Mr. Chairman, the National Housing Law Project appreciates this opportunity to contribute to this Subcommittee's consideration of comprehensive legislation to restructure the Section 8 project-based portfolio. The views presented here reflect the work of the Project over the almost three decades since its creation in 1968. During that time we have served as a technical support center on housing and community development matters for lawyers and other housing advocates working with tenant leaders and community groups nationwide seeking housing justice for low-income Americans. Our support role has included legal research, advice and co-counsel regarding litigation matters, legislative and administrative advocacy, publication of our Housing Law Bulletin and housing law manuals, and training and technical assistance. Working with these local housing advocates, dealing with the day to day problems and opportunities presented by implementation of federal housing laws and programs, has developed the views we express today.
After providing some brief background considerations for shaping restructuring policy, our statement covers the major and considerable strengths of S. 513, before reviewing some remaining concerns. We understand that a revised discussion draft of the bill will be released shortly, and thus we request leave to submit a separate memorandum addressing technical points raised by that draft. The general preservation approach taken by S. 513 represents the best proposal advanced over the past two years to address these important and complex issues. We commend the leadership of the Chairman and the extensive efforts of your Subcommittee staff in developing this bill. Although we would prefer a bill that explicitly assures protection of Section 8 assistance for the same number of assisted families and the same occupancy profile, rather than leaving this fundamental question to the annual appropriations process, passage of S.513 would move the process forward in the right direction.
The Budget Challenge. An essential objective of any Section 8 restructuring program is to address the fiscal problems facing the Section 8 budget over the next decade. Saving discretionary budget authority and outlays by reducing Section 8 contract rents is thus the main focus of S. 513 and other proposals. Because of the peculiarities of federal budget accounting, this goal is especially important as the federal government moves toward a balanced budget. By reducing subsidies on those properties receiving higher subsidies to market' 'levels, S. 513 achieves important discretionary savings that will help to reduce outlays.
A second major fiscal challenge is the unique Section 8 budget problem presented by growing numbers of expiring contracts. The recent Balanced Budget Agreement and the budget resolutions reportedly include explicit designation of full Section 8 renewal funding. For the restructuring policy of S. 513 to succeed, Congress must actually deliver this funding for Section 8 through the appropriations process every year, and provide the needed outlays for the program and its current residents.
The Policy Challenges. Often obscured in this extraordinary fiscal challenge is the central question surrounding the future of this enormous project-based Section 8 housing stock with expiring contracts and the residents and communities that need it.
Who is served. The inventory consists of about 1. 3 million units, financed in a variety of ways and subsidized under various Section 8 subprograms (e.g., New Construction, Substantial Rehabilitation, Moderate Rehabilitation, Loan Management Set-Aside, etc.) . All units share the common feature of project-based Section 8 funding that eventually expires. The stock serves residents with very, very low incomes, averaging around $8,000 per family annually. Tenant families pay an average of about $180 monthly toward the rent, with the balance covered by Section 8 assistance. These tenants cannot afford even operating costs of private market rental housing. The availability of Section 8 as an operating subsidy is critical for meeting their needs, even if assisted properties had no debt burdens. About half of these families are people of color, and about half are elderly or people with disabilities.
Growing Low-Income Housing Needs. In developing a comprehensive restructuring policy for this portfolio, Congress must also consider the general housing picture facing Americans with low incomes. Because incomes of people near or below the poverty line are out paced by growing housing costs, worst case housing needs, concentrated among unassisted families and individuals with very low incomes, are growing. Now, these housing needs are growing faster than the society's commitment to meet them. This will increasingly be the case as rental housing markets of moderately priced units around the country continue to tighten, as excess capacity produced during the early 1980s -- fueled by since-repealed real estate tax shelter subsidies -- is increasingly absorbed.
Thus, preservation of the levels of housing assistance and inventory currently devoted to addressing worst case needs is absolutely essential. Any significant reduction in outlays for Section 8 that reduces the number of units or families assisted, or shifts the use of these resources to families with higher incomes, invariably means that we will fall further behind in meeting worst case housing needs. The inevitable consequence will be more housing deprivation, manifested as overcrowding in generally substandard housing or homelessness. The resulting economic and social costs are unacceptable.
