Hi, I’m your tenant. Are we going to have a long-term relationship or not? Am I going to be your tenant from hell or not? You thought I was here to talk about Exit Options — you’re right: your exit, my exit. But there are two sides to this equation: You as the Owner, and me as the tenant. Are we going to have a good relationship or not?
Since you’re here, let’s talk about you and your financial statement. You own two 515 projects — one before December 21, 1979, and one between 12/21/79 and 12/14/89. Two projects that you’ve spent all these years listing them under assets on your Financial Statement because you really believe they’re worth something. Well, are they? Let’s think.
PRE-1979 PROJECT
You’re a good guy — you built a 515 project in 1978 in what was then a rural town. You’ve housed tenants at affordable rents and kept the Agency happy enough that they’ve let you own and manage it all these years.
The issue, as you see it, is that you feel like you’ve done your job and you now want to take this project into the conventional market. You’ve done a survey and realized that you could rent the units at $500 a month on the open market. What was rural is no longer. The location is now a commuter suburb or desirable resort area. So you sit there and realize that if you could collect $500 a month in rent, you could actually make some money. Let’s run through the numbers:
$500 rent
-$200 O & M expenses
$300 Net Operating Income Monthly
x 12 = $3,600 Annual NOI
Divide the NOI by 10% (just accept that as the number, 10%) and you have $36,000 value (disregarding the Reserve of $2,000 for that unit)
You owe $14,200 on your mortgage.
Thus, you could actually pay off the mortgage and have some operating income left.
No, that’s too easy. This is 515, which is not easy.
Under 515, you have to submit a request to the Agency to pay off the loan. The Agency will evaluate the request (specifically, can you pay it off and run it as a conventional project?) and come back to you and try to make you an offer you can’t refuse (keep in mind, that phrase comes from Hollywood, and Hollywood is as real as the offer you’re going to get):
The Agency (how clinical; remember when it was “FmHA?”) will offer an equity loan! In particular, it will offer the difference between 90% of the $38,000 (remember the Reserve) and what you owe. Thus, 90% of $38,000 equals $34,200. You owe $14,200. Thus, they’ll offer $20,000! Of course, you’ll have to reenlist for 20 years, but money is money.
Not so fast. Well, you’re about to be had.
The offer of $20,000 has to be stacked up like cord wood on a list in Washington, DC. When the Agency has the money, they’ll give it to you. How long, you ask? How long, indeed. Say 10 years, 15 years, who cares, not today. You choke back your tears and figure that in 15 years, you will reenlist for 20 years. Thus, in 2012, you’ll get your money. By then, you might be able to get $800 in rent (same calculations, O & M equal $400, NOI = $400 equal $48,000; Reserve = $2,000, why change when you have a number you can work with?) for a value of $50,000, loan at $10,000, $40,000 equity: $35,000 equity loan potential then.
Or, being the Agency that is customer-friendly, it may not offer a dollar figure until your time comes on the list (no offer made before its time). You get to wait until then to find out what the offer is.
You grumble a bit, look at the loan documents and realize with a flash that you were youthful when you made that loan and didn’t know all you know now. That loan had no restrictions regarding prepayment. That’s the reason I picked a loan obligated prior to December 21, 1979. There were no restrictions regarding prepayment.
Being 515, this is the good news and the bad news: no restrictions imposed when the loan was made.
You ask the Agency about other options, and they outline three or four:
1. You could try to get a bank loan in that amount, but they’ve never done that, and the loan costs would drive up the rents (and increase the use of RA).
2. They could offer you an increased Return on Investment. They could consult a training manual from last year’s National Office training, and offer you a total return of, say $700 on this unit. An increase from the $80 you’re getting now. They’d reason that 20 years at $700 = $14,000, and you’d probably accept because this is close enough to $20,000.
If you accept, then I have a bridge to sell you. You’d be getting an increase of $620 annually over 20 years for a total of $12,400. Since a dollar in 20 years isn’t what it is today, you’d really be getting, say, $6,000 NPV. After taxes, this is $4,000. Thus, would you settle for $4,000 versus $20,000? Call me — I have title to the bridge.
3. If this is a Section 8, you can withdraw the excess Reserves and take the excess cash flow (which is why you have the excessive Reserve) as additional Return.
4. You could actually prepay.
Well, you think the Agency has lost its mind — let you prepay! In a heartbeat.
The only requirement the Agency will impose is that if you prepay, because you have no restrictive use clause in place (remember, this is a pre-’79), you must agree to keep the tenants in place at the same rent they’re paying now, and that the rents can’t be increased just because you prepay. Oh yes, you keep the tenant (and the rent) at the same rent (adjusted for 30% of income as time rolls on) until the tenant moves.
Remember me? The tenant? Am I the tenant from hell? Well, it depends.
Let’s go through the scenarios:
— This is a straight 515, no RA, no Section 8. I’m your ideal tenant. I pay $280; you prepay, I pay $280 until I move. It’ll be a long time before I move because I can’t replace my unit at any rents under $500 (and that wouldn’t be as good as the dump I presently rent). It’ll be a long relationship.
— This is an RA unit. I pay $25 a month toward the rent — the RA pays the rest. You prepay, I pay $25 a month, for life or until I move. Take that to your bank. Tell your banker the O & M (not including debt service) is $200, your rent is $25. When the banker stops laughing, he will send you on your way. I’m the tenant from hell.
