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As real estate investors, we are always on the lookout for opportunities for unique and creative ways to finance our deals. At times, government programs incentivize certain types of real estate investing, and the HUD 223(f) loan is exactly that.
So how can real estate investors use the HUD 223(f) loan? In short, this program allows investors to acquire or refinance a multifamily property using a nonrecourse, higher leverage, low-interest rate, and lenient DSCR loan.
Here's an overview of HUD 223(f) for real estate investors, the pros and cons of this loan product, and whether real estate investors should try to get in on the action.
HUD multifamily loan 223F: An overview
Implemented in 1975, this HUD financing product was designed to help encourage the development and renovation of multifamily assets, particularly for affordable housing. This loan has had a reputation as being only for nonprofit, low-income, and affordable housing projects. This is a common misconception, and it’s why many real estate investors are missing out.
Although the application process can take a bit longer, the 223(f) multifamily loan has extended terms and amortization at lower rates than typical lending products. Because it’s a government loan, the loan submission requirements are burdensome.
The HUD 223(f) loan is also fully assumable. This also gives investors a unique exit strategy down the road if they want to liquidate, as potential buyers can assume the desirable terms (see below) of this lending product.
This loan is available to all multifamily assets, and despite taking a bit longer to close than traditional loan products, it has some key positive features that are worth noting:
- 35 years fixed amortizing loan period, but not exceeding 75% of the remaining economic life of the property.
- The loan can be assumable.
- Interest rates are competitive, but borrowers pay a mortgage insurance premium (MIP).
- Properties must be at least three years old.
- Units must have funding or replacement reserves.
- An annual audit of operations.
- Fixed interest rate determined by market conditions.
- 85% LTV or 80% if a cash-out refinance.
- DSCR: 1.18x for market-rate properties and 1.15x for affordable housing.
The MIP consists of a one-time fee of 1% of the loan amount, due on closing, and an annual fee of 0.60% of the loan amount for nonaffordable housing properties, or 0.45% for properties deemed affordable projects.
The 35-year term and low fixed interest rates eliminate some key risks for investors. First, there is no refinance risk associated with the longer term, and the prospect of rising interest rates is muted by the rate lock at a fixed rate. Further, personal liability is minimized because it's a nonrecourse loan.
The following are some of the disadvantages of the HUD 223(f) loan that real estate investors should note:
- The application process can take four to seven months.
- Much more paperwork and submission requirements.
- Higher cash reserves requirement (about $1,000 per unit).
- High application fees.
- MIP requirement.
- Annual CPA audit requirement.
As of March 2020, the HUD approval process was also updated to shrink the minimum age of the building from three years to 30 days.
Multifamily 223(f) acquisition and refinance checklist
According to HUD, there are a number of application requirements needed for this type of mortgage loan to help ensure a successful application. These include, but are not limited to, the following:
- FHA Application Fee (0.3% mortgage amount/$3.00 per $1000.00)
- Completed firm application checklist.
- Lender’s underwriting narrative.
- Resumes for individuals submitting third-party reports.
- Description of condition of property, list of repairs and improvements made in the last two years, and their estimated cost.
- Legal description.
- List of required repairs.
- Appraisal report.
- Phase I Environmental Site Assessment (ESA) [Phase1].
- Operations and maintenance plan.
- Preliminary title report.
- Verification of zoning and code variances.
- Evidence of utilities and municipal services (copies of monthly bills).
- Historical occupancy rates.
- Operating budget (12 months, including census mix and occupancy data).
- Initial lease-up budget.
- Articles of Incorporation and corporate bylaws.
The borrower can find all the Section 223(f) multifamily acquisition and refinance checklist instructions on the HUD website.
How can real estate investors use the HUD 223(f) loan?
Because the HUD 223(f) loan has better terms, longer amortization, and lower interest rates than traditional lending products, even those from Fannie Mae and Freddie Mac, this loan can be used in a number of ways by savvy real estate investors.
New acquisitions: Investors can simply leverage this loan to conduct a new re-sale acquisition as long as the loan requirements are met. Because this application process can take time, a longer due diligence period may be required before the multifamily borrower makes a deal firm. Further, you may want to consider running in parallel traditional apartment loan options should the HUD 223(f) loan not work out.
Value-add projects: The terms of the loan allow for the substantial rehabilitation of an existing structure and still benefit from the excellent terms of HUD 223(f). Refinance percentages of value-add projects are based on the criteria of the estimated value of the property after the renovations are complete at:
- 87% for projects with 90% or greater rental assistance.
- 85% for projects that meet the definition of "affordable housing."
- 83.3% for market-rate projects.
Refinancing: Under the terms of the HUD 223(f) loan, investors can conduct cash-out refinancing. These are allowed when 80% of value exceeds existing debt; however, only 50% of the net cash will be released at closing. In this scenario, the remaining 50% is held in escrow until all required renovation is completed.
Affordable housing: Rental assistance properties were built for the HUD(f) loan, as it gives even better terms for homes deemed to be affordable housing. Although these HUD loans can be used for market rate properties, they are designed for an affordable property with certain rent control restrictions.
The HUD loan is a low-interest rate and longer amortization loan available to investors that is also nonrecourse and assumable. This presents many unique opportunities for investors, even with the acquisition of assets that don’t qualify as affordable housing.
Although the application process can be a bit longer and more expensive, the benefits of this program surely outweigh the drawbacks. Real estate investors can use the HUD 223(f) loan to acquire resale multifamily assets, renovate existing ones, or refinance current properties in their portfolios.
Be sure to speak with an experienced broker for this type of loan product. As we head into 2021, this HUD loan is one savvy investors should consider using as a financing vehicle.
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