HUD cost certification: proving what the project actually cost

What cost certification is for

The National Housing Act says an insured loan on new or rehabilitated multifamily housing cannot exceed the approved percentage of the project’s actual cost. HUD underwrites from estimates, so at the end of construction the borrower has to prove what was really spent. Section 227 of the Act (12 U.S.C. 1715r) requires the borrower to certify, before final endorsement, either that the approved percentage of actual cost equaled or exceeded the loan, or by how much the loan exceeded it, and to pay any excess against principal. 24 CFR 200.95 puts that agreement into the closing documents (form HUD-93305M, Agreement and Certification).

The result is form HUD-92580, Maximum Insurable Mortgage, a required exhibit for final endorsement. Once HUD approves the certificates and issues it, the certification is final and incontestable, except for fraud or material misrepresentation (MAP 13.28).

Who has to certify

The tax credit exemption comes from the Housing and Economic Recovery Act of 2008. HUD tests it at firm commitment, using the total estimated replacement cost (form HUD-92264, Section G line 74) in place of actual cost, which is not yet known (MAP 13.2). The MAP Guide’s own example: a $13,000,000 project with $5,000,000 of tax credit equity and an $8,000,000 loan is at 62%, so it is exempt. The statute’s text (12 U.S.C. 1715r(b)) refers to LIHTC equity and a ratio “less than 80 percent”; the MAP Guide applies it at 80% or less and to historic and New Markets credits as well.

Exempt does not mean undocumented. An exempt deal can submit the final sources and uses from the state allocating agency or the title company, and HUD issues a modified HUD-92580 against the replacement cost estimate. A cost certification audit fee is not mortgageable on an exempt deal unless the borrower chooses to certify anyway.

Who else certifies when the borrower must (MAP 13.4):

• The general contractor, if it has an identity of interest with the borrower (whenever it arose) or used HUD’s cost-plus construction contract, on form HUD-92330-A.
• Subcontractors, suppliers, equipment lessors and industrialized housing manufacturers at any tier, also on HUD-92330-A, where they have an identity of interest with the borrower or a certifying contractor and their combined contracts exceed 0.5% of the mortgage.

Long form, simplified form and the 223(f) form

Sources: MAP 13.3, 13.9, 13.10. The accountant on a long form must meet the Government Auditing Standards (GAO Yellow Book) qualifications for independence and continuing education, follow HUD’s Consolidated Audit Guide (Handbook IG 2000.4), and must not be on the government-wide debarment list (MAP 13.10.2.A.6).

The timeline

1. Pre-cost certification conference. HUD notifies the lender, borrower and contractor when the project is 80% complete (as early as 70% for new sponsors and contractors) and holds the conference before 90% completion. It covers completion and cut-off dates, the documents needed, how liquidated damages are computed, and any labor issues (MAP 13.5). On bond deals the lender also has to show how negative arbitrage and any rebates to the sponsor will be treated; a rebate from the lender, issuer or bond underwriter reduces mortgageable cost (MAP 8.15.6).
2. Substantial completion. The architect signs the Permission to Occupy (form HUD-92485). Final completion is the date the HUD inspector signs the final Trip Report (form HUD-95379).
3. Cut-off date. Certification runs from the final Trip Report date, and the borrower may include soft costs incurred up to 60 days after it. The balance sheet and operating statement must be dated to the same cut-off (MAP 13.6). If a project sits at 95% complete and then gains less than 2% a month, HUD can set an administrative completion date instead (MAP 13.7).
4. Submission. Within 30 to 45 days after the cut-off date and no less than 30 days before the desired final closing (MAP 13.8). The lender reviews the certificates first, then sends them to HUD.
5. HUD review. HUD sends a deficiency letter within 5 workdays if something is missing; once everything is in, combined processing should take no more than 15 workdays (MAP 13.11). A detailed review is done when a mortgage increase is requested or the Regional Center Director orders one.
6. Final endorsement. HUD issues form HUD-92580, the final advance is released against it, and the loan is finally endorsed at the lower of the closed amount and the maximum insurable mortgage.

The day after the cut-off date also starts the project’s first fiscal period for annual audited financial statements.

What gets counted

Certifiable costs are costs paid in cash, or to be paid in cash within 45 days of final closing (MAP 13.1). Four items count whether or not cash is paid: land value (HUD calculates it), general overhead, BSPRA where the borrower and contractor have an identity of interest, and a nonprofit developer fee.

For the construction contract itself (MAP 13.14.1):

• Lump sum (allowed only with no identity of interest): the lesser of cash actually paid or the contract price adjusted for approved change orders and liquidated damages.
• Cost-plus (required with an identity of interest): the lesser of cash paid, HUD’s allowed cost, or the adjusted contract price. Change orders caused by architect errors are recognized only to the extent there are savings in the mortgage.

