FHA Multifamily Commercial Mortgages

Mortgages of the Federal Housing Authority, FHA, of the United States Department of Housing and Urban Development, HUD, provide the highest loan to value ratio mortgages available to acquire US apartment complexes. These mortgages have been consistently available with essentially similar terms during long periods of time including changing market conditions such as the present, whereas many other commercial real estate mortgage programs have come and gone. For further information, see http://www.hud.gov. Enter "HUD FHA multifamily mortgages"into the HUD web site search box. Alternatively, enter "FHA 223F multifamily mortgages" and "FHA 221D4 multifamily mortgages" into the HUD search box. Visit the HUD website at http://www.hud.gov/offices/hsg/mfh/progdesc/purchrefi223f.cfm. FHA provides US Federal Government insurance to private HUD designated lenders against future default of the apartment complex mortgage. FHA multifamily mortgages may be issued/resold in the secondary markets as Ginne Mae mortgage-backed securities. FHA multifamily commercial mortgages are currently active and available at this time, although with a delay in processsing time owing to high demand. FHA's Office of Multifamily Housing issued Mortgagee Letter 2010-21 that became effective September 7,2010. This changes FHA multifamily underwriting requirements and proceedures. These changes include: revised underwriting standards, enhanced verification of property financial performance, expanded borrower mortgage credit analysis, and pre-screening of proposals before an application is submitted. Some of the ratios and requirements shown below have been changed from previous levels. The information appearing below remains to be verified and possibly changed at the time of FHA mortgage application.

FHA 223F AND FHA 221D4 (Program Details appear below in corresponding left to right order).

LOAN PURPOSE. Acquisition, refinance. New construction and major rehabiliation

FINANCING SIZE. $1,000,000 to $50,000,000 $1,000,000 to $50,000,000

TERM AND AMORTIZATION. Maximum 35 years Maximum 40 years

LOAN TO VALUE RATIOS. FHA has changed loan to value/cost ratios as follows. 221(d)(4) with 90% or greater rental assistance-no change 90.0%, 221(d)(4) affordable housing 87.0%, 221(d)(4) market rate housing 83.3%, 221(d)(3) affordable housing 95.0%, 223(f) refinance of a Section 202 property 90.0%, 223(f) with 90% or greater rental assistance 87.0%, 223(f) affordable housing 85.0%, 223(f) market rate apartment complex refinance 83.3%.

DOWN PAYMENT. Down Payment to reach settlement is 100% minus the foregoing ratios. There may be changes in the loan to value ratio, repair costs, and overruns once the mortgage underwriting process has begun, according to a FHA mortgage broker.

BUYER JOINT VENTURE WITH SELLER. Equity to mortgage. Property equity via the Seller above the mortgage amount in a joint venture with the Purchaser is permitted instead of a cash down payment from the Purchaser. This would be considered a partnership and a refinance by FHA223F and FHA221DF. The loan to value ratio (in criterion 10 of the HUD 92264-A) for cash out refinances remains unchanged at 80%. Fifty percent of any cash out proceeds after funding transaction costs, including the assurance of completion requirements, must be held in escrow by the Mortgagee until the required non-critical repairs are completed and HUD approves the release.

DEBT SERVICE COVERAGE RATIOS. Debt Service Coverage Ratios have been changed as follows. 221(d)(4) with 90% or greater rental assistance-no change 1.11, 221(d)(4) affordable housing 1.15, 221(d)(4) market rate apartment complex 1.20, 221(d)(3) affordable housing 1.11, 223(f) refinance of a Section 202 property 1.11, 223(f) with 90% or greater rental assistance 1.15, 223(f) affordable housing 1.176, 223(f) market rate refinance or acquisition 1.20.

COLLATERAL. Multifamily apartment complex including garden, midrise, highrise, and cooperatives.

POINTS. HUD/FHA and lender mortgage broker fees can be up to 3.5%. Lender fees may be funded in the new FHA mortgage balance.

APPLICATION FEES. $3 per $1000 (30 basis points) of the mortgage amount. Market rate apartment complex pre-applications must pay a nonrefundable 15 basis point review fee, which fee will be credited to the 30 basis point Firm Commitment fee if an invitation letter is issued and a Firm Commitment application is submitted. Affordable housing transactions that submit a two stage processing must pay the 30 basis point fee at the Firm Commitment stage, but will not be charged a fee for pre-application review.

FEES PAYABLE BEFORE SETTLEMENT. Third party reports (see below), loan commitment fee 50 basis points refundable at closing, 50 basis points nonrefundable inspection fee for the lender.

