Overview of Federally-Assisted Multifamily Housing Programs:
Historical Perspective and Status of Legislation and Regulations
The Older Assisted Housing Stock:
Section 221(d)(3) and Section 236
Between 1965 and 1975, over 600,000 units of affordable housing were built under HUD’s Section 221(d)(3) and Section 236 programs. Along with the Section 202 program created in 1959, this was the first time the private sector was invited to participate in producing low- and moderate-income housing, previously the sole domain of public housing authorities. The private sector programs were structured very differently from public housing. Under these programs, FHA-insured 40-year loans were provided, accompanied by either a below-market interest rate (Section 236), interest rate subsidies (Section 221(d)(3) Below Market Interest Rate-BMIR) or rent subsidies similar to Section 8 for the residents (Section 221(d)(3) Market Rate). The Section 202 program for the elderly was strictly limited to nonprofit owners. The other programs were not, however, and with a minimal amount of cash required from developers to participate, they quickly became popular with for-profit owners.
In exchange for participating in these programs, the profit motivated investors were required to make the units available to low and moderate income households at HUD-approved rents throughout the term of the mortgage. Built into these rents was a modest limited dividend return on the owner’s investment. Although the mortgages had 40-year terms, program regulations allowed most owners to prepay their mortgages after 20 years. By pre-paying, owners could terminate the rent and income restrictions, often called "use restrictions".
At the time the programs were developed, they were viewed as a solution to a temporary problem that would evaporate as the economy grew and incomes rose. Further, using the public housing experience up to then as an example, it seemed extremely unlikely that these developments might ever be worth more than their subsidized mortgages, or that there would be a strong potential for their conversion to market-rate use.
The next two decades brought many changes. The energy crisis of the 1970s, combined with the declining economic fortunes of many subsidized housing residents, drove many projects into mortgage default, assignment and foreclosure. Others on the brink of disaster were rescued with infusions of new federal subsidies. One commonly used approach was the Section 8 Loan Management Set-Aside (LMSA) program, where project-based Section 8 subsidies were provided both to increase revenue and make the housing more affordable to very low income families. HUD also began replacing the rent supplement program administered in tandem with most projects developed under the Section 221(d)(3) Market Rate program with project-based Section 8 funds. Most of the older assisted developments ended up with project-based Section 8 subsidies for some or all of their units.
During this time, national tax policy also played an important role in the programs. Starting in the late
1960s, tax incentives provided a significant additional inducement for private owners to sponsor developments under these programs. Later, the Economic Recovery Tax Act of 1981 stimulated the transfer of about 40% of the nation’s Section 221(d)(3) and 236 housing stock to new tax-motivated owners, generating some new capital for the developments as well as substantial tax benefits for the original investors. Thus, what started out as a good development opportunity turned out, over the years, to be influenced very strongly by national tax policy.
Because of the way these programs were structured, they provide some of the most affordable rental housing in our community, with rents far below market. Today, their future in high cost housing markets is severely threatened. Not only have they increased substantially in market value, but many of these developments are also a tax liability for their original owners because the tax benefits have expired and the projects are generating phantom income, "paper" income on which owners must pay taxes. More recent buyers have seen their tax benefits eroded substantially by federal tax reform. Right now, there are few incentives to retain the property’s original use, and many incentives to prepay the mortgage and convert to market-rate housing.
The Federal Government’s First Response: ELIHPA (Title II)
In the mid-1980s as the first pre-payments occurred, the government and housing advocates looked closely and realized that immense waves were developing on the horizon. The Emergency Low Income Housing Preservation Act of 1987 (known as ELIHPA, or Title II), was the result. This law was intended to be a temporary measure to preserve low-income housing resources while Congress developed a long-term solution to the mortgage prepayment problem. Under this legislation, Congress took the unusual step of restricting owners’ contractual prepayment rights, citing the importance of protecting residents and preserving the original social purpose of the housing.
