Authors: Ryan Allen, Susan Bergmann and Max Geitz
The USDA Section 515 multifamily subsidized housing program is a longstanding and vital component of the affordable housing stock in rural communities in the U.S. With a track record of over 50 years, the Section 515 program has successfully created subsidized housing to support low-income households across most counties in Minnesota. Indeed, in some cases it is likely that housing projects in the Section 515 program represent the majority of subsidized housing in these counties. The program’s emphasis on smaller scale, less dense housing projects fits well in the rural context and, when paired with additional subsidies from other USDA programs, has been vital for supporting very low income households.
Despite the successes of this program, it currently faces substantial challenges. A large portion of the housing units in the Section 515 program in Minnesota will soon be eligible to leave the program and adjust to market-rate rents, potentially reducing the supply of the limited subsidized housing in rural areas and creating housing instability and other forms of hardship for current tenants. In addition to the potential exit of housing units from the program in the future, the program has recently been buffeted by changing economic conditions and demographic trends in Minnesota resulting in fluctuating demand for housing in different regions of the state. Some projects are increasingly characterized by obsolescence because of deteriorating physical condition and a lack of amenities that are increasingly expected in contemporary housing. Complex bureaucratic rules and procedures governing the Section 515 program have produced discontent among a portion of the owners of housing projects in the program, potentially increasing the proportion of owners who would like to exit the program.
This report uses data from over 30 interviews with stakeholders in the Section 515 program in Minnesota, including owners of Section 515 properties, housing advocates, and government officials, to investigate several questions: First, what needs does the Section 515 program serve in Minnesota? Second, what currently works well in the Section 515 program and what are areas of improvement? Third, what are the owner's motivations for being a part of the Section 515 program and how have these motivations changed over time? Together, answers to these questions help to define potential actions that could improve the experiences of owners and tenants of Section 515 properties, and reduce the exit of properties from the program in the future.
In this report we describe several noteworthy findings based on the stakeholder interviews we conducted:
- Substantial differences exist in the motivations of limited profit and nonprofit owners of the Section 515 properties, with the former motivated primarily by profit and tax benefits and the latter more interested in preserving affordable housing in the communities where they operate.
- When combined with common perceptions of owners that the Section 515 program is difficult to navigate and that the transfer of Section 515 properties is slow and cumbersome, the motivation to remain in the program has waned for limited profit owners, but remained constant, if not increased, for nonprofit owners.
- Long term trends and changes in tenants have resulted in a larger proportion of families and individuals with disabilities living in Section 515 properties.
- Stakeholders perceived structural flaws in the Section 515 program, such as insufficient capital reserve requirements, that have resulted in substantial deferred maintenance in many properties and the prospect of obsolescence in some.
- Frustrations with the complexity of transferring ownership of Section 515 properties, the inflexibility of rental assistance subsidies attached to some Section 515 units, and limitations on an owner’s ability to layer different subsidies onto Section 515 housing units to increase its affordability were also prominent points made by Section 515 program stakeholders.
Evolution of the Section 515 program
Generally, stakeholders had positive assessments of the intentions and origins of the Section 515 program. Many stakeholders indicated that the program served the vital need of providing affordable housing in rural communities, where subsidized housing was especially scarce. In addition to being attractive to mission-driven, nonprofit housing providers, the Section 515 program, in combination with the LIHTC and the allowance of accelerated depreciation, offered an attractive product for profit-driven, limited-profit developers. However, in the 1980s the landscape for Rural Development and, consequently, the relationship of stakeholders to the program, changed dramatically. As a result, many interviewees perceived that changes in the market and in the program itself had made it less attractive to owners.
Section 515 property owners can be divided into two major groups: for-profit owners and mission-driven owners (primarily nonprofit organizations and local housing authorities). In many cases, for-profit owners we interviewed were the original developers of their properties and thus had decades of experience with the program. Given the significant gap between the low interest rates charged on Section 515 property development loans in comparison with prevailing market interest rates at the time, the loan product used to create Section 515 projects was highly desirable at the program’s inception. Accelerated depreciation, along with cash flow from tenants often underserved by other developers (e.g., rural single mothers, rural elderly) could help for-profit owners turn a steady profit. Stakeholders who worked with former owners indicated that small-scale owners, who may have owned only a single property with fewer than ten units or who lacked experience in real estate, viewed their Section 515 properties as an investment vehicle with an eye toward eventual retirement. Mission-driven stakeholders we interviewed purchased the majority of the properties in their portfolio from original owners in order to preserve affordable housing in their community. Both mission-driven owners and the majority of profit-driven owners agreed that an important goal of investing in Section 515 properties was to provide affordable, decent housing for a population underserved by the market.
