National Housing Law Project Housing Law Bulletin

This renewal and restructuring program alone will not produce immediate or far-reaching change in the overall Section 8-assisted housing stock. Expirations during FY 1998 will be governed by a slightly revised FY 1997 demonstration program, so that only contracts in excess of 120 percent of Fair Market Rent (FMR) will likely face restructuring. Owners of other properties will renew at current rents or let the Section 8 contract expire ("opt out"). While the overall size of the assisted stock may shrink slightly, most buildings should get renewed.

Eventually, however, under this new program commencing in FY 1999, the structure and operation of portions of the inventory could change significantly. Some buildings may exit the system because the federal government refuses to pay true market-level returns or owners decline to renew where true market rents exceed current levels or what HUD will offer. Other properties or owners may fail the standards for renewal, and the properties may be transferred to new ownership or face conversion to tenant-based assistance. Some project-based contracts may also be replaced with tenant-based assistance after restructuring. Finally, operations may change as administration of the restructured and renewed stock is transferred to other agencies that may make different decisions about the physical and financial aspects of restructuring or other regulatory policies and operational matters where they have latitude to do so.

The new program generally intends to use restructuring to preserve the current project-based program, and it may make some modest improvements by getting rid of some bad owners, fostering tenant participation, transferring oversight and providing some new regulatory enforcement tools to HUD and the new regulators ("Participating Administrative Entities" (PAEs), often state housing finance agencies) that will assume restructuring and future regulatory functions. The possibilities for positive change are there, but the actual implementation via HUD and PAE rulemaking, policies and project-by-project decisions over the next few years will tell the real story.

Most at risk of loss under this renewal and restructuring program will be tenants of units in multifamily properties which are:

Findings and Purposes

The program’s findings⁶ include a need for decent and affordable housing, 10,000 HUD-insured properties with expiring project-based Section 8 serving about 1.6 million families, many with rents above market and expiring within a few years, growing needs for budget authority for renewals, and defaults requiring insurance claims if Section 8 authority runs short. The findings also include assertions that about 15 percent of the inventory is physically or financially distressed, with some mismanagement, and that HUD is unable to oversee the health of the stock due to its diminishing administrative capacity and budget constraints. Congress thus finds that the stock is best served by reforms that reduce federal assistance costs, address physical, financial and management problems, and transfer administrative responsibilities to other capable public and private entities.

The program’s purposes⁷ include:

When a Section 8 contract expires, if the property or the owner is not disqualified for prior program violations, the owner may renew or restructure and renew (depending on the rent level), or may decline a renewal and opt out.

Affected Properties

While the law addresses the renewal of all properties with expiring project-based Section 8 contracts, not all of these properties are eligible for the restructuring program. The restructuring portfolio includes only those multifamily developments (more than four units) with: (1) project-based Section 8 for some or all of the units, (2) a mortgage insured or held by HUD, and (3) current rents (on an average per unit or per room basis) currently higher than true market value.⁸ The final version deleted the Senate’s earlier proposal to use the HUD-published area FMR for the applicable size units as an alternative eligibility benchmark where comparables were unavailable. Virtually all types of project-based assisted housing meeting the HUD-insured or HUD-held and above-market criteria are eligible, including Section 8 New Construction, Substantial Rehabilitation, Moderate Rehabilitation,⁹ Loan Management (LMSA, including conversions), and Property Disposition, as well as the few Rent Supplement and Section 23 properties still remaining.

While other Section 8 properties are exempt from or ineligible for restructuring, they may execute renewal contracts or they may opt out. Generally they should receive a renewal offer at the lesser of current rents (as adjusted by a HUD-established operating cost factor) or budget-based rents, or possibly comparable market rents where higher.¹⁰ These properties include:

Substitution of Tenant-Based Assistance

If contracts are not renewed for any reason, HUD must provide tenant-based assistance to tenants in residence at expiration, if Congress has provided sufficient funding.¹² These reasons could include disqualification, owner opt-outs or PAE-approved conversions. In another last-minute change, the final law authorizes so-called "enhanced" or "sticky" vouchers with assistance levels set above normal FMRs or payment standards for at least some higher value properties that are not renewed.¹³ It is unclear whether these special vouchers are available for any situations where project-based assistance is not renewed (i.e., where owners opt out, for restructured properties that are converted, or for properties that are disqualified from restructuring or renewal), or just for the restructured properties that are converted.¹⁴ Despite this higher assistance level, this provision may not explicitly prevent displacement, in that it fails to require owners to accept these subsidies for all current tenants.¹⁵ However, for any restructured property that the PAE converts to tenant-based assistance, the owner is prohibited from refusing to lease a "reasonable" number of units to tenant-based subsidy holders because of their status as such.¹⁶ There is no similar protection for any voucher holders’ access to other properties.

Disqualified Properties

HUD or the PAE may refuse to consider a restructuring plan or a renewal for any disqualified properties. These are properties that are technically eligible for restructuring or renewal but "prohibited" either because of prior actions by the owner or seriously deteriorated conditions requiring costly rehabilitation.¹⁷

The final version of the law makes disqualification discretionary with HUD, rather than mandatory, once HUD or the PAE makes the disqualification finding, which may avoid some of the confusion surrounding HUD’s alleged authority to renew for borderline cases that arose under prior law. Once disqualified, these properties may be renewed only as part of a restructuring and transfer plan to new ownership.¹⁸

Disqualification standard. The statutory disqualification standard centers on the new administrator’s determination that the owner (or purchaser)¹⁹ has engaged in "material adverse financial or managerial actions or omissions" with regard to the property, or with respect to other federally insured or assisted properties.²⁰ The final version modified this language to remove the need to show, with respect to other properties, a pattern of mismanagement that would have provided grounds for HUD suspension or debarment. The required showing includes:

HUD may also refuse to consider a restructuring plan or request for renewal if HUD or the PAE finds that "the poor condition of the property cannot be remedied in a cost-effective manner," as determined by the PAE.²² The law specifies no standards for the PAE to make such a finding. Presumably, properties that cannot carry any necessary rehabilitation debt service and operating costs with all of their underlying first mortgage written off, with Section 8 exception rents generally capped at 120 percent of FMR — all of which would be possible under a restructuring plan — would fit within this category. However, PAEs could use their discretion here to push other, less costly properties over the cliff.

