Detroit Housing Commission

Replacement Housing Factor Program

Section 202 Supportive Housing for the Elderly Program

Section 202—The New Syndication Frontier
By Richard Michael Price, Esq. , Nixon Peabody, LLP, CARH's General Counsel

Recent developments have sparked renewed interest on an old housing program—the Section 202 program. This program, enacted as part of the Housing Act of 1959, has provided loans and capital advances to non-profit sponsors for years. New legislation and a recent Department of Housing and Urban Development (HUD) Notice now allow private equity investment, which should provide new financing for non-profit organizations and new opportunities for developers and investors.

A Word About the Section 202 Program
The Section 202 program provides funding for development costs and rental assistance to elderly housing facilities. Projects developed until 1990 were funded with a direct loan from HUD at a market interest rate. Initially, Section 202 direct loans were made to non-profit borrowers without the benefit of an ongoing rental subsidy. Later, from about 1976 until 1990, Section 202 projects also received twenty-year Section 8 HAP contracts.

Congress dramatically changed the funding of the Section 202 elderly housing program through the Cranston-Gonzalez National Affordable Housing Act of 1990. As a result, starting in 1991, HUD funded Section 202 projects through a grant of funds called a "capital advance," rather than through a direct federal loan. The capital advance is contingent on the owner's agreement that the housing remains available for very low-income elderly persons for 40 years. In addition, Congress no longer provided a twenty-year HAP contract along with the section 202 Capital Advance. Instead, the revised Section 202 program called for a twenty-year project rental assistance contract ("PRAC"). The PRAC operates in essentially the same way as the Section 8 HAP Contract, but funding is appropriated under the Section 202 program directly and the initial PRAC term is generally five years.

Statutory changes in 1992 allowed pre-existing Section 202 owners to limit occupancy to the elderly and provided for a separate program for persons with disabilities, called the Section 811 program.

What are the Recent Developments?
More recently, the American Homeownership and Economic Opportunity Act of 2000, and provisions in the Fiscal Year 2000 and 2002 HUD Appropriations Acts, amended past requirements to allow financing and investment in Section 202 elderly housing projects outside of traditional non-profit sponsors and direct HUD funding. For-profit limited partnerships may now own Section 202 elderly projects, so long as the sole general partner of the limited partnership is a private non-profit organization, or a corporation wholly owned and controlled by a private non-profit organization. Moreover, assistance provided under Section 202 may be treated as amounts not derived from a Federal grant, which provides favorable treatment for purposes of the Low-Income Housing Tax Credit (LIHTC). There are similar changes to the Section 811 program.

HUD Notice H 2002-16 ("Notice"), issued on August 23, 2002, implements the congressional Section 202 elderly housing loan prepayment and refinancing provisions. However, refinancing opportunities under the Notice are limited to two types of Section 202 projects: (1) Section 202 direct loans, i.e., projects funded with direct loans from HUD under the Housing Act of 1959; and, (2) Section 202 direct loans with project-based Section 8 HAP Contracts. The Notice does not address the possible prepayment and refinancing of the Section 202 capital advance/PRAC projects, but there is nothing in the Section 202 statute that would prohibit HUD from considering such requests.

Why is This Process Important?
In addition to making it easier for Section 202 elderly housing sponsors to bring private financing into new project development, these changes facilitate refinancing and syndication of Section 202 projects funded by HUD before 1991. Generally, the projects affected by these provisions are those projects funded during the late 1970s and the 1980s with direct loans from HUD and twenty-year section 8 HAP Contracts.

Many of these projects need rehabilitation and the sponsors need to find ways to finance such rehabilitation. Many other properties are in good physical condition, but have large reserve accounts that sponsors and owners want in order to finance project improvements or additions. There is a growing need to convert some dwelling units to assisted living facilities to better serve the needs of the residents, and in particular the frail elderly who now represent a large proportion of the Section 202 elderly population. The new law is intended to help the sponsors and owners of these projects achieve these goals.

The Prepayment Process May Be Required or Just a Good Idea
The Promissory Notes used in Section 202 projects varied somewhat over the years. Generally, between 1977 and 1982, Notes usually contained a provision conditioning the right to prepay only on a 30-day written notice to HUD. These Notes do not require HUD approval for prepayment, other than this 30-day notice. However, HUD will not accept the prepayment unless certain materials are provided under a prepayment checklist provided in the Notice.

