This is the text of a speech I made in December 1998 at the annual meeting
of the Housing Assistance Council in Washington, D.C. It seemed to be well received both by the non-profit members and by Agency
(RD/RHS/FmHA) staff in the audience.
__________Prepayment: Doing Well with Less
The Agency has issued an AN approving the use of outside loans for equity
loans; it wouldn’t be too much of a stretch to approve outside loans for
rehabilitation loans as well, particularly if a special form of RA can be
enacted by Congress.
My best thought is to stay tuned to CARH and NAHB.
Before the Prepayment Legislation was passed in 1988 or so, and
before
the prior moratoriums on prepayment were enacted by Congress, Owners prepaid
their 515 projects at will.
With the passage of the legislation, prepayment slowed up. Initially,
Owners were offered and accepted incentives not to prepay. The incentives
included equity loans, RA, etc.
Then the Administration started getting reduced appropriations
funding for construction of new projects under the program. And the
Administration’s amounts set aside out for equity loans declined in extreme
proportion to the dwindling amounts for the program.
Thus, prepayment requests started getting stacked up on the lists
awaiting the offering of incentives. But, as they waited, a funny thing
happened in the Agency; the unthinkable became the expected, and the Agency
began to turn on the program.
I guess that having a son is the best analogy. When a baby boy is
born, you think he is cute and worthwhile. You decide to keep him. But when
he gets to be a teenager, you realize he’s eating you out of house and home.
You know your budget will never withstand the ravenous hunger of a teenage
boy.
Well, 515 projects are the same. In the late 70’s, the Agency started
by putting the projects on a diet supplemented with RA and felt really good
about housing eligible very low-income families. There was a good feeling to
the program. Congress provided RA to house ever lower income tenants; the
amount needed for RA to house these very low-income families began to
increase. Then, the need for money for supporting aging projects started to
loom large — and some of this money would necessarily come from RA (the
whole Social Security issue is parallel). Ever lower incomes and ever
increasing demands for money made the Agency start the mantra that RA
wouldn’t continue forever.
Even worse, the Agency started realizing that RA for equity loans and
increased Returns to Owner would chew up the RA budget just so the much-maligned owner would get money he didn’t really deserve and certainly never
earned.
But the Agency had constructed its own trap for the Owners. For the
pre-79 projects, the Restrictive Use provisions mean a tenant has a life
estate on the unit at, roughly speaking, the current cash rent. An owner
with
very much RA at all can’t afford to prepay because the cash rents can’t
support even the O & M expenses, not to mention any debt service. So the
Agency put the owner in golden handcuffs — it wouldn’t and couldn’t fund
equity loans, and the Owner couldn’t prepay.
For the post-79 projects, the Agency cut off any incentives not to
prepay. Which is actually the best thing to happen to a project. Those
projects with too much RA can prepay just before their 20 years are up and
at
the end of the 20 years, the tenants are out in the cold without
protections.
The Agency is, in several states that I’m roughly aware of, almost
promoting prepayment by saying we don’t have any equity loan funds and
almost
no prospect for ever seeing any, and if you get Section 8 for your RA
tenants, you can prepay and be out the door.
What’s happening is that the Agency is losing its better projects,
especially those projects without too much RA and is losing its Section
8/515 projects with overfunded Reserves. A few years ago, I rarely saw any
prepayments — now I am involved with a large number of projects which are
prepaying and which have prepaid. Yes, they accept the Restrictive Use
provisions; no, I don’t monitor them after they prepay.
Why would an Owner take a leap into the prepaid arena? An offer of an
equity loan which is unlikely to ever be funded is an empty offer; an actual
equity loan supported by RA which is likely to end could leave the owner
high
and dry. An offer of an increased Return to Owner supported by RA and funded
in a budget arbitrarily approved by the Agency is an equally empty offer.
Why
would an Owner snuggle up with the Agency when the Agency is so busy saying
that the RA will end?
There are Owners who feel the Agency has broken faith with them. No
funds for equity loans, RA is going to end, servicing is now more
adversarial, and the Agency and OIG are coming after them.
What can be done? The Agency can fund the equity loans and fund the
transfer loans to non-profits (I am involved in a few that would transfer to
a non-profit in a heartbeat). Easy to say, but the Agency has to flinch at
the sheer cost with the RA. Say the Agency doesn’t flinch at the cost of RA
(and we’ll come back to this), there isn’t enough equity loan money. I
contend the Agency can’t even speculate on how much it would take to fund
the
equity loans on projects which have submitted prepayment requests — $100
million? $75 million?
Let’s say the Agency decided to proceed into this unknown amount and
permit the projects to get outside equity loans — say from a bank, State
Housing Agency, other lender. Right now, there’s a crisis in the credit
market because Crimi-Mae melted down and the secondary market convulsed.
Loans are being quoted at 8.5% or so on the small loans under $3 million.
Since the debt service on a conventional loan can become the biggest
single line item in a budget, let’s cut the cost of the debt service.
