34664 Federal Register / Vol. 61, No. 128 / Tuesday, July 2, 1996 / Notices

DEPARTMENT OF HOUSING AND

URBAN DEVELOPMENT

[Docket No. FR–4099–N–01]

Office of the Assistant Secretary for

Housing—Federal Housing

Commissioner

Mark-to-Market/Portfolio

Reengineering Demonstration: Notice

of Demonstration and Initial Program

Guidelines

AGENCY: Office of Assistant Secretary for

Housing—Federal Housing

Commissioner, HUD.

ACTION: Notice of demonstration

program and initial guidance.

SUMMARY: This notice announces a

demonstration program that is designed

to restructure the financing of projects

that have FHA-insured mortgages and

that receive Section 8 rental assistance.

The purpose of this Congressionally

authorized demonstration is to test the

feasibility and desirability of

multifamily projects meeting their

financial and other obligations with or

without FHA insurance and with or

without above market Section 8

assistance and utilizing project-based

assistance or, with the consent of the

project owner, tenant-based assistance.

In negotiating agreements with eligible

project owners, HUD must act to, among

other things, take into account the need

for assistance of low- and very lowincome tenants; address structural

problems of projects; and protect the

financial interests of the Federal

Government. This notice also provides

initial guidance on how the Department

plans to operate the demonstration

program. HUD anticipates that, over

time, it will publish additional guidance

that reflects in more detail how the

program will operate as well as the

experience derived through the

execution of successful agreements with

project owners.

DATES: This demonstration program

guidance is effective July 2, 1996. In a

separate notice, HUD will publish

information requirements that

demonstration participants will need to

comply with.

FOR FURTHER INFORMATION CONTACT:

George Dipman, Office of Multifamily

Housing, Department of Housing and

Urban Development, 451 Seventh Street,

SW., Washington, DC. 20410–4000;

Room 6174; telephone (202) 708–3321.

(This is not a toll-free number.) Hearing

or speech-impaired individuals may call

1–800–877–8399 (Federal Information

Relay Service TTY).

SUPPLEMENTARY INFORMATION:

I. Background:

This demonstration, titled FHA

Multifamily Demonstration Authority, is

authorized by section 210 of the

Departments of Veterans Affairs and

Housing and Urban Development and

Independent Agencies Appropriations

Act (Pub. L. No. 104–134, 110 Stat.

1321, April 26, 1996). It reflects concern

of both the Congress and the

Administration about social issues and

budgetary costs associated with the

renewal of Section 8 project-based

assistance contracts on multifamily

properties having FHA-insured

mortgages. As of August 1995, the HUD

portfolio contained 8,563 projects, with

a total of over 850,000 units, that have

HUD insured loans supported by

Section 8 rental assistance contracts.

Under existing contracts, most of which

are due to expire over the next few

years, many projects receive projectbased Section 8 rental assistance for

rents that exceed those charged on

comparable, unassisted units within the

local market. At the same time, these

projects often have substantial unmet

capital needs. The Federal assistance, in

the aggregate, is costly. If assistance

contracts were to be renewed on a long

term basis, based on current contract

rent levels, the annual cost to the

Federal Government would increase

dramatically by the year 2000.

Consequently, Congress has opted not to

renew Section 8 contracts on these

projects for more than one year, while

the Department seeks alternative

solutions to the housing and budget

issues.

For many project owners, if their level

of Section 8 assistance is reduced or

eliminated, and all else remains

constant, the likelihood is that they will

be unable to continue to meet project

financial obligations, including

mortgage debt service payments, current

and future capital needs, and operating

expenses such as project reserve and

repair costs. This could lead to mortgage

defaults, deterioration of this important

housing stock, and the possible

displacement of thousands of lowincome families and seniors nationwide.

Over the past year, Congress, owners,

lenders, tenants, and other interested

parties have proposed various

alternative solutions to this long term

and serious problem. Congress has

authorized this demonstration, enabling

HUD to test various methods of

restructuring the financing of these

projects. One goal of the demonstration

program is to test alternative creative

solutions that will provide long-term

viability of the properties as affordable

housing, which will benefit local

communities and their tenants.

The remaining sections of this notice

provide the following information:

Section II. Summarizes provisions of

Section 210, including project owner

eligibility requirements, and tools that

HUD can employ to carry out the

demonstration.

Section III. Describes HUD’s primary

objectives in implementing the

demonstration, and how HUD

anticipates working with owners in

reaching agreements.