NONRECOURSE. FHA multifamily mortgages are nonrecourse, with the exception of fraud, misappropriation, or misuse of funds.

INTEREST RATE. Interest rate 150 to 225 to 250 basis points over the 30 year US Treasury bond rate (See http://www.bloomberg.com, market data, government bonds, US Treasuries).

OCCUPANCY STANDARDS. Properties must have an average physical occupancy rate of at least 85%. For market rate properties, the maximum underwritten physical occupancy rate is 93%. For affordable housing apartment complexes, the maximum underwritten physical occupancy is 95% if a property has: a) at least 90% of units covered by a rental assistance contract, or b) affordable rent restrictions on 100% of units with all unit rents at least 20% below comparable market rents.

Projects must demonstrate a pattern of stable occupancy, i.e. the average occupancy standards noted above, for a period of six months prior to submission of the Firm Commitment application, and maintain that occupancy through to the date of Initial/Final Endorsement. Continued occupancy consistent with the underwriting conclusions must be documented with an updated rent roll no more than 30 days prior to closing. If HUD determines that the updated rent roll shows a significant change in occupancy from that submitted at the time of application and that was assumed in the loan approval, then this Commitment shall be of no force or effect and will be cancelled by HUD.

The occupancy provision described above applies to all Section 223(f) applications, with the exception of those applying for a 3-year rule waiver.

MARKET STUDY. Section 223(f) proposals typically do not require a market study separate from that contained in the appraisal, however, in volatile or declining markets, the Lender should consider and may be required to obtain such a study to support the underwriting conclusions of market demand for the subject property over the long term.

MORTGAGE CREDIT ANALYSIS AND TERRORISM CHECK OF PRINCIPALS. The Lender's mortgage credit review must include the following. The balance sheets for all principals should include, in addition to other relevant schedules, a Schedule of Real Estate Owned, and a Schedule of Mortgage Debt. The Lender's mortgage credit review and Firm Commitment submission should address the creditworthiness of all principals, and contain a written analysis of the financial position and contingent liabilities, particularly all mortgage debt with near or intermediate term balloon payments (i.e. within the next 5 years). The Lender's analysis of the various properties' net operating income, outstanding indebtedness, valuation estimates, etc. with details supporting the Lender's assessment of the likeliehood of successful refinancing projects with maturing balloon debt, assuming current capital market conditions and the current availability of alternative long term financing sources. The Lender's analysis should reconcile the data, and come to a conclusion as to the principals' and borrowers' creditworthiness. Particular attention should be given to principals with a history of anticipated incidence of adverse credit actions including (but not limited to) bankruptcies, foreclosures, or a pattern of renegotiation of debt. A financing plan for any shortfall or anticipated lack of credit should be provided. The US Patriot Act requires US Department of the Treasury Office of Foreign Assets Control Terrorism checks and verification on principals prior to initial endorsement.

FINANCIAL STATEMENTS FOR UNDERWRITING SECTION 223(f) REFINANCING AND ACQUISITION. To confirm the accuracy of the property financials, the Borrower must provide three years of tax returns for the project or borrowing entity. In addition, the Borrower must provide a property financial statement that is reviewed by an independent third party Certified Public Accountant and includes actual copies of the insurance and property tax bills.The CPA review is applicable for the most recent full year financial statement and Borrower certifications are acceptable for the required previous years' statements.

RESERVES FOR REPLACEMENTS. The minimum reserve for replacement deposit is $250 per unit or such higher amount as is indicated in the Property Capital Needs Assessment. The reserve schedule and deposit requirements will be applicable during the first ten year term of the mortgage.

UNDERWRITER SITE INSPECTION AND RENTAL LEASE AUDIT REQUIREMENT. The Multifamily Accelerated Processing (MAP) approved underwriter must perform an on-site lease audit and physical inspection representing a sample of each unit type. An analysis, underwriter trainee, or MAP approved underwriter acting under the direction of the underwriter (i.e one that does not report to the originator) may perform the site visit and physical inspection of the units. The Lender must compare the terms of the lease agreements to the rent roll, verifying the unit number, tenant name, lease commencement date, concessions if any, and monthly rent, and confirm that this data is consistent with the assumptions used in the underwriting analysis.

NEW PROJECT CONCEPT MEETING. Mortgage applicants participate with the Program Center in person or by teleconference where the project has an early review before submitting a pre-application or direct to Firm application. Strongly encouraged but nor required for FHA223F. Required for FHA221(d)(4).

