HUD audits: What is cost certification?

When a new multifamily project is constructed under the U.S. Department of Housing and Urban Development (HUD) program, the project typically must undergo a cost certification performed by an independent accountant before HUD issues a final endorsement of the project’s insured mortgage loan. When considering a HUD-insured loan, it’s important to understand the program’s benefits, eligibility requirements, and the role cost certification plays in the final endorsement process.

Benefits of the HUD program

Real estate developers and owners of multifamily construction projects may consider one of many HUD-insured loans for several reasons:

• HUD-insured loans are available to both for-profit and nonprofit entities.
• Subject to the terms of the HUD Regulatory Agreement, owners may be permitted to distribute surplus cash periodically.
• They offer high loan-to-value ratios, enabling developers to obtain a larger loan with a lower downpayment, according to HUD. 
• Because the loans are insured by HUD, they generally offer low fixed rates over a long repayment term.
• They are generally non-recourse loans, meaning investors are not required to provide personal guarantees.

Eligibility

Because HUD insures mortgages issued by private lending institutions, projects must meet a series of eligibility requirements. As part of the process, an independent accountant performs procedures to verify that the multifamily project complies with HUD guidelines governing allowable, or certifiable, construction costs. This review helps determine the project’s actual development costs and establishes the maximum insurable mortgage amount at final endorsement.

Once HUD approves the trip report, the project is considered substantially complete following the final construction inspection. Project leaders then have approximately 90 days to complete the cost certification process, including a cost certification audit performed by an independent accountant under HUD’s cost certification requirements, before submitting the certification package to HUD as part of the final endorsement process.

Construction projects may be eligible for a HUD loan if they involve:

• New multifamily construction, or
• Substantial rehabilitation of multifamily rental or cooperative housing for moderate-income households or displaced families.

The minimum HUD loan amount is $2 million, although typical loan amounts exceed $15 million. Separate requirements apply to qualify for the maximum loan amount.

Cost certifications

Owners (mortgagors) and general contractors must both perform a cost certification when an identity of interest or other related business relationship exists. For mortgagors, a cost certification is always required. Contractors, however, are required to obtain a cost certification audit only when:

• An identity of interest exists between the mortgagor and the contractor, or
• The contractor used a cost-plus construction contract.

According to HUD, a subcontractor must also complete a cost certification when: 

• The total of all subcontracts, purchases, and leases exceeds 0.5% of the mortgage, and 
• An identity of interest exists between the subcontractor, equipment lessor, material supplier, or manufacturer of industrialized housing and either:
  • The mortgage, or
  • The contractor, when the contractor is required to submit a cost certification.

The purpose of the cost certification process is to provide HUD with assurance that only eligible project costs are included in the final mortgage calculation and that the project complied with HUD requirements throughout construction.

What’s next

At Sikich, we perform cost certifications year-round and have extensive experience assisting owners, contractors, and developers through the final endorsement process. Because cost certification is a critical step in establishing the final insurable mortgage amount, we encourage you to speak with a member of our team to help ensure your construction project is a success.