Section IV. Employs a Question and

Answer format to address a variety of

specific issues, and is intended to

further clarify HUD’s approach to

implementing the demonstration

program.

Section V. Describes certain

certifications that HUD makes in

connection with publication of this

notice of demonstration program.

II. Section 210—Goals, Mandates and

Tools

A. Eligible Program Participants

Eligible projects, defined in the

legislation, include those multifamily

properties

1. Whose owners agree to participate;

and

2. Whose mortgages are FHA insured

and which receive project-based

assistance under Section 8 of the United

States Housing Act of 1937; and

3. Whose present Section 8 rents are,

in the aggregate, in excess of the Fair

Market Rent (FMR) for the area in which

the project is located.

B. Goals

Consistent with the legislative

objectives, HUD’s goal will be to carry

out this demonstration program in a

manner that will:

1. Result in significant discretionary

cost savings through the reduction of

above-market Section 8 assistance

through early terminations and

restructuring of long-term project-based

assistance contracts.

2. In the least costly fashion—

a. Maintain existing housing stock in

a decent, safe, and sanitary condition;

b. Minimize the involuntary

displacement of tenants;

c. Restructure mortgages in a manner

that is consistent with local housing

market conditions;

d. Support fair housing strategies;

e. Minimize any adverse income tax

impact on property owners; and

f. Minimize any adverse impact on

residential neighborhoods; and

3. Protect the financial interests of the

Federal Government.
Federal Register / Vol. 61, No. 128 / Tuesday, July 2, 1996 / Notices 34665

Congress provided, in addition, that in

determining the manner in which a

mortgage is to be restructured or the

subsidy reduced, the Secretary may

balance competing goals relating to

individual projects in a manner that will

further the purposes of this

demonstration.

C. Mandates

Section 210 provides that, under the

demonstration, HUD can pursue these

goals with respect to project mortgages

securing up to 15,000 units. Moreover,

Congress has appropriated $30,000,000

for the cost of modifying mortgage

loans, as such costs are defined in

section 502 of the Congressional Budget

Act of 1974, as amended. Also, the

legislation authorizes HUD to directly

enter into joint venture arrangements

with third parties, under which the

Secretary may assign some or all of the

functions, obligations and benefits of

the Secretary, and to purchase

reinsurance, enter into participations, or

otherwise transfer the economic interest

in contracts of insurance or mortgage

insurance premiums on such contracts

of insurance. (This notice, however,

does not address the implementation of

the third party joint venture component

of the demonstration. Guidelines for

joint venture partners shall be released

at a later date.)

D. Tools

The demonstration program will use a

variety of tools and authorities to

restructure the financing of assisted

FHA-insured projects. The basic

approach will work through the

voluntary participation of the project

owners and lenders to move rents and

operating costs toward market levels

immediately or over time, and to reduce

the outstanding principal balance to

reflect any decline in net operating

income that may result. The

restructuring process attempts to put the

projects on a sound financial and

physical footing with market rents,

sufficient to service the remaining debt

and operating costs, including

replacement reserves.

Reasonable rehabilitation costs may

be supported first through the release of

reserves and residual receipts accounts,

and then by further reduction of the

principal balance. Extraordinary

rehabilitation needs may require capital

infusions from partners and state and

local government assistance.

Existing tenants will continue to be

assisted with tenant based Section 8

assistance or by project based Section 8

assistance. Section 8 assistance for

projects with contracts expiring in 1997

shall be renewed only after annual

budget authorizations by Congress. To

support mixed-income developments,

some tenants who receive tenant-based

assistance and vacate the project may be

replaced with families that are not

eligible for Section 8 assistance.

Post workout refinancing methods

may include leaving the existing FHAinsured loan in place, refinancing the

mortgage with an FHA-insured mortgage

under an FHA refinancing program,

obtaining a new loan and FHA

insurance, and financing through

conventional sources.

Existing tax law will apply to

reengineered, assisted FHA projects.

Mitigating any tax consequences

resulting from debt cancellation will be

the responsibility of the owner. HUD

will consider any approach that is

revenue neutral to the property owners

and investors.

