223(f)

BACKGROUND

The FHA / HUD 223(f) loan program provides attractive, federally insured financing for the acquisition, refinance, and moderate rehabilitation of existing multifamily apartment rental projects.  The credit enhancement afforded by the FHA / HUD loan insurance program provides for one of the most attractive permanent financing solutions available in the market.  Key characteristics of this 223(f) loan program include:

• Fully amortizing;
• Longer term / amortization (35 years);
• Low interest rate, fixed for the term of the loan;
• Higher leverage, with no discrimination between markets and asset class (up to 80%-90% of value); and
• Non-recourse.

The following is a detailed discussion on the 223(f) loan program. A summary term sheet can be accessed here: 223(f) Term Sheet.

ELIGIBLE PROPERTIES

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. 

Qualifying projects include existing market rate, affordable and subsidized multifamily rental housing projects that have obtained a certificate of occupancy and achieved stabilization. In addition, the scope of any proposed repairs and rehab cannot exceed $15,000 per unit, adjusted for the HUD published local high cost factor, nor 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.

COMMERCIAL SPACE

This HUD loan program is intended to promote housing.  Accordingly, commercial space is generally limited to 25% of net rentable area and 20% of effective gross income. 

BORROWER TYPE

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.

GUARANTEES

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.

LOAN TERM & AMORTIZATION

The FHA / HUD 223(f) loan has a term up to 35 years and is fully amortizing, subject to such term not exceeding 75% of the project’s remaining economic life as determined by an appraisal. 

INTEREST RATES

Between 2019 and 2023, average interest rates on 223(f) loans ranged from approximately 2.40% to 5.40%, according to HUD published data.  You can visit here for more current indications.  

LOAN PARAMETERS

The loan sizing parameters for FHA / HUD 223(f) loans below $125 million are as follows:

Cash-out refinance transactions for all property types are limited to 80% LTV.

The loan sizing parameters for FHA / HUD 223(f) loans at or above $125 million are as follows:

Cash-out refinance transactions for market rate and affordable properties are limited to 70% LTV. Subsidized properties are limited to 80% LTV.

Affordable properties is generally defined by HUD as those having at least 40% of units @ 60% AMI or 20% units @ 50% AMI. Subsidized properties is generally defined by HUD as those having greater than 90% units subject to LIHTC restrictions or project-based rental assistance.

LOCKOUT & PREPAYMENT PENALTIES

Lockout and prepayment penalties 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 closing).

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, 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.  

ASSUMPTION

223(f) 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. 

LENDER FINANCING FEE

Typically, 0.5% – 1.5%.  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 223f loans up to 3.5% of the loan amount, except on transactions involving bond financing where such fees are permitted up to 5.5%.   

HUD APPLICATION FEE

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.  The HUD application fee is due to HUD at application submission.  The application fee paid to HUD at application submission equals 0.30% of the loan amount applied for. The final application fee owed to HUD is based on the final loan amount at closing.  Any difference between the fee paid at application submission and the fee owed based on the final loan amount is due at closing.

HUD INSPECTION FEE

HUD imposes an inspection fee equal to $1,500, $30 per unit or 1% of repair cost, depending on the level and scope or repairs.  This fee is intended to cover HUD’s cost of performing site inspections during its initial review of the Application and post-closing to inspect completed repairs.  This fee is collected at closing.

HUD MIP 

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 and Broadly Affordable projects; 0.35% for Affordable projects; and 1.00% (initial) & 0.60% (annual) for Market Rate projects.  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 1.00% MIP due at closing for year-1 and 0.60% MIP annually thereafter.

Here is a link to the most recent notice regarding HUD multifamily MIP rates.

THIRD-PARTY REPORTS

Appraisal, Capital Needs Assessment (CNA), & Phase I ESA are always required.  Radon test reports are now required on all projects regardless of their EPA radon zone.  Asbestos test reports are required for projects built pre-1989. Lead-based paint test reports are required for projects built pre-1978.

