FHA/HUD

What are HUD & FHA Loan Executions?

The Department of Housing and Urban Development, also known as HUD, oversees and guarantees residential and multifamily lending and insurance programs throughout the country. The Federal Housing Administration, or FHA, is recognized as the loan insurance provider for these programs. These loan programs are in place under the federal government to promote investment in real estate - both commercial and residential. For single family homes, they tend to be more flexible with interest rates, credit worthiness, and down payments because the properties that they work with are cheaper and all-in-all less risky than a commercial property. Additionally, most single-family home borrowers plan on actually living in or renovating their FHA/HUD-financed home. On the other hand, multifamily loans are most typically granted to investment firms who have a business plan to make rental income on the property. Therefore, the vetting process for multifamily borrowers is slightly more standardized than single family and places greater emphasis on the sponsor’s ability to operate their asset.

Real estate industry players tend to view the FHA and HUD as synonymous, but HUD also holds a wide array of responsibilities outside of real estate lending. 

Difference between HUD and FHA:

Although HUD & FHA are commonly viewed as interchangeable, there is one main distinction between their functionalities and the programs that they offer, that is, HUD oversees the FHA. The FHA provides mortgage insurance for single family and multifamily loan programs, but the regulations that encompass these programs are enforced and guaranteed by HUD. Both HUD and FHA aim to increase safe and affordable rental housing options, fight housing discrimination, and reduce the level of homelessness on a national scale. 

Commercial Multifamily Loans:

Multifamily mortgages, provided by FHA/HUD through their rental property loan program, are referred to as Section 207/223(f) loans. The purpose of these mortgages is to enable borrowers to purchase or refinance an existing multifamily property and extremely agreeable terms while protecting lenders against a loss on mortgage defaults. They also allow for the financing of long-term mortgages through Government National Mortgage Association (GNMA) Mortgage-Backed Securities. HUD 223(f) mortgages are made available for purchase on the secondary mortgage market, so loan funds are more accessible and interest rates are more favorable. 

The requirements of a Section 207/223(f) loan are the following:

1. Units must contain at least 5 units with complete kitchens and baths.
2. Units must have been substantially rehabilitated or complete at least 3 years prior to the date of the application for mortgage insurance.
3. Units must not be in need of significant repair work.
4. Any critical repairs must be done prior to closing; non-critical repairs can be done after closing.
5. The mortgage term cannot exceed 35 years or 75 percent of the lifespan of the property’s physical improvements.
6. Both for profit and non-profit borrowers are eligible to apply.

What is the HUD 221(d)(4) Loan?

The HUD 221(d)(4) loan was created for the purpose of construction or substantial rehabilitation on qualifying multifamily properties. Multifamily developers can use this loan type to build developments ranging from market rate to low income, rental assistance and other multifamily development projects. 

Characteristics of HUD 221(d)(4) Loans:

1. Loan size can range from $2 million to $100 million or more.
2. Can take a long time to close, between eight months and a year.
3. One of the only fixed-rate construction loans in the multifamily development business.
4. They offer some of the lowest rates and highest loan-to-cost proceeds in the industry.
5. These loans are a great fit when merged with the LIHTC (Low-Income Housing Tax Credit) Program. 

Benefits of an FHA/ HUD Loan:

FHA/HUD loans can be significantly advantageous for commercial real estate investors. Their generous terms include low interest rates, high leverage, and long payoff terms. For investors that are purchasing, building or renovating multifamily properties, this may be a worthwhile opportunity to look into. See below.

1. The FHA’s guarantee of FHA/HUD loans allows lenders to know that a default is protected against. As a result, they are able to provide more generous commercial loan terms.
2. FHA/HUD loans are non-recourse, meaning investors cannot be held liable for the balance remaining on the loan. 
3. Higher leverage loans are available given the insurance that backs every deal. Loan-to-value ratios of 80%, and sometimes 90%, are common and significantly higher than typical conventional loan programs (banks, agencies, debt funds, etc.) that offer between 65% - 80%. 
4. The size of FHA/HUD loans can range from a few hundred dollars all the way up to millions.
5. Amortization can be anywhere between a few years and decades, with some programs even going through 30 years.
6. Interest rates are lower on average, often below-market rates when being compared to conventional loans. 

Hurdles of HUD-Insured Loans:

Despite all of the benefits of FHA/HUD-insured Loans: lengthy term availability, high leverage, rates, and amortization of up to 35 years, there are some hurdles that a borrower must overcome before committing to the FHA/HUD process. One example is that FHA/HUD-insured loans require annual financial audits that can cost up to $2,500 per year. Additionally, the length of time that it takes to close a HUD-insured loan is quite lengthy. For example, 223(f) loans can take up to 120 days and 221(d)(4) loans take even longer (10 or more months). Finally, HUD requires third-party assessments and closing costs, which add to the upfront spend that borrowers must be able to afford in order to close. 

Conclusion:

With fixed origination costs, lack of ideal terms for small balances, and a long application timeline, HUD-insured loans are best suited for a very specific subset of borrowers. They must be able to meet certain requirements, such as proof of operational experience and  a solid business plan, supported by reasonable underwriting parameters and market comparables. With benefits such as low interest rates and high leverage, this may be a worthwhile funding avenue for specific investor groups. On the other hand, if timing is a big factor in their deal - i.e. they need financing quickly - this loan option may not be the best choice. Since all loan applications are reviewed solely by FHA/HUD, underwriting of the loan takes longer than conventional commercial real estate loans. If your project requires a quick closing or immediate renovations and progress, this component may stall the approval process. Prepayment penalty structures can also function as an obstacle, preventing borrowers from paying off the loan sooner than expected. All of these considerations are key when choosing to opt for FHA/HUD loans for commercial real estate projects.