In this Issue:
Multifamily Finance
A. HUD Delegation of FHA Processing
HUD’s Multifamily Accelerated Processing (MAP) will reduce HUD-FHA insurance processing times by delegating application review to mortgagees. The program will provide selected lenders with greater control over the process while giving owners less cumbersome and quicker treatment of applications.
A revised Multifamily Accelerated Processing Guide was posted on HUD’s Web site in March. FHA approved multifamily mortgagees may now apply as MAP processors. Potential applicants should review the MAP Guide, with attention to Chapter 2, containing lender requirements.
HUD’s initial deadline for applications from MAP lenders ended on May 2, 2000. Lender packages submitted after May 2 will be grouped for processing at a later date. Announcement of approval or disapproval of initial applicants is scheduled for the first week in June.
B. 100 Percent Debt/Equity Financing
We have previously discussed in the Housing Update a new participation loan program which reintroduces the availability of 100 percent financing for profit-motivated developers of HUD-insured multifamily projects.
On April 18th, we assisted American Mortgage Acceptance Company (AMAC), a publicly traded company and an affiliate of Related Capital Company of New York, in closing a total participating finance loan package of $10,495,300. The package included a 221(d)(4) FHA Insured Mortgage for $8,946,100 and an Equity Loan of $1,549,200 to principals of the Borrower. The property was a new construction apartment project in Greenville, North Carolina.
The Loan represents a breath of new life for a program popular about six years ago. In essence, 100% financing is offered in exchange for negotiated percentages of excess cash and residuals generated by the property. We have been advised by AMAC officials that the new variation offers more "humane" terms to borrowers than were available under many of the older variations on the basic theme.
Participation loans for HUD-lending transactions, while common earlier in the decade, fell from favor with lenders as demand for conventional lending methods increased and interest rates decreased. The FHA participation mechanism, however, served developers of viable projects well by providing favorable interest rates available under FHA programs while requiring little or no up-front investment on the part of the borrower. For-profit owners were able to obtain up to 100 percent financing; a leverage rate which is generally only permitted, if at all, to strong non-profit organizations through the use of complex financing structures.
Under the new participation program, developers obtain FHA-insured mortgages which are purchased by AMAC. As a rule, HUD guidelines allow no higher than a 90 percent loan to value ratio, with the shortfall in loan proceeds over costs being supplied by owner equity investment. Under the AMAC model, the equity requirement is satisfied by additional uninsured debt. This second debt is secured by subordinate mortgages, which are repaid from surplus operating income and residuals produced by the project.
Our lawyers were among the most active in this type of financing in the early 1990s and look forward to the success of AMAC’s program.
Tax Credits and Tax-Exempt Bonds
A. Prepayment of Bonds for Tax Credit Projects
Although the IRS had previously provided similar guidance, three recent Private Letter Rulings have again indicated that tax-exempt bonds issued to finance a portion of a tax credit project may, at least in some circumstances, be repaid immediately upon the project being placed in service, without causing the loss of LIHTC benefits. The three PLRs, 200006020, 200006021 and 200006022, were substantively similar. All three described a limited partnership or limited liability company owner utilizing tax-exempt bonds issued to finance the construction or rehabilitation of a low-income housing project. In each case, at least 50 percent of project basis was financed with bond proceeds, allowing the benefit of low income housing tax credits to be obtained without need for an allocation of state volume cap.
Each PLR also noted that additional incentives were available to the projects, including property tax abatement certificates and favorable permanent loan terms, but that taking advantage of these incentives required the tax-exempt bonds to be repaid upon project completion. As a result, the project owners intended to redeem the tax-exempt bond immediately upon the projects being placed in service, and asked the IRS if this redemption would cause a loss of eligibility for the "automatic" 4 percent credit. The IRS stated that the redemption of the bonds at any time on or after the date on which the projects were placed in service would not result in a determination that the project was not financed with tax-exempt bonds for the purposes of the 4 percent credit.
