How are FHA and Al Capone the same?  Well, let me share a story…

One night in the 1920s, Al Capone went to an Italian restaurant in Cicero, Illinois. The Capone entourage sat down, the waiter came up to the table to get the drink order and as he was leaving, Al Capone slipped the waiter a $100 bill, saying “take good care of us”.

Five, Ten, Fifteen minutes went past and the waiter hadn’t returned.  Al went back into the kitchen and said, “hey, where’s my waiter”?  One of the help said “He came back here holding a $100 bill, and said ‘I quit this lousy job’ and walked out the back door”.

The Answer: Neither Al Capone nor FHA wants the person they are doing business with to get the benefit of the bargain before they get their bargained-for value.

Let me amplify on this:

FHA is prepared to recognize the Fair Market Value of the land that is to be used in the construction of apartments it intends to insure. In some cases, land equity plays a big role in the leverage a developer can obtain in a 221 (d) 4 transaction.  Take a look at the following:

Assume:          $ 9,000,000 hard and soft costs

$ 1,500,000 land value (for fun, let’s assume this to be free and clear)

$   900,000  BSPRA

$11,400,000 Total

@      83.3% Maximum Loan (Market Rate)

$  9,496,200   Maximum Loan

$  1,903,800   Cash Required

($ 2,400,000)  BSPRA and Land Equity

$     496,200   Excess land value

Under the new rules promulgated in the Revised Map Guide, in addition to the items inside the loan, the development entity must produce an Initial Operating Deficit Escrow equal to 3% up to 6% of the loan amount (most likely 3% on this transaction, subject to some exceptions).  In addition the Working Capital Escrow has been increased to 4% of the loan.  That means the cash requirements outside the loan are now, in this example, around 7% of the loan, or $664,734.  The $496,200 can be used to defray the amount, so that at closing, all things being equal, the borrower would need to come up with $644,734-$496,200, or $168,534. Not bad, huh?

FHA is emphasizing security on these loans more than at any time before.  This also gives me an opportunity to tell another story:

I went on a run in the mid-‘80s with a very famous acquisition specialist.  Along the run, he started talking in the first mile about his $10 million deals, the second mile about his $50 million deals, the third mile his $200 million deals and the last mile about his involvement in Star Wars (the government program, not the movies).

After the run, I asked him about how he structured his partnerships.  His response was very candid and very instructive: “Basically, if we get hurt, they get buried.”

FHA is moving towards a similar approach.  The risk of stabilization under the new rules has largely and effectively been transferred from FHA to the Borrower.

All the money in the IOD, the land value and the working capital is a source for debt service up until the property stabilizes for a time period satisfactory to FHA.

MAP Guide Section 8.13.J reads as follows:

J. Cash-Out From Land Equity.


If land, or the “as is” property value for a substantial rehabilitation project, is contributed to meet the sponsor’s equity requirement, any cash out from the excess land or property equity above what is required at initial endorsement must be deferred (See Appendix 12A paragraph E) until the project is complete and it has demonstrated to the Hub/PC’s satisfaction that it has achieved 6 consecutive months of break-even occupancy. This does not prevent applying land value equity to fund operating deficit or working capital escrows, or other cash requirements at initial endorsement. To the extent that there are excess mortgage proceeds available from land value (or “as is value”) or other equity, excess mortgage proceeds may be set up at Initial Endorsement and used for all the purposes described in Appendix 12A, paragraph D, including funding the working capital construction contingency escrow. See Chapter 12 Section 12.8 and 12.15 for guidance.

Chapter 12.16.F. Cash-Out From Land Equity must be held by the Lender at initial closing and is funded by excess mortgage proceeds, if any.


1. Cash out from the excess value of the land, or, for a substantial rehabilitation project, the “as is” property value, that was contributed to meet the sponsor’s equity requirement at initial endorsement, above what was required at initial endorsement must be deferred and held by the Lender. The Lender will have discretion as to the form of escrow to use to hold back any cash out from land equity, refer to Appendix 12A paragraph E.

2. The Lender will hold the cash out funds until project operations have demonstrated to the HUD field office’s satisfaction that it has achieved 6 consecutive months of break-even occupancy. (Break-even occupancy is defined as 1.0 debt service coverage, based on all sources of project income including ancillary income.) HUD Mortgage Credit staff will consult with AM staff prior to approval of a release to obtain AM’s approve of the release. Multifamily Hub/Program Centers should exercise caution to be certain that monthly results are not erratic or seasonal and that 1.0 or better debt service coverage will be sustainable after release of the escrow funds. HUD will approve a request for release of funds on Form HUD-92464M from the Lender. The Lender’s file should contain the HUD approval and documentation supporting the release.

Similar rules apply to Working Capital and the Initial Operating Deficit.

So, like Al Capone, FHA is getting tougher about getting what it wants and under the new rules it looks like they will get a stabilized property under their terms before you as an owner see your cash back.