Process for disqualification. The statute provides a specific process for making "rejection" decisions.²³ The process includes a (presumably) written notice to the owner from HUD or the PAE following a renewal request or submission of a restructuring plan, which in turn commences a 30-day period for the owner to dispute the basis for the rejection or to cure the deficiency. HUD or the PAE may then make a final decision to affirm, modify or reverse the rejection, specifying the reasons. HUD must also establish an administrative review process for owners to appeal the final decision, and final decisions are expressly exempt from judicial review.²⁴ Because the final version of the statute omits disqualification as a specified event requiring tenant and community participation, it remains unclear whether HUD and PAEs must solicit and permit such involvement.²⁵ Where contracts are not renewed on disqualified properties, tenants must receive tenant-based assistance and HUD-determined reasonable moving expenses.

Transfers of disqualified properties. For properties disqualified from restructuring or renewal,²⁶ HUD must develop procedures to facilitate the "voluntary sale or transfer" of the property as part of a project restructuring plan, with preference for purchase by tenant organizations and tenant-endorsed community-based nonprofit and public agency purchasers. Unfortunately, HUD has shown little initiative to implement a similar duty under the FY 1997 demonstration program. Moreover, without some kind of tax relief, owners have little incentive to relinquish control of properties at a time that would permit workable transfers soon after contract termination, prior to foreclosure, absent an opportunity to gain some kind of economic advantage over sitting tight and stalling foreclosure. Aggressive abatement, mortgagee-in-possession and foreclosure strategies by HUD and PAEs will be essential to provide real solutions, rather than myopic conversions and displacement.

For properties that are transferred, purchasers would then negotiate a restructuring plan with the administrator, which could include renewal of the Section 8 assistance contract.²⁷

Implementation Delegated to
"Participating Administrative Entities"

Implementation of the restructuring program will generally be delegated to qualified administrators, "Participating Administrative Entities."²⁸ Generally, PAEs should be qualified state or local public agencies. PAEs are defined to include public agencies (including state and local housing finance agencies (HFAs), nonprofits, or any other entities (including for-profit law and accounting firms) that meet the selection criteria.²⁹

Selection criteria. The PAE selection criteria include:

HUD role if no qualified applicant; private entity participation. Where no PAEs seek designation or are qualified for the role for particular eligible properties, HUD may assume the role or contract with other qualified entities (public, nonprofit or for-profit) to perform some or all of the functions.³⁴

Permitting for-profit organizations to participate in the administrative, financial, and policy functions required by the restructuring and renewal program was a key compromise between the Senate proponents, which wanted these functions to be exclusively public, and the Administration, which has long sought a role for the private sector. Where a for-profit entity is selected as the PAE, it must enter into a partnership with a public entity or with HUD.³⁵ Neither PAEs nor HUD may benefit from equity created or received as a result of the restructuring agreement.³⁶ HUD is also supposed to develop conflict-of-interest guidelines to prevent abuse or manipulation of the PAE role or other roles for private benefit, rather than public purposes.³⁷

Preferential application period for public agencies. Both state and local public agencies seeking PAE status have an exclusive unspecified preference period for applying to HUD.³⁸ Before that exclusive period expires, HUD must select them, if HUD determines they are qualified, or notify them of the reasons for their rejection and provide them an opportunity to respond. Congress intends that PAEs usually be public agencies because of their public accountability and experience with multifamily housing.³⁹ Where the PAE is a state HFA, it may negotiate a particular portfolio of properties within the state as its responsibility with HUD, and the same is true with local HFAs (with the local jurisdiction providing geographic limitation of the portfolio).⁴⁰

PAEs would presumably perform both restructuring and ongoing regulatory oversight functions, although the restructuring agreement could treat these duties separately. PAEs that are qualified Section 8 contract administrators may assume this role on request for any contracts executed through the restructuring process.⁴¹ Thus, apparently any private/public partnerships that get approved as PAEs could assume the contract administrator role only if one party had obtained or could obtain approved administrator status. It is unclear how other regulatory oversight functions could be allocated. PAEs must also establish standards governing project management and conflicts of interest, pursuant to HUD guidelines.⁴²

HUD/PAE relationship: "portfolio restructuring agreements." The relationship between HUD and PAEs will be governed by a "portfolio restructuring agreement" establishing the parties’ respective rights and duties.⁴³ This
agreement must identify the eligible properties or groups of properties for which the PAE will be responsible for developing and implementing individual project restructuring plans, and requires the PAE to review and certify project rehabilitation needs assessments, allocates the respective duties of HUD and the PAE for implementing individual restructuring plans (including proposed actions to disqualify properties and proposed restructuring tools), and contains other HUD requirements. The agreement must also cover compensation for all reasonable expenses of the PAE, including appropriate incentives for superior performance in meeting program objectives. Where the PAE is a public agency, the agreement must indemnify the PAE for its activities, excepting willful misconduct or negligence.

