National Housing Law Project Housing Law Bulletin

Of course, the ultimate renewal decision for most properties will involve many variables, making predictions hazardous. However, the program includes designated opportunities and some financial support for tenant and community participation during the restructuring process, which will hopefully provide greater clarity about the future path of some of the affected properties. In addition, local HUD tenant organizations or coalitions, or HUD-supported VISTA volunteers, along with local Legal Services or other nonprofit housing organizations, may have information or expertise that can help sort things out. This article provides only some rough initial guidance to get you started in assessing the specific risks a property might face.

Brief Review of the Program

The new Section 8 law³ establishes different rules depending on the scheduled expiration date of the property’s project-based Section 8 contract. Remember that every tenant should be receiving at least six months’ notice prior to the expiration date, regardless of the owner’s intentions.⁴ Because it contains little definite information about what will happen to a particular development, that notice will often generate many questions from tenants.

For contracts expiring during Fiscal Year 1998 (October 1, 1997, through September 30, 1998),⁵ almost all owners may request a renewal at the current Section 8 contract rent so long as it is less than 120 percent of the published area Fair Market Rent (FMR) for Existing Housing.⁶ Others that cannot operate at 120 percent of FMR may have to seek a restructuring of the property’s debt service and operating expenses by negotiating with HUD or a HUD designee. Properties with certain kinds of financing are exempt and may receive renewals at current rents. Thus, most properties will receive one-year Section 8 contract renewals.

For FY 1998 expirations, then, just two categories of properties are unlikely to receive renewals. A few will not be eligible, usually due to prior actions of the owner or the condition of the property. Others owners may not seek a renewal because they believe that a comparable or better opportunity is available on the private market, with a transition assisted by vouchers for the current residents. In addition to the general six-month expiration notice, owners who are "opting-out" must serve tenants a three-month notice if the expiration will result in any rent increase for the current tenants.⁷ In cases where conversion prospects are unclear, some owners may seek a one-year renewal while assessing feasibility of their conversion options.

For the new program commencing in FY 1999 (October 1, 1998), the picture is different and more complex. Certain categories of properties are exempt or disqualified. The threshold for defining the owner’s renewal option is no longer 120 percent of FMR, nor is it determined by an arbitrary number. "Market rent" will be the key factor. Properties above "market" will apparently have to restructure under the terms of the new law and regulations and guidelines yet to be issued by HUD and other administrators (called Participating Administrative Entities or PAEs). Properties below "market" (hence "ineligible" for restructuring) must be renewed by the government upon owner request at the lesser of existing or budget-based rents (both as adjusted for operating cost increases).⁸ The law also authorizes HUD to increase Section 8 assistance for these properties to levels that do not exceed "comparable market rents" on HUD-prescribed terms and conditions.⁹

Thus, for FY 1999 expirations, the law leaves primarily with the owner the decision about continuation of the subsidy upon expiration, while establishing a general framework for determining the amount of the government’s subsidy offer. Remember that some kinds of properties are "exempt" (e.g., Section 202, state or local bond-financed, and Rural Housing Service Section 515 developments). Usually those owners have a renewal option at current rents, although the contract rent may be reduced by the government to a budget-based level if the property can adequately operate on less.

The major exception to the "owner choice" principle is where the owner or the project is "bad" (caught violating significant HUD rules, in poor condition or rehabilitation is too expensive). In addition, there is still a chance that HUD will decline to make project-based renewal offers to "ineligible" properties.¹⁰

The primary influence on the future of the property will therefore usually be an evaluation of the owner’s economic alternatives — comparing the new government offer with the returns from a market-rate conversion (cushioned by vouchers).¹¹ In some cases, the owner will have a realistic choice; in others, restructuring may be the only practical option.

To more accurately assess what will happen to a specific property, the starting point is to determine the likely market rent for the various unit sizes in the property. There will rarely be a precise figure for "market," especially in those situations where the property is 100-percent Section 8 and no unsubsidized rents have ever been collected there. Location, condition, amenities, management, occupancy and services always vary from building to building, so forecasting comparables is often difficult. Nevertheless, one can usually arrive at some ballpark figures based upon similar neighboring market-rate properties. In the interim, many local advocates are finding it useful to use 100 percent of the published FMR for the applicable unit size, on the assumption that most of the project-based Section 8 units in standard condition have market values near this figure. This assumption may not be applicable in your market area for some or all of the properties you are evaluating.

Next, you need to know the current Section 8 contract rent.¹² Although occasionally inaccurate, this figure may be obtained from the Section 8 inventory on HUD’s Website.¹³ For many properties, this current rent may represent the upper limit on the government’s new renewal offer. Certainly it is the figure that owners will be working with in making their initial decisions about renewal, conversion, or restructuring.

