Subcommittee on Housing and Transportation

Hearing on S.2733 - The Affordable Housing for Seniors Act

Prepared Testimony of Mr. David A. Smith
Recapitalization Advisors, Inc.

2:00 p.m., Tuesday, July 18, 2000 - Dirksen 538

Chairman Allard, Senator Santorum, Senator Kerry, Senator Sarbanes, members of the Subcommittee, thank you for doing me the honor of inviting me here today.

My name is David Smith; I'm founder and president of Recapitalization Advisors, Inc., a small consulting firm specializing in the finance of existing affordable housing. We pride ourselves on being a national leader in inventing and doing transactions that work. Over the last six years, our company has been directly responsible for the preservation of over 200 affordable housing properties constituting over 25,000 apartments through our work as:

America needs affordable housing. It is good policy that fosters strong families and a stronger society. But we need affordable housing to work to succeed socially, operationally, financially, and physically. Residents need good housing. Taxpayers deserve economical housing. In a nutshell, Recap works for the real estate because the property needs an advocate.

Because we care about these properties, we provide a lot of volunteer advice and policy/ quantitative analysis to Congress, HUD, GAO, CBO, state HFA's, almost anyone who will listen. I'm here today to tell you briefly:

1. Though painful, mark-to-market (M2M) is reinvigorating the inventory but its implementation has been slow and tortuous and it has had many unexpected consequences.

Four years ago, I was privileged to testify before your committee about the then-hypothetical business of marking properties to market. From that testimony came the informal working group, convened by Senator Mack and on which I was delighted to serve, that helped shape what became the MAHRA Act, the Mark-to-Market (M2M) statute.

M2M is painful. It is hard to do right. It creates stress in the system and anxiety in the stakeholders. It makes people think in new ways. For all that, M2M is desirable, because if done right it results in:

  1. Genuine underwriting of each property as real estate.
  2. Pruning away the regulatory thicket and aligning incentives.
  3. Ending the Federal/state mismatch between who pays and who benefits.
  4. Reducing Federal contingent liability by weaning properties away from dependency on Washington, subsidy, and regulation.
  5. Rewarding the good and penalizing the bad properties and owners.
  6. Stimulating transfer from old to newer ownership.

We outlined these points in greater detail in an article, Five Good Things About Mark-to-Market (available as Appendix 1).

M2M is such a good idea that we are recognizing it should be applied more broadly, such as to 202 properties indeed, M2M-type reasoning underlies the 202 recapitalization provisions captured in Title I of S. 2733. 202 properties are twenty or more years old, delivering excellent affordability at tiny rents but, being slowly starved of capital, drifting slowly into deterioration. Though 202 properties need recapitalization every bit as much as older 221d3 and 236 properties do, as outlined in Exhibit 1, under current program rules they have virtually no way of bringing in that new money. As proposed, Title I of S. 2733 will do some good, and we strongly support it. But Congress will need to go further, and soon, to allow 202's capital flexibility.

Meanwhile, while the theory of M2M is compelling, in practice M2M's implementation has been disjoint, turgid, slow, and frustrating. In its regulatory expression, the M2M program now in place differs in several material ways from that Congress intended, and needs corrections but this is not the appropriate forum to review M2M's implementation sequence nor to propose M2M improvements.

What matters for this hearing is that by now M2M is also probably irreversible. Of the 850,000 apartments originally targeted as being in the broad M2M universe, today more than 65% have already experienced one Section 8 contract expiration. For five years two years of legislative debate and three of activity, first in the demonstration and now in the permanent program owners have seen M2M coming. And M2M does not mean just lowering rents; many rents are being marked up to market (MUM). Between them, M2M and MUM are bringing a sea change in how everyone thinks about affordable housing.

Whether they embrace or dread market rents, whether or not they can escape debt restructuring, owners are increasingly having to operate their property on market principles: the resident is the customer, property quality matters more than paper compliance, properties have genuine upside and downside, and good performance is rewarded while bad performance suffers. All of this is very healthy, but it has had consequences. Many properties are going market. Many others are pursuing it or thinking about it. States and localities that took affordability for granted are discovering hidden creativity and new financial resources. Because of all this, enacting MAHRA began but did not finish Congress's work on M2M. We need to do more and now, three years into the program, we are better able to say precisely what.

