What is a HUD Loan in Multifamily Real Estate Deals?

by | Jul 11, 2023 | Investing Process, Passive Investing, Real Estate Investing 101 | 0 comments

For real estate investors looking to finance the acquisition or refinance of a multifamily property, a HUD loan can be an attractive option. The U.S. Department of Housing and Urban Development (HUD) offers a variety of loan programs for multifamily properties, including both market-rate and affordable housing properties. 

In this blog post, we’ll explore what a HUD loan is, how it works, and the benefits and drawbacks of using one in a multifamily real estate syndication.

What is a HUD Loan?

A HUD loan is a mortgage loan that is insured by the Federal Housing Administration (FHA) and offered by HUD. HUD loans are designed to encourage the development and preservation of affordable rental housing by providing financing for multifamily properties that meet certain criteria. HUD loans are typically issued by private lenders, such as banks or mortgage companies, and are insured by the FHA, which means that if the borrower defaults on the loan, the FHA will pay the lender the outstanding balance.

“These are agency backed loans, they are very long-term and they are fixed. So on the good side, if you develop a multifamily property and get a HUD loan, it’s 40 years [example] of fixed rate interest, and 40-year amortization. And, if you go from 20, to 25, to 30, to 40 [years], that type of amortization really increases cash flow.” says Tom Burns, real estate developer and author.

How Does a HUD Loan Work?

HUD loans are available for both the acquisition and refinancing of multifamily properties. To qualify for a HUD loan, the property must meet certain criteria, including:

  • Being a multifamily property with at least five units.
  • Being in good physical condition and well-maintained.
  • Being located in an area with strong rental demand.
  • Meeting certain affordability criteria for certain types of HUD loans.

Once the property meets the criteria, the investor(s) can apply for a HUD loan through a lender that is approved by HUD. The lender will underwrite the loan and determine the terms, such as the interest rate, loan amount, and repayment term. If the loan is approved, HUD will insure it, which means that the lender is protected in the event of a default.

Benefits of Using a HUD Loan for Multifamily Real Estate Properties

There are several benefits to using a HUD loan for a multifamily real estate property, including:

Lower interest rates

HUD loans often have lower interest rates than conventional loans, which can result in lower monthly payments and higher cash flow.

Longer Repayment Terms

HUD loans can have repayment terms of up to 35 years, which can provide greater flexibility and lower monthly payments.

Non-Recourse Financing

HUD loans are typically non-recourse, which means that the lender cannot pursue the borrower’s personal assets in the event of a default.

Preservation of Affordable Housing

While not all HUD loans involve affordable housing, certain types of HUD loans, such as the Section 221(d)(4) program, are designed to preserve and improve affordable housing.

Drawbacks of Using a HUD Loan for Multifamily Real Estate Properties

While there are many benefits to using a HUD loan, there are also some drawbacks to consider, including:

Lengthy Application Process

HUD loans can take longer to process and close than conventional loans, which can delay the acquisition or refinancing of the property.

Strict Underwriting CriteriA

HUD loans have strict underwriting criteria, which means that the property must meet certain standards for physical condition, location, and affordability.

Fees and Expenses

HUD loans can have higher fees and expenses than conventional loans, including up-front and annual mortgage insurance premiums and higher replacement reserve contributions. The prepayment penalty can also be significantly higher early on in the life of a new loan compared to a conventional loan.

What Does A HUD Loan Mean For A Passive Investor?

For a passive investor considering a real estate syndication that includes a HUD loan, there are a few key takeaways to keep in mind.

First, a HUD loan can be a positive sign for the syndication, as it can provide lower interest rates, longer repayment terms, and non-recourse financing. This can result in greater cash flow and a more secure investment for the passive investor.

Second, it’s important to understand that the application process for a HUD loan can be lengthy, so the acquisition or refinancing of the property may experience delays. This may not be a problem for a refinance, but could cause an issue with a new acquisition, depending on the terms of the purchase and sale agreement (PSA). 

Additionally, the strict underwriting criteria for HUD loans means that the property must meet certain physical condition, location, and affordability standards. As a passive investor, it’s important to ensure that the sponsors have carefully evaluated the property and are confident in its ability to meet these standards.

Finally, it’s important to consider the fees and expenses associated with a HUD loan, which can be higher than conventional loans. These fees can impact the overall return on investment for the passive investor, as well as the planned length of the hold time (based on the prepayment penalty).

In summary, a HUD loan can be a positive financing option for a multifamily property, but it’s important for passive investors to understand the potential benefits and drawbacks and to carefully evaluate the syndication’s ability to successfully navigate the HUD loan process.

Conclusion

A HUD loan can be a valuable financing option for real estate investors looking to acquire or refinance a multifamily property. With lower interest rates, longer repayment terms, and non-recourse financing, HUD loans can provide attractive terms and greater flexibility than conventional loans. However, the application process can be lengthy, the underwriting criteria can be strict, and the prepayment penalties can be onerous, so it’s important to weigh the benefits and drawbacks carefully before deciding if a HUD loan is right for your multifamily real estate syndication.

Further reading: The Inside Scoop on Investor Webinars: What They Are and What to Ask