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How Long Does it Take to Fix A Mistake?

5 min read

How long does it take to fix an original-sin mistake? An enlightened corner of the Department of Housing and Urban Development is offering an answer to that question.

Four decades ago, in the dark times before the Low Income Housing Tax Credit, HUD was both capitalizer (via Federal Housing Administration-insured lending) and subsidizer (via Section 8). As LIHTC’s role in capitalizing affordable housing has inexorably increased to virtually monopolistic status, HUD’s dried up, leaving only two narrow channels:

  1. Funding conduit for Section 8 resident income subsidy (whether property-based or Housing Choice Vouchers); or
  2. Caretaker of Congress’s orphanage of properties developed under prior regimes and schemes and left to roll forward into the changing future with legacy physical systems, regulatory agreements, subsidy resources and rent structures.

All these years of adverse selection left HUD with an inventory hodgepodge of at least eight major Section 8 types, all subject to variations in their rent-adjusting structures. Although all the original Section 8 contracts have long since expired and been extended or renewed, the rent-adjusting rules for each type, specified in the regulation and implemented in excruciating detail via HUD’s Section 8 Renewal Policy Guidebook, have persisted as if frozen in amber. Even worse than the complexity and administrivia involved, 25 years ago the Multifamily Assisted Housing Reform and Affordability Act of 1997 (MAHRA) codified into rent-adjustment regulations the atrocity known as the Operating Cost Adjustment Factor (OCAF). 

OCAF was dumb from birth. To apply it, HUD assembles its own operating expense increase index, derived by comparing year-on-year cost increases in nine broad expense categories, and then applies that derived OCAF not to the total rent but only to the previous year’s actual operating expenses. The result is an increase that never tracks the market, never tracks an affordability metric, never adjusts for spikes in costs (even if exogenous) and virtually guarantees that the upcoming year’s net Operating Income (NOI) will be lower than the previous ones. For most OCAF properties, rent-reset relief is offered once every five years, when the owner may humbly petition for an increase by commissioning a Rent Comparability Study (RCS), a milestone that owners reach like marathoners gasping for water. They’re the lucky ones: for even more obscure historical reasons, properties that went through Mark-to-Market (M2M) or Rental Assistance Demonstration (RAD) are saddled with OCAF without market reset for 20 years, a curse that nobody deserves.

Unlike most of the folks now suffering under OCAFs, I was present at its maculate conception. Back in the early 1990s, I was involved pro-bono in conceptualizing the Low Income Housing Preservation and Resident Homeownership Act of 1990 (LIHPRHA) and heard about OCAF when it emerged abruptly one evening late in the statute’s final drafting. I was instantly aghast. Despite my frenetic erudite faxing demonstrating that OCAF would be a ticket to penury, Congress was weary of the preservation wrangle, resentful of for-profit owners ‘cashing out big’, unwilling to give them the prospect of rising post-preservation cash flow, and deaf to quant-policy-geek chatter at ten o’clock at night. OCAF slid aboard the closing doors of the LIHPRHA statute…and there we were. 

Fortunately for property viability, OCAF proved a low ebb. The emergence of M2M exposed that the Fair Market Rents (FMRs) Congress and everyone used as the rule of thumb for local markets were, as I had long quipped, ‘neither fair nor market nor rent’ because the rent-estimation algorithm imposed by OMB during the LIHPRHA era had gamed FMRs down to artificially low levels. As more and more M2M-eligible owners opted out, owner flagellation lost its appeal and economic viability became paramount. M2M rapidly birthed renewed affordability as a strategy, facilitated and standardized via Shaun Donovan’s small masterpiece of regulatory conjuring, Mark Up to Market.

Those same viability-first principles found their way into even the legacy public housing inventory, the last redoubt of suffocating regulation. Reform and revitalization found their first expression in the ill-fated PETRA proposal, then in its better-marketed successor RAD. Now ten years old, RAD has been the salvation not just of the public housing inventory, but also of the public housing authority as a place-based, locally accountable, social entrepreneur capable of doing innovative joint venture partnerships with nonprofit and for-profit developers alike.

The remaining obstacle is the thicket of program requirements that, as HUD’s Federal Register notice explained, “contribute to program complexities [and] a standard program regulation and contract would reduce the complexity faced by owners, tenants and HUD. A single program regulatory structure and a single program contract” not only benefits HUD but also “may affect an owner’s decision-making process in considering whether to request a renewal.” In other words, it might keep more properties affordable. This is a huge initiative, which I’ll cover in detail next month. 

OCAF, the misbegotten scion of a list of micromanaged rent structures still with us, deserves the sendoff once reserved for a feckless parliament: “you have sat too long here for any good you have been doing. Depart, I say, and let us have done with you. In the name of God, go.”  

David A. Smith is founder and CEO of the Affordable Housing Institute, a Boston-based global nonprofit consultancy that works around the world (60 countries so far) accelerating affordable housing impact via program design, entity development and financial product innovations. Write him at [email protected].