B. Tax Credit and Bond Financing for Assisted Living
Another recent Private Letter Ruling, 199949044, appears to have indicated an expansion in the permitted use of tax credits for assisted living, and has surprised some tax credit and tax-exempt bond practitioners. Prior to release of a 1998 Revenue Ruling, Rev. Rul. 98-47, there was some ambiguity in determining the eligibility of elder care and other assisted living facilities for financing with private activity housing bonds. Although the Ruling may have expanded somewhat on the circumstances under which such facilities could qualify as "residential rental properties" for exempt bond financing under Section 142 of the Internal Revenue Code, it had generally abided by the expectations of those practicing in the affordable housing field. The Revenue Ruling did not revise the requirement that each rental unit must contain a full complement of amenities, including separate bathroom, living quarters and functioning kitchen, nor go far outside of what had been commonly understood to be appropriate limits on tenant services. Of some note, Rev. Rul. 98-47 did clarify that rules governing whether elder care facilities qualified as "residential rental property" for low-income housing tax credit purposes were generally the same as those that applied to low-income housing bonds.
The new Private Letter Ruling, however, has muddied the waters a bit. The IRS appears to have approved the eligibility of an assisted living facility for tax credits, even though that facility would not be considered residential rental property under guidance available concerning tax-exempt bond financing.
Under Section 142, tax-exempt bonds are available to qualified residential rental properties, but not to nursing homes or dormitories. Prior to 98-47, projects that provided rental units exclusively to the elderly and also provided services for the care and special needs of these tenants, often did not appear to satisfy the non-transient requirements of the definition of "residential rental properties." Under prior guidance, the IRS had even considered projects with complete residential facilities in each unit (kitchens, bathrooms, etc.) to be more akin to nursing homes than residential rental projects, where such facilities offered broad nursing or care services and included costs of meals served in common dining rooms in each tenant’s rent. Rev. Rul. 98-47 allowed that a project providing rental units to elderly with special needs and providing services beyond those generally required by more able rental housing tenants might still be qualified as residential rental housing, if the project offered residents fully appointed residential units, including separate kitchens, and did not provide continual or frequent nursing or medical care.
Rev. Rul. 98-47 set out three scenarios and circumstances of three separate properties. All catered to the elderly. All offered, as part of the tenant monthly rental payments, laundry, housekeeping, 24-hour monitoring emergency call devices in each unit, and regular daily meals in a common dining room (although each unit contained a full kitchen).
The first building provided no other services.
The second building also offered technicians for medication management and intake, consultations with a nurse if needed, and assistance during waking hours by non-medically certified aides for assistance in dressing, eating and bathing. Continual nursing or medical services were not available.
The third building offered all of the services of the second, but also provided tenants with registered nurses on duty 12 hours each day, licensed practical nurses on duty 24 hours a day, and nurses to provide care for medical or psychiatric needs.
Guidance available concerning Section 142 prior to the ruling would have given an uncertain qualification to the second building. Although each unit in the facility was complete, the cost of common meals included in rent and the level of care provided tended to show that the facility would not be properly classified as residential rental. Nevertheless, the IRS stated that for the purposes of 142, guidance provided under low income housing tax credit regulations should be applied. Regulation Section 1.42-11 distinguishes health care facilities from residential properties by focusing on the nature and degree of services provided by the facility. Rev. Rul. 98-47 stated that building three of the above scenario was not residential rental due to the degree of services provided (referring to the licensed nurses available for medical services at all hours), but that the second building with a lesser degree of care was indeed a residential rental property eligible for financing with tax-exempt bonds.
This ruling was in line with prior IRS authority, limiting the level of continuous care, and maintaining that all living units in each apartment be fully functioning and include adequate food preparation facilities. By its reference to Section 42 of the Code, the Ruling appeared to also acknowledge that the residential rental rules applying to tax-exempt bonds also applied to tax credits.
Nevertheless, PLR 199949044 seems to have instigated a schism between qualification of housing for bonds and for tax credits. The PLR provides a scenario in which tax credits are permitted for a project providing services to tenants needing assistance with living, but not providing "continual or frequent nursing, medical or psychiatric services." The subject project offered tenants travel escorts, adult day care/socialization activities and essential shopping, health maintenance, housekeeping and laundry services, as well as medication assistance and other personal care services, but the availability of registered nursing staff was limited, with non-licensed personal care assistants providing aid to quadriplegic and mobile ventilator-dependant tenants.