Restructuring policy should incorporate the lessons of the past in developing a vision for the future. Using the event of contract expiration only to pursue a narrow fiscal goal of restructuring rents, subsidies and debt burdens would be incredibly short-sighted, deferring for but a few years the need to face any other important problems. We must also control costs as much as possible by adopting rent increase methods that provide adequate income for cost increases and involving residents to make sure that project funds are being properly spent.
Experience over the past 20 years demonstrates that we must use public investments in housing more wisely, to produce quality living environments and neighborhoods for assisted residents. The public investment should be linked to quality performance standards and long-term preservation of the housing resource, to avoid the instability and cost of both market conversions when conditions permit more profitable uses and public bail outs when they do not. A redesigned Section 8 program should also build stronger relationships and accountability between residents, housing providers, regulators and surrounding communities, through both positive incentives and requirements of participation and consultation. Finally, housing should be integrated with job training and employment opportunities, and supportive social services such as child care and transportation.
Restructuring policy should consider these broader goals. If we cannot address all of these goals now in S. 5,13, we must at least assure that we are taking steps in the right direction. America simply cannot afford to bypass this unique opportunity to use the event of contract expiration to improve the housing delivery system, channeling any additional benefits and resources to ensure more accountable and cost-effective operations and to produce permanent investments in our affordable housing supply.
At stake in this restructuring process is the control and future operation of at least 500,000 "oversubsidized" HUD-insured units, many of which have little or no true equity beyond their current debt burdens. We must bear in mind that the Section 8 subsidies provided over the next 10-20 years will contribute significantly to the retirement of principal obligations on the reduced first mortgages, which inures to the benefit of the owner. Sound public investment strategies to retire capital costs, if linked to transfers into the restricted nonprofit or public ownership sector or to long-term use restrictions, could reduce eventual renewal costs to those required for operating and recapitalization expenses.
By virtue of the impending expiration of the subsidy contract, the federal government now effectively controls what happens to these properties. The terms of Congress' restructuring program, and the mix of benefits provided and burdens imposed will determine the responsiveness of using this stock as a future tool to meet still-expanding affordable housing needs among very low-income families.
The benefits of restructuring for owners could include subsidy levels, debt restructuring or forgiveness, rehabilitation resources, and even tax relief. The burdens could include long-term use and affordability restrictions, second mortgage repayment obligations, transfer rights or preferences for tenant-endorsed and community-based purchasers. Defining this package provides the fundamental challenge bef ore us, a tremendous, once-in-a-lifetime opportunity to construct a new and improved system of performance accountability.
Evaluated under these criteria, the current version of S. 513 contains a solid foundation and represents a giant step in the right direction. Instead of proposing radical and untested large-scale substitutions of vouchers, S. 513 generally seeks to use restructuring to reduce Section 8 discretionary spending while preserving the current project-based program. It would also make some modest improvements by getting rid of some bad owners, fostering tenant participation, and providing some new regulatory enforcement tools. S. 513 contains the following vital components:
Reduction of Section a demands on scarce discretionary budget authority and outlays through rent, subsidy and debt reduction.
Preservation of project-based assistance. Voucher substitutions would be limited to certain higher-cost troubled properties or owner opt-outs where renewal rents would not cover true market values.
Retention of the public investment in restructuring for the public interest. S. 513 would accomplish this through the form of FHA insurance for the remaining first loan, and through the combination of the deferred second mortgage (instead of debt forgiveness) and use restrictions that, for the life of the second mortgage, require the owner to accept Section 8 subsidies offered by the government and maintain the restructured rent levels (105). This essential component linking an often significant deferred second mortgage obligation to strong use restrictions represents a major improvement over last year's version of the bill (S. 2042, 1996). (However, to preserve affordability, S. 513 should also prohibit prepayment of this second note, and require restructured owners to maintain cost-based rents after restructuring.)
Recognition of the essentially public purpose role for the new administrator. PAEs that are state or local housing agencies, or HUD, would execute these important duties.
Establishment of a specific planning process with resident and community participation and funding for technical assistance to implement it (104(f)). S. 513's requirements that residents and communities must be allowed to participate by commenting on both the administrator's plan and on individual project plans, and authorizing resources for technical assistance and capacity building are particularly important. S. 513 specifies the procedures that HUD must include, such as notice, access to information, and comment and meeting rights.
Recognition of the need for rehabilitation planning and significant federal resources and owner contributions (107(a)(7)).