Both 401 and 402 of S 2733 are logical, desirable, even urgent extensions of M2M, and it is these that are the principal subject of my comments.

2. We must preserve our at-risk properties; one way is via renewed affordability.

The Congress that enacted M2M had preservation fatigue and placed little faith in warnings that many properties would go market. After four more years of a roaring economy, we know now that many properties can go market. More than 100,000 apartments have already left the inventory and the pace is steady if not rising.

But we have also learned that even as we respect owner's contractual rights and congratulate them on their economic success we can find ways to create renewed affordability that levers available resources Federal, state, and local to capture the same property that opts out of HUD to opt in to a new paradigm, one where the property is recapitalized and healthy but preserved for a long term. Recap pioneered this concept a year and a half ago, in an article first published in NHC News. Since then we have repeatedly put it into practice.

Renewed affordability is hard to do but it works. Its key principles are:

Critical is finding that magic combination of genuine commitment to affordability and robust business enterprise. This means new entities that combine for-profit and non-profit sensibilities, bridging the illusory chasm between disciplines. Twenty years ago, an entity was either for-profit (which people interpreted as capable but indifferent to the mission) or non-profit (which people interpreted as mission-committed but amateur). Today we recognize that we can synthesize by drawing from the best of both arenas. A few entities are in fact doing this now.

Congress needs these new combined-capacity entities mission-oriented but business-capable because these entities will take on the work Congress wants done. As discussed below, 402 of S 2733 will both preserve at-risk properties and foster the creation of a new breed of owners that our country needs.

3. In recapitalizing properties, we have to protect current residents.

When properties are at risk of opt-out and market conversion, of recapitalization and refinancing, and of deterioration and default residents are at risk too. In recent years, Congress has recognized that current residents living in at-risk properties need a special safety net that will at least protect them from involuntary displacement. Its principal element is the enhanced voucher, which two vital features for current residents:

Enhanced vouchers work well. They generally prevent involuntary displacement by paying the owner a fair rent, and they give the resident confidence to stay.

Enhanced vouchers are new, housing authorities are unfamiliar with them, and they don't cover everyone they should. Today about 28,000 households, most of them elderly, are living in post-conversion properties where, because the owner opted out before Congress applied enhanced vouchers to opt outs, they are struggling to make ends meet with a regular voucher whose rent level is just too low. Although this is not yet in S 2733, I make a personal plea to you, Senators, to correct this inadvertent omission and ease these people's burden. Details are provided in Exhibit 2.

Even if enhanced vouchers protect current residents, when that resident moves, the apartment is lost to affordability. So we must do more we must redouble our efforts to preserve properties at risk and we must create new programs that facilitate preservation.

4. Congress must not only reform old programs, it must sponsor new ones.

In the last five years, Congress and HUD have done more to reform and improve Section 8 than was done in the fifteen preceding years. That is a noble and worthy achievement. But Congress has done little to create new paradigms. It's not enough just to stanch the outflow of apartments lost to the private sector, we must also create new affordable apartments through new programs.

This activity must combine Federal and state involvement. States can implement programs; as the LIHTC has shown, they can innovate and customize when given a large resource with well-defined program rules. Congress has a responsibility to establish the vision and provide broad wholesale resources; states and localities have an obligation to custom-design programs that stretch those scarce dollars as far as they can reasonably go.

There will be other forums to discuss specific proposals, but they all should learn from our experience. In thirty years of Federal affordable production, we have learned a great deal about what works and what doesn't. I have listed a set of proven and useful principles on Exhibit 3.

These principles have very little to do with political or ideological bent and a great deal to do with the practicalities. They are evolutionary and results-based, hence not the exclusive province of either for-profits or non-profits. We have a new generation of entrepreneurs who understand affordable housing and value it as a business unique unto itself, not an adjunct to conventional housing. Rather than succumb to either/or thinking mission-oriented or business-capable these entrepreneurs and entities combine both.