Prepayment of Section 236 and Section 221(d)(3) mortgages was prohibited without a HUD-approved Plan of Action (POA) assuring that there was no adverse impact on current residents or the local affordable housing supply. Preservation incentives were available, but only to owners whose properties had a demonstrably higher and better use than low-income housing. In exchange for these incentives, owners or purchasers were required to maintain the historical occupancy profile of their developments, with correspondingly affordable rents, for the balance of the HUD-assisted mortgage term.
The Next Step: LIHRPHA (Title VI)
In November of 1990, Congress passed the Low Income Housing Preservation and Resident Homeownership Act of 1990 (LIHPRHA, or Title VI), an effort to develop a comprehensive solution to the prepayment problem. Its basic objectives were: to assure that the prepayment inventory of assisted housing was preserved and remained affordable to low-income households; provide opportunities for tenants to become homeowners; and to do so while at the same time fairly compensating owners for the value of their properties. Unlike its predecessor, LIHPRHA includes the following key elements:
- Owners were guaranteed fair market value incentives, typically in the form of capital grants, to retain ownership of their developments or a fair market sales price if they wished to sell
- Owners and purchasers who received federal incentives were required to preserve the low and moderate income use of the housing for its remaining useful life (at least 50 years)
- Tenant groups, nonprofits and public agencies were given a genuine opportunity to purchase prepayment eligible properties, with priority purchase rights on any property offered for sale, and technical assistance grants for predevelopment expenses and resident capacity building.
- The regulations and handbooks for LIHPRHA provided a highly structured regulatory process with specific time frames.
At first, HUD gave equal priority to applications by existing owners to retain ownership and extend the use of the property as low and moderate income housing (known as "extensions") as it did to the sale of properties to new owners willing to meet the requirements. Later, however, HUD approved funding solely for the sale of properties to nonprofit organizations.
LIHPRHA Today
In 1996, with owners’ lawsuits nipping at its heels, Congress restored their right to prepay their mortgages. An avalanche ensued. In FY 1998, funding for the federal incentives dried up, a victim of congressional concern that inflated property appraisals were resulting in undue enrichment of many owners. A long list of developments with approved Plans of Action remain in HUD’s pipeline, but the likelihood of funding for these is extremely remote. Meanwhile, it is important to point out that owners of all properties eligible to prepay their mortgages may now do so, regardless of whether they are ELIPHA or LIHPRHA projects. The distinction is that ELIPHA and LIHPRHA developments remain bound by the income and rent restrictions in their use agreements, regardless of whether the mortgage is outstanding.
Preservation Vouchers for Residents
Recognizing the displacement problems that could result from the conversion of Section 236 and 221(d)(3) developments to market rate housing, in 1996 Congress also created a new form of Section 8 tenant-based assistance, referred to as "preservation", "sticky", or "enhanced" vouchers. Originally, these vouchers were available only to low and moderate income tenants living in Section 236 and 221(d)(3) developments on the date their owners prepaid their mortgages with a resulting increase in rents. They are now also available to low and moderate income residents in developments with project-based Section 8 assistance at the time the owners of these projects opt out of their Section 8 contracts, as discussed below. Sticky vouchers allow the residents to remain in their units paying 30% of their income for rent with HUD making up the difference between that amount and "street" or market rent. If a tenant moves from the property they may take the housing assistance voucher with them. However, once they move they lose the increased value of the preservation voucher, and the level of Section 8 assistance drops to the general payment standard for vouchers in their jurisdiction. Initially, due to a lack of clarity in the authorizing legislation, it was determined that these vouchers could only cover the street rent for one year, with tenants paying any increases above the first year amount out-of-pocket. The FY 2000 VA/HUD Appropriations Act enacted in October 1999 resolves this problem by making clear that enhanced vouchers carry with them the authorization to raise the Section 8 assistance level as landlords raise rents annually.
