On April 29, 1999, HUD Secretary Andrew Cuomo held a press conference describing a new plan for preserving Section 8 properties. Effectively immediately, HUD is authorizing its field offices to negotiate with owners of projects with project-based Section 8 contracts to renew for a five-year term and to mark the rents up to local market rent levels. The purpose of this new plan is to stem the tide of owners who are seeking to opt out of Section 8 due to the disparity between market rent levels and allowable rents under Section 8 contracts. Secretary Cuomo also indicated a concern for substantial confusion created by tenants receiving annual notices that there Section 8 rent subsidy may be terminated.
As of this writing, the formal implementation notice has not been issued, but rather only informal guidance. Also to be addressed in the formal notice will be guidance as to resolving conflicts between the new policy and projects covered by Section 8 contracts which were entered into in conjunction pursuant to a “Plan of Action“ approved under the Low Income Housing and Preservation Act (LIHPRHA), or the Emergency Low Income Housing Preservation Act (ELIHPA). In broad terms, the new policy affects older Section 221(d)(3) and Section 236 projects. To be eligible, the project must be owned by a profit-motivated entity, and project rents must exceed 110% of the fair market rents published by HUD.
According to William Apgar, Assistant Secretary for Housing, a third-party market study will be used to determine market rent levels. Apgar stressed that there will be an effort to ignore the HUD-published Fair Market Rents (FMRs). The focus will be to determine the true market rents for the covered units given their location and comparable housing in the immediate vicinity of the covered project.
HUD's NEW INITIATIVE TO GET THE LEAD OUT
The HUD Office of Lead Hazard Control, and the HUD General Counsel's Office of Finance and Regulatory Enforcement, in conjunction with the Environmental Protection Agency, are undertaking a 25-city lead-based paint enforcement initiative. HUD is focusing both on federally-assisted and market-rate apartment complexes built before 1978. Though this is a joint effort, EPA's authorization for lead-paint enforcement is primarily contained in Section 16 of the Toxic Substances Control Act(15 U.S.C. ' 2615). HUD's authority on the other hand, lies in the Residential Lead-Based Paint Hazard Reduction Act of 1992 (42 U.S.C. ' 4851 et seq.). While these statutes are not new, HUD's enforcement initiative is.
These statutes, together with the HUD and EPA regulations that implement them, establish three types of obligations.
- First, there is a broad prospective prohibition against using lead-based paint in federally-assisted housing. This obligation has actually been in effect for many years, and is easy to comply with because lead-based paint is not used for residential environments.
- Second, HUD requires owners of HUD-assisted multifamily housing to eliminate lead-based paint hazards. Essentially, this means that owners of apartment complexes built before 1978 that receive HUD rental assistance or mortgage insurance should inspect, and abate or encapsulate lead-based paint hazards.
- Third, all owners of apartment complexes built before 1978, assisted and unassisted, must make certain disclosures to prospective tenants prior to renting units including:
- a lead hazard information pamphlet;
- a lead warning statement; and
- a statement disclosing any known lead-based paint or lead hazard.
While these obligations have been in existence for several years, HUD has only recently begun a concerted enforcement effort. This effort, however, appears very significant, and HUD officials and investigators are following EPA's Interim Enforcement Response Policy, which can subject an owner or property manager to tens of thousands of dollars in civil and criminal fines for each failure to provide the required notices to prospective tenants. Additional fines may be levied in HUD-assisted housing for failure to impact and abate or encapsulate a lead hazard.
In recent months, HUD has undertaken a concerted effort to enforce the lead-based paint (“LBP“) regulations and guidelines that have been on the books for years. Broadly stated, the rules and guidelines require multifamily owners and managers to notify residents of potential LBP hazards. As noted in the HUD guidelines, LBP was widely used in properties constructed before 1978. HUD's enforcement efforts include taking owners to task over the form and content of LBP notices, even in cases where the property was purchased from HUD.
The LBP notices and disclosures required by HUD are not onerous. However, HUD's new enforcement efforts are particularly troublesome for multifamily properties which are already saddled with financial or physical difficulties, especially if there are insufficient funds to undertake a massive abatement effort. Undaunted by requests for flexibility in crafting compliance responses, the LBP enforcement initiative is rolling on.
A Measure of Relief
There appears to be an ever-increasing cycle of enforcement at HUD and other federal agencies. What is most characteristic of this cycle, and most disturbing, is that the enforcement appears to be against businesses for failure to comply with highly technical rules. Various congressmen have in recent years expressed concern with the proliferation of enforcement statutes and the civil and criminal investigations and suits that result.
These concerns resulted in the Small Business Regulatory Enforcement Fairness Act of 1996 (5 U.S.C. ' 601 note) (“SBREFA“), which is Title II of the Contract With American Advancement Act of 1996 (Pub.L. 104-121 (March 29, 1996)). SBREFA was intended to help small entities (as defined by the Small Business Administration (“SBA“), which includes small businesses, non-profit organizations, and certain local government agencies), to cope with the ever increasing tangle of federal regulation.