PREPAYMENT AND PENALTIES. Generally LOCKOUT (no mortgage prepayment) for 5 years, followed by decling prepayment penalties: 5%, 4%,3%,2%,1% during years 6,7,8,9,10.

SECOND MORTGAGE (subject to approval by FHA). With a FHA 223F mortgage, a seller held second mortgage in the amount of 7.5% may be allowed by FHA. This additional obligation may only be represented by a Promissory Note. HUD is apprehensive about second mortgages. These have to be approved internally by HUD. With a FHA 211D4 mortgage, the maximum mortgage is 83.3% of the HUD/FHA replacement cost estimate and no second mortgage is allowed.

TIME TO REACH SETTLEMENT. Increasing consumer demand has lengthened FHA mortgage approval times. FHA 223F approval may require 6-8 months. FHA 221D4 may require 10-12 months.

THE FOLLOWING ARE QUESTIONS AND ANSWERS REGARDING SPECIFIC FHA ISSUES.

Q. THIRD PARTY REPORTS. May third party reports be included in the new mortgage balance? A.Yes, however, they will need to be paid to the third party vendors before settlement.

Q.LENDER'S INSPECTION. Concerning the 50 basis points inspection fee, of what does this inspection consist? A.Physical inspection by a lender representative and possibly if the property is older by an engineer.

Q.Does this duplicate the property inspection for the purchaser designed to identify property deficiencies that may be remedied including repair amounts in the new mortgage balance? A.No. It is the lender's own inspector and for their benefit only. This fee is paid by the borrower at the time of service. If there is room in the new mortgage balance, the borrower may be repaid at settlement.

Q.PROPERTY INSPECTION. This report is provided by a third party independent contractor for the benefit of the Purchaser.

Q.Are the foregoing two sets of property inspections and fees one for the lender, and the other for the Purchaser, separate or combined? A.Separate.

Q.SURVEY. Various kinds of surveys exist to define title and title insurance. Does FHA require an ALTA survey? A.Yes. ALTA.

Q.ENVIRONMENTAL. On apartment complexes that have had the same use for decades, does FHA require an environmental report, e.g. Phase One or Phase Two, or may this report be foregone if there is no indication of environmental contamination from the existing historical property use? A.There will always be a Phase One environmental report completed for each transaction.

Q.May lender points and mortgage broker fee be included in the new mortgage balance? A. Yes, however, it depends on the overall price paid for the property and how the loan dollars are sized against the underwriting guidelines and actual net operating income.

Q.What property information is required initially? A.Complete rent roll and three years income and expense statements to give an indication of sizing of the FHA mortgage.

Q.Q.With FHA 223F, are property upgrades and repairs OPTIONAL or REQUIRED? A.OPTIONAL, no more than 15% of the mortgage amount, no large capital improvements allowed.

Q.With FHA 221D4, are property upgrades REQUIRED OR OPTIONAL? A.REQUIRED. This mortgage is for substantial property rehabiliation. The GREATER OF 15% of the estimated replacement cost after completion of all repairs, replacements, or improvements, OR $500 per unit, OR two or more major building components being substantially replaced regardless of cost.

Q.Does the FHA multifamily loan to value ratio vary or differ depending on the age of the apartment complex?

A.The LTV ratio is determined by the debt service and not by the age of the apartment complex.

Q.Sizing the mortgage. A.It may be easier to start by underwriting the deal and letting the Purchaser and Seller discuss strategies directly with the underwriter. There are some nuances that if followed are beneficial to the parties.

Q.What information is needed to accompany a mortgage application. A. 1.Three years income and expense statements, year end and month to month trailing 12 months. 2. Current complete rent roll. 3. Five year proforma income and expense statement. 4.Complete description of repairs made during the past five years and deferred maintenance repairs needed. 5.Contractor estimate of needed apartment complex rehab. 6. Third party reports noted above. 7.Thirty or more color pictures inside and out. 8.Comparable rental survey of the current area including vacancies of other similar apartment complexes and any new apartment complexes. 9.Current mortage information. Lender, loan, type, rate, term, and any prepayment penalty. 10.Market rent or low income, subsidized rent, section eight review. 11.Resume of all parties and personal financial statements of all owners of ten percent or more. Three years of property or borrowers' tax returns and property financial statements to be reviewed by a CPA. 12.General credit of each applicant including mortgage lates and bankruptcies. See above for further details.

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Source of the foregoing information. Selected FHA multifamily mortgage brokers over an extended period of time. FHA Mortgageee Letter 2010-21 effective September 7,2010.

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Ron Neufeld, Comreb Limited Partnership, Lic. Florida Real Estate Broker. email: comreb@bellsouth.net

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