profit Risk Allowance. It is an option under the Section 221(d)(4) program which requires: (1) an established identity of interest between the borrower and general contractor and (2) the general contractor’s profit to be satisfied outside of loan proceeds. In exchange for this structure, the recognized costs in a development (not including land) are artificially increased by 10%. The 85% loan to cost calculation is then made on the higher cost figure. This results in a higher insured loan amount (roughly 93% of recognized cost) provided minimum debt service coverage and statutory mortgage limits support the underwriting. BSPRA is not available on Section 241(a) and requires a cost-plus construction contract.

Commercial space limitations vary, depending on the mortgage insurance program. Under Section 221(d)(4), the maximum allowable commercial space is 25% of total rentable project area and the maximum underwritten commercial income is 15% of project income. Also, as part of the Section 221(d)(4) program, commercial occupancy is limited to 80%, regardless of the market occupancy. In the determination of total development cost, HUD will recognize the cost of completing white box commercial space only. Any tenant specific improvements are a cash requirement of the sponsor. Under Section 223(f), commercial space is limited to 25% of total net rentable space, and the maximum underwritten commercial income is 20% of project income. Section 223(f) permits a maximum 90% occupancy factor on commercial income.