The Newer Assisted Housing Stock: Section 8
In January of 1973, President Nixon placed a moratorium on all subsidized housing programs, and then proposed replacing these project-based assistance programs with tenant-based subsidies. The outcry at this abrupt policy change ultimately resulted in the creation of the Section 8 program, with both tenant-based and project-based elements. Between 1974 and 1983, 800,000 apartments were developed under the project-based program, including Section 8 New Construction, Substantial Rehabilitation and Moderate Rehabilitation. These developments receive federal subsidies in return for which owners are required to rent a specific number of units to low-income families and the elderly.
Unlike the older assisted housing programs, project-based Section 8 is solely a rental subsidy program, not provided in tandem with a specific government mortgage loan program. Instead, owners could opt to use a wide variety of mortgage financing options, with or without FHA mortgage insurance, and the owner could contract to use Section 8 subsidies in all or only a portion of a development’s units. Owners were generally required to sign twenty-year subsidy contracts for new construction and rehabilitation developments or15-year contracts for LMSA and moderate rehabilitation developments. These contracts began expiring in 1991, and some owners already have exercised their right to opt-out of renewing their contracts.
Contract Renewal Dilemma
In the original design of these programs, Congress provided long-term contracts to owners that were intended to be renewed in like manner at the end of the original term. Thus, it was anticipated that a property with a 40-year mortgage would receive two 20-year Section 8 contracts. Over time, however, federal budgetary pressures (some would say "accounting issues") made these long-term renewals unsustainable. Congress currently renews funding for the Section 8 program on a year to year basis. All of the Section 8 contracts expire over the next decade. The total number of Section 8 contract renewals is therefore cascading because Congress must "re-renew" funding for contracts that were renewed the year before.
In 1995, HUD responded to this problem by proposing a profound shift in the program: eliminating project-based subsidies as contracts expire; eliminating regulatory requirements governing the housing; paying mortgage claims triggered by the elimination of the subsidy; providing some rehabilitation to a portion of the stock; and providing residents with Section 8 certificates administered by local public housing authorities. The concern and opposition voiced across the public-private-nonprofit spectrum convinced HUD to shelve this proposal. In 1996, HUD shifted its focus to developments with Section 8 contract rents that are higher than comparable market rents, where the government is paying more than it should to provide affordable housing.
Unlike the 236 and 221(d)(3) programs, where the rents are based on each development’s annual operating budget (budget-based rents), the Section 8 program originally used Fair Market Rents (FMRs) as its foundation. FMRs are a HUD-established norm for a given area and housing type, intended to reflect market rents for non-luxury housing. HUD then made up the difference between these FMRs and the amount a low-income family can pay in rent using 30% of its adjusted annual income. When a development was approved under Section 8, the FMRs were set. After that, owners could apply HUD’s Annual Adjustment Factor (AAF) to increase their rents automatically every year. In some cases, this resulted in Section 8 rents exceeding comparable market rents.
Portfolio Re-Engineering: The New Initiative
In response to the problems identified by HUD, Congress first authorized two consecutive nationwide demonstrations addressing the need for "portfolio re-engineering," focusing on properties with contract rents above 120% of FMRs, i.e., with rents substantially above market. Then it bit the bullet and passed comprehensive legislation to address properties with expiring Section 8 contracts, the Multifamily Assisted Housing Reform and Affordability Act of 1997 (MAHRA).
Mark-to-Market
HUD’s initial focus in implementing this legislation was the Mark-to-Mark program. The program’s goal is to preserve low-income rental housing affordability while reducing the long-term costs of providing project based rental assistance. The "restructuring" element of the program focuses on HUD insured properties with Section 8 rents above comparable market rents. The approach is designed to reduce HUD rental subsidies while assuring that the owners still have sufficient funds to pay their HUD insured mortgages, helping owners avoid default and HUD avoid massive claims on the FHA insurance fund. Tenant and community participation is built into the restructuring process.
Restructured properties must include project-based rather than tenant-based assistance for the elderly and handicapped and for projects in tight markets with vacancy levels below 6%. In other situations, however, the use of project-based assistance is discretionary, and HUD may approve "vouchering out" the development, i.e., issuing sticky vouchers to the residents. When project-based assistance is used, owners must agree to renew their Section 8 contracts (presumably annually) for at least 30 years.
