Subcommittee on Housing and Transportation

Hearing on the HUD Section-8 Opt-out Crisis

Mr. Chairman, Ranking Member Kerry, Members of the Subcommittee, my name is William Apgar and I am the Assistant Secretary for Housing/Federal Housing Commissioner at the United States Department of Housing and Urban Development (HUD). On behalf of HUD Secretary Andrew Cuomo, I am pleased to testify today at this important hearing.

Recently, Secretary Cuomo announced an emergency initiative to stop the loss of affordable housing through opt-outs from the project-based Section 8 program. This initiative has already convinced many owners to reconsider their earlier decisions to leave the Section 8 program. While we have taken substantial steps to address the issue of opt-outs, we are also looking at a related set of issues presented by the prepayment of HUD subsidized mortgages. These cases are somewhat different from opt-outs and will require a different strategy. Indeed, the main element of our opt-out strategy, selectively increasing Section 8 subsidies, is not an option for units without these subsidies. A carefully designed strategy will be sensitive to the specifics of the mortgage subsidy programs, continue to protect low-income tenants, and continue access to affordable housing, especially in tight markets. As with the opt-out strategy, it is unlikely that one approach will be the best for all properties. One thing we have learned from past preservation policies is that it is vital to target and calibrate incentives to balance the needs of properties and tenants with fiscal responsibility. Recognizing these needs, Secretary Cuomo joined with members of this Subcommittee and many of your colleagues in pledging to work towards a more comprehensive solution to the loss of HUD-subsidized multifamily housing. Today I would like to describe the steps HUD has already taken, and more importantly, discuss a policy framework for considering a more comprehensive solution.

Communities At A Cross-Roads: The Challenge Facing HUD Multifamily Housing

Twenty-five years ago, the Federal Government created what would become the largest rental housing subsidy program in the Nation's history: the Section 8 program. The Section 8 program complemented HUD initiatives already in place to subsidize privately owned affordable housing, particularly the Section 236 and 221(d)(3) subsidized mortgage programs. Section 8 now helps 3 million families around the country afford decent housing, more than double the number of families assisted by the next largest housing program, while the 236 and 221(d)(3) programs assist over 500,000 families, 60 percent of which also benefit from project-based Section 8 subsidies. Between these three programs (Sections 8, 236 and 221(d)(3)), HUD multifamily housing provides assistance to thousands of families in each and every State around the country in urban centers and rural farmland, in high rise apartments and single family homes.

Today, HUD's multifamily subsidy programs stand at a cross-roads, facing a challenge that could threaten their viability well into the next millennium. Starting in 1975, HUD signed twenty year contracts with private owners to subsidize their properties with project-based Section 8. These long-term contracts are now expiring, creating widespread uncertainty about whether the properties will continue as affordable housing or "opt out" of the Section 8 program. HUD's recent actions, which I will discuss more fully in a moment, have done a great deal to calm this uncertainty. A complete response, however, will require not just a strategy for opt-outs, but an appropriate strategy for prepayments as well. HUD research has documented the scale of the challenges facing its multifamily subsidy programs:

• Trends in affordable project-based housing. When prepayment restrictions or Section 8 contracts expire, owners can choose to leave HUD's multifamily programs. Since October 1996, more than 30,000 subsidized units in over 500 project-based Section 8 properties have left the program. An even larger number have prepaid their HUD-subsidized mortgages during the same period.



• Section 8 expirations are increasing. During the next 5 years, two-thirds of all project-based Section 8 contracts will expire, totaling almost 14,000 properties containing I million subsidized housing units. By September 2004, 89,000 units will expire in California, 8 1,000 in New York, 69,000 in Ohio, 46,000 in Texas, 41,000 in Illinois, 40,000 in Pennsylvania, 35,000 in Florida and Michigan, 34,000 in Massachusetts, and 29,000 in Indiana. Every State in the country has more than 1,000 units expiring in the next 5 years.



• One-year renewals compound the problem. Unlike the original long-term contracts, budget constraints have limited contract renewals to I year, multiplying the number of contracts that face expiration each year. This magnifies the uncertainty of residents and owners face regarding the security of their housing.



• These trends threaten the best affordable housing. Owners who choose to opt out or prepay can do so because they have good properties in good neighborhoods. The latest data show that 90 percent of the subsidized units in properties whose owners say they will likely opt out are located in low-poverty neighborhoods, where good housing also brings better opportunity-more jobs, better schools, and less crime.

