Chicago FHA mortgages against mixed-use 2 to 4-unit properties are harder on borrowers than any other type of mortgage loans.
Applying for an FHA Mixed-Use Loan
Not all loan originators know how that it is possible to get an FHA loan against a mixed-use 2 to 4-unit property.
In addition, some of those who do, do not fully understand the rules.
But most of all, hungry for loans, take the application anyway. Some even try. Hard. And fail.
That means long delays for the borrower. Which mean stress. If the application is for a purchase, the closing deadlines add to the stress.
Getting an Appraisal for a Mixed-Use 2 to 4-Unit Property
Appraisers come in two types: residential certified appraisers and general certified appraisers.
Residential certified appraisers can appraise only residential properties.
General certified appraisers can appraise any type of real estate property as long as they have the experience to do it.
Mixed-use properties have at least one non-residential unit, therefore, they are considered commercial properties. That means, residential certified appraisers cannot appraise them.
Lenders (loan officers) cannot hire an appraiser directly; they must hire an appraisal management company that hires the appraiser.
In real life, that means that the appraisal management company announces the job for the mixed-use property to all the appraisers on their roster. The first appraiser to say they want it, gets the order.
Appraisers say yes to orders without doing any type of research, without even reading the notes the management company or the loan originator adds to the order.
Since appraisal management companies have few general residential appraisers and many residential certified appraisers, the above means that an unqualified appraiser accepts the order. They set up the appointment for a few days in the future. The day of the appointment, or the day before, when they get ready, they realize they are not qualified to do it, and turn it down.
Worse, they go to the appointment, and only then realize they cannot appraise it.
So, the appraisal management company posts the job again. This time, they make the notes more clear and, often, a general certified appraiser accepts the order.
Often but not always. Sometimes, this dance repeats two or three times before the appraisal management company locates a qualified appraiser who accepts the order.
In other words, by this time, the appraisal is delivered anywhere between 7 and 20 days later than then it should have been.
Qualified Appraisers and Mixed-Use Properties
General certified appraisers have no obligation to accept an appraisal order. When they appraise a commercial property, they get paid more than when they appraise a residential one: commercial appraisals require more skill and more effort.
A mixed-use property often requires more work then a residential one. No as much as a commercial one, but it can be significantly more.
They way appraisal management companies work, it is hard for appraisers to charge extra for a mixed-use property appraisal.
So, many appraisers who could appraise turn down the offer: they figure they could not find comparables acceptable to the management company. Or they could not do it as fast as the appraisal management company rules require.
Mixed-Use Properties and Qualified Appraisers
All general certified appraisers are allowed to appraise mixed-use properties; not all general certified appraisers are qualified to appraise a mixed-use property.
The FHA insures mixed-use loans as long as the residential part takes up 51% or more of the property. In cased of 2-story, 2-unit properties or 2-story or 4-story, 4-unit properties, some appraisers’ way of measuring the property kill the deal.
Example: you have a 2-unit, 2-story property where the first floor is used as a flower shop, the 2nd floor is an apartment. Measured on the outside, each floor is 1000 square feet. In other words, only 50% of the property is residential in nature, so no FHA loan is possible.
Better appraisers note, though, that there are stairs to go to the first floor unit in the front and in the back of the property. And there is a little hall on the first floor that can be used only to access the 2nd floor. Those stairs and hall take away from the commercial use. Not much, maybe 32 square feet.
But if you reduce the commercial space by 32 square feet and give those 32 square feet to the residential side, you end up with 968 square feet vs 1032 square feet. Or 51.6% residential use. Or: the FHA would insure a loan against this property.
The Big, Unsolved Mixed-Use Property Mystery
The powers that be want general certified appraisers to appraise properties that have any non-residential component because one of the approaches used to determine value is the income approach. They, rightly so, want appraisers who can calculate and compare income streams to appraise.
When it comes to FHA loans, appraisers do not use the income approach to determine value. They only use the comparable approach. Yes, they only have to bother with gross building areas, number of bedrooms, number of bathrooms, number of units, lot size, condition differences, age.
Those are things residential certified appraisers are qualified to deal with.
So, why is there no exception for appraising mixed-use properties for FHA loans? Why must only certified general appraiser appraise these properties?
The Self-Sufficiency Test and Mixed-Use Properties
As far as HUD is concerned, rents paid by non-residential units are not allowed income. That means the 3 or 4-unit mixed-use property can only get an FHA loan if it passes the self-sufficiency test with 75% of the lower of the market or actual rent from the residential units.
Residential Loan Options for 3 and 4-Unit Properties
If you’re looking for a 3 or 4-unit mixed-use property and want to avoid the self-sufficiency hassle, shoot for one where 90% of the sale price (value) is $1 higher than Fannie Mae’s loan limits for the state for the number of units you’re interested in. And the commercial part is artist live-in space.
Because there are lenders that will give you a loan against such properties with only 30-year loan with 10% down and no mortgage insurance.
Which is better than a commercial loan, as they have much larger down payments, pre-payment penalties, and are shorter term.
The Value of the Non-Residential Unit(s) and the FHA-Insured Loans
A man purchased a 2-unit property in Chicago’s West Eldson neighborhood with a store on the first floor (taking up about 1/3rd of the floors) and residential space on the 1st floor in the back and on the 2nd floor for $144,000 in 2013.
In 2019, he wanted to refinance and get some of his equity out. He figured his property was worth at least $220,000 to $230,000 based on his improvements and the fact that values in his neighborhood had increased significantly since he had purchased the property.
The appraiser, however, came in at only $200,000. The appraiser had appraised only the residential part of the property. He was instructed to do so by the lender. The lender’s understanding of FHA’s guidelines was that only residential apartments can be given value.
That meant that the appraiser did not give value to some 450 square feet of property.
Last month I had the following situation:
A man who had purchased a mixed-use 3-unit property in 2012 for $168,000 in the Pilsen neighborhood of Chicago. The 1st floor had a store in the front, an apartment in the back, and there was an apartment on the 2nd floor).
This man also wanted to cash-out some of his equity.
The lender understood the FHA rules differently, so the store was appraised together with the residential part. The value given was $399,202. Had the appraiser taken out the store, the value would have been lower, probably $330,000.
In both cases, the owners did get cash-out. But the 2nd one was a lot happier, as he could cash-out up to 85% of the full value of his property.
(Just an aside: one of my pet peeves with appraisers: Did you notice the appraiser’s $399,202 estimated value. Estimated! Me, I would have called it $400,000. Or $399,000. You know, because it’s an estimate.)
Chicago FHA Mortgages Against Mixed-Use Properties and the Right Mortgage Specialist
A good mortgage broker / specialist is always great to have. That is especially true when you’re dealing with mixed-use property loans.
If you’ve got a mixed-use property and would like to talk, call me at 847-840-8884.