The level of care available at the project, as well as the nature of the disabilities of some of the tenants, does seem to expand on allowable tenant services for tax credit residential rental properties. Additionally, the PLR indicates that each project unit had a bedroom and bathroom, but kitchen, living and dining facilities were communal.
The subtle increase in allowable care services, and the recognition of eligible residential rental housing where tenant units do not contain complete living facilities, is a departure from prior guidance. Additionally, in again noting that tax-exempt bond and tax credit standards for residential rental housing are the same, the IRS appears to have expanded the use of both financing tools for assisted living.
Developers of assisted living or elder care facilities should be aware that private letter rulings do not provide precedential guidance. They may not be relied upon by any party other than those to whom they are addressed. The variance of the new ruling’s standards for residential property and that of prior rulings concerning tax-exempt bond projects causes the PLR to be of questionable authority. Those intending to build assisted living projects with bonds or tax credits should consult knowledgeable counsel before moving forward, where plans provide for high levels of tenant care or limited tenant facilities.
Section 8 Contracts
(Expiration and Renewal)
Owners, potential purchasers and lenders each have an interest in the level of rents available to projects with expiring Section 8 contracts. Although an owner’s concern for continued income stream is obvious, purchasers and lenders also pay great attention to HAP contract renewal potential as the art of underwriting subsidized projects becomes less certain. Section 8 renewal procedures and terms were once again fine-tuned by Congress during last year’s passage of the VA/HUD appropriations bill. In the Preserving Affordable Housing for Senior Citizens and Families Into the 21st Century Act of 1999 (the 2000 Act) Congress made several revisions to the Multifamily Assisted Housing Reform and Affordability Act of 1997 (MAHRAA) in an effort to further reduce Section 8 opt-outs and provide greater assistance to low income families, where such opt-outs cannot be avoided.
HUD did not delay in addressing changes made by the 2000 Act, and, in December, released comprehensive instructions for owners of properties with expiring Section 8 contracts. The new notice, H99-36, supercedes prior Notices H98-34, H99-08, H99-15 and H99-32, consolidating procedures and requirements into one lengthy document, which includes sample forms, notices, schedules, renewal contracts for several circumstances and step-by-step instructions for owners.
Current renewal procedures provide several options to owners depending on their circumstance. Mark-Up-to-Market procedures instituted by HUD last year as an "emergency initiative" are now explicitly authorized by statute, and contracts that would have been renewed at current rents under MAHRAA are now generally renewable at rents increased to market levels or at current rents adjusted by an Operating Cost Adjustment Factor (OCAF). Rules governing nonprofit-owned projects and renewals involving sales to nonprofits have been modified, and HUD’s authority to offer Section 8 contract renewal terms of up to five years is now being implemented. Notice H99-36 also includes some new guidance for LD owners and BMIR projects, and we have recently concluded a successful restructuring with HUD and local authorities of a Mark-up to Market project, including the renegotiation of terms for the project’s flexible subsidy use agreement.
A. Notice Requirements and Comparability
The threshold questions that must be answered for each project prior to planning for contract renewal or opt-out have not changed. Owners must determine if their current subsidized rent levels are greater than those of comparable properties, and whether they have provided the notices necessary to undertake the course of action they desire. In order to leave their options open, project owners should review their HAP contract expiration dates and mark their calendars, noting the dates that are one year, 120 days and 90 days prior to expiration.
Notice Requirements:
One Year Notice. Owners are required to give tenants and HUD notice of contract expiration one year prior to the end of their current HAP contract term. Notice H99-36 contains suggested language for this notice, specifying whether the owner intends to renew or opt-out of their HAP contract upon expiration. However, one year prior to contract expiration, owners are not likely to have finally determined whether or not they will renew. Despite the suggested language, owners are not required by law to notify HUD or tenants of their intent to renew or opt-out at the time of this one-year notice. Owners are better served to provide the notice of termination with a statement that the contract may or may not be renewed at the end of its term. To lessen the concerns of project tenants, the owner should include specific language, which is required by the 2000 Act, describing the possibility of HUD and the owner reaching an agreement on contract extension and the potential for tenant-based assistance if no such agreement is reached.