Without further reform to counter these threats, I-IUD's multifamily programs risk losing the best of their project-based housing, displacing thousands of low-income families and seniors, while being left with properties that do not have the resources to meet their physical and financial needs. By continuing to remake these programs, however, a different future is possible-a future which preserves the best project-based housing at a fair price for the taxpayer, a future that expands housing opportunities for the millions of families around the country who go without any housing assistance at all.

Policy Principles For Further Reform

To guide the needed reform, HUD proposes two simple policy principles:

• Offer a fair return
• Preservation is not enough

Principle 1: Offer a Fair Return

Returns HUD offers to property owners must be based on what a property is worth. HUD should not offer more than an owner could get on the open market, but neither should HUD expect owners of good housing in good neighborhoods to accept less than a fair return. While HUD's multifamily subsidies were always intended as market driven programs dependent on the private sector to provide affordable housing, over time the programs have moved away from that promise. A mismatch between subsidies and market rents has evolved over time as rent adjustments have not tracked changes in local markets. Recent Congressional and HUD actions have begun the process of reform. We now have the opportunity to finish remaking the programs into the market-driven models they were meant to be.

• Rents above market. Based on the latest data, about half of all project-based Section 8 properties have rents above market. Estimates of the rate HUD pays above market run as high as $1 billion per year. As instructed by historic legislation passed in 1997, HUD has set up the Mark-to-Market program to renew these Section 8 properties while reducing their subsidies to market. The Mark-to-Market program is preserving the best project-based Section 8 proper-ties, improving those that need additional resources, and returning the project-based Section 8 program to its original vision of a market-oriented housing program. This critical first step can now be extended beyond the Mark-to-Market legislation with new policy reform.



• Rents below market. While tremendous attention has been focused on project-based Section 8 housing with rents above market, HUD multifamily properties with rents below market had until recently been nearly forgotten. HUD estimates that below-market Section 8 properties receive between $600 and $800 million less per year than they would on the open market. With rents rising rapidly in some market areas, many owners of these properties have had a significant financial incentive to opt out of Section 8 contracts or prepay HUD-subsidized mortgages, posing the most dramatic risk to project-based multifamily housing. Building on HUD's recent actions, we can now move beyond prevention of opt-outs to meet the full range of challenges facing below-market multifamily housing.

Principle 2: Preservation is Not Enough

Despite 6 years of unprecedented economic growth, worst case housing needs remain at or near the all-time high of 5.3 million households. According to a recently released HUD study, "Ironically, the strong economy is a key factor pushing rent levels to new record highs. Rather than benefitting from the surging economy, low-income renters are left to compete for the dwindling supply of affordable rental housing available on the private market." By its self, preservation of HUD-subsidized multifamily housing cannot address the growing rental housing crisis. Instead, the Section 8 voucher program can be used to complement the preservation of project-based housing and attack the desperate shortage of decent affordable housing.

• Better protect residents. No matter what HUD does to preserve the best project-based multifamily housing, there will always be some properties that leave the programs. HUD protects residents in properties that opt out or prepay by providing vouchers, which can be used successfully by residents in most areas to remain in their current units or move to other housing. Yet while vouchers are a critical tool, they do not effectively protect residents everywhere. In higher-rent neighborhoods where opt-outs and prepayments are more likely, residents can be faced with substantial hikes in the portion of the rent they pay. Unable to afford these increases, residents are forced to move and compete for a dwindling supply of affordable housing. This can be avoided by allowing the payment standard for the voucher to rise to the market rent for as long as the resident remains in the unit. By keeping the resident portion of the rent at an affordable level of 30 percent of income, this "enhanced" form of vouchers protects the resident from the threat of displacement. Currently, HUD can offer these "enhanced" vouchers only in prepayments, not in opt-outs. By broadening this authority, Congress can avoid resident displacement and ensure that vouchers are an effective tool in all neighborhoods.



• Increase the number of vouchers. With the Nation facing an affordable housing crisis, Section 8 needs more than reform - it must also grow. HUD research shows that, while Low Income Housing Tax Credits, HOME and other forms of housing subsidies are critical tools in building affordable housing, Section 8 is the most effective housing program for helping households with worst case housing needs. Only by expanding the number of new vouchers each year can we fulfill the Nation's commitment to its neediest citizens. Last year, in landmark legislation to reform the public housing program, Congress authorized 100,000 new vouchers for fiscal year 2000.

