Uncle Sam May Raise The Rent

For 20 years, North Avenue Tower in Council Bluffs, Iowa, has been a beacon of success in the often-maligned market for subsidized housing. The apartment complex for the elderly has staff on call 24 hours a day in case of emergencies, and tenants at the six-story building are like family: Everyone hangs a doily outside their door each evening; if it isn't removed in the morning, residents check in to see if their neighbor has fallen ill.

Unfortunately, such a cozy lifestyle comes at a hefty cost--to taxpayers. More than half of the average $505 monthly rent for the building's 100 residents comes from the U.S. Housing & Urban Development Dept. But that system could be scuttled next June when the complex's 20-year subsidy contract with HUD expires. Thanks to Congress' deficit-reduction drive, such costly agreements face the guillotine. But North Avenue Tower manager Randy Lenhoff worries that lower subsidies will put his facility out of reach for many elderly. "There will be even less choice for low-income people in the future," he frets. "And buildings like this just won't have the same sense of community."

The repercussions of such changes will be felt far beyond Council Bluffs. Beginning next year, a wave of subsidized housing contracts under HUD's so-called Section 8 program begin to expire. But simply slashing subsidies paid on these properties could become a fiscal nightmare. That's because 9,300 subsidized apartment buildings--valued at $28 billion--are also backed by Federal Housing Administration (FHA) mortgage insurance. A drastic cut in rental assistance could trigger mortgage defaults and massive claims on the insurance fund.

"Done badly," cautions David A. Smith, a low-income housing consultant in Boston, "this restructuring could end up costing the federal government much more than it saves and doing permanent damage to residents and properties."

Ironically, the current dilemma stems from a hugely successful effort by the federal government to lure private capital into the affordable-housing market. Beginning in the mid-1970s, the feds offered hefty rental subsidies to investors who rehabilitated or constructed affordable apartments for rental to tenants earning less than 80% of local median income. Many of the properties were financed by tax-shelter partnerships that relied heavily on debt. That federally assisted housing boom yielded over 1 million privately owned apartments.

DEFAULT DELUGE? To investors' delight, federal aid on newly constructed buildings was hiked annually by HUD based on how local market rents were rising. But when market rents declined, HUD didn't cut the subsidies. The result: subsidized rents that in some cases are 75% above market rents. HUD officials estimate simply renewing these subsidy contracts would cost taxpayers a staggering $222 billion over the next 25 years.

No way, say budget-slashing lawmakers. "We're in a crisis," says Representative Rick A. Lazio (R-N.Y.), who is drafting housing-reform legislation. "These subsidies will squeeze out everything else in housing." Even HUD officials agree subsidy contracts will only be renewed at market rent levels. Recapitalization Advisors Inc., which has studied the impact of such a move, figures that would send roughly 4,000 properties housing 450,000 families into default.

Fearing such turmoil, HUD is considering a proposal to form joint ventures with private investors to restructure the mortgage loans before they default. The FHA insurance fund would cover losses up to a cap based on the losses HUD would take by working out the loan itself. HUD figures its restructuring proposals would cost $186 billion over 25 years, saving about $36 billion.

The final tab will depend on how the new system is implemented, but more uncertain is the cost to tenants. Although the aid tenants receive, potentially in the form of vouchers, will still be based on the expectation that they will pay roughly one-third of their income toward rent, some residents could end up contributing more for decent housing. And some critics worry that pegging subsidies to market rents will penalize well-run buildings in rural or inner-city areas. In such cases, rents in nearby apartments are very low--but often so is the housing quality. That could slash income for some better properties, causing them to deteriorate over time.

TAX HIT. The housing overhaul may also hold an unpleasant surprise for investors. Recapitalization's Smith figures as many as 60,000 individuals have invested in subsidized-housing partnerships. If their buildings go through a restructuring under HUD's plan, the result could be a mortgage write-down or foreclosure. In either case, the resulting write-down or forgiveness of any part of that debt by the feds could be considered a gain to investors--creating a sizable tax hit.

Low-income property owners warn that a failure to legislate a way around that tax penalty would chill the future flow of capital into affordable housing. "People who were enticed into putting their money into low-income housing may be left holding the bag," contends John E. Autry, whose firm owns and manages subsidized apartments in the Southwest.

Of course, this market turmoil may be a double-edged sword for some players. J. Roderick Heller, CEO of NHP Inc., a big Washington-based affordable-housing manager, says his company would have "an enormous competitive advantage" and would likely gain market share as smaller, financially troubled players were forced out. But even NHP would feel the pinch: About 19% of its management portfolio is in buildings that could see declining rents, or possibly mortgage defaults, under the new regime.

Regardless of the fallout, policymakers vow to act before losses start mounting. Already, HUD Assistant Secretary for Housing Nicolas P. Retsinas says some owners are having trouble refinancing because of the uncertainty. Others are putting off necessary maintenance investments. "This is one case where inertia cannot prevail," he argues. For investors, property managers, and residents, the only certainty low is that their insulated and comfortable world is about to change--big time.

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