Getting Creative: HUD 221 (D) (4)

By: Andrew Hanzl

Take notice! The landscape is shifting: In anticipation of a market slow-down, commercial real estate lenders are dialing back their leverage and exercising greater caution with lending practices. This isn’t necessarily however, a cause for concern – your deal can still go through. The financiers at Metropolitan Capital Advisors (“MCA”) understand how to dig deep, get creative, and still make successful deals in this changing market! In fact, we are currently working on a highly leveraged loan request to develop a large multi-family project in a secondary market in Utah. We consider this a request to tackle headfirst in the challenging current environment! We know that the capital is available if we are creative in our approach and look for it hard enough. We searched far and wide, showing this particular deal to over 50 capital sources including: local, regional, and national banks; life insurance companies; and, agency debt. We even considered sourcing a piece of preferred equity in our pursuit to complete the assignment.

If you are currently seeking a similar loan to facilitate the development of an apartment complex, you may want to think outside the box and consider the Housing and Urban Development (“HUD”) 221 (d) (4) loan program. Guaranteed by the U.S. Department of Housing and Urban Development, this category of loan is the highest leverage, lowest cost and least liability (non-recourse) fixed rate loan currently available. The leverage is far more aggressive than is available at conventional banks – most currently max out at 75%, (if you are lucky!)  where the 221 (d) (4) program leverage starts at 83.3% LTC for market rate properties and tops at an astounding 90% LTC for rental assistance properties.  Additionally, it offers a 40-year fixed and fully amortizing term with interest rates between 3.95% and 4.30% (as of March 2017).  Further sponsors are also given a three-year interest only period during the construction phase (making this effectively a 43-year loan).
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The single combined structure (construction + permanent) eliminates both the interest rate risk at takeout as well as the payment of additional fees upon conversion.  The program is not only available for development deals, but also for existing properties requiring substantial rehabilitation. It caters to all project sizes, starting from loans as small as $2 million. Although there is technically no limit, loans over $40 million are subject to more conservative leverage and DSCR restrictions. Another advantage of the 221 (d) (4) program is that the loans are non-recourse (subject to standard carve outs) during both the construction and permanent phases. This feature is rare amongst other sources of capital. Forty years is a long time to own a property and therefore sponsors are often concerned about disposition. Buyers are able to fully assume 221 (d) (4) loans subject to FHA approval and a small fee.

Clearly the program has a lot of upside for sponsors, however, it does come with some disadvantages. Like with most things that involve the Government, the process is time consuming, thorough, paperwork intensive, and, comes with additional fees. Let’s take the example of the timing for affordable and rental assisted properties: it is typically a 5 to 7 month timeline from loan start to close.  For market rate properties the timeline is closer to a year (8-12 months). It usually takes 90 days just to secure a soft commitment that basically says they ‘like’ your deal! Unlike bank loans, HUD loans are absolute asset based, which require a longer time to scrutinize the location, pro-forma rents and expenses, and the experience of the sponsors. Another issue with the program is that it is fee intensive, 5.3% of the total loan amount is paid up-front.

Nonetheless, despite the higher fees as compared to traditional bank financing, the attractive structure and low interest rate is well worth the additional costs. Furthermore, the properties are carefully monitored to ensure they are performing on an ongoing basis. HUD loans require an annual audit of operations. The tighter monitoring of the cash flow results in less frequent distributions to equity investors; restricted to every 6 months or annually – where banks permit distributions monthly or quarterly.

Although not often considered for multi-family development, the HUD 221 (d) (4) program offers tremendous benefits for sponsors willing to wait for approval. Navigating the process can be overwhelming, but an experienced mortgage broker can help and simplify the process tremendously. If you would like more information about HUD financing, or help securing other forms of capital please contact Andrew Hanzl at ahanzl@metcapital.com.

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