HUD 221(d)(4) Loan for Multifamily Construction

By Terry Painter/Mortgage Banker, Author of The Encyclopedia of Commercial Real Estate Advice – Wiley Publishers, Member of The Forbes Business Council

 

The HUD 221(d)(4) Loan is for new construction or substantial rehabilitation of multifamily properties of 5 units or more. Multiple residential buildings of 1 – 3-units on one or individual tax lots that are not allowed. However, multiple 4-unit buildings that are contiguous are acceptable. Mixed-use properties are accepted where the commercial space is no more than 25% of the rentable square footage or 20% of the gross rental income. This is a 3-year construction loan that rolls over to a 40-year fully amortizing permanent loan. 

 

HUD 221(d)(4) Requirements and Guidelines

For New Construction or Substantial Rehabilitation of Multifamily Properties

• Loan Sizes:  $10,000,000 minimum, Unlimited Maximum
• Loan Modification Allowed to Lower Rate if Rates Come Down
• Mixed Use:  25% Commercial Space Allowed
• Loan to Cost: 85% Market Rents, 87% Affordable Rents, 90% Subsidized Rents
• Up to 3 years on Construction Loan
• 40-Year Fixed Rate on Permanent Loan at the same rate as the construction loan
• 40-Year Term and Amortization on Permanent Loan
• 1.176 DSCR  - Market Rents,1.15  - Affordable Rents, 1.11 – Subsidized Rents
• Non-Recourse
• No Tax Returns
• No Debt to Income or Global Ratio for Borrower 
• Assumable with a .50% fee
• Loan Fee: 1 – 2%
• HUD Approval Fee: .30%
• HUD Exam Fee: .40%
• Mortgage Insurance Monthly: .25% for Green, .60% for Standard Properties
• Replacement Reserves Required Monthly for Future Repairs and Replacements
• Current Multifamily Ownership Experience Required
• Current Multifamily Development Experience Required
• Any size Market Okay
• Good Credit Required
• No Minimum Net Worth Requirement
• Declining Prepayment Penalty 1st 10 years
• Rate Lock at Loan Approval.
• 9 – 10 Months for Closing

 

Advantages of HUD 221(d)(4) Multifamily Loans

As a commercial mortgage banker since 1997, the most fun part of my job is working on ground up construction deals. What I love the most is teaming up with the developers who I find to be some of the most creative, interesting, and resourceful entrepreneurs on the planet. They take the greatest risks and if the project is successful, reap the largest rewards.     

 

Construction Loan Rolls Seamlessly Over to a 40-Year Fixed Perm Loan                    

My favorite multifamily construction loan product is without question the HUD 221(d)(4).  Why? Because it is a Non-Recourse Loan and has the highest loan to cost and lowest Debt Service Coverage Ratio, which means I can lend more money. Also, this program can lend in any size community anywhere in the country and is one of the few multifamily construction loans that roll over seamlessly to a 40-year fixed fully amortizing permanent loan, after up to a 3-year construction loan.

 

The 221(d)(4) Loan to Cost is Not Limited by an Appraisal

All other commercial construction loans have their loan to cost limited by the LTV on an estimated appraised value on the completed stabilized project which might take 2 years to build and rent up. This makes this value very speculative. This almost always results in a lower loan to cost which lowers the risk for construction lenders. HUD appraisals are an exception to this. And although they do contain a value for the land, they do not contain a value for the completed rented project. So, most of the time results in a higher loan to cost as the loan size is not limited by future appraised value, but just by projected net operating income. 

 

Perm Loan Rate Locked when you Lock Your Construction Loan Rate

HUD 221(d)(4) Loan Rates, are often the lowest commercial construction loan rates.  Amazingly, you get one of the lowest rate construction loans that rolls into a permanent loan at the exact same rate locked on your construction loan. Can you imagine what a benefit it is to not have to live with the uncertainty of a year or more as the project is being built and rented to find out what your perm loan rate will be?  Click on this link to learn about all the important aspects of HUD Multifamily Loans in detail. 

 

And here’s a HUD Multifamily Loan Glossary with 74 terms defined for a fast look up.

 

Lower Your Rate in the Future with a Loan Modification

If rates come down in the future from the rate on your perm loan, simply apply for an interest rate reduction loan modification and exchange it for the lower rate on the principal balance. All other loan terms stay in effect. Process takes about 90 days and there is a nominal fee involved. 