The 50/75 rule. On a cost-plus contract, no general contractor fee (general overhead and profit) is allowed if more than 50% of the contract sum goes to one subcontractor, supplier or lessor, or 75% or more goes to three or fewer. Related subcontractors count as one. If the rule is broken the contractor forfeits its profit and only the sponsor’s allowance (SPRA) is allowed (MAP 13.14.13). It does not apply to industrialized housing manufacturers, work done by the contractor’s own payroll, supplemental loans, or rehabilitation short of substantial rehab.

Liabilities nobody disclosed. Debts on the balance sheet that were not disclosed at firm commitment or initial endorsement cannot become project obligations, and their discovery triggers a detailed review (MAP 13.10.2.A.4).

Income during construction. Net operating income earned before the accounting cut-off (three months before the first scheduled principal payment) is reported. If the replacement cost test (Criterion 3) does not control the loan, it can cover soft cost shortfalls, change orders and escrows, with any balance to the borrower, the reserve or principal. If Criterion 3 does control and interim NOI is 1% or more of the original mortgage, the whole amount is deducted from certified cost and none of it goes to the borrower (MAP 13.2.1.3, 13.10.2.A.5).

When the loan gets smaller

If certified costs are lower than the estimate, the maximum insurable mortgage falls. Before final endorsement the lender prepares a modification agreement and the loan is endorsed at the lower amount; that reduction is not treated as a prepayment (MAP 13.30.2.2). Refunds, rebates, discounts, unused escrows and later bond or surety recoveries also reduce cost (MAP 13.20).

After final endorsement, “to be paid in cash” items listed on the HUD-92330 go into a post-closing escrow that should be paid out within 45 days. At 60 days HUD recomputes: anything not actually paid is disallowed, and if the recomputed mortgage is below the endorsed loan, prepayment is mandatory, applied in amounts equal to scheduled monthly principal payments with any remainder to the reserve for replacements. The annual MIP is not reduced for those prepayments (MAP 13.20.D).

Unspent mortgage proceeds left after paying for completion go into the reserve for replacements, unless the loan is cut at closing instead (MAP 13.30.1.4). Separately, operating income earned between the cost certification period and three months before amortization starts can be required as an advance principal payment (MAP 13.30.1).

When the loan can get bigger

A mortgage increase is considered only once the project is complete, the cost certification is in and final endorsement can follow straight away (MAP 13.21). The grounds are listed: necessary changes from differing site conditions, local code compliance, health and safety conditions not foreseen, economically justified betterments, HUD-approved time extensions beyond the contractor’s control, new local requirements, uninsured hard cost from a declared natural disaster, concealed subsurface conditions, replacing a contractor terminated for cause when the surety failed, and substantial HUD processing errors.

Not grounds: ordinary cost overruns, changes for the convenience of the borrower or contractor, or replacing a “straw contractor” set up for BSPRA (MAP 13.22). The MAP Guide says an increase must be greater than 2.5% of the original mortgage or $400,000, and it must be supported by the net operating income underwritten at firm commitment or initial endorsement. An approved increase pays a $3 per $1,000 application fee on the increase, plus $5 per $1,000 inspection fee if hard costs are involved (MAP 13.24).

The 223(f) modified form

On a 223(f) purchase or refinance, the borrower certifies the total cost of the acquisition or refinance on form HUD-2205-A, signed by an authorized agent, with no accountant’s opinion, balance sheet or income statement (MAP 13.10.3). It is filed after all critical repairs are complete and at least 15 days before closing; the lender submits it and HUD computes the maximum insurable mortgage in Section II of the form.

Two rules differ from construction deals (MAP 13.18):

• No netting. Savings on one line item cannot offset an overrun on another.
• Deferred repairs get a second certification. Where non-critical repairs were escrowed, the borrower files a supplemental HUD-2205-A within 15 days of completing them. If actual costs were lower and the maximum insurable mortgage falls, the borrower covers the difference from the repair escrow, a deposit to the replacement reserve, or a prepayment to the lender.

In a purchase where the allowable acquisition cost exceeds HUD’s value estimate, the rent formula is recomputed. A 207/223(f) loan at 80% or less of value at firm commitment needs no cost certification at all.

Where cost certification goes wrong

HUD’s review steps target a handful of problems: missing dates and signatures, identity-of-interest subcontractors that were never approved (their overhead and profit is disallowed), undisclosed liabilities, and items shown as paid that were actually paid with HUD-approved notes rather than cash (those are disallowed). Where discrepancies look like more than honest error, HUD refers the books to the Office of Inspector General and does not issue the HUD-92580 until that is resolved (MAP 13.27). The draw-side rules that feed the certification, from change orders to retainage, are in the construction draws guide.