New HUD office and oversight. The final version of the statute includes the establishment of yet another entity for operating the restructuring program, a new Office of Multifamily Housing Assistance Restructuring (OMHAR) within HUD to set up and oversee the program.⁴⁴ Establishing this office was a key compromise with the House authorizers. OMHAR will be run by a Director appointed by the President, with the nomination to be submitted to the Senate within 60 days following enactment. The HUD Secretary acts through the Director in administering both the restructuring and renewal aspects of the program. The Director’s actions (including rulemaking) will be subject to the review and approval of the Secretary, with a semiannual OMHAR reporting requirement to the Secretary.

In addition, the Secretary must review the program and file various semiannual and annual reports with Congress.⁴⁵ The GAO must perform a program audit and evaluation within 18 months after issuance of final regulations, with a report to Congress and legislative recommendations due another 18 months later.⁴⁶

The Director may delegate functions, powers and duties only to officers and employees of the Office, not to contractors or consultants. However, the Director need not secure any approvals, even those of the Secretary, before making any comments or submissions to Congress if accompanied by appropriate disclaimers, and the Director may blow the whistle to Congress about alleged Secretary interference at any time. The statute also addresses personnel, budgeting and reporting requirements, as well as annual GAO auditing.⁴⁷

The entire program sunsets if a Director is not appointed within 12 months.

Restructuring Tools

Restructuring debt and subsidies on eligible properties. The primary method for reducing spending while preserving assisted housing will be through the technique of reducing the serviceable debt and the subsidy levels on eligible properties, all of which have above-market rents (primarily the "newer assisted" stock). This is made possible by the other criterion for eligibility, namely the presence of a loan and mortgage insured or held by HUD.

Screening by the PAE or HUD, based on criteria such as physical inspection reports, capital needs assessments and audits, would first cull eligible projects with "good" owners from those that are disqualified. Then, restructuring would generally occur through a negotiated process of setting new market rents and corresponding debt and subsidy levels with the PAE⁴⁸ before or at contract expiration. This process takes place for almost every eligible property through a vehicle called the "Mortgage Restructuring and Rental Assistance Sufficiency Plan."⁴⁹ Because completion of the plan may not coincide with the scheduled expiration date of the Section 8 contract, expiring contracts could be renewed on a short-term basis at current rents until the restructuring plan has been executed and the transaction has closed.⁵⁰ Exempt from the restructuring plan requirement, and thus entitled to renewal at current rents or similar levels, are state or locally financed or insured properties, Section 202 or 515 properties, or McKinney Act Section 441/Section 8 Single Room Occupancy properties.⁵¹

New underwriting via project restructuring plan. The foundation for each property’s restructuring plan will be the new underwriting performed by the PAE based on market rents and capital and operating needs. While the statute requires these plans to contain a few specified components, HUD and PAEs will undoubtedly have to establish clearer guidelines and procedures for developing the plan to reduce the degree of negotiation required with affected stakeholders for each property in its inventory. The statutorily required provisions⁵² include:

Market rents. The basic assumption is that the new underwriting will usually be based first upon identification of comparable true market rents.⁵⁵ From that level, PAEs will have to determine the supportable debt based upon the establishment of new operating budgets for the property and other applicable underwriting criteria. Formula rents set at 90 percent of the published area FMR could be used if two market comparables do not exist.⁵⁶

HUD will have to establish effective safeguards or incentives to ensure that these new rent levels are not "low-balled" at the expense of the mortgage insurance fund, especially if owners and managers can financially benefit from a share of more cash flow from setting rents slightly below true market. It will also be necessary for PAEs to ensure that all of the components of the operating budget covered by the new rent levels are reasonable in light of the project’s particular needs. Vacancy and bad debt allowances, debt service coverage and loan-to-value ratios used in the new underwriting will also prove especially important. If the operating budget or underwriting criteria are too generous, then debt burdens will be reduced excessively to fund waste or cash flow. Conversely, if they are insufficient, operating problems could result in eventual deterioration of conditions or services. Establishing appropriate incentives or controls over the size of the debt reductions and insurance claims will be especially important.

Flexibility for exception rents. The program permits several exceptions to the market rent or the 90-percent-of-FMR standard. Higher rents are permissible if the PAE determines that the ordinary rent standards do not meet the community’s housing needs.⁵⁷ For some units where operating costs alone exceed market rents, and full debt write-down would not be sufficient to provide for operations, the PAE may set rents pursuant to a budget-based method to support:

Restructured mortgages. The final version of the law requires each non-exempt project’s plan to include the primary tool — a restructured or new first mortgage sustainable at the new market or formula rent levels, and a second mortgage generally reflecting the "bad" debt.⁶¹ While usually the principal amount of this second mortgage will equal the difference between the prior indebtedness and the new lower first mortgage, for tax purposes the statute adds that it should reflect the amount that HUD or the PAE reasonably expects to be repaid. This technique of mortgage bifurcation is intended to permit the owner to avoid adverse tax consequences from cancellation of indebtedness. However, until the IRS issues rulings in specific cases, the success of this technique — and hence the owners’ willingness to restructure rather than face market rents without debt relief (and possible default and foreclosure) — will remain a central question.

The interest rate on the second mortgage will be set by the PAE somewhere between zero and the prevailing Applicable Federal Rate.⁶² The second’s term must equal the term of the restructured or new first mortgage,⁶³ which could be as short as the remaining term of the original first mortgage. Both the interest rate and term provisions were changed in the final version of the statute, presumably to improve the chances that the secondary indebtedness would be viewed by the IRS as valid, so that more properties would be able to avoid tax problems while using restructuring.⁶⁴ The second mortgage is accelerated at the option of the holder if the first is terminated or satisfied, the property is transferred and the second is purportedly assumed in violation of HUD guidelines, or the owner has failed to cure material violations of the applicable program(s).⁶⁵

The statute does not clearly state who will hold these second notes — HUD, the PAEs or other third parties. To facilitate transfers to tenant organizations or tenant-endorsed nonprofits or public agencies, HUD has discretion to modify or forgive the second if it holds the note.⁶⁶ Although earlier versions permitted debt forgiveness as a more generally available tool, the final version does not explicitly authorize this. However, "bad" debt could be forgiven by the PAE in reducing the face amount of the second mortgage to "repayable" levels.