SBREFA provides several tools for small entities. First, SBREFA requires federal agencies to provide compliance guides to explain the actions small entities are required to take to comply with agency rules. Further, federal agencies must respond to questions from small entities about the scope and effect of federal rules and laws as they apply to specific fact patterns. This complements the Freedom of Information Act and provides another resource to entities trying to seek guidance from agencies.
In applying sanctions to small entities, SBREFA requires agencies to provide some proportionate balance. Agencies are supposed to establish a policy for the reduction or waiver of civil penalties for violations by a small entity. Under this new law, if an agency institutes an adversary adjudication against a small entity, but receives a substantially smaller penalty than was sought, then that agency may be required to pay the defendant's legal fees.
In order to provide an avenue for public response, SBREFA establishes within the SBA an Ombudsman's office that receives complaints and conducts investigations into complaints about abuses of enforcement authority. As an additional measure, SBREFA establishes Regional Fairness Boards to hear testimony about such abuses and report such information to Congress.
Because SBREFA is a relatively new statute, it is yet to be tested. Similarly, the Ombudsman's office has been in operation for less than two years and is still establishing itself. It remains to be seen what real effect SBREFA will have on government enforcement overzealousness. Nevertheless it is reassuring to know this tool is available to people who believe they are being subject to enforcement abuses.
HUD PUBLISHES INTERIM RULE ON CIVIL PENALTIES FOR FAIR HOUSING ACT VIOLATIONS
As part of its effort to expand its enforcement role, HUD has published an interim rule which amends HUD's regulations governing civil penalties for violations of the Fair Housing Act (64 Fed. Reg. 6744, February 10, 1999). The rule provides that, in a given case, an Administrative Law Judge (ALJ) may, and in some circumstances should, assess more than one civil penalty where a respondent has committed separate and distinct acts of discrimination. The rule also amends the regulations to instruct ALJs to consider housing-related “hate acts“ in conjunction with the six factors ALJs use to determine the amount of the civil penalty. It is part of President Clinton's “Make 'Em Pay“ initiative to fight housing-related hate crimes through stepped-up anti-discrimination enforcement and civil penalties.
HUD published the proposed rule to this interim rule on December 18, 1997 (62 Fed. Reg. 66488). In supplementary information to that proposed rule, HUD concluded that no language in the Fair Housing Act (which provides ALJs the authority to assess civil penalties against offenders) limits ALJs to imposing only one penalty per case when the offender engages in multiple acts of discrimination.
The interim rule defines a “separate and distinct discriminatory housing practice“ as “a single, continuous uninterrupted transaction or occurrence that violates Section 804, 805, 806, or 818 of the Fair Housing Act. Even if such a transaction or occurrence violates more than one provision of the Fair Housing Act, violates a provision more than once, or violates the Fair Housing Rights of more than one person, it constitutes only one separate and distinct discriminatory housing practice.“ In an example from the interim rule, HUD explains that a landlord who refuses to rent to a mentally disabled man, although a unit is available, and several weeks later refuses to rent to the man's mentally disabled sister has engaged in two separate and distinct discriminatory housing practices. Even if the brother and sister bring a joint action against the landlord, the ALJ may assess more than one penalty.
The interim rule also codifies from case law the six factors that ALJs take into consideration in determining the amount of a civil penalty. These factors are:
- a previous adjudication as to unlawful housing discrimination;
- the financial resources of the accused;
- the nature and circumstances of the violation;
- the degree of culpability ;
- the goal of deterrence; and
- other matters as justice may require.
The rule also provides that if the ALJ finds the offender's behavior constitutes a “housing-related hate crime“, the ALJ can justifiably levy the maximum allowable penalty. A housing-related hate crime is one that constitutes a discriminatory housing practice under the Fair Housing Act and “is accompanied or characterized by actual violence, assault, bodily harm and/or harm to property; intimidation or coercion that has such elements; or the threat or commission of any action intended to assist or be a part of any such act.“ In essence, a civil action may be used by HUD to impose what amounts to a criminal penalty.
Critics of the rule charge that it is just one more confusing layer in the already murky area of fair housing regulation and enforcement. They argue that the definitions of “separate and distinct discriminatory housing practice“ and “housing-related hate crime? are unclear and might be interpreted both too broadly or too narrowly. Likewise, critics contend that the six factors ALJs consider in determining the amount of a civil penalty may be broadly construed. HUD attempted to address several comments it received after the proposed rule by clarifying some definitions in the interim rule. Despite these concessions, the interim rule remains largely unchanged from the December 1997 proposed rule.
PARTING THE SEA OF CONFUSION: Owners' Options for Expiring Section 8 Contracts
We have received numerous inquiries from concerned parties who are awash in the ever-changing currents of HUD policy on section 8 contract renewals. Although the following article is not “news,“ it is an attempt to succinctly describe the current options available to owners with expiring Section 8 contracts. Note that these options are exclusive of the “marking up to market“ option which is described in greater detail elsewhere in this issue.
