Multifamily Housing Mortgage and Housing Assistance Restructuring Program (Mark-to-Market)

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Parts 401 and 402

[Docket No. FR-4298-F-07]

RIN 2502-AH09

Multifamily Housing Mortgage and Housing Assistance Restructuring Program (Mark-to-Market)

AGENCY:

Office of Multifamily Housing Assistance Restructuring, HUD.

ACTION:

Final rule.

SUMMARY:

This final rule implements the Mark-to-Market Program through which section 8 rents for multifamily projects with HUD-insured or HUD-held mortgages will be reduced. Currently, the Program is operating under the authority of an interim rule that took effect on October 11, 1998. The purpose of the Program is to preserve low-income rental housing affordability while reducing the long-term costs of Federal rental assistance, including project-based assistance, and minimizing the adverse effect on the FHA insurance funds. A separate final rule will be published for those sections of the interim rule that govern renewal of section 8 project-based assistance contracts for projects outside of the Mark-to-Market Program.

EFFECTIVE DATE:

April 21, 2000.

FOR FURTHER INFORMATION CONTACT:

Dan Sullivan, Public Policy Analyst, Office of Multifamily Assistance Restructuring, Department of Housing and Urban Development, 1280 Maryland Ave., Suite 4000, Washington DC 20024, 202-708-0001. (This is not a toll-free number.) For hearing-and speech-impaired persons, this number may be accessed via TTY by calling the Federal Information Relay Service at 1-800-877-8339.

SUPPLEMENTARY INFORMATION:

I. Background

II. Comments Received on Part 401

III. Changes Made to Part 401 in Final Rule

IV. Findings and Certifications

I. Background

A. Mark-to-Market

HUD issued an interim rule on September 11, 1998 (63 FR 48926) to implement subtitles A and D of MAHRA (the Multifamily Assisted Housing Reform and Affordability Act of 1997, title V of Pub. L. 105-65 (approved October 27, 1997), 42 U.S.C. 1437f note.

MAHRA authorized a new Mark-to-Market Program designed to preserve low-income rental housing affordability while reducing the long-term costs of Federal rental assistance, including project-based assistance from HUD, for certain multifamily rental projects. The projects involved are projects with: (1) HUD-insured or HUD-held mortgages; and (2) contracts for project-based rental assistance from HUD, primarily through the section 8 program, for which the average rents for assisted units exceed the rent of comparable properties. The program objectives will be accomplished by (1) reducing project rents to no more than comparable market rents (with certain exceptions discussed below), (2) restructuring the HUD-insured or HUD-held financing so that the monthly payments on the first mortgage can be paid from the reduced rental levels, (3) performing any needed rehabilitation of the project, and (4) ensuring competent management of the project. The restructured project will be subject to long-term use and affordability restrictions.

MAHRA is intended to provide a long-term solution to the rapidly growing cost to the Federal Government of assisting affordable rental housing. Over 900,000 housing units in approximately 10,000 multifamily projects have been financed with FHA-insured mortgages and supported by project-based section 8 housing assistance payment (HAP) contracts. In many cases, these HAP contracts currently provide for rents for assisted units that substantially exceed the rents for comparable unassisted units in the local market. Starting in Fiscal Year 1996, those contracts began to expire, and Congress and the Administration began providing 1-year extensions of expiring contracts. While annual HAP contract extensions for these projects maintained an important affordable housing resource, they came at great expense. Every year more contracts expired, compounding the cost of annual extensions.

To begin to address this growing problem, Congress authorized demonstration programs beginning with section 210 of the Departments of Veterans Affairs and Housing and Urban Development, and Independent Agencies Appropriations Act, 1996 (see HUD notices regarding the demonstrations published at 61 FR 34664 (July 2, 1996), 61 FR 28757 (July 25, 1996), 62 FR 3566, (January 23, 1997) and 63 FR 36130, (July 1, 1998)). MAHRA builds on the demonstration programs with similar objectives and many similar provisions, but also some significant differences.

Organizationally, MAHRA established within HUD a new Office of Multifamily Housing Assistance Restructuring (OMHAR) to develop and actively manage, administer, and oversee the Mark-to-Market Program through a decentralized structure of Participating Administrative Entities (PAEs). OMHAR has established the framework of the Program through an interim rule, this final rule, and an Operating Procedures Guide, and is managing the program by selecting and monitoring Participating Administrative Entities (PAEs). In recognition of limited HUD resources, MAHRA gives PAEs the role of negotiating with the owners of individual projects and developing the Mortgage Restructuring and Rental Sufficiency Plans (Restructuring Plans) that will establish the future responsibilities of the owner, the PAE and HUD for projects that are marked-to-market. MAHRA also contains substantive differences from the previous demonstrations. For example, it includes projects with HUD-held mortgages in addition to HUD-insured mortgages and requires a second mortgage with deferred payment from net cash flow after accounting for all project expenses.

The preamble to the interim rule outlined implementation steps taken through September 11, 1998. Since then, the Senate confirmed President Clinton's appointment of Ira G. Peppercorn as the Director of OMHAR. OMHAR is currently hiring staff, and has established its Headquarters at 1280 Maryland Avenue SW, Suite 4000, Washington D.C. 20024. OMHAR Regional Offices have been established in New York, Chicago, and San Francisco. A Regional Office co-located in OMHAR Headquarters has full responsibility for the Southeast.

Before publication of this final rule, HUD was required to conduct at least three public forums at which organizations representing various groups may express views concerning HUD's proposed disposition of recommendations from those groups (specifically, the recommendations for certain provisions of MAHRA that were implemented in §§ 401.200, 401.201, and 401.420 of the interim rule.) The Department conducted these forums in New York, Chicago, and San Francisco on October 1, 1998. Forum participants representing a variety of interests made presentations that expanded and clarified written comments on both the matters covered in the section identified above, and other topics related to the Department's implementation of the Mark-to-Market Program. The vast majority of the issues discussed at the forums have been raised in one or more written public comments and will be addressed in the context of the written submissions. Thus, the issues raised at

the public forums will not be independently addressed in the preamble to this final rule. Written public comments in response to the Interim Rule were due October 26, 1998. In addition to the public forums, OMHAR convened a focus group on November 18, 1998, in Washington D.C. This meeting was helpful to OMHAR in hearing discussion and debate between commenters concerning several controversial policy issues contained in the regulations.

HUD issued a Request for Qualifications (RFQ) for eligible entities interested in being Participating Administrative Entities, 63 FR 44102, August 17, 1998. A bidders conference was held August 27, 1998, and submissions were due September 16, 1998. OMHAR identified 52 Public Entity applicants and 11 Non-Public applicants as meeting the PAE technical qualifications. All Public Entity applicants were informed by January 19, 1999, and all Non-Public applicants were informed by July 2, 1999. OMHAR provided an initial technical assistance briefing for potential PAEs on January 12, and 13, 1999. OMHAR has conducted an orientation session for each PAE after its Portfolio Restructuring Agreement (PRA) was signed. Each PAE also participated in one of five 2-day technical assistance sessions addressing underwriting issues. OMHAR will conduct additional training for PAEs in the upcoming months. OMHAR is continuing to negotiate PRAs with the public PAEs that have not yet executed a PRA. OMHAR expects each asset submitted by an owner for restructuring to be allocated to a PAE by the end of 1999.

MAHRA authorizes $10 million per year of technical assistance funding to tenant and non-profit groups, and public entities. These funds will be used to build tenant capacity to participate meaningfully in the Mark-to-Market program by organizing and training (OTAG grants), and to provide technical assistance to tenants of specific Mark to Market properties (ITAG grants). The initial funding for FY 1999 was awarded through the Department's SuperNOFA process, and grant agreements were executed in January 1999. OMHAR conducted training for the ITAG and OTAG grantees on November 30, December 1, and 2, 1998.

A general brochure explaining the basic program features is being prepared and will be distributed to tenant groups and other interested stakeholders. Once published, copies may be obtained by calling the Multifamily Housing Clearinghouse at 1-800-685-8470, or downloaded from OMHAR's Webpage at http://www.hud.gov/omhar. OMHAR and the Office of Housing conducted a distance learning seesion on September 21, 1999. In addition to the training already conducted, OMHAR will be conducting distance learning and on-site training for PAEs, HUD Field Offices, and other interested parties in the upcoming months.

The Mark-to-Market Program Operating Procedures Guide has been completed and made available to the public. OMHAR will make additional information on the Mark-to-Market Program available on its Webpage. Among other information, OMHAR has provided a list of addresses of OMHAR Regional Offices with jurisdiction over the Program, a list of PAEs that have been selected, the list of assets assigned to PAEs, and a list of Intermediary Technical Assistance Grant (ITAG) and Outreach and Training Grant (OTAG) providers and contact persons for technical assistance grants related to Mark-to-Market Program restructuring.

B. Renewing Section 8 Project-Based Assistance Without Mark-to-Market Restructuring

Section 524 of MAHRA and part 402 of the interim rule authorize renewal of expiring section 8 project-based assistance contracts for projects without Restructuring Plans under the Mark-to-Market Program, including projects that are not eligible for Plans and eligible projects for which the owners request contract renewals without Plans. At this final rule stage, we are separating parts 401 and 402. Minor changes are made in this final rule to §§ 402.1, 402.4, and 402.6. The rest of interim part 402 continues in effect until other changes to part 402 are published later as a separate final rule.

C. Changes in Legislation

After MAHRA became law, Congress enacted the Departments of Veterans Affairs and Housing and Urban Development, and Independent Agencies Appropriations Act, 1999 (Pub. L. 105-276, approved October 21, 1998) and the Departments of Veterans Affairs and Housing and Urban Development, and Independent Agencies Appropriations Act 2000 (Pub. L. 106-74, approved October 20, 1999). The first law amended the underlying statutory authorization for some provisions in the interim rule. HUD issued two corrections to the interim rule, on October 15, 1998 (63 FR 55333) and December 28, 1998 (63 FR 71372). The second correction included one change to part 402 to incorporate a provision of Pub. L. 105-276. Other changes needed to reflect Pub. L. 105-276 are included in this final rule and discussed in Section III of this preamble.

Pub. L. 106-74 also changed the underlying statutory authorization for some provisions in the interim rule. The most extensive changes affect provisions in part 402 and will be dealt with in separate rulemaking. Statutory changes related to part 401 are included in this final rule, as discussed in part III of this preamble, to the extent possible in a final rule.

In deciding what statutory changes can and should be reflected in this final rule, HUD considered its general rulemaking procedures in 24 CFR part 10, the provisions of section 502 and section 503 of Pub. L. 106-74, and the provisions of section 522 of MAHRA. Section 503 makes the new changes to section 524 of MAHRA effective immediately upon enactment (October 20, 1999) and states that the authority to issue regulations (

e.g.,

in section 502) may not be construed to affect the effectiveness or applicability of provisions such as section 524. The newly-effective section 524(g) of MAHRA applies the amended section 524 to all contract expirations or terminations on October 1, 1999 or afterwards. Thus, HUD must promptly take appropriate action that recognizes that some of the matters covered in interim part 402 have changed.

Section 502, however, requires that any implementing regulations that the Secretary determines “may or will affect tenants of federally assisted housing” may be issued only after notice and comment rulemaking. Ordinarily, HUD has the discretion under 24 CFR part 10 to issue substantive changes to regulations for effect, without notice and comment rulemaking (

i.e.,

through an interim or final rule), if HUD determines that a public comment period before effectiveness is unnecessary, impracticable, or contrary to the public interest. Section 502 limits this discretion.

Finally, section 522 of MAHRA (enacted in 1997), which directed HUD to implement section 524 of MAHRA by interim and then final rule, was not expressly amended. HUD is already overdue in issuing the final rule required by that section. But HUD cannot now proceed to replace the interim rule with a final rule without recognizing the intervening changes to section 524 that are now in effect but are inconsistent with various provisions of the interim rule.

There is no clear guidance in the statutes on how to reconcile the later instructions on rulemaking procedure in section 502—which apply not only to

MAHRA changes, but to many unrelated programs such as the section 202 and section 811 assisted housing programs—with earlier instructions on rulemaking procedure that apply to specific provisions of MAHRA. In this final rule, HUD has reconciled those sections by applying the following five principles:

1. HUD should continue to honor Congressional intent for rapid final implementation of the Mark-to-Market Program, in accordance with section 522 of MAHRA, by publishing part 401 in final form as soon as feasible.

2. Provisions in the interim part 401 that conflict with later amendments to MAHRA should not be published in final form without making conforming changes, to avoid confusion and facial conflict with current statutory provisions.

3. Conforming changes that simply reproduce or paraphrase new statutory language do not “affect” tenants within the meaning of section 502, since any effect derives from the statute rather HUD's rulemaking. Thus, section 502 does not require a new proposed rule for such changes.

4. Conforming changes that simply reproduce or paraphrase new statutory language also do not have substantive effect on tenants, owners or others that would require prior notice and comment rulemaking under 24 CFR part 10. Such procedure is properly regarded as both unnecessary and contrary to the public interest.

5. Any changes to the interim rule that are made in response to new statutory language but that make substantive additions to the statutory provisions should be made only through a separate notice and comment rulemaking procedure commencing with a proposed rule—in accord with 24 CFR part 10 and (to the extent the substantive additions may affect tenants) section 502. Thus, no such changes should be included in this final rule.

D. Other Background Information

This final part 401 is based on HUD's consideration of: (1) Public comments received on the September 11, 1998, interim rule; (2) discussions at the public forums; (3) the initial development of working relationships with PAEs; and (4) certain provisions in Pub. L. 105-276 and Pub. L. 106-74 as mentioned above. HUD has also refined certain policies due to further consideration when preparing and revising the Mark-to-Market Program Operating Procedures Guide (called the “Operating Procedures Guide” in this preamble.)

The interim rule was signed by Secretary Andrew Cuomo in the absence of an OMHAR Director. OMHAR has now begun operations, and OMHAR Director Ira Peppercorn has statutory authority to sign this final rule because it is limited to part 401 and projects eligible for the Mark-to-Market program. As required by section 573(b) of MAHRA, this rule is issued with the approval of Secretary Cuomo.

II. Comments Received on Part 401

We received 61 comments that are included in the docket file for the interim rule. We disregarded five comments as not pertinent to the interim rule. The discussion in this section of this preamble summarizes the other comments and HUD's responses to them, except that a comment that pertained solely to part 402 of the interim rule, and HUD's response, will appear when part 402 is published as a separate final rule. In this section, we have grouped the sections of interim part 401 into major areas of related subject matter, as shown in the outline set forth below. Discussion is generally in the order in which the areas are first covered in interim part 401. We have not listed the sections that received no public comments.

A. §§ 401.2, 401.99 and 401.100, General provisions and eligibility.

1. Definitions (§ 401.2).

a. Eligible project.

b. Eligible project costs.

c. Priority purchaser.

d. Tenant organization.

2. Actions needed to request a renewal of project-based assistance (§ 401.99).

3. Projects eligible for a Restructuring Plan (§ 401.100).

a. 236/202 projects.

b. Preservation projects.

B. §§ 401.101 and 401.403, Rejection of project or owner.

1. Designation as “bad” project.

2. Designation as “bad” owner.

3. Treatment of civil rights violations.

4. Project transfers to “good” owners.

C. §§ 401.200, 401.200 and 401.304, PAE selection and compensation.

1. Civil rights violations.

2. PAE compensation.

a. Incentives.

b. Timing of HUD payments.

c. Same fee schedule for public and private PAEs.

d. Environmental review responsibilities.