120-Day Notice. Owners must decide whether they will renew, opt-out or enter Mark-to-Market not less than 120 days prior to contract expiration. Notice of their selected course must be provided to HUD. For most renewals, this will also require the preparation and delivery of a comparability study prepared by an independent appraiser.
90-Day Notice. Although not specified in H99-36, owners intending to opt-out of the Section 8 program and subsequently raise rents should be aware of an additional 90-day notice requirement. Regulations concerning tenant notice of opt-out and rent increase have not been modified by the 2000 Act. For HAP contracts entered into after October 1, 1981, or renewed or amended after October 1, 1984, a project owner choosing to opt-out must provide each subsidized tenant with notice of any increase in the amount the tenant will be required to pay. The notice must be delivered by first class mail and by personal delivery to the tenant’s unit. The 90-day notice should state the date on which the HAP contract will expire, an estimate of the new rental charges, and the increase in required tenant contribution. A certification by the owner that appropriate notice was given must also be delivered to HUD.
Comparability Study.
In most cases, an owner choosing not to opt-out at contract expiration must provide a comparability study to HUD along with the 120-day notification (exceptions noted below). Comparability studies must be prepared following the instructions contained in 99-36, although the rules for completing the study have not been substantively modified from prior guidance. Except for projects that have received prior one-year extensions, the study delivered to HUD must have been completed by a licensed appraiser within 90 days prior to submission.
The comparability study, prepared at the owner’s expense, is then reviewed by HUD. For other than Mark-Up-to-Market renewals (described below), HUD is not required to obtain its own comparability study for comparison to the owner’s. Instead, the Hub Director may use judgment in accepting or rejecting the owner’s market evaluation. The owner must appeal any rejection within 30 days.
For Mark-Up-to-Market renewals, HUD will obtain its own market study, and H99-36 provides a specific methodology for evaluating the owner and HUD results to determine a final comparable market rent level for the property. According to the Notice, owners are not permitted to negotiate or appeal HUD’s final Mark-Up-to-Market determination. In practice, however, we have found HUD offices willing to work with the owner in resolving discrepancies between owner and HUD studies.
B. Below Market Properties
Mark-Up-to-Market.
The most popular option for owners of eligible projects with current rents below comparable market levels will likely be renewal of their contracts at subsidized rents increased to market levels. HUD’s "emergency" Mark-Up-to-Market initiative, as proscribed by Notice H99-15, was authorized by specific statutory provisions of the 2000 Act. Notice H99-36 describes the Mark-Up-to-Market treatment now available, and implements some modifications to the prior initiative, including increased eligibility for nonprofits.
Eligibility.
To be eligible for Mark-Up-to-Market upon contract expiration a project must have current rents set below comparable market rents and:
for the most recent assessment, have received a Real Estate Assessment Center (REAC) score of 60 or greater with no uncorrected Exigent Health and Safety (EHS) violations
be owned by a for-profit or LD owner (nonprofit exceptions discussed below)
have comparable market rents greater than 110 percent of FMR
not be subject to an extended affordability use restriction which cannot be eliminated by unilateral owner action (e.g. Flexible Subsidy, Tax Credit restrictions, some tax-exempt bond use agreements) (some exceptions available as discussed below)
not be owned by an entity that has engaged in material adverse financial or managerial actions or omissions with respect to the project or other federally subsidized or insured projects (Bad Owner).
Contract Term. All projects renewed under Mark-Up-to-Market will be renewed for a five-year term. Although the owner will be obligated to extend the contract each year during this period, HUD’s obligations will be contingent on appropriations.
Contract Rents. Contracts renewed under Mark-Up-to-Market will have rents set at the lesser of 150 percent of FMR or comparable market levels.
Some exceptions to this 150 percent of FMR cap are available. HUD will consider rent increases above the 150 percent threshold for projects that (i) have a high percentage of elderly, disabled or large family tenants, (ii) are located in low-vacancy areas, or (iii)are a high priority for the local community (demonstrated by local or state contribution of funds).
Rents during the term of the new HAP contract will be adjusted each year by an Operating Cost Adjustment Factor (OCAF), which will be published by HUD for specific geographical areas.
