National Housing Law Project Housing Law Bulletin

But the sheer magnitude of this crisis has unfortunately obscured yet another fundamental issue raised by the impending expirations of those Section 8 units with project-based assistance: the question of just who should control this enormous housing stock in the future, and with what level of additional public investment. Unless housing advocates, policymakers and the public understand what is at stake here and act accordingly to design policies responsive to the needs of tenants and local communities, the federal government could pour billions into a system that fails to guarantee long-term decent and affordable housing.

The Budget Problem

First and foremost, expiring Section 8 contracts present a "budget authority" problem. Many Section 8 units are approaching the end of existing contracts expending previously appropriated funds, and the numbers of expirations dramatically increase in FY 1998. Maintaining funding for these existing units and subsidies requires new budget authority. Even under the expedient gimmick of renewing commitments for only one-year terms, the sheer number of expiring units produces a staggering $5.6 billion increase in the budget authority renewal figure, even though actual annual outlays barely increase.²

So far this year, there seems to be bipartisan recognition of the unique Section 8 budget problem on Capitol Hill, and a willingness for the budget resolution to support full renewals by providing sufficient increases in the spending levels allocated for the HUD Appropriations Subcommittee. This solicitude may be explained by the fact that the additional budget authority does not result in new outlay spending, but simply continues the old levels and thus does not make it any harder to reach a balanced budget.

The Budget Resolutions moving toward adoption allegedly contain sufficient funding for full renewal of all Section 8 contracts expiring in FY 1998, both tenant-based and project-based. This commitment comes in the form of an allocation of sufficient additional budget authority for renewals over the next five years -- over FY 1997's level of $3.6 billion -- to permit outlays that are $35 billion more than they would have been had the additional budget authority not been appropriated. Specifically for FY 1998, on June 25, the House VA, HUD and Independent Agencies Appropriations Subcommittee approved $9.2 billion in budget authority for Section 8 renewals, roughly the entire amount requested by HUD for this year for full renewals (since HUD's system already has $1.6 billion on hand in Section 8 reserves).

The Housing Stock Remains Imperiled

Submerged in this big money fight is the central question about what happens to this enormous housing stock with expiring contracts. The inventory consists of at least 1.3 million units, financed in a variety of ways, but all with project-based Section 8 assistance that eventually expires. Properties with HUD-insured mortgages remain the main subject of restructuring, and immediate attention appears focused on so-called "oversubsidized" properties, carrying Section 8 subsidies above true market value.

"Oversubsidized" properties that cannot make it after expiration with market-based rents or subsidies because of intractable debt or operating expenses will be forced to restructure under whatever rules Congress adopts. At stake here is the control and future operation of at least 500,000 units, many of which have little or no true equity beyond their current debt burdens. Sound public investment strategies, if linked to transfers into the restricted nonprofit or public ownership sector or to long-term use restrictions, could reduce eventual renewal costs to those required for operating and recapitalization expenses by retiring the original capital cost.

Because of the impending subsidy expiration, the federal government now effectively controls what happens to many of these "oversubsidized" properties. The terms of Congress' restructuring program, and the mix of benefits provided and burdens imposed, will be central to determining the responsiveness of using this stock as a future tool to meet ever-expanding affordable housing needs among very low-income families.

Defining this package provides a tremendous, once-in-a-lifetime opportunity to construct a new and improved system of performance accountability. On the flip side, providing the benefits of restructuring to owners without restrictions that ensure a fair public exchange presents the risk that enormous investments will benefit private, not public, interests.

Preservation Principles for the Restructuring Program

Restructuring and renewal policy is not just a financial exercise. Any comprehensive program should include at least the following elements:

What Is a Fair Exchange?

Here, the two major proposals currently on the table take dramatically different approaches. While both propose to use the technique of subsidy reduction and mortgage restructuring to reduce discretionary Section 8 spending in favor of mandatory claim payments from the mortgage insurance fund, what happens after that point diverges sharply, with fundamental consequences for the long-term future of the affordable housing system.

The Senate bill, S.513. The Senate's moderate bill (S.513, Connie Mack, R-FL) proposes to restructure mortgages and reduce to "market" levels⁴ and then generally renew the Section 8 subsidies as project-based. It does not adequately address the need to provide resources for renewal of expiring contracts currently paying less than market value. It seeks to avoid adverse tax consequences to owners (from "cancellation of indebtedness" rules) primarily by bifurcating mortgages into serviceable and "sleeping" or deferred "soft second" portions. Partial claims would be paid to existing mortgagees, and FHA insurance or other credit enhancement would be provided for the remaining first loan. Certain bad owners would be excluded from renewal, and HUD must adopt procedures to facilitate the transfer of these properties to tenant-endorsed nonprofit and public purchasers with project-based assistance. Most owners, however, would be eligible for renewal as long as Congress provided the funds. HUD or other public agencies would perform the restructuring and oversee future regulation of the properties. The bill further provides specific opportunities for tenant participation in both the restructuring process and ongoing project operations, with modest federal resources for technical assistance and capacity building.

