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Applying for a Contract Rent Increase: Keeping your Section 202/811 Project in Financial Balance

Every once in a while someone says something in passing that can resonate with you. A few years ago, at an early morning appointment with my eye doctor, a diagnosis was made which required me to add yet another regimen to a growing list of things to do to keep fit. I expressed a grudging acceptance. The eye doctor quickly responded in a straight-forward way, "Life is not static." This was unexpected philosophy so early in the day, and it was good advice.

Things change. You know intuitively that building conditions change. A well-managed project has procedures in place to address emergencies or routine repairs as they occur. The same practice of addressing building maintenance problems should also be applied to the financial management of the project, to make sure that project income is sufficient to cover administrative, operating and maintenance expenses. Too often a review of income and expenses is not done on a regular basis and if expenses outweigh project income, some sponsors allow literally years to go by without addressing this. To amend my eye doctor's saying: project finances are not static.

At what point is the project operating budget established? Prior to the start of operations, before construction starts, HUD issues a firm commitment which indicates on Form HUD-92264, the annual operating expenses and the contract rents required to cover the approved expenses. The initial operating budget is based on estimated expenses, submitted by the Sponsor and reviewed by HUD, sometimes a few years prior to the starting date of actual project operations. Although a well- conceived estimate seeks to anticipate what expenses may be when the project is fully occupied, it is an estimate and may not reflect real expenses when they occur.

What happens if operating expenses increase significantly after the project starts operating? This can happen. Utility costs may spike because of increased fuel expenses. Insurance premiums may rise. Payroll expenses may go up if supers require higher salaries or the cost of security guards increases.
The primary income available to cover Section 202 or Section 811 project expenses includes the total tenant contribution to rent and the HUD operating subsidy made available in the Project Rental Assistance Contract (PRAC). Tenant contribution to rent is limited to 30% of adjusted tenant income. Eligible tenants in Section 202 and 811 projects cannot exceed published income limits for very low income households, so the amount provided by them may not be substantial. The bulk of the income required is typically provided by the PRAC but HUD has reserved a fixed amount for the project under the initial contract that had been established way back in time: i.e., as of the date of fund reservation. If actual expenses exceed the amount available from the tenants and the PRAC, there will be a shortfall of funds.

There is a HUD process available to remedy a shortfall. When actual operating expenses are known and it appears that tenant contributions to rent and the approved PRAC are not sufficient, the Owner corporation should apply to HUD for a contract rent increase. The step by step process is included in Chapter 7 of HUD Handbook 4350.1 REV-1 and it is recommended that the Owner and project management staff familiarized themselves with this.
Here's a rundown of the basic procedure for applying for a contract rent increase:

1. Review the project budget periodically with your management agent or financial officer. For example, after a year has elapsed since the start of initial operations, review your status; now you have actual invoices of expense items and can evaluate whether your project income is sufficient to keep your finances in balance.

2. If it appears that actual expenses are exceeding your project income, contact your HUD project manager, in the HUD Asset Management Division, to determine if an application for a rent increase will be reviewed by HUD or by a private company that has been authorized by HUD to process rent increases, such as CGI.

3. Determine if the rent increase is greater than the Maximum Allowable Rent Potential of the project. This is the amount that HUD has authorized the project to charge, as indicated in the PRAC. If the amount is less, then submit a new Rent Schedule on Form HUD-92458. If the amount of the increase is greater, then additional documents listed in Item 5. below are required. Also, if an application for a rent increase will be submitted to HUD, at least 30 days before the application is submitted, the Owner must notify the tenants of the proposed rent increase. Check with Asset Management at HUD to determine if tenants for your project are required to be notified.

4. Notification to tenants of rent increase. Appendix 1 to Chapter 7 of Handbook 4350.1 outlines in detail the procedure for notifying tenants. The notification must be properly posted and tenant comments are requested. The Guide recommends that you confirm this requirement with HUD Management for a Section 202 or Section 811 project in which 100% of the units or beds are receiving PRAC or HAP subsidies.

5. Initial Submission. The application must include the following:

" Cover letter that summarizes the reasons for the rent increase and the date it will be effective. Description of the building's condition and budgeted improvements and any proposed change in services, equipment or charges with reasons for the change.

" Budget worksheet on Form HUD-92547-A, providing income and expenses for the year following the effective date of the rent increase. This form has three columns. In the left column enter actual expenses based on your last audited statement. In the middle column, enter actual information from the date of your current fiscal year start to the current date and in the right column enter the anticipated budget from your anticipated starting date.

" A brief statement explaining the basis for any increase of any line item which exceeds 5% of the line item on your most recent fiscal year statement. If the increase is less than 5% or $500, no explanation is required. As a guide, the HUD handbook provides samples of explanations. See the attached HUD checklist as a guide to your application preparation which has a PRAC.

" Executed copy of the Owner's Certification Regarding Purchasing Practices and Reasonableness of Expenses (Appendix 3 to Chapter 7).

" A signed request for an increase in the Reserve for Replacement if contemplated.

" For projects with utility allowances, the owner may submit a request for an increase to HUD with supporting documentation indicating what HUD calls "the owner's best estimate of the average monthly utility cost that an energy conscious resident will incur for the year".

If you are seeking an increase to the Management Agent's fee, submit a current Management Entity Profile, Form HUD-9832, a current fidelity bond, and a revised Owner's and Management Agent's Certification, Form HUD-9839-B

Submit required Certifications:

Certification as to Purchasing Practices and Reasonableness of Expenses
Owner's Certification that Project Will Not Participate in the Low Income Housing Tax Credit (LIHTC) Program.
Tax Review and Appeal Certification
Energy Conservation Certification

6. HUD will notify the Owner of its decision and will explain the reasons for the decision to increase the rent and or the utility allowance or to deny all or part of the increase. If the increase is approved, check with HUD to determine if the Owner will be required to give the tenants 30 days written notice of any increase under the terms of the lease. A notice to tenants may not be required if all the tenants are receiving PRAC subsidies. If required, Owners will give the tenants the date that the increase will be effective.

According to HUD, a common error in a submission for an increase is a proposed budget that cannot be justified with supporting documentation or an application that is not complete.