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Guest Blog: Nixon Peabody on Mod Rehab and Rental Assistance Demonstration

07.22.2019

Affordable Housing Finance featured insights from Nixon Peabody’s VanAmerongen and Cushman on the RAD conversion process; the authors tailored a version for Network members.

By Deborah VanAmerongen and Nate Cushman

For owners of properties with Moderate Rehabilitation Housing Assistance Payment (HAP) contracts, conversion through Rental Assistance Demonstration (RAD) is an underutilized opportunity. In New York City, the Mod Rehab contracts are administered by NYC Housing and Preservation Department (HPD). There are other local housing agencies throughout New York State that also administer these contracts. There have been significant changes to Mod Rehab conversions under the Department of Housing and Urban Development’s (HUD’s) RAD since the program was created, and if you have not reviewed your RAD options lately, it may be time to revisit them. There may be an opportunity to increase the property’s cash flow, revitalize its physical condition, and even take out funds to serve your organization’s mission.

This high-level view will detail the advantages of the RAD conversion process and key points to bear in mind as you consider your transaction. Of course, the details of each transaction will affect what is possible for each property.

Background

 

RAD allows owners to convert from their current Mod Rehab contract to either a project-based voucher (PBV) or project-based rental assistance (PBRA) contract. These PBV or PBRA contracts may be at increased rents and will be long-term contracts.

Conversion through RAD has been an option for Mod Rehab contracts since the beginning of the program in 2012. For the first years of the RAD program, however, only a handful of Mod Rehab properties participated. This may have been largely due to the fact that RAD’s first incarnation did not allow for an increase in contract rent above the property’s current Mod Rehab contract rents.

Recent updates to the program have changed the landscape considerably. As a result, more owners are starting to convert. HUD estimates that over 25% of Mod Rehab units have either converted or are in the process of working with HUD to convert through RAD.

For the balance of Mod Rehab projects, now may be the time to revisit whether a RAD conversion makes sense.

Benefits of a Mod Rehab Transaction

The two major benefits of a RAD conversion for a Mod Rehab property are the potential for a rent increase and the ability to obtain a long-term subsidy contract.

Rent Increase: Under current RAD rules, project rents may increase and, in some cases, increase substantially. For conversions to PBRA, rents may be increased to the lesser of market rents for the project as substantiated by a Rent Comparability Study or either 110% or 120% of Fair Market Rent (FMR), depending on project-specific characteristics. For conversions to PBV, rents may be increased to the lesser of the following three thresholds: the PBV payment standard (not to exceed 110% of FMR), the project’s reasonable rent, or the rent requested by owner.

For owners of single-room occupancy (SRO) projects, there is favorable treatment for the FMR tests involved in setting initial RAD rents: The full FMR for an efficiency unit can be used for any SRO units in the initial rent-setting calculations.

In practical terms, this means that a Mod Rehab project with below-market rents may be able to see a significant rent increase, including on any SRO units.

Longer-term contract: A Mod Rehab contract can only be renewed for a one-year term. Under current RAD rules, an owner can obtain a long-term PBV or PBRA contract for a term of 20 years. This can provide stability to the property and can be the foundation for financing on more advantageous terms than would otherwise be available.

Considerations in Structuring

Acquisition/Rehabilitation: A Mod Rehab conversion may present an opportunity to complete a meaningful rehabilitation of the property. This transaction could involve new financing, including debt financing. Some of these deals may work as 9% transactions though federal low-income housing tax credits (LIHTCs) and other funding sources. Supportive Housing Network members have worked, or are currently working with, HPD to reposition some of these properties and address long-term physical needs. The longer term of the RAD contract and the potential for a rent increase may present opportunities to interest lenders and investors in the transaction – potentially on much more favorable terms than existing financing. A Mod Rehab owner with less experience with the complex financing involved in many preservation transactions could partner with a more experienced developer or could offer the property for sale.

Subsidy Swap: Although an extensive rehabilitation of the property is possible, a Mod Rehab RAD conversion could also be much simpler. There is no requirement that the conversion involve any change in ownership or change in financing. Some physical work may need to be done, but for well-maintained properties the work may be minimal. Specifically, for most projects a Capital Needs Assessment (CNA) must be provided. However, the CNA requirement is waived for properties with only a few Mod Rehab units (less than 20% of units in the project or even a higher amount at HUD’s discretion).

In light of all this, some Mod Rehab RAD conversions will amount to essentially a “subsidy swap,” replacing the one-year Mod Rehab contract with a longer-term contract at subsidized rents set under RAD procedures.

Refinance: Many Mod Rehab conversions also involve transactions in the middle ground between the complex preservation transaction or the “subsidy swap” approach. RAD provides broad flexibility to owners in terms of funding sources and financing structures. Nearly any structure is on the table.

As noted above, many lenders would provide more favorable underwriting terms in light of the longer-term Section 8 contract. Higher rents also help. Therefore, a RAD conversion may present an opportunity for a refinance, with funds being used for basic repairs and recapitalization of reserves. There may also be an opportunity to access project equity. For the many mission-driven organizations that own and operate Mod Rehab projects, any funds arising from the transaction could be invested in other aspects of the organization’s mission with no limitations imposed by HUD.

Choosing Between PBRA and PBV: In addition to the differences in rent setting noted above, there are a couple of other considerations that owners may want to take into account in deciding between converting to PBV or PBRA. If rehabilitation work will be done in connection with the RAD conversion, the issuance of the new PBV contract will trigger the requirement of Davis-Bacon wage rates; PBRA would not. Since these Mod Rehab contacts are administered by agencies that also run Section 8 programs, if that agency has a PBV program, they may want the owner to go with PBV so they can continue to oversee the property and receive administrative fees for doing so. In most cases, HPD has expressed a preference for the conversion to be at a PBV contract.

Homeless/SRO/McKinney-Vento Projects: Some owners of Mod Rehab SRO properties for the homeless may not realize that the coordination of homeless-related requirements is actually very manageable. All such converting properties must follow PBV or PBRA procedures to establish an admissions preference for homeless families. A consultation with the local Continuum of Care (CoC) is required, and a letter of support from the CoC is required only if the conversion plan involves reconfiguration of units or serving a population not covered under the HEARTH Act. In order to maintain data on the project’s ongoing housing of formerly homeless persons, the project will continue to be required to report under the CoC’s Homeless Management Information System and the annual Housing Inventory Count. Many owners of these Mod Rehab properties find these requirements quite manageable.

If you own a Mod Rehab property and have not recently analyzed what a RAD conversion might look like for your property, you might be surprised by the advantages and opportunities that a RAD conversion might present for your project.

You can find the original version of this article on Affordable Housing Finance’s website.

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