Participating Administrative Entities (PAEs), selected and monitored by HUD, will review and underwrite these properties, determining the amount of first trust supportable with reduced rents, evaluating the need for project-based assistance in discretionary instances and recommending an overall restructuring plan to HUD. A new Office of Multifamily Housing Assistance Restructuring (OMHAR) in HUD administers the overall program.
The program is also designed to weed out bad owners, those who have materially violated laws or regulations or fail to meet housing quality standards based on inspections by HUD’s Real Estate Assessment Center (REAC). These owners are not eligible for restructuring unless they agree to sell the property as part of the restructuring plan.
Instead of restructuring, owners with above-market rents are also allowed to reduce their rents to comparable market levels, known in the trade as OMHAR-Lite or taking a "haircut." The program also provides guidelines for those owners with rents at or below market comparables who wish to renew their Section 8 contracts once the initial contract term expires, as well as those who want to opt out of the program. The terminology originally developed for these properties reflects the emphasis on rent reduction. For example, projects are "eligible" to renew without restructuring if their rents are at or below market; properties are known as "exception" or "exempt" if they are not required to be restructured even when their rents are above market.
In all cases, contract renewals now rely on budget-based rents or the use of an Operating Cost Adjustment Factor (OCAF) rather than the former Annual Adjustment Factor which automatically increased the gross rent.
Meanwhile, owners have been very wary of participating in the restructuring program. Given the small size of HUD’s staff these days, they are skeptical of its ability to administer the program effectively. HUD’s failure to issue final regulations after issuing interim regulations in 1998 confirms their concerns.
Mark Up to Market
MAHRA also gave HUD room to address properties with Section 8 rents below comparable market rents, the situation most common in high cost markets. These properties are the most likely to opt-out when their initial subsidy contracts expire. With no HUD action on this aspect of the program by the end of 1998, members of both the House and Senate began working on legislation in 1999, specifically mandating what has come to be known as the "Mark up to Market" program. In June of 1999, HUD issued a notice establishing an emergency initiative to preserve below-market Section 8 developments. Under these guidelines, owners of eligible projects wishing to renew at higher Section 8 rents must submit a comparability study (as do owners of projects with above-market rents); HUD then conducts its own market study, and decides where the rents should be pegged. Participating owners must agree to execute a new 5-year Section 8 contract, subject to annual appropriations.
Legislative Initiatives and HUD Implementation
The FY 2000 VA/HUD Appropriations Act signed by the President on October 20, 1999, includes three preservation initiatives: the Mark Up to Market program; changes in key provisions of the enhanced vouchers available only to residents in preservation-eligible properties that prepay their mortgages or opt-out of Section 8; and increased flexibility in the Section 236 program.
Mark Up to Market
The law requires that HUD implement the Mark Up to Market program, rather than making this initiative discretionary. In this legislation, Congress essentially enacted HUD’s emergency initiative into law. One key difference is the authorization for a waiver of the 150% of FMR ceiling now in effect under HUD guidelines. The new Act allows rents in excess of 150% when: particularly vulnerable populations, such as the elderly or handicapped, are involved; it is unlikely low-income households otherwise displaced could find affordable housing in their community; or the project is a high priority locally, demonstrated by support provided with state or local funds. The more of these conditions met by a property, the more HUD is encouraged to bring the allowable rent up to market comparables above 150% of FMRs.
Enhanced Vouchers
The new law expands the availability of enhanced or "sticky" vouchers to households living in units assisted under the Section 8 project-based program when owners opt out, as well as residents of Section 236 and Section 221(d)(3) properties where the owner prepays. Further, Congress specifically authorized an increase in the Section 8 assistance level annually as landlords raise rents, so that this difference does not come out of the family’s pocket. This flexibility is not available with regular vouchers. Another key change is the ability to reduce a family’s share of the rent if its income declines significantly. HUD is expected to issue a separate notice providing more details on implementing the enhanced voucher program later in 2000.
