WASHINGTON, D.C. — The Mark-to-Market (M2M) program, one of the most successful preservation programs ever run by the Department of Housing and Urban Development (HUD), is set to close for business Sept. 30, 2006.

That’s when HUD loses the ability to use money from its Federal Housing Administration (FHA) insurance claim fund to restructure the mortgages of properties that come under the program’s authority.

Properties that have already started the M2M process by September probably will be able to finish their restructurings. Owners who are interested in the program should get started immediately.

“There could be a last-minute scramble,” warned Maria T. Maffei, senior vice president for Recapitalization Advisors, Inc., based in Boston. A typical M2M restructuring can take as little as eight months, though 12 months is more typical.

The approaching deadline might even be good news for affordable housing developers if they hope to buy and preserve old HUD properties. As Sept. 30 nears, the existing owners of these properties are less likely to hold out for the highest possible price, since they realize their projects may be worth less once the deadline has passed.

“Owners are very aware of that now there is a cutoff point,” said Van Vincent, senior manager at the Chicago office of development consultant Virchow, Krause & Co., LLP.

There is also a threatening side to the approaching deadline. After it passes, HUD properties that have contract rents above the rents in their markets will still face a legal requirement to lower those rents without getting the chance to restructure their mortgages.

“In a few months, the tools go away, but not the Congressional mandate,” Maffei said.

M2M began in 1997 with a mandate to save money in the project-based Sec. 8 program. The program applies to properties that have an FHA-insured mortgage or a mortgage held by HUD, receive project-based Sec. 8 rental subsidy and also receive Sec. 8 contract rents that are higher than the rents charged by landlords in the surrounding market. Congress directed M2M to cut these contract rents down to size. The M2M program also offered a chance at partial or even total forgiveness of outstanding debt to projects that would face default otherwise with their new, lowered rents. M2M used money from the FHA insurance claim fund to pay down old mortgages and allow the property to take on new debt to pay for improvements. In exchange, these projects would acquire new 30-year use restrictions.

Officials expected that projects would enter the M2M program when their original Sec. 8 contracts expired in the late 1990s and early 2000s. HUD’s authority to enter into M2M agreements was later expanded to continue through Sept. 30, 2006, to allow the program to finish up with the last projects.

“The first goal of the M2M program is to reduce project-based Sec. 8 subsidized rents,” according to HUD. Preserving and improving the projects came second. But in the years since it started, M2M has become exceedingly good at its secondary goal, according to many HUD experts.

The Office of Affordable Housing Preservation (OAHP), the part of HUD that oversees M2M, has earned a reputation as a smart, flexible dealmaker – the best place at HUD to do a deal. While many talented HUD staffers have left their jobs in other parts of the agency, OAHP has kept a strong team together, according to HUD watchers.

M2M closes many deals, but much left to do

As of July 2003, HUD counted 9,070 FHA-insured properties with project-based Sec. 8 contracts. Another study commissioned by HUD estimated that approximately half or 4,500 of those properties had rents above local market levels and were eligible for M2M restructurings.

As of November 2005, the program had received 3,118 applications and had completed processing 2,803, leaving an active pipeline of 315 properties. Since no one expected all of the projects eligible for the M2M process to go through the program, most experts agree the program has done well and is on track to reach about as many of the projects as could be expected.

But there are still thousands of properties that the M2M hasn’t been able to touch: To begin with, the nearly 4,000 properties that had project-based Sec. 8 rents less than or equal to the rents in the surrounding markets. These properties could go through HUD’s Mark Up to Market program, but they have little incentive to do so because a for-profit owner with an expiring-use contract could just as easily get market rents from the market instead of HUD.

Other HUD properties that are ineligible for M2M sometimes suffer from neglect. “In a lot of cases you have absentee landlords — you have an owner who is not incentivized to be there,” Vincent said.

Many of the owners of these properties have their income from their projects capped by HUD’s limited distribution rules, so that they have neither an incentive nor income from the property with which to make repairs. Also some local HUD offices may lack tools and techniques to deal with troubled properties other than foreclosure.

Fortunately for Sec. 8-assisted properties, just as M2M comes to a close, private-sector lenders are growing much more comfortable with financing these properties. “The perception of risk and mystery associated with refinancing Sec. 8 and other subsidized properties has diminished,” said Mike Johnson, vice president of Reilly Mortgage Group, based in McLean, Va. “Financing for Sec. 8 properties has become more routine.”

Reilly plans to make loans to Sec. 8-assisted projects totaling roughly 2,000 units of housing in 2006. These units will continue to receive project-based Sec. 8 subsidy, but the new debt on the properties will not be FHA-insured, Johnson said. This will preserve the projects as affordable housing, but will free the properties from the HUD regulations that come with their FHA mortgages.

FHA financing remains a viable option, he said. But Fannie Mae and Freddie Mac are also now providing Sec. 8-assisted properties with financing options similar to conventional unsubsidized properties. Wall Street conduits are also active in the Sec. 8 financing arena, Johnson said.

More favorable light cast on Sec. 8 properties

The acquisition market has cast a more favorable light on Sec. 8 properties, according to Johnson. While cap rates have not leveled to equal their unsubsidized neighbors, Sec. 8 property cap rates have become much more aggressive. The American Postal Workers House Associates recently took advantage of the improved Sec. 8 market with a Fannie Mae Delegated Underwriting and Servicing loan through Reilly. The loan provided an 80% loan-to-value ratio with a 1.25x debt-service coverage ratio for its 100% Sec. 8 elderly housing property with an expiring Sec. 8 contract, Johnson said.