FHA 223(f) Apartment Program

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One of the very best apartment progams in the country comes from the Federal government, more specifically the Federal Housing Administration (FHA). Section 223(f) of the National Housing Act authorizes HUD to provide funding programs for refinancing existing debt or for the acquisition of existing apartment or housing co operatives. In English this means you can do both refis and purchase money deals on apartments.

The lenders who originate these FHA 223(f) loans must be approved FHA lenders, and often these mortgage bankers are also FNMA DUS lenders. DUS stands for Designated Underwriter and Servicer, which means they can approve their own deals, and they service these loans as well. Normally FHA lenders and FNMA DUS lenders are huge nationwide mortgage bankers.

The program itself is fantastic! The borrower can get a 35 year fully amortized loan (35/35) up to 85% loan-to-value. In addition, the rate is fixed at only 1.25% over 10 year Treasuries. As of December of 2005 that works out to a fixed rate of around 5.75% for 35 years. Wow!

In addition, there are no tenant income requirements. In other words, you do not have to rent to lowlifes who are going to tear up your building. Nor is their any regulation of rental rates. In other words, the landlord can charge whatever rent the market will bear. There are no rental controls.

There are very few restrictions and disadvantages, and any disadvantages certainly do not outweigh the positives.

One of the few restrictions is that the apartment building must be at least 3 years old. Therefore a developer can’t go out and build a brand new apartment building and get a FHA 223(f) takeout loan. (But see our memo on the FHA 221(d)(4) apartment construction program.)

A big condition to obtaining one of these loans is that the property owner must remedy any deferred maintenance. That’s the bad news. The good news is that the FHA will let you pay for the cost of these repairs out of the proceeds of the loan, and they will base their appraisal on the finished value of the property after renovation. Now the cost of the repairs cannot exceed 15% of the finished value of the property, or $6,500 per unit, whichever is lower. In addition, only one major building component may be replaced.

The Federal government guarantees a portion of these loans. That is why the rate is so fabulous, fixed at only 1.25% over 10 year Treasuries. What the Federal government gets out of the deal is a renovated housing stock.

A buyer can obtain a new loan of 85% of the purchase price, and if the property needs repair, he can obtain 85% of the cost to acquire the property and to complete the repairs. This is true, as long as the loan amount does not exceed 85% of the appraised value of the property after renovation.

Cash out refinances are limited to 70% loan-to-value. But if the borrower needs to pay off existing debt and repair the property, he can obtain a loan to cover all of these costs, as long as the loan does not exceed 85% of the appraised value of the property after renovation. In plain English, a refi-borrower can usually get all the money he needs to renovate a property and pay off the existing debt, as long as he doesn’t try to pull cash out - up to 85% of the finished value.

From the proceeds of the loan, the lender will hold back enough funds to cover the cost of the required repairs. The borrower has up to one year to complete the repairs.

A reserve for taxes and insurance will be collected on a monthly basis. In addition, a reserve for replacements will be funded from the proceeds of the loan and out of the months payments. For example, if the apartment building will need a new roof in 4 years, and if the cost of the roof will be $80,000, the lender may hold back $60,000 out of the proceeds of the loan and may require the borrower to pay, along with his principal and interest payments, $5,000 each year to complete the funding of the roof replacement reserve. Other major reserves and anticipated repairs will be funded in the same manner, with a big, initial holdback and additional monthly contributions.

FHA underwrites these loans using 85% of the net income, which works out to a 1.175 debt service coverage ratio. At these low interest rates, the deals cash flow very well. Loan-to-value ratio will usually be the limiting factor.

Loan fees generally run between one to two points to the FHA approved lender, plus any broker points, depending on the size of the loan. A common minimum loan fee to the FHA lender is $30,000 to $40,000. Most FHA approved lenders will not look at FHA 223(f) loan requests of less than $2 million, although the FHA recently brought out a simplified program for smaller loans.

The loan is locked out (prepayment is prohibited) for the first five years, and there is a some sort of declining prepayment penalty thereafter, often 5% 4% 3% 2% 1% 0% The loan is assumable for a 1% fee.

Despite the involvement of the government, these loans generally do not take more than 90 days or so to fund. This is a great program, particularly for lower quality buildings in lower income neighborhoods and for properties needing maximum leverage to pay off ballooning debt.


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