D. §§ 401.303, 401.309, 401.310, and 401.314, Other provisions of PRA.

1. Indemnification of non-public PAEs (§ 401.303).

2. PRA term and termination provisions (§ 401.309).

a. Term should be longer than 1 year.

b. PRA terminations.

3. Conflicts of interest (§ 401.310).

a. General.

b. Contested matters.

4. Environmental review responsibilities (§ 401.314).

E. § 401.402, Cooperation with owner and qualified mortgagee in Restructuring Plan development.

F. §§ 401.405-.406, Restructuring Commitment.

G. § 401.408, Affordability and use restrictions required.

1. Use restrictions and partially-assisted projects.

2. Use Agreements should last “exactly” 30 years—not “at least” 30 years.

3. If no section 8 funds are available, owners should be required to charge restructured rents or below-market LIHTC rents.

4. There should be no below-market rents.

5. Enforceability of Use Agreements and notice.

6. Pre-existing Use Agreements should be preserved.

7. Use Agreement should be subordinate to conventional loan.

8. Renewal contract terms must remain materially the same.

H. §§ 401.410-.412, Determining and adjusting rents under restructuring with project-based assistance.

1. Difficulties in determining comparable market rents.

2. “Blended” rents considering unassisted but restricted units.

3. Objections to “NOI project” and “positive social asset” requirements for exception rents.

4. Exception rents should be alternative to FMR.

5. Limitation of exception rents to 120 percent of FMR.

6. Need to define “community”.

7. Other factors to be included in expenses.

8. Determination of OCAF.

a. General.

b. Excluding debt service.

9. Negative OCAF.

10. Appeals of OCAF.

I. §§ 401.420-.421, Project-based assistance or tenant-based assistance.

1. What vacancies should be considered in determining the presence of a tight market?

2. Effect of sale to cooperative.

3. Limit conversion approvals to public body PAEs.

4. Requirement for semi-annual reporting in § 401.421(d).

5. How should the final rule handle/present factors to be considered in the Rental Assistance Assessment Plan?

6. Must all units be assisted under a Restructuring Plan?

J. § 401.450-.453, Physical condition of project.

1. Use of FNMA PNA Guidelines should not be eliminated.

2. The final rule should make clear that third party expenses for physical condition evaluation are eligible expenses.

3. Lead hazards.

4. Reserve account deposit.

5. Concern about cost-effectiveness determination in § 401.451(c).

6. PAE certification.

7. Property standards for rehabilitation.

8. HQS should not apply to non-assisted market rent units.

K. §§ 401.460-.471, Mortgage restructuring and payment of claims.

1. How should net operating income available to pay the first mortgage be determined?

a. Expenses.

b. Sizing the first mortgage.

2. First mortgage terms and conditions.

3. Refinancing.

4. Second mortgage terms and conditions.

a. Interest rate.

b. Other terms and conditions.

5. Forgiveness/modification of second mortgage.

6. Return to owner.

7. Third mortgage.

8. Claims.

L. §§ 401.472-.473, Funding of rehabilitation.

1. Opposition to 20 percent owner contribution requirement.

2. Opposition to limit on funding from governmental resources.

3. Other comments regarding 20 percent requirement.

4. Comments regarding use of project accounts for rehabilitation.

5. Section 236(s) rehabilitation grants.

6. Funding of rehabilitation through claim amount.

M. § 401.480, Sale or transfer of project.

1. HUD should be responsible for sale of projects.

2. Preference for priority purchasers.

3. Priority purchasers and competitive sales.

N. §§ 401.481-.484, Other requirements of Restructuring Plan.

1. Subsidy layering limitations on HUD funds (§ 401.481).

2. Leasing units to voucher holders (§ 401.483).

3. Property management standards (§ 401.484).

a. General comments on changes needed.

b. Suggestions for language changes.

4. Management fees.

O. §§ 401.500-.501, Participation by tenants, community and local government.

1. General.

2. Involve others in Rental Assistance Assessment Plan.

3. Intermediaries administering technical assistance grants should receive notice.

4. Notices in other languages.

5. Notice to all tenants and posted in project.

6. Right to organize.

7. Tenant role in PAE selection.

8. Rent levels.

9. Use Agreement changes.

10. Monitoring and compliance activities.

11. Transfer of properties and tenant participation.

12. Tenant involvement for projects not restructured.

13. Access to information.

P. §§ 401.550-.554, Implementation of the Restructuring Plan after closing.

1. Inspections.

2. PAE matters.

3. Role of lender.

4. Servicing of second mortgage.

5. Section 8 contract administration.

6. Enforcement.

Q. § 401.595, Contract provisions.

R. § 401.601 of interim rule and § 402.4(a)(2) of final rule, Consideration of an owner's request to renew an expiring contract without a Restructuring Plan.

1. Determination/verification of rent comparability.

2. Determining adequacy of DSC at market comparable rents.

S. § 401.602, Tenant protection if an expiring contract is not renewed.

1. Is tenant-based assistance mandatory?

2. Notice issues.

a. 6-month notice of non-renewal.

b. When is notice required?

3. Rent levels for tenant-based assistance.

4. Timing of tenant-based assistance.

T. § 401.606, Tenant-based assistance provisions for displaced tenants.

U. §§ 401.645 and 401.651, Owner dispute of rejection and administrative appeals.

1. Tenant appeals.

2. PAE appeals of rejections under § 401.405.

3. Time for owner to dispute approved plan.

4. Owner appeals.

V. § 401.600, Will a contract be extended if it would expire while an owner's request for a Restructuring Plan is pending?

W. Miscellaneous comments.

A. Sections 401.2, 401.99 and 401.100, General Provisions and Eligibility

Summary of Sections

Section 401.2 identifies the terms that are defined in MAHRA and used in the rule, and defines additional terms that are used in the rule. Section 401.99 explains three procedures to be followed by owners who request renewals of section 8 project-based assistance contracts. First, an owner of an eligible project who requests a Restructuring Plan must, at least 3 months before the project-based assistance contract expires, certify to HUD that, to the best of the owner's knowledge, project rents exceed comparable market rents and neither the owner nor any affiliate is suspended or debarred (or that the owner proposes a voluntary sale of the project). Second, an owner of an eligible project who does not request a Restructuring Plan must submit to HUD the certification described above in the same time frame, with the additional items that will permit the PAE to consider the request in accordance with § 401.601 of the interim rule (§ 402.4(a)(2) in this final rule) to determine whether the contract should be renewed under § 402.4. Finally, because part 401 is limited to projects eligible for a Restructuring Plan, this section of the interim rule refers the owner to § 402.5 if the project is not eligible for restructuring but the owner wants project-based assistance renewed.

Section 401.100 of the interim rule (merged with the definition of “eligible project” in the final rule) incorporates the statutory requirements in section 512(2) of MAHRA for an eligible project by providing that project rent exceeds the rent of comparable properties, as required by section 512(2)(A), if the gross potential rent revenue (

i.e.,

at 100 percent occupancy) for the project-based assisted units in the project at current gross rents exceeds the gross potential rent for those units (at 100 percent occupancy) using comparable market rents.

Summary of Comments

1. Definitions (§ 401.2).

a. Eligible project.

Two commenters felt that the definition of “eligible project” in the interim rule would require restructuring for projects whose aggregate rents might not exceed comparable market rents, contrary to Congressional intent, because rent levels for non-assisted units would not be considered in preservation projects or similar projects with unassisted below-market units and above-market section 8 units.

HUD response:

Preservation projects are discussed in the response under Section II.A.3.b. They are no longer eligible for the Mark-to-Market Program.

b. Eligible project costs.

One commenter felt that eligible project costs should include the costs to owners of hiring advisors such as accountants, appraisers, attorneys, real estate specialists, or tax advisors. The commenter argued that many owners are confused and uninformed about the details and impact of MAHRA and that they have limited funds to seek advice.

HUD response:

Such transaction costs can be included in the mortgage restructuring to the extent reasonable and necessary and supportable within a refinancing first mortgage (though not in a modification of the existing first mortgage). If the refinancing mortgage is insured by FHA, normal FHA criteria would be applied. Generally, OMHAR will recognize 50 percent of such costs to the extent they are customary, reasonably necessary, and to the extent they are otherwise acceptable under the terms of the new restructured first mortgage. The owner's share of such costs could only be recognized as

project operating expenses to the extent there was sufficient cash flow in the fiscal year during which the restructuring took place and then only with written approval from the HUD Multifamily Hub or Program Center.

c. Priority purchaser.

Three commenters were concerned about the definition of “priority purchaser”. One felt that the definition should include non-tenant based nonprofit organizations and non-community based nonprofit organizations because many of these groups possessed considerable experience with low-income housing and would be important resources in preserving low-income housing. Two commenters suggested that the final rule clarify that a tenant organization or tenant-endorsed community-based nonprofit or public agency can, as a controlling general partner in a limited partnership formed to raise tax credit equity, retain its priority purchaser status through the partnership, as well as the related ability to qualify for second mortgage forgiveness.

HUD response:

HUD agrees that a limited partnership with a sole general partner that is a tenant organization or tenant-endorsed community-based non-profit organization or public body may be viewed as a priority purchaser for purposes of § 401.461(b)(5) (possible forgiveness or modification of HUD-held second mortgage upon sale of project to priority purchaser) and § 401.480 (preference for sale to priority purchaser when current owner found ineligible for restructuring). HUD does not agree with the suggestion that priority purchasers should include national non-profit organizations without a local community base. There are national groups that can bring experience, but they should either partner with a local group, or else need to compete with other potential purchasers after the period reserved for marketing exclusively to priority purchasers, which will initially be set at 4 months. The applicable statutory provisions (sections 516(e) and 517(a)(5) of MAHRA) clearly show a Congressional desire for community-basing in this context.

d. Tenant organization.

One commenter suggested that the definition of “tenant organization” in the final rule should clarify the details of the election of tenant organization officers to avoid future disputes as to whether an organization is a tenant organization entitled to recognition.

HUD response:

This level of detail is inappropriate and unnecessary for a rule. HUD will address organizational details as needed in the Operating Procedures Guide or subsequent guidance.

2. Actions needed to request a renewal of project-based assistance (§ 401.99).

One commenter pointed out that ordinarily a project has 60 days to complete the annual financial statement and that requiring the statement during this period may cause difficulties for owners. The commenter suggested that, in such instances, the preceding year's financial statement should be acceptable. The same commenter suggested that the reference in § 401.99(c) to § 402.5 should be expanded to include § 402.4 because a project can have its contract extended under § 402.4 if the owner desires. One commenter said that notice of intent to restructure should be given to mortgagees.

HUD response:

The most recently required financial statement must be provided. If the renewal request and expiration is within the 60 day period following the end of the project's fiscal year, the previous year's statement will be accepted. We have added the suggested reference to § 402.5. A project owner must give notice to mortgagees of intent to restructure. This is stated in the interim rule's preamble discussion of § 401.99, and is clearly required in the Operating Procedures Guide. We consider such notice part of the owner cooperation required by § 401.402.

3. Projects eligible for a Restructuring Plan (§ 401.100).

a. 236/202 projects.

One commenter requested clarification of whether the class of “236/202” projects are eligible under MAHRA. (These projects were originally processed under the section 202 program but converted to the section 236 program after its creation in 1968.)

HUD response:

Section 236/202 projects are eligible in the same manner as other section 236 projects.

b. Preservation projects.

One commenter argued that MAHRA should be interpreted to exclude from eligibility preservation projects with plans of action (under ELIHPA or LIHPRHA). The commenter pointed out difficulties in reconciling MAHRA's requirements for restructuring with promises made to owners in ELIHPA/LIHPRHA plans of action, such as the short term use agreements and the unrestricted return to owner approved by HUD under ELIHPA. (Other comments related to preservation projects are mentioned in the summaries in Sections II.A.1.a., II.H.2., II.H.7., and II.K.1 of this preamble, and the response below applies to those comments as well).

HUD response:

Section 531(b) of Pub. L. 106-74 amended MAHRA to make preservation projects with plans of action ineligible for the Mark-to-Market program. This statutory change automatically excludes these projects from the “eligible projects” definition in the interim rule. No change in rule language is needed to make the final rule comply with the statutory change.

B. Sections 401.101 and 401.403, Rejection of Owner or Project

Summary of Sections

These sections implement section 516(a) of MAHRA, which permits HUD to elect to not consider a restructuring plan or a request for contract renewal on the basis of certain actions or omissions by an owner or purchaser of the project or an affiliate, or if the PAE determines that the poor condition of the project cannot be remedied in a cost-effective manner. Under § 401.101, HUD and PAEs will not consider the request of an owner of an eligible project for a Restructuring Plan if the owner or an affiliate is debarred or suspended by HUD unless a sale or transfer of the property is proposed in accordance with § 401.480. The final rule makes a change to § 401.101 regarding affiliates, consistent with the § 401.403 change discussed below.

Under § 401.403 of the interim rule, the PAE is responsible for a further more complete and ongoing assessment of owner and project eligibility while a Restructuring Plan is developed. The PAE must inform OMHAR if: (1) The owner or an affiliate is debarred or suspended; (2) the owner or an affiliate has engaged in material adverse financial or managerial actions or omissions as described in section 516(a) of MAHRA, which may include actions that have resulted in imposition of a Limited Denial of Participation (LDP) or a proposed debarment under 24 CFR part 25, or outstanding violations of civil rights laws; or (3) the PAE determines that the project does not meet the physical condition standards in § 401.453 and cannot be rehabilitated to meet such standards in a cost-effective manner. Under the interim rule, HUD may reject an owner's request for a Restructuring Plan for any of these reasons. In the final rule, debarment or suspension of an owner are automatic grounds for rejection under § 401.403 unless an acceptable sale is proposed. We revised the rule to give HUD discretion whether to accept or reject an owner request for restructuring if an affiliate of the owner is suspended or debarred. When rejection is discretionary, HUD may advise the PAE

to continue processing (under part 401) or decide to continue processing itself (under part 402).

Summary of Comments

1. Designation as “bad” project.

One commenter suggested that the rejection of a “bad project” because of poor condition that cannot be remedied in cost-effective manner needs to be guided by an objective standard of cost-effectiveness (the commenter suggested a standard).

HUD response:

HUD does not agree with this commenter that an objective elaboration on the cost-effectiveness requirement is feasible for inclusion in the final rule. The specific facts and circumstances must be considered by the PAE and OMHAR. The appeal process provided in subpart F is available if there is a dispute.

2. Designation as “bad” owner.

HUD should not reject an owner for a suspension/debarment if the owner's appeal is not yet adjudicated, argued two commenters. One of these commenters also objected to basing a “bad owner” rejection on a limited denial of participation (LDP) or proposed debarment alone because such actions might not be “material” within the meaning of section 516(a) of MAHRA). The commenter suggested that a PAE should examine the facts behind a LDP/proposed debarment and reach its own conclusion regarding materiality.

HUD response:

The rule is consistent with these comments. “Bad owner” determinations are made on the basis of “material adverse financial or managerial actions or omissions” identified in section 516(a)(2) of MAHRA. In the final rule, the Department has decided that an actual suspension or debarment will always be material for purposes of eligibility for a Restructuring Plan. HUD and PAEs are required to make a determination of materiality before rejecting an owner if a debarment or suspension decision has not already been made by HUD.

