For over fifty years the HUD Section 202 program funded the construction of housing and the provision of supportive services for elderly households. The original program authorized federal direct loans with below-market interest rates and little to no rental subsidy to serve moderate-income elderly and disabled families. The program evolved through several financing and rental assistance phases before shifting to capital advances, 40-year forgivable loans, with rental subsidies provided to very low-income elderly families through project rental assistance contracts (“PRAC”). Aside from a modest FY2018 appropriation, Congress last funded new construction of Section 202 units in FY2011. As a result, preservation of the existing stock of Section 202 capital advance units and supportive services is critical to maintaining this housing resource for the growing population of very low-income elderly families.
Background: Section 202 Program
In 2000, Congress acted to preserve a large portion of the Section 202 direct loan inventory by authorizing the repayment and refinancing of those Section 202 properties originally financed with high interest rate loans, which were generally constructed between 1975 and 1992. The program required the owner of a direct loan project to record a long-term use agreement on the property and demonstrate that refinancing would produce debt service savings, a low bar given the low interest rate environment of the early 2000s. Debt service savings could be used to provide additional supportive services and other uses beneficial to the residents, as permitted by the statute. Refinancing also generated funds for needed repairs.
In 2010, Congress expanded the scope of the preservation effort by authorizing the repayment and refinancing of pre-1975 Section 202 direct loans with original interest rates below six percent to allow property owners to address the physical needs of those projects. The expanded program permitted an increase in debt service to fund capital improvements. Accordingly, the statute allowed an increase in Section 8 rents to support the refinance; however the overall increase was limited to mark-up-to-market or mark-up-to-budget rent increases under the Multifamily Housing Reform and Affordability Act. In addition, HUD required any rehabilitation to address significant repair needs and qualify as a substantial rehabilitation, as defined by FHA.
The bulk of the existing Section 202 capital advance properties have operated for at least ten years, and the oldest are approaching twenty-five years of age. As a result, many of these properties require major repairs and updates. Because capital advances do not amortize and PRAC rents are sized accordingly, the financing challenges associated with preservation are somewhat unique but align more closely with the needs of pre-1975 Section 202 direct loan properties as expenses for debt service are expected to increase as a result of rehabilitation.
“The 2018 Act”
Through the 2018 Consolidated Appropriation Act (“the 2018 Act”) Congress expanded the Rental Assistance Demonstration Program (“RAD”), which allows the conversion of certain types of housing subsidy to Section 8 assistance, to permit conversion of PRACs to long-term Section 8 project-based rental assistance contracts and project-based voucher contracts. In addition, the 2018 Act authorized the subordination and/or restructuring of existing capital advances, as necessary, to facilitate restructuring. These changes are designed to allow Section 202 capital advance owners to leverage their rental assistance to make necessary repairs and updates.
HUD is currently drafting a much-anticipated revision of the RAD Notice, which will detail the program requirements for “RAD for PRAC” as a Component 2 RAD program. Congress did not cap the number of units that may convert under Component 2, so the selection process is not competitive. RAD is revenue neutral: it permits conversion of existing subsidy but does not provide additional funding. As a result, this program presents some unique challenges that need to be addressed in the RAD notice:
Rents / Rental Subsidy
PRAC rents were not designed or permitted to support an amortizing mortgage. Even if the existing capital advance “debt” is subordinated or restructured rather than refinanced, Section 8 rents based on current pre-RAD budgets without debt service would limit a Section 202 owner’s ability to support loan amounts necessary to provide adequate funding for transaction costs and necessary repairs/rehabilitation. While the introduction of other sources of financing, including soft loans and low-income housing tax credits, will defray some of this expense, the availability of subsidy and the method of determining rents, both initially and over time, will play a key role in determining the feasibility of this program for individual projects.
Restructuring of Existing Capital Advances
The 2018 Act authorizes the subordination and restructuring of the existing Section 202 capital advance, which currently includes obligations under a note, mortgage/deed of trust and use agreement. Subordination and restructuring of the capital advance must be considered within the context of acceptable project ownership structures, which Congress expanded in 2000 and 2010 to include for profit limited partnerships with various types of nonprofit general partner control. A shift to for-profit ownership will be required for capital advance properties to take advantage of some financing tools. However, the entity that will become the “debtor” under any capital advance note and deed of trust/mortgage, the obligations of the continuing capital advance, and tax implications related to those obligations, must be addressed within the context of potential changes in ownership structure.
Scattered Site Projects
Given that many Section 202 capital advance projects include fewer than fifty units, aggregation of multiple facilities into a single scattered site project, if permitted, would distribute certain fixed expenses and increase the feasibility of the RAD for PRAC program for some projects. Authority to transfer projects would further encourage consolidation and create an opportunity for cost savings. Transfer authority would also provide an opportunity for some smaller sponsors and owners that no longer desire or are no longer equipped to continue in those roles to exit the program and facilitate transfer of properties to those with the tools to take advantage of the RAD for PRAC program.
By statute, the 202 program requires owners to provide supportive services considered essential for elderly residents to continue to live independently. Some owners receive grants to fund those services. For others, employment of a service coordinator is considered an eligible cost under the PRAC. Inclusion of those expenses in the Section 8 operating budget is vital to the continued provision of those services.
About the Author
Susan provides counsel and assistance with housing, community development, and regulatory matters, focusing on HUD/FHA-insured loans and asset management issues.