The Agency could work with the Federal Home Loan Banks to set up a
niche lending program just for 515 equity loans (and rehab loans for that
matter). Say we get an interest rate at 6% or whatever rate the AHP
(Affordable Housing Program) can offer. With only twelve Banks, this should be
achievable.
Another possibility is to approach Fannie Mae (and Freddie Mac) to
set
up a niche secondary market — I know that Fannie Mae would love to have it
and has given some thought to such a niche product.
So there — we can fund equity and transfer loans at less than a
market rate with the Federal Home Loan Banks or at a highly competitive rate
with Fannie Mae.
The Agency would subordinate, thus giving the lender some reassurance
against the unthinkable, and the Agency could require Notice before the
first
place lender can foreclose.
Having skinned that cat, what about the sheer cost of RA? Let’s say
you have a unit with Basic Rents of $280, and a Note Rate Rent of $360, and
no RA. If you put on an equity loan costing $200 a month in debt service,
increased Reserve and vacancy, the new Basic Rent is $480 and the Note Rate
is $560. If the tenant had no RA, the tenant might have been paying $340,
with $60 overage. Suddenly, we have the tenant eligible and receiving RA —
$140 the first month. If the tenant moves, the present priority is for a
very-low income tenant. Let’s say that tenant can pay only $100 cash — the
first month’s RA cost is $380. And what had been a project with I’ll say low
income tenants, becomes a very low-income project.
So you have a major social issue — the low income families are
displaced by very low income. What a sensitive issue that no one can answer
well.
And, you go from no RA cost to $140 a month for the existing tenant,
to $380 a month for the very low-income replacement tenant.There’s a middle
course that the Agency could seize upon. Go to Congress and get a special
incentive RA which will cover the amount attributable to the debt service,
reserve and vacancy rate.
Would this work? The elements are:
— lower interest rate loans though the AHP program;
— a secondary market in Fannie Mae and Freddie
Mac; and,
— incentive RA.
I think we could pull together on this.
Many Agency staff don’t believe any owner should get any money at
all.
I can’t stress this resentment enough. One old friend used to say “Nothing’s
too good for Owners, and Nothing is what they should get.”
There’s a high level of antagonism when they see an owner getting
money, and the Agency picking up the cost. The way they express this
antagonism under the present regulations (apart from resisting the
processing
under 1965-E) is to decide that the owner should contribute most of the
equity loan back to cure the depreciation attributable to the aging project.
One time I tried the following scenario on an Agency employee. I said
suppose you were getting an equity loan from your bank, and the bank had
appraised your home as-is. Then the bank said it would require you to put
some or most of the proceeds into your kitchen because you have a 20-year-old
kitchen. Would you do it? The answer was yes.
I wouldn’t. If the bank wanted to do an as-improved appraisal with a
new kitchen, then I might because the increased value of the new kitchen
would presumably be reflected in the appraisal and in the equity loan
amount.
Right now, the prevailing approach in the Agency is that a 20-year-old
kitchen is deferred maintenance. Everything is deferred maintenance: 20-year-old siding, landscaping, bathtubs, you name it.
Rather than argue about whether the angel dancing on the head of a
pin
stumbled because the maintenance was deferred or because the head was aged,
why not do an as-improved appraisal where the Owner and Agency agree on the
improvements. The money left over after the improvements is the owner’s.
So, let’s consider: Can equity loans and transfer loans preserve
housing? Yes, Owners can make business decisions based upon economics, and
in
most cases they will.
Where the constituency has been abused by the process, and the
Agency’s credibility stretched, emotions can enter into the process. The
ideal is a process that respects the parties involved and which follows the
Instructions and which runs by the numbers.
One further bump on this highway to happiness is that the Agency says
an Owner can’t get an equity loan if he has a project not in compliance. For
example, he can’t get an equity loan on his project in Indiana because his
project in Illinois isn’t meeting its Workout Plan, or hasn’t had six
successful months on a Workout Plan. This is unworkable, but the Agency has
to recognize it.
In summary, the issue for the Agency and the Administration is if
they
want to preserve an irreplaceable housing unit at an apparently high cost,
or
let it go. The Administration is trying to do neither, which doesn’t please
anyone for long. The challenge for us is to work together on a unified
basis.
I said “at an apparently high cost.” Where we have an appraisal
calling out the numbers, what is high? Is high an opinion, or relative? And
high compared to what? Presently, the Agency can’t replace any units lost
because of limited funds, and because of the funding constraints it has
imposed in the NOFA process. It boils down to either preserving the units,
or
losing them. The Agency either pays the cost or doesn’t.
Professionally, as I said, I’m involved in more prepayments than I
would have projected five years ago. There are some very sophisticated
approaches to paying them off and living within the restrictions.
I’m open to preserving the housing, and most Owners are, too. But
there needs to be some money on the table. As the saying goes, money
talks, everything else walks.
Thank you for your attention. I look forward to working with the
non-profit sector and the Agency in a scenario where everyone wins.