FEATURE ARTICLE, AUGUST 2007
AFFORDABLE FINANCE FROM FHA: NOT JUST FOR AFFORDABLE HOUSING ANYMORE
As interest rates rise, FHA loans become more attractive for qualifying market-rate, senior housing and affordable housing projects.
Texas is warming up --— and not just for the dog days of summer, but for investors and developers in our state’s improving multifamily market. The apartment sector continues to demonstrate strong fundamentals and attractive returns, and demand for market-rate, senior and affordable housing continues to rise. This trend means that an increasing number of developers are turning to the Federal Housing Administration (FHA) — many of whom may not have had occasion to even consider the FHA finance route in the past.
This demand for FHA loans is steadily rising in Texas, thanks to both homegrown and national demographics. The aging population means that the demand for senior housing has only just begun, even when considering solely current Texas population figures. However, Texas also is attracting an influx of residents from northern states, based on both job opportunities and climate preferences. Based on these trends, the need for affordable and senior housing appears to have a very long upward trend ahead. FHA statistics are already documenting the rising use of FHA finance in Texas.
Back to Basics: FHA 101
Multifamily and commercial real estate borrowers are demanding combination “construction-to-perm” financing packages, due to the rising interest rate environment, as well as the highly competitive arena for capital providers to the real estate industry. For the FHA, this is nothing new. The FHA offers non-recourse, 40-year, fixed-rate financing, issued through one set of documents and one closing. This financing package covers both the construction or renovation portion of the loan, as well as a permanent mortgage with an interest rate locked-in at the time of construction closing.
To a developer accustomed to conventional financing, this type of loan vehicle may sound like an impossible dream, but FHA-insured mortgages offer all of these features. The FHA is able to do this where non-governmental sources of capital cannot, because the loans support the agency’s goals to encourage and support specific types of development in the multifamily and senior housing sectors.
While the role the FHA plays in providing affordable housing is well-known, the FHA offers a number of loan products suitable for multifamily developers, which do not require a low-income component. These products can accommodate the construction of a new project, or assist in the acquisition of an existing development. There are FHA programs for multifamily and senior housing in both the market-rate and affordable classifications. One type of loan the FHA does not support is luxury apartments. However, if a project falls into the grey area between market-rate and luxury, it is prudent to check to see if the project’s pro-forma qualifies for an FHA market-rate loan.
Obtaining an FHA loan for the first time will indeed require some additional “red tape,” especially for the first-time borrower. However, this investment of time does come with a payoff — quite literally. FHA insured loans incorporate some unique and attractive features such as 35 to 40-year, fully amortizing terms, fixed rates, up to 90 percent loan-to-cost ratios for qualified borrowers and 1.11 Debt Service Coverage Ratio (DSCR) for new construction, or 85 percent loan-to-value and 1.176 DSCR for refinancing of existing mortgages or acquisition loans. Once over the learning curve, many borrowers find the benefits of the FHA loan well worth the extra effort and become repeat borrowers.
To FHA or Not to FHA
If your project qualifies, chances are the terms from an FHA loan will be advantageous over securing a construction loan in the private sector, then obtaining permanent finance at a later date. Particularly in today’s rising interest rate environment, the ability to lock-in interest rates at the construction loan closing becomes an instant advantage. The question becomes, “does this project qualify,” rather than “is FHA right for it?” Different FHA programs carry different qualification considerations, since they are designed to support distinct types of housing.
FHA programs also offer significant advantages even beyond the interest rate equation. FHA insurance provides credit enhancement for tax-exempt financing and is non-recourse during the construction and permanent loan periods. Additionally, the mortgages are fully assumable with prior FHA approval. There are typically no maximum loan amounts under these programs; prepayment is negotiable depending on market conditions, and there is no yield maintenance.
Four main types of FHA loans serve most FHA borrowers in Texas. By far the largest FHA program, the 221(d)(4) program, finances new construction and substantial rehabilitation loans for general multifamily rental housing including apartments for seniors. Alternatively, Section 231 offers loans specifically for multifamily rental housing for seniors and handicapped persons, while Section 232 finances healthcare projects — specifically, nursing homes, intermediate care facilities and assisted living facilities. The 223(f) program provides financing for refinance and acquisition.
FHA Apartment Finance Using 221 (d)(4)
The 221(d)(4) program offers one-stop shopping as it packages an interim construction or rehabilitation loan along with subsequent permanent financing. The interest rates for both the interim and the permanent loan are locked in at the time of closing the construction phase of the loan. The maximum mortgage is generally determined by 90 percent of the development costs or a DSCR of 1.11. Transactions are non-recourse during both the construction and permanent loans and are assumable, with fully amortizing terms of 40 years or 75 percent of the remaining life of the asset.
A project is classified as a substantial rehabilitation if the amount required for repairs exceeds a maximum dollar amount limitation per unit based on HUD guidelines, or 15 percent of the property’s “as complete” value. Also, if two major components of the property are replaced then the project is considered a substantial rehabilitation.
Contrary to common belief, a project does not have to qualify as “low-income housing” to qualify for an FHA loan. The HUD-FHA 221(d)(4) program was structured by Congress to create affordable multifamily housing through a financing vehicle with relatively minimal amounts of equity required. These programs do not have any governmental restrictions on renters’ income or tenant preference. Units may be rented to tenants at any income level as long as the Federal Fair Housing Standards are met. Rental rate restrictions are applicable only if Tax Free Bonds or Housing Tax Credits are used in the financing or equity structure or if required to maintain a non-profit ownership status.
