Health care facilities in need of mortgage or long-term leasehold financing have an alternative to traditional institutional financing thanks to the Section 232 Program offered by the U.S. Department of Housing and Urban Development (HUD).
Section 232 of the National Housing Act of 1934 (12 U.S.C. § 1715w) established federally insured mortgage loans for the owners of certain long-term health care facilities. Section 232 is a loan product, insured by the Federal Housing Administration (FHA), for the housing of the “frail elderly,” i.e., those in need of supportive services. These FHA-insured loans are often one of the few mortgage or leasehold financing alternatives available to health care facilities for the acquisition, new construction, refinancing or substantial rehabilitation of eligible health care projects.
Through HUD’s Section 232 Program, certain residential health care facilities can obtain better loan terms than are normally offered in the noninsured commercial loan market, if the borrower is willing to comply with a myriad of application requirements and post-closing compliance obligations, discussed below. Section 232 loans offer more favorable terms because they are backed by mortgage insurance provided by the FHA, and because of the secondary Government National Mortgage Association (GNMA) market.
Eligible borrowers may be a “nursing home,” “intermediate care facility,” “board and care home” or an “assisted living facility,” all as defined by the National Housing Act (12 U.S.C. 1715w(b)). An eligible facility may also provide some outpatient care for elderly individuals and others who require care during the day.
Eligible borrowers may be for-profit or nonprofit, but in either case, they must be single asset, single purpose entities. Nonprofit borrowers are permitted higher loan limits, but are required to comply with more restrictions on distributions. Projects eligible for the Section 232 program accommodate 20 or more residents who all require skilled nursing care and related medical services, or who need continuous minimum medical care provided by licensed or trained personnel. The facilities must offer the residents three meals a day. A project is eligible only if a first priority lien can be recorded against real estate owned by the borrower in fee simple, or under a lease with a term of at least 99 years which is renewable or has a remaining term of at least 10 years beyond the maturity date of the mortgage.
For Section 232 refinancing or acquisition financing, the facility must have been completed or substantially rehabilitated at least three years prior to the date of the borrower’s application for a “firm commitment.” Projects with additions less than three years old are only eligible if the addition is not larger than the original project in size and number of beds.
Benefits to the Borrower
High leverage. Private nonprofit borrowers can borrow up to 95 percent of the estimated value of the property or project. For-profit borrowers can borrow up to 90 percent of the estimated value of the property or project. The estimated value of a project can include equipment to be used in the operation of the facility and solar energy systems or other residential energy conservation measures.
Low fixed-interest rate. Interest rates are negotiated between the borrower and the private lender. However, the combination of the FHA mortgage insurance and the current low interest rates give the borrower bargaining power to negotiate competitive interest rates, made more attractive by the fact that they are fixed and for a longer term than otherwise available.
Long-term. For new construction or substantial rehabilitation loans, the term can be up to 40 years plus the construction period. For acquisition or refinance loans, the term can be up to 35 years.
FHA insured. The full-faith-and-credit guaranty of the U.S. government backs the mortgage insurance provided by the FHA. This feature encourages lenders to participate in the program as it mitigates the risk upon default. Upon a borrower’s default, the private lender can assign the loan documents to HUD in return for the proceeds of the mortgage insurance.
Nonrecourse/no guaranty. Section 232 loans are made to single asset (i.e., the mortgaged property), single purpose entities. In most cases, in the event of default, enforcement is limited to the collateral of a first priority mortgage on the real estate and the assets associated with the facility, except for the standard carve-outs as required by HUD. This benefit remains subject to consent from the lender. Personal guaranties are not required.
Commercial space possible. If approved by HUD and the lender, for acquisition or refinance loans, commercial space is permissible up to 20 percent of the gross floor area and 20 percent of gross income. If approved by HUD and the lender, for new construction or substantial rehabilitation loans, commercial space is permissible up to 10 percent of gross floor area and 15 percent of gross income.
Assumable. Subject to HUD’s and the lender’s consent, the loans are fully assumable.
