Understanding the FHA Three Year RuleThe Federal Housing Administration (FHA) has implemented a set of regulations for developers and lenders called the FHA Three Year Rule. This rule is designed to ensure that developers who receive FHA-insured financing for their projects maintain a certain level of financial stability for a minimum of three years after the project is completed. This rule applies to all types of projects, including market-rate developments and affordable housing initiatives.
Requirements for Projects Submitted Within Three YearsEvery project that is submitted within three years of the issuance of the final Certificate of Occupancy must be accompanied by a Debt Service Coverage Ratio (DSCR) that meets specific criteria. For market-rate projects, this ratio must be 1.17, while for Broadly Affordable projects, it must be 1.11. This requirement applies to any construction or renovation project that receives FHA-insured financing within the designated three-year period.
The Importance of the Final Certificate of OccupancyThe final Certificate of Occupancy plays a critical role in the FHA Three Year Rule. It signifies the completion of the project and the attainment of necessary zoning, building, and safety codes. It also acts as the starting point for the three-year monitoring period, during which the development must meet the DSCR requirements outlined by the FHA.
Differences in DSCR for Market Rate and Affordable ProjectsThe Debt Service Coverage Ratio (DSCR) requirements for market-rate and affordable housing projects differ under the FHA Three Year Rule. Market-rate projects require a DSCR of 1.17, while Broadly Affordable projects require a DSCR of 1.11. This difference is due to the varying costs associated with building and maintaining affordable housing initiatives, which are often subsidized through government programs.
How to Calculate DSCR for ProjectsTo meet the criteria outlined by the FHA Three Year Rule, developers must calculate the DSCR for their projects accurately. The DSCR is calculated by dividing the net operating income (NOI) by the total debt service (TDS). In essence, the DSCR is the measurement of how much cash flow is available to cover the debt payments. The higher the DSCR, the better the project’s cash flow position.
- Net operating income (NOI) is the gross revenue minus expenses, except for debt service payments.
- The total debt service (TDS) is the sum of all debt payments, including principal and interest.