Positioning a Property for Successful Execution on a Three-Year Rule Transaction

October 7, 2021

Positioning a Property for Successful Execution on a Three-Year Rule Transaction

October 7, 2021

With the issuance of the new MAP Guide in 2020, HUD memorialized their revision of the Section 223(f) policy, which previously required a three year wait before a recently completed or substantially rehabilitated property would be eligible for HUD financing. Elimination of this “three-year rule” can offer substantial benefits to owners now able to refinance immediately upon achieving HUD’s debt service coverage requirements. This provides an opportunity to capitalize on historically low rates, cash out accrued equity on market rate transactions and/or potentially capture some or all of the deferred developer fees on affordable transactions much sooner than before. However, before a client can do so, there are some key HUD requirements they must clear. Through our work aiding clients executing a three-year rule transaction, we’ve come up with three key recommendations on how to best take advantage of this policy. We encourage owners to share this information with their leasing and accounting teams so they can be pro-active in their initial efforts which will facilitate a timelier & more successful refinance.

Know your DSCR requirements

Leverage your lease up data

In addition to a current rent roll, any application will need to document the lease-up history from initial occupancy, including the lease-up projections used to underwrite the current mortgage, as well as concession/incentive history. HUD has stated, “the more comprehensive the lease up data, the simpler the underwriting decision”.

We advise clients to track concessions and avoid short term leases of less than 12-months if offered as an incentive. Standard leasing practices of rent premiums on shorter term leases may avoid scrutiny.

Of course, while concessions are permitted, they will have to be considered and may impact the underwriting unless there is strong evidence they no longer exist at the property and in the market. Even though initial concessions may burn off, the loan will be underwritten to actual collections. As a result, a developer will benefit by taking the concessions at the beginning of the lease term, rather than spreading across the term.

It is also beneficial to keep a copy of the appraisal used to underwrite the construction loan. This facilitates HUD’s requirement to evaluate the difference in originally projected rental rates and the actual rent at lease-up. We advise clients to ask management to document and explain variations from original projections. Sometimes isolated issues unlikely to be repeated can help your underwriter justify the longevity of higher renewal rents.

Diligent record keeping pays dividends

Required financial statements include an income and expense statement from the date of initial occupancy, as well as a budget projecting the 12-months following application submission. We advise all affordable clients approaching the leasing phase to make sure their team is using the current maximum allowed LIHTC rents. For market rate clients, it is equally important that the rents are in line with the market and owner expectations, rather than following the underwritten rents.

It is incredibly beneficial to carefully track capital expenditures as “below the line” charges, rather than normal operating expenses. HUD requires that application be underwritten based on normalized operations, so clients should manage their data to be able to easily differentiate between recurring and non-recurring expenses. This is especially true for one-time costs related to initial property set-up, like initial utility set up fees, initial fees for advertising outlets, etc. These fees can be substantial.  Documenting them appropriately allows for a normalized expense statement that is indicative of how the property will operate going forward and can be supported for loan underwriting. Accurate property operating history coupled with comparable data will also assist the appraiser in determining appropriate conclusions.

A CPA review is required for properties with 12 months of stabilized operations. Again, maintaining accurate and clean records will facilitate this review.

Working together, we’ve been able to identify unique opportunities in-which to apply this change in policy to improve net cash flow and provide cash out for our clients. If you think you might have a property that qualifies, reach out to our team to learn how we can help you make the most of this important policy change.

Carolyn Whatley, Managing Director, Angela Folkers, Associate Director