New Nonprofit Provisions.
Nonprofit-owned projects had not been eligible for Mark-Up-to-Market under HUD’s Emergency Initiative. H99-36 modified this limitation. The Notice now allows for Mark-Up-to-Market treatment of projects if it will facilitate a change in ownership from a for-profit to a nonprofit, or from a nonprofit to another nonprofit. To be eligible for this treatment, the project does not have to meet the eligibility criteria listed above. Practically, this means that if HUD considers the project owner to be a bad owner, or if the project is falling apart, it will do what it can to get rid of the current ownership. We are finding HUD very receptive to owner proposals for nonprofit transfers.
The new nonprofit owner must demonstrate that it has financial and managerial capacity, as well as ties to the neighborhood. The nonprofit Mark-Up-to-Market treatment is also available to tax credit partnerships with a nonprofit general partner. As a final incentive, nonprofit transfers are also automatically eligible for rent increases to market levels that exceed the 150 percent of FMR cap applicable to other projects.
For projects currently owned by nonprofits, but not involved in a transfer as described above, there is a budget-based mark-up option. This option allows nonprofit owners to receive a mark-up of subsidy rents at contract expiration for capital repairs that will maintain the financial and long-term physical viability of the project. The rent increase will be budget-based, may include the cost of increased debt service and must not exceed comparable rent levels. To be eligible, a nonprofit-owned project must have a REAC score greater than 30 and the rent increase must be used toward (i) necessary capital projects (e.g., lead-based paint, energy efficient development, etc.) or (ii) providing for a return on investment to the nonprofit owner.
For a rent increase requested for capital improvements, the nonprofit must submit a Comprehensive Needs Assessment, a financing plan under which the owner demonstrates that it can raise at least 10 percent of the estimated costs from other funds, and a revised estimate of replacement reserve deposits. It is foreseen that the increased rents will be used in conjunction with a refinancing or additional debt.
In return, the nonprofit owner must execute a 20-year use agreement and must meet certain other criteria described in H99-36.
Renewal At Current Rents.
If a project is receiving rents below or at comparable levels, the owner may also request renewal at current rent levels. This option is available to projects not meeting Mark-Up-to-Market eligibility requirements.
Contract Term. Owners renewing under this provision are not required to accept a five-year contract. They may request renewals from one to five years. Subsequent renewals must be requested in accordance with procedures outlined in H99-36, assuming they are not changed by the time the renewed contract expires, but at this time will not require submission of a new comparability study.
Contract Rents. Rents for contracts renewed under this option will be set at current levels adjusted by an OCAF or, at the owner’s request, by a budget-based increase, not to exceed market rates. Future renewals will also be adjusted by an OCAF or budget-based review.
C. Above Market Properties
Owners of projects with subsidized rent levels exceeding comparable market rents may choose to renew their contracts at levels reduced to comparables (commonly referred to as "OMHAR lite" treatment) or may enter the Mark-to-Market program; although some exempted high rent projects may renew at current over-market levels. Given the lack of Mark-to-Market activity, it appears that most owners, not otherwise exempt, are overwhelmingly selecting to opt-out or renew under reduced OMHAR lite subsidy levels.
OMHAR Lite.
Some owners of over-market properties may choose to avoid Mark-to-Market treatment (described below) by accepting renewal of their HAP contracts at reduced comparable market levels. Notwithstanding this selection, however, the project’s application for renewal will be forwarded to the Office of Multifamily Housing Assistance Restructuring (OMHAR).
Owners selecting OMHAR lite treatment must submit a comparability study along with their request, demonstrating that project rents indeed exceed comparables. The owner’s request will be forwarded to OMHAR for determination of eligibility. According to the Mark-to-Market Program Operating Procedures Guide, the owner must also submit to OMHAR the most recent audited financial statements for the project, and an owner evaluation of physical condition. OMHAR or a Participating Administrative Entity will then determine whether the project, with reduced rents, will continue to meet an appropriate debt service coverage ratio, whether the project is in good repair with sufficient reserves, and whether the current project management is competent.
The owner may be required to notify tenants and other interested parties of the availability of the evaluation of physical condition and the comparable rent study, and these parties may comment over a 30-day period. After a few more administrative processing hurdles are met, the owner will execute a new Section 8 contract with HUD, with new rents set at comparable market levels.