The appraisal provides an estimate of the market value of the property as well as the projected income and expenses that the property will achieve in its particular market and provides the basis for the Lender’s underwritten income and expense and value conclusions used to determine the final loan amount.  The CNA provides an assessment of the property and site condition and identifies required immediate and future capital repairs and replacements.  The CNA’s conclusions help determine any required repairs and repair escrow (if completed post-closing), the required initial deposit to replacement reserves due at closing, and the required monthly deposit to replacement reserves thereafter.  The Phase I ESA determines whether any environmental conditions exist at the project that represent an unacceptable risk or which would require further action. 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.

ESCROWS / RESERVES

• Typical tax and insurance escrows (including MIP)
• Replacement Reserves: Minimum annual deposit of $250/unit
• Repairs identified in the CNA not completed prior to closing
• Debt Service Reserve: 9-12 months

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 Lender typically collects an initial deposit at closing and subsequently 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 at initial closing and 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.  At closing, the Lender is required to collect an initial deposit to capital replacement reserves and then bills for and collects funds for monthly capital replacement reserve deposits.  The minimum HUD required initial and annual deposit is $250 per unit.  The actual required initial and monthly replacement reserve deposit can be higher, based on a determination by the Lender and HUD during loan application processing. Such determination is based on the anticipated levels of funding required to meet anticipated capital replacement needs – based on a Capital Needs Assessment completed during application processing – and the HUD Loan Program requirements.  

REPAIRS.  At closing, HUD requires that the Lender collect and maintain an escrow for 100% of the estimated cost to complete required repairs identified in the CNA that are not completed prior to closing, plus a 20% contingency (10% on affordable projects) in case of cost overruns.  The repair escrow is released upon completion of required repairs, except for a 2.5% repair estimate holdback for potential latent defects which may be released 15 months following completion of repair work assuming such repair work is in good order. On cash-out refinance transactions, HUD further requires that the Lender hold back 50% of cash-out proceeds until the completion of all required repairs. 

DEBT SERVICE RESERVE. For loans at or above $125MM involving recently constructed properties with certificates of occupancy issued less than 3 years prior to application, a debt service reserve is required. The required reserve amount is the greater of 12 months of debt service payments or 50% of cash-out loan proceeds. At closing, the debt service reserve must be funded in cash or letter of credit in such form acceptable to HUD. The debt service reserve is eligible for release after the project achieves 6 consecutive months of underwritten debt service coverage. If the project achieves this this threshold prior to closing, the debt service reserve requirement is waived. Additional details are available in HUD Mortgagee Letter 2023-14.

LABOR STANDARDS

HUD 223(f) loan program requirements do not impose any Davis-Bacon prevailing wage requirements.

TIMING

Typically, 5-7 months from engagement to closing. Timeframes may vary significantly, depending on the complexity of the transaction, borrower 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 223(f) loan application process.  For multifamily acquisition and refinance transactions, the loan application process typically involves the following stages: Concept Meeting → HUD Application → Closing.  

CONCEPT MEETING.  The concept meeting provides an opportunity for the lender and borrower to introduce the proposal to HUD and solicit feedback from HUD.  It is recommended on complex transactions or transactions considered higher risk, such as those involving significant capital repairs and cash-out.  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. 

HUD APPLICATION.  The 223(f) loan application requires at minimum a HUD compliant appraisal, CNA, Phase I ESA, radon testing, plus an extensive list of credit and due diligence items on the project and its key principals. The Lender’s loan underwriting synthesizes all the data and analysis into a HUD commitment application for mortgage insurance.  The Lender’s preparation generally takes between 2-4 weeks from the time all requisite items are provided.  HUD’s review can take up to 45 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.  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 30-60 days. 

CLOSING REMARKS

We hope you find this information helpful. If you are interested in seeing what an FHA / HUD 223(f) 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.