TESTIMONY OF JEFFREY W. SACKS, ESQUIRE

before the
Commission on Affordable Housing and Health Facility Needs for Seniors in the 21st Century

September 24, 2001

Thank you for this opportunity to share with you my experiences representing non-profit developers of affordable housing for seniors. I have over 17 years of experience as legal counsel at Brown, Rudnick, Freed & Gesmer to a myriad of organizations which have developed housing for seniors. Since 1990, I have also served as a Commissioner of the Newton Housing Authority, of which I am currently Vice-Chair, which owns and operates over 500 units of affordable housing, primarily serving elderly residents. I would like to set out for you some of the primary concerns faced by my clients and my housing authority in serving the needs of elderly residents in the metro Boston area.

The main challenge facing all developers and operators of housing for seniors is the effective delivery of the range of services which our residents need to live comfortably in their apartments and remain in their community. One particular focus which I would like to highlight today is the importance of creating mixed income housing which can use market forces to provide access for residents the range of services needed. By creating projects of a large enough scale, mixed income developments can create a critical mass which can be a magnet for service providers allowing seniors to age in place.

In Newton, we developed hundreds of units of housing in the 1960's, '70's and '80's and rented them to seniors aged 62 and older. Over one third of our elderly residents are now over age 80. We struggle to find resources to bring services to our residents. This year in an experimental program with the City of Newton, we have utilized our precious reserve funds in a pilot program to fund a coordinator of services to try to bring into our housing some basic services which can make a big difference in our residents lives. For example, we have noted that many of our residents have had eye surgery requiring insertion of contact lenses. For some, this has meant repeated trips to the emergency room. By coordinating ten or fifteen minute visits for each of many residents, we are able to save these emergency room visits and make our residents safer and more comfortable in their units.

With the passage of Title VIII of the Affordable Housing for Seniors Act and Families Act (the "Act") last year, Congress directed the United States Department of Housing and Urban Development ("HUD") to allow non-profit sponsors to form partnerships and use low income housing tax credits in connection with the development of projects under the Section 202 Elderly Housing Program. My clients see this as an opportunity to expand the scope and size of Section 202 elderly developments to include units not subsidized under the Section 202 program which would serve low income and market residents. I think it is worthwhile to understand the likely structure of these deals in order to have a context for some of my recommendations to the Commission for the successful implementation of this.

For your reference, I have provided a chart of a proposed transaction. The following is an outline of the ownership and funding structure of a low-income housing project (a "Project") developed by a non-profit elderly housing corporation (the "Sponsor"), a portion of which would be developed under Section 202 of the Housing Act of 1959 ("Section 202"), and using the following sources of funds: (a) tax exempt bond financing from a housing finance authority (an "HFA") which issues tax exempt bonds, (b) grants from the United States Department of Housing and Urban Development ("HUD"), and (c) equity investment derived from low-income housing tax credits ("LIHTC"). The Sponsor may also utilize state and local soft debt and/or other grants and gifts raised by the developers. The Project is anticipated to include housing for elderly residents with a range of incomes: low, moderate and market rate.

The elements of the proposed ownership and funding structure are more fully set forth below:

1. Sponsor Forms a Non-Profit Corporation to Serve as Corporate General Partner. Sponsor organizes a new non-profit corporation (the "General Partner") which will seek an exemption under Section 501(c)(3) of the Internal Revenue Code. The Sponsor and the General Partner will have identical boards of directors. The General Partner will serve as general partner of the Owner Limited Partnership, as described in Item 2, below.

2. A For-Profit Limited Partnership Will Own the Property. The owner of the Project will be a for-profit entity, and its primary objective must be to develop and operate the Project for the benefit of low-income elderly as required under §891.205 of the HUD regulations. The Owner Limited Partnership will own the Property. The general partner (the "General Partner") of Owner LP will be a non-profit corporation which has been granted an exemption under Section 501(c)(3) of the Internal Revenue Code. The General Partner will control the Owner LP, and will have a .01% interest in the profits, losses and residuals of the Owner LP. The limited partner(s) will be private investors seeking the tax benefits from the low income housing tax credit. The investors will make equity contributions to the Owner LP in exchange for a 99.99% limited partnership interest in the Owner LP, pursuant to which the limited partners(s) will be allocated 99.99% of the Project's low-income housing tax credits.

3. Section 202 Capital Grant from HUD to the Sponsor. The Sponsor will apply for and receive a Section 202 capital grant from HUD.

