WASHINGTON -- Buried in the housing appropriations bill is a provision that would cut off annual increases in federal subsidies to certain low-income multifamily projects, a change that housing proponents say could cause some projects to default.

Project owners under the Section 8 rental assistance program receive the annual increases to cover rising costs. The provision would eliminate those increases for project owners receiving so much subsidy that the rent they take in is above what the Department of Housing and Urban Development deems to he a fair market rent for the surrounding area.

But even with the high rents they receive, "in a lot of situations these projects don't have enough money to operate," said Ken Lore, a housing lawyer with Brownstein, Zeidman & Lore in Washington.

"The result when you squeeze properties that are thinly capitalized is either they go into default or, if they don't go into default, the properties are not maintained and cared for," said Lore, whose firm is general counsel for the National Housing and Rehabilitation Association.

Section 8 is an umbrella term used to describe a number of rental assistance programs that were created by Congress in 1974. Since the early 1980s, most assistance under the program has been provided through so-called portable certificates, which are issued to tenants who use them to make their rent payments.

The provision in question is targeted at older projects built during the early days of Section 8, when rental assistance went directly to the projects, many of which were bond financed and used federal subsidies to help pay debt service.

HUD entered into contracts with project owners, agreeing to make sure they received a return equal to their areas' fair market rents, as calculated by HUD. Tenants paid a small amount toward their rent, and HUD made up any shortfall with subsidy payments to the owners.

The department also agreed to adjust its subsidy amounts annually, to reflect changes in market conditions. In some cases, project owners have been receiving increases regularly for years under the so-called annual adjustment factor, and those increases have caused their rents to exceed the fair market rent in their area.

HUD contends that those projects are receiving excessive amounts of subsidy. To curb that excess, the department earlier this year proposed denying rent increases based on the annual adjustment factor where an owner's rents exceeded area fair market rents.

The proposal was added to the Senate's version of the fiscal 1995 appropriations bill for HUD. House and Senate conferees retained the provision in the final version of the bill, to which both chambers are expected to give final approval later this month. Conference documents state that the provision would save the federal government $110 million in fiscal 1995.

"HUD should no longer over-subsidize projects," the department said in an Aug. 17 letter to Sen. Alfonse D'Amato, R-N.Y., who had expressed concern about the provision.

"The purpose of the provision is to more efficiently assist projects, which in turn increases the number of beneficiaries who gain access to HUD's assisted housing programs," the letter said.

But just because an owner's rent is higher than the area fair market rent, that does not necessarily mean the Owner is reaping a windfall, housing market participants said. A Section 8 owner may for example, be incurring maintenance costs that would make necessary a higher rent than the typical amount charged in other buildings.

Thus, eliminating the annual adjustment for some projects could spell trouble.

"If you've got a project on the edge and you don't get your annual adjustment factor, it's a big deal," said Robin Salomon, a principal with DFC Group, a real estate consulting firm in Bethesda, Md.

Wendy Dolber, a housing analyst with Standard & Poor's Corp., said many of the old Section 8 projects probably were underwritten assuming the rent would be adjusted each year.

If "the underwriting assumed a certain increase in rent and now they're not going to be able to get that, there could be a problem," Dolber said.

But Dolber said she is confident that HUD would try to work with an owner for whom lack of an annual increase would be a hardship.

"I would think that HUD is not out to do anything that would cause Section 8 projects to default," she said.

Dolber noted that the provision would give HUD some leeway by permitting the department to reinstate the rent increases for owners who could prove their rents are not out of line with those for comparable units in the area.

But beyond financial considerations, some housing lobbyists said they are also concerned with the provision for another reason: They believe the provision is illegal, because the contracts that HUD entered into with Section 8 project owners specifically state that the owners will receive an annual rent adjustment.

"We think this is a violation of the [Section 8] contract," said Denise Muha, the executive director of the National Leased Housing Association. Muha said her organization is prepared to file a lawsuit to stop implementation of the provision if it becomes law.

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