Payments on the second mortgage are still deferred as long as the first mortgage remains outstanding, unless excess project income materializes.⁶⁷ If excess income is available, at least 75 percent must go toward payments on the second. The PAE or HUD may allow up to all of the remaining 25 percent to be paid to the owner as an incentive for meeting benchmarks of good management and housing quality.

The program also establishes other tools PAEs may choose from in conjunction with mortgage restructuring, as follows.

Claim payments. Restructuring at lower market or formula rents would require full or partial insurance claims to cover some or all of the debt principal.⁶⁸ The law expressly authorizes HUD to make one-time, non-default partial claim payments without mortgagee approval in connection with restructuring.⁶⁹

FHA insurance and credit enhancement. Remaining debt could carry FHA insurance or other available credit enhancement, including risk-sharing arrangements, irrespective of ordinarily applicable unit limitations.⁷⁰ Similarly, any credit subsidy costs for this insurance are paid from the insurance funds, without any limitation on appropriations. New credit enhancements may be developed with federal, state and local housing finance agencies.

Third-party compensation. HUD may incur costs or make payments, including special incentive arrangements for furthering the program’s purposes, to compensate PAEs and other parties for undertaking activities authorized under the program.⁷¹ Appropriated Section 8 administrative fees may compensate PAEs for compliance monitoring.

Using project accounts. Some properties have substantial restricted accounts that can provide resources for implementing plans. PAEs are authorized to use any residual receipts, replacement reserves and other project accounts not required for operations, to maintain the long-term affordability and physical condition of the restructured property or of other eligible properties. To gain control over these accounts more quickly, a PAE may permit owners a share of the accounts’ receipts, limited to 10 percent.

Rehabilitation. Many eligible properties suffer from deferred maintenance. Rehabilitation is limited to a "non-luxury standard adequate for the rental market [originally intended]."⁷² To address these capital rehabilitation needs, the program provides several possible resources, including the project accounts just mentioned, future Section 8 appropriations, a new rehabilitation grant program for certain Section 236 properties,⁷³ or through further debt concessions or other underwriting techniques in the restructuring transaction.⁷⁴ Deleted in the final version is any arbitrary cap on the federal contribution to rehabilitation.⁷⁵ Owners must contribute at least 25 percent of the rehabilitation assistance received from sources other than project accounts.⁷⁶ However, because the owner also performs the capital needs assessment,⁷⁷ albeit subject to HUD guidelines and PAE review, an obvious incentive will be to understate the true repair needs and load as much as possible onto the maintenance and reserve lines of the operating budget.

Participation by government-sponsored enterprises. The law adds a duty for both FNMA and FHLMC to assist in maintaining the affordability of properties with expiring contracts, and HUD may count such activities toward satisfaction of these agencies’ affordable housing goals.⁷⁸

Compliance Monitoring

PAEs must ensure long-term owner compliance with program requirements through binding contractual agreements and other means.⁷⁹ Compliance agreements between PAEs and owners must provide for PAE enforcement and remedies for owner breach. If a PAE fails to qualify as a Section 8 contract administrator or fails to perform its duties under its agreement with HUD, then HUD has enforcement rights.

At least annually, each PAE qualified as a Section 8 contract administrator must perform a status review of all properties with an implemented restructuring plan, including an on-site inspection to determine compliance with applicable housing codes and other program and contract requirements. Where the PAE is not a qualified contract administrator, then HUD or a qualified state or local housing agency performs the review. Audits of restructured projects by the GAO, HUD or its Inspector General may be conducted at any time.

Affordability and Use Restrictions

Owners of properties that are restructured and receive a project-based Section 8 contract as part of the restructuring plan must renew those Section 8 contracts (presumably annually) during a period of no less than 30 years.⁸⁰ This duty is subject to future appropriations by Congress, and HUD and PAEs must make renewal offers, and owners must accept them. Where Congress fails to provide Section 8 funds for renewals, presumably the owner must operate the property consistently with the rents (market, formula, or budget-based) and occupancy restrictions established under the restructuring plan, if that is required by HUD or PAE regulations or agreements.⁸¹ Currently assisted tenants would thus continue to get Section 8, subject to its availability under future appropriations.

For restructured properties where the PAE approves a conversion of the Section 8 contract to tenant-based assistance, HUD must enter into contracts with PAEs providing for the renewal of the tenant-based assistance, again subject to appropriations.⁸² Apparently the required affordability and use restrictions for these properties would also run for at least 30 years. Whether rents would be set at the restructured rent level (as adjusted by the operating cost factor), or at some other level, and who could reside in the property, appear to depend upon the regulations adopted by HUD and the PAEs and the specifics of the plans. Owners of these restructured but vouchered properties would also be prohibited by their plans from "refusing to lease a reasonable number of units" to tenant-based subsidy recipients because of their status as such.⁸³

Resident and Community Input

HUD must establish procedures to provide opportunities for "timely" and "effective" participation in the restructuring to tenants and other affected parties, including neighborhood residents and the local government.⁸⁴ HUD’s procedures must account for timely notice and appropriate access to relevant information concerning restructuring activities. Generally, HUD’s procedures must also include an opportunity to provide written comments to the PAE or at meetings (which the PAE must consider). In addition, HUD’s procedures must permit participation in at least the following events: the project’s restructuring plan, any proposed transfer of the property, and the rental assistance assessment plan.⁸⁵ Also authorized by the program is up to $10 million annually from appropriations for contract renewals or unspent prior technical assistance appropriations to tenant groups and nonprofit and public agencies for capacity-building of tenant organizations, for technical assistance in furthering any of the purposes of the subtitle (including transfers),⁸⁶ and for tenant services.

