SUMMARY OF SECTION 202 PREPAYMENT ISSUES

Richard T. WashingtonVP, Business Development

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Passed as part of Housing Act of 1959.

Federal government's principal program for production of affordable elderly multifamily housing since 1959.

The physical condition of many of these projects has deteriorated over time and they are in need of recapitalization to replace/repair systems, units, building structures, common areas, etc. Also, additional supportive services are needed to meet changing needs of an aging in place population.

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1977 to 1990 – Section 202 projects were funded with 40 year direct HUD loans, and subsidized with project-based Section 8 HAP contracts.- Loans made at then-prevailing interest rates (often 10% or higher)- Restricted to non-profit ownership- HUD approved budget-based rents- No owner distribution allowed- Allocation of funding authority to each State- HUD approval required for prepayment of many 202 loans

1990 to Present.- Since 1990 the program has provided a capital advance combined

with rental subsidy under a multi-year Project Rental Assistance Contract ("PRAC")

- Awards of 202 capital advance now made annually through NOFA process

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Congress passed legislation in 2000 to address aging 202 portfolio greatly in need of rehab. - Goal was to allow for refinancing with or without FHA insurance, and

use of tax exempt bonds, low income housing tax credits, etc. to rehab and stabilize properties.

- Statute allowed for-profit limited partnerships to participate so long as sole GP is a qualifying nonprofit or a corporation wholly owned/controlled by qualifying nonprofit

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Establish procedures for prepayment of direct HUD 202 loans.

202/Section 8 projects restructured pursuant to the Notices retain their exemption from Mark-to-Market after prepayment. Rents may be initially renewed at lesser of budget-based rent or current rents adjusted by OCAF (future adjustments generally based on OCAF).

Address two types of prepayment scenarios:- 202 loans that do not require HUD approval for prepayment

(generally applies to loans made 1977 through 1982) and may be prepaid on 30 days notice to HUD.

- 202 loans that require HUD approval for prepayment.

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Principal purpose of Notices was to address those loans that require HUD approval for prepayment. Requirements for prepayment include the following:

- At least 30 days prior to the proposed prepayment date, the 202 owner must issue a letter to all tenants informing them of its intention to prepay. The notice must describe to the tenants why prepayment is advantageous to them. In addition, the owner must submit to HUD a detailed plan explaining such benefits.

- The owner must agree to execute a Use Agreement that requires, among other things, (1) the project to be operated until the maturity date of the original Section 202 Loan in a manner that will provide rental housing for the elderly and persons with disabilities on terms at least as advantageous to existing and future tenants as the terms required by the original loan, and (2) the project to accept Section 8 subsidy for the life of the Use Agreement.

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Permitted Use of Existing Project Residual Receipts/Replacement Reserves- Amounts in excess of $500 per unit held in Residual Receipts

Account may be used to pay portion of supportive tenant services. - Amounts in excess of $1K per unit held in Replacement Reserve

Account may be used for rehabilitation, modernization or retrofitting of project.

Permitted Distributions- Maximum annual distribution is 6% of owner's equity (including

LIHTC equity) paid at refinancing of project.

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Section 8 Savings- If Section 8 savings are realized from the refinancing, up to 50% of

such savings may be used for the benefit of the tenants (e.g., pay a portion of increased cost for supportive services; rehabilitation, modernization or retrofitting of project).

Development Fees for LIHTC Projects- Permits development fees at the lesser of (1) 15% of approved

development cost, and (2) the maximum fee allowed by applicable State's QAP.

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Equity Take-Out- Mortgagor not permitted equity take-out. However, potential equity

take-out in purchase transaction (seller limited to equity take out based on lesser of purchase price or unassisted market value of property).

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A. TRANSFER OF HUD SECTION 8 HAP CONTRACTS

B. CONVERSION OF EFFICIENCIES INTO ONE-BEDROOM UNITS

Richard T. WashingtonVP, Business Development

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Section 213 as enacted in the Transportation, Housing and Urban Development and Related Agencies Appropriations Act, 2009 authorizes owners to transfer some or all project-based assistance, debt and statutorily required low- and very low-income use restrictions, with one or more multifamily housing project to another multifamily housing project(s). While this provision has been in place for four years now, HUD has authorized only a handful of projects to transfer some or all of the Section 8 authority.

