With interest rates near record lows, the multifamily housing and health care real estate markets are in the midst of a refinancing boom. Private-sector lending remains constrained since the financial crisis, however.
To meet their credit needs, a number of commercial borrowers are turning to the U.S. Department of Housing and Urban Development (HUD) and its mortgage insurance arm, the Federal Housing Administration (FHA). In the process, they are discovering the qualities that make HUD/FHA loans attractive in any economic cycle.
Here are the most compelling reasons to give these federally backed instruments a try:
1. HUD’s below-market rates generate substantial debt-service savings: Because loans secured through HUD/FHA programs are backed by the federal government, the lower risk they carry allows lenders to extend such loans at below-market interest rates. The resulting debt-service savings are greater than what is available through refinancing alternatives.
In recent months, many owners of multifamily and health care properties have been able to refinance their debt by locking in new, 35-year loans with fixed rates near 4%. That compares with interest rates on non-HUD/FHA loans that are closer to 7%.
In a recent refinancing we arranged for the owner of a senior living apartment complex in Virginia, our client was able to cut its borrowing rate by nearly 200 basis points, lowering its annual debt-service cost by nearly $150,000.
2. Prepayment penalties don’t have to stand in the way: Mortgages frequently carry significant prepayment penalties that can discourage borrowers from attempting to lower their interest rates by refinancing. But given the significant rate discount on HUD-insured loans, borrowers can easily digest prepayment penalties without sacrificing debt savings.
For example, a recent refinancing closed in September 2010 successfully absorbed a 3% prepayment penalty while generating more than $230,000 in annual debt savings. Had the client waited for the prepayment penalty to burn off, he might have lost out on this opportunity to improve his financial standing by refinancing at today’s low mortgage rates.
3. HUD allows the highest leverage available: HUD will allow an owner to cash out as much as 80% of the property’s value, provided enough equity has been built up. In instances where repairs are necessary, owners can still receive half of the cash back before improvements are made.
HUD allows even more leverage with affordable-housing properties. Tax credit properties can qualify for loans of up to 85% of the property’s value; the loan-to-value limit increases to 87% for properties where 90% or more of units receive rental assistance.
4. Refinancing can provide an opportunity to refurbish the property or boost replacement reserves: HUD will require the lender to complete a physical condition and needs assessment (PCNA) when applying for a refinance for any project. The PCNA will identify two types of repairs: critical and non-critical. Critical repairs must be completed prior to the loan closing. Non-critical repairs can be completed up to a year afterward.
Both repair types can be funded with mortgage proceeds. Loan proceeds may also be used to fund or increase the replacement reserve if the balance is too low.
5. Properties already in the HUD-insured portfolio can qualify for unique benefits: Loans already in the HUD-insured portfolio can be refinanced through the 223(a)(7) program. One unique feature of this program is that borrowers can request a refund of half the agency’s standard examination fee of 0.3%.
In addition, HUD may extend the term of the existing loan up to 12 years, resulting in further debt service savings. If repairs are needed or reserves are too low, the loan can also be adjusted back to the full original mortgage amount to cover the borrower’s closing costs.
What borrowers need to know
While HUD/FHA financing can be a reliable and beneficial form of financing for owners and developers of multifamily and health care properties, transactions typically take longer than traditional financing avenues.
Working with a lender who has a track record of working with HUD is one way to ensure that unforeseen challenges don’t arise during the loan processing, further delaying the time it takes to close.
While traditional lenders stay on the sidelines, HUD/FHA’s multifamily and health care loan programs are becoming more and more attractive. With today’s low rates, now is the time for owners and developers to investigate a refinancing that could pay off for years to come.
Laura Saull-Smith is senior vice president of originations in the Washington, D.C. office of Love Funding, a national mortgage banking firm for multifamily and health care properties. Contact her at (202) 887-1851 or [email protected]. Ken Charbauski is assistant vice president of originations at the firm. Contact him at (202) 887-8438 or [email protected].