KeyBank Real Estate Capital provided a $16.8 million new construction/ permanent loan for the Mesquite, Texas, Villas at Mesquite Creek, a 252-unit development with an FHA Sec. 221(d)(4) loan.
An example of a successful recent FHA 221(d)(4) project is the Villas of Mesquite Creek, a $16.8 million affordable housing complex in Mesquite, Texas, funded by an FHA loan financed by KeyBank Real Estate Capital that closed in June. A 252-unit affordable housing complex, the Villas were funded by a Section 221(d)(4) combination new construction and permanent loan. The financing was completed using 4 percent HTCs and private activity bonds, no yield maintenance, and a low debt service coverage ratio. The financing is 40 years, fully amortized, and is fully assumable at a 90 percent loan-to-value ratio. The Villas at Mesquite Creek Apartments consist of 12, three-story walk-up style apartment buildings with nine-foot ceilings, walk-in closets, a swimming pool with a dedicated children’s area, fitness center, private balconies and a sports court. The complex is pre-wired for high-speed Internet and equipped with a common community building and media lounge.
KeyBank Real Estate Capital provided a $11.69 million new construction/ permanent loan for the Amelia Parc Senior Apartments, a 196-unit Fort Worth, Texas, apartment development financed using an FHA Sec. 221(d)(4) loan.
Another notable Section 221(d)(4) project is the Amelia Parc Senior Apartments in Fort Worth. Senior projects can be funded using a variety of FHA programs — including both the 221(d)(4) loans and the Section 231 loans. In the case of Amelia Parc, the $11.7 million, 196-unit senior apartment complex was funded using 4 percent HTCs and private activity bonds, and includes amenities such as a café, a salon, a fitness center, a pool, a business center and a beauty salon.
Notably, in both cases, despite the fact that these apartment complexes are categorized as “affordable housing,” they offer all the furnishings and comforts of market rate projects. It is this fact, among many others, that has attracted potential occupants.
FHA Apartment Finance Using 223(f)
For refinancing using the Section 223(f) program, maximum loans are generally determined by 80 percent to 85 percent of value, an underwritten DSCR of 1.17 or 100 percent of its cost, with the property value based upon its “as complete” value with any needed repairs completed. Acquisition loans must not exceed 85 percent of the financing and acquisition costs. Both transactions are non-recourse loans and assumable with fully amortizing terms of 35 years or 75 percent of the remaining life of the asset.
FHA Apartment Finance Using Section 231 — Housing for the Elderly
The Section 231 program was created to finance housing for seniors and handicapped persons only. In this program, the FHA mandates that all residents be 62 years of age or older or handicapped. This means that Section 231 residences cannot include family members who are younger than the age cut-off. This program allows for some services to be provided on-site for residents, including catered food, housekeeping, limited healthcare services and so on, as approved on a case-by-case basis by HUD.
Like the 221(d)(4) program, these “housing for the elderly” loans also package an interim construction or rehabilitation loan along with subsequent permanent financing, with a locked-in interest rate. For new construction, borrowers are limited in their mortgage loan borrowing parameters to 90 percent of total development cost including the value of the land — 100 percent for non-profit developers. Borrowers can be either for-profit or non-profit entities, although loan limitations are favorable for non-profit borrowers.
FHA Apartment Finance Using Section 232 – Healthcare
The Section 232 program was created to finance healthcare facilities for seniors and handicapped persons. In this program, the FHA mandates that residents require special services typically provided in nursing homes, intermediate care facilities and assisted living facilities. This program also packages an interim construction or rehabilitation loan along with subsequent permanent financing, with a locked-in interest rate.
Trail Guides with “MAPs”
HUD’s Multifamily Accelerated Processing (MAP) program was established in 2000 to increase the efficiency of certain FHA programs and to increase participation in the programs. The MAP guidelines delegated the underwriting of MAP loans to approved lenders and established maximum processing time frames for the HUD offices. As a result, the FHA programs are now more competitive with conventional loan programs, and HUD’s production volume has increased significantly.
FHA loans are overseen in Texas by the Fort Worth Hub office of the Department of Housing and Urban Development (HUD), which has often led the nation in FHA production and has consistently been among the top four Hub offices in production since the MAP Program began. Loans in Texas are processed by HUD field offices in Fort Worth, Houston and San Antonio. Each field office has an experienced staff that is dedicated to meeting the time frames stipulated by the MAP program. Borrowers interested in any of the FHA programs should consult with an experienced MAP lender that specializes in FHA lending, has established relationships with the HUD field offices and has the expertise to guide them through the application process. It is also helpful if the other team members (architect, contractor, property management company and equity provider, among others) are experienced with FHA loans, especially with new construction.
The Bottom Line
The FHA programs definitely should be considered before pursuing a loan for a multifamily or healthcare property. Many have found that the favorable terms of the FHA loans are well worth any additional effort. With the improvements made by HUD since the MAP program began, the FHA programs certainly are worthy of consideration.
Bruce Minchey is vice president, FHA operations manager, with KeyBank Real Estate Capital in Dallas.
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