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Recently we have been speaking to a number of Buyers looking to purchase and/or renovate a property with a store front commercial or retail space and one or more apartments above or behind. There is a residential mortgage for such mixed use properties for owners who will live in them for at least 12 months. It is called FHA 203K Renovation. It can replace the need for a typical commercial loan for mixed use properties.

I wanted to write a post on this subject today to alert Real Estate Brokers trying to sell such properties there is a path to finance them apart from a more complex and perhaps less attractive commercial loan. We have seen listings for such properties stay on the market for extended periods. The lack of a known residential type mortgage option, at a lower down payment than a commercial loan, may be one reason why. In this post I will present the basics and examples of how the FHA 203K can work for a mixed use purchase or even a refinance.

FHA 203K can be used to buy a mixed use property that is already in good condition. The 203K regulation specifies there must be some dollars borrowed for repairs or rehab since it is designed as a renovation loan. My clients in the past have added dollars to do simple painting for example, at a minimum to qualify. This financing can be attractive in that the down payment can be as little a 3.50% of the sale price – plus whatever amount needed for rehab, added to purchase price.

This loan may be a great alternative to a commercial loan for mixed use properties from 2 to 4 units total due to the low down payment and criteria used for loan approval is based on the borrower qualification rather than on current cash flow from the building. The main 203K mixed use regulations are:

  • The commercial or store front space cannot be more than 49% of the total building square footage and the residential portion must be 51% of the total building square footage.
  • None of the borrowed renovation dollars can be used on the store front commercial space itself. The loan renovation dollars can be used for general repairs such as roof, electrical, peeling paint, etc.
  • Limited to properties of 4 units maximum with a commercial square footage mix of 49% and 51% residential, minus common areas like stairways or hallways to the apartments.

I have done a number of these loans in Chicago in the last few years for clients purchasing mixed use properties using the FHA 203K renovation loan. Below I will present each situation as an example of what can be done:

  • 4 unit with 1 commercial store front space and 3 apartments above. The client needed some $100,000 to renovate the 3 apartments and do basic roof and back porch repairs to bring the property up to current building codes. The store front was occupied by a small business that remained.
  • 2 unit with a first floor commercial space and a second floor apartment. The buyer had been considering a commercial loan but didn’t like the interest rate or terms offered. Being self-employed the Buyer was looking for an office to run his business from and a place to live onsite to avoid commuting and paying rent on an office space. The FHA 203K mixed use mortgage provided a solution and a small amount of funds to do painting in the apartment and minor repairs.
  • Buyer clients were looking for a small commercial space for a planned business with an apartment for the convenience of a live/work arrangement in the future. They found a one story mixed use property with a store front that had been an accountant’s office but now vacant. There was a 2 bedroom apartment behind the store front and a full basement, back yard and 2 car garage. This was perfect for their family and future plans to start a business. They borrowed funds for minor apartment updates and a few repairs on the garage.
  • Buyer client was looking for a 2 or 3 unit mixed use building with an eye toward starting a business in the future. The buyer found a newer 2 unit mixed use property with a large apartment above the store front commercial space. The FHA 203K was the perfect solution with a small amount of funds added to repaint the apartment and install new flooring. The listing Realtor was very surprised to learn an FHA 203K could be used in this way on a property with a commercial space. The property had been on the market for an extended period of time before the FHA 203K provided a means of affordable financing.

Currently just in the city of Chicago alone there are some 100 two to four unit mixed use properties available for sale. The FHA 203K can be a solution to financing these properties apart from a typical commercial loan.

Below are 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 comparables to do the appraisal valuation so a loan can be approved-  check on that before signing a purchase contract
  • Future “after renovated” value (ARV) is used to arrive at appraised value based on the amount of work to be done to the property rather than purchase price
  • Property can be mortgaged to 110% of its finished ARV 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.

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. Lower down payment over a typical commercial loan

Let us know how we can help you with a mixed use property purchase or to offer such financing for a mixed use listing if you are Realtor selling one for your client. Sellers may be excited to learn there is a residential mortgage alternative to offer potential Buyers. As a listing Realtor you now have a new tool to offer when speaking to potential Sellers of mixed use properties.

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!