Notice to Tenants and HUD of Expiration or Nonrenewal

The law requires HUD to develop notice procedures⁸⁷ for tenants and owners concerning expiration dates for any projects eligible for restructuring. An owner of any property with an expiring contract who does not agree to extend the contract is also specifically required to give HUD and the tenants at least 12 months’ written notice of the intended nonrenewal.⁸⁸ Presumably, owners who want to extend must continue to provide HUD and tenants with at least six months’ notice prior to expiration, pursuant to recent law,⁸⁹ unless HUD acts to modify that requirement pursuant to the new authority provided in Section 514.

PAE-Approved Conversions to Tenant-Based Assistance

HUD got most of what it sought on this issue. As part of the restructuring process, PAEs must perform a "rental assistance assessment" for every property that is not guaranteed a project-based renewal.⁹⁰ This process and its resulting plan will determine whether the rental assistance after restructuring will be project-based or tenant-based. Assessment plans must address certain criteria, including market adequacy for using tenant-based subsidies and a variety of other factors, and the plans must be made pursuant to a consultative process involving all the stakeholders.

Some projects are guaranteed a project-based renewal. These are properties located in so-called "tight markets," those with a predominant number of units occupied by families who are elderly or have disabilities, or units owned by nonprofit cooperatives.⁹¹ The legislative history indicates that "a six percent rental market vacancy rate is reasonable" for defining a "tight market," and that regulatory flexibility should account for local market variations.⁹² On which properties are "predominantly" occupied by elderly and disabled, the challenge will be to budge HUD from the 90-percent threshold used in its earlier legislative proposal, since properties with significant elderly and disabled populations could still face conversion under such a standard.

Since average rental vacancy rates in most markets currently exceed 7 percent, most localities cannot breathe easily. A particular shortcoming of this standard is that it is not tied to voucher success, in that it includes vacancies in higher rent or luxury rentals as well as substandard units, neither of which are options for recipients of tenant-based assistance. Another defect is that it may be hard to determine the confines of the relevant "local markets," as they are not specifically tied, for example, to Census-defined Metropolitan Statistical Areas.

Other properties are subject to the PAE’s assessment plan. HUD does not have the authority to make or influence these decisions in favor of conversions. While this section of the law requires consultation only with the owner, other provisions and the legislative history require additional consultation with the residents and the local government.⁹³ This assessment process must evaluate each form of assistance under eight factors, including:

The PAE may convert assistance to tenant-based for some or all units over a period of up to five years for the financial viability of the property.⁹⁶ PAEs must periodically report to the Director of OMHAR concerning conversions and situations where tenants supported conversion, but the PAE decided instead in favor of project-based assistance.⁹⁷

Where the PAE approves a conversion, tenants in residence when the project-based contract is terminated receive tenant-based assistance, at enhanced levels if necessary, to avoid displacement.⁹⁸

Rulemaking

The OMHAR Director issues rules for the program, and must develop interim regulations for projects with contracts expiring in FY 1999, presumably at least by the end of FY 1998 (September 30, 1998).⁹⁹ Since final rules for these properties are required before the later of 12 months from the enactment date of October 27, 1997, or three months following the Director’s appointment, the interim rules should probably be issued sooner than September of 1998.

The interim rules must invite public comment. The final rules must consider those comments and use a modified negotiated rulemaking process on two specified issues. In developing the final rules, HUD must seek recommendations from a variety of constituencies concerning (1) implementation of the PAE selection provisions (§ 513(b)) and (2) the criteria for mandatory renewal of project-based assistance (tight market, properties predominantly occupied by elderly and disabled tenants, and co-ops) (§ 515(c)(1)).¹⁰⁰ The identified constituencies include state and local housing agencies, other potential PAEs, tenants, owners and managers, state and local governments, and qualified mortgagees. The process must include at least three public forums concerning HUD’s proposed disposition of these parties’ recommendations.

Transition Provisions

The new program extends the FY 1997 Multifamily Demonstration program to deal with contracts and properties expiring during FY 1998 (October 1, 1997, through September 30, 1998), prior to the time when the new program is operational.¹⁰¹ This means that, if the owner so chooses, many properties expiring during this period may be renewed at the lesser of current rents or 120 percent of FMR. Owners of other properties will either opt out of the program or restructure the rents and debt to market levels, using tools similar to the restructuring process described above. Under the demonstration, some properties (e.g., state and locally financed, Section 202 and 811, Farmers Home Administration/Rural Housing Service Section 515) are exempt from the 120-percent cap and may be renewed at current rent levels.

The new law also makes minor changes to the extended demonstration for contracts expiring in FY 1998.¹⁰² The most important change is that properties with current Section 8 rents over 120 percent of FMR apparently must restructure their mortgages and operating budgets to be sustainable at market rent levels, and cannot simply accept renewals at the 120-percent cap without restructuring. This will likely increase substantially the number of restructured properties, so that HUD and PAE workloads will rise more than the simple growth in the proportion of total expiring properties with higher rents.

Rescission and Reuse of Recaptured Budget Authority

Where existing Section 8 contracts are terminated or amended by enforcement, disqualification or restructuring, HUD must recapture any unspent budget authority and use it to provide assistance for the same number of families for the remaining term of the contract, regardless of the type of assistance that will be used in the future.¹⁰³ Any savings from the shift to reduced assistance levels is rescinded.

