The Technical Aspects of Closing a Faircloth-to-RAD Deal

The Faircloth-to-RAD program was launched in 2021 by the Department of Housing and Urban Development (HUD) as a creative way to tap into authorized but unused public housing funding to create new affordable housing units. Recent Tax Credit Advisor articles have spoken to the historical background, purpose and early impact of the program.

HUD has taken its early learnings to issue updated program guidance as recently as November 2023 (Faircloth-to-RAD Guidance). Additionally, as several of the early Faircloth-to-RAD projects are completing their conversion to the Rental Assistance Demonstration (RAD) program, practitioners are also starting to better understand the legal “nuts and bolts” of how to close a transaction and ensure a smooth transition from Faircloth-to-RAD.

What is and Why Faircloth-to-RAD?
Put simply, Faircloth-to-RAD is a program that allows the development of new public housing units under a housing authority’s existing “Faircloth authority” and immediate conversion of those units to the RAD program. “Faircloth authority” is the number of new units each housing authority is authorized to develop as public housing units that will generate HUD assistance. According to HUD data, there were over 250,000 units of “Faircloth authority” as of October 2023.

RAD allows for the conversion of public housing units into project-based Section 8 assistance, a more flexible funding platform that generally comes with higher rents for property owners. One limitation of the program is that only units currently operating as public housing are eligible to convert.

Therefore, if a housing authority has excess Faircloth authority, the undeveloped units are not eligible to be developed directly under the RAD program. However, the Faircloth-to-RAD program allows a housing authority to utilize its Faircloth authority for the development of new public housing units under the mixed-finance program with the assurance that the units will be immediately eligible for RAD conversion upon construction completion. This allows funders to underwrite the higher RAD rents, which in turn enables the housing authority (or its selected developer) to leverage additional financing for the development of new units.  

Expectations at Financial Closing
One potentially confusing aspect of the Faircloth-to-RAD process for all parties is that the documents entered into at financial closing will reflect a mixed-finance, public housing regulatory regime (e.g., Regulatory and Operating Agreement, ACC payments) even though the project underwriting assumes a RAD rent structure and regulatory regime (e.g., HAP contract and RAD Use Agreement). It is important to ensure that all parties understand the conditions that need to be satisfied for the planned RAD conversion and commit in advance to take the steps necessary to facilitate that conversion.

The primary HUD documents provided at the financial closing evidencing the planned RAD conversion are the Notice of Anticipated RAD Rents (NARR) and RAD Conversion Conditional Approval (RCCA). The NARR and RCCA are crucial to review and understand, as they provide assurance from HUD that sufficient RAD authority will be available at the time of RAD conversion. The documents also provide an estimate of rents and the conditions that will need to be satisfied for RAD conversion.

Several business and legal issues should be resolved at the initial financial closing. Examples include: (i) acknowledgment from lenders and regulatory agencies that they will be required to subordinate their mortgages and regulatory agreements to the RAD Use Agreement, (ii) agreement among the developer, lenders, equity provider and the housing authority on the handling of any reserves that may be in place under the mixed-financing structure but will no longer be applicable upon RAD conversion and (iii) acknowledgment from the property manager of the planned RAD conversion and the impact on its ability to lease the subsidized units prior to conversion.

From a transaction efficiency standpoint and to avoid disputes at the time of RAD conversion, counsel to the transaction parties should be drafting documents in a way such that no amendments are necessary at RAD conversion. Ideally, the RAD conversion closing should involve no more than the execution of (i) releases of all mixed-finance documents, (ii) new RAD subsidy documents and (iii) RAD subordination agreements provided by lenders subordinating their interest to the RAD Use Agreement.

HUD’s guidance directs housing authorities to negotiate mixed-finance closing documents with the “limited lifespan in mind” and for field offices to “[review] with RAD in mind.” Our firm, however, has seen inconsistent application of this guidance as it relates to the ability to contemplate the planned RAD conversion into closing documents. Some HUD field offices have not permitted “flip” provisions that would allow the documents to convert automatically from mixed-finance provisions to RAD provisions upon the RAD conversion.