Above-Market Projects Exempt From OMHAR.
Certain projects were exempted from Mark-to-Market treatment under MAHRAA. Though they may currently have rents greater than market, they are not required to be submitted to OMHAR for renewal approval. These projects include: (i) projects with primary financing or mortgage insurance provided by a unit of state or local government and restructuring would conflict with local law or agreements, (ii) Section 202 and Section 515 projects, (iii) Projects subsidized pursuant to Section 441 of the Stewart B. KcKinney Homeless Assistance Act (SRO Mod Rehab), or (iv) projects without FHA-insured mortgages.
If these projects are subsidized by HAP contracts providing below-market rents, they may renew pursuant to the Mark-Up-to-Market procedures described above. If, however, they are receiving rents greater than market, they are permitted to renew at the lesser of (i) a budget-based rent level or (ii) current rents adjusted by an OCAF. These renewal options may allow the owner to continue receiving rents at greater than market levels, if a budget-based review demonstrates the need for such rents, or if current rents are below budget-based needs, but in excess of market.
Budget-Based Renewal. Owners selecting the budget-based renewal, at rent levels below current rents, need not submit a comparability study. Instead, they must prepare the budget review in accordance with H99-36. If, however, the project has had a budget approved by HUD less than one year before the owner’s renewal submission, a copy of that budget may be submitted in lieu of a new budget. If an owner chooses to submit the prior approved budget, the renewal rents will remain the same as the previous year. Owners desiring a rent increase through the budget-based renewal must submit a new budget.
Current Rent with OCAF Renewal. OMHAR exception project owners requesting renewal at current rents adjusted by an OCAF must also submit a budget review, in order to demonstrate that current OCAF-adjusted rents are indeed less than budget-based subsidy would provide.
Mark-to-Market, Portfolio Reengineering Projects.
For projects that are not exempt from OMHAR, as described above, and with owners that do not wish to opt-out or renew their HAP contracts under OMHAR lite, Mark-to-Market is the sole remaining option (except in limited exception described below).
Although application to the Mark-to-Market program does not require a comparability study, the reengineering process entails extensive review and investigation of a project’s financial, physical and operational character. A project undergoing Mark-to-Market treatment can be expected to have its primary financing reduced or bifurcated into performing and subordinate debt, allowing for a corresponding reduction in Section 8 subsidy levels. The program requires the owner to execute a 30-year use restriction, similar to that utilized for low-income housing tax credits, and reviews the benefits of tenant-based rather than project-based subsidy. Owners are required to fund a portion of necessary rehabilitation, as determined by OMHAR or a Participating Administrative Entity, but may undertake Mark-to-Market in conjunction with a transfer to certain nonprofit organizations.
Although final Regulations for Mark-to-Market were only recently published in the March 22, 2000 Federal Register, the substantive changes made to the rules which have been in effect for over a year and a half now are few. Of note, the new Regulations allow HUD discretion to reject a project where an affiliate of the project’s owner is debarred or suspended. The prior rules had required HUD to reject such a project from the reengineering process. The new regulations also account for the statutory change instituted by the 2000 Act, exempting ELIHPA and LIHPRHA preservation projects from Mark-to-Market treatment.
Nevertheless, the modifications made by the final regulations do not warrant extensive review here. For a summary of the Mark-to-Market program and procedures, see our September/October 1999 edition or an article written by Pepper’s own Sheldon Schreiberg and Scott Fireison, published in the August 1999 issue of Multifamily Executive. D. ELIHPA and LIHPRHA Projects
MAHRAA failed to take into account the long-term use agreements and approved Plans of Action (POAs) entered into between HUD and owners of preservation projects. As a result, the owners were forced into the Mark-to-Market framework without the benefit of bargains already made. The 2000 Act corrected this deficiency, and has now exempted ELIHPA and LIHPRHA projects from other HAP contract renewal limitations. Preservation projects will now be renewed according to the terms of their POAs. For those projects that had renewed under prior guidance, upon the expiration of their current contracts, HUD will now calculate the rent levels which should have been instituted under their POAs and will set rents accordingly.