Section 236 Program Changes
Congress made several changes in the Section 236 program to encourage existing and new owners to retain the housing in the affordable stock. First, they allowed owners to refinance the property, presumably taking out some money as a return on their original investment, and still retain the Interest Reduction Payments (IRP) for the life of the original mortgage, using these funds for any purpose. Since the IRP makes up the difference between a 1% interest rate on the mortgage and then-prevailing rates, this is a real benefit, albeit a diminishing one since the interest portion of a mortgage declines over time. To receive this benefit, owners must agree to continue to serve the property’s original low- and moderate-income population profile for 5 years beyond the original term of the mortgage.
Second, owners are now allowed to retain "excess income", rental income received in excess of the basic rents, so long as it is used for to benefit the property. Finally, the law was changed to allow IRP funds recaptured from prepayments to be provided by HUD in the form of loans as well as grants for owners to rehabilitate their properties at a low cost. Providing the IRP funds as a grant, as was previously authorized (but not yet implemented by HUD), created tax problems for profit-motivated owners.
Matching Grants to State and Local Entities for Preservation
Unfortunately, the legislation adopted in 1999 did not include the matching grant program proposed in both the House and Senate. The matching grant proposals were designed to encourage state and local entities, including housing finance agencies, to develop their own strategies and invest state and local money in the preservation of federally assisted affordable housing in return for matching federal funds. See Comparison of Proposed Matching Grant Legislation chart for a detailed comparison of these unsuccessful proposals. Housing advocates are continuing to push for passage of this legislation in 2000.
HUD Procedures for Section 8 Contracts Expiring in FY 2000
HUD Notice 99-36, implementing the legislative changes in the Section 8 program, was issued at lightning speed in January of 2000. Under the new procedures, HUD has simplified the description of options for renewing Section 8 contracts expiring during FY 2000, and expanded it to include all the various renewal scenarios:
- marking up to market rents
- renewing a contract where the rents are at or below market
- referring projects to OHMAR for Mark to Market or OMHAR-Lite (also known as taking a haircut)
- renewing a contract exempt from referral to OHHAR, even if its rents exceed market
- renewing a contract for either: a) a portfolio re-engineering demonstration project; or b) a preservation project, i.e., a LIHPRHA deal
- opting out of the Section 8 program
The Mark Up to Market program, now mandated by law, is much the same as it was in the 1999 demonstration program, with one key change. Nonprofits, previously ineligible, may now participate as a means of facilitating the transfer of property from either a profit-motivated or nonprofit owner. Equally important, HUD will now allow nonprofit owners to apply at any time for a budget-based rent increase designed to help recapitalize their property, making needed physical improvements, so long as the resulting rents do not exceed market comparables.
Owners will generally have the option to renew their contracts for either one- or five-year terms, with the exception of preservation projects, which are limited to one year. HUD is encouraging owners to go the five-year route. These contracts are, of course, subject to annual appropriations.
HUD has also clarified that owners need not submit a Rent Comparability Study (RCS) every year to confirm that their rents are reasonable. Rather, an RCS will generally be good for a five-year term, although HUD can require one to be performed once within the five-year cycle and adjust rents up or down accordingly.
See FY 2000 renewal options chart for highlights of key HUD requirements and provisions under 99-36. It is discouraging to note that by specifying the timeframe that these provisions will apply, HUD makes clear that they may change for contracts expiring in later years.
Status of Section 202 and 811 Projects
Given the experience with other federally assisted affordable housing programs, it makes sense to question whether projects developed under the Section 202 and 811 programs might also convert to market rate housing. The Section 202 program provides affordable housing for senior citizens in developments owned solely by nonprofit organizations. Initiated in 1957, Section 202 has undergone several changes over time. It was originally structured with a 40-year loan program; Section 8 subsidies were added to the program in the 1970s. Currently, HUD’s financial assistance is provided through: (1) a capital advance that is non-repayable and interest-free so long as the project is available for very low-income elderly persons for 40 years; and (2) a 20-year renewable project rental assistance contract to subsidize shortfalls in project income from dwelling unit rents and other sources. The Section 811 program provides affordable housing to persons with disabilities, with the same nonprofit ownership requirements and financing assistance structure as the Section 202 program. The financing approach for this program, too, evolved over time. Both programs generally require HUD approval prior to a sale.