3. Treatment of civil rights violations.

Two commenters wanted civil rights violations to be considered in a “bad owner” determination only if they have been finally adjudicated and have not been substantially cured. One of these commenters commented on a need to clarify which violations are disqualifying civil rights violations.

HUD response:

Civil rights violations will be addressed by OMHAR after consultation with HUD's Office of Fair Housing and Equal Opportunity. The Operating Procedures Guide details the decision-making process regarding owner eligibility for a Restructuring Plan, including the point at which an apparent outstanding civil rights violation will constitute a bar to further consideration of a Restructuring Plan for the owner. The Operating Procedures Guide provides further information on the civil rights legal authorities that will be considered when making a determination of owner eligibility.

4. Project transfers to “good” owners.

Four commenters thought that the rule was deficient in its treatment of project transfers after “bad owner” determinations. One labelled the interim rule's provisions providing for rejection of certain owners a “misguided policy of forced voucherization” and wanted the final rule to reiterate that contract termination is a last resort and that transfer to a priority purchaser is preferable to conversion. Two others cited a statement by Senator Bond regarding the need for alternative solutions for projects when an owner is disqualified.

HUD response:

The commenters who thought that the rule was deficient did not suggest specific improvements to the rule. The determination to deny a restructuring or to not renew the project-based assistance will be made on a case-by-case basis. The PAE and HUD will consider the impact on tenants, the potential to transfer the project to priority purchasers, and other remedies. The PAE will invite tenant and local community participation and solicit comments in accordance with §§ 401.500 and .501 of the final rule.

C. Sections 401.200, 401.201 and 401.304, PAE Selection and Compensation

Summary of Sections

Section 512(10) of MAHRA, referenced in § 401.200, permits a public agency, a nonprofit organization, or a for-profit entity, to be a PAE. Under § 401.200, the PAE may not have any outstanding violations of civil rights laws, determined in accordance with criteria in use by HUD. Section 401.201 explains that HUD will select PAEs in accordance with the statutory selection criteria and additional selection criteria established by HUD. The selection method will be determined by HUD and may be through a request for qualifications (RFQ). Section 401.304 provides that the PRA will contain provisions on compensation to the PAE regarding a base fee and reimbursement of expenses, and may provide for incentive fees.

Summary of Comments

1. Civil Rights violations.

One commenter had due process concerns with requiring that a potential PAE have no outstanding violations of civil rights laws. This commenter recommended that potential PAEs should not be disqualified unless the civil rights violations are material and the result of a final adjudication. In addition, this commenter felt that violations that have been substantially cured should not become grounds for disqualification.

HUD response:

Please see HUD's response under Section II.B.3. on a similar point.

2. PAE compensation.

a. Incentives.

One commenter felt that it was important to have full and early public disclosure of incentives to PAEs in order to ensure public confidence in the fairness and objectivity of the restructuring process. Three commenters felt that PAE incentives should reflect the statutory intent that economic and non-economic objectives be balanced. One of these commenters suggested incentives similar to those offered PAEs in the Portfolio Reengineering demonstration programs.

HUD response:

The specific details of PAE compensation will be included in the PRA. They are not appropriate for inclusion in regulations since compensation will be subject to revision from time to time. The details of the PAE compensation package will be fully disclosed when the ongoing negotiations with the remaining PAEs without PRAs are concluded. The compensation for private PAEs is determined through a competitive bidding process. The incentive section of the compensation package has been set up to balance the preservation and cost savings goals of the Mark-to-Market Program. The compensation package of the demonstration program is being carefully considered as OMHAR finalizes the PAE compensation package for the permanent program.

b. Timing of HUD payments.

One commenter urged HUD to provide PAEs with a significant portion of their fees early in the restructuring process.

HUD response:

We do not agree that this would be necessary or appropriate. Funds for fees and reimbursable expenses will be released commensurate with completion of work.

c. Same fee schedule for public and private PAEs.

One commenter was concerned about differing fee schedules for public and private PAEs. This commenter felt that a differing fee schedule might lead HUD to choose private PAEs in order to save money, thus contradicting the Congressional mandate to utilize public agencies whenever possible to protect the public interest.

HUD response:

The statute, the regulations, and HUD's implementation of the program have all been consistent with expressed Congressional intent that public entities have a priority in OMHAR's selection process for a PAE within a geographic jurisdiction.

d. Environmental review expenses.

Two commenters noted that the interim rule indicated that the PAE may be expected to assist HUD in complying with HUD's environmental review responsibilities by completing certain forms or checklists. Both commenters suggested that HUD should clarify that any outside expense incurred by PAEs in completing these forms should be considered a reimbursable expense.

HUD response:

Such expenses will be reimbursable subject to the terms of the PRA.

D. Sections 401.303, 401.309, 401.310 and 401.314, Other Provisions of PRA

Summary of Sections

Section 401.303 implements section 513(a)(2)(G) of MAHRA, which requires HUD to provide a PAE indemnity against lawsuits and penalties for action taken by a PAE pursuant to the PRA (except for willful misconduct or negligence) if the PAE is a State housing finance agency or a local housing agency. Under § 401.309, the PRA will have a term of 1 year, to be renewed for successive terms of 1 year with the mutual agreement of both parties. A PRA will be subject to termination by HUD at any time.

Section 401.310 addresses conflicts of interest for a PAE and related persons defined in the section as “restricted persons”. A conflict of interest exists when a PAE or restricted person either: (1) Has personal, business, or financial interests or relationships that would lead a reasonable and knowledgeable person to question the integrity or impartiality of those acting for the PAE; or (2) in a lawsuit, is an adverse party either to HUD or to the owner of a project under the PAE's PRA. In general, HUD will avoid dealing with a PAE with a conflict of interest.

Section 401.314 states that HUD is legally required to retain any environmental review responsibilities under 24 CFR part 50, and that any required environmental review will occur before HUD executes a Restructuring Commitment (see § 401.405). Without delegating any decision-making authority to the PAE, OMHAR has included in the PRA a provision for PAE completion of forms and/or checklists to assist HUD in complying with its requirements under environmental regulations.

Summary of Comments

1. Indemnification of non-public PAEs (§ 401.303).

One commenter felt that HUD should indemnify non-public PAEs. The commenter argued that while section 513(a)(2)(G) of MAHRA specifically requires HUD to indemnify public PAEs, section 517(b)(5) gives HUD broad authority to provide indemnification to non-public PAEs as well. This commenter asserted that the same policy reasons that justify indemnification of public PAEs argued in favor of indemnifying non-public PAEs. Finally, the commenter thought that HUD should make clear in the final regulation that a PAE may indemnify a non-public team partner, if it so chooses.

HUD response:

HUD will indemnify only public entity PAEs. Although PAEs may choose to indemnify teaming partners, such indemnification will not be a reimbursable expense and PAEs may not pass on this cost to OMHAR or HUD. There is no prohibition in MAHRA against PAEs indemnifying teaming partners or subcontractors and, accordingly, this will not be addressed in the final rule.

2. PRA term and termination provisions (§ 401.309).

a. Terms should be longer than 1 year.

One commenter pointed out that preparing an application to become a PAE takes considerable time and effort, and that learning and becoming expert at fulfilling the requirements of the PRA requires significant additional effort. The commenter felt that 1 year would not provide an adequate opportunity for HUD to determine the PAE's capacity. Another commenter felt that the short term would interfere with owner ability to develop long-term relationships with a PAE. The commenter suggested that the terms should be indefinite after the first year. A third commenter had two concerns about the PAE renewal process: that yearly PRA renewals would lead to another burdensome and unnecessary PAE selection process, and that HUD might use the annual review process to replace HFAs with non-public entities because the one-time priority for public entities would not apply after the initial selection. The commenter argued that Congress did not intend for HUD to use public agencies as PAEs only for the first year, and discouraged HUD from trying to circumvent Congress' intent by creating a new PAE selection process in the later years of the program.

HUD response:

If 1 year is not adequate to determine a PAE's capacity, HUD will extend the contract for an additional year. Except in the presumably unusual cases where a PRA was terminated and the assets reassigned to another PAE or to OMHAR itself, the PAE will continue to process the particular projects agreed upon by HUD and the PAE. A 1-year contract term is appropriate both in order to revise provisions as necessary based on experience, and as an administrative convenience for the Department. OMHAR's intent is to renew PRAs with PAEs unless there are performance or capacity problems or there is mutual agreement not to continue.

b. PRA terminations.

One commenter felt that the rule appeared to allow termination with or without cause, and that terminations without cause would cause PAEs to adopt a short-term perspective detrimental to restructuring. This commenter suggested only allowing termination for cause and providing appropriate due process protection. Another commenter agreed that termination should only be for cause and “only in extraordinary circumstances”. One commenter was concerned that HUD could terminate a PRA at any time for cause but that a PAE could not, and that rights to termination for cause should be mutual because Congress intended HUD and PAEs to be partners.

HUD response:

The PRA includes a bilateral right to termination for convenience and is therefore in keeping with the partnership goal. Were OMHAR to exercise this right the PAE would be paid, at a minimum, for services rendered to the point of the termination. We do not believe that the termination for convenience provision of the rule will reasonably affect the PAE's perspective on the PRA or restructuring work.

3. Conflicts of interest (§ 401.310).

a. General.

A number of commenters expressed concerns about the conflict of interest rules. One commenter felt that HUD should be able to waive a conflict involving a potential PAE who is taking an adverse position to an owner, if the owner consents, because it is the owner who is at risk of being damaged. One commenter felt that the conflicts of interest rule was overbroad. This commenter argued that HFAs often work with the same principals in different roles and that an HFA should not be penalized for having legitimate business contacts that do not interfere with their objectivity as a PAE. This commenter suggested that HUD narrow the scope of the conflict of interest provisions so that they apply only to specific properties undergoing restructuring. This commenter also felt that the conflict of interest provisions

would make it difficult for a PAE to provide an owner with other available resources, such as Low Income Housing Tax Credits, HOME funds, and risk-sharing loans, which is unnecessary because HFAs utilize strict, objective allocation plans for these resources.

HUD response:

The conflict of interest provisions are drafted to protect OMHAR and the public interest while allowing flexibility to accommodate varying factual situations. In order to prevent unfairness in particular cases and to allow PAEs to provide owners with other available resources, all waiver requests will be considered carefully. As deemed appropriate on a case-by-case basis, OMHAR will seek information from outside sources when considering conflict of interest determinations and waiver requests.

b. Contested matters.

Two commenters felt that any lawsuit in which a PAE and an owner were adversaries should automatically be considered a conflict of interest and the PAE should automatically be disqualified from exercising any responsibilities under the regulations with regard to that owner. One of these commenters also felt that the final rule should allow owners and other interested parties to seek HUD review of potential conflicts of interest, in addition to the PAE. One commenter asked whether and why a disqualifying conflict of interest would apply, not only to a party to a lawsuit or contested matter, but also to any legal counsel representing such a party. This commenter also felt that the final rule should more fully define the scope of the terms “administrative proceeding or other contested matter” and “adverse to HUD.”

HUD response:

Any lawsuit in which a PAE and an owner are adversaries will be considered a conflict of interest. It will trigger scrutiny and will necessitate a waiver prior to the PAE beginning or continuing work on a Restructuring Plan. OMHAR will carefully investigate conflict of interest allegations or disclosures that are raised by any source. The Operating Procedures Guide and OMHAR's Internet Website provide more information on the specifics of OMHAR's conflict of interest requirements, including affected parties and definitions of terms.

4. Environmental review responsibilities (§ 401.314).

One commenter felt that, if the restructured first mortgage is refinanced with a conventional loan, then HUD should delegate all required environmental reviews to the conventional lender.

HUD response:

Current law does not permit HUD to delegate environmental review responsibilities to a lender.

E. Section 401.402, Cooperation with Owner and Qualified Mortgagee in Restructuring Plan Development

Summary of Section

This section provides guidance for implementation of the requirement in section 514(a)(2) of MAHRA for cooperation among the PAE, project owner and mortgage servicer. The owner must actively work with the PAE and other necessary third parties, including the mortgage servicer, to develop a Restructuring Plan. If the owner fails to cooperate to the satisfaction of the PAE, and HUD agrees, the PAE will not continue with development of a Restructuring Plan.

Summary of Comments

One commenter asked HUD to clarify that an owner who is viewed as insufficiently “cooperative” in helping a PAE develop a restructuring plan that differs from the approach suggested by the owner will not become ineligible under § 402.7 for section 8 contract renewal without restructuring. Another commenter said that HUD should make it easier for servicers to “cooperate” with respect to first mortgages that are too small (before or after a partial claim) to attract servicers. This commenter mentioned such matters as difficulty in getting the consent of securitizers (including Ginnie Mae) or whole-loan investors, a need for an increased FHA servicing fee, reducing the costs of servicing (specifically, not requiring a mortgagee inspection if the PAE inspects), allowing financing costs to include reasonable administrative fees, considering an additional escrow account for servicing fees, and considering rebate of part of FHA premium such as the section 221(g)(4) put for Interest Enhancement Payment.

HUD Response:

We will address the comment on eligibiity under § 402.7 when part 402 is published in final form. Inability of a mortgagee or servicer to obtain investor consent to modify, or their determination that the size of the restructured loan was not financially feasible to originate and/or service, is not considered a lack of cooperation for purposes of § 401.402. As noted in section III of this preamble under § 401.550, the final rule clarifies that HUD will accept an inspection by a PAE in lieu of an inspection by the mortgagee or servicer.

F. Sections 401.405-.406, Restructuring Commitment

Summary of Sections

These sections provide for HUD to approve a Restructuring Plan as submitted by a PAE, require changes as a condition for approval, or reject the Plan. HUD will inform the PAE of the reasons for rejection and the subpart F dispute and appeal procedure will apply. The PAE will deliver to the owner, for execution, a proposed Restructuring Commitment as the final element of a HUD-approved Restructuring Plan.

Summary of Comments

Two commenters said that HUD should be required to approve/disapprove a proposed Restructuring Commitment within a specified period after PAE submission; one of them suggested 10 days.

HUD response:

OMHAR anticipates a standard processing time of 15 days for review of conforming transactions. Conforming transactions are those in which there is limited financial impact or risk to the Federal Government. Specific criteria will be defined in the Operating Procedures Guide and the PRA. The standard processing time for review of non-conforming transactions is anticipated to be 30 days.

G. Section 401.408, Affordability and Use Restrictions Required

Summary of Section

Section 401.408 of the interim rule implements section 514(e)(6) of MAHRA, which requires the Restructuring Plan to provide for affordability and use restrictions on the project for a term of at least 30 years, consistent with the long-term physical and financial viability and character of the project as affordable housing. During a period when at least 20 percent of the units in a project receive project-based assistance, this section provides that the affordability restrictions applicable to such assistance will apply in lieu of other restrictions required to be in the recorded Use Agreement. Otherwise, the Use Agreement will require conformance to the rent and tenant income profile used in the Low Income Housing Tax Credit Program (LIHTC) for any project that is restructured (

i.e.,

either rents set for 20 percent of the units at 30 percent of 50 percent of median income or for 40 percent of the units at 30 percent of 60 percent of median income.) The Use Agreement will specify which interested parties, in addition to HUD and the PAE, will have rights of enforcement.

Summary of Comments

1. Use restrictions and partially-assisted projects.

Two commenters expressed concern that § 401.408 makes use restrictions applicable to an entire project even when that project is only partially-assisted. Both commenters suggested that use restriction agreements should apply only to formerly-assisted units within a partially-assisted project. One commenter thought that a failure to make this exception would cause owners of partially-assisted projects to opt out of the section 8 program, which in turn would decrease the stock of affordable housing.

