Small Changes, Big Benefits: HUD Programs Move Forward

As housing developers well know, the U.S. Department of Housing and Urban Development (HUD) has a litany of programs, provisions and notices designed to improve the availability of housing for low-income residents. Some programs hum along requiring little maintenance, some undergo major transformations regularly and some simply spin their wheels—often as a result of a gridlocked political process.

Sometimes, however, there are relatively simple changes needed that can result in big improvements. Such is the case with recent developments regarding how the Section (Sec.) 202 program could work with the Rental Assistance Demonstration (RAD) program, as well as a law that changes how Low Income Housing Preservation and Resident Homeownership Act (LIHPRHA) properties can be more beneficial to affordable housing developers.

Background on Sec. 202

The Sec. 202 program provides capital advances to nonprofit organizations to finance the construction, rehabilitation or acquisition of supportive housing for very low-income elderly persons. In addition, the program provides rent subsidies for the projects to help make them affordable. As such, it has a well-defined goal—helping low-income people get quality housing. The history of the program, however, is a little less straightforward as the program has undergone numerous changes throughout the years. Prior to 1974, Sec. 202 funds were loans that may or may not have had either Sec. 8 or rent supplemental assistance for all or some of the units. Between 1974 and 1990, all Sec. 202 funds were provided as loans and subsidized by project-based Sec. 8 contracts.

In 1991, the Sec. 202 program was converted to a capital advance grant with a project rental assistance contract (PRAC) for operational expenses, known as Sec. 202 PRAC. Since these properties were not originally funded with loans, the current Sec. 8 housing assistance payment (HAP) contracts were not set at high enough limits to allow for debt service. This has caused problems now that these projects need major capital repairs, preventing much-needed financing projects from moving forward.

Legislative Changes

Through the fiscal year (FY) 2017 Transportation, Housing and Urban Development, and Related Agencies (THUD) Appropriations Act, the industry is proposing to allow Sec. 202 PRAC properties to convert from short-term contracts to long-term contracts through HUD’s RAD program. This would allow Sec. 202 PRAC properties to use debt and other financing mechanisms in a manner not possible under current program guidelines. According to HUD data, there are over 120,000 units of housing covered by PRACs, thus a legislative fix that would allow them to convert to long-term contracts under the RAD program would be a major win for housing developers.

The RAD program is supposed to be budget neutral, but some properties are in poor enough condition that they need additional funds. With additional funds, the RAD program could increase rents, much like a mark-up-to-market rent increase through the Sec. 8 program. The 2017 appropriations act contains a symbolic amount of additional funding ($4 million) that could be used to increase rents for individual properties. Although $4 million might only be enough for one project, getting it into the bill would open the door for allocating any money to the program with the hope that the amount would increase significantly in a later year. 

Members of the U.S. House of Representatives left Capitol Hill for an election year summer recess without completing any FY2017 appropriations bills, including the THUD bill. The Senate passed its version of the THUD bill on May 19, but the House’s THUD bill has only made it through the full House Appropriations Committee thus far. Congress returns to Washington, D.C. on September 6 and FY2017 begins on October 1, so there is a window where this bill could be passed. The Senate’s version of the THUD bill includes the provision that would allow Sec. 202 PRACs to convert to RAD, meaning housing developers are hoping the House passes that version. Should Congress not pass a full budget, which is always a distinct possibility but even more so in an election year, there are two options to keep the government operating:

  • Omnibus bill. This would be a win for the housing industry as the current Senate omnibus spending bill includes Sec. 202 PRAC to RAD. An omnibus spending bill is a bill that packages many of the smaller regular appropriations bills into one larger single bill that could be passed with only one vote in each chamber. There are 12 different regular appropriations bills that need to be passed each year to fund the federal government and avoid a government shutdown; an omnibus spending bill combines one or more of those bills into a single bill.
  • Continuing resolution. A continuing resolution (CR) would be a loss for the housing industry. If the Senate and the House can’t agree on a budget, the government can continue to operate through a CR. This basically says “do the same thing as last year” and thus wouldn’t include Sec. 202 PRAC to RAD. It’s anticipated that congress will do something by the middle of September to avoid a government shutdown, but it’s not going to pass a full budget. It will likely get pushed to sometime in December, after the presidential election.

The possibility of Sec. 202 PRACs and the RAD program working together is not the only legislation housing developers are keeping tabs on. There is another bill that has been around for 24 years that has seen significant recent developments.

New Life for LIHPRHA

Enacted by Congress in 1992, LIHPRHA is designed to keep owners of older assisted housing from buying out of subsidized mortgages, which would reduce the number of available affordable housing units. Certain FHA Sec. 236 loans and FHA Sec. 221(d)(3) below market interest rate (BMIR) loans qualified. Part of the National Affordable Housing Act, the law codifies steps an owner of a property must take in order to sell it or end HUD's affordability restrictions. In addition, it incentivizes owners to stay in HUD's programs, provides protections to tenants should the owner choose to sell and provides incentives to nonprofit organizations who might be interested in purchasing the properties. Incentives include the approval of Sec. 241(f) equity take-out loans and/or additional Sec. 8 subsidy, as well as the availability of Sec. 8 rent increases and/or capital grants.

Currently, HUD oversees an inventory of approximately 640 properties with more than 75,000 units subject to LIHPRHA provisions. Through a restrictive use agreement, the owner agrees to keep a property in the affordable housing stock in return for additional HUD subsidies. Many current LIHPRHA use agreements restrict periodic distributions of surplus cash generated by properties to 0% or 6% of initial equity. Some use agreements also restrict owners from realizing any proceeds from project refinancing. Other LIHPRHA use agreements expressly prohibit owners from bringing low-income housing tax credit (LIHTC) equity into the project. This has discouraged many owners from rehabilitating their properties, which contradicts HUD’s mission of maintaining quality and safe affordable housing.

Late last year, Congress passed a law (Section 77001 of the Fixing America’s Surface Transportation Act)) that allows distributions on all free cash flow for these projects and increases access to any residual receipts. The law also provides other beneficial changes. It allows a property to do an equity take-out refinance, it allows a budget-based rent increase, which can include the new debt service and market loan coverages, and it provides protection to tenants from large rent increases. The official rules are soon to be released through a HUD notice, but this important change is a transformative shift for these properties. These projects can also apply for an Option 5 mark-up-to-budget rent increase to help fund additional debt. This change will also make LIHTC deals easier, because the increase in distribution can be used to pay down deferred developer fees, or pay throughout the entire cash flow waterfall process.

One challenge remains: finding the owners of projects with LIHPRA use agreements. It is possible to find the properties with LIHPRA use agreements, however there is not a database listing the owners, thus contacting them has been difficult. Developers who own one of these projects, or those interested in obtaining a list of LIHPRA projects in a certain area, would be well advised to contact their mortgage banker and keep an eye out for any additional updates.

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