With a nationwide shortage of affordable multi-family units, many municipalities have enacted inclusive housing ordinances requiring developers at market rates to reserve 10% to 30% of new construction units for affordable housing.
While some ordinances provide mechanisms to compensate for the cost of delivering units and lost revenue, many do not, and the project’s capital stacks are shattered as the “good” banks release the construction loan dollars from the government. project cash flow. Mortgages insured by the US Department of Housing and Urban Development can be an attractive alternative to traditional bank financing with a higher loan-to-cost ratio and lower debt coverage thresholds, thus making more apartments at lower rates. economically viable market and mixed income.
As a federal agency, HUD leads national policy and programs that meet our nation’s housing needs and provides mortgage insurance on loans made by multi-family lenders approved by the FHA. This includes a variety of loan programs for new construction projects. Most of the market rate developers are familiar with Freddie Mac and Fannie Mae and have viewed HUD primarily as a niche lender for affordable projects. However, almost two-thirds of mortgages insured by HUD are guaranteed by traditional apartments at market rates, and HUD is very active. It insured approximately $ 31.8 billion in 2021, an increase from $ 26.5 billion in 2020. That means its annual start-ups are on par with the historic annual start-ups of multi-family life insurance companies.
While many inclusive developments are not categorized as “affordable” by HUD’s definition, HUD views the inclusion of all affordable units favorably, and affordability is not a prerequisite for funding. HUD funds many projects that are 100 percent at market rate.
HUD vs traditional funding
For construction loans at market rates, the HUD can underwrite the lesser of 85% LTC or a debt coverage ratio of 1.18, compared to 75% LTC for banks. So, from an SLD perspective, the HUD offers an immediate benefit.
However, most projects using bank financing with inclusive and affordable units are limited by cash flow, not cost. Banks typically use an artificial interest rate and amortization to emphasize their exit underwriting, effectively limiting the loan proceeds to around 60% LTC. HUD, however, uses the real interest rate, a 40-year amortization, and a DCR of 1.18. Current all-inclusive rates, including a mortgage insurance premium, assuming the property meets HUD green building standards, are around 3.35%, fixed for the term of the loan. On the net, this can result in loan proceeds 25% more than a bank can achieve. From an equity perspective, the higher leverage and lower interest rate combined with long amortization can also make low return on cost inclusion projects acceptable to investors because the return cash is always attractive.
Also note: HUD construction loans are non-recourse and subject to standard exclusions. HUD also offers attractive prepayment flexibility with a tapering penalty from year one and no penalty after year 10.
Why don’t all developers use the HUD? There are a few drawbacks to browsing:
- HUD loans for new construction at market rates take about 12 months to process, compared to three to four months for a typical bank loan. Developments that meet HUD’s definition of affordable can be completed in as little as seven months.
- HUD requires prevailing wages. In cities without a strong union presence, or on smaller projects, this requirement can increase costs by 10% or more.
- Finally, for first-time HUD developers, HUD will require some HUD experience on the development team – a general contractor who has done HUD transactions or a construction consultant – and an experienced HUD property manager for the first year.
If a developer is not 12 months old or limited by labor costs, they can also use HUD as a lender to go during stabilization. HUD will advance 80% LTV on a cash refinance with a DCR of 1.18. The current refinancing rates are 2.75% (assuming a green project) for a term and amortization of 35 years.
A developer considering a HUD for a construction loan should contact the HUD lender early and consider bringing in a GC and an architect with previous HUD experience. The HUD has nuanced rules about what it will count for hypothetical project costs versus market rate lenders, and it’s also more concerned with FHA accessibility compliance. Making sure the project meets these requirements early in the design process will save you a lot of time.
Inclusion zoning policies can create significant holes in the capital stack in development projects, as reduced cash flow limits loan dollars and returns on equity to the point that many projects are not completed. more financially viable. HUD financing, with its higher LTC, competitive rates, long amortization, and more stringent debt coverage requirements, provides a solid alternative to traditional bank financing for apartments at market rates and mixed income. Developers can talk to loan providers, including HUD-approved direct lenders and mortgage bankers, to determine if a HUD loan is the right choice for them.
Matthew Wurtzebach is senior vice president of the Commercial Finance group of Draper and Kramer.