To receive these "rollover" benefits, under the current version of the bill, owners would be obligated to accept the offered renewals as long as the second mortgage on the property remains outstanding (not an arbitrary 20 years, as under the prior version), together with any other restrictions imposed by the new public administrator. After restructuring to "market," rents will be regulated through operating cost adjustment factors adopted by the agency -- which in some markets will yield some level of relative affordability over time, even absent Section 8 -- together with a requirement not to discriminate against holders of tenant-based Section 8 assistance.

Thus, the deferred second mortgage, bearing interest at the applicable federal funds rate, becomes a key mechanism for assuring continued public control over the value of the silenced debt and the long-term use of the housing resource. This second note could effectively safeguard against privatization of much of the project's income potential. During the term of the new reduced first mortgage, the second is payable only from surplus cash. The current version of S.513 provides that the new regulatory agency may permit a portion of surplus cash (25 percent) to flow to the owner if certain performance standards are met, as an incentive for good performance, and the balance may go toward reducing the amount due on the second note. When the new reduced first loan is retired through tenant rents and public subsidy over its remaining term of 10 to 20 years, the "sleeping" deferred second note would be awakened and require servicing, at the level of the debt service on the first. Depending on the terms of the second note and actual market rent levels, some properties may be capable of providing additional financial returns, but those owners will be required to preserve the restructured rent levels and accept Section 8 renewals so long as the second note is outstanding. Many owners' groups support the general thrust of S.513, bill, although some have pushed for additional changes included in a recent House bill developed by Reps. Pryce and Moran (H.R. 1508).

Having now addressed the major issue of ongoing affordability in this fashion, the Senate bill still raises a final fundamental question: Is this a sufficient system to ensure the provision of decent housing during the restricted use period? Its proponents hope that an affirmative answer results from a combination of shifting regulatory oversight closer to the property and providing some stronger enforcement tools, screening bad owners, requiring rehabilitation assessment and providing some resources, providing modest performance incentives and invigorating resident participation.

HUD's bill, H.R. 1433. HUD, on the other hand, has recently proposed a different approach in H.R. 1433. HUD's bill would also restructure mortgages and reduce subsidies to market levels. It differs from the Senate version on several key points, however:

The Administration's proposal, unveiled jointly with Treasury Secretary Rubin, has so far failed to gain a following on Capitol Hill, as few apparently support such widespread vouchering of the stock and no one seems to believe that tax relief for owners is realistically possible this year or anytime soon enough to be part of a comprehensive legislative program.

Current status. At the Senate Housing Subcommittee's June 17 hearing on S.513, HUD Secretary Cuomo voiced support for moving forward with restructuring legislation in the reconciliation process. At the same time, he stressed three major objections of the Department to S.513: (1) not enough conversion to vouchers; (2) insufficient flexibility to use private organizations, not just public agencies, to conduct the restructurings; and (3) the absence of a comprehensive tax solution for owners, in light of some concern that the IRS will not approve debt bifurcation as a legitimate tool. The following day, the Senate Banking Committee then quickly folded S.513 into its budget reconciliation package that was forwarded to the Budget Committee and headed for a Senate floor vote before the July 4 recess. The House reconciliation package, on the other hand, does not include any Section 8 restructuring proposal. Thus, the mammoth conference committee negotiation scheduled for July will determine the ultimate content of Congress' policy. Hopefully, Congress will seize this unique opportunity to use the event of contract expiration to improve the housing delivery system by ensuring more accountable and cost-effective operations and permanent investments in our affordable housing supply.

1. A prior version of this article appeared in THE NETWORK BUILDER (Issue 30, Spring 1997), a publication of the Chicago Rehab Network.
2. See Section 8 Renewals Pose Extraordinary FY 1998 Budget Challenge, 27 HOUS. L. BULL. 167 (Dec. 1996).
3. See Not-So-New Proposals for Section 8 Program Restructuring, 27 HOUS. L. BULL. 71 (May 1997), and HUD Introduces 1997 Version of Section 8 "Mark-to-Market" Legislation, 27 HOUS. L. BULL. 91 (June 1997).
4. If "market" comparables do not exist under the bill's narrow definition, then S.513 requires use of a 90-percent-of-Fair-Market-Rent standard for setting rents.