Let’s talk Amortizations and the FHA 223 (f)

I am getting a lot of calls by small investors interested in buying 16 to 100 unit properties.  Some have money; some do not.  The properties are ranging from 1930s to 1970s, mostly, with most being 1960s and 1970s product.  They are typically over 85% occupancy with average rents for 1 and 2 bedroom unit properties averaging rents of $550-$600.  These are found in Texas, Oklahoma and Kansas.

All of these buyers are looking for cash flow, unlike my typical 221 d4 owners, who are looking for cash flow if they can get it but mostly they don’t want to feed it.  The d4 people seem intent on building as much as they can at less than 4.50% rates and then preparing to sell their units in 5 years when the units are occupied, at higher rents than were underwritten and when interest rates are 7% (or more) and cap rates are 5% (or thereabout).


As a result, when cash is dear, the little guys want leverage and a great return.  Almost all of these syndications are partnerships with  a General Partner and 2-5 people putting in money to make the deal work.


Look at the 2 examples described below:  In each case, the rents and expenses and occupancies are the same, the repairs are the same ($4,815 per unit) and the cap rates and costs are the same ($1,000 per unit initial deposit to the replacement reserve).  The variable is the amortization.


The client is putting in $356, 798 in each case, as required by the terms of the loan, but in the 25 year amortization scenario, they get a cash flow of $56,895.  This is a 15.9% return on investment.


In the 35 year am, their return on the same investment is $76,459, or a 21.4% return.


For small investors, this difference is critical, largely because the limited partners are likely to get a preferred or guaranteed return before the General Partner makes anything.  The GP likes using other people’s money but at the end of the day, needs to make something on the deal.


Why should FHA care?  Note that these 85% (+) properties are getting a $4,815 facelift that will include new appliances, carpets, mechanicals and other needed repairs.  These older units won’t get the benefit of these improvements if the transaction (and the FHA loan) doesn’t go through.


FHA wants skin in the game, not being the only one at risk. Let’s talk risk:  Imagine the predicament of the GP who doesn’t hit these returns.  These loans involve important money to these investors.


Let’s look at this from FHA’s point of view: When the FHA Multifamily Industry started paying attention to amortizations in 2001, it was because someone figured that the older properties would be decrepit in the 35th year so FHA needed to get out in sometime shorter, maybe 25 years.


Ever wonder why these deals were 35 years in the first place?  It was because, with all the fees, costs, reserves in an FHA deal, the longer amortization was needed to get the cash flows to the investors comparable to cheaper shorter term loans (bank loans) so the FHA financed deals would get done in the first place.


The reality is these FHA deals are most at risk in the early years, so let’s look at breakeven for each of these transactions:


XYZ Apartments:


Number of units:                54

Average Rents:                  $585

Other Income:                   $26

Income per Unit/Mo:             $611

Income per Month:               $32,994

Annualized:                     $395,928

At 93% Occupancy:               $368,213

Less Expenses:                                  $185,316  ($3,432/unit;$4.03/nrsf)

NOI:                                         $182,897


The Loan amount is limited by either the statutory limits or the lesser of these 3 calculations:


  1.  Value:

Value at 8% cap rate:             $2,287,600

83.3% of Value:                                  $1,905,500


  1. Debt Service:

Debt Service Coverage:                               120%

Income avail. for Debt Service:           $152,507

Maximum Loan based on 25 yr am:         $2,291,600 (Loan Constant of 6.652%)


Maximum Loan based on 35 yr am:         $2,712,400 (Loan Constant of 5.620%)


  1. Eligible, Mortgage-able Transaction Costs:


100% of Eligible Trans. Costs:            $1,895,800


In this transaction, the loan is $1,895,800.


The 25 year am deal requires $126,114 to debt service the $1,895,800 loan and $185,316 in expenses to breakeven.  This amounts to $311,430 per year, $25,952 per month, or collections of $517 per unit at 93% occupancy.


The 35 year am deal requires $106,550 to debt service the $1,895,800 loan and the same $185,316 in expenses to breakeven.  This amounts to $291,866 per year, $24,322 per month, or collections of $485 per unit at 93% occupancy.  Which one is the safer deal to you?


Only 2% of the FHA loans are expected to go to the full 35 year term.  Those units can be maintained with diligent asset management and increasing replacement reserves to ensure their ongoing viability.  Most FHA loans are paid off in less than 15 years, many at the 8 or 9 year mark. The major worry is not in year 25 but in year 3 or 4, if the market were to change and the owner needed rent flexibility to drop rents during a weak rental market.  A 25 year amortization doesn’t provide the flexibility of a 35 year loan.  FHA would be better served with a 35 year amortization rather than the shorter term presently being used.


From an affordability standpoint, that $32 in rent savings could be a major factor in quality of life for a resident working minimum wage.


SUMMARY:  Putting these older deals into the hands of small syndications will provide active ownership interested in making the properties run efficiently and profitably, ensuring debt service is met.  Providing the moneys to retain the operations of these units will protect their affordability and their sustaining for the duration, especially with large reserves and large reserve contributions. The longer amortizations help the owners and tenants and helps FHA, by keeping rents low during times of stress in a market.


Everyone wins with longer loan amortizations.