To the extent that the figures are accurate, this evaluation may help you sort a property into one of the following types, each of which faces a different future. On some properties, the market projection may be too uncertain to produce reasonable predictions at an early stage. This uncertainty may mean that the property may fall into more than one category until you know more.

Types of properties. Properties are likely to fall into the following categories:

One-year renewals ("drifters"). In many jurisdictions, this will probably be the largest group of properties. These are properties whose owners probably want to renew the Section 8 contract. They are either (1) exempt from the new law (due to their type of financing) or (2) ineligible for the restructuring program because they lack HUD-insured financing or their Section 8 rents are below market. Their Section 8 rents are probably close to true market — usually equal to or slightly less than market. Occasionally, Section 8 rents may possibly slightly exceed true market but they are close enough that the owner can show comparables sufficient to avoid the effort of a formal restructuring. The Section 8 rent for "exempt" properties may greatly exceed market value. The presence of another cloud on value, like a Flexible Subsidy Use Agreement or a local zoning variance or rent control, may keep properties in this category for a while.

Renewal at current Section 8 rents is a relatively good deal for these exempt and ineligible properties, when compared to the risks and benefits of a market conversion or the effort and expense of restructuring. Owners will generally prefer the short-term certainty of a annual one-year renewal at current rents (perhaps with modest budget-based rent increases for those under the Section 236 program). Properties owned by nonprofits will also invariably renew, even if the market rents substantially exceed Section 8 rents, because of their affordable housing mission.

Owners of properties with Section 8 rents slightly above market value might seek this renewal option (by demonstrating slightly higher market comparables than warranted) in order to avoid the effort and expense (financing fees, consultants, rehab contribution) of restructuring, and to preserve maximum flexibility, especially where there are prospects for local market improvement. Conversion remains an annual option, since there is no long-term use restriction.

These "drifter" properties may also head in the other direction. Now or in the future, they may lack the revenue or capital for deferred maintenance and rehabilitation, and conditions may begin to deteriorate. Congress has provided no real additional resources in this program for meeting these needs. For the near future, oversight and monitoring of these properties will apparently remain with a downsized HUD that has diminished capacity for this function, so local vigilance may become increasingly important.

Conversion candidates ("opt-outs"). These are properties with profit-motivated owners, usually with Section 8 contract rents significantly below true market.¹⁴ Market returns will meet or exceed those available from continuing in the Section 8 program.

Since the new Section 8 program generally establishes the maximum rent at the lesser of current Section 8 rents or true market rents, conversion will most often threaten those properties where true market rents exceed current Section 8 rents by enough to outweigh the transaction costs and risks inherent in a market conversion. Most of these properties will lack any other cloud on their value, such as a Flexible Subsidy Use Agreement, local zoning variances or rent control. Usually, these will be older assisted properties with HUD-subsidized mortgages and HUD rent control (e.g., Section 236 with Section 8 Loan Management Set-Aside), where the "opt-out" from Section 8 will occur about the time of a mortgage prepayment terminating the HUD regulatory agreement. Occasionally, they may be Section 8 New Construction or Substantial Rehabilitation properties located in hotter market areas, where market rents have outpaced Section 8’s formula-adjusted levels.

Note: The Section 8 law¹⁵ gives HUD the discretion to raise the Section 8 rents on these properties to market levels, which, along with local resources, may be an essential preservation tool. HUD has so far given no indication of its intent to use this important tool, or a proposed policy to guide its usage.

It is important to note that under the new law conversions may occur for other reasons. Occasionally, owners of properties that lack a significant profit gain from conversion will also "opt-out" for other reasons, especially where the transition to market operations can be cushioned by vouchers for current residents. Other conversions will also occur as a result of owners or properties being disqualified (discussed infra), or because HUD or the PAE decides to convert the subsidy to vouchers after restructuring the property.¹⁶ Properties serving families located in "non-tight" markets where state agencies or local governments might favor vouchers may be especially vulnerable.

Disqualified properties or owners ("troubled properties"). These are properties in poor condition, or those owned by owners with other properties in extremely poor condition or that have committed serious HUD program violations. Section 8 rents in these properties may be at any level with relation to market, but are often greater than true market value.

These properties may end up converting to market-rate because they are "disqualified" — the government (HUD or PAE) chooses not to offer a renewal contract to an otherwise eligible and willing owner. This can also occur simply because HUD or the PAE finds the cost of rehabilitation to be "too expensive." HUD and the PAE have considerable discretion on disqualifications, which will probably be exercised somewhat inconsistently until greater experience develops precedential guidelines. One safeguard against conversions from disqualifications is that HUD must develop procedures to facilitate the transfer of such properties to qualified new ownership, preferably to tenant- endorsed nonprofit or public owners, along with a renewal of the Section 8 contract.

