Remarks by:
John B. Meyers
Consultant
Louisville, KY
502.451.2727
Options for Older 515 Projects
Older projects fall into one of two categories:
— obligated before December 21, 1979 (pre-’79)
— obligated from December 21, 1979 to December 14, 1989
(post-’79).
Projects obligated since December 14, 1989 are, for this purpose, newer projects and will not be considered.
For projects obligated before December 21 1979, the first option is always to do nothing. This is sometimes the best option, and you should always keep it in mind. The second option was expressed in a Wall Street Journal cartoon: “If anyone feels squeamish about arson, we’ll move on to our other options.” Thus, there are a few “other” options.
The Agency (FmHA, Rural Development or Rural Housing Service) has had a program of offering equity loans to owners of projects obligated before December 21, 1979 as an incentive to keep the units in the program once the owner showed it can prepay the Agency loan and operate the units in the conventional, unsubsidized market. However, the Agency has not been funding these equity loans because the Agency has not chosen to make the funds available, preferring instead to fund new construction projects. The Agency presently has a 10+ year backlog of equity loan offers outstanding.
Thus, as the 1996 National Office Training Notes indicate, the Agency has been considering alternative incentives other than an equity loan; the incentive is primarily a higher Return to Owner and up to 100% RA.
1996 Legislation
For post-’79 projects (obligated up to December 14, 1989), the FY 97 Agriculture Appropriations bill, signed by the President in early August, included “reform provisions” for the 515 program. The reforms included the language that:
(C) Approval of assistance. — The Secretary may approve assistance under subparagraph (B) only if the Secretary determines that the combination of assistance provided for assisted housing only if the restrictive use period has expired for any loan for the housing made or insured under section 514 or 515 pursuant to a contract entered into after December 21, 1979, but before the date of the enactment of the Department of Housing and Urban Development Reform Act of 1989, and the Secretary determines that the combination of assistance provided
— [revised, added in 1996 with FY 97 Agriculture Appropriations bill]
Subparagraph B, in case you wonder, lists the incentives that the Agency may offer:
(i) Increase in the rate of return on investment.
(ii) . . . . provision of interest credits. . . .
(iii) Additional rental assistance. . . .
(iv) An equity loan to the borrower. . . .
(v) Incremental rental assistance. . . .
(vi) In the case of a (Section 8/515) . . . permitting the owner
to receive rent in excess. . . .
Thus, it appears that:
1) the Agency can no longer offer any incentives to post-79 projects for prepayment requests submitted after August 1996.
2) there is the strong possibility for post-’79 projects that the legislative language will be interpreted by the Agency to mean that even where offers have been made, particularly equity loans, the Agency cannot obligate equity loans. It is possible that the Agency will take the position that additional RA cannot be made available.
This second interpretation is only my opinion at this time because the language refers to the Secretary approving assistance. It might be advisable to go back to Congress to get a clarification on this. It is possible that when the Agency supported this “reform,” it thought the language would simply cut off equity loans to post-’79 projects. But, in Washington, D.C., no good deed goes unpunished
The Agency should be sending out an Administrative Notice regarding the changes in prepayment. The AN should address how to handle post-79 prepayment requests now in processing by the Agency; it could address the issue of outstanding incentive offers for post-’79 projects.
Thus, the following options may apply, but only to pre-’79 projects.
Return to Owner Incentive Plus RA — First Scenario
The Agency can offer a Return to Owner based on a redetermined equity, and a redetermined rate of return.
For example, if the loan was originally for $1,000,000, and the initial investment was $50,000, you are presently getting an annual $4,000 RTO (8% on $50,000). The Agency can offer to redetermine the equity as the difference between the initial appraised value ($1,050,000) and the current loan balance, say $700,000; and to offer a rate of return based upon the 30 Year Treasury Note Rate plus 2% (say, 9%). Thus, using these numbers, The Agency could offer a $31,500 RTO annually for 20 years (9% on $350,000). And the Agency can offer up to 100% RA so no tenants have an increase in rent overburden.
Loan
+ initial investment
- loan balance
= “Equity”
x Rate of Return (say 9%)
= New Return to Owner
And the Agency could then approve a second mortgage secured with this Return (or a portion of the Return, so a new owner can get a Return if you choose to sell the project). Let’s say you could place a $275,000 second mortgage at 10%, 20 years.
Return to Owner Incentive Plus RA — Second Scenario
If the pre-12/79 project has appreciated, then the Agency may offer an 8% return on the equity, which is the difference between the appraised value (appraised as a conventional, unsubsidized project) and the loan balance.
Looking at the project as though it were a conventional project, let’s say the units will rent for $500 monthly. If the O & M costs (let’s use the Agency budget) are $250 monthly, then there is a $250 monthly Net Operating Income, or $3,000 annually. Dividing this $3,000 by 10% (just accept this 10% as a fixed number), gives $30,000. This is an income value of the unit.
Subtract the loan balance of, say, $15,000 per unit from the $30,000, and you have $15,000 equity per unit.
Thus, 8% on $15,000 equals $1,200. The Agency could offer this Return per
unit plus RA.
Appraised Value
- loan balance
= “Equity”
x 8% Rate of Return
= New Return to Owner
Multiply this by the number of units, say 30, and you have an RTO of $36,000.
And the Agency could then approve a second mortgage secured with this Return (or a portion of the Return so a new owner can get a return if you choose to sell the project). Let's say you could place a $10,000 second mortgage per unit at 10% for 20 years.
You’re the General Partner — Do you want to?
When the Partnership Agreement gives you 5% or so of the cash flow, there’s not much reason to proceed. Unless, of course, you renegotiate with the Limiteds because such a redetermination significantly increases the cash value of the Return.
With the new Return to Owner, the project can be retained or transferred.