Rehabilitation Grants for Certain Insured Projects

The law permits HUD to make capital grants from a central funding pool for rehabilitation of certain insured or formerly insured properties that had Section 8 assistance as of October 27, 1997.¹⁰⁴ The law requires that, in order for a property to be eligible, the mortgage not be held by a state agency, and that the owner agree to HUD-set housing quality standards and not be "disqualified" under the restructuring and renewal program standard. Finally, the owner must convince HUD that grant assistance is necessary for project rehab pursuant to a comprehensive needs assessment, and that project income cannot support the rehab needed. The grant funds may be used for reserve payments, debt service payments on non-federal rehab loans, or for payment of the capital repair costs.

HUD must require that grants be terminated¹⁰⁵ if the property falls into substandard condition, that the owner agree to HUD-set affordability and use restrictions, or any other HUD-set conditions. HUD may delegate administrative responsibilities to state or local governments.

Funding sources for the grants are primarily unobligated Interest Reduction Payments (IRPs from Section 236 projects) from properties whose mortgage insurance is extinguished or IRP funds that become available because of reductions of debt principal, "uncommitted balances" from an unknown source, or any other source.¹⁰⁶ However, for any recaptured IRP funds, HUD must ensure that the outlays do not exceed those which otherwise would have resulted absent extinguishment of the mortgage insurance or principal reduction.

This appears essentially to permit HUD to provide scarce IRP resources to buildings that have left the federal program, with looser restrictions than existed previously. In other words, HUD could use them for properties that agree to leave the federal system and mark up the rents to market levels, when owners might have trouble doing that on their own because the new market rents do not provide sufficient economic incentive to support refinancing that includes rehabilitation. Unless HUD’s rules shape this differently, this looks like bad policy.

Sunset Provisions

Most of the restructuring program sunsets on October 1, 2001, three years after it becomes operational, with the Secretary taking over any remaining responsibilities from the Director of OMHAR.¹⁰⁷ Binding commitments under the program remain applicable.

Enforcement Tools

The law also provides stronger enforcement tools to address troubled properties.¹⁰⁸ These include expanded civil money penalties against owners and agents for equity skimming or other program violations, such as failing to provide decent housing or knowingly submitting false claim vouchers. Whether these will have any real effect in improving program compliance remains to be seen, since the primary issue has always been HUD’s willingness and capacity to use the tools it already possessed, not reliance on some magic bullet.