Depending on the particular

characteristics of a project, HUD and an

owner and, where applicable, with the

consent of affected third parties, could

enter into a restructuring agreement that

includes, but is not limited to, one or

more of the following actions:

1. Restructuring rents at or above

market where, in the latter instance,

market rents are insufficient to cover

operating costs irrespective of debt

service;

2. Forgiving and cancelling any FHAinsured mortgage debt that a

demonstration project cannot carry at

market rents while bearing reasonable

operating costs;

3. Paying all or a portion of a project’s

debt service, including monthly

payments from the appropriate

Insurance Fund for the full remaining

term of the insured mortgage;

4. Replacing FHA mortgage insurance

with uninsured debt or continuing FHA

mortgage insurance, if warranted;

5. Not renewing expiring existing

project-based assistance contracts with

the provision of tenant-based assistance

to previously assisted households;

6. Providing project-based assistance

with rents at or below fair market rents

for the locality and negotiating other

terms acceptable to HUD and the owner;

7. Deciding to remove, relinquish,

extinguish, modify, or agree to the

removal of any mortgage, regulatory

agreement, project-based assistance

contract, use agreement, or any

restriction that had been imposed by the

Secretary, including the restriction on

distribution of income; and

8. Requiring the owner of an assisted

property to apply any accumulated

residual receipts toward effecting the

purposes of the reengineering initiative.

III. HUD’s Portfolio Reengineering

Program—Overview

HUD’s Portfolio Reengineering

program, which will implement the

Demonstration, is designed to soften the

impact of Section 8 budget reductions.

Under its Portfolio Reengineering

program, HUD seeks to reduce Federal

assistance payments while stabilizing

projects physically and financially and

reducing reliance on Federal insurance,

and to do so with the least possible

disruption to tenants and

neighborhoods.

These objectives will be accomplished

by, among other things, (1) reducing

rents and operating costs to market

levels; (2) making corresponding

reductions in the principal balances of

outstanding mortgages; and (3)

improving the ability of the current

assisted residents to pay market rent

levels. Reengineering may also provide

tenants with tenant-based rental

assistance or continued project-based

rental subsidies at lower rent levels.

HUD will implement the

demonstration through a combination of

HUD field and headquarters staff,

private consultants and third parties or

joint venture partners. As previously

noted, these guidelines do not address

guidelines for the involvement of joint

venture partners. Guidelines for joint

venture partners will be released at a

later date.

Project readiness will be a significant

criterion for allocating demonstration

resources. HUD seeks reengineering

projects with very real prospects for

support from the existing mortgagee,

owners, new lenders, and the

community, including tenants.

Under the demonstration, HUD

intends to ensure that affected tenants

and representatives of the local

community and government have a

meaningful opportunity to review and

react to a proposed agreement before

any agreement is finalized.

Reviews of proposals made under the

demonstration will be conducted on an

‘‘open window’’ batched basis with

monthly reviews by a loan workout

committee that will consider various

workout approaches as described in

section II. D. Proposals that contain a

number of the following characteristics

will be given priority if demand for the

demonstration exceeds authority and

resources. HUD may add additional

priority criteria, in future notices that

provide additional guidance under the

demonstration. HUD prefers projects

and proposals that meet the following

criteria:

1. Have Section 8 contracts that

extend beyond 1997, and which reduce
34666 Federal Register / Vol. 61, No. 128 / Tuesday, July 2, 1996 / Notices

rental assistance over the remaining life

of the contract, or use rental assistance

to prepare the project for market rents;

2. Reduce rents to market rents, rather

than to an above-market level;

3. Minimize the impact of credit

subsidy requirements resulting from the

modification of the existing mortgage

debt or the provision of new FHA

insurance;

4. Maximize reduction of Federal

expenditures through—

a. Low principal reduction (i.e.

minimum partial payment of claim);

b. Section 8 savings; or

c. Reduced operating costs;

5. Eliminate project-based rental

assistance in favor of tenant-based rental

assistance;

6. Eliminate or reduce the existing

FHA mortgage insurance;

7. Achieve restructuring through the

use of non-HUD personnel;

8. Preserve some long-term

affordability;

9. Serve housing needs of low- and

very low-income tenants; and

10. Illustrate efforts to raise the

economic value of property by

increasing the earning power of the

existing tenant population through

initiatives such as education, job

training and entrepreneurship.

IV. Ongoing Clarification of

Demonstration Guidelines

The primary goal of the Portfolio

Reengineering Demonstration is to

provide HUD, Congress, and assisted

FHA project owners and tenants a

testing ground for wide-scale

restructuring and stabilizing of this

endangered housing resource. As the

demonstration evolves, questions that

arise through field testing approaches to

reengineering will be answered through

periodic published question and answer

bulletins. The following ‘‘Qs and As’’

address some issues already

communicated to HUD.

Q. One goal of the demonstration is to

test alternative creative solutions that

will provide long term viability to the

properties and their tenants. What kind

of alternative creative solutions would

be considered?