We can use that knowledge to build better programs, and we should be creating new programs. Most HUD subsidy/ financing tools we use today are largely unchanged from 20-30 years ago, when we had much less financial infrastructure and sophistication than we have now. We have to evolve past these first-generation products and not use support for old delivery mechanisms as a litmus test for supporting affordable housing. We have to be faithful to the goals but iconoclastic about tools, finding ways to do things better, cheaper, more efficiently. (We have done this for ten years at Recap.) If, as an industry, we use public resources better, if we show more success at less cost, then preservation can capture resources in volume and do the job the country needs.

This is why we need 401, with its matching grants, and 402, which will help capture at-risk properties so they can be preserved. Both, and especially 402, encourage the creation of efficient new entities, embodying the principles outlined above.

5. 401 matching grants are a necessary adjunct to Congress's overall recapitalization policy.

Mark-to-market was never intended as a preservation strategy; indeed, it recognized there would be triage among those properties with value greater than the cap the Federal government was now establishing.

Few expected the triage to be so great, or the activity so rapid, but markets move quickly and the economy has been strong. In the meantime, however, states have done what Congress would want them to do they have come up with significant new financial resources they will apply to preserving at-risk affordable housing. Today more than a dozen states have tax credits that piggyback or parallel the Federal LIHTC and a dozen states have legislature-approved bond issues, trust funds, or other financial resources they are targeting to preservation. And in doing so, they are picking up Congress's mantle. After all, until M2M this housing was a Federal production. It was conceived by Congress, financed by FHA, subsidized and regulated by HUD.

Section 401 rewards states who have risen to Congress's challenge. It encourages them to show leadership and take ownership of this issue. And every time a property uses a 401 or similar grant, the property will move out of HUD's orbit and into the state's orbit. Thus 401 grants serve several important Federal purposes:

Section 401 also helps states replace debt with equity. As shown in Exhibit 4:

High debt means

high debt service, which means

high rents, which means

subsidy dependency, which means

affordability lasts only as long as subsidy does.

Recapitalizing by replacing debt with grants or equity changes the dynamics, as follows:


Low debt means

low debt service, which means

low rents, which means

many residents can pay those rents, which means

subsidy independence, which means

permanent affordability can be achieved.

We took this analysis a step further via the schematic chart of Exhibit 5. Oversimplifying just a little, rents at or above HUD's current FMR can be afforded only by people at 60% of median income or above, so to house families below those levels, you need Section 8. But when debt is replaced with grants or equity that does not require a cash-on-cash return, you can lower rental affordability to 35% of median income. That is, people at 35% of median or above can afford the cheap rents without Section 8. (Below that level, the problem is not housing affordability, it's household poverty.)

In other words, debt restructuring and renewed-affordability preservation using 401 grants lowers required rents, which means the property will need less Section 8 and more residents won't need it at all. It moves properties toward self-sufficiency and away from subsidy dependency. It makes permanent affordability possible.

6. Congress must also foster growth of capable preserving entities by enacting 402 so they can preserve at-risk properties before they are lost forever.

In a year, 300 properties go market, almost one a day. They're not just in places with an active non-profit community; they're in Ogden, Utah; Kalispell, Montana; Burlington, Iowa; Keene, New Hampshire; and Toledo, Ohio. These are places where non-profits may be small, unsophisticated, and financially limited, simply not up to the task of intervening quickly, surely, and effectively. When there is no capable or interested non-profit, the result can be chaos, anxious residents, and a crisis approach. One such example in Denver, still going on, is summarized briefly in the Appendices.

Buying an at-risk property from a for-profit owner is no business for first-timers; it is very sophisticated and requires both capital and risk tolerance. Many of the properties are facing Section 8 expiration that uncertainty is a principal reason why the owner is receptive to selling so the buyer has to be prepared to reposition the property. Often the owner has a whole portfolio of multiple properties straddling programs and geographies. Most owners are perfectly willing to sell to a preservation buyer if that buyer pays fair market value and can actually close on the whole portfolio. Most of them cannot.

