Loan considerations

• 40-year fixed and fully amortizing interest rates are highly competitive, though borrowers must pay a mortgage insurance premium.

• 221(d)(4) loans are interest-only during the construction period, providing up to a three-year additional period of financing at the same fixed rate.

• All loans must go through a HUD preliminary review process.

• Adherence to Davis-Bacon prevailing wage standards is required.

• An annual audit of operations is required.

• Hard second liens are not allowed, but soft seconds and stock pledges are allowed if structured in accordance with HUD requirements.

• The project requires a bonded general contractor.

• The minimum loan amount is $4 million, although exceptions can be made on a case-by-case basis. However, most 221(d)(4) construction loans are $10 million and above. There is no maximum loan amount.

Eligible Properties

Despite some common misconceptions, HUD 221(d)(4) financing is available for a broad spectrum of developments — not just affordable housing.

The loan may be used for the construction or substantial rehabilitation of detached, semi-detached, walkup, row, and elevator-type multifamily properties, including market-rate, low-to-moderate income, and subsidized multifamily, cooperative housing, and affordable housing properties with at least five units.

Commercial Space Limitation 

Commercial and retail space is limited to 25% of net rentable area and 15% of underwritten effective gross income. Up to 30% of underwritten EGI is permitted in urban renewal areas defined under Section 220.

Eligible Borrowers 

Borrowers must be single-asset, bankruptcy-remote, for-profit or nonprofit entities.

Use of Proceeds (Substantial Rehabilitation Only) 

To qualify for substantial rehabilitation financing, a property must meet one of the following requirements: 

• The cost of repairs, replacements, and improvements to the existing property must exceed the greater of 15% of the replacement cost of the property after completion of all work, or $6,500 per unit adjusted by the local HUD office for the specific area.

• The rehabilitation plan will replace two or more buildings, regardless of cost.

Loan Amount, Leverage, DSCR

The loan amount will be the maximum proceeds, subject to the lesser of:

• 87% LTC (or replacement cost), 87% of net operating income, or 1.15 DSCR for market-rate properties

• 90% LTC (or replacement cost), 90% of net operating income, or 1.11 DSCR for affordable housing properties or rental assistance properties

Escrows

• Replacement reserves are required in accordance with HUD guidelines.

• Taxes and insurance escrowed monthly (post construction).

• Working capital reserve account equal to 4% of the loan amount (paid in cash or letter of credit), with any unused amount refunded.

• Operating deficit reserve equal to at least 3% of the loan amount; the unused amount is later refunded.

Mortgage Insurance Premium 

A mortgage insurance premium is paid annually. The MIP is payable at closing for each year of construction, then annually after construction. The mortgage insurance premium is 65 basis points for market-rate properties, 45 basis points for Section 8 or new-money LIHTC properties, and 70 basis points for Section 220 urban renewal projects that are not Section 8 or LIHTC. An MIP of 25 basis points is available for properties that qualify for a Green MIP reduction.

Term & Amortization

Loans have a maximum term of 43 years, which includes a maximum 36 months for construction and an additional 40 years of fully amortizing, fixed-rate payments.

Interest Rate

Interest rates are fixed throughout the life of the loan (both construction and permanent stages) and determined at commitment by prevailing market conditions. Thirty- to 80-day rate lock commitments are available. An early rate lock feature is available, allowing the borrower to lock the rate after preliminary underwriting.

There is a 1% rate lock deposit payable at the time of the lock, which is refunded at closing. 

Recourse

All loans are non-recourse to key principals during both construction and permanent financing, subject to standard carve-outs.

Assumability

All loans are fully assumable subject to FHA approval and a fee of 0.05% of the original FHA-insured loan amount. 

Prepayment Penalties

Generally, for best pricing, 10 years of call protection with a two-year lockout, followed by a step-down from 8%. There is no prepayment penalty if a loan is assumed. 

Replacement Reserves

Annual deposits are required for replacement reserves equal to the greater of:

1. 0.6% of the total cost for new construction (or 0.4% for substantial rehabilitation projects).