HUD response:

HUD does not share the concerns of these commenters. Use restrictions run with the land because the entire project benefits from a debt restructuring. To the extent owners can opt out from further project-based assistance, they do not need the restructuring (and would not be subject to the Use Agreement).

2. Use Agreements should last “exactly” 30 years—not “at least” 30 years.

Four commenters were concerned about the requirement that the Use Agreement be in effect for “at least” 30 years. These commenters recommended that the final rule require the Use Agreement to be in effect for “exactly” 30 years because the interim rule language might allow PAEs to specify terms greater than 30 years indiscriminately. One commenter thought all Use Agreements should last for 30 years except where unusual conditions specified in the Operating Procedures Guide are present and the PAE decides that a longer term is consistent with statutory intent. Another commenter felt that a PAE's discretion to use terms longer than 30 years should be tightly overseen by HUD.

HUD response:

MAHRA requires a Use Agreement term of at least 30 years. The decision to require a longer term should be left to the PAE as the party most familiar with particular circumstances that may make longer restriction periods appropriate.

3. If no section 8 funds are available, owners should be required to charge restructured rents or below-market LIHTC rents.

Two commenters felt that owners should be required to charge the lesser of restructured rents or Low Income Housing Tax Credit (LIHTC) rents (which may be below-market) in the event that section 8 funds are not available in the future.

HUD response:

The owners of properties subject to Use Agreements will be limited to rents at the lesser of market or below-market LIHTC rents in the event that section 8 funds are not available in the future. Since market conditions will more likely improve or worsen rather than stay static, the market rents the units will command at that time will probably not be the restructured rents.

4. There should be no below-market level rents.

One commenter felt that the rule contemplated establishing below-market rents when fewer than 20 percent of the units in a project receive project-based assistance. This commenter was concerned about adverse tax consequences and strongly recommended that no project be required to reduce its rents below market level. Another commenter felt the final rule should indicate that owners will not be required to accept project-based or tenant-based assistance if the final rule does not allow for payment to the owner of market rents. This commenter also argued that, because LIHTC restrictions are not imposed by MAHRA, imposing such restrictions could cause owners to evict tenants with higher incomes or hold units vacant for unreasonable time periods. The commenter suggested less restrictive affordability requirements. If LIHTC requirements are maintained, this commenter felt that owners should have the choice of affordability mix options.

HUD response:

When fewer than 20 percent of the units in a project receive project-based assistance, the Use Agreement will have the practical effect of requiring the lesser of market rents (as a result of the operation of the local rental market) or the LIHTC rents (as specified in the Use Agreement). Further, the owner has the option of selecting the tax credit standard (20 percent of the units with rents affordable at 50 percent of median income, or 40 percent of the units with rents affordable at 60 percent of median income) which yields the highest net operating income. For the inventory of projects with above-market section 8 rents, the LIHTC rents are often greater than market rents. In cases where the LIHTC rents are less than market rents, the impact on the supportable secured debt (and thus the tax consequences of the restructuring) will typically be nominal. A less restrictive affordability requirement is not appropriate.

5. Enforceability of Use Agreements and notice.

Two commenters felt that tenants and tenant organizers should always be given the right to enforce Use Agreements, which the interim rule did not seem to demand. Another commenter felt that third parties should not be allowed to challenge matters that both the PAE and the owner agree upon, or without prior written permission from the PAE. This commenter also felt that the rule should make clear that the owner should receive notice of any enforcement actions as well as a reasonable opportunity to cure any problems. One commenter felt that the right of parties to enforce a Use Agreement should be tightly controlled. One commenter felt that HUD should identify the specific remedies provided each party that may enforce a Use Agreement. This commenter also felt that HUD should, at a minimum, indicate that all enforcement actions must be initiated by HUD/PAE and that HUD/PAE will have sole responsibility for determining what steps an owner must take to cure any violations.

HUD response:

Section 401.408(i) of the final rule makes it clear that Use Agreements will include the parties listed in that paragraph as third party beneficiaries. Further, a Use Agreement must require the party bringing enforcement action to give the owner notice and a reasonable opportunity to cure any violations. The PAE or HUD will typically be the entity bringing enforcement action, but this provision has been specifically crafted to allow other parties to bring action. This will ensure that other interested parties such as tenants are able to protect their interests in cases where a project is not covered by a PRA, or where HUD or the PAE is unable or unwilling to take action. In the rare case where HUD perceives clear abuse by a third party that is not exercising enforcement rights in good faith, HUD may exercise its right to modify a Use Agreement to require the third party to obtain prior HUD approval for any enforcement action concerning the Use Agreement.

6. Pre-existing Use Agreements should be preserved.

Two commenters suggested that a Mark-to-Market Use Agreement should be subject to any pre-existing Use Agreements, which should be preserved. One of these commenters felt that the final rule should make clear that the restructuring process should not be used to lessen any previous affordability restrictions.

HUD response:

Restructuring under the Mark-to-Market Program will not automatically relieve a project of any existing Use Agreements and affordability restrictions. If an owner considers that existing agreements and affordability restrictions are based on section 8 terms and policies no longer authorized by Congress, or will interfere

with achieving the objectives of a proposed Restructuring Plan, the owner should bring this concern to the PAE's attention so that the PAE can consider proposing appropriate changes for HUD's approval.

7. Use Agreement should be subordinate to conventional loan.

One commenter felt that if the restructured first loan is refinanced with a conventional loan, then the Use Agreement should be subordinate to this loan (

i.e.

the Use Agreement should not survive foreclosure). This commenter argued that most conventional lenders will refuse to refinance mortgages subject to Use Agreements if the agreements survive foreclosure.

HUD response:

Section 514(e)(6) of MAHRA requires a Use Agreement to apply for at least 30 years and any subordination that could lead to termination of the Use Agreement upon foreclosure of a conventional loan would conflict with this MAHRA requirement.

8. Renewal contract terms must remain materially the same.

Five commenters said that renewals of project-based contracts should be required to contain terms that are materially similar to the initial post-restructuring contract. Two commenters argued that unless this is done, general partners will have difficulty recommending the restructuring transaction to limited partner investors. One commenter suggested that the final rule make it “crystal clear that HUD cannot decrease the benefits to the owner upon subsequent renewal offers.” Another commenter felt that Use Agreements should contain conditions for automatic expiration of the agreement should there be changes to the agreement that are detrimental to the original terms and conditions of the restructuring plan. One commenter felt that an owner's obligation to renew section 8 assistance should terminate if HUD/PAE fails to renew for any year. The same commenter felt that under the final rule there should be no circumstances, other than unavailability of funds or HQS violations by the owner, under which HUD/PAE may refuse to renew project-based section 8 assistance. Another commenter felt that HUD should guarantee that section 8 funds would be available in the future as long as necessary to assure affordability. This commenter felt that imposing use restrictions would be meaningless without a guarantee of section 8 funds for the project.

HUD response:

Under section 515(a) of MAHRA, either the Secretary or a PAE acting under a contract with the Secretary is required to offer to renew or extend an expiring contract, subject to the availability of amounts provided in advance in appropriations Acts. In addition, Pub. L. 106-74 amended section 524 of MAHRA (which applies to contract renewals after a Restructuring Plan is in place) to make renewals mandatory upon owner request, also subject to appropriations. MAHRA does not expressly require that the offer be in accord with the contract renewal terms provided in the approved Restructuring Plan and implies that the level of appropriations may not always permit such an offer to be made. There is no guarantee of, and the Department does not have the authority to obligate, section 8 funds unless Congress appropriates the funds. Section 515(a) protects the owner by only requiring the owner to accept the renewal offer if the offer in “in accordance with the terms and conditions specified in” the Restructuring Plan. If the section 8 contract terms are offered under terms less favorable than those which would result by application of the OCAF as provided in the Restructuring Plan (to the extent, if any, permitted by MAHRA section 524), the owner will not be required to accept the renewal offer, but the project will remain subject to the Use Agreement for the remainder of its term.

H. Sections 401.410-.412, Determining and Adjusting Rents Under Restructuring With Project-Based Assistance

Summary of Sections

Section 401.410 provides guidance to the PAE for determining comparable market rents, as well as for an owner making a preliminary determination of eligibility under § 401.99(a)(1). Comparable market rents are rents charged for “comparable properties” as defined in section 512(1) of MAHRA. The determination of whether rents in a project are comparable to market rents considers only the rents for units in the project that receive project-based assistance.

Section 401.411 provides for budget-based “exception rents” (not to exceed 120 percent of Fair Market Rent without a HUD waiver), instead of comparable market rents, if the PAE determines that the housing needs of the tenants and the community cannot be adequately addressed through a Restructuring Plan that provides for comparable market rents, and if the project would be a negative Net Operating Income (NOI) project at comparable market rents. The preamble to the interim rule—but not the rule itself—stated that in order to receive exception rents, projects must meet the following test (which we will call the “positive social assets” test in the following discussion):

[The projects] must be determined by the PAE to be positive social assets in the community whose operating expense levels and lack of debt service capacity are not a function of bad management. They should be unique, appropriately situated, and affordable housing, with no other comparable housing alternatives available in the submarket.

Exception rents are based on the factors listed in section 514(g)(3) of MAHRA. They include debt service (allowed in the interim rule only on the second mortgage under § 401.461 or to support a rehabilitation loan included in the Restructuring Plan), project operating expenses, a PAE-determined allowance for a reasonable rate of return to the owner, contributions to adequate reserves, and other necessary project operating expenses as determined by the PAE.

Section 401.412 concerns adjustment of restructured rents by an operating cost adjustment factor (OCAF) as required by section 514(e)(2) of MAHRA. A Restructuring Plan will provide for adjustments using OCAF under this section, but this section will not prevent HUD from offering renewal with rent levels higher than those resulting from OCAF adjustments, if legally authorized.

Summary of Comments

1. Difficulties in determining comparable market rents.

One commenter noted that there are unlikely to be comparable unassisted projects in low-income areas. Another noted that, for projects with special needs populations (elderly, disabled), comparisons must take special features and services into account.

HUD response:

HUD agrees that determining comparable market rents will be problematic in some cases. Section 401.410 (both the final rule text and the interim rule preamble explanation) address this issue with a methodology consistent with express Congressional intent that assisted projects not be used for rent comparables.

2. “Blended” rents considering unassisted but restricted units.

Three commenters wanted the final rule to clarify the treatment of projects for which unassisted units with long-term affordability restrictions (such as in ELIHPA/LIHPRHA preservation projects) considered together with assisted units with above-market rents would result in a “blended” average rent not exceeding market comparable rents. The commenters argued that such

projects should qualify as projects with rents not exceeding market comparable rents and, therefore, should be eligible for contract renewal as exception projects under § 402.5(a)(2). This could enable the projects to achieve sufficient net operating income to achieve owner returns anticipated in preservation program Plans of Action.

HUD response:

HUD will only consider units assisted under the expiring section 8 contract in determining whether the aggregate rents are higher or lower than market. Preservation projects with approved plans of action under ELIHPA or LIHPHRA are no longer eligible for the Mark-to-Market program. Please see the related response under Section II.A.3.b. of this preamble.

3. Objections to “negative NOI project” and “positive social asset” requirements for exception rents.

Many commenters objected to either § 401.411 concerning when to use exception rents, or to preamble discussion supplementing that section regarding negative NOI projects and the “positive social assets” test. One commenter objected to the limitation of exception rents to negative NOI projects, stating that Congress included exception rents for cases such as rural projects and inner cities or special populations needing budget-based rents and that requiring no debt service would make the “rate of return” factor in section 514(g)(3) of MAHRA a “nullity”. One commenter stated that exception rents must have a second mortgage debt service component adequate to support “reasonable likelihood of repayment” requirement to avoid adverse tax consequences to the project owner, while another suggested that all LIHPRHA projects with Plans of Action should be treated as exception rent projects, even without negative NOI, if the statutory test is met.

Eleven commenters objected to the positive social asset test in its entirety on grounds that it is unnecessary and not provided for in MAHRA. Two of these commenters also objected specifically to the statement that exception rents should not derive from bad management. Another commenter who objected to the positive social asset test said that, if it were to be included, there must be clear guidance and objective standards in the Operating Procedures Guide on how it would be applied. Another objected to routine application of the test but felt it could be appropriate for a determination about waiving the 120 percent limit.

HUD response:

HUD gave particular consideration to this issue in light of the volume of comments received from a broad spectrum of interest groups, and convened a focus group on November 18, 1998, in part to discuss the matter. We are concerned that there appears to have been widespread confusion regarding HUD's intent in including the “positive social assets” test in the interim rule preamble. By including the language in the preamble, and not in the rule itself, HUD tried to provide additional help to the PAEs that must apply the actual statutory test for exception rents (which also appears in the rule itself): that “the housing needs of the tenants and the community cannot be adequately addressed” through comparable market rents. In other words, if housing needs can be adequately addressed through a Restructuring Plan with comparable market rents, the PAE may not consider exception rents.

But equally important, exception rents also cannot be approved if a Restructuring Plan with exception rents would not adequately address tenant and community housing needs. The statute demands more than simply a negative test regarding use of comparable market rents: the PAE must be convinced that (rent issues aside) the project is worthy of restructuring in lieu of some other approach to meeting tenant and community needs. As we attempted to suggest in the interim rule preamble, this necessarily requires that a project have certain positive attributes that justify continued approval of rents that exceed the market. Since many commenters viewed the interim rule preamble as an attempt to graft onto MAHRA new considerations that were foreign to the statutory provisions, we consider it advisable not to repeat the “positive social assets” test as stated in that preamble. PAEs must, however, be aware of the need for meeting all aspects of the statutory objective that we have discussed above.

In particular, PAEs must recognize that exception rents should never be approved if the project would otherwise be rejected for restructuring under section 516 of MAHRA because of serious ownership or physical condition problems that cannot be remedied. A PAE's recommendation of exception rents for a project presumes that, at a minimum, the project and owner have been determined and confirmed eligible for restructuring as required by § 401.403. Thus, exception rents should not be approved for projects that are determined by the PAE to have an irreversible detrimental impact in the community, for reasons such as unacceptable management practices that adversely impact the community, or are deemed ineligible for a mortgage restructuring due to the poor condition of the project. In order to receive exception rents, the PAE must make a determination that the housing needs of the tenants and the community cannot otherwise be adequately addressed. In making this determination, the PAE should ensure there are inadequate comparable housing alternatives available in the sub-market, so that the outcome without project restructuring at exception rents would be displacement of those tenants who would experience difficulty in finding comparable housing, such as the elderly, persons with disabilities, and large families.

We agree that rural and inner city projects in certain jurisdictions will be more likely to need above-market exception rents, due to typically low market rents relative to operating expenses. The rule makes provision for PAEs to request a waiver (based on special need) of the limitations on the number of units that can receive such rents. Restricting exception rents to projects with negative NOI, or rehabilitation needs in excess of that which can be supported by new financing at market rents, is consistent with MAHRA.