To determine which expiring properties fall into this category, you need to become more familiar with the file information and perspectives of the asset management staff in the local HUD office, and find out whether the property or the owner has been referred to the new Assessment and Enforcement Center at HUD Headquarters. For properties in questionable condition, request the last few annual HUD Physical Inspection and Management Review Reports. Also, those 450 properties that were on HUD’s "Notice" list of potential disqualifications for FY 1997 renewals might still be ripe for future disqualification if HUD gathers more evidence or if last year’s quick-fix remedies begin to fall apart.

Restructuring candidates. These are properties where Section 8 rents exceed true market value, often by a significant amount. The government wants to reduce the Section 8 cost, and the property cannot pay its current debt service and operating expenses with rental income reduced to market. The property needs relief, in whole or in part, from its current debt service obligations. For those developments with HUD-insured loans, restructuring will usually reduce the amount of the first mortgage to levels serviceable with Section 8 set at market rents, placing the non-serviceable portion of the prior loan into a deferred second mortgage. Where debt reduction fails to yield sufficient savings to operate at market rents, budget-based Section 8 rents ("exception rents") to cover operating expenses may be used.

Restructuring brings other risks and opportunities, as a specific plan must be developed for each property. The restructuring process may be transferred to a new agency other than HUD (the PAE). In the restructuring plan, key issues will include:

Conclusion

Most jurisdictions have far more Section 8 properties with expiring contracts than there is local capacity to oversee. Selecting among expiring properties for various kinds of risks may be an important initial task for getting started locally. Please contact Jim Grow at the Project’s Oakland office if you need technical help in this process.

1. See The New Section 8 Renewal and Restructuring Program: An In-Depth Review, 27 HOUS. L. BULL. 175 (Nov. 1997); HUD Notice H 97-66, "FY 1998 HUD Appropriations Act" (Nov. 12, 1997, expires Nov. 30, 1998); and New HUD Guidelines for FY 1998 Section 8 Contract Renewals and Opt-Outs, 28 HOUS. L. BULL. 8 (Jan. 1998).
2. See Moving Forward on Project-Based Section 8 Expiring Contracts, 27 HOUS. L. BULL. 195 (Dec. 1997).
3. Pub. L. No. 105-65, tit. V, 111 Stat. 1344, 1384 (Oct. 27, 1997).
4. Pub. L. No. 105-18, § 10002 (June 12, 1997), amending 42 U.S.C.A. § 1437f(c)(9) (West Supp. 1997).
5. This includes those with original expirations during FY 1998, as well as those that expired previously but have been renewed for one-year terms, often successively.
6. See New HUD Contract Guidelines for FY 1998 Section 8 Contract Renewals and Opt-Outs, 28 HOUS. L. BULL. 8 (Jan. 1998). Owners may also take a reduction and renew at 120 percent of FMR if their current rent is higher.
7. 42 U.S.C.A. § 1437f(c)(8) (West Supp. 1997); HUD Notice H-97-66 (Nov. 12, 1997).
8. Pub. L. No. 105-65, § 524(a)(2) (Oct. 27, 1997).
9. Id. § 524(a)(1).
10. That is, those properties that lack HUD-insured financing and that are not entitled to renewals as "exempt" or that have Section 8 rents below "market."
11. Of course, there may be other non-economic factors motivating an owner toward a particular choice, such as internal partnership dynamics or the desire to contract with a government program, but these are more idiosyncratic.
12. The new law (Pub. L. No. 105-65, § 512) does not define "rents." This article generally assumes that the relevant figure is the Section 8 contract rent, the total rent collected from the tenant and the Section 8 Housing Assistance Payment ("HAP"). Note that for those Section 236 units with a Section 8 Loan Management Set-Aside contract, the total "government rent" currently benefiting the owner includes an additional component, the value of the Section 236 Interest Reduction Payment ("IRP") paid by HUD to the lender to reduce the project’s debt service payments. On average, the IRP is worth an additional $700 per unit per year, or about $60 per unit per month. This is reflected in the calculation of the Section 236 "market rents," which include both the Section 236 Basic Rent that is covered by the tenant contribution and HAP payment under the Section 8 program, and the value of the IRP. Thus, the Section 236 "market rent" is the figure to use for these properties.
13. The data for almost all Section 8 contracts in the country is found at: http://www.hud.gov/hsg/hsgmfint.html. Procedures for downloading the information are described at HUD Provides Improved Data on Section 8 Projects Via the Internet, 27 HOUS. L. BULL. 201 (Dec. 1997).
14. Note that some properties with nonprofit owners in standard condition — which otherwise might be conversion candidates — are generally going to be renewed if the government’s renewal offer permits economically viable operations, since profit maximization is not an organizational objective.
15. Pub. L. No. 105-65, § 524(a)(1) (Oct. 27, 1997).
16. Id. § 515(c).