Mortgage CreditOrganizational Documents

Wednesday, May 29, 2013FHA Multifamily Underwriter Training

2013 SMAC

Denise “Denny” TroeschelDeputy Chief Underwriter

Common Types of Ownership

• Individuals• Partnerships– General Partnerships– Limited Partnerships– Joint Partnerships– Joint Ventures

• Corporations• Trusts• Tenants in Common (TICs)

HUD Allowable Owners

• The Mortgagor (Borrower) must be a single purpose, single asset entity.

• The key person(s) in control are the Principals who are the prime decision makers– Decide how to operate the property– Decide how to manage the property– Make the financial decisions– Make the financial contributions

Organizational Documents

• Partnerships–Partnership Agreement

• Corporations–Articles of Incorporation–Bylaws

Principals in Partnerships

• General Partnerships– Two or more individuals or entities in which each

partner is “jointly and severally” responsible for the activities of the partnership. Each partner possesses all of the powers of the partnership and is accountable for all of the actions and responsibilities of the partnership even though they may have been performed by another partner.

– The partners may be: individuals or another business entity.

– Each partner is a General Partner and each partner is a principal.

• Limited Partnerships– At least one General Partner, who generally

exercises broad management authority; and– One or more Limited Partners, who invest money

but have limited powers and liabilities.

• The limited partnership agreement defines:– The powers of the partners– The percentage of ownership interests– The duties and rights of all of the partners– The methods for remedying problems or

disputes among partners.

• Limited Partners:– Are not involved in the day-to-day management– Possess no singular powers to buy, sell or obligate

the limited partnership– Usually cannot lose more than their capital

contribution– Typically cannot be compelled to make additional

contributions except in accordance with the specific provisions of the limited partnership agreement.

– Usually receive a specified share of the cash flow, change in property value, and income tax consequences arising from the ownership.

• HUD defines principals in a limited partnership as:– All general partners– All limited partners with 25% or more interest

Limited partners with less than 25% interest are not principals because they are passive investors with no additional financial commitment to the property. No documentation is required for underwriting.

Corporations

A corporation is an entity organized under the corporation laws of a state. It allows for the greatest separation of individuals from the business activities conducted by the corporation. The corporation is owned by stockholders or members. They elect a board of directors and officers. The officers and the B of D actively manage the business of the corporation.

Shareholders or members cannot be held liable for any acts, debts, or obligations of the corporation (barring certain exceptions for fraud or unlawful acts committed by persons acting through the corporation.

The only loss a shareholder or member can experience is the cash paid to purchase the his/her shares.

For Profit Corporations

Purpose is to make money for its shareholders or members through the payment of dividends and/or appreciated stock prices if publically traded. Earnings are subject to state and federal income taxes.•All Officers and members of B of D and all shareholders with 10% or more of the voting shares are principals. However, an employee with a title whose economic interest is limited to salary with no options to purchase shares is not a principal.

Nonprofit Corporations

Purpose is to accomplish charitable or other social objectives without distributing earnings to shareholders. Excess earnings (income in excess of expenses) is retained and used for charitable purposes for which the corporation was created. Nonprofit corporations are usually exempt from state and local taxes. In some cases they are exempt from real estate taxes. In order to be exempt from federal income taxes, they must apply to the IRS for an exemption under Section 501(c) or 501(c)(3).

• For non-profit corporations, HUD requires only the officers of the Board of Directors be considered principals for mortgage credit and financial review. However, all members of the Board of Directors are subject to Previous Participation Certifications.

Subchapter S Corporations

• Not used commonly for multifamily real estate ownership

• Limited to a small number of shareholders• Permitted to make a one-time election for

earnings to be taxed at the corporate level or for earnings to be passed through directly to shareholders for income tax purposes.

Limited Liability Corporation (LLC)

• Known also as a Limited Liability Company• Become the favored legal entity for ownership of

real estate.• Similar to a partnership, an LLC is a pass-through

entity for purposes of income taxes.• Advantage is that all of its members have limited

liability, including those that participate in management activities.

• “Partners” are called Members. Managing Members or members with more than 25% interest are considered prinipals.

Trusts

• Rarely a single asset, single purpose entity so would not be Mortgagor or Borrower

• May be a principal, in which case the Trust Indenture would detail who the trustees are, what the trustee’s powers and responsibilities are. The Trust Indenture must state that the trustee has the powers to incur debt, sell or lease the property.

• The trustee(s) that are active in the day-to-day business of the trust are considered principals for mortgage credit and HUD-2530 purposes.

Organizational ChartsGeneral Partnership

Organizational ChartsLimited Partnership

Organizational ChartsCorporations

Organizational ChartsLimited Liability Corporation

Organizational ChartsTrust