HUD Testimony

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Statement of Orlando J. Cabrera Assistant Secretary for Public & Indian Housing U.S. Department of Housing and Urban Development Hearing before the Committee on Appropriations Subcommittee on Transportation, HUD, and Related Agencies United States House of Representatives

March 13, 2007

Status of Public Housing

Chairman Olver, Ranking Member Knollenberg, Distinguished Members of the Subcommittee:

I am Orlando Cabrera, the Assistant Secretary for Public and Indian Housing at HUD. Last year at a hearing on Public Housing in the 21st Century, I said that public housing was at an important crossroads: that crossroads is where public housing is finally joining the world of multifamily housing in terms of finance, management, and oversight.

As public housing moves forward with this transition, the most effective way to illustrate what it is about is to use financial analysis. Yet it is the method that is used the least when discussing public housing.

First, a brief and very general history of public housing finance might help.

Public housing first came about as a way to provide decent housing for lower-income workers in our cities. Nationwide, but particularly in our larger cities, most of the developments that are used as public housing today are about 70 years old and were the stock used to house those workers. The federal government paid to construct the units and the rents covered the operating costs.

In 1968, Congress passed the Brooke Amendment, which fixed rents at 25 percent of tenant incomes. While Brooke protected tenants, it hastened the financial crisis at many large PHAs. It wasn't for another six years until Congress established a comprehensive operating subsidy program and another decade or more until it established a comprehensive program for capital improvements. Once we began to finance public housing operations and capital improvements through appropriation, we discouraged public housing authorities from operating in accordance with sound real estate practices - that is, we disincentivized PHAs from charging adequate rents and creating capital reserves. That persisted until it became clear that public housing's capital stock had aged and was in dire need of capital improvement. Some capital investment occurred during the late 1970s and early 1980s, but essentially, very little changed when it came to improving public housing's capital stock.

In 1998, Congress passed the Quality Work and Housing Reform Act (QWHRA), creating a new operating fund and capital fund programs. Congress directed HUD to develop these programs through negotiated rulemaking.

A byproduct of QWHRA was that Congress began to reconsider the business model that public housing had used for decades. It commissioned a study known as the Harvard Cost Study.

The Harvard Cost Study examined the way PHAs were funded. It looked at the costs of operating under HUD housing programs in similar markets. It recommended a new formula for determining operating subsidy, replacing a system that traditionally disfavored the nation's growing population centers in the south and southwest from those parts of the country that were losing population.

Based on Harvard's research, Congress directed HUD to undertake asset management and HUD did. The operating fund rule was produced after a 2-year negotiated rulemaking process and set forth the path for change.

Asset management contemplates that public housing authorities will run their units in a way that actually recognizes the economics of running each of the developments under a PHA's management. First, asset management is not mandatory for PHAs that have fewer than 250 units. Second, asset management requires PHAs to make decisions based on the economics of managing units. Third, asset management requires PHAs to know the cost of running their business. Fourth, asset management encourages local flexibility by minimizing HUD involvement in operations.

The 2007 joint funding resolution provides $3.8 billion in operating funds and $2.4 billion for the capital fund. This $3.8 billion in operating subsidy will fund every PHA at 84 percent of their subsidy eligibility. The President's 2008 Budget requests $4 billion for the operating fund, the highest amount ever, and $2 billion for the capital fund.

With the capital fund, QWHRA recognized that the world that PHAs operate in had changed significantly over the past 70 years. Since the implementation of the provisions of QWHRA, capital funds have been used to leverage over $2.9 billion in private funds to accelerate the redevelopment of total portfolios such as in Chicago and New York City.

The Department's overall request for capital funding is sufficient to meet the $2 billion annual capital accrual need of the public housing inventory estimated by the 1998 modernization needs study conducted by the Department. The modernization needs study also estimated that there was a backlog of approximately 24 billion of unmet need, which is currently estimated to by $18 billion. Since that time, the backlog of capital needs for public housing has been reduced through demolitions of over 100,000 of the most distressed public housing stock as well as modernization and redevelopment of several hundred thousand units. In addition, the Department has put in place multiple mechanisms to leverage existing capital funding to increase the total amount of funds available to PHAs over and above the appropriated funds to address backlog needs. These mechanisms include the ability to borrow funds under the capital fund financing program, the ability to undertake mixed finance modernization (utilizing tax credits), and energy performance contracting. In light of the foregoing, the Department's request provides adequate resources to meet PHA's modernization needs.

The amount of operating funds requested for 2008 will fund housing authorities at an 80 percent proration level. In addition to the operating subsidy provided, the eligible needs under the operating formula assume a freeze in the level of formula income collected by PHAs. This means that any increase in rents charged and collected by PHAs will not decrease the amount of operating subsidy that they receive. PHAs are also allowed to keep approximately $300 million in other income that they earn. This amount also does not decrease the amount of operating subsidy earned by the PHA.

Implementation of the new operating fund means that about 75 percent of PHAs are gainers under the new formula while about a quarter are decliners. As part of phasing in asset management, the negotiated rulemaking committee recommended and HUD ultimately adopted a concept called stop loss that applies only to those PHAs that are declining in subsidy. Stop loss means that a declining PHA, with subsidies decreasing over a six-year period, may stop those declines as soon as the PHA implements asset management. The PHA would need to complete certain steps and then apply for the stop loss designation. If HUD determines that the PHA meets the criteria, the multi-year declines in the subsidy would stop. Stop loss is a very small component of asset management.

There have been allegations that asset management was prescriptive. Some went further and alleged that asset management was micromanaging. My sense is that most of those comments relate to stop loss, not asset management. Asset management, as previously mentioned, is a move toward greater local control and less centralized control. Stop loss, which is a small subset of asset management, effectively guarantees that a decliner can lock in its former subsidy level at the expense of other gaining and declining PHAs, so in order to achieve stop loss, HUD has required that stop loss applicant PHAs demonstrate that they are achieving efficiency on their own and within their budgets without external subsidy.

Another aspect of asset management fundamental to most businesses is better financial reporting. Asset management was developed after consulting with accountants in order to achieve a model that better conforms with generally accepted accounting principles consistently applied. Achieving a better financial structure means that PHAs will be better equipped to access financial markets because the former model was not a model that most stakeholders in the financial community, namely rating agencies, investment bankers, bond insurers and others, who might better assess PHAs as entities if they were structured in a manner that was more comprehensible.

The transition toward asset management has begun, with full conversion by 2011.

I feel strongly that they statutory and regulatory environment governing public housing should be simple, flexible, and progressive. Public housing authorities should be given greater authority to locally manage their developments.

As asset management is successfully implemented, the future for public housing means that PHAs will evolve using a variety of business models, not just one. It means that PHAs will be better positioned to access debt and capital markets in order to improve the condition of existing units. The transition to asset management will focus on the sustainability of each property, and allow housing authorities to become true asset managers, in line with the private sector. Today, housing authorities own and operate billions of dollars in assets, yet the value of these assets is generally unavailable for securing loans, private investment, and other forms of leverage. Moving our entire portfolio of 1.2 million units to this asset management model will create untold opportunity for greater sustainability, development of new and improved affordable housing options, and linkages to private financing that were previously unavailable. Ultimately, the issue is change and adaption.

Thank you for your time and attention. I am ready to answer any questions that you may have.