MARKET OPPORTUNITIES

PRESERVATION

A Time to Move Forward

BY STEPHEN J. WALLACE

AFFORDABLE HOUSING FINANCE • SEPTEMBER 2007

Affordable housing preservation is a hot topic. This is a good thing. Protecting the existing stock of affordable housing is essential in meeting the nation’s housing needs, and there’s been strong activity on this front throughout the year. In April, the U.S. Government Accountability Office (GAO) issued a report to Congress urging the Department of Housing and Urban Development (HUD) to update its policies to keep pace with the changing affordable housing market. And now, Rep. Barney Frank (D-MA), chairman of the House Committee on Financial Services, is preparing to draft legislation that will make it easier to preserve and rehab HUD’s aging affordable housing portfolio.

Why the urgency?

The answer is simple: Waiting any longer substantially reduces the ability to preserve the existing HUD portfolio as affordable housing. Consider that the original 40-year Federal Housing Administration-insured mortgages in the Sec. 221(d)(3) portfolio are now expiring. And with the mortgage expiration so goes the HUD regulatory agreement requiring affordability. Following closely behind the Sec. 221(d)(3) portfolio expirations are the expirations of the Sec. 236 portfolio, and soon thereafter, the Sec. 8 portfolio. Also, the marketplace is much more competitive. Recently, there has been increased interest in the HUD portfolio by marketrate developers, particularly in tight markets like Los Angeles and New York City.

What should we do to reduce risking this valuable resource?

We should adopt the lessons learned 10 years ago when the industry and HUD successfully worked side by side to cobble together the Sec. 236 “decoupling” program. This joint effort has preserved more than 650 Sec. 236 properties throughout the country. And the properties weren’t just preserved through an extended-use agreement. The underlying housing asset also was renovated through a rehab program, which on average added $25,000 to $30,000 per unit of physical improvements. Compare this result to that of HUD’s mortgage restructuring program, in which the upfront rehab is less than $2,000. The Sec. 236 preservation program has been a huge success, but unfortunately HUD has not extended the lessons learned to the rest of the HUD portfolio.

Consider this possible scenario: An owner constructed a Sec. 221(d)(3) property 30-plus years ago, and then in a second phase, constructed another property across the street under the Sec. 236 program. Both properties were of similar size and construction. Recently, an affordable housing developer skilled in preserving aging HUD properties entered into purchase agreements for each property. However, only the Sec. 236 property closed. The purchaser used the familiar preservation tools of tax-exempt bonds, 4 percent low-income housing tax credits, and retention of the Sec. 236 (interest reduction payment) IRP subsidy and received a budget-based rent increase pursuant to the Sec. 236 decoupling program, which also permitted the new debt service to be included in the rent increase calculation.

The Sec. 221(d)(3) property did not fare as well. It was not preserved. Rather, it was converted to market-rate housing by a local developer. No rehab was undertaken— there was no requirement to do so— and the residents of this property now look across the street at a completely rehabbed Sec. 236 property, which also has been preserved as affordable housing, and wonder why they were not treated as well.

What new policies would help?

The GAO is right: HUD needs to update its policies to effect more affordable housing preservation. It is the most efficient and least costly way to continue to provide affordable housing to those who need it. In a recent survey, the National Housing Trust reports that more than 63,000 units were preserved in 2006 using low-income housing tax credits—a three-fold increase since 2000. HUD, which held a symposium on preservation in May, could increase that number even further by changing some of its policies and procedures.

These changes should include:

• Increasing budget-based rents to include new debt service up to an amount not to exceed the comparable market rent for post-rehab units. Rents would be approved up front but not implemented until completion of the rehab. This arrangement worked well in the Sec. 236 decoupling program.

• Eliminating all restrictions on distributions for all ownership entities—forprofits and nonprofits. Any restriction is a disincentive to the efficient management of an affordable housing property. Congress endorsed this concept in the late 1990s when it authorized “marking up to market” of Sec. 8 rents and eliminated all restrictions on cash flow.

• Reconfiguring the unit mix to eliminate studios and small one-bedroom units where feasible. The market demand for units of this size is virtually nonexistent, leading to high vacancies. This policy was endorsed in the recent GAO report.

• Immediately stopping the arbitrary practice of limiting or reducing a nonprofit seller’s sales proceeds. This unauthorized policy prevents the preservation of these properties today. HUD will have no leverage to encourage these properties’ owners to remain affordable at the time of mortgage maturity.

Many are hopeful that legislation to assist in furthering the preservation of HUD’s aging portfolio will be enacted this year. Industry stakeholders are working closely with Chairman Frank’s staff on legislation.

Some of the key provisions they are pushing for include:

• Providing enhanced vouchers at the maturity of a Sec. 221(d)(3), 236, or 202 mortgage.

• Converting the remaining projectbased rental subsidy contracts under the Rental Assistance Program and the Rent Supplement Program to project-based Sec. 8 contracts.

• Clarifying the process for moving certain project-based assistance and use agreements from one project to another project or projects and including the Sec. 236 interest reduction subsidy.

The recent buzz of activity in our nation’s capital on affordable housing preservation issues is encouraging. Preserving affordable housing needs to be a priority, and with thoughtful policy changes, we can substantially increase the preservation of HUD’s aging portfolio.