Self-amortizing. Fully amortizing, equal payments of principal and interest for the life of the loan are the normal amortization schedule for Section 232 loans. This provides the borrower with certainty in its budgeting and cash flow, and avoids the discomfort of a balloon payment that must be refinanced at the end of the loan term. The program allows for an interest-only period during construction for new construction, during which the borrower is only responsible for paying the monthly interest payments on the debt. Variation may be permitted for transactions involving bond financing and/or tax abatement.
National program. The Section 232 program is a federal program available nationwide. According to HUD, since 1934, over 4,000 Section 232 mortgage commitments have been issued in the 50 states. There are currently over 50 lenders throughout the country that have been approved by HUD to make Section 232 loans.
Securitized. The lenders may securitize the closed loans into pools of multifamily, mortgage-backed securities (MBS) that are packaged and sold to GNMA investors. The GNMA guaranty allows mortgage lenders to obtain a better price for their mortgage loans in the secondary market. The lenders can then use the proceeds to make more mortgage loans available. GNMA guaranties that, regardless of whether the mortgage payment is made, investors in a GNMA MBS will receive full and timely payments of principal and interest.
Self-improving program. Frequent updates and revisions to the Section 232 application protocol are issued to improve the program’s processes and reduce the amount of time to underwrite the applications, based on feedback from the public. The application process has been streamlined with standardized work product and process to deliver a consistent result. The more efficient process has removed duplicative and unnecessary requirements.
Burdens on the Borrower
First, the Section 232 program requires that the lender and borrower comply with a myriad of reporting and substantive requirements. For example, the borrower is required to submit an annual audit of operations to HUD and the lender. In addition, all mortgagors must execute a HUD “regulatory agreement for multifamily projects,” which governs the operation of the financed project and which will be recorded upon initial endorsement. The regulatory agreement:
- limits the use of the project to the approved intended use;
- prohibits commercial use greater than that originally approved by HUD;
- requires that the borrower remain a single asset, single purpose entity;
- establishes reserves for replacement;
- establishes record-keeping and accounting requirements;
- prohibits transfer of the project without HUD’s prior written consent;
- prohibits wrongful discrimination against its residents and prospective residents;
- prohibits the amendment of the organizational documents of the borrower in a way that materially modifies the terms of the organization; and
- prohibits materially changing any unit configurations or number of units in the mortgaged property.
Upon any declaration of default, the regulatory agreement allows HUD to collect all rents, take possession of the property, apply for an injunction and, if the note is held by HUD, declare the remaining loan amount immediately due-and-payable and foreclose. If the note is not held by HUD, it may notify the holder of the note of the default and request that the holder declare a default under the note and mortgage. The holder may then declare the remaining indebtedness due-and-payable and foreclose.
In addition, one drawback, which is a byproduct of the program’s continual self-assessment, is frequent revisions of the application procedures for counsel to monitor.
Finally, all eligible facilities must be properly licensed by the state. In New Jersey, a “certificate of need” and a valid license for an existing facility must be obtained or be on record prior to commencing the application process.
There are a couple of recent changes of significant import. First, the most recent Multifanily Accelerated Processing (MAP) Guide dated Nov. 23, 2011, no longer addresses the Section 232 program. The MAP Guide had been the authority for Section 232 borrowers, lenders and counsel: however, a new Section 232 handbook is being developed. In the interim, interested parties are advised to refer to Chapter 3 of the current MAP Guide for guidance until the new handbook is issued.
Second, the maximum loan-to-value (LTV) ratios have informally changed. Over the last few years, the statutory maximum loan amounts have decreased from the 85-95 percent of market appraisal value range to 75-90 percent of market appraisal value. The underwriter determines the maximum loan amount in the application process. On new construction or substantial rehabilitation, the maximum LTV has dropped 10 percent for skilled nursing facilities and 15 percent for assisted living facilities. For acquisitions or refinances, the maximum LTV has dropped 5 percent for skilled nursing facilities and assisted living facilities.
HUD’s Section 232 program is a viable mortgage financing alternative for eligible health care facilities. For many prospective borrowers, the benefits outweigh the burdens of complying with the program’s requirements.