WASHINGTON -- Key lawmakers are putting heat on the Department of Housing and Urban Development to amend proposed rules that would make it difficult for 501(c)(3) organizations to use tax-exempt financing to buy low-income housing units under a new federal program.

Congress passed legislation in 1990 to encourage private nonprofit entities to buy the units from private developers as a way of keeping them from being converted into expensive properties. But the regulations proposed by HUD in April to implement the program make the sale process too cumbersome and the debt financing needed for the purchases too costly, housing industry officials have warned.

As a result, Sen. Alan Cranston, D-Calif., and Sen. Barbara A. Mikulski, D-Md. -- both of whom chair Senate subcommittees dealing with housing issues -- recently warned HUD that if it does not revamp the rules voluntarily, they may propose legislation to force the department to make the changes.

"I am deeply troubled by the department's approach," Sen. Cranston said in a speech before the Senate late last month.

"I strongly urge the department to respect the legislative intent of Congress and revise their regulations to conform to that intent," said the senator, who is chairman of the Senate Banking Committee's subcommittee on housing. HUD is scheduled to release the final version of the regulations later this month.

Last year's legislation was intended to help solve the so-called prepayment problem, which involves thousands of housing units built in the 1960s and 1970s by private developers with HUD-subsidized 40-year mortgage loans. Developers received the subsidies on the condition that they rent the units to low-income tenants for 20 years.

With a good portion of the mortgages now 20 years old, many developers want to prepay their loan balances -- thus ending the low-income requirement -- and turn the units into more expensive rental or condiminium projects, particularly in areas where land values have risen sharply over the period.

The 1990 law mandated a program under which HUD will offer financial incentives to developers if they avoid prepayment by selling the properties to entities -- mainly 501(c)(3) organizations -- whose main interest is preserving the stock of affordable housing. Housing industry officials have predicted those organizations would use mortgage loans financed by billions of dollars of tex-exempt 501(c)(3) bonds to finance their purchases.

But that may not be possible until problems in HUD's regulations are solved, according to housing lobbyists and the two lawmakers.

One problem mentioned by Sen. Cranston is the requirement that buyers offer a 1% "earnest money" deposit when they bid on a property. That kind of large initial out-of-pocket expense is likely to make purchases under the program impossible for many nonprofits, housing industry officials have warned.

Another problem is the way the regulations give top priority to tenant groups or "resident councils" as purchasers of the units. To give those groups a chance to make an offer, bids from nonprofits or other interested purchasers cannot be accepted for the first 12 months after a property goes up for bid. Such a long wait will discourage nonprofits from coming forward, industry officials have said.

Sen. Cranston and other legislators wrote to HUD in May, describing those and otehr problems with the rules. But HUD Secretary Jack Kemp responded by defending the proposed regulations, Sen. Cranston told the Senate. That left Sen. Cranston worried "that the department is unlikely to revise the regulations to conform with legislative intent."

Sen. Cranston delivered his speech during a debate over the Senate's version of the fiscal 1992 HUD appropriations bill. Sen. Mikulski, who chairs the Senate sub-committee that oversees HUD appropriations, told Sen. Cranston she shared his concern and urged the department to revamp their rules before Congress takes final action on the appropriations bill in the fall.

At that time, housing lawmakers will meet to resolve differences between the House and Senate versions of the appropriations measure, offering an opportunity for Sen. Mikulski and Sen. Cranston to insert language ordering HUD to change the regulations.

The senators' conversation is significant because "it says to HUD 'You're on notice this is going to be done in conference if you don't do it on your own,'" said a lobbyist who asked not to be identified.

Failing to change the rules would mean "there will be real funding gaps that can't be filled by 501(c)(3) bonds alone," said Robin Salomon, a housing lobbyist with the law firm of Brownstein, Zeidman & Schomer.

"The only other sources out there are state and local governments or the low-income housing tax credit. Unfortunately, governments are broke, and HUD is doing its best to discourage use of the credit," Mr. Salomon said.

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