1. Prior to review of the final statutory language, a very brief version of this article appeared in last month’s Bulletin, Section 8 Restructuring Program Finally Approved, 27 HOUS. L. BULL. 153 (Oct. 1997).
2. Conference Report on HUD-VA-IA Appropriations for Fiscal Year 1998, H.R. REP. NO. 297, H.R. 2158, 105th Cong. 1st Sess., Title V, Pub. L. No. 105-65, ___ Stat. ___ (Oct. 27, 1997). For recent background, see Section 8 Renewals Pose Extraordinary FY 1998 Budget Challenge, 26 HOUS. L. BULL. 167 (Dec. 1996); Not-So-New Proposals for Section 8 Program Restructuring, 27 HOUS. L. BULL. 71 (May 1997); HUD Introduces 1997 Version of Section 8 "Mark-to-Market" Legislation, 27 HOUS. L. BULL. 91 (June 1997); Section 8 Expirations: Housing Resource Up for Grabs, 27 HOUS. L. BULL. 97 (July 1997); and HUD Multifamily Inventory Awaits Decisions, 27 HOUS. L. BULL. 139 (Sept. 1997).
3. See Not-So-New Proposals for Section 8 Program Restructuring, 27 HOUS. L. BULL. 71 (May 1997).
4. As reviewed infra, the major changes concern the criteria and process for conversion of project-based assistance to tenant-based, and which entities will perform and oversee the restructurings.
5. Pub. L. No. 105-65, § 524(a)(1). This point was erroneously reported in last month’s article because the final statutory language was not available at press time. Presumably, HUD could authorize PAEs to do the same.
6. Id. § 511(a).
7. Id. § 511(b).
8. Id. § 512(2). A "comparable property" is elsewhere defined specifically to mean an unassisted property in the same market area that is similar to the subject eligible property based upon numerous factors, including neighborhood (and crime risk), location, access, street appeal, age, property size, apartment mix, physical configuration, property and unit amenities, utilities, etc. Id. § 512(1). The final version of the statute deleted the Senate’s earlier proposed prohibition on using rent-regulated units as "comparable." See the floor colloquy between Senator D’Amato and Senator Bond, 143 CONG. REC. S10737 (Oct. 9, 1997).
9. Coverage of Moderate Rehabilitation units by this law (and the FY 1997 demonstration that is extended through FY 1998) means that HUD’s recent Notice seeking to "voucher out" all properties with Section 8 Mod Rehab contracts expiring in FY 1998 will have to be immediately rescinded. See HUD Notice PIH 97-46 (Sept. 4, 1997).
10. Pub. L. No. 105-65, § 514(h) ("Exemptions from Restructuring"), § 524(a)(1) (HUD discretion to offer "rent levels that do not exceed comparable market rents for the market area"), and § 524(a)(2) (above-market existing or budget-based rent (as adjusted) levels available at owner request for "exception projects," namely those exempt from restructuring, rather than those ineligible). The final version removed from the formally "exempt" category those properties where restructuring would result in only insignificant savings to the federal government.
11. 42 U.S.C. § 11401.
12. This obligation is set forth at various places in the statute, sometimes qualified by the "subject to appropriations" language. See Pub. L. No. 105-65, § 514(d) (apparently any project where owner opts out), § 515(a)(2) (general authority for PAEs to renew tenant-based contracts where converting from project-based), § 515(c)(3) (obligation to provide tenant-based assistance to each assisted family where PAE approves conversion), § 516(d) (obligation to provide tenant-based assistance for tenants in disqualified properties), and § 523(c) (recapture and reuse of budget authority).
13. Pub. L. No. 105-65, § 515(c)(4). This is another important change from the information reported in last month’s summary article.
14. The statute (§ 515(c)(4)) establishes eligibility for this higher level of tenant-based assistance as those assisted families residing in properties covered by a project-based Section 8 contract under any subprogram (referencing § 512(2)(B)) at the time of termination of the project-based contract. Some confusion could be caused by Section 515(c)(4)’s reference to Section 515(c)(3) concerning eligible tenants, which in turn contains a limiting reference to properties where the PAE approves a conversion. Section 514(c)(4)’s reference to "any family described in paragraph (3)" probably means "any assisted family [other than those already receiving tenant-based subsidies] residing in the project [upon contract termination]," not such families who reside in properties approved for conversion. The more specific reference to a broader class of eligible properties in Section 515(c)(4) should govern.
15. State or local law, applicable contractual use agreements or other provisions of federal law may, however, impose limitations on an owner’s power to reject voucher holders who are existing tenants.
16. Pub. L. No. 105-65, § 514(e)(9).
17. Id. § 516(a).
18. Id. § 516(e).
19. The term "owner" or "purchaser" also includes affiliates that have interlocking control relationships with the owner (§ 516(a)), and this language will surely raise issues of coverage once implementation results in disqualification of owners for whom renewal means economic survival.
20. Id. § 516(a).
21. Id. § 516(a)(3).
22. Id. § 516(a)(4).
23. Id. §§ 516(b) and (c).
24. Id. § 516(c).
25. See id. § 514(f)(2).
26. The statute requires HUD to establish sale facilitation procedures for properties rejected from restructuring due to actions of the owner (§ 516(e)), and the legislative history adds that this duty also applies to properties rejected from renewal (i.e., below-market or non-HUD-insured properties that are ineligible for restructuring). See the floor colloquy between Senators Sarbanes, Mack and Bond which instructs HUD to use the same procedures for properties disqualified from renewal as those disqualified from restructuring, and permit these properties to retain project-based assistance if underlying problems are addressed through "creative" preservation approaches, rather than voucher conversions. 143 CONG. REC. S10738 (Oct. 9, 1997).
27. Id.
28. Pub. L. No. 105-65, § 513. Apparently, at least for the time being, HUD will still administer the renewal and oversight process for those properties and contracts that are ineligible for restructuring but eligible to renew if the owner so elects.
29. Id. § 512(9).
30. The legislative history indicates that PAEs must have a history of responsiveness to tenants, or partner with other organizations who have that experience. They should provide for meaningful resident and community participation, including timely and adequate notices, access to relevant information and a reasonable time to provide comments. See floor statement of Senator D’Amato, 143 CONG. REC. S10737 (Oct. 9, 1997). Since few PAEs may have this experience themselves, this will be a key issue for discussion with prospective PAE applicants.
31. This may include risk-sharing arrangements with FHA and administering restructurings under the FY 1997 demonstration program.
32. Pub. L. No. 105-65, § 513(b).
33. Id. § 513(c)(6)(B).
34. Id. § 513(b)(4).
35. Id. § 513(b)(7).
36. Id. (PAEs); § 517(d) (HUD).
37. See id. § 517(e) and floor colloquy between Senators Mack and Bond, 143 CONG. REC. S10738-39 (Oct. 9, 1997).
38. Pub. L. No. 105-65, § 513(c)(5).
39. See floor statement of Senator D’Amato, 143 CONG. REC. S10737, and floor colloquy between Senators Mack and Bond, 143 CONG. REC. S10738 (Oct. 9, 1997).
40. Pub. L. No. 105-65, § 513(b)(6).
41. Id. § 517(b)(5).
