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Capitalizing on HUD Section 232 financing

April 7, 2014
by Michael Vaughn
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Michael Vaughn

If you’re considering applying for a Housing and Urban Development (HUD) loan to update, purchase or refinance a long-term care facility, now may be the time.

In 2013, the HUD Office of Healthcare Programs made $5.8 billion available in insured mortgage loans for assisted living facilities (ALFs), board-and-care facilities and skilled nursing facilities (SNFs) under the Section 232 program. A total of 766 loans were made last year for facilities across the country.

The terms being offered through this program make it a real opportunity for owners, administrators and directors of ALFs throughout the United States. The average loan last year was for $7.6 million, and the terms are very attractive—including 35-year fixed rates for non-recourse, assumable loans. The Lean process improvements instituted by HUD have made the approval process more predictable and timely as well. (Lean is a methodology to increase efficiency by reducing waste.)

As with any government program, requirements must be met to pass muster. The most important requirements:

  1. Physical exam. A project capital needs assessment is part of the application process. A third-party building specialist will evaluate the physical plant and systems of the building; identify critical, non-critical and upcoming capital improvement items; and develop a reserve schedule. Owner-elected repairs also may be included. For a normal Section 232/223(f) purchase or refinance loan, the escrow for repairs and improvements may constitute up to 15 percent of the loan amount, so many owners view these loans as a good option for properties that need certain repairs and replacements to maintain condition and competitiveness. HUD does not have arbitrary age limits on buildings but does consider the issue of functional obsolescence (for instance, a large number of four-bed wards) and estimated useful life. Properties with more extensive physical replacement needs may be eligible for loans under the Section 232 substantial rehabilitation program.
  2. A clean compliance and care record. The HUD application considers the compliance record of the property, including state surveys for SNFs and ALFs and Centers for Medicare & Medicaid Services (CMS) ratings. HUD will not issue a commitment on a SNF that is designated as a special focus facility. HUD may consider a facility with a one-star rating from CMS, but the problems identified in the survey must be clearly addressed, and the overall care level must clearly be improving.
  3. Formal incident reporting. For all facilities insured under the program, HUD requires a formal software-based incident-reporting risk-management system, either in-house or third-party.
  4. Credit-related factors. The HUD application evaluates the experience, credit history, financial stability, previous participation with HUD and status of other facilities on the part of the mortgagor, operator and principals/parent entity. Either third-party or identity-of-interest operators are acceptable under the program.
  5. History and experience. HUD evaluates the length of time both the owner and operator have been in their roles for the subject facility and also for other facilities owned or operated. HUD looks at the type of facility, size and average occupancy levels, CMS ratings and locations. Although HUD borrowers may be single-facility owners or operators, they must demonstrate a history of successful ownership and operation of the subject and/or other facilities.
  6. Underwriting constraints. The basic Section 232 purchase or refinancing program (223[f]) has fairly straightforward underwriting constraints, including value, purchase price, existing indebtedness and cost to replace (see sidebar, "Underwriting constraints," on the next page).
  7. Specific HUD requirements. HUD has specific requirements for properties located in flood plains as well as requirements for compliance with the Americans with Disabilities Act. Typically, these conditions are identified when the project capital needs assessment is completed.
  8. The right candidates. HUD requirements for new construction loans are more stringent than for loans on existing properties, especially regarding owner and operator experience in developing similar properties, financial strength and owner capitalization of the property. HUD is looking for outstanding candidates for this program, and the combination of experience and financial commitment—not just an acceptable market study—is key.
  9. Special review for certain portfolios. HUD has special review requirements for larger portfolios and requires master leases for three or more properties that have the same ownership. The basic criteria remain the same, and HUD makes a special effort to process these applications with the same team.
  10. Interim financing. Because of the cash-out requirements, timing considerations and need to stabilize operations after a purchase or change in management, it often makes sense to place interim financing on a property. The right lender can provide a bridge loan with the right terms for your property and maximize the value of the HUD permanent financing.

Will you pass muster? Is your long-term care facility ready for financing at unbeatable long-term stable rates? If your facility meets or has the potential to meet these requirements, then it’s time to take action. In a rising interest rate environment, locking in long-term financing at current rates is the smart strategic move.