The FHA / HUD 221(d)4 loan program provides attractive, federally insured financing for new construction and substantial rehabilitation of multifamily apartment rental development projects. The credit enhancement afforded by the FHA / HUD loan insurance program allows for the type of construction financing that is virtually unmet in the market. Key characteristics of this 221(d)4 loan program include:
The following is a more detailed discussion on the 221(d)4 loan program. A summary term sheet can be accessed here: 221(d)4 Term Sheet.
Eligible properties include multifamily apartment rental projects with 5 or more units in all 50 states. At least 50% of residential buildings must contain or 4 or more units. Detached single-family subdivision rentals are not eligible.
FHA / HUD commercial loan programs are often incorrectly associated with low-income housing. Indeed, the FHA / HUD loan program is a strong option for affordable and subsidized projects, many of which already benefit from other HUD subsidy programs. However, traditionally the majority of projects financed under this program have been unrestricted market-rate multifamily projects, including Class A apartment complexes.
To qualify as substantial rehabilitation, the scope of repairs needs to exceed $15,000 per unit adjusted for the HUD published local high cost factor, or replace two or more major building systems. The five major building systems identified by HUD regulations include: (1) structural frame, (2) building envelope, (3) mechanical, (4) electrical, and (5) plumbing.
This HUD loan program is intended to promote housing. Accordingly, commercial space is generally limited to 25% of net rentable area and 15% of effective gross income. In qualified urban renewal areas, HUD allows up to 25% of net rentable area and 30% of effective gross income for projects.
The Owner/Mortgagor entity can be either for-profit or non-profit, but must be a single asset entity whose sole asset represents the project under financing consideration.
FHA / HUD insured loans are generally non-recourse. No individual assumes personal liability for payments due under the loan documents or not under its control. However, key principals can be personally liable for retaining project funds or property which it is not entitled to or for authorizing the conveyance, assignment, transfer, pledge, encumbrance, or other disposition of the mortgaged property without prior approval from HUD.
The FHA / HUD 221(d)4 loan term covers the anticipated construction period plus two months during which interest-only payments are made; after which the loan converts to a fully amortizing loan with a 40-year term.
|
Year
|
Average
|
|
2019
|
3.90%
|
|
2020
|
3.13%
|
|
2021
|
2.86%
|
|
2022
|
3.89%
|
|
2023
|
5.77%
|
|
AVERAGE
|
3.74%
|
Between 2019 and 2023, average interest rates on 221(d)4 loans ranged from approximately 2.85% to 5.80%, according to HUD published data. You can visit here for more current indications.
The loan sizing parameters for FHA / HUD 221(d)4 loans below $125 million are as follows:
|
Property Type |
Loan-to-Cost |
Minimum DSCR |
|
Market Rate |
85% |
1.176x |
|
Affordable |
87% |
1.15x |
|
Subsidized |
90% |
1.11x |
The loan sizing parameters for FHA / HUD 221(d)4 loans at or above $125 million are as follows:
|
Property Type |
Loan-to-Cost |
Minimum DSCR |
|
Market Rate |
75% |
1.30x |
|
Affordable |
80% |
1.25x |
|
Subsidized |
87% |
1.15x |
Affordable is generally defined by HUD as those properties having at least 40% of units @ 60% AMI or 20% units @ 50% AMI. Subsidized is generally defined by HUD as those properties having greater than 90% units subject to LIHTC restrictions or project-based rental assistance.
HUD program requirements generally do not allow for 221(d)4 loans to be prepaid during the construction period of the loan. Lockout and prepayment penalties after construction are negotiable, but best interest rate pricing is typically secured with a 10-year call protection (a lockout period and/or prepayment penalties over the 10 years following construction).
Sample prepayment penalty language from a Note of a HUD insured loan.
A common prepayment penalty structure is the “10-9-8-7-6-5-4-3-2-1-0” structure where the prepayment penalty is 10% in year 1 following construction, followed by a 1% reduction upon each 1-year anniversary so that the prepayment penalty is 0% upon the 10-year anniversary. Shorter call protection may increase the interest rate the FHA Lender is able to offer. For example, borrowers have been quoted a 50-60 basis point interest rate premium for a shorter 5-year call protection.
221(d)4 loans are fully assumable, subject to Lender & HUD approval and fees. HUD typically imposes a 0.50% TPA (Transfer of Physical Asset) fee for full ownership transfer transactions. Lender fees may vary but are typically commensurate with incurred legal and administrative fees.
Typically, lender financing fees range from 1.00% - 2.00%. Lender financing fees are determined based on market conditions and the size and complexity of the proposed transaction, subject to HUD limitations. Current HUD regulations permit maximum lender fees on 221(d)4 loans up to 3.50% of the loan amount, except on transactions involving bond financing where such fees are permitted up to 5.50%. HUD regulations further note that such fees are usually 2.00%. Such fees are collected at closing.