The final rule provides for exception rents adequate to pay debt service on the second mortgage and the other items detailed in section 514(g)(3) of MAHRA. Because of a recent amendment to MAHRA in Pub. L. 106-74 that authorizes full payment of claims, there is no longer any need for a Restructuring Plan to provide for any nominal restructured first mortgages. Also, see Section II.K.6. of this preamble for a separate discussion of how return to owner is considered in determining exception rents. The Operating Procedures Guide specifies that the rents should be set to estimate the owner return that would be realized if there were a positive but nominal NOI, and to make payments on the new second mortgage. The second mortgage will be sized based on the amount that can reasonably be expected to be amortized by 75 percent of the anticipated net cash flow (

i.e.,

three times the owner's estimated return). A third mortgage may be required to the extent the claim paid by HUD under § 401.471 exceeds the amount of the second mortgage.

4. Exception rents should be alternative to FMR.

One commenter said that the rule should let a PAE choose exception rents under § 401.411 instead of using 90 percent of fair market rents (FMRs), which the rule identifies as a last resort under § 401.411(d). The commenter felt that FMRs are often not useful.

HUD response:

To the extent the PAE is unable to develop a comparable rent using the methodology outlined in § 401.410, 90 percent FMR may be used (as a last resort) as a proxy for comparable rent as provided by statute. Exception rents for projects undergoing Mark-to-Market restructuring are limited by statute to cases where the comparable rent (or 90 percent FMR) is inadequate to meet expenses with no debt service or where the supportable debt is insufficient to fund short term rehabilitation needs.

5. Limitation of exception rents to 120 percent of FMR.

A commenter characterized this 120 percent limit as “arbitrary” and said that “waivers may become the rule”.

HUD response:

This limit is specified by section 514(g)(2)(A) of MAHRA.

6. Need to define “community”.

One commenter focused on the definition of the “community” impacted by a failure to allow exception rents, and urged HUD to consider supply of affordable housing in an entire jurisdiction, not just a neighborhood.

HUD response:

HUD will rely on the PAE's judgment to make this determination.

7. Other factors to be included in expenses.

Commenters had suggestions for expenses to consider when determining the budget-based exception rents. In addition to the comments noted above regarding mortgage debt and return to owners, two commenters stated that the return to an owner anticipated in a LIHPRHA Plan of Action should be factored into exception rents, and one commenter suggested expenses should include health and social services for elderly/handicapped projects.

HUD response:

Project operating expenses may include social services (such as for elderly/handicapped service coordinators, or other Departmental initiatives such as Neighborhood Networks) to the extent they have been approved by the Department, and/or have been determined by the PAE to be efficiently managed and unique and necessary for the project's continued operation as an affordable housing resource. LIHPRHA projects with approved plans of action are no longer eligible for the Mark-to-Market Program.

8. Determination of OCAF.

a. General.

Three commenters said that HUD should base OCAF on inflation indicators published outside of HUD; while another commenter “applauded” HUD for restricting increases to documented operating cost increases. Two others noticed that the geographical area considered when determining OCAF is left undefined in the rule. They remarked that it should not be too large to pick up local fluctuations in taxes, utilities,

etc.

HUD response:

A HUD analysis of operating cost data for FHA-insured projects showed that their expenses could be grouped into nine categories—wages, employee benefits, property taxes, insurance, supplies and equipment, fuel oil, electricity, natural gas, water and sewer. States are the lowest level of geographical aggregation at which there are enough projects to permit statistical analysis. Operating expense-related data on a more localized basis are not available on a current or consistent basis. HUD's OCAF calculations use data series prepared by the U.S. Bureau of Labor Statistics, the Bureau of the Census, and the Department of Energy. Owners may apply for a budget-based rent review in the presumably unusual case that application of the OCAF does not address unexpected project specific fluctuations. We expect, however, that such fluctuations and other temporary constraints on net operating income will be covered by excess debt service coverage.

b. Excluding debt service.

Two commenters objected to excluding debt service from the expenses to be adjusted by OCAF. One said the exclusion will make projects increasingly vulnerable to periods of low occupancy and less likely to support a second mortgage, requiring some other means to boost rents; another said the exclusion will decrease attractiveness of the project to investors who want increase over time in debt service coverage.

HUD response:

Congress' use of the term “Operating Cost Adjustment Factor” (OCAF), which has historically been applied only to operating expenses, rather than the term “Annual Adjustment Factor” (AAF) suggests that Congress expected the Department to not apply the increase to the entire rent. Debt service payments remain constant, so it is not appropriate to apply an inflation factor to the debt service. The debt service component of the effective gross income is the only portion that will not be inflated by the OCAF; the Reserve for Replacement deposits and the portion of the debt service coverage estimates for owner return will increase and presumably remain constant with inflation.

9. Negative OCAF.

Three other commenters objected to the reduction of rents by using negative OCAF. Two of them questioned the legality of rent reductions in light of section 8(c)(2) of the United States Housing Act of 1937.

HUD response:

We have removed the reference to negative OCAF in response to section 531(a) of Pub. L. 106-74.

10. Appeals of OCAF.

One commenter wanted an owner right to appeal OCAF determinations.

HUD response:

OCAF is not determined on a case-by-case basis and adjustment of OCAF through appeal for a particular project is not appropriate. However, the commenter probably was interested in the ability to appeal the rent adjustment that resulted from use of OCAF. OCAF is used for rent adjustments for projects with and without Restructuring Plans, but HUD retains the discretion to use a budget-based rent adjustment instead at the request of the owner. The statutory reference to using OCAF in Restructuring Plans, and the corresponding regulatory provision in § 401.412, does not preclude HUD from approving a larger budget-based increase when appropriate even though a project is under a Restructuring Plan.

An owner may request a budget-based rent adjustment if the owner can demonstrate that available operating revenues are insufficient to maintain a project. The published OCAF factors are based on independently produced estimates of changes in major costs items, and should prove adequate in most projects. If rent adjustments through use of OCAF are inadequate, however, budget-based review provides the most relevant basis for reviewing the adequacy of overall project funding.

I. Sections 401.420-.421, Project-Based Assistance or Tenant-Based Assistance?

Summary of Sections

These sections implement section 515(c) of MAHRA, which: (1) Provides for mandatory renewal of project-based assistance in a Restructuring Plan for projects in tight rental markets and elderly or cooperative housing projects; and (2) requires the PAE to develop a Rental Assistance Assessment Plan for any other project to determine whether assistance should be renewed as project-based assistance or whether some or all of the assisted units should be converted to tenant-based assistance. The Plan is developed by assessing the impact on eight specific areas described in section 515(c)(2)(B) of MAHRA. Section 515(c)(2)(C) of MAHRA requires periodic reporting by the PAE to HUD on certain matters concerning the form of assistance; this requirement is also included in the rule.

Summary of Comments

1. What vacancies should be considered in determining the presence of a tight market?

Six commenters objected to a PAE considering all kinds of vacant units when determining the presence of a tight market. These commenters felt that a PAE should consider only vacancies in comparable units in standard condition (neither luxury nor substandard) with rents not exceeding the payment standard for tenant-based assistance. Four commenters objected to considering vacant units in the entire market only and indicated that a PAE should determine whether the vacancy rate in the sub-market or neighborhood is at or below six percent. Another commenter said that in determining whether a project was predominantly elderly, individual phases should be considered if the project was developed in phases.

HUD response:

Consistent with Congressional intent, as indicated in the Conference Report accompanying MAHRA, the tight market “safe harbor” for project-based assistance will be applied to metropolitan areas with vacancy rates less than or equal to 6 percent. HUD agrees that comparable units in the relevant affordable housing sub-market should be considered by the PAE in the context of the Rental Assistance Assessment Plan developed under § 401.421. The PAE has flexibility in this decision on a project-by-project basis, and is expected to apply its knowledge of the local market and use its judgment in recommending the type of rental assistance.

2. Effect of sale to cooperative.

One commenter inquired whether project-based assistance was mandated if a sale of the project to a cooperative is planned.

HUD response:

Yes, project-based assistance is mandated if the project is sold to a “nonprofit cooperative ownership housing corporation or nonprofit cooperative housing trust” (pursuant to section 515(c)(1)(C) of MAHRA, referenced in § 401.420(a)).

3. Limit conversion approvals to public body PAEs.

A commenter suggested that only PAEs that are public bodies should be able to approve Restructuring Plans with conversion to tenant-based assistance.

HUD response:

All PAEs are permitted to develop Restructuring Plans with conversion, if conversion is consistent with the final rule. OMHAR will be required to approve all Restructuring Plans, including the type of rental assistance, regardless of the category of PAE. Particular attention will be paid during review of project specific transaction, and through the reporting requirements of § 401.421(d), to projects converting to tenant-based assistance and projects that retain project-based assistance despite the general support by the tenants to convert to tenant-based assistance. Under § 401.200 of the final rule, non-public PAEs will be required to form a partnership relationship with HUD if no other public entity is involved. (Note that the final rule omits the requirement in interim rule § 401.200 that the partnership relationship meet all legal requirements for a partnership.)

4. Requirement for semi-annual reporting in § 401.421(d).

One commenter objected to what the commenter saw as a requirement for “continuous” reporting rather than “one-time”. Another asked how much data gathering/tracking of tenants is required by the PAE, and at what cost?

HUD response:

The reporting requirement is for semi-annual reports and is not continuous. The amount of data gathered by the PAE from the tenants will be detailed in the Operating Procedures Guide. Reimbursement of costs for gathering such information from tenants will be addressed in the PRA.

5. How should the final rule handle/present factors to be considered in the Rental Assistance Assessment Plan?

Four commenters wanted HUD to clarify the weighting of the statutory factors and to give more guidance to the PAEs. Three commenters said that all statutory factors should be set forth in full in the final rule, instead of only stating the factor regarding cost comparison. Two commenters felt that the rule should state a presumption in favor of project-based assistance in order to recognize the cost to tenants of conversion. One commenter indicated that the factor regarding ability of tenants to find housing in the local market should focus on the ability to use tenant-based assistance effectively in the neighborhood. One commenter felt that HUD should specify the criteria that will be applied to determine whether a project will receive project or tenant-based assistance. One commenter suggested that conversion to tenant-based assistance should be approved only if rehabilitation needs are so extreme that restructuring is not feasible.

HUD response:

The statute and regulations are both neutral with regard to the type of assistance to be provided, assuming the project does not meet the criteria of section 515(c)(1) of MAHRA. The interim rule's specific mention of the comparative cost of project-based versus tenant-based assistance as one of the required considerations was not an indication that this criterion should be weighed more heavily than the other items detailed in section 515(c)(2)(B) of MAHRA. Consistent with the Conference Report for MAHRA, the PAE should apply its knowledge of the local market conditions, and consider the various factors, with no one factor weighted more heavily than others except to the extent appropriate on a project-by-project basis. We agree with the commenters that there may be a benefit from full presentation of the statutory items to be considered in a Rental Assistance Assessment Plan, and we have made this change in the final rule. (See Section II.W.5. of this preamble for a general discussion of including statutory language in the final rule.)

6. Must all units be assisted under a Restructuring Plan?

One commenter said the interim rule was ambiguous on whether a Restructuring Plan must commit an owner to putting 100 percent of the units in a project under project-based or tenant-based assistance, and suggested that 20 percent of the units could be reserved for unassisted “market rate” tenants.

HUD response:

Tenants residing in all previously-assisted units will have the opportunity to receive either tenant-based or project-based assistance. Unassisted market rate tenants may be served to the extent a project converts to tenant-based assistance and tenants move out, subject to (1) the Use Agreement requirements that the minimum number of units be reserved to meet low income housing tax credit rent and income requirements and (2) the prohibition in § 401.556 of the final rule (§ 401.483 of the interim rule) against refusal to lease units to prospective tenants solely on the basis of their status as section 8 voucher holders.

J. Sections 401.450-401.453, Physical Condition of Project

Summary of Sections

The Restructuring Plan must provide for rehabilitation of the project necessary to achieve the property standards set forth in § 401.452. (In this preamble and in the final rule itself, the term “rehabilitation” is being used in a broad sense—comparable to the broad use of the term in section 531 of MAHRA—that includes nonrecurring maintenance (repairs) and payment into project replacement reserves.) The first step is an owner evaluation of the physical condition and rehabilitation needs of the project (including consideration of appropriate measures to ensure accessibility). The PAE is then responsible for an independent

evaluation of the rehabilitation needs (a Physical Condition Analysis, or PCA) of the project, and for reviewing and certifying to the accuracy of the owner's evaluation (which may be modified to address deficiencies identified by the PAE.) Based on the completed PCA, the PAE must consider rejecting a request for a Restructuring Plan if the PAE cannot determine that proceeding with restructuring involving rehabilitation is more cost-effective in terms of Federal resources than rejecting the request and providing tenant-based assistance for displaced tenants. Any such consideration must be made in light of the need to minimize displacement of tenants and to ensure that there are alternative housing options available in the community.

As provided in section 517(b)(7)(A) of MAHRA and § 401.452, the standard for rehabilitation to be performed upon approval of restructuring is a non-luxury standard adequate for the rental market intended at the original approval of the project-based assistance. The physical needs identified should be those necessary for the project to retain its original market position as an affordable project in decent, safe and sanitary condition (including those improvements the project requires to achieve any rentals in the non-subsidized market), resulting in a marketable project that competes on rent rather than on amenities and that meets accessibility requirements. Over the long term, the owner must maintain the project in a decent, safe, and sanitary condition based on the housing quality standards identified in § 401.558 of the final rule (§ 401.453(a) of the interim rule). For a project receiving project-based assistance, the applicable standards will be HUD's Uniform Physical Condition Standards. Otherwise, local codes will serve as the standards as long as local codes are as strict as HUD standards and do not severely restrict housing choice in the view of the PAE. In addition, any unit in which the tenant receives tenant-based assistance must comply with the housing quality standards of the section 8 tenant-based programs.

Summary of Comments

1. Use of FNMA PNA guidelines should not be eliminated.

One commenter strongly believed that the elimination of an assessment presentation format for the owner under § 401.450 would lead to unnecessary and costly disputes in processing transactions. This commenter's experience in the demonstration program led the commenter to conclude that failure to prescribe an assessment presentation format would cause a high probability of frequent disputes that focus on presentation issues rather than substantive issues.

HUD response:

Based on our experience in the demonstration program, we do not believe the format of an owner's assessment of the physical condition of the property will result in delays or disputes. The information specified in Section 401.450 must be presented in a form acceptable to the PAE. The owner may update and submit previously-prepared physical inspections. The PAE is required to independently evaluate the condition of the property. The Operating Procedures Guide contains more specific information.

2. The final rule should make clear that third-party expenses for physical condition evaluation are eligible project expenses.

Two commenters suggested that the final rule should make clear that third-party expenses for the owner's physical condition evaluation are eligible project expenses. One of these commenters pointed out that a customary fee for a physical condition evaluation is in the $5,000 range.

HUD response:

Third party expenses for physical condition assessments are eligible project expenses if cash flow is sufficient to support such an expense. If cash flow is not sufficient, the expense is not an eligible project expense and will not accrue or carry over.

3. Lead hazards.

One commenter felt that the final rule should explicitly require a lead hazards analysis as part of the physical conditions evaluation.

HUD response:

Inspection for lead-based paint will be part of both the owner's evaluation and the PAE's PCA. This requirement is set out more fully in the Operating Procedures Guide. If such paint is found in a family project in a peeling condition on chewable surfaces, it must be remedied. If found, but not posing immediate risk, the owner will be required to submit a “Maintenance Plan” to prepare for any future risks/remediation. Effective September 15, 2000, all projects with section 8 project-based assistance will be subject to HUD's revised lead-based paint regulations published on September 15, 1999 (64 FR 50140).

