A loan through the U.S. Department of Housing and Urban Development isn’t for the faint of heart. The red tape can cause headaches for multifamily housing owners (“investors”) and real estate management companies not familiar with the ins and outs. However, with the proper guidance, you can achieve a true understanding of annual compliance requirements.

“Today, more and more investors in this economic environment are not able to get conventional financing, as they once used to, for their apartment buildings and multifamily housing complexes,” says Lori M. Crow, CPA, COS, associate director in assurance services for SS&G. However, HUD has been able to continuously insure and help fund these loans, she says.

“With many companies deciding to refinance with HUD, there are complexities to understand when moving into a heavily regulated environment, many of which investors and real estate management companies do not know about since they may have only used conventional financing for their apartment buildings,” she says.

Smart Business spoke with Crow about financing a multifamily housing loan through HUD and how to adhere to regulations.

Who finances with the Department of Housing and Urban Development and what are the benefits?

HUD issues insurance and direct loans to for-profit and not-for-profit entities. As far as for-profits, generally partnerships and LLCs participate in the program and receive insured loans. For example, a for-profit partnership approaches a third-party financial institution that deals with HUD; that institution will obtain the loan, but HUD insures it so in the event of any defaults the financial institution is protected. Nonprofits can have both insured and direct loans with HUD.

In fiscal year 2011, HUD insured mortgages for 442 projects nationwide — that’s approximately 60,000 apartment units with loans averaging $3.5 million.

The biggest benefit to a HUD loan is financial institutions aren’t 100 percent on the line; HUD is backing them up or insuring them in the case of default. Since the 2008 economic downturn, banks have been hesitant about the stability of apartment buildings and other multifamily complexes.

The loans have fixed interest rates, too. In 2011, 3.5 percent was the average fixed rate. Generally speaking, a HUD loan is 85 percent of the property’s appraised value and the partnership or LLC only needs to invest 15 percent equity into the property. Often, conventional financing is variable or for a lower amount.

What are the disadvantages of HUD financing?

Problems come from investors who are re-financing into HUD but aren’t as tuned in to the regulations. When investors obtain a HUD loan, a regulatory agreement is executed both by HUD and the owning entity, and there are a minimum of 10 types of compliance requirements that the owner must follow on an annual basis. As long as the owning entity understand these requirements, it’s not hard to follow them. However, a lot of investors moving into it for the first time don’t realize everything they signed on to.

Another factor is time. It’s a lengthy process. For example, it can take more than a year to close on a loan for an entity that already has an established relationship with HUD.

What regulations are most often not adhered to?

Annually, an independent HUD audit is required that will provide an opinion on both the financial statements, as well as compliance with the requirements as set forth in the Regulatory Agreement.  The three biggest non-compliance issues auditors identify are:

  • Unauthorized distributions. This is the biggest noncompliance problem. You cannot distribute cash back out to the investors more than twice a year based on HUD’s strict calculations of surplus cash. That differs from conventional loans, where you may be able to take money out of the property whenever there’s cash in the business.
  • Unauthorized loan of project funds. This is where an entity may loan money to a partner, another entity within management’s portfolio, or to any other related or nonrelated party.
  • Unauthorized change of ownership. This occurs when either the general or majority-limited partners exit or transfer their interest without HUD’s prior authorized approval.

There are other regulations to follow, as well, such as ensuring you have the proper internal controls over the federal programs and complying with affirmative fair housing rules.

What happens if an owning entity doesn’t comply with HUD regulations?

The auditor will qualify their opinion on compliance and provide detail findings of the noncompliance identified stating the issue, cause and effect, any questioned costs, the auditor’s recommendation for correction and management’s response to the finding.  Then the owning entity will have to follow up with implementing the corrective action, paying money back to the property, if necessary, or undertaking other actions to become compliant again. If it’s a significant noncompliance issue, the owning entity may be sent to the Departmental Enforcement Center (DEC), which then moves the noncompliance and the entity’s corrective action out of the local HUD office and this could prohibit the investor or management company from obtaining HUD financing for other properties in their portfolio.

Normally once the audit is submitted, you’ll hear from HUD in a couple of days. If you don’t, then there’s often a problem.

What’s your advice for those new to HUD loans?

Early in the stages of entering into a firm commitment with HUD, a CPA should become involved who has HUD expertise, somebody who audits similar entities on a day-to-day basis. A lot of times, CPAs are not engaged until transactions or unauthorized distributions have already occurred, normally when an owner is looking for a firm to complete its first annual audit. If an expert comes in early to assist the owning entity in understanding all the regulations, it will tremendously help with a clean transition into HUD financing.

Lori M. Crow, CPA, COS, is an associate director in assurance services for SS&G. Reach her at (440) 248-8787 or lcrow@ssandg.com.

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Published in Akron/Canton