 

Bring Less Cash to the Closing Table with BSPRA

The HUD 221(d)(4) is the only construction loan that allows the developer to put less money down by using a tool called BSPRA. This stands for Builder Sponsor Profit & Risk Allowance. This provision allows the contractor to contribute their profit on the project as equity, in exchange for a small percentage of ownership in the project. This can reduce the developer’s cash at closing by as much as 3%, and also give the contractor a strong incentive to perform since they are a minority partner. 

 

Large Loans are not a Problem for HUD 

Where most multifamily construction lenders have major heartburn on loans over $20 million, HUD is not intimidated by loan size if the market supports a larger project.  However, HUD does scrutinize projects much more on loan requests over $75 million.  Recently, I booked a $66,070,000 HUD 221(d)(4) loan to build 372 units in Houston for Pierre, a previous developer client of mine. This guy was born to invest in commercial property. I made his first multifamily loan when he was only 19. That was 21 years ago.  He had come to me 8 months ago with this project roughed out. I told him that in this high interest rate climate, and with the threat of recession, the only loan program I felt confident we could hit a home run with was HUD. Because it would take too much time to close, he wasn’t interested. 

 

Pierre took the deal to every bank he knew and some life companies as well. It was really important to him to build the project in one phase. The banks couldn’t do a loan that large and wanted to break it up into many phases. The insurance companies could only lend up to 65% of cost and wanted to do it in 2 phases. We consulted with Pierre to partner with another developer who had extensive HUD experience so the project would qualify for being built in one phase. With a current market study in hand we got the deal pre-approved last week by HUD for all 372 units in one phase and the 75% loan to cost he wanted. 

 

Raise Most of the Down Payment from Investors

HUD is exceptionally user friendly for developers who want to raise most of the down payment from investors. On the project mentioned about Pierre is using a Real Estate Syndication to raise capital from private investors.  Click on these links to learn more about the Advantages of HUD Multifamily Loans and the Disadvantages of HUD Multifamily Loans.  

 

Disadvantages of HUD 221(d)(4) Loans

Prevailing Wages Required

Now that I’ve wowed you with some of the pros of the 221(d)(4), let’s go over some of the cons. Number one is that it’s going to take a good 8 months to close one of these loans. Take a look at the time frame further down in this article. Second on the list is that HUD requires that the contractor pay Davis-Bacon Wages, also called the prevailing wage. This raises the cost of labor – especially during tough economic times when there is often an abundance of construction workers. During boom times, wages tend to go up close to where prevailing wages are set.  Because of the lower construction loan rate and the 40-year amortization on the perm loan, your monthly payments will still be lower than building conventionally without HUD.  

 

Larger Stronger General Contractor Necessary 

HUD 221(d)(4) loans work best when the developer chooses a larger financially strong general contractor with HUD experience. The GC will need to be capable of posting a performance bond or have 15% of the hard costs in working capital.  

 

Two Stage Approval Process

After HUD preapproves the project after the concept meeting, It will take the lender 1.5 to 2 months to prepare the pre-application and submit it to HUD. If HUD feels the project is viable, they will issue an invitation letter allowing the lender to apply for the loan. Most developers wait to have their plans and specs completed until they get the invitation letter from HUD. After about 90 days with plans and specs completed and a firm itemized construction contract, the lender submits the firm application to HUD. HUD ideally will take 45 days to approve the loan, but this can take up to 90 days if HUD is slammed.

 

To save time, if the developer has the plans and specs completed at the beginning, HUD might allow them to go Straight to Firm. This makes this a one step approval process that can trim several months off the time frame.  

 

Higher Closing Costs Including Mortgage Insurance

Another disadvantage is that these loans have higher closing costs than most commercial loans. A market study, appraisal and environmental report will is required. There is a loan fee to the lender, HUD and an initial fee to start mortgage insurance premium, which is required because of the high leverage of most of these loans and so HUD can guarantee the loan.   

 

Minimum Loan $10,000,000 Loan Size                                                                  

The 221(d)(4) doesn’t work for small loans. Because of all the work and time involved, most HUD lenders require a minimum loan of $10 million.  

