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Department of Housing and Urban Development

Recommendations and Actions

HUD04: Create an Assisted Housing/Rent Subsidy Demonstration Project

Background

The private owners of apartment projects constructed under the Section 8 New Construction and the Substantial and Moderate Rehabilitation programs have high rental income from HUD payments under their Section 8 assistance contracts. The above-market rents were part of the HUD program design. Some of those long-term contracts are now reaching the end of their terms with many more ending over the next decade. When those contracts end, the only funds available to make mortgage payments will be from rental at market rents (unless Congress appropriates more funds to continue above- market rent payments from HUD).

Many of these projects have FHA-insured mortgages in amounts significantly greater than the amount that could be justified by the inherent value of the real estate collateral. When the Section 8 rent assistance ends, HUD may face default on FHA mortgages. On the other hand, continuing Section 8 rent payments in excess of market values of apartments would only benefit project owners and private holders of FHA-insured mortgages (which may be at rates much higher than current mortgage rates and are, almost certainly, at rates higher than government borrowing rates).

The problem for HUD is made more complex by the negative tax consequences of mortgage forgiveness through negotiation or foreclosure for limited partner project owners. Such forgiveness of debt may be treated as income by the Internal Revenue Service (IRS). That may tend to make owners more inclined to lobby actively for continued subsidy support and/or to litigate foreclosure.

Many privately owned Section 8 assisted-housing projects have management problems similar to public housing. Tenant preference policies intending to concentrate scarce assistance resources to the most needy have resulted in concentrating the most needy into assisted-housing projects. The result is a lack of positive role models for youth and increased stigmatizing and resentment of project living. The very benefit intended for tenants is diluted by the reduced value and comfort of the housing development.

These tenants in HUD-assisted projects cannot achieve the position of a market-rate tenant (or Section 8 certificate or voucher-assisted tenant) who is a paying customer with the empowerment residing in that status. While the tenant in an assisted project can complain about deteriorating conditions, he or she cannot effectively "vote with the feet'' until the residence is so bad that its market value is lower than the assisted tenant's monthly payment. At that point, comparable bad housing is available at the same cost in the private, unassisted market.

This lack of leverage by the tenant in a HUD-assisted project creates a cushion for even well-intentioned property managers, permitting them to avoid many hard decisions, such as firing less-than- satisfactory maintenance staff or evicting disruptive tenants. Arguably, this is a key ingredient leading to the deteriorated state of much of the stock of public housing and assisted privately owned housing.

Some of the problems of HUD-assisted housing may be improved by shifting to market rents and providing tenants portable subsidies. The empowered tenants, who can move with the subsidy, will bring a market discipline to property managers, who will have to serve the paying customers. This will improve the efficiency and responsiveness of management, give more options to tenants, and, if some tenants do move out and are replaced by market-rate tenants, the stigma and negative effects of the low-income housing project will be ameliorated.

The needs of assisted tenants and the future problems of over- mortgaged projects are such that reasonable and flexible experimentation on a voluntary and negotiated basis would seem appropriate. This may produce some alternatives that could improve conditions for some tenants and be consistent with long-term goals of preserving the affordable housing stock. Indications are that some property owners would like to stabilize their projects by moving to market-rate rental with portable subsidies for the needy if the projects are viable and the interests of partners are respected.

Actions

1. On a demonstration basis, HUD should be authorized to conduct negotiated restructuring of assisted-housing projects.

HUD should have flexibility in negotiating the restructured projects, but each should be consistent with the following goals:

--- long-term opportunities for affordable housing should be preserved;

--- present and future tenants assisted by the project should have improved living conditions and have the ability to move with the value of their housing assistance;

--- HUD costs should be reduced, or at least not increased; and

--- the rights and legitimate interests of property owners and participants in HUD programs should be respected.

2. Demonstrations should include allowing project rents to float to market rates with tenants receiving their assistance in a portable format (like portable Section 8 certificates) to make up the difference between tenant contribution and the market rent.

A tenant will be permitted to take the value of the portable assistance and use it in any other unit of his or her choice. Funding of the portable assistance will come from conversion of some of the project-based Section 8 payments presently obligated to the project.