Like mortgage securitization, buying portfolios requires a mixture of detailed local knowledge and precision combined with national economies of scale. It demands new entities that can act as a warehouse and then clearinghouse by:

That is what 402 is all about. It recognizes that all the money in the world, even if we had it, would not solve the problem unless that money is smartly deployed. So it endorses non-profit acquisition intermediaries because they are a crucial bridge across the restructuring chasm from the old subsidy-dependent HUD approach to a renewed-affordability, permanent preservation.

7. Congress must encourage creative innovations in both programs (401) and entities (402).

The stakes involved in recapitalizing the inventory are huge. Its replacement cost is probably $40-45 billion. In adopting M2M, Congress accepted its willingness to absorb about $10 billion in net FHA insurance claims to put it on a sound footing and fix program flaws visible now in hindsight. The great wave of Section 8 expirations is now upon us, with roughly two thousand properties currently somewhere in the M2M pipeline alone.

The task is daunting, the nation is enormous and marvelously varied, and the preservation resources are all too few and far between. But in the last year and a half, we have seen several fine organizations extend themselves into the uncharted territory of becoming national intermediaries focusing on preservation:

Our company has had the pleasure of working with several of these organizations as they, in their individual ways, tackle these difficult preservation issues. Groups like these will embrace the opportunities presented by 401 and 402. They will create efficiencies within the system to help the system. In particular, NHDC is creating an acquisition intermediary focusing on just these issues we are discussing today and using the principles outlined in Section 6. Last year NHDC was an important force in developing the original concept expressed in 410 of HR 202 (which passed the House 405-5) and now presented as 402 of S 2733.

We all need to innovate, and we need a lot of innovators. To take one simple example, we are trying to bring Internet thinking to real estate finance. On the Internet, information wants to be free, transaction costs plummet, efficiency rises, and volume rises. We want to bring that kind of forward thinking to affordable housing finance, so that small non-profits can partner with national organizations that can bring the technical expertise, cheap capital, and financial wherewithal to preserve these precious properties as quality affordable housing.

8. Congress should act now, even if only to authorize experiments.

Unlike production, which starts when Congress wills it, preservation is driven by decisions made years ago. Every month that goes by, another 3,000 or more apartments go market, another 3,000 families face loss of their homes. The world moves faster than it once did, and Congress must keep pace.

The initiatives represented by 401 and 402 were introduced last year as responses to phenomena we saw in rental markets across the country. Significantly, no one materially opposed either provision indeed, the entire legislative process was characterized by a consensus seldom found in affordable housing. That consensus is still present. These are good provisions. They deserve enactment so we can both continue to experiment and, more importantly, intervene to save properties for renewed affordability in perpetuity.

We need Title IV to preserve properties that will otherwise be lost to market conversion. Please enact Title IV of S 2733 this year.

Mr. Chairman, Senators, that concludes my remarks. I would be delighted to answer your questions.


  1. Obstacles to Section 202 recapitalization; recommended program changes. Summary of the programmatic and regulatory obstacles inhibiting needed recapitalization of Section 202 properties.
  2. Upgrading Regular Opt-Out Vouchers to Enhanced. Narrative describing a legislative correction needed to protect residents still in their apartments in properties that opted out.
  3. Affordable housing: What works and what doesn't. Comparative chart listing defining attributes.
  4. Debt levels and affordability. Moving from high debt (Section 8 dependency, affordability leased for intervals) to low debt (low rents, permanent affordability).
  5. Income-to-rent-to-value. Schematic diagram relating resident income to supportable property value.


(Space limitations precluded providing them with the testimony but they are available from Recap at, or via email at

  1. Five good things about mark-to-market, article from Affordable Housing Finance.
  2. Renewed Affordability, a paradigm for existing affordable housing, article from NHC News.
  3. Summary of events, at-risk property in Denver (East Village).
  4. Income-to-rent-to-value, calculations, analysis, and narrative explanation.

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