4. Sponsor Loans Capital Grant Money to the Owner LP. The Sponsor will loan the funds obtained from HUD to the Owner LP, and Owner LP will be responsible for the management and operation of the Project. The loan will not require any current payment of principal or interest. The Sponsor will covenant to HUD that any repayment made will be used only for services to senior citizens in accordance with Sponsor's charitable purposes. The Owner LP will grant a second mortgage on the Property to the Sponsor to secure the loan of the grant funds. By borrowing the funds from Sponsor and utilizing the funds to construct units eligible for the LIHTC, the Owner LP will have tax credit basis in the expenditures. Sponsor will agree that, if requested by HUD following a default by the Owner LP, it will assign its mortgage interest in the Project to HUD. The second mortgage will contain all of the HFA's secondary financing provisions and requirements, including a prohibition on foreclosure without the HFA's approval. The grant will be nonrecourse to the Sponsor and HUD will agree to seek repayments solely from the Owner LP under the second mortgage in the event of a default thereunder.

5. Record Section 202 Affordable Housing Agreement. Owner LP, HUD and Sponsor will enter into and record an Affordable Housing Agreement which will limit the use of at least the units at the Property to "occupancy by very low income elderly persons for not less than 40 years," as required by Section 202(d). The Affordable Housing Agreement will also require the Owner to operate the Project and provide services tailored to the needs of elderly persons occupying the Section 202 units in the Property in accordance with Section 202(g), 202(i), and 202(j). Further, as discussed in Item 6 below, it will specify that the HFA will supervise the Project on behalf of HUD, pursuant to standards set forth in the HUD Regulations. This will ensure that, even if the Owner LP defaults on the HFA first mortgage (described in Item 8 below), and the mortgage is foreclosed, the Property will continue to be used in accordance with statutory requirements of Section 202. HUD should look to the model set forth in Section 8 of the United States Housing Act of 1937 for guidance in the creation of the relationship between the HFA and HUD. The HFA could contractually agree with HUD to administer the Section 202 grant, such that the HFA's duties would be clearly defined and independent of its role as a risk sharing lender.

6. Operations and Maintenance. While the Project will be operated in accordance with the HUD regulations and with the standards set forth in the applicable HUD handbooks, HUD will be requested to allow the HFA to have oversight of the administration and operation of the Project in accordance with the standards utilized by the HFA under the risk sharing program approved by HUD pursuant to Section 542(c) of the Housing and Community Development Act of 1992 and the regulations set forth in 24 C.F. R. Part 266. For example, the HFA will administer reserves in a manner which respects the needs of the overall development, while assuring that all HUD requirements and procedures and the needs of Section 202 Project are met. Specifically, for example, a Replacement Reserve account for the Section 202 portion will be maintained separately from that of the non-Section 202 portion of the Project. The Section 202 Replacement Reserve Fund will cover a portion of the cost of replacing common building systems equal to the proportionate number of Section 202 units in the whole Project, and any releases from the Section 202 Replacement Reserve Account will be subject to existing HUD guidelines and contract administrator or state HFA approval. To the extent that Owner LP's obligations under risk sharing conflict with those imposed by Section 202, the risk sharing requirements will supplant the Section 202 regulations. For example, if risk sharing requires the Owner to maintain larger reserves than would be required under Section 202, the Owner would satisfy the more stringent risk sharing requirement.

7. HFA Issues Tax Exempt Bonds. The HFA will issue tax exempt bonds to finance a portion of the costs of the Project, and will loan the proceeds to the Owner. The Owner's obligation to make debt service payments will be secured by a first mortgage on the Project, as described in Item 8, below. Debt service, however, will be paid from cash flow from the non-Section 202 portion of the Project. There will be no cash flow from the Section 202 portion of the Project. The PRAC subsidy described in Item 9, below, will not be utilized for debt service. Provided that the HFA bonds are subject to "volume cap," which requires the bonds to be "private activity" bonds, rather than 501(c)(3) bonds, and that the Owner LP finances more than 50% of the aggregate basis of the Property and any building situated on the land, the Project should qualify for 4% low income housing tax credits without need of any tax credit allocation. (IRC Section 42(h)(4)).

8. First Mortgage. As noted above, the HFA bonds will be secured by a first mortgage on the Project. The mortgage will be endorsed by HUD for risk sharing under Section 542(c) of the Housing and Community Development Act of 1992 and the regulations set forth in 24 C.F. R. Part 266. The HFA will underwrite the mortgage amount to be calculated solely on the cash flow of the non-Section 202 portion of the Project; the PRAC will not be pledged to pay debt service on the HFA mortgage and will not be included in the appraised value of the Project. Debt service coverage will be based solely on the non-Section 202 portion of the Project. The appraisal of the value of the Project will take into account the limitation on value of the Project created by the Affordable Housing Agreement described in Item 5, above. No cash flow from the Section 202 units will be included in the calculation of the appraised value of the Property. HUD must confirm that while the Affordable Housing Agreement will be senior to the first mortgage, but it is not a financing instrument, and will not be deemed a violation of the "first lien" requirements set forth in the 12 USC §1707.

