Many people tend to think of HUD mortgage insurance as a single government program, but there are about a dozen different programs covering healthcare, multifamily housing and hospital facilities! Moreover, HUD has three distinct delivery modes for these programs – Lean, Multifamily Accelerated Processing (MAP) and the Office of Hospital Facilities (OHF).
Since Sims Mortgage Funding (SMF) is active in all three spaces, we think it would be helpful to provide you on a periodic basis an “insider look” at the programs, so you know what are the key issues and challenges, and how to best navigate them to obtain maximum success with your HUD-insured financing.
Historically low interest rates have made the HUD Section 223(f) mortgage insurance programs a very attractive refinancing option, so with deference to the departing David Letterman, here is our “top three” list of things you should know about using them.
1. Under the Lean Section 232/223(f) program, your project’s value (and loan sizing) is usually only as good as the last 12 months of operations.
Nursing and assisted living facilities are typically valued on a market basis using the three-year historical performance of the project measured against comparable data from the market at large. However, in a typical Lean underwriting, this market value is often replaced with a valuation solely using the last 12 months of performance. Lean’s emphasis on “trailing 12” can create valuation and loan sizing challenges if that timeframe includes a temporary period of reduced revenues or increased expenses relative to the overall performance of the project over the prior three years. Therefore, it is critical in the underwriting process for the lender to be able to explain to HUD short-term variances in performance in relation to the longer-term historical results so as to maximize the appraised value and insured loan amount.
2. Under MAP, Section 223(f) refinancing loans permit cash-out equity.
Unlike its counterpart for skilled nursing and assisted living projects, the Section 223(f) program for multifamily rental housing does allow for an equity take-out to be included in the insured loan. This obviates the need for bridge financing. Moreover, the cash-out provision applies to market rate and subsidized projects. SMF has recently closed several Section 223(f) loans that included cash-out to borrowers. The key to success is to develop an underwriting of the project so that a loan based on 80% of the market value generates excess proceeds after paying off the existing debt and covering repairs and closing costs. HUD will not allow 100% of the cash-out to be distributed at closing unless all of the required repairs are completed. If the repairs are not completed at closing, HUD will authorize the release of 50% with the balance disbursed after all work is done.
3. Hospital refinancings are largely driven by ratio analysis.
The Section 242/223(f) program for hospitals is relatively new: it was permanently authorized in February 2013. SMF closed the first-ever 242/223(f) refinancing in 2011 for a community hospital in California when there was a temporary authorizing regulation in effect. The key to success is being able to understand early in the process the how to evaluate a hospital’s profitability, liquidity and leverage in the eyes of HUD. This is basically done through a rigorous ratio analysis of a hospital’s last three audited financial statements. In order to meet basic eligibility requirements, a hospital has to have an average three-year operating margin of at least 0.00% and an average debt service coverage ratio of 1.40. Think an operating margin test of 0.00% is a relatively low bar? Not when it includes non-cash items like depreciation and amortization!
If a hospital does not meet these basic qualifying ratios, HUD will allow a pro-forma calculation that substitutes the actual interest rate of the debt being refinanced with the interest rate on a HUD-insured loan. And, if the calculations still do not meet the minimum levels because of unusual or one-time conditions, HUD will allow the “off year” to be replaced with another year.
For additional information, contact us.