Section 213 creates an opportunity for developers to deconcentrate poverty in high-density buildings through the transfer of some or all of its Section 8 authority. Further, where a building has deteriorated beyond compare and/or the surrounding location has become economically nonviable, as in the case of parts of post-Katrina New Orleans, Section 213 provides an opportunity to save the Section 8 subsidy through a transfer rather than losing the subsidy outright. Preserving the Section 8 is a valuable national asset that should be a priority of all affordable housing owners, developers and policy makers.

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However, in some circumstances it is no longer cost-effective to preserve the physical structure where a building is in vast disrepair or obsolete in design. In these rare instances, it is important that an affordable housing developer have the flexibility to transfer the Section 8 project-based subsidy in order to provide high-quality, stable affordable housing for the residents, de-concentrate poverty, and in the long-term preserve the Section 8 subsidy that would otherwise be lost if a transfer were not approved.

Yet as drafted, the ten conditions which must all be met in order for HUD to authorize a Section 213 transfer remain overly restrictive and have proven to be prohibitive.

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(b)(1) The number of low-income and very low-income units and the net dollar amount of Federal assistance provided by the transferring project shall remain the same in the receiving project or projects.

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(b)(2) The transferring project shall, as determined by the Secretary, be either physically obsolete or economically non-viable. The transferring project (i) shall be either physically obsolete or economically non-viable or in a case involving a partial transfer of project-based assistance, shall require reconfiguration of units because the units to be reconfigured are physically obsolete or economically non-viable, all as determined by the Secretary or (ii) shall in its present configuration represent an over-concentration of poverty and social problems that could be ameliorated by a reduction in density, all as determined by the Secretary, provided that any transfer pursuant to determination under this subsection (b)(2)(ii) shall be a partial transfer and that any receiving project shall, as determined by the Secretary be of such character and in such location(s) as are likely, in the determination of the Secretary, to improve the lives of the tenants.

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(b)(3) The receiving project or projects shall meet or exceed applicable physical standards established by the Secretary.

  (b)(4) The owner or mortgagor of the transferring project shall notify

and consult with the tenants residing in the transferring project and provide a certification of approval by all appropriate local governmental officials.

  (b)(5) The tenants of the transferring project who remain eligible for

assistance to be provided by the receiving project or projects shall not be required to vacate their units in the transferring project or projects until new units in the receiving project are available for occupancy.

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(b)(6) The Secretary determines that this transfer is in the best interest of the tenants.

  (b)(7) If either the transferring project or the receiving project or

projects meets the condition specified in subsection (c)(2)(A), an lien on the receiving project resulting from additional financing obtained by the owner shall be subordinate to any FHA-insured mortgage lien transferred to, or place on, such project by the Secretary, provided, however, that the Secretary may waive this requirement upon determination that such waiver is necessary to facilitate the financing of acquisition, construction or rehabilitation of the receiving project.

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(b)(6) The Secretary determines that this transfer is in the best interest of the tenants.

  (b)(7) If either the transferring project or the receiving project or

projects meets the condition specified in subsection (c)(2)(A), an lien on the receiving project resulting from additional financing obtained by the owner shall be subordinate to any FHA-insured mortgage lien transferred to, or place on, such project by the Secretary, provided, however, that the Secretary may waive this requirement upon determination that such waiver is necessary to facilitate the financing of acquisition, construction or rehabilitation of the receiving project.

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(b)(8) If the transferring project meets the requirements of subsection (c)(2)(E), the owner or mortgagor of the receiving project or projects shall execute and record either a continuation of the existing use agreement of a new use agreement for the project where, in either case, any use restrictions in such agreement are of no lesser duration than the existing use restrictions.

  (b)(9) Any financial risk to the FHA General and Special Risk

Insurance Fund, as determined by the Secretary, would be reduced as a result of a transfer completed under this section.