— This is a Section 8 where the HAP contract runs out in 1998, next year. I’m your tenant and pay $25 a month in rent; the Section 8 rent is $450. (The Reserve has big dollars in it because of the excess Section 8.) You take that to the bank. The bank is interested until it finds out that once the Section 8 runs out next year, you get to keep me at $25 a month. When you and the banker have stopped laughing, you’re back on the street. I’m the tenant from hell.
Are you done laughing yet?
Did I say what your options are? Actually, I did. You can go blind or go blind!
POST-’79 PROJECT
Alternatively, you’re still a good guy — you built a 515 project in 1980 in what was then a rural town. You’ve housed tenants at affordable rents and kept the Agency happy enough that they’ve let you own and manage it all these years.
Same numbers: $500 rent, $200 O & M.
But there are several things we need to discuss. When you closed in 1980, you agreed to a restrictive use clause that said:
The borrower . . . agrees to use the housing for the purpose of housing people eligible for occupancy as provided in Section 515 . . . and FmHA regulations then extant during this 20 year period beginning (date). No eligible person occupying the housing shall be required to vacate prior to the close of such 20 year period because of repayment. The borrower will be released from these obligations only when the Government determines that there is no longer a need for such housing, or that Federal or other financial assistance provided the residents of such housing will no longer be provided.
It is refreshing that you were older when you signed this than in 1978 when you didn’t have a restrictive use clause offered. You were out of your youthful indiscretion. If you’ve considered this clause, it actually doesn’t say that you can’t prepay — it spells out what happens if you do prepay within this 20 year window.
And when you go to the Agency to ask what the options are, they explain that if you submit a request to prepay, they can’t offer any incentives to keep you from prepaying and in order to convince you to stay in the program:
— They can’t offer a Return to Owner.
— They can’t offer an equity loan.
— They can’t offer anything.
Oddly, this may be your lucky day. The restriction the Agency will impose upon prepayment requires (are you ready?)—requires that you protect the tenants for the remainder of the 20 years, and then the tenants are out in the cold. The RA ends when you prepay — and, at 20 years, the tenant has choices (ain’t it great?): Pay the new rent or not. If not, move.
In other words, I’m your $25 tenant — and you prepay. When you prepay, I pay my $25 until the 20 years are up — whether I’m getting RA or Section 8. Of course, with the Section 8, you get the difference until the HAP Contract runs out.
So if you’re really thinking you’ll prepay right before the 20 years are up, you’ll lose the subsidies and, sadly, you’ll lose tenants like me that can’t pay. Your banker won’t have a cow.
So there you are, calculating when the 20 years are up.
Have you ever eaten octopus? I’m told that if you cook it just the right amount of time, it is tender. I’ve eaten tender octopus. But if you cook it too long, it turns into rubber. I’ve eaten rubbery octopus. And if you cook rubbery octopus long enough, it is—are you ready for lunch?—tender!
Prepayment where you have a restrictive use clause is like octopus (in more ways than one — sorry). If you prepay at or before the end of 20 years — you’re home free, and you can get out. But if you prepay under the present rules at 20 years and 1 month, you’ve got me for life — my life, not yours. Timing is important.
You’re wondering what your options are. Frankly, so am I.
— push on the Agency (and your Congressional delegation) to have equity loans funded, or to permit bank loans.
— push on the Agency to offer an acceptable Return to Owner. “Acceptable” means, to me, a guaranteed Return which can be securitized and pledged at the bank.
— push on the Agency to permit you to prepay loans without restrictive use clauses under the same restrictions as post-’79s.
— push on Congress to provide for incentives to post-’79’s.
— or accept the incentives and sell the project to someone else. Just don’t tell them about your tenants. (Of course, if you get an equity loan, that adds to the basis for the acquisition Tax Credit. )
— or (and this is new to my thinking about exit strategies) you can possibly sell the project to a limited partnership as a cooperative for the tenants. If 1089(c) still exists in the Tax Code, there are additional tax benefits from selling the project to the tenants; it may be that a Leasing Co-op (rather than an Ownership/Equity Co-op) qualifies for 1089(c). As a leasing Co-op, it would be eligible for Tax Credits; at the end of the compliance period, it would be sold to the Co-op for $1 over the mortgage. To my knowledge, this hasn’t been done and there are some tricky issues to work out.
In summary, I’ve told you what your options are: Eat octopus. It might be tender, and it might not be. Ideally, it’s dead before you start chewing, but this is 515. It might grab you tenderly in the night, or just hold hands with you, but dead or cooked, it’s not letting go of you.
Why won’t it let you go? Let’s talk about who the 515 customer is for the Agency (that clinical word again).
How many say the property manager is the customer?
The Owner?
The tenant from hell?
You got it — the tenant. The Agency is slowly, reluctantly admitting that to serve the customer, it is going to have to fork over money, big money in equity loans and RA, bank Loan approval and RA, Return to Owner and RA, or, as long as it can hold on, restrictions that won’t let go of the tenant.
Frankly, I doubt that you’ve ever had so much fun.
I’ve told you everything but how to cook an octopus. Any questions?