HUD imposes an application fee of 0.30% of the loan amount to review the application to determine whether the proposed loan qualifies for HUD mortgage insurance. If the application is being filed in two stages, one half of the HUD application fee is due at Pre-Application submission to HUD with the balance due at Firm Application submission to HUD. If the Application is being filed in one stage (referred to as “Direct-to-Firm” submission), and for affordable projects, the full HUD application fee of 0.30% of the loan amount is due at Firm Application submission. The final application fee owed to HUD is based on the final loan amount at closing. Any difference between the fee(s) paid at application submission and the fee owed based on the final loan amount is due at closing.
HUD imposes an inspection fee equal to 0.50% of the loan amount for new construction projects and 0.50% of the total cost of improvements on substantial rehabilitation projects. This fee is intended to cover HUD’s cost of performing site inspections during its initial review of the Application and post-closing to monitor construction progress. This fee is collected at closing.
0.25% annually for Green projects and Broadly Affordable projects,
0.35% annually for Affordable projects, and
0.65% annually for market rate projects.
The HUD mortgage insurance premium fee (HUD MIP) is a fee charged by HUD for providing a credit enhancement in the form of FHA mortgage insurance which provides access to the advantageous interest rate terms available under the HUD loan program. Presently, the initial and annual HUD MIP rates imposed by HUD are 0.25% for Green projects and Broadly Affordable projects, 0.35% for Affordable projects, and 0.65% for market rate properties. Examples of Green projects which qualify for the reduced 0.25% HUD MIP rate include projects that meet industry-recognized standards for green buildings including ENERGY STAR, National Green Building Standard, U.S. Green Building Council's LEED-H, and others. Such projects must achieve an ENERGY STAR score of 75 or better using EPA's Portfolio Manager. Examples of Broadly Affordable Projects which qualify for the reduced 0.25% rate include projects with 90% or more units that are subject to LIHTC restrictions or Section 8 project-based rental assistance. Examples of Affordable projects which qualify for the reduced 0.35% rate include projects with 10‐90% of their units subject to Low Income Housing Tax Credit (LIHTC) restrictions or Section 8 project-based rental assistance. Unrestricted, market-rate projects that do not meet HUD green standards are subject to a 0.65% MIP rate.
Here is a link to the most recent notice regarding HUD multifamily MIP rates.
Appraisal, Market Study, Phase I ESA, and Architecture and Cost Review are always required. Radon test reports are required on all projects following construction completion regardless of EPA radon zone. For projects involving sub-rehabilitation, asbestos test reports are required for projects built pre-1989 and lead-based paint test reports are required for projects built pre-1978.
The Appraisal completed for HUD 221(d)4 financing provides an estimate of the as-is market value of the development site and the projected income and expenses that the property will achieve upon completion and stabilization, which provides the basis for the Lender’s concluded land value used in the Loan-To-Cost mortgage calculation and income and expenses used in the Debt Service Coverage mortgage calculation in determining the final loan amount. The Market Study provides an in-depth supply-demand analysis to confirm whether there is sufficient sustainable demand for the proposed development as well as its surrounding market. The Phase I ESA determines whether any environmental conditions exist at the project that represent an unacceptable risk or which would require further action. The Architecture and Cost Review determines whether the project design meets HUD's design requirements – including Minimum Property Standards, local codes, and applicable accessibility requirements – and whether the project can be reasonably constructed within the proposed cost estimate and time frame. Radon testing confirms the existence of any unsafe radon levels that needs to be mitigated. Asbestos and lead-based paint testing evaluate the existence at the project of any asbestos containing material and lead-based paint and whether its condition poses a potential hazard which requires remediation or other follow-up action.
TAX & INSURANCE. HUD requires that the FHA Lender collect and maintain tax and insurance escrows in order to ensure that: (a) there are sufficient funds available to pay real estate taxes; and (b) there are sufficient funds available to pay insurance premiums for insurance coverages as required by the HUD Loan Program. The construction loan budget typically allocates funds to cover anticipated taxes and insurance during construction. After the construction period of the loan and upon commencement of loan amortization, the Lender typically bills for and collects funds to cover tax and insurance expenses along with each monthly principal and interest payment. The tax and insurance amounts collected each month is based upon the amount necessary to pay all insurance premiums, real estate taxes, and governmental assessments at least thirty days prior to each due date for each year during the term loan.
REPLACEMENT RESERVES. HUD requires that the FHA Lender collect and maintain capital replacement reserves to ensure that there are sufficient funds available to fund capital replacement needs as they come due. Replacement reserves are typically held in escrow by the Lender in an interest-bearing account with an acceptable financial institution. After the construction period of the loan and upon commencement of loan amortization, the Lender typically bills for and collects funds for capital replacement reserves. The monthly replacement reserve deposit is determined by HUD during loan application processing based on the anticipated levels of funding required to meet anticipated capital replacement needs based on a Capital Needs Assessment (included with Architect and Cost Review) completed during application processing. An initial deposit to replacement reserves at closing may also be required.
OPERATING DEFICIT ESCROW. HUD requires that the FHA Lender collect an operating deficit escrow on new construction and substantial rehabilitation applications to provide funding for operating expenses and debt service when sufficient cash flow is not available during the initial lease-up period following construction completion. The operating deficit escrow is fully funded at closing and posted with Lender with cash or letter of credit (in form acceptable to HUD). If funded in cash, such funds are typically held in escrow by the Lender in an interest-bearing account with an acceptable financial institution.
