When clients consider purchasing a mixed-use property to earn income and provide them with a home, they can run into challenges when seeking an FHA loan. FHA mortgages are preferable over a commercial property loan because they only require 10% down without mortgage insurance and have longer terms.
Today, we take a look at the appraisal process and how a mixed-use property qualifies for an FHA loan.
Assigning an Appraiser
In Illinois, there are residential certified appraisers and general certified appraisers. Since mixed-use properties have both commercial and residential space, an experienced general appraiser appraises mixed-use properties. This is because residential certified appraisers are not certified to appraise commercial properties.
The appraiser is hired through the loan providers’ appraisal management company, which announces the job on their roster. They assign the job to the first appraiser who expresses interest. Unfortunately, the appraiser is not provided with information about the job until the day before or the day of the appointment. Because many lack the experience to perform the job, they turn it down with short notice, or in some cases arrive at the property and can’t perform the appraisal.
This means the management company must repost the job with more information about the property. As a result, the appraisal can face further delays, and the job can be posted several times before a qualified appraiser accepts. This tends to add at least a week to the appraisal process and in many cases up to 20 days.
It’s important to note that since the housing market crash circa 2009, there has been a firewall between lenders and appraisers per Consumer Financial Protection Bureau regulations. Prior to then, a lender would hire an appraiser who would give the appraisal they wanted--i.e. the contract price. Now, lenders must hire appraisal companies who are independent and are not allowed to speak with the lender, purchaser or broker, so that their appraisals are based on their own research and not based on any "coaching".
The Mixed-Use Appraisal for Loans
The FHA ensures mixed-use loans for properties with 51% or more of the space dedicated to residential use. However, the businesses occupying the commercial space cannot put residents’ health and safety at risk. How the appraiser measures the property can lead to issues with FHA loan approval, especially for 2-story, 2-unit properties or 2 or 4-story, 4-unit properties.
If the appraiser does not take the time to look at the square footage usage properly, it can ruin the chances of the property qualifying for the FHA loan. A common mistake is an appraiser only considering the usage from the exterior. Because they see the bottom floor dedicated to commercial use, and the second floor dedicated to residential use, they split the property 50-50.
However, inside the property, a further share of the main floor is assigned to residential use because the stairs and halls on the main floor are only used to reach the residential unit(s). This space provides the minimum 1% more space needed for the residential area. Although this space is quite small, it still increases the residential space and reduces the commercial space.
The Self-Sufficiency Test
Adding to the challenges of the mixed-use property appraisal is the approach taken to assess the value. For commercial buildings, the income is calculated as part of the value, whereas residential properties use comparables. Since rents for the residential units are not considered income by HUD, that leaves one more option: the self-sufficiency test.
This includes residential rent collected as income. The appraiser factors in 25% of the rental income as a vacancy rate, which means 75% of the rent must pay for the principal, interest, mortgage insurance, property insurance, and property taxes (PITI). If the property meets the 51% requirement and the rental income covers PITI, then approval is more likely.
The bottom line is that you can find lenders willing to provide FHA loans for mixed-use properties. However, the process is more challenging than a residential property. In addition, your client should be aware that the self-sufficiency test can negatively impact their property value when they want to sell or access their property’s equity.
The Minchella & Associates Difference
With over 40 years of experience in Illinois real estate law, Erica Minchella has represented thousands of home sellers and buyers, landlords and commercial and investment property owners. For information, schedule a consultation today.