4. Reserve account deposit.

One commenter felt that owners should be permitted to assume that their section 8 contract will be renewed for 20 years when calculating the amount of deposit to the reserve account.

HUD response:

No assumptions should, or need to, be made regarding the continued availability of section 8 assistance in determining the reserve for replacement accounts. The regulatory agreement will be modified to require the monthly deposit requirement to be adjusted annually by the OCAF.

5. Concern about cost-effectiveness determination in § 401.451(c).

Numerous commenters were concerned about the cost-effectiveness determination required by § 401.451(c). Six commenters were concerned that the cost-effectiveness determination was not consistent with statutory intent. Three of these commenters asserted that it was Congress' intent that all properties that met statutory criteria and whose owners were willing to restructure should be restructured, and expressed concern that the interim rule placed cost-effectiveness above all other considerations. At least five commenters said that § 401.451(c) should be removed from the rule.

One commenter felt that the standards and methodologies used to disqualify a project based on cost-effectiveness should be published for public comment. Another commenter felt that the rule was ambiguous and that, without clearly articulated standards in the Operating Procedures Guide, PAEs would be faced with a difficult decision regarding what represented cost-effective use of Federal resources. Another commenter stated that the cost-effectiveness determination needed to be guided by an objective standard. One commenter suggested that the PAE should be given other factors to consider before concluding that a project was cost prohibitive, and that there should be a clear presumption in favor of preserving the housing stock and maintaining the project-based rental assistance. Another commenter felt that “non-economic objectives should take precedence” as long as a project met tenant and community housing needs. Another commenter felt that the rule must make clear that the impact on tenants and the community is an integral part of the cost-effectiveness determination and not “some minor, peripheral consideration.”

HUD response:

HUD discussed implementation of the “cost-effectiveness” test with a broad variety of interest groups at the focus group meeting on November 18, 1998. While PAEs are required to ensure that all repair items are cost-effective, the determination required by this section is intended to ensure particular scrutiny by the PAE of those projects that have significant rehabilitation needs so that other less costly approaches (either in the scope of work or by recommending rejection of the Restructuring Plan) are considered. We expect the PAE to

exercise judgment in balancing the competing economic and social objectives in every case rather than relying on an “objective” standard set by HUD.

6. PAE certification.

One commenter felt that it would not be possible for a PAE to certify the accuracy and completeness of an owner's evaluation of a project's physical condition. The commenter was concerned that requiring a PAE to certify the owner's evaluation would put the PAE in an untenable position because physical condition assessment is often complex and “ultimately not empirical.” The commenter suggested that the PAE merely “confirm that the owner's plan reasonably reflects their own findings and they believe the needs are addressed cost-effectively.”

HUD response:

The rule and MAHRA both require a PAE to certify an owner's evaluation of project physical condition. The PAE should give the owner the opportunity to revise the owner's evaluation after consultation regarding any disputed work items or costs. Alternatively, the PAE must recommend rejecting the Restructuring Plan. OMHAR will be responsive to PAE questions concerning rehabilitation standards; however, it is a PAE's responsibility to bring its professional judgment to bear as it evaluates the owner's proposal, the PAE's independent third party report, and tenant and local community input when developing the Restructuring Plan.

7. Property standards for rehabilitation.

One commenter felt that “lowering the bar to modest competition” by effectively accepting diminished physical conditions would have a negative impact on quality-of-life and public relations because eligible projects—while not luxurious—may compare favorably to other conventional properties in the area. Another commenter suggested that this “non-luxury” standard be removed from the final rule because it is not effective guidance (amenities affect rent and vice versa and what is an amenity in one market is a marketing necessity in another) and the standard would be cited to discourage rehabilitation to a level that might attract a mixed-income occupancy. Another commenter felt that the standard might not be consistent with the legislative goal of assuring that projects be able to function in the marketplace without assistance.

One commenter felt that calling for the “least costly rehabilitation plan” may cause owners to purposefully underestimate their physical condition assessments in order to avoid disqualification. This commenter suggested that rehabilitation standards should be based on actual need determined with tenant assistance. One commenter suggested that the final rule reference the physical condition standards prescribed in § 401.453 of the interim rule if a project's Restructuring Plan is to provide for continued project-based assistance. The commenter recommended that rehabilitation for these projects should be sufficient to meet the Uniform Physical Conditions Standards in 24 CFR § 5.703. One commenter felt that a lender who refinanced the first mortgage a conventional loan should be able to require whatever rehabilitation the lender considers appropriate. In addition, this commenter felt that HUD should indicate whether rehabilitation is supposed to address issues raised in the PCA or satisfy the physical conditions standards in § 401.453 of the interim rule.

HUD response:

The final rule requires restoration suitable for the market for which the project was originally approved. Thus, materially diminished physical standards would not be acceptable as part of a Restructuring Plan. The PAE's inspector must ensure that the project meets the applicable physical condition standards, but immediate threats to health and safety are not eligible work items that may be deferred until completion of the Restructuring Plan. Rather, they must be corrected immediately and, since the existence of these matters violates the Regulatory Agreement, the PAE must evaluate the project's eligibility in accordance with § 401.403(b)(2)(ii). The repair work items should address the issues raised in the PCA. The rehabilitation standard requires a project that can compete in the marketplace. To the extent the market requires a particular amenity, it should be added to enable the project to compete on the basis of rent. We expect the PAE to exercise professional judgment and to apply their knowledge of local conditions in determining if the lack of an amenity would render a property unmarketable. The PAE is required to independently evaluate the physical condition of the project, including evaluating the accessiblity of the project to persons with disabilities, and to solicit tenant and local community comments. The PAE can recommend that OMHAR approve lender rehabilitation requirements so long as they are consistent with the requirements of the Restructuring Plan.

8. Physical condition standards should not apply to non-assisted market rent units.

One commenter argued that section 8 units (both project-based and tenant-based assistance) are already covered by physical condition standards by virtue of HAP contracts so that the only effect of § 401.453 of the interim rule would be to make the standards applicable to non-assisted market rent units. This commenter suggested that the final rule should provide that HQS will be applicable to assisted units in restructured properties through the terms of assistance contracts and that the local housing code should be the applicable standard for non-assisted units.

HUD response:

Section 514(e)(5) of MAHRA does not permit non-assisted units to be excluded from the physical condition standards. This is a reasonable result because the entire project benefits from a mortgage restructuring. In keeping with 24 CFR parts 5.703 and related changes in other regulations, this rule recognizes that the separate section 8 HQS has been eliminated for projects with project-based assistance.

K. Sections 401.460-401.471, Mortgage Restructuring and Payment of Claims

Summary of Sections

Section 401.460 explains the standards for restructuring with a modified or refinanced first mortgage. The first mortgage will be a fully amortizing, level payment mortgage with a principal amount sustainable at rent levels that do not exceed the lower of section 8 rents allowed under the Mark-to-Market Program or rents permitted under the Use Agreement under § 401.408. The PAE should take into account any need for financing needed rehabilitation when sizing the first mortgage and determining the appropriate amount of mortgage insurance payment by HUD. The monthly payment for the first mortgage under the Mark-to-Market Program will not exceed the current first mortgage payment. Interest rates and other terms must be competitive in the market, with any fees and costs above normal processing fees to be paid by the owner from non-project sources. Due to the significant potential for conflicts of interest if the PAE provides the first mortgage financing, HUD will apply an exceptionally high level of review whenever this is proposed as part of the Restructuring Plan, with special HUD approval needed for any PAE risk-sharing under 24 CFR part 266 for a refinanced first mortgage. HUD will approve risk-sharing when appropriate in accordance with Pub. L. 106-74.

Section 401.461 provides standards for the new HUD-held second mortgage which is needed whenever the insured or HUD-held mortgage debt is written down through payment of a section 541(b) mortgage insurance payment by HUD. The second mortgage is limited to an amount that the PAE reasonably expects to be repaid by the owner, and may not exceed the difference between the first mortgage before restructuring and the modified or refinanced first mortgage after restructuring. HUD may require a HUD-held third mortgage if the amount of a partial claim under § 401.471 exceeds the principal amount of the second mortgage. The second mortgage will bear simple interest of at least 1 percent, but no more than the applicable Federal rate determined by the Department of the Treasury. The term will be concurrent with the term of the modified or refinanced first mortgage or, if the existing first mortgage is completely paid off, the term will be set by HUD. The mortgage will become due and payable as provided in § 401.461(b)(3). At least 75 percent of the project's net cash flow after payment of first mortgage debt service and operating expenses must be used to pay principal and interest on the second mortgage. The rest of the cash flow may be paid to an owner who meets certain property management and physical condition standards. HUD will consider modification or forgiveness of the second mortgage if: (1) The project has been sold or transferred to a priority purchaser under § 401.480; and (2) HUD determines that modification or forgiveness is necessary for recapitalization to preserve the project as affordable housing.

Summary of Comments

1. How should net operating income available to pay the first mortgage be determined?

a. Expenses.

Commenters offered ideas about the expenses to be paid from operating income before determining “net” operating income for this section. One commenter listed a number of lender-required costs that should be allowed in the case of conventional refinancing. Three commenters felt that a reasonable rate of return to the owner needed to be considered; one of them said it should not be below the return already allowed. Three commenters said that the owner compensation provided under a plan of action for preservation projects needed to be considered.

HUD response:

Reasonable expenses to meet requirements of the lender (whether the first mortgage is FHA-insured, HFA-originated with risk-sharing, or conventional debt) will be acceptable so long as the financing is competitive. See the discussion of return to owner at Section II.K.6. Preservation projects are no longer eligible for the Mark-to-Market Program.

b. Sizing the first mortgage. We received other comments relating to sizing the first mortgage. Two commenters objected to sizing on the basis of LIHTC rent levels if lower than comparable market rents. Two others wanted HUD to state a debt service coverage ratio (DSC) in the rule: One suggested 1.20, the other suggested at least 1.25 for conventional loans. Another said the DSC should be adequate to permit sale of the mortgage at or very near “par”. A commenter said that a restructuring plan for a project with an existing insured second should write the second mortgage off completely before any restructuring of the insured first mortgage.

HUD response:

To the extent the LIHTC rents are lower than comparable market rents, the first mortgage should be sized accordingly. While the section 8 assistance remains in place, all extra net cash flow will be applied to payment of the second mortgage so that the owner does not benefit unduly from this sizing of the first mortgage based on LIHTC rents. The owner or PAE could (with lender approval) request a waiver to allow a compensating decrease in the debt service coverage ratio in such cases. A specific DSC is not appropriate for the final rule; guidelines are contained in the Mark-to-Market Program Operating Procedures Guide. Generally we would expect a DSC of 1.2 but a higher ratio may be appropriate for smaller loans or to facilitate conventional financing.

2. First mortgage terms and conditions.

We received the following miscellaneous comments on first mortgage terms and conditions:

• The interest rate and DSC should be adequate to permit sale at or very near “par”.

• “Normal processing costs” needs to be clarified (with examples of costs that should be included).

• The PAE should be able to continue with existing above-market terms if the lender requires this as a condition of accepting a partial claim or if the PAE thinks this is the best approach.

• A PAE certification of “competitive” terms should be conclusive, or a mortgagee certification should be conclusive absent bad faith or manifest error.

• HUD should allow balloon loans as conventional loans and base competitiveness of rates, processing fees,

etc.,

for conventional loans on the conventional market.

HUD response:

• The interest rate and other terms of any refinancing are expected to be competitive.

• Processing costs must be reasonable and customary as determined by the PAE (and the lender of any new financing); examples include title and closing costs, and loan origination fees.

• It is unlikely that OMHAR will approve above-market terms for any financing. To the extent the existing lender is unable to provide competitive terms, the owner should pursue alternative financing sources.

• The Operating Procedures Guide requires documentation that the terms are competitive within a reasonable range.

• Balloon payments are not acceptable. The modified or refinanced first mortgage must be fully amortizing through level monthly payment). The PAE may consider shorter amortization periods if warranted by the condition of the property and availability of financing.

3. Refinancing.

One commenter said that the existing lender must be given a reasonable opportunity to refinance before another lender is involved. Two other commenters urged HUD to support the use of the section 223(a)(7) program; suggestions included allowing OMHAR rather than FHA to handle processing and providing priority or incentives for section 223(a)(7) refinancing to finance rehabilitation. Two commenters object to requiring special HUD approval for PAE risk-sharing as unnecessary and leading to delays. Finally, a commenter said that a small (under $300 thousand) first mortgage, even if supportable by rents, would be difficult to obtain on competitive terms so that a refinancing of a small first mortgage should not be required to take out the lender who will not accept a partial payment of claim.

HUD response:

The final rule requires the owner to contact the mortgagee prior to seeking other sources of funding for the Restructuring Plan. This issue is addressed in more depth in the Operating Procedures Guide and other guidance from OMHAR. The issues raised by the suggestion supporting the use of the section 223(a)(7) program involves delegations of authority within HUD and will be addressed in the Operating Procedures Guide. We are neutral as to the source of new financing so long as the terms are competitive, except to the extent that section 219 of Pub. L. 106-74 requires HUD to use risk-sharing. Questions involving PAE risk-sharing raise conflict of interest

issues to be decided on a case-by-case basis after expeditious but thorough technical reviews. We anticipate the market will set the terms of new financing, in part dependent on the size of the loan, and acknowledge that a good faith effort by the owner to obtain new financing on reasonable terms may not succeed. A PAE then may consider a Restructuring Plan with full payment by HUD of a section 541(b) claim and an increased second mortgage. However, it is not acceptable to allow above-market rents to support the existing debt due to a perceived difficulty in refinancing.

4. Second mortgage terms and conditions.

a. Interest rate.

We received the following suggestions regarding interest on the second mortgage:

• Clarify in the Operating Procedures Guide that the interest rate should be low enough so that an owner is clearly likely to repay; the interest rate should be 1 percent unless HUD requests otherwise (or 0 percent if the aggregate loan amount exceeds 100 percent of value).

• Permit a 0 percent rate since it is not ruled out by the Revenue Ruling.

• Set standard at 0 percent except when that would lead to payoff of the HUD-held second and third mortgage in less than 10 years.

HUD response:

For interrelated legal and policy reasons, we have elected to retain the 1 percent minimum interest rate. Our interpretation of section 517(a)(2) of MAHRA is that some interest is required to be charged on the second mortgage. The minimum rate that we have selected is nominal and should not cause undue burden on the mortgagor. Additionally, the factual premise of IRS Revenue Ruling 98-34 includes a statement that the new second mortgage “provides for interest”.

b. Other second mortgage terms and conditions.

We received the following miscellaneous comments on second mortgage terms and conditions:

• Set the term “concurrent” rather than “concomitant” with the term of the first.

• Acceleration for violation of HUD requirement should be only for material violation of a material HUD requirement, and should be allowed only after written notice to owner of the violation.

• HUD should ask for a statutory change allowing for longer terms.

• Use a standard form.

• HUD should specify conditions to be in second mortgage, consistent with first mortgage.

HUD response:

• We agree that the term “concurrent” is preferable.

• There are adequate safeguards in the final rule to guard against unfair acceleration of a second mortgage. Safeguards include a requirement of materiality for violations (now included expressly), and notice and an opportunity to cure prior to acceleration of a second mortgage. Additionally, the rule provides an administrative dispute and appeal procedure for any acceleration decision (unless acceleration is based on payment or termination of the first mortgage, or unauthorized sale and assumption, as provided in MAHRA).

