Budget-Based Rent Adjustments Possible for Qualifying Mark-to-Market Section 8 Properties 

Section 8 property owners who refinanced their debt through the U.S. Department of Housing and Urban Development’s (HUD) Mark-to-Market (M2M) program, mainly in the late 1990s through early 2000s, may qualify for budget-based rent adjustments under a new program launched this year by HUD.

On February 29, HUD issued guidance on how it would allow budget-based rent adjustments (BBRA) on qualifying properties that have not been able to raise their rents due to M2M finance restructurings done decades ago. HUD accepted applications for the first round of rent adjustments through March 28. Additional rounds of adjustments are expected to be offered within the next year and beyond.

The BBRAs target properties that are operating at a budget shortfall, especially those where the property owners take money out of their own pockets to cover costs. Properties that need renovations and failed HUD inspections may also qualify.

“Many properties that went through M2M restructuring have struggled in recent years to keep up with operating costs, capital needs and other costs,” explains Deborah VanAmerongen, strategic policy advisor and deputy practice leader of affordable housing and real estate at Nixon Peabody. “This program provides relief for properties that have been struggling.”

Denise Muha, executive director of the National Leased Housing Association, says her organization and others have been lobbying HUD for years to allow for budget-based rent adjustments.

“This was a technical correction to the law. It was long overdue,” explains Muha. “Some of these properties have been struggling for years. In order to keep the properties from deteriorating, the owners have been loaning their money to their properties.

Muha adds, “This is an opportunity for some of these properties to do a major renovation for the long term and the rent increases will help to leverage financing for that.”

The History
Much of the affordable housing financed by HUD in the late 1970s and early 1980s was also provided with Section 8 project-based rental assistance contracts. Some of those properties were provided mortgage insurance from HUD through the Federal Housing Administration (FHA). This financing package is how a lot of Section 8 housing was built and many of those properties are still in the HUD portfolio. The Section 8 properties generally had subsidy contracts with 20-year terms and rents adjusted by an annual adjustment factor that was published by HUD. When the contracts began to expire in the late 1990s and early 2000s, some of the contract rents were below market and others were above market. Congress agreed to renew the contracts and maintain affordability, but not pay more than market-level rents, which meant some properties would have to reduce rents.

Properties needing to reduce rents were at risk of defaulting on their federally insured mortgages. Congress did not want the properties to default, so they restructured their FHA debt and only included as much debt as was supported by the lower rents. If a portion of the old mortgage had to be deferred, HUD created second or third mortgages, and payment was only required on them if there was surplus cash available. Those refinanced properties were bound by 30-year use agreements that limited rent increases and tied them to a published operating cost adjustment factor (OCAF). However, since those agreements were inked, many of those properties have increased expenses beyond the OCAF increases, require major capital improvements and/or are struggling financially. Some of the increased expenses come from raised costs of insurance, taxes and other costs. Property owners could not get financing for the improvements because of the lower rents. Some property owners have had to reach into their pockets to cover expenses or pay for improvements.

“The properties that need it are the ones where their rents have not kept pace with the market while their operating expenses went up significantly,” explains Muha.

Eligibility and Application Process
Housing advocates have lobbied for years for HUD to develop a process to allow for budget-based rent adjustments to provide relief to property owners who cannot cover operating costs or costs of improvements with their level of rent. After years of lobbying, Congress ultimately included language in the Consolidated Appropriations Acts of 2023, which allowed the BBRAs. HUD developed and issued the new BBRA guidance in January of this year.

HUD accepted its first round of applications for BBRA through March 28. Housing advocates say they believe there will be more rounds of applications accepted as other tranches of funding become available to cover the costs of these rent adjustments. Properties that qualify but did not make the March deadline may still apply, but those that made the deadline will get higher priority when eligibility determinations are made.

Approximately 2,000 Section 8 properties are under M2M agreements, but not all are eligible for the BBRA. The first group of eligible projects, termed Group A, must meet one of the following criteria:

• REAC Score – The property’s real estate assessment center (REAC) inspection is below 30 or had two previous consecutive scores below 60;
• Operating Cost Coverage Ratio – The project’s OCCR is less than 1.0;
• Owner Contributions – Owner contributions were made in excess of $3,000 per unit in the most recent fiscal year or in excess of $1,500 per unit in each of the last three fiscal years;
• HUD Disposition Action – The project is within the HUD disposition process because HUD has either acquired the first mortgage debt or the property, through a FHA insurance claim foreclosure or other action, is subject to a disposition action; or
• Vacancy – The average physical vacancy rate is 25 percent higher for the most recent 24-month period.

“They [HUD] are trying to figure out what properties need it the most,” says Muha. “They want to make sure that another year or two doesn’t go by and they deteriorate to the point where people can’t live in them.”

Muha adds, “If your rents are not under the market, you are not eligible. The market is the cap. The properties that need it are the ones that have not kept pace with the market while their operating expenses went up significantly.”

Applications for the BBRA can be found on the HUD website along with additional details. After meeting the initial criterion, applicants proceeding to the next level will have to provide backup materials, such as a budget worksheet that covers payroll, insurance, debt service, maintenance costs and other costs. If an owner needs more than a five percent increase, they will need additional backup documents, such as insurance bills, utility bills and proof of other costs.

If property owners are given an adjustment, they will need to agree to their properties staying in HUD affordability for an additional 20 years.

Funding and Future Rounds of Accepting Applications
Muha and VanAmerongen say affordable housing advocates are lobbying for additional funding for future rounds of BBRAs.

“We are also as an industry pushing for Congress to provide additional Section 8 funding so any property in the M2M portfolio that has this need can work to have the need addressed,” says VanAmerongen.

Muha estimates there will be $50 million from HUD for the first tranche of money for the rent adjustments. Subsequent rounds could be from $150 to $200 million, advocates estimate, but there is no certainty.

“We think they [HUD] need to figure out what rent increases are going to cost,” she says.

Muha estimates that 100 to 125 properties may be going through the BBRA applications process currently in Round A. She predicts that applications will reopen at some point during the year.

Muha says she believes that HUD has had this authority all along to provide the BBRAs considering that its regulations provided for such an increase. HUD disagrees, believing its authority to provide BBRAs was not certain. Now they clearly do have the authority given the language included in the Consolidated Appropriations Acts of 2023.

“It took about three or four years to get this done on the Hill,” explains Muha, who reiterates that it has been unfair that some property owners have had to dip into their funds to keep some properties afloat.

“They should not have to do that forever because of a glitch in the law,” she adds.