For the renegotiated project to be viable at market rents, the outstanding mortgage will have to be written down (reduced) to an amount supportable by the net operating income of the project. The written-down mortgages will be paid off and/or refinanced by HUD if to do so would be in the financial interest of the government, or HUD could continue to make an incremental payment on the outstanding mortgage with part of the continuing Section 8 project-based funds.

If an assisted tenant should leave a project with his or her portable assistance, the owner would be free to rent to an unsubsidized tenant at market rent. That would result in no income increase to the owner or diminution of the number of assisted tenants. The one assisted tenant who moved would simply be living in a different apartment because of personal preference.

3. If, over time, the market value and/or net operating income of the project improves because of better management or because of a better environment through improved income mix, the owner and manager should receive some of the benefit.

Most of the benefit, however, should flow to HUD to finance higher portable assistance payments for tenants living in the project and more portable assistance for tenants living out of the project.

4. Each demonstration should be structured so that HUD payments for the project, the obligations of the owner, and assistance to tenants would continue for at least as long as under contracts outstanding at the start of the demonstration.

Section 8 costs would not be permitted to exceed those that would otherwise have occurred without the demonstration. Also, no additional benefits would flow to the project owner unless accompanied by additional benefits to assisted tenants. Funding for assistance after current contract periods end would be available on the same basis (under the new arrangement) as for other expiring Section 8 projects.

5. HUD should work with IRS to explore ways to deal with competing public objectives of the tax code and housing programs.

For example, donation of a project to a nonprofit with mortgage write-down thereafter might meet the needs of project owners to avoid negative tax benefit recapture problems while still meeting public interests in tax collection and provision of low-income housing.

6. These demonstrations should be real experiments in modified approaches to assisted housing.

There should be a substantial research element structured to track tenant satisfaction, operating costs, neighborhood impact, project and HUD image in the community, and overall cost/benefit of HUD expenditures. The demonstration should be large enough to be statistically valid and should have comparable control units for comparison. Assisted housing is a major public activity and expenditure, and an important purpose of this demonstration would be to advance the state of the art.

7. HUD should seek legislation to shift multifamily projects from above market to market rents while protecting the existing tenants.

The legislation should enable HUD to restructure the debt at the time of contract renewal whenever possible and fiscally preferable. The renewals under the current rent formula should only be permitted if those rents are no greater or only slightly above the actual market rents. All other contracts should be renewed with the rents being changed to a budget-based formula with sufficient revenue to operate, probably with a restructured debt.

HUD should have the authority to reuse any Section 8 units that are not renewed and to convert some of these units to tenant-based subsides. HUD should also be able to use recaptured authority from current contracts for either project-based or tenant-based subsidies, as appropriate.

Implications

For the project owner, mortgage financing would be established at a supportable level without the uncertainty of potential foreclosure resulting from HUD failure to continue subsidies. HUD would be freed of the obligation to either maintain subsidy payments at high rent levels to the project owner or face a mortgage default. HUD would be able to continue subsidies on a market-rent, portable-subsidy basis, which is clearly better for the tenant and would result in a better tenant income mix, improve the value of the property for the long run, and ease management problems and costs.

The most important beneficiaries would be the assisted tenants. They would be empowered to deal with property management as would any equivalent market-rate tenant. As tenant income mix improved conditions in the development, assisted tenants would have an improved environment and lose much of the housing project stigma as they became indistinguishable from unassisted tenants in the same development.

Fiscal Impact

The demonstration activities should have no net fiscal impact. The full amount of Section 8 assistance funds that would otherwise have been spent under present contracts should be expended for tenant assistance. The benefit to tenants and neighborhoods, and thus the return on the taxpayers' expenditure, should be substantially improved.

Although HUD will have to pay off and write down insured mortgages to make outstanding mortgages reflect market values, that would merely recognize insurance fund losses already incurred. A loan that is viable only because HUD is making above-market rent subsidy payments is already a partial loss to HUD. In addition, if the interest rate on the loan is higher than the government borrowing rate, it may be a cost saving to recognize the loss and refinance the loan, paying off the amount not being amortized by the market income of the property.

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