9. PRAC Subsidy. Owner LP and HUD will enter into a Project Rental Assistance Contract ("PRAC") with respect to the Section 202 units in the Project. Pursuant to 24 CFR 891.400-891.490, the PRAC will require the Owner LP to comply with certain requirements and standards in connection with management of the Project. In return, HUD will commit to make rental assistance contributions toward operation of the Project based on the difference between the total tenant payment and the HUD-approved per unit operating expenses. In accordance with 24 CFR §891.400(e), the Owner LP will use payments by HUD under the PRAC solely to pay operating costs of the Section 202 units and will not use those funds to pay debt service on the HFA loan.

10. Cash Flow From Owner. Under the terms of the Section 202 Affordable Housing Agreement (Paragraph 5, above), the partners of Owner LP will not be entitled to receive any cash flow from net income on the Section 202 units. Cash flow from the Section 202 portion of the Project will be kept in a segregated Residual Receipts Account established in accordance with the terms of the Affordable Housing Agreement, and releases from said Account will be subject to prior HUD or contract administrator, or state HFA approval. Cash flow, if any, to the partners will be generated solely by the non-202 units.

RECOMMENDATIONS

1. HUD SHOULD IMPLEMENT THE SECTION 202 MIXED FINANCE PROGRAM WITHOUT REGULATIONS.

Section 803(b) of the Act makes clear that key sections are self-executing and do not require regulations. Handbooks and other guidance through the annual NOFA should be sufficient to allow HUD staff to implement the Act.

2. HUD SHOULD LIMIT ITS DIRECT ROLE IN THE DEVELOPMENT OF SECTION 202 MIXED FINANCE PROJECTS TO AWARDING THE FUNDS AND TO DELEGATE PROJECT UNDERWRITING AND ASSET MANAGEMENT FUNCTIONS TO ITS HOUSING FINANCE AGENCY PARTNERS.

Selection of projects for Proposed 202 awards is a core HUD function, which should continue to be handled by HUD staff through the NOFA process. HUD is charged to maintain the integrity and nonprofit character of the program through the sponsor/borrower approval process. Projects that envision the use of tax credits should not be required to be feasible without tax credits. HUD should require a letter from the allocating HFA (whether of bond cap with 4% credits or of 9% credits) stating that the project is eligible to apply for credits and that the sponsor be allowed 12 months from Section 202 award to obtain an allocation of bond cap or credits. To relieve the HUD staffing burden and to simplify the process for sponsors, HUD should also delegate underwriting and subsidy layering review be handled by the allocating agencies, which already have substantial experience doing so under existing agreements with HUD involving tax credit projects that also use CDBG, HOME, HOPE VI and other HUD-sourced funds. HUD should also delegate to HFAs the ongoing monitoring of regulatory agreements and other compliance.

3. HUD SHOULD DELEGATE ASSET MANAGEMENT FUNCTIONS INCLUDING ESTABLISHMENT OF PRAC SUBSIDY LEVELS TO ITS HOUSING FINANCE AGENCY PARTNERS.

HUD has experience in the public housing area with the utilization of statutorily defined operating subsidies in Mixed Finance developments which include tax credit and market units. Section 9 of the National Housing Act provides public housing subsidies which pay a portion of the operating costs of mixed finance public housing developments which may include tax credit and market rate units in addition to the public housing units which are subsidized by the Section 9 payments. Separate operating reserves are established in those developments to assure HUD that the public housing subsidy funds are utilized solely for the public housing units. Similarly, in Section 202/tax credit projects, the PRAC subsidies should be used solely to pay the operating costs and reserve contributions attributable to the Section 202 units and not to fund debt service or reserves for the non-section 202 units.

4. CONGRESS SHOULD CLARIFY SECTION 42(D)(5)(A) TO ADD PRAC PAYMENTS TO THE LIST OF SUBSIDIES WHICH SHOULD NOT BE TREATED AS FEDERAL GRANTS CAUSING REDUCTION OF TAX CREDIT BASIS.

Section 42(d)(5)(A) of the Internal Revenue Code currently lists several types of rental subsidy, such as Section 8 rental subsidy payments, which are deemed not to be federal grants for purposes of the reduction of a projects low income housing tax credit basis. Section 832 of the Act, provided that "notwithstanding any other provision of law, assistance amounts provided under this Section may be treated as amounts not derived from a Federal Grant." This language amended Section 202 (h)(6) of the Housing Act of 1959. Congress failed to make a similar adjustment to Section 42(d)(5)(A) of the Internal Revenue Code which creates some uncertainty among tax counsel with respect to the proper treatment of the PRAC payments. In the low income housing tax credit market place, this uncertainty may lead to inability of project sponsors to sell the low income housing tax credit project or may result in reduced payments for the credits by investors.

Thank you very much this opportunity to address you this morning. I welcome the opportunity to discuss any aspects of my testimony with you.