Eligibility and Required Documents
What Makes an Existing Property a Good Candidate for Financing?
This section will discuss the benefits of the FHA 223 (f) program for existing properties that are operating at a minimum 85% occupancy. This is the standard FHA has adopted for submitting a loan for Firm Application.
Most properties break even at around 82% to 84%, meaning the proposed properties should be cash flowing at least a little. When one thinks the new interest rate will likely be lower than presently on the existing loan, the possibility for greater cash flow occurs, an appealing proposition.
So here are some characteristics to consider when contemplating FHA financing:
- We as lenders are allowed to charge 3.50% max for the Placement (1.50% max) and Financing fees (2.00% max). This amounts to $35,000 on a $1,000,000 loan.
- The problem is, we as HUD MAP lenders, have approximately $40,000 in fees attached to every deal (approximately half goes to our attorneys for the closing).
- This means that we lose $5,000 on a $1,000,000 loan, unless we raise the interest rate that creates a premium for our fee. This is counterproductive in two ways:
- It makes the loan riskier as the property must support higher rents to pay the higher loan costs.
b.It cuts into the cash flow to the borrower, making the owner less inclined to feed the nonrecourse loan during times of stress.
- The ongoing costs are also prohibitive: each year, the owner must obtain audited financials of the property as part of the regulatory agreement and as a condition preceding making the initial semi-annual cash flow distribution. This cost can range from $4,500 to $7,000 easily. I have a client who is paying $13,000 for this audit. This negatively impacts the property’s performance for at least one month as that is a hefty dent in a month’s cash flow.
- Neither of these items are a problem on a bigger deal but both hurt the small deal and the small deal owner.
- Can we do a million dollar deal? Absolutely. Does it make sense? Probably not.
So what kind of deal works?
- The program works great for a borrower seeking long term, non-recourse, assumable financing. If you are thinking of a 3-5 year hold, the financing might not be the best for you, as potential buyers might not want the FHA involvement in their operations. If you are contemplating a 7 year hold, this loan makes a lot of sense.
- Let’s say you have taken a downtrodden property, fixed it up and now are making a lot of money. Perhaps you are contemplating a cash-out. This program is excellent for such a situation. If some of the valuation is enhanced by anticipated repairs/replacements, you can pay for these repairs inside the loan and still get an 80% loan to value loan based upon the after repair/replacement value. We have clients that have taken millions out tax free in this situation.
- So think of it this way: You spend $100,000 on fix-up and it appraises for $200,000 more (based on rental increase from new appliances or say, less expenses from energy efficient mechanicals). Here, you could obtain $160,000 more in loan proceeds, less the $100,000 in repairs/replacements, netting $60,000 more.
- FHA works in secondary and even tertiary markets. Not all loan programs will go to the smaller towns.
- Let’s say you have a tired project, needing new appliances, interiors and ceiling fans in order to be competitive or to maximize income when compared to newer, better properties. FHA loves to upgrade in this area. This is a sweet spot for FHA financing.
- Assume you bought on a bank loan, fixed the property up and now want permanent financing, preferably nonrecourse. Talk to us. This is what we do.
FHA financing does not work in every situation. For example, there are a lot of properties that are say, 65% occupied that could really use this financing to fix things up and to stabilize. If you have a property like this, give us a call, because I think we could get FHA to see the merits of such an approach.
When the financing works, it works great. Rarely do I have a client who only does one FHA deal. Once they come to understand the process and see the benefits, they love the leverage and the nonrecourse.
FHA is always in the market and the underwriting rarely changes. It is something you can count on, and you should.