New HUD Loan Policy Change

The Real Estate Espresso Podcast

New HUD Loan Policy Change

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New HUD Loan Policy Change

Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce. On today’s show, we’re reporting on a change to financing rules in the U.S. that stands to improve the numbers for multifamily apartment projects. We’re talking about HUD financing. This is more difficult financing to get than agency debt like Fannie Mae or Freddie Mac, but it is superior financing.

There are several different loan types and I’m only going to focus on the HUD 223f loan today. However, everything I’m about to say applies to the 221d4 and several other loans. The 221d4 is, of course, a construction loan that is combined with a permanent loan. The reason we’re talking about it now is as a result of a new policy change that’s being announced by Secretary Scott Turner, and it affects the mortgage insurance premium.

But first, let me describe the basic parameters of the HUD 223F loan. This is a loan for stabilized assets in the U.S. which meet the requisite debt coverage ratio of 1.15 for a minimum of 30 days. The loan will max out at an 87% loan to value with that debt coverage ratio of 1.15, whichever is lower. There are even more generous terms for buildings that meet the HUD affordability criteria, but for now, I’m confining the discussion to market rate apartments. The loan is a fully amortized 35-year loan. It’s a non-recourse loan that’s assumable, that means you can sell the loan with the property. There’s a 10-year lockup which means you’re going to be paying a prepayment penalty if you refinance out of the loan in the first 10 years.

The FHA Mortgage Insurance premiums, or MIPS as they’re called, are one of the most important expenses you need to account for in your budget. For example, for most 223 F borrowers, the annual MIP is 0.6% of the loan amount for conventional properties. By contrast, affordable properties have a reduced MIP of 0.45%. Yet the Green MIP reduction gets you a discounted 0.25% Annual MIP, as long as you make energy efficient improvements to the property and receive a high enough score on an approved certification. This week the Federal Housing Administration proposed an across the board leveling of the up-front capitalized and annual Mortgage Insurance premiums down to 25 ACEs Points for all multifamily programs.

So ALL FHA loans including the 223 F, the 221 D4 are automatically being granted a quarter point annual MIP rate. The Green MIP is essentially being eliminated and there will be no longer any hoops to jump through to qualify for the lower MIP rate. The quarter-point MIP rate is now the standard across all FHA Loans.

For loans that previously closed under a green, 0.25 percent rate, the requirements to evidence the initial green building achievement and the annual reporting of energy performance are being eliminated. The annual energy audit, the scoring requirements is completely gone on any loans that previously closed under the green MIP program.

So let’s look at what this reduction means in terms of borrowing costs for a borrower. It’s safe to say that loans in today’s environment are going to be limited by debt coverage more so than the loan-to-value ratio. The HUD 223-F loan is limited to 87.5 percent loan-to-value and a debt coverage of 1.15. The loan rate is going to be set using an offset from the yield on the ten-year treasury. Most HUD lenders today are pricing the loan around five-point-seven-five percent interest rate.

For those that are looking only at the interest rate you might find a cheaper rate out there in the marketplace, but it’s going to be for a much lower ratio loan with higher debt coverage. And then you need to remember that a bank loan or an agency loan will have a term associated with it. The amortization for a Fannie Mae loan might be 30 years but it might have a five-year, a seven-year, or a 10-year term. The longer the term, the higher the rate. Fannie Mae loans today are pricing around five-point-eight percent for a 15-year term at 65 percent loan-to-value and at 6.1 percent for a 15-year term with an 80 percent loan-to-value, so it’s more expensive financing than HUD.

Of course, 65% is not considered very high leverage. For stabilized assets, you may want to consider higher leverage, a competitive rate, and a longer amortization, which means the HUD loan is the only game in town.

So let’s look at the impact of the MIP reduction on a loan. If the rate is lower, then all other things being equal, you should be able to increase the loan amount slightly and correspondingly reduce your equity requirement on a new acquisition or on a stabilized asset. When you do the math, assuming the loan is debt coverage limited which it almost certainly is, for every dollar in monthly loan payment you can increase the loan amount by $7.87.

Now there’s a lot of math behind that calculation, so let me break it down for you with an example. Let’s imagine you bought an apartment complex with a few hundred units and your loan amount is, let’s say, thirty million dollars at a 5.75% interest rate. This loan is going to cost you $166,050 a month, every month for the next thirty-five years. That’s going to be your loan payment.

The 35 basis point reduction in interest rate with the elimination of the Green MIP means that you can increase your loan size by $1.3 million and maintain the same loan payment, or conversely reduce your equity requirement by $1.3 million and maintain the same loan payment. But of course, the amount of equity your need is a function of the cap rate you paid for the property. We’ve seen cap rates expand over the last couple years which means prices for apartments have fallen in most markets since the peak in 2022. Some estimates put the fall in values anywhere between 20 to 30% as a result of the higher interest rates.

So this increase in loan proceeds is approximately 4% compared with the loan size associated with the higher mortgage insurance premium at 0.6%. It’s going to take a few months for the change to be fully implemented, but this is good news for the industry as a whole. As you think about that, have an awesome rest of the day. Go make some great things happen!