HUD Notice 99-6, issued in April of 1999, specified for the first time the circumstances under which HUD will approve prepayment of Section 202 projects. Except for 202s approved during a timeframe from 1977 to 1981, these properties may prepay their mortgages only with the approval of the Assistant Secretary for Housing. To qualify, a restrictive covenant must be recorded to keep the development in nonprofit ownership and continue its operations for the term of the original mortgage loan in a manner as least as advantageous to current and future residents as under the original loan. In a 202 development which recently prepaid its original loan by refinancing with tax exempt bonds, the majority of the capital released will be deposited into an endowment fund to provide services to residents of the project, or to subsidize their payment to move to an assisted living facility on the same campus.
It is also conceivable that a nonprofit owner might decide to sell a Section 202 property once the mortgage is paid in full. The 811 program is newer, and will not reach the 40-year mark soon. An example of a 202 sale has already occurred, where a teacher’s association decided to sell the property at the end of the mortgage term, using the profits to help finance a life care community. This is probably the exception, however, rather than the rule.
The key question in assessing the possibility of a prepayment or sale and its impact on the affordable housing stock is the nature of the nonprofit sponsor, including both its fundamental mission, and whether it has local roots. Most often, Section 202 developments are sponsored either by entities affiliated with religious groups or by local groups providing services to special needs populations. These properties help fulfill their sponsoring organization’s goals, and thus it is highly unlikely they would want to sell them, although the time may come where it makes sense to refinance them.
A more pressing problem is the need to recapitalize some of the older 202s, providing funds to update and modernize these facilities and provide funding for new services. Congress addressed this in the HUD/VA FY 2000 Appropriations Act by authorizing a study of debt forgiveness for these properties, and by authorizing grants for both substantial capital repairs and conversion of dwelling units to assisted living facilities. The Act also authorizes the use of Section 8 vouchers in assisted living facilities, limiting the voucher payment to the cost attributable solely to housing, not social services. The new emphasis on assisted living facilities reflects the aging population of senior citizen housing, and the growing need for additional services by this population.
Conclusion
We created federal housing programs and invited the private sector to participate, offering a reasonable profit and the ability to exit the program at the end of the contract term. Now we realize we need to retain this essential stock of affordable housing in which we have invested so much, but political support at the federal level for the cost of doing so in any large-scale way is almost nonexistent. The incentives to existing owners are slim to none unless their properties are over-priced in the current marketplace, and therefore eligible to restructure their financing to reflect market realities. This restructuring, of course, is primarily designed to reduce Section 8 subsidy costs and protect HUD’s FHA insurance fund. The owner retains the property, though now at a lower value, and is required to commit to an additional 30-year affordability term.
Owners of properties with below-market Section 8 rents have virtually no financial incentives to maintain Section 8. The Mark Up to Market program requires owners to go through a fair amount of effort and commit to remaining in the Section 8 program for 5 years, all for the benefit of raising the level of Section 8 subsidy support. The question is why they would want to do this if they can obtain these higher market rents on their units without any federal rules, regulations and paperwork. This is particularly true when Congress is authorizing funding for the program on an annual basis, giving no financial assurance for the future.
A few federal tools remain, such as the Low Income Housing Tax Credit program and tax-exempt bond financing, both typically used to "make the numbers work" for a new purchaser. Meanwhile, the only housing assured to be retained in the long-term affordable stock is that owned by nonprofit organizations and public agencies. This is not an indictment of the private sector. The fact is our public policy leaders have yet to design a plan that successfully melds the profit-motivated nature of the private sector with the need to guarantee that our investment in federally assisted housing results in a permanently affordable housing stock. This calls for both creativity and compromise, with the best hope for solutions to be found in the efforts of progressive state and local governmental entities.
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