The best alternative in such situations is to have all parties agree to the form of amendments needed for their respective documents to be executed at RAD conversion. This will help in limiting any negotiation related to the change in deal structure. Even still, the housing authority and developer need to re-engage the financing parties long before the planned RAD conversion.

Resident Lease-Up and Engagement
Another tricky aspect of the Faircloth-to-RAD conversion is that the underlying leasing structure changes upon RAD conversion, impacting both owners and residents. The updated Faircloth-to-RAD Guidance further outlines the implications for resident lease-up and engagement activities that owners and their respective property management teams should carefully review before proceeding with leasing activities.

If units are leased before the RAD conversion, then those leases are governed by the existing public housing mixed-finance rent structure. For the owner, this means that for at least some period, the owner will be leasing units at public housing mixed-finance rents set forth in the Regulatory and Operating Agreement, which are generally less than the underwritten RAD rents. The other significant implication is that if units are originally leased as public housing units, then the resident notice and engagement requirements for a traditional RAD conversion become applicable. This requires extra effort by the property management company and could result in delays in the RAD conversion.

The cleanest approach to avoiding these issues would be to delay leasing of the units until the RAD conversion has been completed. If this is possible, units would be leased immediately subject to the RAD program and the complication of different subsidy types is avoided altogether. Delaying the lease-up, however, may present financial burdens and delay the delivery of tax credits to the investor. Care should be taken to ensure that the tax-credit delivery schedule takes into account the timing needed for the conversion of units from mixed-finance subsidy to Section 8 under RAD. Of note is that the Faircloth-to-RAD Guidance provides a reminder that on multi-building projects, the RAD conversion cannot happen until the last building is complete.

If delaying resident lease-up is not possible or if the Faircloth-to-RAD conversion involves a building with existing residents, then the resident notice and engagement requirements involved in a traditional RAD conversion are triggered. HUD has modified these requirements slightly for Faircloth-to-RAD projects, as outlined in more detail in Notice H-2023-08 PIH2023-19 (HA).

At a minimum, for new units leased under the mixed-finance scheme before RAD conversion, tenants must receive prior to lease-up (i) a RAD Information Notice, (ii) a written explanation of the leasing and occupancy changes that will occur at RAD conversion and (iii) individual meetings with residents discussing the conversion. For existing residents of occupied buildings, more robust requirements are triggered, including multiple resident meetings and providing written responses to comments.

The Faircloth-to-RAD Guidance calls for “robust and transparent” communication with residents. If property owners are in a situation where lease-up must occur before RAD conversion, then it will be important to keep this principle in mind and pay careful attention to the implications of HUD-required tenant engagement.

Ensuring a Smooth Conversion
The goal in all Faircloth-to-RAD transactions should be to minimize the time between construction completion and conversion to RAD. Aside from the upfront planning discussed above, housing authorities and their development partners should begin preparing for the RAD conversion process months before construction completion.

HUD’s Faircloth-to-RAD Guidance requires notifying HUD at least 60 days prior to estimated construction completion. This allows HUD to be prepared to initiate the RAD conversion process as soon as the units are officially placed online as public housing units. The units can be placed online in the public housing system (i.e., PIH Information Center (PIC)) once 95 percent of units in the project have received certificates of occupancy.

After the units are in the public housing system, HUD will issue the Commitment to Enter into a Housing Assistance Payments Contract (CHAP) and the RAD Conversion Commitment (RCC), at which point the housing authority can submit its closing package to HUD. After submission, HUD estimates a 45- to 60-day closing process. Housing authorities and their development partners should begin convening their financing partners and preparing their RAD evidentiary submission well in advance of that date. If evidentiary packages are prepared in advance, this will limit the time between construction completion and completion of this RAD closing process.

HUD has demonstrated that the agency is committed to making the Faircloth-to-RAD program a streamlined process for housing authorities and their development partners. As more projects are converted, it is expected that this process will be further refined, facilitating the development of 250,000 Faircloth units.