HUD Actions Have Limited Section 8 Opt-Outs

On April 29th, Secretary Cuomo announced a two-part strategy to protect residents and preserve the best of project-based multifamily housing. First, HUD acted immediately on an emergency basis to prevent certain "opt-outs" from the project-based Section 8 program using its current limited authority and resources. The second part of the strategy called for the Administration and Congress to work together on a comprehensive policy solution to the remaining challenges.

The first part of the strategy, HUD's emergency initiative, offers increased rents to properties that have substantial financial incentives to opt-out because they are currently receiving subsidized rents below what they could receive in the private market. The initiative allows rents to increase to full market to avoid the loss of the best properties, but targets the increases to certain properties - without this targeting, the cost of the initiative could be $600-$800 million per year. Already this emergency initiative has limited the number of opt-outs - owners around the country have reconsidered abandoning the Section 8 program and submitted requests for renewals. This includes owners already in the process of opting out, who were allowed to reverse their earlier decisions and return to the program. It also includes owners of so-called "older assisted" properties, who were able to benefit from the initiative despite a number of complexities that many thought would stop their participation.

With limited resources, HUD's initiative targeted the properties most at risk for opting out, and those where an opt-out threatens displacement of residents. Elements of this targeting include:

• Owners who provide good housing. HUD is only offering market rents to properties that are providing the highest quality affordable housing. This criteria is based on a good or excellent score on the new physical inspection system developed by HUD's Real Estate Assessment Center. In addition, owners subject to administrative sanctions are disqualified.



• Properties in strong markets. Opt-outs have led to the loss of project based Section 8 housing in the strongest markets - those with the lowest poverty rates and highest rents. These are the same neighborhoods where housing vouchers - which are provided to protect residents by replacing the project-based subsidies - do not always shield residents from significant increases in their rent payments. HUD targeted these strong markets by selecting only properties with market rents higher than 110% of the area rent standard (FMR). Because this criteria does not capture all properties that provide a critical housing resource, HUD is also offering market rents to a small group of properties that demonstrate they are critical housing resources on a case-by-case basis - for example, properties targeted by state and local governments for their own housing resources.



• Properties most likely to opt out. To ensure that this policy matches HUD's limited resources, HUD further targeted properties most likely to opt out. For-profit owned buildings that have financial incentives to opt out are eligible, while non-profit owners or buildings already restricted to offering affordable housing, for example by receiving Low Income Housing Tax Credits, are disqualified.

The initiative was crafted to offer targeted owners a financial return closer to what they would receive in the market in exchange for preserving their properties as affordable housing. Care was taken, however, not to oversubsidize properties or increase rents for unsubsidized residents. This was accomplished by:

• Requiring a five-year commitment. To guarantee the preservation of affordable housing for a longer period, a five year commitment to accept project-based Section 8 renewals is required in return for market rents.



• Scrutinizing market rent levels. To ensure that subsidies are reasonable, HUD is performing its own comparability studies to determine accurate market rents, and the rents offered are capped at 150% of FMR.



• Offsetting market rents for current subsidies. For owners who already benefit from subsidized mortgages through HUD's other multifamily programs, the market rents are reduced by the amount of the interest subsidy. This ensures that total return to the owner for the Section 8 units matches a market alternative, but does not exceed it.



• Increasing limited distributions. Previously, distributions to owners were limited to a fixed percentage of the initial equity invested in the projects. With these limits, increased rents would not have increased the return to owners, and therefore would not have provided any incentive to remain in the Section 8 program. To counter this, HUD allowed a dollar-for-dollar increase in the distributions to owners to match the increase in rents, thereby stopping opt-outs while keeping reasonable limits on profits.



• Protecting non-Section 8 residents. The Section 8 program shields low-income residents from rent increases under the initiative by limiting their contribution to 30% of income. Residents of properties with subsidized mortgages who do not benefit from Section 8 payments, however, would have paid any increases themselves due to the fixed level of subsidy provided by the mortgages. To avoid the hardship and potential displacement of residents that would result, the initiative limited rent increases in partially Section 8 properties to only the Section 8 units.