  (b)(10) The Secretary determines that Federal liability with

regard to this project will not be increase.

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Issues:

- Many owners/sponsors have encountered overly stringent HUD interpretations of “physically obsolete” and “economically nonviable” which have made their attempts to transfer some or all of the section 8 assistance to other properties very difficult, if not prohibitive.

- Provision should be made to warrant temporary relocation of the tenants in the case of a partial transfer where rehabilitation of the dwelling units in the transferred building cannot be done without temporarily relocating tenants.

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Issues (Continued):

- It is not altogether clear whether the Secretary must transfer the debt, and if so, that could unnecessarily complicate a new financing. No superior debt to the transferred HUD debt has often been a ‘deal killer’ for those working to transfer Section 8 assistance to other properties. HUD should revise this language to state: If either the transferring project or the receiving project or projects meets the condition specified in subsection (c)(2)(A), any lien on the receiving project resulting from additional financing obtained by the owner shall be subordinate to any FHA-insured mortgage lien transferred to, or placed on, such project by the Secretary, provided, however, that the Secretary may waive this requirement upon determination that such waiver is necessary to facilitate the financing of acquisition, construction or rehabilitation of the receiving project.

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On February 1, 2008, Acting Deputy Assistant Secretary for Multifamily Housing Programs, John L. Garvin, issued HUD’s “Policy and Procedures on the Conversion of Efficiencies into One-Bedroom Units” in a memorandum to all multifamily hub directors and their staff.

The policy outlined in this long-awaited memorandum (the “Memo”) applies to many properties seeking to complete preservation transactions, but are not feasible because they need to convert efficiency units into one-bedroom units, including Sections 202, 811, 236 (insured and non-insured), and 221(d)(3) properties, to name a few. The Memo also applies to properties with project-based Section 8 HAP contracts, with or without an accompanying FHA-insured mortgage loan.

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The new policy outlines seven programmatic requirements that any application to convert efficiencies into one-bedroom units must satisfy. Among the criteria are the requirements that:

(i) the average vacancy in the efficiency units be at least 25% for at least 24 months of the preceding 36-month period;

(ii) on completion of the unit conversion, the project debt service coverage ratio must be 1.1 or greater;

(iii) the proposed conversion must only involve units of the same subsidy type;

(iv) the proposal must not result in an increase in the amount of existing budget authority available to the subject property;

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(v) the owner must be in compliance with all business agreements with HUD, and in the event of non-compliance the owner believes it will be cured through a conversion describing how and when compliance will be achieved. The Hub must concur that this will be the case;

(vi) a market study must be submitted to prove that efficiencies are not in demand in the market area and the converted units will be in demand; and

(vii) the proposed conversion must not result in any violation of Section 59444 of the Rehabilitation Act of 1973 or HUD's implementing regulations at 24 CFR Part 8 and 24 CFR Section 8.23.

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The new policy outlines additional program-specific requirements whose applicability depends on the type of subsidy available at the subject property. For example, in the case of a property with a project-based Section 8 HAP contract, post conversion rents must be established at the lesser of (i) the current one-bedroom rent or (ii) the combined unit rents of the two converted efficiency units. Future rent setting pursuant to MAHRA may be based on the new unit size. In addition, the Memo states that if Low-Income Housing Tax Credits (LIHTCs) are used in the proposed financing, the rents may not exceed the lesser of LIHTC rents or comparable market rents. This Section 8 rent cap marks a dramatic change in HUD’s Section 8 rent-setting policy and is at odds with MAHRA.

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Section 236 properties are also singled out for special treatment under this new policy. The Memo requires that in the case of a Section 236 property that receives interest reduction payment (IRP) subsidy, the IRP must be reduced in a manner proportional to the reduction in units, but the reduction does not take into account unit size, which will have an adverse impact on properties with larger-sized units. The Memo notes that whether the IRP must be reduced depends on the requirements in the original Section 236 mortgage.

Finally, the new policy requires that owners submit a conversion request application, in accordance with the requirements set forth in the Memo, including evidence of a notice, a comment period provided to residents, a sources and uses statement, and evidence of local government support.

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