E. Sections 236 and 221(d)(3)BMIR Projects and LD Owners
Sections 236 and 221(d)(3) BMIR projects receive the benefit of below market interest rate loans or interest subsidy. These projects are, however, eligible for Mark-Up-to-Market if they are not otherwise subject to an extended use agreement. Notice H99-36 provides the methodology by which these projects can receive increased subsidy upon HAP contract renewal, while limiting these increases to account for the interest subsidy.
The new guidance also allows an increased distribution to LD owners renewing pursuant to the Mark-Up-to-Market procedures described above. Effectively, the owner is entitled to a distribution increased by the full amount of the rental increase realized upon the marked-up contract renewal. ‚
The deadline for HOPE VI grant applications is approaching. Revitalization grant applicants must make their submissions no later than May 18, 2000. Demolition grant applications are due June 14. Although 2000 HOPE VI funds will be available to a few PHAs, many smaller authorities, or those with less success in the NOFA process, may nevertheless undertake significant capital improvement and development utilizing other mixed-finance mechanisms. In addition to benefitting from private financing sources, however, PHAs are also experiencing the same difficulties encountered by private owners subject to HUD’s Uniform Physical Condition Standards. Instituted in September of 1998, the physical inspection program has caused owners throughout the country significant difficulty, and has failed to provide consistent and reliable results. The recently amended Public Housing Assessment System (PHAS) includes a physical evaluation under HUD’s Uniform Physical Condition Standards. As HUD moves forward with final implementation of PHAS, PHAs have raised those same concerns voiced by private industry with regard to physical inspection and scoring procedures.
A. 2000 HOPE VI NOFA
Approximately $563.8 million is available in this year’s HOPE VI NOFA. Revitalization grants will account for $513 million, with the remaining $50 million allocated to demolition projects. Eligible applicants include (i) any PHA not designated as "troubled," (ii) any PHA for which a private housing management agent has been selected or for which a receiver has been appointed, or (iii) any PHA that has been designated as "troubled" but is designated for reasons that will not affect its capacity to carry out revitalization, is making substantial progress toward correcting its troubled status, or is otherwise determined by HUD to be an acceptable applicant.
HUD will rank applicants on a scale of 100, with two bonus points available to projects planned for Empowerment Zone/Enterprise Communities. Points will be awarded in 24 subcategories consolidated into five sets, including: Capacity (20 points); Need (20 points); Soundness of Approach (40 points); Leveraging Resources (10 Points); and Coordination and Community Planning (10 points).
Despite Congressional and Administration support for the HOPE VI program and large appropriations each year, many cities have undertaken plans for public housing revitalization without expectation of award. We have worked with smaller housing authorities in Pennsylvania, Kentucky, Arizona and other states moving forward with substantial rehabilitation and new construction projects by taking advantage of other tools now available for public housing revitalization efforts.
The Quality Housing and Work Responsibility Act of 1998 (QUAHWRA), passed as part of the FY 1999 VA/HUD Appropriations Act, included many provisions that allow these entrepreneurial PHAs to accomplish redevelopment goals by utilizing private funding and other sources, including tax credits, tax-exempt bonds and FHA insurance, as well as other available state and local programs.
Public housing authorities now regularly look to innovative ownership structures for new public housing stock. With QUAHWRA provisions for greater flexibility in the use of operating funds, as well as joint-ownership structures, operating fund subsidies and capital funds may now be contributed to projects owned by LIHTC partnerships, nonprofit PHA affiliates or other privately owned entities operating under a PHA ground lease or PHA right of first refusal.
Tax credit units may also be combined with public housing units in a single project, where rents for tax credit tenants may be set at the maximum for the LIHTC program, while retaining rents for public housing residents that do not exceed public housing limits.
The formation of PHA-affiliated nonprofit organizations is no longer uncommon. We have been involved in the formation of several new nonprofits controlled by a PHA or jointly controlled by a PHA and another local authority. The new nonprofit is treated as a separate entity for financing and contracting purposes and is generally free to operate as a private developer to the extent permitted by the PHA parent. By acting as owner or general partner of a tax credit partnership owner, the PHA’s nonprofit affiliate is able to attract debt and equity by offering recourse to lenders and investors which could not be provided by a PHA without HUD approval. The PHA parent may commit subsidy to the new project to meet underwriting criteria of lenders or bondholders, and the nonprofit may choose to contract with the PHA for management services. The PHA manager is therefore able to ensure the maintenance of each project as a well-run community asset, while sponsoring affordable housing development beyond what would be permitted by public housing capital funds alone.