A Policy Framework

The initiative I have just described has gone a long way to stopping opt-outs from the project-based Section 8 program, but HUD does not have the authority or resources to address a number of other challenges that face HUD's multifamily programs. Our assessment suggests there are five areas for HUD and Congress to focus on going forward:

• Market rents for certain properties. Building on HUD's emergency actions, a longer-term program should be established to raise selected properties' rents to market. This program should include targeting criteria for which properties' rents will be increased and specific commitments that will be required from owners in return for increased rents. By extending the criteria and commitments embodied in HUD's initiative described above to a full fiscal year, the Administration proposes to spend up to $ 1 00 million for this purpose in Fiscal Year 2000.



• Improve Section 8 renewals. Recent changes in renewal policy have led to greater insecurity for residents and owners through frequent resident notifications and changing rules. Recognizing this, Congress provided for a single notification under a five-year contract that could replace the current annual notifications. HUD is using this provision as part of the five-year commitment required from owners under its emergency initiative described above. More can be done, however. Extending this authority to allow a single notification prior to the expiration of a contract of any length would encourage longer-term preservation of affordable housing while removing the fear among residents caused by misleading notices each and every year. Second, renewal of Section 8 contracts could provide greater security to owners while reducing HUD's administrative burden. Currently, owners may be required to perform a study of comparable market rents each year at the renewal of the contract. A better alternative would be to allow an operating cost adjustment to be applied for four years, with a comparability study needed only every fifth year to ensure that rents remain in line with the local market.



• Market returns for other properties. While lifting Section 8 rents to market and providing more secure renewals can limit opt-outs of valuable affordable housing, these actions will have limited success in avoiding prepayments in properties that are important to preserve as project-based housing. Limiting prepayments is more difficult than limiting opt-outs because the subsidy level provided by the mortgages is fixed. Part of a potential solution could be a reexamination of current limits on rents, distributions and "excess income," all of which were called for by statute at a time when subsidized rents were not linked to local markets. Now that Congress has realigned project-based Section 8 rents so they are driven by local market conditions, we could further this change by realigning rents, distributions and "excess income" more closely to market in HUD's other privately-owned project-based properties. These changes could be targeted to the best properties and none of them would require additional appropriations. Rents in Section 236 and 221(d)(3) properties could be capped at the market level (offset for the interest subsidy) instead of the current budget-based formula, although still limited to 30% of residents' incomes. Distributions could be revised to allow for recognition of project equity built up over time instead of remaining tied to the original equity contribution. And continuing a trend by Congress over recent years, "excess income" could be made available to the owners of certain 236 projects to better approach a true market return.



• New resources and ownership. Even when owners choose to remain in HUD's multifamily subsidy programs, there are cases when new ownership or resources are needed to preserve decent affordable housing. Whether for tax or other business reasons, owners may be effectively locked into ownership despite a waning interest in running the property. Or in markets where local rents are below what is needed to pay for recapitalization later in the project's life cycle, other forms of resources may be necessary outside of current rent and interest subsidies. Any effort to stop the loss of affordable housing should take account of these cases by encouraging the transfer of properties to more motivated owners, particularly tenant organizations and non-profits. One way to do this is through targeted increases in Section 8 rents to market for valuable properties in strong markets that would not otherwise be eligible but agree to a transfer to a tenant organization or non-profit. A second method would be to target federal subsidies to affordable multifamily properties that receive state and local contributions subsidizing a transfer or recapitalization. Finally, the current legislation guiding the disposition of properties foreclosed by HUD could be made permanent, including the option to transfer properties to resident organizations and non-profits with Up-Front Grants in negotiated sales.



• More effective resident protection. Even with a comprehensive proposal that includes all the suggested changes I have discussed, there will still be cases where owners choose to opt out. In these cases, HUD can better protect residents by offering "enhanced" vouchers that allow them to remain in their homes without substantial rent increases when an opt-out occurs. Any proposed solution should give HUD the authority to offer "enhanced" vouchers in all opt-outs at up to market rent levels. In addition, Congress could clarify the permissible increases in "enhanced" rent levels over time by allowing them to track reasonable increases after the first year.

This concludes my formal written statement, Mr. Chairman. HUD looks forward to continuing our work with you and the other members of this Committee on this critically important issue.

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