Interviewees indicated that changes in the rural economy, as well as USDA disinvestment and other Section 515 amendments, had made the program less attractive to owners. The 1980s agricultural crisis led to high rural housing vacancies, while the 1986 Tax Credit Act changed the profitability mechanism of owners from accelerated depreciation to tax credits. In addition, funding to expand the program stalled in Congress, resulting in a substantial slowing of the construction of new Section 515 housing. Interviewees noted that changing the original twenty year affordability compliance periods to a fifty year affordability compliance period in the 1990s prevented many owners from exiting the program according to their original timelines.
Many stakeholders referenced, or even participated in, Franconia Associates v. United States, 536 U.S. 129, 19, a 2002 Supreme Court case that focused on the right of investors in affordable housing projects to prepay their mortgages and exit the program. The case involved provisions of the Emergency Low Income Housing Preservation Act of 1987, which prohibited the Farmers Home Administration (the original agency overseeing Section 515 before USDA Rural Development) from accepting mortgage prepayment for new loans unless the developer agreed to maintain the units for low-income renters for 20 years. Plaintiffs argued that this provision of the legislation violated property owners’ rights to prepay on their own timeline, representing a breach of the original contract that had been motivated by pressure from low-income housing coalitions. One owner indicated that other profit-driven owners quit developing housing in the Section 515 program as a result of this decision, as it had “soured us on the program pretty good.” This owner suggested that allowing prepayment of the loans would increase the amount of funding available to the government to make new loans, which would allow developers to re-invest money towards new low-income housing to the benefit of everyone. As a result of the lawsuit, owners had the option of taking a cash settlement contingent on keeping their units in the program until the maturity of the loan. According to one interviewee, of approximately 14,400 units in Minnesota, 4,000 left the program under this agreement.
Motivations to participate in the Section 515 program have changed dramatically in recent years among for-profit owners. Most for-profit developers we interviewed expressed a desire to “be done” with the program--their continued involvement was a result of policy restrictions and program exit/transfer rules rather than continued profit. Stakeholders who did express interest in funding or developing more rural housing no longer seemed to conceive of Section 515 as an effective program to earn a reasonable profit. As one nonprofit owner spoke of involvement in the program, “[you] need to do it [invest in the program] more as a mission than…[because] it's a great investment, because it's not a great investment.” For-profit owners argued that obligations to the Section 515 program meant the property and its restrictions could continue past the original owner’s life or capacity, leading to the properties being passed on to their children against the will of both the owner and the prospective heirs. The clock ticking down towards the future of properties after the owners’ death was not just a concern to the owners and their families, but also to mission-driven buyers racing against the clock to acquire properties via a transfer before the estate became infinitely more complicated.
Economic and Demographic Changes
After the intense initial development phase in Minnesota during the 1970s, the Section 515 program stabilized and became subject to changes occurring in communities, including changes to local economies, the aging of local populations, and the increased importance of proximity to large urban areas driving labor and housing markets. The economic health of communities across the state has grown increasingly uneven in recent decades. The Southwest and West Central regions experienced declining economies in recent decades. As economic opportunities decreased, out-migration increasingly resulted in slow, or in some cases even negative, population growth, and an aging population. The North and Central regions, however, were more likely to experience economic stability and growth. Larger companies in these communities, such as Polaris and DigiKey, provided employment and drew younger people. Population growth was seen not only in regions with employment opportunities, but also in micropolitan and rural communities surrounding regional growth centers, such as Rochester, Mankato, St. Cloud, and Duluth.
Section 515 properties were directly impacted by these changes. In areas with less vibrant economies and population growth, Section 515 properties may struggle due to lack of investment. A Section 515 consultant noted:
It's kind of a vicious cycle as that population declines. So there starts to be some occupancy issues, there's then not enough money to fix the property, the property goes into decline, and then you can never get people to come because of the condition of the property.
On the other hand, keeping a property in the Section 515 program in thriving areas of the state was less attractive for some owners given the possibility of higher market-rate rents. A long-time advocate of the Section 515 program recognized the financial incentive for owners near economically vibrant regional hubs to leave the 515 program, commenting, “…whatever their current [rental] rates are…they could probably triple them [in the private market].”