• Alteration of the second mortgage term would require an amendment of the statute. HUD has no basis for seeking such an amendment at this time.

• The Operating Procedures Guide will provide a standard form for second mortgages. The terms of the second mortgage are largely set by MAHRA and are detailed in the final rule and the Operating Procedures Guide. The second mortgage is different in nature from the first mortgage and will not be identical to the first mortgage.

5. Forgiveness/modification of second mortgage.

Two commenters said that forgiveness/modification should be available for a priority purchaser whether or not the property has been disqualified for restructuring under existing ownership. One commenter argued that forgiveness should also be allowed for a limited partnership purchaser controlled by priority purchaser.

HUD response:

Section 401.461(b)(5) of the final rule allows modification or forgiveness of the second mortgage if certain conditions are met. This availability of modification or forgiveness is not dependent on the existing owners being disqualified from restructuring. See Section II.A.1.c. of this preamble for a discussion of a limited partnership controlled by a public body.

6. Return to owner.

One commenter opposed allowing the PAE to set the owner's share of net cash flow below 25 percent, arguing that a lower share will discourage owners from restructuring. Another commenter said that an owner right to 25 percent may be incentive for owners to neglect upkeep of project (

i.e.,

in order to reduce expenses and boost net cash flow) and that tenants should be involved in determining if a project meets the property management standards as a precondition to paying the owner share.

HUD response:

HUD is sensitive to the fact that restructured projects (particularly those with large decreases in rents) will have tighter operating budgets and thus will require larger debt service coverage ratios to compensate. Section 517(a)(3) of MAHRA restricts the owner's return to a maximum of 25 percent of Net Cash Flow. There is no statutory provision for additional return to an owner, even for exception rent projects or other projects that may previously had an approved rate of return that would permit larger payments to the owner. Section 514(g)(3)(D) of MAHRA provides for an allowance for a reasonable rate of return to the owner when determining the level of exception rents, but we do not consider this an allowance for an additional owner return beyond that permitted for non-exception rent projects. The setting of rents above market will provide for the return permitted by section 517(a)(3) (assuming the owner's operation of the project is efficient so that Net Cash Flow meets or exceeds the underwriting estimate.)

While the typical return permitted by a Restructuring Plan will not be less than 25 percent of the Net Cash Flow, the PAE will retain discretion to negotiate the amount on a case-by-case basis. Further, to the extent the potential for LIHTC rents in the absence of project-based assistance constrains net operating income for underwriting purposes, the project will effectively be oversubsidized during the time project-based section 8 assistance is provided. The portion of Net Cash Flow to pay the second mortgage must be increased accordingly. HUD or the PAE will require the project meet management and physical condition standards as a condition of distribution of the owner's portion of the net cash flow. Tenants (and other interested parties) can address their concerns to HUD or the PAE.

7. Third mortgage.

Four commenters opposed the possibility of a HUD-held third mortgage as provided in the interim rule. One said it would lead to “overleveraging” a project; two others said a third mortgage should be limited to an amount reasonably likely to be repaid that was excluded from the second only because of statutory limitations on the aggregate of the first and second mortgages. Another commenter suggested using budget-based exception rents whenever a third mortgage would otherwise be needed. Another commenter asked when a HUD-held third mortgage would be forgivable.

HUD response:

A third mortgage, when necessary, would not “overleverage” a project. First, it would require no payments on principal or interest until the second mortgage is satisfied. Second, a third mortgage would accrue only nominal interest and this interest will not compound. Third, the final rule allows a PAE to negotiate a reduction of the maximum third mortgage amount that would otherwise be required initially under a Restructuring Plan, within limits set by HUD, in order to recognize the imputed tax consequences to the owner of the restructuring. The Operating Procedures Guide will initially allow the PAE to negotiate a reduction of the initial mortgage amount by up to 30 percent. Finally, the final rule permits HUD to forgive or modify the third mortgage on the same conditions as apply to a second mortgage under § 401.461(b)(5). Exception rents are designed to address specific housing needs of tenants and communities and may not be used solely to prevent a section 541(b) claim. Accordingly, we have rejected the suggestion to use budget-based exception rents whenever a third mortgage is required.

8. Claims.

One commenter said the rule should include in the partial claim amount accrued interest on the mortgage amount to be prepaid by the claim at the note rate up to the date of prepayment. Another commenter concluded that payment only of a partial rather than a full claim would mean that exception rents would never be allowed under § 401.411(b) because that provision makes no allowance for payment of any first mortgage debt remaining after a claim payment. A commenter said that HUD should clarify in the final rule that a servicer incurs no obligation to Ginnie Mae security holders for accepting a “compelled” partial payment from HUD, and HUD should indemnify the lender.

HUD response:

When HUD pays an insurance claim for a mortgage that is in default, the claim includes an amount for the unpaid interest that would have been included in the defaulted payments. There is no similar need to compensate the mortgagee through a section 541(b) claim, which is made only for a mortgage that is not in default. The commenter is correct that HUD will restrict debt service paid from exception rents to payments on the second mortgage for negative Net Operating Income projects or to payments on a new rehabilitation loan, but exception rents will be needed only for projects which also require a full payment of claim and which, thus, will not continue the existing first mortgage even at a nominal level. We have no legal authority, or program interest, in becoming involved in a lender's relationships with Ginnie Mae security holders. Moreover, the commenter's concern about “compelled” partial claim payments is unfounded. Under the final rule, OMHAR or FHA will not compel a lender to accept a partial claim payment. If the lender is not able to obtain approvals from investors, such as Ginnie Mae security holders, needed to accept a partial claim payment, the owner must refinance the first mortgage with a lender willing to make a new loan that will pay off the first mortgage amount in excess of the partial claim payment.

L. Sections 401.472-.473, Funding of Rehabilitation

Summary of Sections

Section 517(b)(7) of MAHRA and § 401.472 identify some potential sources for funding needed for rehabilitation of the project. The interim rule includes the requirement of section 517(b)(7)(B) of MAHRA that an owner contribute from non-project funds at least 20 percent of the total cost of rehabilitation. The preamble to the interim rule stated that a reasonable proportion of the owner's contribution must come from non-governmental resources, which we estimate would be a minimum of 3 percent of the total cost of rehabilitation. One of the potential Governmental sources of rehabilitation funding is the grants authorized by section 236(s) of the National Housing Act. Section 401.473 addresses the use of these grants in connection with restructuring.

Summary of Comments

1. Opposition to 20 percent owner contribution requirement.

Three commenters wanted HUD to exempt nonprofit owners from the requirement for a contribution of 20 percent of rehabilitation expenses. One commenter observed generally that owners of all types are unlikely to contribute 20 percent. Four others opposed the requirement without an incentive to make the contribution. These commenters suggested treating the contribution as a self-amortizing market-rate loan to the project that would be repayable as project expense, or providing some type of priority return or some set rate of return.

HUD response:

The owner contribution is required by section 517(b)(7) of MAHRA and the return to the owner is constrained by section 517(a)(3) of MAHRA. Other than the exemption permitted by statute for housing cooperatives, nonprofit owners cannot be exempted from the owner contribution requirement without a statutory change. Eighty percent of the rehabilitation costs will come from sources other than owner contributions, and the interim rule preamble and Operating Procedures Guide both allow the owner to include any available funds from other government sources to meet their contribution requirements, except as discussed in the following topic.

2. Opposition to limit on funding from governmental resources.

One commenter opposed a limitation on funding from nongovernmental sources while another said that any such limitation needed to be in the rule. Five commenters said that all nonprofit owners should be exempt from the limitation, while two others said the PAE should be able to waive it for nonprofit owners. Two commenters asked HUD to clarify that equity raised by syndicating Low-Income Housing Tax Credits (LIHTC) is a non-governmental source of funding.

HUD response:

The preamble to the interim rule contained two points of elaboration on the 20 percent owner contribution requirement that appears in MAHRA and in the interim rule. The preamble stated that a “reasonable proportion” must come from non-governmental sources, and estimated that this proportion would be set at a minimum of 3 percent. We continue to believe that it is reasonable to expect each owner to contribute towards the cost of rehabilitation from the owner's own resources, because the owner will benefit from the resulting increase in project value. We recognize that owners of restructured projects may have severe limitations on the ability to make additional investment in the project, but in cases where other public funds are available, owners will cover only a small part of the costs from their own resources. The commenters did not provide convincing evidence that these preamble requirements would prevent PAEs from developing Restructuring Plans with all necessary and cost-effective rehabilitation—whether for for-profit or non-profit owners. Because of the substantive impact of our decision to require owners to use their own resources toward partial implementation of the statutory requirement for an owner contribution, we have decided that the matter properly belongs in the text of the final rule itself. The precise level of required non-governmental resources, however, will continue to be set in the Operating Procedures Guide.

PAEs will have limited ability to request waivers of this regulatory requirement in exceptional cases (

e.g.

to facilitate the transfer of a troubled project to a priority purchaser), but no waiver is possible for the statutory 20 percent requirement. As stated above, MAHRA permits housing cooperatives to be exempted from the owner contribution requirement. Broadening this exemption option would require a statutory change. Equity contributions from the syndication of LIHTC will be considered a non-governmental source of funding for rehabilitation funding purposes, but will trigger a thorough technical review of the Restructuring Plan.

3. Other comments regarding 20 percent requirement.

One commenter wanted HUD to clarify that non-Federal government funding such as State/local grants or loans will be counted in the 20 percent owner contribution. Three commenters asked about borrowed funds as part of the contribution; one of them specifically mentioned insured section 223(a)(7) or 223(f) refinancing loans secured by the project and another mentioned conventional refinancing of the project. One commenter wanted the rule to specify conditions for a PAE requirement for a contribution of more than 20 percent.

HUD response:

FHA-insured loans (or conventional secured debt that is not subordinate to the § 401.461 second and third mortgages) are considered project resources and may not be used to fund the owner's contribution. The PAE has discretion to negotiate a larger owner contribution. State/local grants or loans can be used to meet most of the owner's contribution. OMHAR has provided further guidance in its Operating Procedures Guide concerning the source of funds that an owner may utilize toward rehabilitation financing.

4. Comments regarding use of project accounts for rehabilitation.

One commenter cautioned against violating an owner's contract right under the regulatory agreement to distribution of surplus cash. Another commenter suggested that the lender for a conventional refinanced first mortgage should be able to use funds in project accounts to establish escrows and reserves required by the lender's usual underwriting standards.

HUD response:

Section 517(a)(3) of MAHRA changes the distribution of surplus cash. The first and second mortgages for a project restructured under the Mark-to-Market Program will reflect the statutory change. As part of a closing, owners will be required to execute a Modification of Regulatory Agreement. It will modify the terms of an old or new FHA Regulatory Agreement, reference the Restructuring Plan documents as controlling the owner's distribution, and specifically delete the requirement of a residual receipts account as long as the second or third mortgages are in place. In a non-FHA refinancing the existing Regulatory Agreement is canceled.

Section 517(b)(6) of MAHRA authorizes use of project accounts in connection with restructuring but does not preclude a PAE (as part of a Restructuring Plan involving conventional financing) from recommending the use of existing project account balances to fund the initial deposit to a new reserve for replacement account or to fund tax and insurance escrows.

5. Section 236(s) rehabilitation grants.

Three commenters said that HUD should target rehabilitation grants to new priority purchasers as well as existing nonprofit owners for projects undergoing restructuring; two of them also said that section 236(s) grants should be available on a preferential basis to nonprofit owners or below-market projects renewing under part 402 without restructuring. Two commenters pointed out that treating section 236(s) grants in a rule only for projects undergoing restructuring (

i.e.,

part 401) puts exception projects seeking grant money at a disadvantage; one of them asked that HUD add a new section to part 402 on section 236(s) grants. Finally, one commenter asked whether section 236(s) grants can be structured as loans to avoid adverse tax consequences to owners.

HUD response:

As noted in the preamble to the interim rule, HUD is pursuing a separate rulemaking procedure regarding use of the section 236(s) grant authority outside of the Mark-to-Market program. To the extent a Mark-to-Market restructuring generates Interest Reduction Payment (IRP) recaptures, those funds will be used to assist with rehabilitation financing for the restructured property, or for other properties through procedures to be defined in the separate rulemaking.

6. Funding of rehabilitation through claim amount.

A commenter suggested that HUD's intent behind § 401.472(a)(2) regarding facilitating rehabilitation through the claim amount was to permit the claim to be large enough to reduce the first mortgage debt so the project rents could support a refinanced first mortgage that paid off remaining debt and financed rehabilitation. Another commenter suggested that it would be simpler to pay rehabilitation costs directly from the FHA insurance fund instead of through a larger partial claim/smaller first mortgage.

HUD response:

The first commenter has correctly interpreted HUD's intent in § 401.472(a)(2). Unlike the demonstration program, the Mark-to-Market Program does not include HUD authority to directly fund rehabilitation through a payment from the FHA insurance fund as suggested.

M. Section 401.480 Sale or Transfer of Project

Summary of Section

This section covers the sale or transfer of a project undergoing restructuring at the owner's initiative (

i.e.

, a voluntary sale) or following a determination that the current owner is ineligible for restructuring (

i.e.

, an involuntary sale). A PAE will develop a Restructuring Plan with an involuntary sale only if, within 30 days of notice of rejection, the owner notifies HUD or the PAE of the owner's intent to transfer the property. The owner must also provide a notice to potential purchasers that describes the project and the procedure for submitting purchaser offers; the notice is subject to review and approval by HUD or the PAE. The owner must distribute and publish an approved notice as required by HUD. This section gives a preference to certain “priority purchaser” groups, defined as tenant organizations, tenant-endorsed community-based nonprofit organizations, and tenant-endorsed public agency purchasers. The owner must inform the PAE of any intention to accept a purchase offer. An eligible owner desiring to sell or transfer a project through a voluntary sale should provide notice as part of its initial request for a Restructuring Plan or at any later time when it is still feasible to develop a Restructuring Plan involving sale or transfer, but the owner is not otherwise subject to the requirements of this section. All project sales are subject to PAE approval and HUD approval of the Restructuring Plan.

Summary of Comments

1. HUD should be responsible for sale of projects.

Three commenters felt that, in order to better protect the interests of tenants, HUD should maintain overall responsibility for the sale of projects.

HUD response:

OMHAR will maintain overall responsibility for all aspects of the Mark-to-Market program, including approval of the sale of projects. We will carefully review PAE recommendations and input from tenant and local

community groups, whenever a project is proposed for sale or transfer.

2. Preferences for priority purchasers.

Four commenters were concerned about preferences for priority purchasers. One commenter argued that the interim rule improperly creates an absolute priority instead of the preference provided in MAHRA. The commenter further argued that, in the case of voluntary sales unrelated to disqualification, MAHRA does not support even a preference for priority purchasers and the owner should have sole discretion to choose the project purchaser. Three commenters questioned the rationale for granting a preference to priority purchasers because tenant and community-based groups are not necessarily better at maintaining a project as decent, safe, and affordable housing than other nonprofit or for-profit groups. According to the commenters, qualified nonprofit or for-profit groups could include organizations that would not meet the definition of priority purchaser because of a city-wide mandate or a tenant-endorsed non-profit housing group with a demonstrated track record.