Although HOPE VI appropriations will continue into the foreseeable future, those PHAs that learn to work outside of the traditional public housing regulatory and funding framework will be successful in meeting their communities’ needs whether HOPE VI is available or not.
B. HUD Inspections and PHAS
"Final" rules implementing PHAS were issued on September 1, 1998, and became effective in October of that year. These rules were to be applied to all PHAs with fiscal years ending on or after September 30, 1999. Due to pressure from Congress, HUD delayed implementation of the program for another year while the Government Accounting Office analyzed PHAS procedure and results, and PHAs were permitted additional comment time. Subsequent proposed rule changes and description of PHAS scoring indicators were published on June 22 and 23, 1999. During the 1999 delay in PHAS implementation, PHAs were inspected and reviewed under existing PHAS guidance, but were only issued advisory reports.
On February 1, 2000, HUD issued its revised final rules for PHAS. The rules became effective on February 10, 2000, but have not yet been fully implemented. HUD officials and other speakers were questioned during a March 21 Senate housing subcommittee hearing concerning PHAS. Despite statements by several senators of their preference that HUD further delay final implementation of the PHAS program, Secretary Cuomo has indicated HUD’s intent to move forward without delay.
Under PHAS, housing authorities will be evaluated based on four indicators: (i) the physical condition of their properties; (ii) their financial condition; (iii) their management and operations; and (iv) the results of tenant surveys.
Although difficulties exist in all four indicators, the review of physical condition utilizing HUD’s current Uniform Physical Condition Standards (UPCS) may be most troubling. The UPCS, as initially published on September 1, 1998, provides for REAC contractors to perform physical inspections of public and privately owned HUD assisted housing. During 1999, PHAs have almost universally come to agree with what many private owners had been saying over the same period. The UPCS procedures have only served to allow for apparently arbitrary and random results, and have not served as an adequate and consistent indicator of property maintenance and condition.
We have seen regions of the country where a single REAC inspection contractor has been responsible for the extraordinary failure of an overwhelming majority of publicly and privately owned properties. Private owners are simply referred to the HUD enforcement center, where they often must arrange for a reinspection, only to have it confirmed that the initial inspector had been over-enthusiastic. Even with enforcement center clearance, these projects, however, continue to be marked with an unacceptably low REAC score, thus limiting the ability of owners to sell or to benefit from Mark-Up-to-Market Section 8 treatment. PHAs with low scores will now be referred to a Troubled Agency Recovery Center.
Although the appeal process provided to private owners is also available to PHAs, they are likely to find that the 30-day deadline for appeal requests does not provide enough time to gather photographic and other evidence necessary to submit the appeal. This is most often due to findings of multiple minor deficiencies, where better judgment might have found none, but, nevertheless, now require extensive time and documentation to disprove.
PHAs were successful in lobbying HUD to make some common sense revisions in the final PHAS rule, as well as the UPCS Dictionary of Deficiency Definitions. The new PHAS rule acknowledges that local housing and safety codes may now be taken into account, where they conflict with HUD guidelines. UPCS inspectors may now also consider modernization work in process rather than posting negative findings due to holes in walls where construction work is obviously taking place. PHAs are also granted the ability to review and comment on inspection before they are made final, and aggregate adjustments for building age and depressed neighborhood conditions may also be applied to physical condition scores.
Despite some revision to the PHAS final rules, physical inspection scores will likely continue to be a source of discomfort to PHAs. The new rules leave several troubling provisions unchanged, and do not address the fact that there are thousands of points in potential deductions available in a physical inspection system that is scored on a 100 point scale.
The Housing Update is a publication of Pepper Hamilton llp. The material contained herein is based on laws, court decisions, administrative rulings, and congressional materials and should not be construed as legal advice or legal opinions on specific facts.
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