John Meyers
Consultant
Louisville, KY
502.451.2727
Legislative and Regulatory Reforms
Needed for Owners to Exit Old
FmHA 515 Projects
The Section 515 Rural Rental Housing program (Title V of the 1949 Housing Act) is administered in the Department of Agriculture — not in HUD. 515 provides rental housing in rural areas. 515 was originally similar to Section 236 — rents were based on a mortgage at 1% and there was no deep rental subsidy for very low income tenants. The major difference remains that the 515 loan is made directly by the government agency, formerly the Farmers Home Administration, now called Rural Development.
As a consequence of being a housing program in USDA, legislation has not always paralleled HUD’s.
In the early days up to 1979, 515 projects were financed and were made subject to a requirement that when conventional financing was available, the projects would be refinanced away from the direct government loan. There were no restrictions imposed regarding prepayment. And, these projects were funded without any Rental Assistance (the deep subsidy similar to that on 236 or Section 8). Moderate income and low income tenants were housed.
Beginning in 1979, Congress imposed prepayment restrictions on new loans - for both new projects and subsequent loans for existing projects; the restrictions ran for 20 years, and provided that if the loan were prepaid within the 20 year period, the housing would be used for 515 purposes until the 20 year period ended. Arguably, the 515 purposes were for housing low and moderate income tenants.
In the late 1970’s, the deep subsidy Rental Assistance (RA) was made available by FmHA for both new projects and for existing projects; the RA pays the difference between 30% of the tenant’s income and the Basic Rent (the 1% rent). With the RA, it was now possible to rent to very-low income tenants, including those with no income.
Around 1985, a 515 project in California prepaid the loan in order to convert the units to condominiums. This raised an outcry and concern in Congress. Until legislation was passed in 1987, prepayment was limited by Congress to those occasional days that the Agency was not prohibited by Congress from accepting prepayment.
In 1987, Congress enacted the initial legislation that provided for the Agency to offer equity loans and other incentives as inducements for owners not to prepay. From 1988 through 1994 the Agency made about $150 million in equity loans. Beginning in FY 1995, the Agency started restricting equity loan funding, putting the projects on a list to await funding. I estimate that given everything, at a rate of $2.5 million annual funding for equity loans (as seems to be the current funding level), projects going on the list today could face up to a 20 year wait for an equity loan.
There are presently about 500,000 units in 18,000 some projects. Of course, being 515 and not HUD, the scale is very different: 515 projects average 27 units!
This is a long way of getting to what the problems are. There are a number of categories of problems (and possible remedies).
The two major categories are those projects with equity and those projects without equity. This discussion is applicable only to projects before December 21, 1989, when a 50 year restriction on prepayment was imposed.
PROJECTS WITH EQUITY
1. PRE-1979 PROJECTS
EQUITY LOANS
If an offer of an equity loan has been made and accepted, it may be years before the loan is funded. For example, Stone Place was submitted in December 1993; an equity loan of $375,000 ($5,900 per unit) was accepted in June 1994. Based upon the last list I saw, the loan could be funded as soon as 2005, eleven years after the appraisal. But, at the present time, the Agency policy is that it would refuse to fund the loan because the owner is deficient on the Reserves of other 515 projects; of course, the owner wants to sell the project, and the proposed purchaser wants to apply for acquisition and rehabilitation Tax Credits on it.
Reforms Needed
* An Agency policy or Legislation to give a priority to using funds for preserving existing projects over funding new projects.
* Additional funds from Congress for funding equity loans.
* An Agency policy to re-appraise projects and revise the equity loan offer when the appraisal is more than a year or two old.
* An Agency policy to fund equity loans in conjunction with a transfer when the owner has been determined by the Agency to be out of compliance.
PREPAYMENT
If an owner wants to prepay a project loan and take the project out of the 515 program and into the conventional rental market, the Agency is requiring that as a condition of accepting prepayment, the owner must agree to a restrictive use clause that provides, in part:
Rents, other charges, and conditions of occupancy will be established to meet these conditions for these tenants such that the effect will not differ from what would have been, had the project remained in the FmHA program. Existing tenants are protected to ensure that none experience new or increased rent overburden as a result of owner actions until each voluntarily moves from the project.
This seems to mean that following prepayment, the Tenant Contribution stays the same: if the tenant is receiving RA and paying 30% of their income (say, $85) toward the rent (with RA paying the remainder), the tenant cash contribution would remain at the greater of $85 or 30% until the tenant moves.
