Commercial Space Limits on HUD Multifamily Loans

Key points

• The MAP Guide limits are 25 percent of area and 20 percent of income for 223(f), 25 and 15 percent for 221(d)(4), and 25 and 30 percent for Section 220.
• Underwritten commercial occupancy on 223(f) is the lowest of market, actual occupancy, or 90 percent.
• Parking income from non-residents counts as commercial and is underwritten at no more than 50 percent occupancy.
• Regional Center Directors can waive the limits in defined cases, such as a long lease with a creditworthy tenant.
• Commercial space financed by the mortgage is subject to the same ban on transient or hotel use.

The limits by program

The MAP Guide sets limits by section of the National Housing Act. For 221(d)(4) new construction and substantial rehabilitation, commercial space is limited to 25 percent of total net rentable area and commercial income to 15 percent of effective gross income. Section 220, designed for mixed-use projects in urban renewal and other designated areas, allows 25 percent of area and 30 percent of income. For 223(f) acquisition and refinance, the limits are 25 percent of area and 20 percent of income. Confirm current limits under HUD guidance before relying on them.

Both tests apply. A building with a modest amount of high-rent retail can pass the area test and fail the income test, which is common in dense urban neighborhoods where ground-floor retail rents per square foot are well above apartment rents.

What counts as commercial

HUD defines commercial broadly: any space permitted for non-residential use from which income is derived. Resident fees for community rooms and parking are ancillary income, not commercial. Parking or facility income from non-residents is commercial. Where a property rents monthly parking to the public, the lender must determine the share of non-tenant parkers and include that share in the commercial tests, and underwritten occupancy on that parking is capped at the lower of market or historic performance, or 50 percent. Percentage-rent parking contracts are not permitted without a waiver.

The space occupied by resident parking and community facilities is excluded from the area calculation. Lenders still need a clear allocation, so expect questions about how garage spaces are assigned and billed.

How commercial income is underwritten

The appraiser must analyze commercial income, vacancy, expenses and reserves separately from the residential side, using at least three commercial comparables, and must value the commercial portion by applying the program limits used to set commercial net operating income. Project-paid tenant improvements are treated as a leasing expense. For 223(f), underwritten commercial occupancy is the lowest of what the market indicates, the subject's actual occupancy, or 90 percent. For other programs it is the lower of market or 80 percent.

Two practical consequences follow. A fully leased retail strip still takes a vacancy haircut, so commercial income contributes less to loan sizing than the rent roll suggests. And a vacant storefront at application hurts twice, because actual occupancy caps the underwritten figure.

Waivers and structural alternatives

Regional Center Directors may waive the income limits as long as the property remains primarily residential. The MAP Guide gives examples of mitigants: a long-term lease to a creditworthy tenant such as a government agency, a multi-tenant space whose tenants have occupied it for five or more years and whose full occupancy is not needed for break-even, substantial borrower equity or local government funds, and existing 223(f) properties with an established history of commercial income above 20 percent but no more than 30 percent. HUD may require a credit analysis of the commercial tenants. Space limit waivers require showing the space will not harm residents, has market support, and has easement, insurance, parking and zoning issues resolved.

Some owners consider separating commercial space into its own legal parcel or condominium unit outside the HUD collateral. That can work but involves title, zoning, reciprocal easements and HUD and counsel review, so raise it early.

Using the bridge period on a mixed-use building

If the HUD exit depends on commercial income, use the bridge period to sign long leases with credible tenants, document their payment history, and resolve any short-term or percentage-based arrangements. If the commercial share is close to a limit, model the HUD loan with commercial income at the capped level and decide whether the deal still works.

• Commercial rent roll with lease dates, options and tenant improvement obligations
• Copies of all commercial leases and estoppels
• Parking agreements and a breakdown of resident and non-resident users
• Square footage schedule reconciling residential, commercial and common areas

Where to go next

For Bravo's 223(f) terms on existing mixed-use buildings, see HUD 223(f) loans.

For new construction and substantial rehabilitation with commercial space, see HUD 221(d)(4) loans.

For mixed-use buildings in New York City, see HUD loans in New York City.

Related guides: How HUD Loan Sizing Works in a Bridge-to-HUD Plan; Planning for a Bridge-to-HUD Proceeds Gap; HUD 223(f) vs. 221(d)(4): Which Exit Fits the Property?; HUD Financing for Rent-stabilized Buildings in New York City.

Related terms: Underwritten NOI: How HUD Calculates Net Operating Income; HUD Appraisal: How HUD Values a Property for Loan Sizing; Debt Service Coverage Ratio (DSCR) in HUD Loan Sizing; What Is a HUD Section 223(f) Loan?.

For portfolio figures by state, metro and program, see the HUD multifamily data hub. Bravo Capital’s record: all 26 HUD firm commitments received since April 2022 have closed, totaling $526.0 million (HUD Closing Scorecard).