Whether you’re developing a new multifamily community or refinancing an existing property, a new incremental change in HUD rules can increase loan proceeds.
“The new changes can close the gap a little in terms of the equity borrowers need and makes HUD loans a bit easier for developers,” says Barry Wolfson, chief FHA underwriter for Greystone. “This change goes into effect immediately and applies to all loans that haven’t yet closed. Even if you already have a commitment for a loan, the new formula and loan amount applies without changing your pricing.”
New Calculations for LTV/LTC and DSCR for HUD Multifamily Loans
Two mathematical equations that impact borrowing options have been adjusted by HUD with the goal of increasing availability of HUD financing: the loan-to-value (LTV) for refinancing or loan-to-cost (LTC) for new developments, and the debt service coverage ratio (DSCR).
Financing for affordable developments using Low Income Housing Tax Credits (LIHTC) will increase from 87% to 90% LTV/LTC and the debt service coverage requirement drops from 1.15 to 1.11. Financing for market rate developments or multifamily communities using LIHTCs without a rent advantage will increase from 85% to 87% LTV/LTC and the debt service coverage requirement changes from 1.176 to 1.15.
“In effect, this increases borrowing amounts by approximately 2.6% for market rate deals,” Wolfson says. “The big difference is for new construction, because the competition for HUD financing, such as banks and insurance companies, are currently lending at around 65% of cost.”
In theory, Wolfson explained, HUD lends up to 85% now on market rate new developments (and 87% under the new rule), but high interest rates and the debt service coverage requirement mean that loans are more often 70% to 80% at most.
“That’s a lot better than current financing with many banks but still, this means developers need to come up with significant equity,” Wolfson says. “This HUD debt service coverage change closes the gap a little bit and increases the proposed loan proceeds at a time when we're not even close to maxing out on the loan to cost that we could get on most proposed HUD loans. This makes it easier for them to actually climb that mountain and get to the place where they have enough money to close the deal.”
The LTV/LTC and debt service coverage formula is unchanged for financing for buildings with 90% or more units designated for tenants using rental assistance.
Another element of the HUD multifamily loan program that is not changing is the minimum underwriting vacancy factor, which ranges from 3% for developments with 90% or greater units with rental assistance to 5% for properties using LIHTCs and a rent advantage to market to 7% for market rate communities.
“Some of the rules instituted for risk mitigation after the 2008 financial crisis included 7% minimum vacancy underwriting, which means that even if your property is 100% full and has been for the last 20 years, we can count only 93% of the potential gross income,” Wolfson says.
More Options for HUD Multifamily Financing – New Middle Income Category
HUD also announced a new category of FHA-insured mortgage loans on properties where at least 50% of the rental units are targeted to individuals and families with incomes at or below 120% of the Area Median Income (AMI). The new set of underwriting thresholds for the development of “middle income” rental housing responds to market needs using the existing FHA 221(d)(4) loan program. “The HUD formula for debt service coverage and loan-to-value for multifamily developments with half of their units restricted to households making no more than 120% of AMI could allow a borrowing increase of as much as 6%,” Wolfson says. “That is a gamechanger. In probably more than three-quarters of markets in the country, the rent levels produced for 120% AMI would be at or above market rates. So, it’s not much of a restriction, especially since 50% of the rents would be market rate. This new category significantly increases the borrowing power for many developers.”
According to HUD, “These changes increase financing flexibility for lenders and developers seeking to use the programs to create new or refinance existing affordable multifamily rental properties and create new or substantially rehabilitate properties that provide rental opportunities for “middle income” individuals and families.”
Greystone will continue to provide updates on multifamily HUD financing requirements and other changes that can impact the multifamily market as they develop.