2. $250 per unit per year.

In certain circumstances, HUD may consider waivers if calculations exceed $500 per door. 

Application

Market-rate property applications follow a two-step process: a pre-application followed by a firm application. Affordable and rental assistance properties may use MAP one-stage processing.

Synopsis of Costs

• Application fee: usually $25,000 to cover lender due diligence and third-party reports, including:

  • Appraisal

  • Phase 1 environmental review

  • Construction cost review

  • Market study

  • Plans and specs review

• FHA exam fee: 0.30% paid as 0.15% at pre-application and 0.15% at application

• FHA inspection fee: 0.50% paid from mortgage proceeds

• Financing and placement fees, typically capped at 3.5% of the loan amount paid at closing from mortgage proceeds

• Good-faith deposit (rate lock and commitment): between 0.50% and 1% of loan amount paid at the time of commitment and refunded at closing

• Lender’s legal, title, and other standard borrower closing costs

Timing

Timing is not a HUD 221(d)(4) loan's strong suit. One-stage applications for affordable and rental assistance properties generally take around eight or nine months to close, whereas two-stage applications for market-rate properties generally close in 12 months (and sometimes longer), subject to deal specifics. 

Property Insurance Requirements

The multifamily insurance requirements for HUD 221(d)(4) loans depend on what phase the project is in. During construction, insurance including builder's risk and professional liability are required. Afterwards, property insurance requirements depend on several factors.

Additional HUD Requirements and Items for Consideration

• An initial operating deficit account may be required to cover operating shortfalls incurred prior to stabilization.

  • Usually, the amount will be equal to the greater of an appraiser’s or underwriter’s estimate, or four months of debt service for garden apartments, or six months of debt service for elevator buildings.

• A working capital deposit in the form of cash or a letter of credit is required by HUD on all new construction projects in the amount of 4% of the loan amount. For substantial rehabilitation, the deposit is equal to 2% of the loan amount.

• Unused working capital and initial operating deficit escrows are released at the later of 12 months from the final endorsement or six months from break-even occupancy.

• Stabilization must be projected as achievable within 18 months of the certificate of occupancy.

• The borrower must retain a qualified arms-length supervisory architect during the construction.

• A cost certification for the general contractor and owner are required upon construction completion.

• The general contractor must execute a GMP contract, provide a 100% performance and payment bond (either by cash escrow or letter of credit), and have a liquidity position equal to at least 5% of the project construction contract plus all incomplete construction work.

• Loans more than $75 million may be subject to more conservative leverage and DSCR requirements.

• Maximum underwritten occupancy of 93% for market-rate properties and 95% for 90% rental assistance properties.

• Qualifies for Ginnie Mae-guaranteed, mortgage-backed securities, direct placement, or may be used to credit enhance tax-exempt bonds

Learn More About 221(d)(4) Financing

Think a HUD 221(d)(4) loan might be right for your multifamily development of substantial rehab? Fantastic — fill in the form below, and we'll source you free quotes today.

And if you're interested in other types of financing, visit Multifamily Loans for more options including bank financing, life insurance company financing, Fannie Mae, Freddie Mac, and many others.

In this article:
1. Non-Recourse, Ground-Up Development and Substantial Rehabilitation Multifamily Financing
2. HUD 221(d)(4) Terms & Qualifications
3. Loan considerations
4. Eligible Properties
5. Commercial Space Limitation 
6. Eligible Borrowers 
7. Use of Proceeds (Substantial Rehabilitation Only) 
8. Loan Amount, Leverage, DSCR
9. Escrows
10. Mortgage Insurance Premium 
11. Term & Amortization
12. Interest Rate
13. Recourse
14. Assumability
15. Prepayment Penalties
16. Replacement Reserves
17. Application
18. Synopsis of Costs
19. Timing
20. Property Insurance Requirements
21. Additional HUD Requirements and Items for Consideration
22. Learn More About 221(d)(4) Financing
23. Get Financing