HUD response:

In the event of an involuntary sale or transfer of a project, the Operating Procedures Guide will permit offers to be accepted only from priority purchasers during a reasonable period (to be determined by HUD, currently 4 months) after notice of sale or transfer. After that period there are no restrictions on sale or transfer of the project. The rule also states that voluntary sales or transfers do not have any priority purchaser requirements. The preference for priority purchasers in the event of involuntary sale or transfer is based on the requirements of MAHRA and HUD's goal of maintaining safe and affordable housing for low income individuals and families. Priority purchaser offers will be subject to substantive review by both the PAE and OMHAR. Offers will be rejected if not in the best interest of the community and HUD. MAHRA requires priority purchasers to have a local community or tenant base. Otherwise-capable non-profits can partner with such groups to obtain this preference.

3. Priority purchasers and competitive sales.

Four commenters were concerned about the effect of the preference for priority purchasers on an owner's ability to demand competitive offers. Two commenters suggested that the final rule should clarify how long an owner must hold a property exclusively for sale to priority purchasers and what actions an owner must take to demonstrate a good faith effort to sell to a priority purchaser. One of these commenters felt that PAEs should not be required to withhold approval of a sale to a non-priority purchaser for an unreasonably long period of time. One commenter felt that the final rule should give wide discretion to the PAE to approve non-priority purchasers and that the PAE should be able to waive the requirement for tenant approval if approval is unreasonably withheld.

HUD response:

Priority purchasers will have a preference only in the event of an involuntary sale or transfer of a project, and then only for a limited period of time. This preference should have a minimal impact on an owner's ability to demand competitive offers because the Operating Procedures Guide requires that priority (and all) purchaser offers be reviewed carefully by both the PAE and OMHAR. The Operating Procedures Guide also requires that the PAE must attempt to mitigate losses to the Government while not placing sole priority on purchase price. In the event the PAE believes tenant approval is being unreasonably withheld, OMHAR should be consulted on a case-by-case basis.

N. Sections 401.481-.484, Other Requirements of Restructuring Plan

Summary of Sections

Section 401.481 explains the subsidy layering certification that a PAE must make under section 514(e)(7) of MAHRA. The purpose of the subsidy layering certification procedure is to ensure that any HUD assistance provided to the owner of a project under the Restructuring Plan is no more than is necessary to permit the project to continue to house a tenant mix that is comparable in income to the tenant income mix of the project before the Restructuring Plan is implemented—after taking into account other Federal, State, or local governmental assistance of any kind such as grants, loans, guarantees, or tax credits or other tax benefits. HUD may rely on the PAE's certification if HUD has already approved the PAE to do subsidy layering certifications for other purposes.

Section 514(e)(9) of MAHRA prohibits refusal to lease a “reasonable number” of units to section 8 voucher holders because of their status as voucher holders. Under § 401.483 of the interim rule (§ 401.556 of the final rule), the Restructuring Plan will not permit an owner to reject any prospective tenants solely because of their status as voucher holders. (Note that title V of Departments of Veterans Affairs and Housing and Urban Development, and Independent Agencies Appropriations Act, 1999, merged the voucher and certificate programs into a consolidated voucher program. HUD has proposed to Congress technical corrective legislation that will conform MAHRA to this change. The final rule refers solely to vouchers to carry out clear Congressional intent, but the term “vouchers” is defined to include any tenant-based assistance under the definition in MAHRA, which is also the section 8 definition.)

Section 401.484 of the interim rule (§ 401.560 of the final rule) implements part of section 518 of MAHRA, which requires a PAE to establish management standards for a project pursuant to HUD guidelines and consistent with industry standards.

Summary of Comments

1. Subsidy layering limitations on HUD funds.

One commenter was “pleased” that HUD allows PAEs with delegated authority for subsidy layering to serve that function under MAHRA. Another commenter questioned the interim rule's reference to limiting assistance to that needed to continue housing “tenants with an income mix comparable to the income mix of the project” before restructuring. The commenter asked how this could be reconciled with a possible need to reconfigure project (

e.g.

, convert efficiencies to 1-bedroom units).

HUD response:

We do not intend to limit the ability of owners to reconfigure projects and we thank this commenter for pointing out this potential misunderstanding. We have amended language in § 401.481 to address this issue.

2. Leasing units to voucher holders.

Among commenters favorable to this section, one generally supported it, another wanted the 100 percent requirement to be in a recorded instrument as well as in the Restructuring Plan, and the third wanted HUD to require an owner to “seek and accept” tenant-based assistance for units without project-based assistance. Two commenters opposed the section, stating that it is unreasonable to require 100 percent of units to have tenant-based assistance and that HUD should encourage mixed-income projects. One of them specifically objected to requiring an owner to accept tenant-based assistance that does not permit the owner to realize market rents. One commenter said that the rule needs to specify the term during which this section applies. Three commenters suggested that owners should not be under an obligation to

renew tenant-based contracts unless the tenant is lease-compliant. One commenter was concerned that this section could establish an unconditional renewable lease.

HUD response:

We agree with the comment that the non-discrimination provision of § 401.483 of the interim rule (§ 401.556 of the final rule) should be included in the recorded Use Agreement and we have amended § 401.408 accordingly. The final rule does not require an owner to renew contracts with non-compliant lease holders and HUD will not require owners to “seek and accept” tenants with tenant-based assistance. The final rule merely prohibits the owner from discriminating solely on the basis of the tenant's (or potential tenant's) status as the holder of a section 8 voucher. The rule does not require the owner to rent to tenants who are unable to pay the rent or are otherwise not in compliance with the terms of a lease.

3. Property management standards.

a. Need uniform standards.

One commenter urged HUD to establish uniform standards that reflect expected outcomes.

HUD response:

The final rule reflects the statutory requirement that the PAE establish management standards consistent with industry standards and with minimum general requirements from HUD (section 518 of MAHRA). More specific guidance on reporting and compliance is in the Operating Procedures Guide. Projects with FHA mortgage insurance or a HUD-held mortgage after restructuring will be required to comply with the Regulatory Agreement and all relevant HUD Handbooks and Directives (including the HUD Real Estate Assessment Center's procedures), except to the extent specifically modified by the Restructuring Plan, the Operating Procedures Guide, the final rule, or MAHRA.

b. Suggestions for language changes.

Two commenters urged HUD to make the requirement for a manager to maintain good relations with tenants more objective (

e.g.

, it should relate to tenants' opportunity to comment and respect for tenants' rights, not the level of tenant satisfaction with manager). One of these commenters also said that a reference in the preamble to less than “satisfactory” HUD review should apply only if a PAE agrees with HUD findings and the findings are not cured in reasonable period after notice. The same commenter suggested the following specific language changes:

• Add to paragraph (b) an express requirement for HUD's guidelines to be consistent with industry standards.

• Strike “through preventative maintenance, repair or replacement” from paragraph (b)(1) to avoid unproductive arguments over methods of achieving goal.

• Delete an unclear reference in (b)(2) to routine cleaning—which the commenter said duplicates provisions of the physical condition standards.

• Add a provision that a management agreement should permit the PAE to terminate the manager for cause.

HUD response:

In our opinion, the commenter's suggested language regarding tenant relations is less, not more, objective. Adding “consistent with industry standards” to paragraph (b) is redundant since it is already specified in paragraph (a). The language regarding “preventative maintenance, repair or replacement” is necessarily more specific than just requiring maintenance of the long term physical integrity of the property. The requirement for routine cleaning, while admittedly duplicative, is appropriate for an explicit statement in this context. HUD does not at this time contemplate delegating the authority to require new management; the Regulatory Agreement/Management Certification contains a provision permitting HUD to require the owner terminate the management agreement.

c. Management fees.

Two commenters wanted HUD to ensure a management fee system that provides adequate compensation and removes the link to (possibly falling) rent levels or that carries forth current method with higher percentage of rent to reflect drop in restructured rents. Another commenter asked HUD to clarify that allowable management fees will not be reduced as a result of restructuring.

HUD response:

Underwriting standards for management fees (and other operating expenses) are detailed in the Operating Procedures Guide. While management fees may well be reduced as a result of restructuring, the fee should be adequate to competently manage the property as an affordable housing resource. To the extent the fee has been based on a percentage of the gross rent and will be inadequate after reducing the rents as a result of restructuring, the percentage yield will be recalculated based on an adjusted comparable market fee and adjusted with the OCAF.

O. Sections 401.500-401.501, Participation by Tenants, Community, and Local Government

Summary of Sections

Under §§ 401.500 and 401.501, a PAE must solicit and document the consideration of tenant and local community comments. These sections (and the related new §§ 401.502 and 401.503 in the final rule) describe the minimum procedures for ensuring that third parties affected by the restructuring of a project through the Mark-to-Market Program are kept informed and provided the opportunity to provide comments at crucial stages of the process, including required notices and public meetings at which the PAE will hear presentations and receive comments on the desired contents of a Restructuring Plan and a Rental Assistance Assessment Plan (if one is required), and on any proposed transfer of the project.

Summary of Comments

In the following summary we have included all comments relating to participation by tenants in the restructuring, implementation and contract renewal process, even if the comments were specifically directed to a subject covered in a different section of part 401 or part 402.

1. General.

A significant percentage of commenters (approximately 26 commenters) were dissatisfied with the level of tenant, community, and local government participation guaranteed by §§ 401.500 and 401.501 of the interim rule. These commenters all felt that tenants, and the community and local government, needed to be given the opportunity for broad participation in the entire restructuring process.

Almost all of the commenters argued that broad tenant and community participation was vital for the success of the Mark-to-Market Program. A few commenters also argued that the interim rule failed to follow both the letter and the intent of MAHRA by not providing tenants with the ability to offer “timely and meaningful” input at the various stages of the restructuring process. Some commenters specifically cited section 514(f)(2)(c) of MAHRA as requiring that tenants be consulted on the completed rental assistance assessment plan.

The following table summarizes the general suggestions made by commenters (a number of more specific subject areas are discussed later):

Suggestion

Number of commenters

Tenants should participate fully in PAE selection

6

Tenants should participate in decisions to find an owner ineligible for restructuring or section 8 renewals

2

Tenants/community should have right to have access to relevant documents and information, before they are final, in order to be able to give meaningful input to documents and the overall process. For example, right to access to draft appraisals, physical condition analyses, rental assistance assessment plans, capital needs assessments, management reviews, comparable market rent analyses, proposed restructuring plan, data used in making any decisions about the need for project versus tenant-based assistance, cost-effectiveness of rehabilitations, or disqualification of the owner, and other information necessary for meaningful tenant input

10

Funds should be provided either to PAE or tenant groups to support tenant participation activities

4

Tenants/community should be given notice of and allowed to participate fully in all aspects of restructuring process. For example, in developing and/or reviewing rehabilitation analysis restructuring plan, cost-effectiveness determination under § 401.451(c), any proposed transfer of property, eligibility/disqualification decisions, restructuring/renewal decisions, development of PRA, negotiation of Restructuring Plans, conversions to tenant-based assistance, formulation of rehabilitation and management assessments, Restructuring Commitments

18

Tenant participation and notice in monitoring of PAE's actions under PRA, and further participation of tenants in future implementation and enforcement of the Restructuring Plan, is needed

7

Many more meetings should be required and public comments accepted throughout entire restructuring process

6

HUD response:

HUD recognizes the importance of providing opportunities for full and informed involvement in all aspects of project restructuring. Such opportunities, however, must be provided in a manner that permits efficient and timely development of a Restructuring Plan that responds not only to tenant needs but also to wider community and local government needs, the needs of project owners, and the social and financial goals of the Federal Government reflected in MAHRA. HUD considers the tenant participation opportunities provided in the interim rule as consistent with the express minimum demands of MAHRA, but we agree with the commenters that the final rule should require more in order to implement the spirit of the statute. While it is important to streamline the restructuring process and to allow the PAEs flexibility to respond to local conditions, we share the commenters' concerns that the interim rule was not prescriptive enough to guarantee that the tenants and local community groups would be provided adequate opportunity for meaningful participation in every case.

In the interests of providing even greater opportunities, we have concluded that a second consultation meeting should be mandated as an opportunity for tenants and local community groups to review and comment on the PAE's proposed Restructuring Plan (including plans for future section 8 assistance) before the PAE submits the Restructuring Plan to OMHAR. As a minimum, the PAE will be required to conduct two (rather than just one) public meetings. Section 401.500(c) and (d) now require public access to the draft Restructuring Plan and a second meeting no later than 10 days prior to submission to OMHAR. The PAE must document and provide a brief narrative explanation of the disposition of all tenant and local community comments.

This revised procedure will not only ensure appropriate early input into the development of the Restructuring Plan, but also will provide a safeguard against inadequate consideration or misunderstanding of tenant and community concerns by the PAE, without unduly hampering timely and efficient completion of the Restructuring Plan. Persons given the opportunity to comment on a proposed Restructuring Plan will not have appeal rights under subpart F. HUD emphasizes that the tenant and community participation procedures mandated by the final rule are minimum procedures that may be supplemented by a PAE to the extent consistent with the objectives of MAHRA and the local circumstances. Other changes intended to strengthen HUD's collaborative efforts with tenants and local communities are detailed in the following sections.

2. Involve others in Rental Assistance Assessment Plan.

Two commenters said that the PAE needed to consult with tenants, the locality, the PHA and the owner before developing this plan, and specifically with regard to the tenants' ability to use tenant-based assistance. Five commenters said that tenants should have a right to comment on the plan after it was developed, with some commenters arguing that this is required by section 515(f)(2)(C) of MAHRA. One commenter suggested that any conversion to tenant-based assistance should require the approval of

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of the tenants.

HUD response:

The initial consultation meeting required by the interim rule provides the opportunity requested by commenters for input prior to the development of the Rental Assistance Assessment Plan. HUD does not interpret section 515(f)(2)(C) as requiring an additional opportunity for tenant comment after that plan is completed, but will provide such opportunity as part of the second consultation meeting to be held upon completion of the draft Restructuring Plan as described above.

3. Intermediaries administering technical assistance grants should receive notice.

One commenter suggested that Intermediaries administering technical assistance grants for the Mark-to-Market Program should be recognized as “affected parties” for the purpose of receiving notices. This commenter felt that this information was required for Intermediaries to perform their functions in a timely and efficient manner.

HUD response:

HUD agrees that this requirement is appropriate.

4. Notices in other languages.

One commenter suggested that notices be provided in other languages.

HUD response:

HUD will publish general information brochures in various languages. While the PAE and the owner should make every effort to provide notices (or translation services) to reach non-English speaking tenants and local community groups, it is impractical to require this by regulation.

5. Notice to all tenants and posted in project.

A number of commenters felt that all notices should be delivered to each tenant and tenant organization, as well as posted in each project.

HUD response:

HUD agrees with this comment.

6. Right to organize.

Tenants should be able to organize in projects that have been restructured through the Mark-to-Market Program.

HUD response:

As explained in HUD's corrective rule published on

December 28, 1998 at 63 FR 71373, section 599 of Pub. L. 105-276 amended section 202 of the Housing and Community Amendments of 1978, concerning tenant participation in certain multifamily housing projects, to apply that section to all projects with project-based assistance or enhanced (“sticky”) vouchers under the Mark-to-Market Program. Tenant participation under section 202 (including the right to organize) is the subject of 24 CFR part 245. We issued a separate proposed rule to amend part 245 to reflect section 599 and to make other changes (64 FR 32781, June 17, 1999). A final rule is being developed.

7. Tenant role in PAE selection.

Three commenters were concerned that tenants were not given any role in selecting PAEs. Two commenters also felt that tenants should have a role in the negotiation and renewal of PAE agreements. One commenter pointed out that since P

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