Investing in HUD Properties

An Introduction to the U.S. Department of Housing and Urban Development Program 

As a real estate professional, you are always looking to grow your investment portfolio and add new properties. Let’s say that you are presented with an investment opportunity in a multi-family property that has a loan program or rental subsidy with the U.S. Department of Housing and Urban Development (“HUD”). The property meets your standard investment criteria; however, you are not familiar with the HUD program and unsure if it is the right investment for you. In order to help you make an informed decision, let’s explore the various HUD programs and their financial and reporting requirements.

There are many HUD programs created by the National Housing Act (the “Act”). These programs primarily fall into four general categories: (1) multifamily mortgage insurance, (2) direct HUD loans and capital advances, (3) rental assistance and (4) grants. These HUD programs may require an annual independent audit, depending on funding levels, which consist of two components: a financial statement audit of the entity and a compliance audit of the entity’s HUD program(s). The financial statement audit must be performed in accordance with Generally Accepted Auditing Standards (“GAAS”), issued by the American Institute of Certified Public Accountants (“AICPA”), and Generally Accepted Government Auditing Standards (“GAGAS”), issued by the Comptroller General of the United States. The compliance audit is to be conducted in accordance with the Consolidated Audit Guide for Audits of HUD Programs (the “Guide”). The specific compliance requirements applicable to an entity are dependent on the HUD program under which funding was received. Detailed compliance steps can be found in the HUD Audit Guide.

The first two categories, multifamily mortgage insurance and direct HUD loans and capital advances, are very similar. In multifamily mortgage insurance programs, HUD simply provides mortgage insurance for a property’s commercial mortgage debt as detailed in Sections 207, 220, 221(d)(3), 221 (d)(4), 223(a)(7), 223(f) and 231 of the Act. In direct HUD loans and the Capital Advance Program, HUD provides direct mortgage funding as detailed in Sections 202 and 811 of the Act. The various sections of the Act are based on the types of housing provided for by each individual program. In both types of programs, HUD requires the property owner to sign a Regulatory Agreement that details the financial and reporting requirements. A few key requirements of interest to most owners pertain to rents, owner distributions and management fees. While the programs do not place restrictions on the rents that can be charged, they do restrict the amount of owner distributions and management fees paid out of the entity’s operating funds. Also, HUD charges up-front fees such as application fees and mortgage insurance premium fees at the time of financing, as well as annual mortgage insurance premium fees. 

In the Rental Assistance Program, HUD provides a project-based rental subsidy as detailed in Section 8 of the Act. The rental subsidy is provided directly to the property on behalf of low-income residents. The residents will go through an annual certification process to calculate their adjusted annual income. Residents pay rent equal to 30% of their adjusted annual income and the remaining 70% is provided by HUD in the form of rental subsidy. HUD requires the property owner to sign a Housing Assistance Payment (“HAP”) contract. The HAP contract establishes the initial project rents by unit and the process to request annual rent increases, as well as detailing the financial and reporting requirements. The Rental Assistance Program places a restriction on the rents and the management fees that can be charged and, in some cases, the owner distributions. 

The last HUD program category is Grants, which is far less common than the three types of HUD programs previously described. In grant programs, HUD provides funding to private, nonprofit owners as detailed in Section 202b of the Act. The funding is used to convert some or all of the dwelling units in the project into an Assisted Living Facility or Service-Enriched Housing for elderly residents aging in place. HUD requires the property owner to sign an Assisted Living Conversion Grant Agreement which includes a requirement to sign a Declaration of Restrictive Covenants. The grant agreement details the program requirements while the unit conversion is in process. A Closeout Agreement will be issued upon project completion. The Declaration of Restrictive Covenants details the requirement to continue operating the project as a facility for the elderly for at least 20 years beyond the final maturity date stated in the mortgage agreement. 

You can go to HUD’s website at www.hud.gov to do a deeper dive before making your final investment decision. As always, if you have further questions, speak with your advisor.