The federal loan program is a reliable source for multifamily borrowers.
In today’s tight credit market, multifamily owners and developers are challenged with finding financing that works now as well as in the uncertain future. In such turbulent times, the Federal Housing Administration loan programs serve as good, reliable sources of capital that meet these evolving needs.
FHA provides high-leverage and long-term nonrecourse financing that may be the ideal solution for developers and owners who have discovered that traditional financing is tough to find. FHA lenders always have capital to lend with favorable terms, and loans are available in all markets nationwide for multifamily housing, which includes seniors-housing and healthcare facilities. Surprising to some may be that the lock-out period and prepayment penalties on FHA loans can be structured to meet borrowers’ requirements, providing maximum flexibility.
Borrowers can use FHA loan programs to secure financing for permanent (acquisition or refinance), substantial rehabilitation, or new-construction loans.
FHA loans for new construction are one of the best products available in the market. Developers can lock in the interest rate for both construction and permanent financing prior to the project’s start. The loan term generally begins amortizing two months after the facility is completed and ends 40 years after completion of construction. Financing is based on the lesser of two options: 90 percent loan to value or the amount of debt the property can carry at a 1.11 percent debt service coverage ratio.
To utilize FHA’s new-construction loan program, developers must meet several requirements, including using the government’s established minimum wage rates, known as Davis-Bacon wages, and posting a 2 percent working capital escrow and initial operating deficit until the property is stabilized. Put in place for the developer’s security, these escrowed items are returned if not used.
The FHA’s new-construction healthcare financing programs can be used to fund skilled-nursing, assisted-living, and board-and-care facilities. The terms for new construction of healthcare facilities outlined in the U.S. Department of Housing and Urban Development’s 232 program are similar to available market-rate loans. The main exception is that the FHA loan amount is determined by the same options as above (90 percent LTV or 1.11 percent DCR). These loans also are constrained by 90 percent of the market value of the fully completed and stabilized facility. Construction loans for healthcare facilities also come with a 40-year, fully amortizing term and nonrecourse to the developer.
Permanent financing for acquisition loans or refinancing existing debt also is available for multifamily housing and healthcare facilities. For acquisitions and refinances, the FHA provides fully amortizing 35-year loans with a loan amount the lesser of 85 percent of the market value with a 1.1765 percent DCR (85 percent of net operating income) or 100 percent of the transaction cost for a refinance and up to 85 percent of the transaction cost for a purchase. The FHA does not allow a cash-out refinance for healthcare facilities; however, multifamily borrowers may get a cash-out refinance of up to 80 percent of the property’s value.
Securing a $1 million FHA refinance loan for the 32,440-square-foot Colonial Village in Columbia, Tenn., allowed the borrower to pay off an existing 7.7 percent interest-only loan, lock in a fixed interest rate of 6.1 percent, and renovate all units, the building’s exterior, and its grounds. Photo credit: Love Funding
FHA vs. Conventional Funds
FHA programs provide developers and owners access to a capital source that features competitive terms and is always available. Lenders actually fund these loans, but the FHA provides mortgage insurance. Because the FHA insures lenders against loan default losses, it takes a close look at the underwriting prior to committing to provide the mortgage insurance.
Once the FHA mortgage insurance is in place, lenders structure the insured loans into Ginnie Mae mortgage-backed securities and sell them to investors. Backed by the U.S. government, the Ginnie Mae security guarantees timely payments of principal and interest to investors. This, coupled with FHA mortgage insurance, makes Ginnie Mae securities highly rated with a very active secondary market, thereby making these instruments very liquid. This combination of the FHA mortgage insurance and the Ginnie Mae securitization provides a mechanism for FHA lenders to fund and securitize loans and sell the mortgage-backed securities to replace the loan capital. The result is a source of capital that is always available.
In addition, the loans’ interest rates are determined by the rate of return Ginnie Mae investors require. Investors consider various factors when pricing Ginnie Mae securities, including loan type (higher yields typically are required for new-construction loans than permanent loans), Community Reinvestment Act implications, and the lock-out structure required by the borrower, to note a few. Once the Ginnie Mae security is sold, the interest rate becomes fixed, and the loan can then proceed to closing. After the closing, the borrower begins making loan payments to the loan servicer who passes through the principal and interest to the investor.
One perceived drawback of utilizing FHA loan programs is the reputation of an onerous, time-consuming process. The closing often can take longer to complete than typical transactions. However, HUD has made great efforts in recent years to streamline its processing and has become more efficient than most borrowers realize. In addition, FHA lenders have developed good working relationships with the various HUD offices around the country, so using an experienced FHA lender is essential for smooth loan transactions.
The processing and underwriting of FHA-insured loans is specifically mandated and requires all the typical third-party reports, such as market studies, appraisals, environmental studies, and architectural reviews. The FHA lender compiles all the necessary information and underwrites the loan according to FHA requirements. The lender then makes the recommendation to HUD for FHA mortgage insurance. A good lender will guide a borrower through the closing efficiently, making the process similar to what might be found with conventional financing.