For example, Beech Tree Apartments, a 515 project in the Northeast, would be valued at $1.7 million (at a 9% cap rate on the NOI) as a non-subsidized project; with a restrictive use clause in place, it would be valued at $190,000 (at a 9% cap rate on the NOI):
— $340,000 Gross Rent Potential as a conventional project
— $189,000 cash rental income as a prepaid 515 project — about half the Potential Rent, and about the O & M expenses of $170,000.
The negative cash flow, with no assurance of a positive cash flow, makes the loan impossible to refinance with any lender. This is a project which has no restrictive use clause.
Reforms Needed
* An Agency policy or Legislation that tenants have no more rent protection than HUD tenants after prepayment, say two months.
* An Agency policy or Legislation that would permit the Rental Assistance to be provided to tenants even when the underlying 515 loan is prepaid.
SALE TO NON-PROFIT
If an owner wants to sell the project to a non-profit, the Agency will provide 100% financing. However, the availability of the funds depends upon the list — funding may not be available for years. Some proposed sales are three or four years old.
Reforms Needed
* An Agency policy or Legislation to give a priority to using funds for the sales of such projects over funding new projects.
* Additional funds from Congress to fund such sales.
* An Agency policy to re-appraise projects and revise the sale price when the appraisal is more than a year or two old.
2. POST-1979 PROJECTS
EQUITY LOANS
If an offer of an equity loan has been made by the Agency and accepted by the owner, but not closed, it may be that recent legislative changes make the Agency unable to fund such a loan. Presently, the Agency apparently cannot offer any incentives to owners not to prepay to post-79 projects, i.e. projects obligated after December 14, 1979 and before December 21, 1989. The FY 1997 Agriculture Appropriations Bill intended only to preclude equity loans as an incentive for post-79 projects, but cut out all incentives — no good deed in Washington goes unpunished.
For example, a Section 515 with a 20 year Section 8 HAP Contract may have over $300,000 in excess funds in the Reserve. One of the incentives eliminated was that the owner could withdraw the excess Reserve Funds. With this incentive cut off, the owner faces the prospect that upon expiration of the Section 8 and with the 515 loan still in place, the Agency may require the excess funds to be used as tenant subsidies until the funds run out. The alternative, as is being done, is to prepay the loan, which will remove the project from the program and the units from their availability once the Section 8 expires.
Reform Needed
* Legislative correction which provides that incentives other than equity loans may be offered to post-79 projects.
PREPAYMENT
The restrictive use clauses which would be imposed upon prepayment (lifetime protection as long as they live there) are far more restrictive than the clause originally agreed to.
For example, a project without any RA (including Section 8/515 projects) could possibly prepay and live with the original restrictive use clause which provided:
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.
And, a project with any RA could probably also live with this clause because the Federal assistance (RA) would end with the prepayment. This has not been tested.
Reform Needed
* An Agency policy or Legislation to roll back the more restrictive use clauses and implement only the clause agreed to.
PROJECTS WITHOUT EQUITY
Not all 515 projects have been in growing communities such as Pensacola, Florida. Many projects are in towns which have declined in population, employment and economic base. There are stories told of projects on the Great Plains where the units were literally trucked to another town and put on a new site.
1. Negative Capital Accounts — No Equity
Overriding characteristics of the older projects include phantom income and negative capital accounts. Owner interest in getting out is lukewarm, at best, because of the tax consequences.
Assuming a purchaser will assume the loan balance, secure rehabilitation funds, and get Tax Credits, there may not be enough money on the table to pay the owner enough to pay the taxes. This is an old song, and I know it. But, the Agency is becoming aware of this as an issue to attract new, interested owners.
Reform Needed
* An Agency policy or Legislation to permit Agency loan funds to be used for payment of the original equity, for example.
2. Appraisal for Less Than Mortgage
In some cases, a project is appraised as-is and without subsidies for less than the outstanding loan in the case of a request for a subsequent loan in conjunction with a transfer. This can result in a write-down of the mortgage with a corresponding gain to the owner; the gain increases the tax liability of the seller.
It is because of the subsidies that these projects have value, whether as new projects or as existing projects. In many cases, the rehabilitated project will end up with close to 100% RA.
Reform Needed
* An Agency policy to provide that appraisals include the value of the subsidy.
SUMMARYBecause of the small sizes of the projects, diversity of owners, and relatively small dollar amounts involved in any one project, there has been no industry approach to these 515 program problems and issues.
Any one regulatory or legislative change will have to wait until someone’s ox is gored. There is one group of 515 owners forming to pursue a class action suit for damages related to the impediments to prepayment. This may be productive, and then again. . . .
Next: FYI