Encouraging better performance through screening out bad owners and making improvements to the post-restructuring enforcement structure (Title II). We strongly support Title II's strengthening of tools to enforce program rules against owners, such as expanded equity skimming prohibitions and extending double damages remedies to all HUD-insured, risk-sharing and Section 202 programs, and broadening civil money penalty liability to include general partners, officers and directors, and certain managing agents, and making violation of Section 8 contracts an offense subject to the penalties.
In contrast to other proposals under discussion, these provisions of S. 513 would improve rather than abandon Section 8 housing policy. Of special importance are provisions reportedly contained in the revised draft to maintain use restrictions including acceptance of Section 8 as long as the second mortgage is outstanding, to permit the PAE to forgive the second note in the case of a sale to a nonprofit or public agency, and to ensure that project-based assistance will continue in the case of the approved transfer of a disqualified owner's property. A few of these provisions require greater specificity, as mentioned infra.
However, we believe that S. 513 inadequately addresses other key components of a comprehensive restructuring program. The most important overall question is whether S. 513 ensures quality and responsive performance by owners that restructure.
Specific concerns include the following:
No tax solution/incentives. There is no lasting solution to the tax problems caused owners by restructuring, so owners may only reluctantly participate or may defer participation until the eve of expiration, depriving the government the "savings" of earlier restructuring. The hope is that IRS will issue a ruling that the bifurcated debt approach (creating a deferred second mortgage out of that portion of the current debt that cannot be serviced at restructured rents) avoids immediate taxation as "cancellation of indebtedness". Without this favorable ruling, perhaps only the desperate will restructure. Nor is there any solution to the exit tax problem facing owners who face a tax liability on any sale due to their use of prior tax shelter benefits that produced substantial depreciation in basis.Most will simply extend their participation and hang on to get whatever benefits are left via management fees, identity of interest contractsor any permissible cash flow, rather than transfer the property to more responsible parties. Wherever possible, owners may allocate funds away from project needs toward debt service to avoid default, with reductions in housing quality to the detriment of tenants. This will not prove to be a sound system of incentives to ensure quality performance over the long haul. Tax relief should be provided, but only where linked to transfers to tenant-endorsed nonprofit or public ownership.
Potentially inadequate accountability reform. Restructuring under S. 513 is essentially a foreclosure avoidance program for almost all Section 8 "over subsidized" property owners if there is no real equity value. Beyond substituting new administrators armed with some new enforcement tools, S. 513 contains assurance that project operations will become more responsive to tenants after restructuring. S. 513 apparently presumes that PAEs will be more responsive to residents needs and "bad owners" will be excluded. However, since many PAEs may not have a solid track record of working with deeply subsidized properties and residents, S. 513 should also specify in greater detail the monitoring obligations of the PAEs and the tenants' participation role, although hopefully the overall plan and compensation structure will provide more staff for this essential function than HUD had. The bill should also clarify that tenants may participate in physical inspections whether before or after restructuring (104(f) (2)), and that these should occur no less than annually. The bill should require mechanisms adequate to permit direct tenant empowerment through individual and joint action where owners and regulators are not performing, such as rent withholding for violations or third party judicial enforcement rights.
Care should also be taken to ensure that the bill language does not inadvertently inhibit later reform initiatives by Congress, HUD or PAEs. For example, the requirement that owners accept Section 8 renewals after restructuring if offered "on the same terms and conditions" (105(b)) might prove problematic if owners could claim that any subsequent reforms were new "terms", thereby permitting a rejection of the new term. Some owners could seek to shed the Section 8 contract because the rents will be at or slightly below market, and the second loan will not become payable until retirement of the remaining first mortgage.
Insufficient transfers to tenants and nonprofits. S. 513 explicitly encourages transfers only of disqualified "bad owner" properties. Transfers should be encouraged because of the significant capacity developed in the nonprofit sector, which can provide improved local accountability, access to local resources for project or resident needs, and less tension between affordability goals and the potential for private gain. The program should include incentives for marginal owners that would not necessarily be excluded under the narrow "bad owner" screen to exit the program in favor of qualified tenant-endorsed purchasers. This could be accomplished through a combination of a specific funding allocation to assist preservation purchasers, tax relief to cover exit taxes (as suggested in H.R. 1433), and stronger performance review and accountability standards. In addition, for transfers to qualified tenant-endorsed nonprofits, the PAE should have discretion to forgive the deferred second note or subordinate it to permit acquisition financing. (We understand that this provision may be incorporated into the most recent draft of S. 513.) While this would not resolve the owner's exit tax problem, it would provide an important competitive advantage to dedicated purchasers and avoid adverse tax consequences.
