Regulatory Agreement: The HUD Contract That Governs Operations

Key points

• Multifamily deals use form HUD-92466M; Section 232 deals use separate borrower and operator regulatory agreements.
• Distributions can come only from surplus cash, calculated at fiscal year end and optionally at mid-year.
• Many actions need HUD's prior written approval, including transfers, new debt and changes to management.
• Annual audited financial reports are required within the period the agreement and HUD set.
• The agreement continues as long as HUD insures or holds the note.

What the agreement is and when it applies

The multifamily Regulatory Agreement (form HUD-92466M) is signed at closing, recorded against the property and subordinate to the security instrument. HUD enters into it in exchange for an action: endorsing the note for insurance, consenting to a transfer, or similar. It stays in force as long as HUD is the owner, holder or insurer of the note. Section 232 healthcare loans use a borrower regulatory agreement and a separate operator regulatory agreement, because the operator controls the license and revenue.

Borrowers sometimes treat the agreement as boilerplate. It is better read as the operating manual HUD will hold the borrower to for decades.

The provisions that matter most day to day

Undocumented expenses are treated as ineligible project expenses unless HUD decides otherwise, so record-keeping is a compliance issue, not just an accounting preference.

• Surplus cash and distributions: owners may take money out only from surplus cash, computed under a defined formula.
• Borrower advances: money the owner puts in can be repaid only with HUD approval or from distributable surplus cash.
• Reserves: the reserve for replacements must be funded and used as HUD requires.
• Books and records: monthly posting, documented expenses and availability for HUD inspection.
• Annual financial reports: audited statements prepared to HUD standards.
• Maintenance: the property must be kept in good repair, and HUD can require repairs.
• Management: management agreements must meet HUD requirements and can be terminated at HUD's direction in a default.

Actions that require HUD's prior written approval

Section 35 of form HUD-92466M lists actions the borrower may not take without HUD's prior written approval. Among them: transferring or encumbering the property or any interest that creates or eliminates a principal, borrowing money other than for reasonable operating expenses, paying compensation to principals except from surplus cash, entering into or changing management contracts or operating leases except as program rules permit, remodeling or demolishing beyond minor alterations, using the property for another purpose or expanding commercial use, and materially amending the borrower's organizational documents.

The agreement also requires copies of executed organizational document amendments to be delivered to HUD within ten days of their effective date.

How the agreement changes life after a bridge loan

Bridge loans typically allow the owner to sweep cash monthly once debt service and reserves are paid. Under a HUD Regulatory Agreement the owner calculates surplus cash at fiscal year end (and, if permitted, mid-year) and distributes only within the following accounting period. Owners used to monthly distributions should plan their own cash needs accordingly.

Bridge-loan side arrangements also need to be cleaned up at the HUD closing. Affiliate loans to the property, asset management fees paid from operations, and pledges of membership interests to mezzanine lenders all need to be retired or conformed to HUD's rules.

Common compliance failures

The failures HUD sees most often are not exotic. They include distributions taken when the property had unpaid obligations, repayment of owner advances without approval, related-party contracts priced above market, late or deficient annual financial statements, and unresolved physical deficiencies. The agreement bars distributions when HUD has issued notice of a violation, when the loan is in default or forbearance, or when required services or repairs are outstanding.

If HUD gives notice of a violation and it is not corrected within the cure period, HUD has remedies that range from requiring corrective action to seeking control of rents. A good asset manager keeps a compliance calendar tied to the agreement.

How it connects to other HUD terms

Surplus cash, the annual financial statement, replacement reserves, Transfer of Physical Assets and non-recourse carve-outs all have their source in the Regulatory Agreement. Reading it once before closing, with the asset manager and accountant in the room, prevents most of the problems that show up years later.

Where to go next

For answers to common questions about living with a HUD loan, see HUD loan FAQ.

For how HUD's operating covenants compare with other permanent debt, see HUD vs agency and bank loans.

Related guides: After the HUD Closing: Asset Management Obligations; The First-Time Borrower’s Guide to a HUD Exit; HUD Reserves and Repair Escrows: What Gets Funded at Closing.

Related terms: Surplus Cash: How HUD Limits Owner Distributions; Annual Financial Statement: HUD's Audited Reporting Rule; Non-Recourse Carve-Outs: Where HUD Personal Liability Applies; Transfer of Physical Assets (TPA): How HUD Loan Assumptions Work.

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).