Getting Rent Right: Current Challenges and Market Factors

The ripple effects from an unsteady economy and uneven housing market continue to be felt in the assisted housing industry. Depending upon your geographic location and the type of housing your site includes, you're probably encountering vexing issues, such as ever-growing waiting lists for Section 8 units, market rents that have the potential to wreak havoc on your budget, and operating expenses that continue to climb. And still you must contend with HUD's expectations that you remain fiscally sound and adhere to regulations and requirements for occupancy and determining rents.

The Insider spoke with professionals in several areas of the industry about the current state of affairs regarding these important rental income issues. Their comments reflect what they're seeing right now in their respective areas of expertise and how it's anything but business as usual. It's not a picture of gloom and doom, though. HUD-assisted housing remains a strong anchor for many families and communities; site owners and managers are vital to HUD's programs to provide and preserve affordable housing.

This special issue represents the viewpoints of an independent housing consultant, an operations manager for a contract management company, an appraiser, and a senior housing expert. They are based in different parts of the country and have weighed in with comments on what they see locally and, where applicable, across the country.

Comparable Rents Taking a Hit

Rent comparability studies (RCSs) factor into the operations of many assisted housing sites, particularly with the renewal of Section 8 contracts and often with requests for annual rent increases at other property types. These studies look at rents charged at comparable market-rate sites (those not HUD-subsidized) in your specific geographic area. HUD regulations require you to work with an appraiser to complete the RCS, which determines the rents you could charge if your site wasn't supported by HUD assistance. In most cases, to get your Section 8 contract renewed or your rents increased, your RCS must show that your site's rents are below comparable market rents.

What happens when the market to which your site is being compared has taken a hit from an economic recession and high unemployment? Michael Klion, a Nevada-based assisted housing consultant, says the markets he's most familiar with are hurting.

“Because of the recession, comparable rents have dropped significantly,” Klion says. “As a result, Section 8 rents are dropping and the ability of owners to manage their properties is affected. In some cases where the comparable rents are lower than the Section 8 rent, HUD is giving no rent increases. If the property is in decent financial situation, no rent increases are being given. I know of comparability studies that were done and then not taken into consideration after they were completed because of the low market rents.”

Klion points out that he is referring to the Las Vegas area. Las Vegas, he says, is the number-one city for foreclosures in the country and the latest unemployment figure stands at 14.3 percent. But Klion believes the problem is not just in that market. “This has now become a national issue, and HUD is looking at ways to deal with it,” he says.

In general terms, when a site seeks a rent increase, there are two ways to do it, Klion explains. First is through an annual adjustment factor (AAF), which he describes as “a small percentage,” determined by HUD on the basis of Consumer Price Index data relating to changes in residential rent and utility costs. These AAFs are established for different regions of the country, including more than 100 metropolitan areas and four Census regions. Sites don't have to submit much information for the AAF, Klion notes. They apply for it, and it's added to their following year's budget. The second is a budget-based rent increase, which sites may seek when there's an increase in budget expenses that can't be covered by existing rental income levels or by surplus project funds.

Owners of Section 8 sites have to conduct comparability studies at least every five years, says Klion. Owners must contract with a private, third-party appraiser to assure an independent market review and analysis, he explains. He says the studies done recently have been the most problematic for Section 8 owners because with the down economy, market rents are turning out to be lower.

“Last year and this year especially have been bad,” he says. “The problem is, how do we account for the RCS and the fact that we are over market in terms of rent? Just as an example, last year in Las Vegas, the adjustment factor was about 4.4 percent. If comparability studies from before the recession had been factored into the equation, they would have actually raised a resident's rent about 8 percent.”

Klion says he has been told by regional HUD personnel that some RCS studies are being put on hold. Owners can go ahead with rent increases based on annual adjustment factors, but not on the basis of comparability studies, he explains. “It appears HUD is providing for some amount of increase in rents, but trying to hold off in some cases when it comes to the comparability studies,” Klion says. “When the market turns, as everyone hopes it will, the studies will be used. At this point, it's all conjecture on the part of those involved.”

It can be a real challenge when owners can't adjust rents upward as operational costs and expenses rise, Klion notes. “Rent is all the property owners have to operate their properties,” he says. “They can't cut services. They still have utility bills and other bills to pay, and those keep going up.”

Klion pointed to another sign of the times in the way some HUD subsidies were funded. When Congress does not pass the budget on a timely basis, HUD can spend only about 80 percent of what it had in the prior year's budget, he explains. The result of this delay in the last budget year is that sites were not receiving their full Section 8 subsidies for months.

“What this administration did, and it's to their credit and Congress’ credit, was to add $900 million to the following year's budget,” Klion says, “so Section 8 properties would continue to receive their subsidies. It really helps. Many properties were in danger of defaulting or foreclosure.”

Klion feels things may get worse before they get better, especially with Section 8. “The waiting lists grow, for both families and the elderly,” he says. “There's no new money for Section 8 construction. There hasn't been for years. Luckily, there is money for [Housing Choice] vouchers. We're all at the mercy of the market.”

