How to Buy and Rehab a Mixed Use Building with a 203K
One of the little known uses of FHA 203k financing is to purchase (or refinance) a small building that has both commercial space and residential space. This is allowed by FHA only for owners who will live in the residential space. The commercial space can be leased to a new business, an existing business or house the owners business.
The FHA guideline is that of the total square footage in the building, at least 51% must involve the residential space and no more than 49% the commercial space. The key on this rule is how to count square footage. A 2 story structure with a commercial storefront on the first floor and an apartment on the second floor is a common type of property. It might appear to be a 50/50 split. But there are staircases to climb up to the apartment that are not counted as part of the commercial space. The reason why is the commercial space users have no reason to enter the second floor residential apartment. So most times the commercial space should be less than the residential space square footage.
The 203K loan must have some minimum rehab component to it for this to work. Here is an example. A buyer wishes to purchase a 2 story property with an office space on the first floor and one apartment on the second floor. The purchase price will be $250,000. Additionally the buyer wants $10,000 to update a bath in the residential space. The total transaction is $260,000. The down payment can be as little as 3.50% down with this type of loan. The down payment is calculated on the total transaction cost of $260,000. The buyer may want to run a business out of the commercial space and live upstairs. The 203K loan is perfect for this situation.
The 203k is a great alternative to what otherwise might have to be done as a commercial loan with less favorable terms for a mixed use property. Additionally there may be tax advantages for a business owner to lease commercial space, in effect from themselves. Please check with your CPA for expert guidance.
The maximum size of the building is limited to 4 units total, including the commercial space. In Chicago and many other cities there are buildings with a small storefront on the first floor and 1 or 2 or 3 apartments above. These properties are ideal for this type of financing provided the residential part of the building is to be owner occupied. The 203k cannot be used by investors planning to lease out the entire building.
One last item to consider is whether there are other similar buildings close by that can be found by an Appraiser to be used as comparable sales. There must be closed sales within about the last year close by to be used to do a valuation report on the mixed use property. The valuation or appraisal is done to the final “as finished” value of the building based on a contractors description of the rehab work to be done as part of the 203K financing. In the above example we would look for a valuation of $260,000 with the $10,000 of remodeling planned based on a $250,000 purchase price. Finding “like” comparable closed sales is necessary for the mixed use 203K loan to be approved.
I hope this has been helpful. Please send comments or questions any time.
Perry Farella firstname.lastname@example.org Down payment and terms shown are for informational purposes only and are not intended as an advertisement or commitment to lend. Please contact us for an exact quote and for more information on fees and terms. Not all borrowers will qualify. Not intended as accounting or investment advice. Contact your tax preparer for more information.