Matt Avital is the Principal & Founder of Ascenda Capital, located in Los Angeles, CA.
Surprisingly, the loan program that provides multifamily property owners with the longest amortization, the highest leverage and often the lowest interest rate is a program that is not well known even by many of the industry’s top players. In the multifamily space, property owners looking to place new loans on their properties have a wide variety of financing options available to them. Fannie Mae, Freddie Mac, life insurance companies, commercial mortgage-backed securities (CMBS) and conventional banks are all great financing options that each serve a purpose by filling different borrower needs in the multifamily financing market.
That said, many multifamily property owners are missing out on one of the industry’s best kept secrets: HUD insured financing. As the principal and founder of a firm operating in the lending niche of HUD financing for multifamily properties, I’d like to share some important considerations.
What are the benefits of HUD insured financing?
Broadly speaking, HUD (the U.S. Department of Housing and Urban Development) insured financing is ideal for the long-term investor seeking consistent returns and long-term appreciation of capital while minimizing risk. All HUD insured loans are long-term; the acquisition/refinance program, referred to as the 223(f) program, provides the borrower with a 35-year fully self-amortizing non-recourse loan at a fixed interest rate. By offering borrowers with long-term financing a fixed interest rate, the borrower is enabled to eliminate much of the risk associated with owning real estate. As a self-amortizing loan, HUD insured loans completely eliminate the balloon date risk associated with other financing options such as most Fannie Mae, Freddie Mac and CMBS fixed-term balloon loans.
In addition, HUD insured loans eliminate interest rate risk, as the interest rate remains the same for the duration of all HUD insured loans, unless rates go down. Unlike other financing options, HUD insured financing allows borrowers to decrease their interest rate should rates go down through its interest rate reduction (IRR) program. This allows the borrower to fully eliminate the risk of both a rising and falling interest rate.
HUD insured loans also offer the borrower unique flexibility, as they are fully assumable and have a simple 10-year step-down prepayment penalty (10% year one, 9% year two, etc.). After 10 years, the property can be refinanced or sold without any penalty. This unique prepayment flexibility combined with the lengthy loan term make HUD loans a perfect fit for any investor aiming for a medium- to long-term hold period.
What do you need to know?
It’s important to understand the role of each party involved in a HUD insured financing transaction. A sponsor seeking a HUD insured loan must send an application to HUD through a MAP (multifamily accelerated processing) approved lender. HUD loans are underwritten by the FHA (Federal Housing Authority) to determine whether or not a proposed mortgage fits within HUD’s risk tolerance as an insurer.
If the application is approved, the MAP-approved lender will lock the loan rate on the secondary market as a government national mortgage association (GNMA) mortgage-backed security. HUD acts as the insurer for these loans, collecting a mortgage insurance premium (MIP) on each loan to offset borrower default risk.
So, while these loans are nominally referred to as HUD loans, it’s important to keep in mind that HUD acts as the insurer, viewing the property from a risk management perspective rather than a purely profit-seeking perspective. It is this lens that encourages HUD to offer a loan product to the borrower that minimizes the risk of HUD losing money to borrower default.
Historically, HUD financing has been underutilized. Each loan program has had a significant drawback that has acted as a barrier, preventing property owners from taking advantage of HUD’s attractive terms. Fortunately, some recent changes have made HUD a lot more appealing to borrowers.
In the past, HUD did not insure the refinance of newly constructed multifamily properties, requiring developers to wait at least three years after the property’s last certificate of occupancy before applying for refinance. HUD maintained this policy because it did not want developers to circumvent the prevailing wage requirements associated with developing ground-up new construction through its construction and permanent loan program, called the HUD 221(d)4 program. After a comprehensive portfolio review, HUD decided in March 2020 to lift this policy. Now, all new construction multifamily greater than five units in size is eligible for HUD financing.
In addition, HUD recently began permitting borrowers seeking to finance an acquisition with a HUD 223(f) loan to close on the property with a bridge loan. Previously, acquiring a property using HUD’s acquisition program required the seller to agree to a lengthy closing period during which the borrower would go through the entire HUD application and underwriting process before closing on both the loan and the acquisition. Because the HUD application and underwriting process can be lengthy (often longer than six months), it was difficult for borrowers to take advantage of the HUD acquisition program. Under the new policy, as long as the borrower’s application to HUD is submitted before the borrower closes on the property, the borrower is able to purchase an existing property with a bridge loan while still taking advantage of the more favorable terms HUD provides for an acquisition (85% LTV as compared to 80% LTV for refinance).
As a result of these recent changes, HUD is busier than ever; while 2021 reports are not yet out, I speak with a number of HUD lenders on a weekly basis and it is fairly well known in the industry that HUD is processing a record high volume of loans. HUD is well-positioned to claim a significant share of the multifamily financing market this year. Any property owner planning on holding their multifamily asset medium to long-term would be wise to consider leveraging their property with a HUD insured loan.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.