Mixed-use buildings and HUD: how much commercial space a loan can carry

The limits by program

HUD insures apartment loans, not commercial loans. HUD regulations let a project include the commercial and community facilities the Commissioner accepts (24 CFR 200.73(b)), so a mixed-use building is fine, but the commercial part is held inside two caps, one on floor area and one on income, and the income cap is the one that changes from program to program (MAP Guide 7.7.12.9 and Appendix 3).

Section 220 adds a purpose test: the commercial space should serve the needs of the project’s residents and other residents of the area (MAP 3.4.2). Section 220’s loan ratios and debt service coverage are otherwise the same as 221(d)(4)’s.

On a 223(f), the space must already be there. The program does not allow construction of additional units, and new ancillary improvements such as a community building or pool are limited to 5,000 square feet of gross floor area in total (MAP 3.7.5.C).

How HUD underwrites the commercial income

The appraiser treats the commercial space as a separate operation inside the property. Income, vacancy and collection loss, operating expenses and replacement reserves for the commercial space are calculated apart from the apartments, and owner-paid tenant improvements are counted as a leasing expense (MAP 7.7.12.9.A).

Three haircuts apply on top of the caps:

1. Occupancy cap. On construction and rehab loans the underwritten commercial occupancy is the lesser of what the market shows or 80%. On 223(f) it is the lesser of the market, the property’s actual occupancy, or 90%.
2. Vacancy floor in the appraisal. The appraiser must use a commercial vacancy factor of at least 10% for 223(f) and 20% for 221(d) and 220 new construction or substantial rehabilitation (MAP 7.7.14).
3. A separate operating deficit. On a construction loan, the commercial lease-up gets its own operating deficit estimate, added to the residential one. Rent the commercial space earns during the deficit period does not offset the residential deficit (MAP 7.14.E).

A worked illustration (hypothetical figures). A new 221(d)(4) building projects $4,000,000 of residential effective gross income and $900,000 of commercial rent at full occupancy. Underwriting cuts the commercial rent to 80%, so $720,000. Total effective gross income is $4,720,000, and 15% of that is $708,000. The commercial income still exceeds the 15% cap, so the lender either underwrites less of it, seeks a waiver, or, if the site is eligible, moves the deal to Section 220, where the cap would be 30% ($1,416,000). Calculations from the MAP Guide percentages; the deal is an illustration, not a quote.

What the appraisal has to show

For the commercial component the MAP appraiser must analyze at least three commercial rent and expense comparables (with tenant, use, size, rent, vacancy, concessions and main lease terms), support the subject’s commercial vacancy against the market, and set out every lease: tenant, square footage, term and dates, rent and reimbursements, cancellation and renewal clauses. All commercial expenses the owner pays are project operating expenses on form HUD-92264 (MAP 7.7.14). On construction deals, the market study must describe the commercial submarket, although HUD notes that level of detail is likely not needed for commercial space under 5,000 square feet (MAP 7.5.14).

What counts as commercial

“Commercial” means any nonresidential space that produces or is expected to produce income (MAP 7.7.12.9.B). The distinctions that trip up mixed-use deals:

Item	Treatment
Community rooms and parking used by residents	Ancillary income, not commercial; area excluded from the commercial space test
Parking rented to non-residents (not customers of on-site commercial tenants)	Commercial income and space, pro rata by the share of spaces reserved for them
Underwritten occupancy on that non-resident parking	Lower of market and historical performance or 50%
Third-party operated parking	Contract income can be used if it is a fixed monthly payment; percentage rent needs a waiver
Rooftop, cell tower, cable and internet leases	Commercial leases; SNDAs allowed on any insured property

For existing properties that sell monthly parking, the lender must identify the share of monthly parkers who are not tenants so their income goes into the commercial limits. Where the owner runs the garage for residents and commercial tenants, parking income is based on the last three years of operations and the trailing 12 months.

The transient-use ban also reaches the commercial side: the prohibition on leases under 30 days and hotel services applies to any commercial space financed by the mortgage (MAP 3.1.24).

Waivers

A Regional Center Director may waive the commercial income limit as long as the result is still primarily a residential property, and the approval has to document how the commercial component supports HUD goals such as sustainable communities or transit-oriented development. HUD may ask for a full credit analysis of existing or pre-leased commercial tenants. The MAP Guide’s examples of mitigants (7.7.13.A):

1. a long-term lease to a creditworthy tenant, such as a government agency or a large established business;
2. multi-tenant space where most tenants have five or more years of occupancy and full occupancy is not needed to break even;
3. substantial borrower equity or local government funds; or
4. an existing 223(f) property with an established history of commercial income above 20% but no more than 30%.

Waiving the space limit requires showing that the extra space will not hurt residents or create a nuisance, that the market will absorb it within the projected period, and that easements, liability insurance, parking and zoning are resolved first (7.7.13.B).

Commercial leases and SNDAs

National retailers commonly insist on a subordination, non-disturbance and attornment agreement, which keeps their lease in place if the loan is foreclosed. HUD barred these before Mortgagee Letter 2011-14 and now permits them (MAP Appendix 8, A.8.6):

• Rooftop, cell tower, cable and internet leases: SNDAs allowed on any property with an insured mortgage or applying for one.
• Other commercial leases: allowed on non-assisted, non-subsidized properties, if the lease is at fair market rent, the tenant’s use will not harm residents and suits a residential building, and there is no identity of interest between the borrower and the tenant.
• Approval: the HUD Satellite Office or Regional Center reviews the lease and SNDA during firm commitment processing, using HUD’s sample SNDA form, with the proposed lease, forms HUD-92458 and HUD-92264, a commercial market rent study and details of any build-out.

Properties with project-based rental assistance or older subsidy programs fall under a narrower part of that guidance, so check it before signing a lease there.

Condominium-split buildings

A building platted as a condominium can carry a 223(f) loan if a single owner holds the whole regime. Separate condominium units may be created for the commercial and residential uses, but the insured mortgage must cover all the rental apartments plus the mortgageable commercial space, with defined joint-use agreements and an equitable split of condominium costs (MAP 3.1.31).

Insurance on mixed-use properties

The commercial portion is covered by the same HUD insurance minimums as the apartments: general liability of $1 million per occurrence and $2 million aggregate, casualty cover tied to each building’s insurable value and the deductible cap. See HUD insurance requirements.