A. HUD will give highest priority in

restructuring to owners who can

demonstrate a decreasing need for

Section 8 assistance because of the

implementation of programs which

enhance the ability of assisted residents

to pay an increasingly greater portion of

the market rent. The additional effects

of increased tenant earning capacity will

be to reduce other governmental

expenditures and increase tax receipts

and also to stabilize and enhance

property values. Illustrations of

alternative solutions, in addition to

reliance on the financing and

rehabilitation tools specified above,

include investment of owner and/or

project resources targeted at resident job

training and placement, education, selfsufficiency, enterprise development,

entrepreneurship and social services;

and commitments from community

related organizations to assist in similar

endeavors. Owners whose proposals

include such initiatives should outline

specifically the goals they plan to

achieve and how the implementation of

such programs will result in enhanced

financial capacity for the real estate and

the tenants.

Q. What is the definition of market

rents?

A. Market rents refers to the rent

achievable by the project without rent

subsidy when competing in the market

place for new tenants. Two or more

market rent projections for a given

project may be considered in

reengineering negotiations. For

example, there may be a market rent for

a project in ‘‘as-is’’ condition, another

rent for a rehabilitated project, another

rent for a project to which amenities

have been added, and still another rent

that is achievable two or three years

after restructuring is completed and

income mixing has occurred.

Q. How will operating expenses be

determined for the purposes of

calculating the mortgage supportable

after rents are moved to market?

A. HUD’s due diligence contractor

will evaluate project operating

statements, will reduce costs that are a

product of HUD requirements and

processes that can be eliminated, and

HUD will negotiate the balance of any

operating expenses that appear to

exceed market levels with the owner in

light of industry standards for market

rate developments.

Q. Will HUD keep existing FHA

insurance in place after restructuring?

A. It is HUD’s preference to extinguish

existing insurance immediately or over

time and transition reengineered

projects to freshly underwritten

permanent financing. This preference is

driven by both HUD budget

considerations, and well established

banking principles regarding the

restructuring of troubled assets.

However, HUD will consider

extenuating circumstances that may

justify leaving existing insurance in

place.

Q. Will projects with HUD held

mortgages be considered for the

demonstration?

A. No. The demonstration is limited

to insured mortgages.

Q. What rehabilitation levels and

capital improvements will be supported

by the demonstration?

A. Restructuring must be designed to

ensure the long term physical integrity

of the project. HUD will consider

rehabilitation necessary to achieve that

objective. In addition, HUD will

consider the addition of amenities when

the owner can demonstrate they will

support higher market rents that will

reduce net long term costs to the Federal

Government. This could include, for

example, improvements that promote

the economic self-sufficiency of the

tenants. Any project rehabilitation or

capital improvements supported by

HUD will comply with 24 CFR part 50.

Q. What owner administrative costs

will HUD allow to be offset in the

workout process?

A. Non-profit owners may include

reasonable transaction costs and

administrative fees as eligible uses of

funds in loan workouts.

Q. How will the demonstration

approach projects in which market rents

are insufficient to support operating

costs?

A. These projects are not included in

the initial focus of the demonstration,

but will be addressed in future

guidelines.

Q. Will the demonstration include

projects in which restructuring occurs

in conjunction with a sale or transfer to

a new owner?

A. Yes.

V. Other matters

Executive Order 12612, Federalism

The General Counsel, as the

Designated Official for HUD under

section 6(a) of Executive Order 12612,

Federalism, has determined that the

provisions in this NOFA are closely

based on statutory requirements and

impose no significant additional

burdens on States or other public

bodies. This notice does not affect the

relationship between the Federal

Government and the States and other

public bodies or the distribution of

power and responsibilities among

various levels of government. Therefore,

the policy is not subject to review under

Executive Order 12612.

Executive Order 12606, The Family

The General Counsel, as the

Designated Official under Executive

Order 12606, The Family, has

determined that this notice does not

have potential for significant impact on

family formation, maintenance, and

general well-being, and, thus, is not

subject to review under the order. The

notice implements a statutorily
Federal Register / Vol. 61, No. 128 / Tuesday, July 2, 1996 / Notices 34667

authorized demonstration program and

is intended to find ways of reducing the

impact on families that might otherwise

not be caused by the nonrenewal of

Section 8 project-based rental

assistance.

Dated: June 26, 1996.

Nicolas P. Retsinas,

Assistant Secretary for Housing—Federal

Housing Commissioner.

[FR Doc. 96–16790 Filed 6–27–96; 4:03 pm]

BILLING CODE 4210–27–P