Low rehab cap, unadjusted for geographical variation. The $5,000 cap on federal contributions toward rehabilitation may not be workable. It assumes both geographical consistency and that the owner, purchaser or the state or local government will be willing and able to contribute the balance of any necessary resources to the property. HUD's data shows that the average repair needs substantially exceed this amount. While S. 513 properly requires a contribution from owners, S. 513's cap on federal resources (via exception rents, further debt concessions, residual receipts, or rehab grants) will place a substantial number of properties at risk, particularly in high cost areas, unless rehab needs can be covered from other sources or via reserves built through sound operating budgets negotiated with the PAEs. The cap should be increased, and based upon a multiple of FMRs to inject some degree of geographical variance.
Getting "bad owners" out of troubled properties. S. 513 explicitly encourages transfers of disqualified "bad owner" properties, but provides no clear way to evict those owners. The program should ensure fast and certain foreclosure consequences because, absent a tax solution, many of these owners will hang on as long as possible despite withdrawal of the Section 8. H.R. 1433's provision exempting HUD and RHS multifamily foreclosures and related actions from the automatic stay provisions of the Bankruptcy Code would be an important addition. In addition, HUD and PAEs will need a clear and consistent enforcement plan, adequately staffed and funded. (We understand that the latest draft of S. 513, 106(e) addresses another key problem by allowing the nonprofit purchaser to renew the Section 8 contract.)
Insufficient incentives to preserve higher value properties. The bill provides insufficient incentives for owners to retain some of the inventory's best properties that are exempted from restructuring -- whose subsidized rents are currently below true market value -- or to transfer these properties for preservation purposes. (The latest draft's language permitting an operating cost adjustment after renewal will help for those properties where the gap is small, but not for many others that are sufficiently more valuable than their current Section 8 rent levels to cover conversion costs.) For example, left unprotected are those older assisted properties with below-market rents whose owners would renew with a subsidy closer to FMR, and where an owner's conversion would trigger a federal obligation to pay replacement tenant-based subsidies at that same higher FMR level!
Similarly, it appears that S. 513 would not provide tools for properties that carry subsidies above objective market levels, or where market values exceed the 120% exception rent caps, because they are strong real estate or in higher value submarkets. (We understand that the latest draft may include waiver authority for PAEs to approve budget-based rents in excess of 120% of FMR for another category of high-cost units -properties with high operating costs in relation to area FMRs.) Presumably owners of some high-value developments could restructure through forgiveness of good debt, but without a tax solution no owner would have any incentive to do so. None of these properties would be expected to remain in the affordable housing stock.
S.513 should provide sufficient tools and resources to enable PAEs and owners to preserve these properties as low-income housing; enhanced vouchers to avoid displacement will cost the same as these tools. There is no good reason to put families and elderly and disabled tenants at unnecessary risk of opt-out and displacement.
Displacement protections. The Administration's bill, H.R. 1433 provides for "enhanced vouchers" in the event of non-renewal, increasing the amount of tenant-based assistance to the reasonable rent) to avoid economic displacement of tenants. S. 513 should also provide such assistance to all tenants where contracts are not renewed for any reason. Owners should be obligated to accept these vouchers as long as the tenant complies with the lease terms. Any buildings that undergo restructuring but for some reason later lose their project-based Section 8 contracts should be obligated to accept all current resident voucher holders, and refrain from discrimination against tenant-based recipients for all units.
Eligibility for tenant-based assistance (S. 513, 104(d)) should also be determined as of the date of the termination notice, since some tenants are inevitably driven out by the uncertainty and lack of accurate information. A more specific notice sufficiently prior to any termination of project-based assistance must be required, in sufficient time to enable the replacement subsidies to be provided by HUD to the local PHA and then placed by residents in alternative units (two steps consuming around eight months in other conversion situations and markets).
We appreciate the opportunity to present these views to the Subcommittee, and look
forward to working with you and your staff as the development of a federal restructuring
policy advances in the 105th Congress.
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