Escrow and Replacement Reserves for FHA Multifamily Construction Loans
If you want to apply for a HUD multifamily loan, part of the HUD 221(d)(4) process involves making sure you have enough money saved in escrow (see below). This is money in a third-party account which has been set aside to cover a variety of expenses. According to HUD guidelines, an owner/developer needs:
What are Replacement Reserves?
2-4% (typically 4%) of the amount of the loan in working capital reserves
3% of the loan amount as an operating deficit reserve
By having these funds in reserve, building owners can proactively save funds to replace necessary equipment and components.
Both of these, if unused, will be refunded at a later date, typically after 6 months of "break-even" operations(the project's monthly income is meeting or exceeding the project's expenses). In addition, after the project is finished, taxes and insurance will also need to be placed monthly in an escrow account.
What is Escrow?
Merriam-Webster defines escrow as “a deed, a bond, money, or a piece of property held in trust by a third party to be turned over to the grantee only upon fulfillment of a condition.”
In real estate, escrow allows large sums of money to be held until a transaction is finalized. For example, when the sale of a property comes with conditions, funds are held until the conditions are met. Afterwards, the escrow company then transfers the money to the buyer.