At the expiration of a project-based Section 8 contract, owners can either opt out of the Section 8 program or renew the expiring Section 8 contract. If the owner chooses not to renew, a one-year notice to the tenants of the owner's intent to opt out must be provided to the residents. At contract expiration, tenants will receive regular Section 8 vouchers for rental assistance at the “Fair Market Rents“ annually set and published by HUD (FMRs).
In the alternative, if an owner chooses to renew the Section 8 contract, the owner will either restructure the project's mortgage through the “Mark to Market“ program or renew the contract without going through mortgage restructuring. As with the opt-out, if the owner seeks to renew, a one-year notice must be provided to the tenants.
Mortgage Restructuring
The objective of mortgage restructuring is to enable renewal of the Section 8 contract rents at a level that is comparable to unassisted market rents. A mortgage restructuring will alter the project's debt service obligations so that it can be supported by the renewed rent levels. Projects eligible for restructuring must: be FHA-insured, have rents in excess of the comparable market rents, and have a project-based Section 8 contract. Further, the owner (or its affiliates) must not be a “bad owner.“ A “bad owner“ is someone who has materially violated any law, contract or regulation or failed to meet Housing Quality Standards.
At least three months before expiration of the Section 8 Contract, an owner seeking to restructure must make a request to participate in the program. The owner and a state or local agency designated as a participating administrative entity (PAE) by HUD's Office of Multifamily Housing Assistance Restructuring (OMHAR) will work together to develop a Mortgage Restructuring Plan (Plan) in conjunction with project's mortgagee, unless the mortgagee refuses to cooperate. The Plan must indicate that the project will be subject to a use restriction agreement for 30 years. In general terms, the use restrictions require that the owner meet the tax credit eligibility test of either renting 20% of the units to tenants with incomes below 50% of median, or 40% of the units to tenants whose incomes do not exceed 60% of median. The owner must also accept any offer of project-based assistance if it is in accordance with terms and conditions specified in the Plan.
The restructuring will involve establishing a first mortgage (either through a write down of the existing first mortgage or through a new first mortgage) in an amount that can be supported by the project's net operating income based on the lower of the restructured Section 8 rent or the rents allowed by the use restrictions. The balance will reflected in a second mortgage, held by HUD, which bears interest at the rate of at least 1%, which will accrue but not compound. If the project generates net cash flow, 75% of the cash flow must be utilized to repay second mortgage, and HUD may permit owner to keep the remaining 25%. The PAE must limit second mortgage to an amount that can be reasonably expected to be repaid. This limitation is essential for the second mortgage to be deemed valid debt under the IRS Code.
There are certain instances where even if the existing FHA-insured debt is eliminated, the operating expenses cannot be met by collecting comparable rents. In such cases, HUD may approve a Section 8 contract renewal with budget-based rents (which include the cost of operating the project, debt service payment to the reserve for replacements and a reasonable return to owner). In this scenario, budget-based rents cannot exceed FMRs by more than 120% except if approved by HUD.
As part of a restructuring, the Owner must evaluate the project for capital repair needs and submit a funding plan for rehabilitation. The rehabilitation plan must provide for a level of rehabilitation needed to restore the project to a non-luxury standard adequate for the rental market for which the project was originally approved, resulting in a project that can attract non-subsidized tenants and compete on rent rather than on amenities. The funding for rehabilitation can come from debt restructuring, the project's residual receipts or replacement reserve, as well as a direct grant from HUD under Section 236(s) of the National Housing Act or an increase in Section 8 budget authority. Twenty percent of the rehabilitation funding must come from sources other than those listed above. The owner contribution must be at least 3%, and the balance may come from HOME, CDBG or state or local funds.
Renewals without Restructuring
HUD or the PAE will permit owner of a project which is otherwise eligible for restructuring with rents above market to mark down to market if the project can be operated on market rents. In addition, other projects can be “marked to market“ if they are not eligible for restructuring -- for example, projects where the primary financing was provided by either the state or local government, projects financed under Section 202 of the Housing Act of 1959 or Section 515 of the Housing Act of 1949, or projects which have an expiring contract under Section 8 pursuant to the McKinney Homeless Assistance Act. In such cases, the Section 8 contract can be renewed at the lower of current rents (if they are below comparable rents) or budget-based rents. While HUD has the authority to mark up the rents to comparable rent levels on projects with expiring contracts where the rents are below comparable rents, HUD has yet to exercise this authority.
Owners seeking to renew must provide HUD with a comparable market rent analysis. If an owner of a project eligible for restructuring wants to renew without going through restructuring, the owner must provide HUD with the most recent audited financial statements of the project and an owner's evaluation of the physical condition of the project.
*article courtesy of Nixon Peabody LLP.