FHA Condo Approval Specialist

FHA Condo Approval - New Construction Strategy: Legal Phasing

One of the items that HUD 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 HUD, there is a pre-sale requirement of 50% before the first FHA loan may be used to purchase a unit. This means that at least 50% of the units in the project must be sold prior to a unit being eligible for FHA financing. [Incidentally, Fannie Mae requires 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 in the world can a developer sell 50% of the units in a complex?

The answer is Legal Phasing.

First off, HUD 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 HUD.

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, 50 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 area(s) are completed, only 5 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 completed, the pre-sale requirement of 50% is already met even before selling a single unit in the second building.

Legal phasing also affects the owner-occupancy ratio. 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.)

[NOTE: Until the end of June 2011, the numbers are more favorable than mentioned above. For the time being, HUD has only a 30% pre-sale requirement and is allowing up to 50% FHA concentration. Since we are nearly in April, I can't imagine that these figures would apply to many developers moving forward.]

For developers looking to build new condominium projects, the financing of the completed units is a key factor. Without FHA and Fannie Mae financing available in the in project, developers must rely on cash buyers or providing financing to buyers in the form of seller take-back mortgage loans.

Before exiting the mortgage industry, I knew of NO LENDERS who provided financing for "non-warrantable" condos. This would have to come in the form of niche lending, maybe through a partnership with a local bank.