Still, the Notice provides that where properties can prepay by right, the owner may elect to process the prepayment and the refinancing under the terms of the Notice. In exchange, HUD would permit the project that refinances with FHA mortgage insurance to remain exempt from Mark-to-Market processing under Multifamily Assisted Housing Reform and Affordability Act of 1997 ("MAHRAA"). MAHRAA permits HUD to reduce HAP payments upon contract renewal. Exempt properties may retain current rents that could otherwise reduce rental subsidy payments.

Section 202 direct loan projects that do not contain prepayment rights are subject to HUD's approval to prepay. HUD will accept prepayment where the owner executes a new Use Agreement and refinancing results in continued operation by the current owner, a limited partnership where the sole general partner is the current ownership entity or its affiliate, or an acceptable and experienced non-profit elderly housing provider.

Paperwork Requirements
The HUD Notice contains twenty-six pages, which set out the specific requirements of a prepayment package and naturally focuses on owners who must seek or who want HUD approval to prepay. Owners that have a prepayment right must still follow a "prepayment checklist" attached to the Notice. In all events, the owner must notify tenants of the owner's intention to prepay at least 30 days prior to submitting a prepayment request to HUD in accordance with the procedures in the Notice and at 24 CFR Part 245. The prepayment request must include a copy of the (i) section 202 direct loan note and mortgage, (ii) the Section 8 HAP contract, (iii) the section 202 Regulatory Agreement, (iv) tenant comment and owner evaluation, (v) any other use agreements or financing documents that are in place at the time of the request for prepayment, (v) list of households in assisted units, (vi) list of commercial leases in place, and (vii) if applicable, statement regarding any new application for FHA insurance application or Risk Sharing financing.

Where HUD approval is required, the owner must also submit: (i) a detailed narrative on advantages to tenants, (ii) detailed narrative justifying the future use of the full rental assistance currently being provided to the project, (iii) a draft copy of Use Agreement to be recorded at time of prepayment, and (iv) a prepayment plan that demonstrates how the prepayment is at least as advantageous to the existing and future residents as the original Section 202 loan agreement or any applicable rental assistance. The Notice presupposes that the owner will achieve cost savings, and the owner must show how savings in rental assistance or refinancing will be used to: (i) increase availability of supportive services, (ii) rehab, modernize, or retrofit structures, common areas, or dwelling units, (iii) construct an addition or other facility, (iv) achieve rent reduction for unassisted tenants, and (v) comply with Section 504 requirements.

Cost Savings and Other Benefits
In exchange for processing through the Notice, HUD will allow the owner to receive the benefit of cost savings and the use of certain reserve funds. Section 8 savings would presumably be calculated on the difference in the debt service that would have resulted from financing the original mortgage amount at the lower interest rate, as compared with the current debt service requirement on the project. Savings must be used in a manner advantageous to the tenants, such as increasing supportive services, rehab and modernization, construction of an addition or other facility, or rent reduction. Project-based Section 8 contract rents, however, cannot be increased in conjunction with prepayment.

HUD also allows the project sponsor to use any residual receipts held for the project in excess of $500 per dwelling unit for not more than 15% of the cost of activities designed to increase the availability or provision of supportive services. The Notice does not address what, if any, other purposes the project sponsor may use the excess residual receipts for. HUD will allow the project sponsor to use any Reserve for Replacement in excess of $1000 per unit for rehabilitation or adding an addition.

Tax Credit and FHA Restrictions
The Notice also provides a maximum 9% developer fee if the refinancing involves tax credits. Also, HUD limits distributions of surplus cash of 6% of the owner's equity paid at the refinancing of the project. The Notice provides that the tax credit equity investment and other government funds provided for the refinancing (e.g., HOME and CDBG funds) may not be considered in determining the owner's equity.

Clearly, the Section 202 program has evolved to create greater access to capital investment. There are a number of steps to go through, but the potential for refinancing old properties and syndicating new ones opens new opportunities.

Richard Michael Price, Esq., is a partner in the law firm of Nixon Peabody, LLP. Nixon Peabody, LLP is located in Washington, D.C. and is CARH's General Counsel.