Disadvantages of HUD Multifamily Loans
By Terry Painter/Mortgage Banker, Author of The Encyclopedia of Commercial Real Estate Advice – Wiley Publishers, Member of The Forbes Business Council
The 12 Disadvantages of HUD Multifamily Loans
| *Takes a Long Time to Close | *Older Properties May Have to be Remodeled |
| *Higher Closing Costs | *Monthly Replacement Reserves Required |
| *Minimum Loan $3,000,000 | *Working Capital Reserve for Construction |
| *Annual Financial Audits | *Davis-Bacon Wages Required for Construction |
| *Biannual Draws for Owners | *Mortgage Insurance Required |
| *Large Amount of Paper Work. | *Surprise Annual Inspections from HUD |
The 12 Disadvantages of HUD Multifamily Loans the Details
I do have to say after closing over 50 of these loans over the past 24 years that as astoundingly great the Pros are, the Cons are equally astoundingly unsavory. So why then do so many apartment building investors take out these loans? The answer is because it’s easy to be bought by the benefits of landing the highest leverage, lowest long term fixed rate – non-recourse multifamily mortgage in America.
1. Time Frame to Close – HUD after all is the government, which isn’t known for getting things done quickly. For the HUD 223(f) Loan for Acquisition or Refinance, you better allow 7 months, although it is possible to close in 6 months if everything goes well. Under the Multifamily Accelerated Processing Process (MAP), HUD is supposed to take 45 days after they receive the completed application to respond. But if they are backed up, this can take 90 days.
For the HUD 221(d)(4) Loan for New Construction and Substantial Rehabilitation, you need to allow 8 – 10 months for closing. This is usually a two step process. The first part takes about 4 months for HUD to review what is called the pre-application. If they like the deal, they will issue an invitation letter to fully apply for the loan. While you are getting your plans and specs done and then a full construction contract with an architectural and cost review, your lender is preparing the firm application. This is then sent off to HUD which has 45 days, under MAP guidelines, but could take up to 90 days to approve the loan.
2. Higher Closing Costs – Where most commercial loans charge a loan fee, appraisal fee, environmental report fee and processing fee, HUD Multifamily loan fees are higher. Note that these can all be financed with the loan. Here they are:
- Loan Fee: 1 – 2%
- HUD Application Fee: .30%
- HUD Exam Fee: .40%
- Processing Fee: $7,500
- Market Study for New Construction: $8,500 – $9,000
- Appraisal: $8,000
- Environmental Report – Phase 1: $7,500
- Mortgage Insurance Premium: 1% of the Loan Amount at closing
3. Annual Financial Audits – CPA audited financials are required annually before owners can take their two annual draws which are based on these reports. Examined are profit and loss statements as well as balance sheets for the business.
4. Biannual Draws for Owners – Within 30 days of the annual financial audit, owners can draw the actual net income from the property for the previous 6 months. A second draw is allowed 6 months later. Keep in mind that because HUD does not require as much financial strength for the key principals, they need to make sure that the property is running profitably, and that the funds the owners are drawing from the operating account are from profit and not just from cash flow.
5. Monthly Replacement Reserves – Your HUD lender will collect an average of $400 per unit per year with the loan payment for a rainy day fund to cover repairs and replacements on the property. Owners are reimbursed from this fund for actual expenses about 30 days after they are paid for. If too much accumulates in this account you can apply with HUD to stop contributing for a year at a time.
6. Minimum $3,000 Loan Size – HUD would allow a much smaller loan. But it’s actually the lenders that prefer their purchase and refinance loans to be at least $5 million. But some will go down to $3,000. This is because of the exceptional amount of time and paperwork needed apply with HUD and close these loans. Even at $5 million, unless the lender charges a larger loan fee will not get paid adequately for their time.
7. Mortgage Insurance Required – HUD Multifamily Loans require mortgage insurance for two reasons. First, because of the risk HUD assumes by approving high leverage loans. Second, mortgage insurance makes it possible for HUD to guarantee these loans with the full credit of the United States Government. Keep in mind that HUD does not fund these loans, but only guarantees them. This allows the loans to be funded by the sale of Ginnie Mae Bonds on Wall Street which has the highest credit rating of all bonds. The cost for mortgage insurance is 1% of the principal amount at closing to start the policy and then .25% for green buildings, and .60% of the principal amount for standard buildings paid monthly with the mortgage payment. Most lenders just add this cost into the rate.
8. Property Inspections Required – HUD Inspectors make surprise visits annually, to inspect the condition of all major systems including electrical, plumbing, HVAC and structural components.
9. Rate Floats Until Loan Approval – HUD Multifamily Loans take a long time to be approved, and the rate cannot be locked until loan approval. So, the borrower has to live with a longer period of uncertainty as to what the rate and final loan amount is going to be.
10. Older Properties May Need to Be Remodeled – HUD Multifamily often does not make financial sense for properties that are over 25 years old, unless they have been maintained in very good condition. HUD requires an extensive property condition report called a PCNA, and all major systems will need to be brought into very good condition. Although the cost of the renovations can be financed with the loan, this can be cost prohibitive. Therefore, if the borrower does not want to extensively improve the property, this loan will not be a fit.
11. Surprise Annual Inspections from HUD – As long as you are not planning on being a slumlord, this shouldn’t be a problem. HUD’s mandate is to provide more quality Housing in America, so they will just give you a week or two notice before showing up to inspect the property.
12. Massive Paperwork – I like to say that applying for a HUD loan is like applying for three loans. Although the lender will prepare most of it, there is still a lot more for you to do as well.
HUD Financing did not Work for This Guy
Every one of my clients has had to endure the headaches of applying for this loan product and waiting for it to close. Just like giving birth, as the saying goes, after it was all done and months and years after the loan closed, they all felt it was worth it. All except one, that is, who literally hated the loan. About 7 months after his HUD 223(f) Loan closed, I called him to see how he was doing. He told me, “OMG, I’m in bed with the government. His misery started when he could not take an owner’s draws after a few months of ownership. “How can they tell me I can’t pay myself every month”? I did warn him about this at the beginning – but it didn’t really sink in that he could only take two draws per year after financial audits were completed.
I also warned him that he would need to hire a professional management company with HUD experience for at least the first year. But he insisted on self-managing. He literally went nuts trying to fill out all the forms. Then what really broke the elephant’s back (camel too small), was when HUD showed up for their first surprise annual inspection in August and cited him for a health and safety violation. Seniors could die from the broken HVAC units he was told. He told me the letter he got from HUD made him feel like a slumlord. “I don’t know what the problem is,” he said. “I told them I would get it fixed when I have the money just as I do with my other apartment buildings.” That just doesn’t work with a HUD loan. Turns out this guy really preferred being a slumlord.
Advantages of HUD Multifamily Loans
Now that you have looked at the disadvantages, be sure to check out the Advantages of HUD Multifamily Loans.
And here’s a HUD Multifamily Loan Glossary with 74 terms defined for a fast look up.