By Stephen L. Rudow, Senior Vice President
AGM Financial Services
The Challenges: Structuring the refinance to meet the numerous and sometimes conflicting FHA/HUD requirements from three different loan programs - the existing Section 202 loan and the two new loans under Sections 223(f) and 241(a). This was particularly difficult since this loan combination had not been used in this way before, and two different HUD offices needed to approve the innovative loan structure.
The FHA regulations covering the refinance of the existing Section 202 loan impose many requirements, with the two most difficult being: 1) the debt service cannot increase, even if the property has the ability to pay a higher amount, and 2) a Section 8 rent increase is not allowed in conjunction with the refinance. Even though interest rates today are well below that of the existing loan, these two conditions severely limit the size of the new FHA-insured first mortgage.
The Solution: Two new FHA-insured loans crafted to meet a myriad of FHA requirements from the various loan programs. The relatively low new FHA Section 223(f) first mortgage was supplemented by a new FHA Section 241(a) second mortgage. Although the two loans were processed simultaneously, they were separate transactions. A rent increase specific to the second mortgage, as opposed to the refinance of the first, provides the necessary additional cash flow to service the new debt. As an added benefit, the 223(f) loan achieves a lower interest rate than a construction/permanent loan.
1st Mortgage - FHA Section 223(f)
||Debt Service is paid by property’s existing cash flow|
2nd Mortgage - FHA Section 241(a) $4,445,400
||Debt Service is paid by
combination of existing excess cash flow & new HUD Section
|Owner’s Funds - existing escrows, residual receipts $278,241||
||Future property cash flow & Escrow releases|
The Owner: The non-profit property owner is Jaycee-HDC, Inc., an affiliate of the non-profit Housing and Development Corporation (“HDC”). Jaycee-HDC has owned the property since it was developed; no change in ownership structure was necessary.
The Property: Lancaster House South (“LHS”) is located at 315 North Prince Street in Lancaster, PA. The facility consists of an 11-story, 150-unit apartment building for elderly and disabled residents which was built in 1979. The first floor of the building also includes leasing/management offices and several community rooms. The building was in fair to good condition but has felt the effects of 30 years of wear and tear. In addition, significant repairs were needed to correct potentially serious issues regarding the brick façade of the building.
The Rehab: The scope of work included extensive repairs to the building’s brick façade, new windows, upgrades to the fire safety and elevator systems, extensive bathroom renovations, replacement of 85% of the kitchens and appliances, replacement of most AC units, extensive renovations to 20 units for handicap accessibility, and complete renovation of the management offices and common areas. A canopy was be added at the main entrance. The owner chose to engage an architect and a general contractor to provide a professional, comprehensive, timely renovation with a minimum of disruption to the residents and the best possible pricing.
Existing Financing: The project was originally developed with a direct loan from FHA’s Section 202 program, which is specifically for the non-profit development of rental senior housing communities. The initial principal balance was $4,450,200, at an interest rate of 6.8750% and a 463 month term (38 years, 7 months). The loan balance at closing of the refinance was $2,264,009. The owner had the right to pay off the existing loan; FHA has issued two Housing Notices (02-16 and 04-21) regarding the prepayment and refinancing of Section 202 loans which set forth a number of requirements applicable to this process.
Section 8 Contract: The property has a long term Section 8 contract for all 150 rental units. The monthly Section 8 rent at the time of refinance was $554/unit, with the landlord responsible for all utilities. The market rates for the building were analyzed during the refinance and conservatively correlated to $775/unit, thus the Section 8 rent was well below market.
Financing Alternatives: HDC consulted
with AGM Financial Services, Inc., an FHA loan specialist, to
understand their refinance options within the FHA universe. The two options were both within the FHA “MAP” program for loans with FHA mortgage insurance: either Section 223(f) or Section 221(d)(4). The two programs are similar in format and processing, but Section 223(f) is intended for refinance of apartments with only modest repairs, while Section 221(d)(4) is for substantial rehabilitation of apartments. Section 221(d)(4) includes both an interest-only construction loan and a 40-year permanent loan with combined processing and fees; its processing includes a unit by unit inspection by an architect, use of a general contractor, and a requirement that the contractor pay Davis Bacon wages (aka prevailing wages).
Typically, a project of this type would be a likely candidate for refinance and renovation under the Section 221(d)(4) program, in combination with Low Income Housing Tax Credits (LIHTC’s) which would provide a substantial amount of new equity through the sale of the tax credits. In this scenario, the new loan would be funded by the sale of tax-exempt bonds and insured by FHA. HDC and AGM initially proposed this structure, however, a proposed rehabilitation with LIHTC was rejected by FHA because the owner would lose their tax exempt status, resulting in the need to increase the Section 8 rents in order to pay real estate taxes. FHA’s challenge to AGM was to find a way to use their programs without affecting the property’s tax-exempt status (i.e., without LIHTC’s).
Commercial Davis Bacon wages will be paid since the combined renovation would fall under the definition of substantial rehabilitation.