FHA limits mortgage amounts to profit motivated developers of new construction and substantially rehabilitated properties to 90% of FHA recognized costs. This creates a hard equity requirement of not less than 10% of costs. However, when Congress enacted the 221(D) program it wanted to encourage contractors to develop more FHA insured apartment properties. In order to accomplish this goal, the 221(D) multifamily program, under certain conditions, will recognize as a "cost" Builder's and Sponsor's Profit and Risk Allowance (BSPRA), in lieu of a contractor's profit.
Typically, a contractor's profit would be limited to 4 1/4 - 7% of the hard construction costs. BSPRA, on the other hand, is 10% of all costs with exception of land value, and contingency reserve in substantial rehabilitation properties. Therefore, if BSPRA is "waived" by the contractor/developer, the minimum hard equity requirement is reduced from 10% to approximately 3%. Of course each transaction varies depending upon the dollars involved, but the generally the inclusion of BSPRA will reduce the required hard dollar equity.
In order to be eligible for the inclusion of BSPRA in the transaction there must exist an identity of interest between the contractor and the owner. An identity of interest can be created in many ways, but the most frequently used methods are for one of the general partners of the owner to acquire a small interest in the contractor, or for the contractor to acquire limited partnership interest in the owning entity.
BSPRA means the developer and contractor are waiving of the builders profit or BSPRA in lieu of cash equity. By waiving BSPRA there is no allocation within mortgage proceeds for the payment of a contractor's profit. If the contractor is not actually the developer, and the identity of interest is created as outlined above, it unlikely that the contractor would be willing to waive his profit. In some cases, the contractor is willing to accept a "piece" of the project in lieu of his profit. Where a contractor requires that his profit be paid, only a portion of BSPRA may be waived, or the profit must be paid from other than mortgage proceeds and by someone other than the owning entity. This is typically accomplished by the use of a "side agreement" wherein the general partner or partners of the owning entity agree to pay the contractor's profit based upon a completion schedule, i.e. at 25% completion, 25% of the contractor's profit is paid. The payments under the side agreement can be unsecured or secured by assets other than the project. The major advantage of the side agreement is that the contractor's profit is paid during the course of construction, rather than effectively being put up with the mortgagee prior to the start of construction.
If the contractor insists that his profit be including within the mortgage proceeds and the contractor is unwilling to create an identity of interest necessary to qualify for BSPRA, all is not lost. FHA has another category of recognizable cost called SPRA. SPRA Stands for Sponsor's Profit and Risk Allowance, Of course! In a transaction in which you have SPRA, a contractor's profit would be included in eligible costs and paid from mortgage proceeds. SPRA would be equal to 10% of all costs with the exception of land, contingency reserve and construction costs. Therefore, what would be lost in "eligible costs" in a SPRA transaction as opposed to BSPRA transaction, would be the difference between the amount of the contractor;s profit and 10% of the construction costs.