The required escrow amount is determined by HUD during application processing, generally based on the size of the loan, the anticipated operating deficit during lease-up until project stabilization, and other risk factors associated with the project. HUD guidelines provide the following minimum operating deficit requirements:
CONSTRUCTION CONTINGENCY. HUD requires a construction contingency for new construction and substantial rehabilitation applications to provide funding for eligible change orders and cost overruns not covered within the original HUD-approved construction loan budget. On new construction applications, the required construction contingency equals 2% of the loan amount and is escrowed for as part of the working capital escrow. On substantial rehabilitation applications, the required Construction Contingency amount typically ranges from 10-15% of the construction budget (depending on the type and condition of the project), is mortgageable, and may be funded out of the construction loan budget.
WORKING CAPITAL ESCROW. HUD requires that the FHA Lender collect a working capital escrow on new construction and substantial rehabilitation applications to provide funding for taxes, insurance, costs of furniture, fixtures and equipment, marketing and lease-up expenses and other eligible expenses following construction completion. The working capital escrow is fully funded at closing and posted with Lender with cash or letter of credit (in form acceptable to HUD). If funded in cash, such funds are typically held in escrow by the Lender in an interest-bearing account with an acceptable financial institution.
For new construction applications, the working capital escrow equals 4% of the loan amount, half of which is allocated for a construction contingency. The working capital escrow on sub-rehab applications is only 2% of the loan amount, with the construction contingency being funded out of loan proceeds.
Davis-Bacon wage rates are required on new construction and substantial rehabilitation transactions.
The general contractor and subcontractors working on 221(d)4 projects are required to comply with wage payment and reporting requirements under the Davis-Bacon Act. Davis-Bacon requires contractors and subcontractors to pay laborers and mechanics no less than the locally prevailing wages and fringe benefits for corresponding work on similar projects in the area as determined by the Department of Labor which can be found here. Contractors and subcontractors are required to submit online certified payroll reports each week evidencing compliance with such requirements through Elation Systems and obtain DOL clearance upon construction completion.
Typically, 9-12 months from engagement to closing. Timeframes may vary significantly, depending on the complexity of the transaction, developer cooperation, and the volume of loan applications being processed by HUD.
To better appreciate the timing considerations, it is important to understand the FHA / HUD 221(d)4 loan application process. For multifamily new construction and substantial rehabilitation projects, the loan application process typically involves the following stages: Concept Meeting → Pre-Application → Firm Application → Closing.
CONCEPT MEETING. The concept meeting provides an opportunity for the lender and developer to introduce the proposal to HUD and solicit feedback from HUD. It is generally a pre-requisite to submitting an insured loan application into HUD. Securing a concept meeting date with HUD typically takes 2-3 weeks from the time such requests are made. Such requests are typically accepted when coupled with a detailed write-up of the proposal (“concept memo”) which meets HUD requirements. HUD usually issues a follow-up letter inviting the deal for application submission within a week of the concept meeting.
PRE-APPLICATION. The 221(d)4 loan application process is generally divided into two stages: the (1) Pre-Application and (2) Firm Application. This is done to save the developer from the cost of obtaining a full set of plans and specifications and construction bids before the overall market, development team, and environmental considerations have been investigated. Accordingly, the pre-application requires a HUD compliant market study, appraisal, and Phase I environmental site assessment, along with resumes and qualifications of the development team (owner, architect, GC, and management agent). Pre-Application preparation generally takes 4-8 weeks assuming full cooperation from the Developer and no major issues. HUD’s review can take up to 60 days per its internal requirements, although it often takes longer. Once HUD has completed its review of the pre-application and is satisfied with the proposal, HUD will issue its approval to proceed to firm application submission in the form of a HUD Invitation Letter. Such letter will set forth any special terms and conditions.
FIRM APPLICATION. If the developer wants to proceed, the developer will need to provide a full set of plans and specifications along with a draft construction contract with a detailed cost breakdown for Lender review. The Lender will commence third-party review of the plans and specs and construction cost breakdown to confirm it meets HUD requirements and is reasonable within industry standards. The appraisal will also need to be updated if more than 120 days will have passed between the appraiser’s initial site inspection and Firm Application submission. Overall, the Lender’s Firm Application preparation can take between 4-8 weeks from the time all requisite items are provided. HUD’s review can take up to 60 days per its internal requirements, although it often takes longer.
CLOSING. Once HUD has completed its review and is satisfied with the application, HUD will issue its approval in the form of a HUD Commitment for mortgage insurance along with its terms and conditions to close. If acceptable to the parties, the attorneys will be engaged to prepare and review the loan documents and required due diligence items. Lender’s counsel will assemble a pre-closing package and, upon completion, submit to HUD. HUD will then review the pre-closing submission and, if acceptable, clear the project to close. This process generally takes between 45-75 days.
We hope you find this information helpful. If you are interested in seeing what an FHA / HUD 221(d)4 loan can do for your project, you can Apply Here. If you have further questions or would simply like to speak with an expert in the field, feel free to Contact Us.
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