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A New Rent Increase Opportunity will Provide Relief to Mark-to-Market Portfolio

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There is a subset of affordable housing multifamily apartment complexes referred to as Mark-to-Market (M2M). The defining feature of these properties is significant federal mortgage and rental assistance with strict financial limitations. These limitations have caused financial problems at many of the more than 2,000 apartment complexes that went through full M2M mortgage and rent restructuring. The Biden administration has supported a solution to this problem, which was enacted into law, as part of the Consolidated Appropriations Act of 2023 (2023 Act). The 2023 Act was signed into law on December 30 and funds the government for the balance of the 2023 federal fiscal year. This is a lifeline for many M2M properties that have significant physical and operational needs, and until now did not have a financially viable method to address those needs.

M2M Program Background
The M2M program was authorized in the Multifamily Assisted Housing Reform and Affordability Act of 1997 (MAHRA).

To participate in the M2M program, a property would have both a Federal Housing Administration-insured loan and a project-based Section 8 Housing Assistance Payment (HAP) Contract with above-market rents. A so-called “Full” restructuring involves both: (1) a renewal of the project’s HAP Contract, with rents reduced to market rents as determined within the M2M program guidelines; and (2) restructuring of the project’s FHA-insured debt through an FHA-insured refinance loan and Department of Housing and Urban Development-held subordinate debt to allow.

Interestingly, when the MAHRA statute was enacted, the presumption was about 10,000 such apartment complexes had rents above market. However, as those properties were processed many had rents below market, and many more had rents about equal to market. Only about a quarter of both had rents below market and proceeded through Full M2M processing. Projects at the time with rents at or slightly above market could renew as a M2M “Lite” and likely would not have the same limitations as a project processed as a Full M2M. Also, there were several rounds of demonstration programs that could be subject to variations of these requirements.

In a Full restructuring, the owner is obligated to enter into a 30-year Use Agreement with HUD (in some cases this Use Agreement could be up to 50 years), during which time annual rent increases on HAP contract units have been limited to increases only by the Operating Cost Adjustment Factor (OCAF). In many rental markets, these OCAF adjustments have not kept pace with market rents, and in many cases operating costs have accelerated faster than the M2M underwriting projections made at the time of restructuring. In many cases, these increased costs have outpaced project rents and strained or even exceeded project reserves.

HUD published the Final Rule governing Mark-to-Market restructurings in March of 2000. Most Full M2M refinancing transactions date from the early 2000s. This means that most of the projects in the portfolio subject to M2M Use Agreements were restructured 15 to 20 years ago and have rent increases limited to OCAF increases during that time.

The best way to think about the M2M program is as a forced workout program—the owner did not default but MAHRA authorized HUD to act as if the project would default, as a way to reduce the Section 8 budget outlays for HUD, thereby saving the taxpayer money. As such, M2M was a rent and debt restructuring program, and not a rehabilitation program. There is no minimum requirement for a scope of rehabilitation work at a Full M2M restructuring closing, and most projects did not go through substantial rehabilitation at the time of the closing. The M2M underwriting process was intended to establish significant reserves and future annual reserve deposits for the next 20+ years, based on costs and projections at that time. Those initial projects often proved to be different from the actual needs of properties that arose over time.

Many existing M2M projects entered the program as aging properties and still have not had a substantial rehab in decades. The HUD regulations allowed for increased rents through a budget-based approach, but HUD has not allowed that approach, going so far as to propose amending the regulations to remove the budget-based option in 2020. As a result, there are hundreds of properties with significant physical and operational needs across the existing portfolio. Two affordable housing trade associations—the Institute for Responsible Housing Preservation and the National Leased Housing Association—have advocated for Congress to give HUD this critical tool to address these widespread needs.

New Federal Legislation 
The 2023 Act amends MAHRA to create a new Section 8 Housing Assistance Payments Contract renewal path for M2M properties. Rents on these HAP contracts may be increased up to the lesser of a rent based on a budget of project needs or a rent equal to comparable unassisted market rent. The owner must demonstrate to HUD’s satisfaction either that income is insufficient to operate and maintain the project, or that the owner will take out new debt to fund necessary rehabilitation.

The 2023 Act limits the opportunity for rent increases to once every ten years. Many M2M properties have approximately ten or fewer years left on their initial 30-year M2M commitment, and those projects therefore will only benefit from this renewal option once. Owners and purchasers should be careful to maximize the benefit to the property created through such a renewal. HUD will also require an extension of the project’s affordability and use restriction for an additional 20 years beyond the initial Use Agreement term. The 2023 Act also clarifies that, once a M2M property has satisfied the original 30-year Use Agreement term, such a project is free to renew under any other MAHRA option that it is otherwise eligible for.

Outlook for implementation
HUD is currently working on administrative guidance to implement the new law. It is likely HUD will issue guidance later in 2023, following the 2023 Act and providing owners with the new budget-based rent increase as a HAP renewal option. At this writing, we assume HUD will utilize, in part, the HUD budget-based renewal guidance contained in Handbook 4350.1, REV-1, Chapter 6. This provides a concrete process to rehabilitate and stabilize otherwise important and needed housing.

We expect most owners will come to appreciate this new process. We also expect HUD to move diligently in implementing the new authority, which will begin to create demonstrated benefits across the M2M portfolio shortly after that implementation occurs.