FHA Condo Approval Specialist: March 2011

FHA Condo Approval - New Construction Strategy: Legal Phasing

One of the items that FHA reviews when doing condominium project approvals has to do with legal phases. This is a VERY important concept for any developer who is looking to build a condominium project.

Once a condominium project becomes approved with FHA, there is a pre-sale requirement of 30% before the first FHA loan may be used to purchase a unit. This means that at least 30% of the units in the project must be sold prior to a unit being eligible for FHA financing. [Incidentally, Fannie Mae and the VA require that 70% of the units are sold prior to a allowing a loan in a project.]

So, with the lack of availability of financing options for buyers, how can a developer sell 30% of the units in a complex?

One answer is Legal Phasing. 

First off, FHA differentiates between "legal phasing" and "market phasing". The latter would refer to a situation where the developer builds a certain number of units, sells them and then repeats the process until the project is completed and sold.

Legal phasing is doing this same thing, except that the phasing is clearly written in the legal documents. This seemingly small distinction makes all of the difference in the world to FHA.

For example, let's say that a developer is looking to build a 100-unit complex consisting of 10 buildings. If the project only has one phase, 30 units would need to be sold prior to being eligible for FHA loans.

However, through the use of legal phasing, the developer could specify 10 legal phases. This way, one building consisting of 10 units may be built at a time. Then, once the first building and the common areas are completed, only 3 units would need to be sold prior to using FHA financing. Then the developer can move onto the second building of the project and repeat this process.

Interestingly, upon completing the second 10-unit building, if all of the units in the first building were sold, the pre-sale requirement of 30% is already met even before selling a single unit in the second building.

Legal phasing also affects the owner-occupancy ratio, which must be 50% or greater. This ratio is calculated on the first phase and then cumulatively on subsequent phases. For example, if 8 out of 10 units in the first phase are owner-occupied and 4 out of 10 units in the second phase are owner occupied, then the owner-occupancy rate is 60% (even though the second phase had less than 50% owner-occupancy) and the project still meets FHA's standards.