HUD 221(d)(4) Time Frame (although estimated at 8 months, it can take longer if HUD is slammed)

Part 1  PRE-APPLICATION    60 Days

     1. Project has had a successful concept meeting with HUD

     2. Order Appraisal, Market Study and Phase 1 Environmental Report 30 days.  

     3. Pre-Application Package is assembled by the lender with and sent to HUD  

Part 2   HUD INVITATION Letter Issued – 45 Days

     1. HUD has 45 days to review the package and invite the borrowers to apply 

Part 3    FIRM APPLICATION SUBMISSION – 60 Days 

     1. Plans and Specs are completed
     2. General Contractor Issues Firm Construction Contract
     3. Architectural & Cost Review completed by third party vendor
     4. Underwriting completed by the lender
     5. Firm Application is completed and sent to HUD

Part 4   HUD Review of Firm Application & Firm Commitment – 45 days

HUD takes an average of 45 days to review the firm application and issue a firm commitment letter

Part 5  CLOSING -   30 Days

      1. Rate is Locked

      2. Documents are prepared 

      3. Documents are review by borrowers attorney and signed by the borrower 

      4. HUD's attorney reviews the signed documents

      5. Loan Closes.

Total  240 days =  8 Months 

 

Eligible Properties

The HUD 223(f) requires Multifamily properties to have 5 units or more. Multiple residential buildings of 1 – 3-units on one or individual tax lots that are contiguous are not preferred by HUD. However, multiple 4-unit buildings that are contiguous and on one or individual tax lots are acceptable. Mixed use properties with a maximum of 25% commercial space are acceptable. 

 

For a property to qualify for substantial rehabilitation the cost of repairs, replacements and/or improvements to the existing property must exceed $15,000 per unit adjusted by the applicable high cost factor for that sub-market; or two or more major building components are being replaced regardless of cost (plumbing, electrical, HVAC, are examples of building components).  

 

This program is permitted for age-restricted properties under section 231 as long as all occupants are 62 or older. 

 

Eligible Borrowers

Borrowers must have current multifamily ownership experience and prior development experience of a similar size project. Having HUD ownership and development experience is a plus.  

 

Professional Management

HUD does not encourage self-management but does not mandate that the borrower cannot self-manage. I always recommend that first time HUD 21(d)(4) multifamily borrowers that want to self-manage hire professional management with HUD experience for at least the first year or two until the ropes are learned. Otherwise, it could be a daunting task to figure out the extensive paperwork required by HUD as it pertains to the property’s maintenance/repair and financial requirements which tie into the required annual financial audit. 

 

Other HUD Requirements

• Working Capital Escrow – New Construction: 4% of loan amount (2% allocated to construction contingency and 2% to working capital expenses)
• Working Capital Escrow – Substantial Rehabilitation: 2% of loan amount
• Construction contingency balance at final endorsement may be released at that time
• Unused working capital and initial operating deficit escrows to be released later of 12 months from final endorsement or 6 consecutive months of break-even occupancy
• Initial operating deficit escrows will be required and can be posted in cash or letter of credit, which will be the greater of:
• Amount determined to be appropriate based on underwriting analysis and appraisal;
• Three percent of the mortgage amount; or
• Four months debt service (principal and interest and MIP) if the property is walk-up, or 6 months debt service if the property is an elevator building where a single certificate of occupancy must be issued before any of the units or entire floors can be rented.
• The absorption period used in estimated market demand for the proposed number of units is restricted to 18 months
• Any “off-site” construction costs or demolition costs require separate funding by the borrower
• An “Initial Endorsement” will commence the construction phase
• The general contractor must pay Davis-Bacon prevailing wage rates as required by the Department of Labor
• The mortgagor must retain a qualified arms-length supervisory architect during construction
• A cost certification for the owner will be required after construction completion. General contractors are required to submit a cost certification if there is an identity of interest with the borrower
• The general contractor must execute a lump sum or cost plus contract depending on relationship between owner and contractor, provide a 100% performance and payment bond (or cash escrow or letter of credit acceptable to FHA), and have liquid net worth equal to at least 5% of the project construction contract plus all other uncompleted construction work
• FF&E may be included in the mortgageable project cost
• Large loan sizes are subject to more conservative underwriting
• Escrows for property taxes, insurance, MIP and replacement reserves required

 

Getting Pre-Qualified

Call one of our friendly highly experienced loan officers to discuss your transaction to see if you and the property are a fit for a HUD 221(d)(4) loan. We will be pleased to size a loan for you that will give you a quote for maximum loan amount, along with loan expenses and projected time involved.