Background. The U.S. Housing and Urban Development’s (HUD) 221(d)(4) program allows for long-term mortgages (up to 40 years) that can be financed with Government National Mortgage Association (GNMA) Mortgage Backed Securities for the purpose of providing construction-to-permanent financing to for-profit developers of market rate multi-family rental housing.
Why They Are Attractive. These loans are attractive to for-profit developers because they can receive a maximum mortgage of 90 percent of the HUD/FHA replacement cost estimate, and they are non-recourse. Developers also do not have to have to get permanent financing separately from the construction loan.
But At What Cost? We all know there’s no free lunch. What makes these loans potentially unattractive is the overall process takes longer than that for obtaining traditional financing, by about 2-3 months depending on the timeline and the particular transaction in question. Also, as you might suspect, the paperwork associated with getting public financing is substantial.
Tricky Modeling. Additionally, the modeling for these loans is tricky due to the HUD requirements that revolve around the following elements:
- Initial Operating Deficit
- Working Capital Reserve
- Funded Interest Reserve
What makes it tricky is how to size these amounts without creating circular references in your model, which can distort your calculations dangerously as they relate to the debt and equity cash flows.