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Recently I started working with a client looking to buy a property with a commercial space on the first floor and 3 apartments above, one he will live in. It happens the property does need some updating so a 203k renovation loan was a great choice. I was reminded why the 203k solves problems for those purchasing a mixed use property so I’m writing more about how this financing can be done.

If you have ever looked at a commercial loan for mixed use property you may have found a few aspects not appealing or helpful about a commercial loan. Among them below might be:

  • Generally a commercial loan has a shorter repayment term, perhaps 20 years or 15 years so monthly payment is higher than a 30 year term 203K
  • Down payments can range from 20% to much more versus as little as 3.50% for 203K
  • Often the rate is adjustable every 5 years on commercial loans
  • Some commercial loans may have a “balloon” feature that requires a complete refinance of it every 5 years
  • The commercial loan is based mostly on the current cash flow & expenses of the property rather than on the borrowers credit score/income/assets, etc.
  • Commercial lenders want to see the building generating at least a 15% to 20% profit above all operating expenses per month including a future management company fee should a foreclosure have to be done by a commercial lender who will need professional management
  • If a building is mostly vacant or all vacant it generates no cash flow per month usually making it impossible to buy with a commercial loan unlike a 203K loan based on both the borrowers income stream and the FUTURE rental income stream when leased out
  • Commercial loans generally do not provide any funds to rehab a mixed use property

Now I want to list aspects of FHA 203K renovation financing that are helpful on 2 to 4 unit mixed use properties and very different from commercial lending:

  • Buy a vacant mixed use with 203K and count the FUTURE rents as determined by an Appraiser toward qualifying for the size mortgage you need
    • FHA allows 75% of future gross rents to be counted as income
  • Add rehab dollars into a 30 year term mortgage to update the residential areas and common areas ( no borrowed rehab funds can be used to repair/update the commercial space per FHA 203K rules)
  • As long there is a square footage split of no more than 49% commercial and minimum 51% residential use the property meets FHA 203K guidelines
    • Here a hallway or staircase leading to the residential space is not counted as part of the 49% commercial space so most mixed use properties will be within the guidelines
  • Must be owner occupied in the residential space for 12 months  before moving out and converting  to all tenant occupied
  • The commercial space must be in usable condition as no rehab dollars of the 203K loan can be spent there per FHA 203K guidelines
  • There must be similar mixed use properties in the area for the Appraiser to use as a comparable property to do the appraisal valuation so a loan can be approved-  check on that before signing a purchase contract
  • Future “as finished” value is used to arrive at appraised value based on the amount of work to be done to the property rather than what you pay for it
  • Property can be mortgaged to 110% of its finished value when done as a 203K loan at purchase time to give an extra margin of flexibility to approve the loan – FHA wants to see such properties returned to use in communities everywhere
  • Borrower may add in up to 6 months of house payments into the rehab dollars borrowed if necessary while property is under rehab and not generating cash flow
  • Buyer may ask Seller to pay up to 6% of purchase price back to Buyer to pay all closing costs, pre-paid property tax escrow, first year insurance premium, attorney fees, title fees, etc.

A client recently closed on a 2 unit, one story mixed use property with a commercial space in front and an apartment in the rear of the building. It met the 49% commercial 51% residential split regulation. He lives there and plans one day to open his own business in the commercial space.

The advantages of a 203K purchase loan versus a commercial loan are many on a 2 to 4 mixed use property purchase. Perhaps the 3 best advantages can be summed up below:

  1. Use of future rents to qualify on vacant properties
  2. Use of future value to qualify on vacant properties
  3. Low down payment over a commercial loan

I hope this post has been helpful and encouraging to those that may have thought a Renovation project was too complex or beyond their ability to manage. My intent is always to inform, educate, and generate discussion. Please call me or email me directly or visit my website for more information on renovation loans. I welcome your comments and questions!

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