HUD HUD Hike!

NEW YORK CITY—With the Super Bowl right around the corner, it is hard not to have football on the mind. And in a sport where a game-plan is essential for success, it is difficult not to draw parallels to what we do in our work as financial advisors and intermediaries. I have been arranging capital for owners and developers for over three decades. I enjoy the challenge required in developing a new game-plan for each engagement. Just as the X's and O's of the gridiron have advanced to evolutionary playbooks, there are no more “off-the-shelf” answers to a financing assignment.

Case in point—When the CEO of a prominent family-owned real estate company approached me about refinancing its portfolio with the goal of upgrading its properties, restructuring its debt service, and providing substantial cash proceeds from the refinancing for the company to use in furthering its business, I started designing some plays. One innovative approach stood out—the highly effective, yet often overlooked, 223(f) HUD-insured loan program (U.S. Department of Housing and Urban Development).

The program has historically been utilized much less frequently than the more popular Fannie Mae and Freddie Mac programs, but, for long-term owner/operators, HUD-insured financing is an owner's dream. It permits loans to be underwritten based on future, to-be-achieved post-renovation rents as opposed to other lending programs, which traditionally limit their loan sizing to a property's in-place rent levels.

What was accomplished: Ultimately, our client upgraded an 11-property portfolio by renovating apartment units and common areas. By funding the renovation program with $20 million of low-cost loan proceeds, we were able to preserve the family-owned company's strong cash position and enable the company to use its capital to expand its business.

The secret to our success was developing a comprehensive strategy specific to the company's needs and working collaboratively with the company through each step of our program like a well-coordinated offensive coordinator and head coach.  Here is the play-by-play for applying the HUD strategy:

-          Extremely attractive interest rates for 35-year term, as well as 35-year amortization. The interest rates on the loans including the mortgage insurance premium average 4.53% and amortization is based on a 35-year term. This combination of low fixed long term interest rates and higher amortization provide the family with substantial additional annual cash flow during each of the 35 years compared to its pre-existing debt service, and a more rapid buildup in equity.

-          Free-up substantial cash proceeds for family purposes. The new loans enable the family to achieve net proceeds of almost $100 million in excess of what was required to repay existing loans, cover costs of financing and prepayment penalties.

-          Leverage. 80% LTV (based on POST-RENOVATION values) together with 1.20 DSC. While the family had historically opted for conservative lower leverage debt, they found the higher leverage acceptable in light of the elimination of refinancing risk for 35 years. The loans funded all prepayment penalties (which were tax deductible costs).

-          No Yield Maintenance. The new loans do not require yield maintenance and contain favorable prepayment penalties with the elimination of all such penalties after 10 years. This provides unparalleled optionality for the family -- a 35-year loan combined with the ability to repay without penalty after 10 years with this right continuing for 25 years thereafter.

-           No additional financing transaction costs for 35 years. This will save the family an estimated $5 million over the 35-year term.

-          Project Cap Rates. Because of the long-term favorable cash flow, and assumable long-term financing, assumable at a cost of only 5 bps, cap rates will be reduced by more than 50 bps (based on traditional band-of-investment methodology).

-          Provided substantial reserves. $1,250 to $1,500 per unit is now set aside as part of the HUD underwriting to cover future capital replacement costs. 

-          Eliminated refinancing risk. The new loans are fixed-rate fully non-recourse loans having a 35-year maturity.  This structure eliminates refinancing risk and creates security for future generations. In the words of the company's patriarch, Greystone Bassuk created “sleep-well-at-night loans.” Touchdown! Game Over.

I make a habit of sitting with my team and the client after each engagement to review our approach to the assignment and evaluate our effectiveness. In closing billions of dollars of loans over my career, I can't say that every play works. But often, as in this instance, the execution of the game plan is wholly successful prompted by innovative thinking. The use of the often overlooked HUD program proved to be perfect play-calling to achieve the goals of this family-owned real estate portfolio. Accordingly,
Greystone Bassuk now is actively assisting other wealthy families, institutional investors, and other long-term multifamily investors in using this program to gain similar results.

Richard Bassuk is founder and president of Greystone Bassuk Group. The views expressed in this column are the author's own.