Past Practices Colliding with Current Realities

John Doyle says you have to go back a few years to really understand what's going on today for site owners and their rental income. The convergence of past practices, market factors, and the economy has created a perfect storm that's battering site budgets and bottom lines, says the Pennsylvania-based real estate appraiser and HUD rent study expert.

First, some background. Contract rents are re-set once every five years, Doyle explains. In 2005, they were set at market rates, for the most part. Then, each subsequent year, site owners were given an operating cost adjustment factor (OCAF).

“Nearly every Section 8 property owner benefited,” Doyle says. “In many states the OCAF averaged 3.5 percent per year or more. Even in years when the market was flat, the rent went up. The compound effect was a 20 percent increase in rents over the five-year period from 2005 to this year. HUD landlords were getting double-digit rent increases while private property owners were, in some cases, having to lower their rent.”

As an example, Doyle uses a rent figure of $500 for a one-bedroom unit in a HUD site five years ago. Today that rent is $600. But nonsubsidized rents aren't in the same ballpark. Take the southern tier of New York State, for instance. It's a market in which Doyle has conducted rent comparability studies. What he is seeing there currently is playing out in other parts of the country, too. “Five years ago, there were rents of $500 for a one-bedroom unit,” he says. “Today, that rent is $475 to $525. So rents are being re-set to market rates.”

The impact of this rent adjustment—called mark-to-market—is being felt by owners in various ways. If they have a HUD-insured mortgage, Doyle explains, HUD determines whether there is adequate cash flow or not. If not, they could be forced to refinance, he says.

“Owners are faced with having to look at their operating expenses to see where they might make cutbacks,” Doyle says. “They have payroll, maintenance, repairs…there aren't a whole lot of places to cut. A lot of expenses can't be cut. You could appeal your property taxes if your revenues are going down, but it's not likely your utility bills are going down.”

Owners can really find themselves between a rock and a hard place. “Those with senior housing might think about cutting nonshelter services or amenities,” Doyle says. “Say they have a service coordinator to help residents find medical screenings or transportation services. If they have to cut the service coordinator's job, they can't offer those services any longer. A rent comparability study would take into account that such services are not available at the site and the rent would be lower.”

Looking back, the OCAF levels were unsustainable and misguided, and made changes to keep rents more in line with market rates. “HUD realized that the unchecked adjustments were an issue,” Doyle says. “Now contracts [and contract rents] are re-set every five years.”

Making Market Studies Work

As operations manager for a HUD contract management company, Cindy Ross works with site owners and management agents across multiple states, focusing on Section 8 housing compliance. One part of her job is to conduct training in contract renewals and rental adjustments. Key to the renewal process, she explains, is the RCS. Done properly, the RCS carries the load when it comes to making the case for adjusting rents. And the key to a well-done RCS, Ross believes, is the appraiser.

“A good appraiser is one who is familiar with Section 8,” Ross says. “She knows where she can add value, to bring the rent up as high as it should be.” A good, experienced appraiser will know the fine points of finding the right comparables, Ross points out. If your building is five stories, the comps should be five stories. The comps also should be of an age similar to your building and they should be located within a couple-mile radius of your site, Ross says. (See “10 Tips for a Compliant Comparability Study” and the Model RCS Checklist in this issue.)

“The point is, it has to be a ‘like’ study within the area of the subject property,” Ross says. “If the area is depressed, that could affect the outcome. If it's a rural area, like some we work with in Nebraska, there may be no comparable properties. Keep in mind that HUD will have a third-party, neutral study done following the owner's initial study.”

Ross says she is not seeing as much in the way of low market rents due to the economy in states she is familiar with as Klion mentioned he's encountering. Ross works with HUD site owners in Washington, Hawaii, Southern California, Utah, and Nebraska.

“What we see in a depressed market is that rents may go up when comparing them to market-rate properties,” Ross says. “With higher occupancy, rates can go up in conventional housing. In a market with vacant units, rents may come down as landlords compete to fill their vacancies.”

Section 8 sites that are coming off their initial 20-year contracts have to face a new reality with their rents. Ross says these owners didn't have to do rent comparability studies with their initial contracts, and their rents were adjusted through the HUD-established AAF. That practice essentially sheltered Section 8 owners from some of the ups and downs of the market. “HUD does want sites to be held to a comparable market rent,” Ross says.

Insider Sources

Colleen Bloom: Assoc. Director for Housing Operations, American Association of Homes and Services for the Aging, 2519 Connecticut Ave., NW, Washington, DC 20008; (202) 508-9483; cbloom@aahsa.org.

John E. Doyle, MAI: Doyle Real Estate Advisors, LLC, 1601 Walnut St., Ste. 509, Philadelphia, PA 19102; (215) 231-9900; jdoyle@doyleadvisors.com.

Michael Klion: MK Consulting Service, Las Vegas, NV (702) 521-6559; mk.consultlv@gmail.com.

Cindy Ross: Operations Manager, Contract Management Services, Norm Dicks Government Ctr., 345 6th St., Ste. 200, Bremerton, WA 98337; (360) 373-0420; cross@contractmgmt.org.

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