One of the beautiful things about FHA financing is its continuing homage to the 1970s. These loans have features that pre-date Disco, with fixed rate loans extending out 35 to 40 years…and non-recourse at that.
I remember early in my career a borrower saying the following: “If you want me to guarantee that I will work as hard as I can for this property to succeed and that I will follow your rules, I will do that. If you want me to guarantee the economic health of Dallas over the next 35 years, I can’t do that.” That to me explained the importance of non-recourse debt better than any explanation before or since.
But the topic today is one of the most misunderstood aspects of FHA new construction financing, that being Builder and Sponsor Risk Allowance. Under no situation can the Sponsor/Developer obtain a developer profit inside the loan. Under certain circumstances, it is better to have the Builder/Contractor paid inside the loan, although in 30 (+) years of FHA Multifamily financing, I have only closed 2 deals with SPRA, Sponsor’s Risk Allowance, where the contractor gets paid inside the loan. Why is that? Because the leverage almost always dictates the Developer and Contractor be paid outside the loan.
Basically, BSPRA is a credit added into the costs of the 221 (d) 4 loan to recognize two legitimate costs that will not be paid inside the loan: the developer/sponsor profit and the contractor profit. Try to imagine the circumstance FHA was trying to avoid when BSPRA came into being:
A mortgage banker would come into the FHA Office and start discussing his loan. The banker might be talking about this great sponsor or the excellent contractor they were going to use. “Of course”, says the banker, “he expects a 10% contractor fee”. The local FHA staff person wouldn’t necessarily know if that was the case, nor would he feel good if he said yes to this contractor but only gave the next contractor 8%. To avoid such decisions, FHA decided to give a flat fee of 10% of the hard and soft costs to the Builder and Sponsor, whenever each was at risk for their fee. That is the reason for the identity of interest requirement for BSPRA to be activated.
BSPRA helps the transaction like this:
Assume $9,000,000 in hard and soft costs and $1,000,000 in land value. If BSPRA were not part of the FHA program, under today’s rules, the maximum loan would be $8,330,000. But when BSPRA gets added to the costs, the loan becomes $10,900,000 with BSPRA equaling 10% of the hard and soft costs. If the loan can debt service the loan amount, the new loan amount becomes $9,079,700.
BSPRA is nothing more than a credit for moneys FHA expects to be paid outside its loan for the developer and for the contractor. It is not real cash but is recognition of an additional, legitimate cost that is not eligible to be paid inside the loan.
How can BSPRA improve leverage? Well, in this example, assume the land is free and clear and the developer and contractor are willing to subordinate their 10% interest in exchange for ownership.
If it costs $9,000,000 in costs to build the apartments, and if the owner is willing to contribute the land to get the deal going (exchanging dirt that the owner pays taxes on for an ownership interest in an income producing property with nonrecourse debt), then we can come very close to 100% financing.
The loan of $9,079,700 is larger than the costs ($9,000,000) but not all costs are within the mortgage: the initial operating deficit and the working capital escrow will need to be accounted for and these will add up to 7% of the loan amount, although they will eventually be (most likely, partially) returned if everything goes well and the property stabilizes. Still, the leverage can be very impressive.
Even if this particular scenario is not matched in your real deal, there is no doubt that BSPRA increases the leverage of the transaction.
So, remember, to be in the FHA game, you need to know and understand the acronyms. BSPRA is one of the biggest acronyms.
I hope this helps.