Although the exact changes in project-based Section 8 programs haven’t yet been determined, change is coming, and it will not only affect present owners and managers of this housing, but will influence whether or not community development corporations (CDCs) should get more involved in acquiring and preserving this stock.
While not on a massive scale, CDCs are already involved with project-based Section 8 housing. Much of the federally-subsidized senior and disabled housing that was constructed in the last two decades was built by CDCs. More recently, nonprofit housing groups have used McKinney SRO Moderate Rehabilitation and the Low-Income Housing Preservation and Resident Homeownership Act (LIHPRHA). California alone has over 90,000 units with Section 8 contracts, two-thirds of which expire in the next four years. In the past several years, CDC and resident-controlled entities have acquired over 4,000 affordable apartments in California under LIHPRHA, demonstrating both an interest and capacity for ownership of the HUD-assisted stock. In other parts of the country, even greater numbers have been transferred to nonprofit and resident owners.
Section 8 Risks and Opportunities
CDCs that do own projects with Section 8 are very concerned – and rightly so – about whether or not Section 8 will continue to be renewed. They’re concerned about both the possible tenant displacement and the effect on the financial feasibility of their buildings.
Besides potential termination of Section 8 contracts, another risk is “slow starvation.” Congress has frozen Section 8 contract rents with contract renewals for the past two years. HUD has embarked on a “get tough” campaign aimed at weeding out “bad owners” which imposes new paperwork and screening requirements on all Section 8 owners.
The driving force behind this – an effort to reduce costs – becomes even more compelling for projects with high contract rents. During the past year, for example, owners with expiring Section 8 contracts above 120 percent of Fair Market Rents (FMR) were made an offer they couldn’t refuse: renew your contract at no more than 120 percent of FMR (i.e., take a reduction in subsidy) or participate in a “Portfolio Reengineering” Demonstration. Under the demonstration, Section 8 rents were to be reduced to the level of comparable rents in that market. The financing on the property was to be reduced or eliminated to keep the property viable with the reduced subsidy. Project-based subsidies could be cut off for projects with “non-performing” owners or extensive repair needs. For projects with non-performing owners, HUD has devised procedures intended to encourage transfers of ownership to CDCs or resident-controlled groups.
Why Purchase Section 8 Housing?
As Congress and HUD seek ways to reduce future funding levels, Section 8 owners are facing more screening and reporting requirements as part of HUD’s efforts to weed out “bad” owners. At this point, why should any nonprofit community development corporation (CDC) worth its weight in pro formas even think about acquiring housing subsidized with project-based Section 8?
There are some very good reasons why CDCs need to take a serious look at this stock. First, more than two million low-income people live Section 8 housing. We need it in our communities. CDCs are natural participants in the discussion of how to preserve it, because of their mission to maintain or improve affordability and their capacity to combine multiple sources of financing and subsidies. Second, if Section 8 housing becomes less profitable, many for-profit owners will want out as much as HUD does. Many will look to sell particularly if the federal government devises strategies to soften the tax blow such owners currently face upon sale of these properties. Third, some Section 8 buildings have been expensive to run – either with high operating budgets or deferred maintenance that has led to expensive repairs. CDCs with experience operating multifamily housing in a more cost-efficient way may be in a better position to preserve the housing, even in a tighter budget environment.
Transferring Ownership to CDCs
LIHPRHA provides positive and negative lessons for CDCs interested in acquiring this housing. Having predevelopment funds for technical and planning costs, as well as early warning on potential sale properties, has played a key role in successful purchases through LIHPRHA. LIHPRHA’s flaws include a highly bureaucratic sales process, causing typical purchases to take from 12 to 18 months. To be competitive buyers, CDCs must have tools to compete with other potential owners.
While LIHPRHA-type financing isn’t available for Section 8 properties, some entrepreneurial CDCs have found they can buy this housing with other funding. They are looking at financing tools such as tax-exempt bonds, tax credits, and locally-allocated funds. There is greater competition for all these funds, and we should continue looking for new sources that could be targeted to this Section 8 stock.
Understanding the Market
Pursuing ownership of Section 8 housing requires some understanding of HUD programs created in the 1970s and some knowledge of the dynamics of aging tax shelter partnerships. Unlike the older HUD-assisted projects built under Sec. 236 and 221(d)(3), which had owners eager to prepay and raise rents to market, the stock now at risk has rents typically close to, and in some cases even higher than, “true market” levels.
National studies indicate that if Section 8 project-based subsidies were abruptly discontinued, over half the stock would likely go into default, potentially causing massive displacement of poor tenants. Because of this, many for-profit owners have supported continuing the program. Exceptions to this occur in the tight, expensive rental markets where owners actually could make more money by opting out. California has many of these tight markets, but this summer rental markets have heated up in other cities – particularly in the east.
The prospect of default or the chance to make more money are both strong incentives to induce for-profit owners to sell. But their behavior is probably more influenced by their tax situation. Most Section 8 projects were developed by limited partnerships that have since depleted their tax benefits. Partners that sell face significant tax liabilities. Transfers to CDCs are much more likely if these partners are offered deferred or reduced taxes in exchange. While it may be necessary in the long run to save the housing, congressional committees have, to date, been reluctant to give additional lucrative tax breaks to this particular group of investors.
Management fees will also influence the selling of this stock. As in the older preservation projects, the general partners often function as the management agent (and collect the fee). CDCs may need to consider retaining the current management agency for a few years, or find owners who don’t manage their own properties.
The most motivated sellers in the current climate are likely to be those owners with troubled properties, those disqualified from Section 8 renewals, or those ready to retire from the business. Identifying such owners will take some research.
Nonprofit Intermediaries as Section 8 Administrators
Besides cost, a major concern about the Section 8 program – and the subject of many press “horror stories” – has been HUD’s uneven capacity to administer and monitor it. One of Secretary Cuomo’s goals is to reduce HUD staffing by another 25 percent. Under the 1997 Multifamily Portfolio Reengineering Demonstration, HUD is authorized to contract with public or nonprofit agencies to administer the restructuring of these Section 8 contracts. HUD has entered into delegation agreements with several state housing finance agencies and issued a call to national and regional nonprofits to serve in this capacity.
Having nonprofit intermediaries (such as LISC or Enterprise Foundation) as the restructuring agencies would facilitate nonprofit acquisition of Section 8 housing. The intermediaries are likely to be more sympathetic to CDC concerns, ranging from the financing sources to the management issues.
Researching Section 8 Developments in Your Community
Despite the pitfalls and obstacles to acquiring Section 8 housing, CDCs nevertheless have an important role to play in preserving this stock. Some, if only a few, of the pieces are in place to enable CDCs to acquire and preserve affordability of a significant part of the Section 8 inventory. In the volatile federal housing policy environment, opportunities could arise at any time, and CDCs should be prepared. CDCs need to be involved, with other housing advocates, in looking for new resources to preserve this housing, new ways of financing it, and advocating for program changes that will prevent loss of this important housing.
For more information on Section 8 properties, HUD has developed a useful Internet web site with information on specific Section 8 developments and demographic information of Section 8 residents by project or by jurisdiction. HUD’s main web site is www.hud.gov or www.huduser.org. The site contains key data such as the mix of bedroom types, current rent levels, the loan balance and contact information for the property manager. Those not connected to the Internet can request documents from their HUD field office. CDCs can also get information about Section 8 housing from the National Housing Trust, 202-333-8931.