42. Id. § 518.
43. Id. § 513(a)(2).
44. Id. § 572.
45. Id. § 520.
46. Id. § 521.
47. Id. §§ 574-577.
48. This market approach differs from the Senate’s early 1996 plan to use a formula reducing rents to 90 percent of Section 8 Existing Housing FMRs.
49. Id. § 514(e).
50. Id. § 514(c). This could be accomplished through extension of the expiring contract or offer of a new contract with rent levels set pursuant to the standards governing new contracts in Section 514(g).
51. Id. § 514(h).
52. Id. § 514(e).
53. Presumably the nondiscrimination duty applies in those situations where the property is less than 100 percent project-based after restructuring, including PAE-approved conversion to tenant-based. Id. § 514(e)(9). The use restrictions must also be in a legally enforceable recorded document and be "consistent with the long-term physical and financial viability and character of the project as affordable housing." § 514(e)(6).
54. See the discussion re Section 519 under Compliance Monitoring, infra.
55. Id. § 514(g). The same definition of "comparables" applies in the underwriting process as in the process of determining eligibility (§ 512(1)), although underwriting will undoubtedly be more rigorous.
56. Id. § 514(g)(1).
57. Id. § 514(g)(3).
58. This is actually an asset management fee for ownership since true equity does not exist.
59. Id. § 514(g)(2)(A). It is unclear whether the 5-percent-waiver quota is based upon all units nationwide, or upon just the units within a PAE’s jurisdiction.
60. See also colloquy between Senators Harkin and Bond re conferees’ intent that exception rents be used for preservation of properties for the elderly. 143 CONG. REC. S10739 (Oct. 9, 1997).
61. Id. § 517.
62. Id. § 517(a)(2).
63. Id.
64. The version of the bill reported out earlier by the Senate Banking Committee as part of the budget reconciliation process set the interest rate at up to the federal funds rate, but did not require the term to be coterminous with the other financing, and in fact deferred payments on the second until retirement of the restructured first mortgage. Section 2107(a)(8) of S. 947 (passed Senate floor June 25, 1997). In addition, the length of the use restriction accompanying the restructuring process ran with the pendency of the second note. Id. § 2105(b). The final version revised this structure, and fixed the use restriction at a minimum of 30 years.
65. Pub. L. No. 105-65, § 517(a)(4).
66. Id. § 517(a)(5). The final version limits this authority to HUD for HUD-held notes, and is silent with regard to PAEs and PAE-held seconds.
67. Id. § 517(a)(3).
68. Id. § 517(b)(1).
69. Id. § 513(b), amending Section 541(b) of the National Housing Act.
70. Pub. L. No. 105-65, §§ 517(b)(3) and (4).
71. Id. § 517(b)(5).
72. Id. § 517(b)(7).
73. As established by Section 531 of the program, adding a Section 236(s) to the National Housing Act.
74. Pub. L. No. 105-65, § 517(b)(7).
75. The earlier cap in the Senate bill was $5,000 per unit.
76. This amounts to at least 20 percent of the rehabilitation cost. PAEs may exempt cooperatives from this requirement, but there is no exception for nonprofit owners or purchasers.
77. Id. § 514(e).
78. Id. § 517(c).
79. Id. § 519.
80. Id. §§ 515(a) and (b), referencing the 30-year minimum term in Section 514(e)(6). The renewal must be consistent with terms and conditions of both the project’s restructuring plan and the PAE’s rental assistance assessment plan.
81. The Reconciliation draft (S.947, as passed by the Senate on June 25, 1997) contained an explicit reference to the restructured rents (§ 2104(e)(6)) that was deleted in the final version.
82. Pub. L. No. 105-65, § 515(a)(2).
83. Id. § 514(e)(9). Whether this translates into a duty to accept a certain number of voucher holders remains unclear, and PAEs should clarify this in their guidelines and plans.
84. Id. § 514(f). Hopefully HUD will also choose to extend these participation opportunities to the full panoply of situations where expiring contracts raise important issues (e.g., opt-outs, renewals or disqualifications, rent levels for expiring contracts with below-market rents, voucher replacements). The final language permits far more discretion to HUD and PAEs to "streamline" the participation process and in cases where participation is required in the name of efficiency, but hopefully these agencies will heed the cautionary advice of the Senate floor statements and adopt rules permitting maximum participation. See the floor statement of Senator D’Amato, 143 CONG. REC. S10737 (Oct. 9, 1997), the floor colloquy between Senators Kerry, Mack and Bond at 143 CONG. REC. S10739, and the statements of Senator Kerry at 143 CONG. REC. S10744 and Senator Sarbanes at S10745.
85. Pub. L. No. 105-65, § 514(f)(2). The reconciliation version had specified additional events where tenant and community participation would be required, including the development of the HUD/PAE overall portfolio restructuring agreement, determination of a project’s eligibility for restructuring, and physical inspections, capital needs and management assessments. Tenants will have to convince HUD and PAEs that the streamlined language did not reduce their procedural rights, based upon the legislative history cited in the preceding note.
86. The subtitle includes both the renewal and restructuring components of the program.
87. It also mandates hearing requirements, whatever that means. Id. § 514(b).
88. Id. § 514(d).
89. Pub. L. No. 105-18, § 10002 (June 12, 1997).
90. Pub. L. No. 105-65, § 515(c).
91. Id. §§ 515(c)(1)(A) through (C).
92. Joint Explanatory Statement ("type of rental assistance"), 143 CONG. REC. H8360 (Oct. 6, 1997). It also notes that probably New York City, Boston, Salt Lake City and the San Francisco Bay Area will be considered "tight" markets.
93. Id. § 514(f)(2)(C). See also Jt. Expl. Stmt., supra note 92; floor statement of Senator D’Amato, 143 CONG. REC. at S10738 (Oct. 9, 1997).
94. Jt. Expl. Stmt., supra note 92.
95. See colloquy between Senators D’Amato and Bond at 143 CONG. REC. S10738 (Oct. 9, 1997); floor statement of Senator Kerry at 143 CONG. REC. S10744 (PAE should maintain project-based assistance except in "rare cases").
96. Jt. Expl. Stmt., supra note 92.
97. Pub. L. No. 105-65, § 515(c)(2)(C).
98. Id. §§ 515(c)(3) and (4).
99. Id. § 522(a)(1).
100. But not the rental assessment plan criteria and process pursuant to Section 515(c)(2).
101. Id. § 522(b). The FY 1997 Demonstration program was created by Pub. L. No. 104-204, §§ 211-212, 110 Stat. 2874 (Sept. 26, 1996). For further details on its provisions, see Another One-Year Reprieve for Most Expiring Section 8 Housing, 26 HOUS. L. BULL. 133 (Oct. 1996); HUD Issues Section 8 Reengineering Demonstration Guidelines, 27 HOUS. L. BULL. 26 (Feb. 1997).
102. Pub. L. No. 105-65, § 522(b). Certain short-term contracts under the demonstration program may also be renewed for additional terms of less than 120 days. Id. § 522(f).
103. Id. § 523(c).
104. Id. § 531. Although this amends Section 236 of the National Housing Act because that is where the money is (the IRP), eligibility for the new grant is broader.
105. Presumably this means that the funds must be repaid in the case of grants already made.
106. The law specifies "uncommitted balances within the limitation on maximum payments that may have been [before October 27, 1997] permitted in any fiscal year." Pub. L. No. 105-65, § 531.
107. Id. § 579.
108. Id. §§ 541-564.