Demand: The Need for Section 515 Housing
Given the changes in communities over time, those interviewed speculated whether there was still a need for this type of housing. Of those who addressed this question, the majority stressed the integral role that Section 515 properties play in communities. One owner identified a 700 unit gap between the number of households needing affordable housing and the number of affordable housing units available in their county. In fact, about one-third of interviewees noted that the Section 515 property might be the only affordable housing within a community or for miles around and others emphasized that the housing was particularly important for seniors and people with disabilities. A mission-driven owner with a small portfolio emphasized that “the rural development properties are very, very good at helping rural communities with very, very low-income people. It keeps people in the communities that they live in and gives them an option to live there at an affordable rate.” Because one property might be serving a large geographic area, the availability of this property had a larger impact on the population than if other affordable housing options were available. As a consultant working in a set of small communities pointed out, “if you have some of these small communities where there's only a couple multifamily properties and one [Section 515 property]...exits the program and converts to market rate, it's a concern.” Waitlists for Housing Choice Vouchers in many areas were long and, as one advocate explained, often carried a negative stigma among many landlords. Section 515 provided an alternative to vouchers as an affordable housing option, while also providing the perception that the tenant was financially self-sufficient. Respondents emphasized that the Section 515 program was unique in that it provided for deep subsidies; no other housing in their communities did so.
Other interviewees recognized the need for Section 515 projects was contingent upon each community’s economic health and population size. For example, some interviewees discussed the impracticality of keeping a property in the Section 515 program when it was located in a community with a small and declining population that resulted in difficulties filling vacancies when they occurred. A small number of interviewees believed that the Section 515 program was no longer viable, citing small populations unable to fill the units and the availability of other affordable housing alternatives. A for-profit owner said:
Every little town has got some type [of affordable housing]…either the churches built some type of housing project for elderly, but there's plenty of housing. Plus, you know, there is also tax credit housing, with market rate housing…I think some of the requirements are that 20 percent has to be low income in these projects. So, I don't think there's a need anymore as there was at one time.
Finally, some interviewees pointed out that Section 515 properties lacked amenities, which encouraged tenants to secure alternative housing. For example, one interviewee noted that in some communities with low housing values, single-family homes were within reach for upper income 515 tenants. Another interviewee argued that elderly tenants often found new assisted living facilities in their communities more appealing given the level of services and support available there.
Supply: The State of Section 515 Housing Units
Interviewees identified several factors that have caused a decrease in the supply of Section 515 housing. Some owners prepaid their mortgages and removed properties from the program, while other owners involved in a failed transfer transaction have, where possible, resorted to selling the property outside of the USDA transfer process. Rehabbing properties frequently costs more than its value, causing some properties to be considered for demolition. Finally, counties with hot housing markets were experiencing increases in rents that made remaining in the Section 515 program unattractive. For example, some counties, such as Koochiching and Itasca, had an influx of pipeline workers and property owners recognized they could capture higher rents if they left the Section 515 program.
Not only were properties removed from the program, but no new units have entered the program in recent decades and many of the remaining units have sunk into disrepair. One interviewee argued that when the properties were originally built in the 1960s and 1970s, although USDA construction-approved materials were used, the properties were of average to lower quality. These buildings, now 50 years old, suffer from deferred maintenance due to the low capital reserves required by USDA. A mission-driven owner noted one property at risk of the roof caving in and identified two other properties that might need to be demolished due to their lack of structural integrity.
One interviewee saw the wide distribution of Section 515 properties around Minnesota as an advantage at the start of the program because it provided a small amount of needed housing to a relatively large number of communities. Now, the small scale, distributed nature of the Section 515 program in Minnesota has created maintenance problems for owners because of insufficient scale in the number of housing units to make repairs financially viable. Additionally, owners have had difficulty identifying and recruiting skilled laborers to perform maintenance tasks in some particularly small or isolated communities.
As the community and economy changed over time, interviewees saw a parallel set of changes in tenant demographic characteristics. Interviewees perceived that Section 515 housing currently serves an increased number and proportion of households with younger tenants, families, and individuals with disabilities. In some cases, demographic changes within Section 515 properties have precipitated friction between tenants and increased complaints about management. During the pandemic, property owners have typically experienced little change in rates of rent collection as many of their tenants received rental assistance. However, the COVID-19 pandemic sometimes had a substantial effect on the general operations of the property, including reduced turnover in units.
Some interviewees noted that long-term elderly tenants electing to move to assisted living facilities increased vacancies and created pressure to house younger families. One owner mentioned that the long-term residency of tenants tended to be among the elderly, with some having lived in the property for over 20 years. In some communities, Section 515 properties with a large proportion of elderly tenants assumed the role of retirement homes. Property owners perceived a shift from elderly tenants to younger families, particularly single mothers, in recent years. In some cases this shift was dramatic, prompting several owners to consider converting their properties to a family designation. This type of change was sometimes associated with increased friction between tenants in a Section 515 property. For example, one owner who made the designation switch noted that “[the younger adults] started smoking pot, not keeping up the building…being noisy, all that fighting, having kids, all this kind of thing. So then of course the old people got mad. They were fighting and it led to a lot of trouble and just went downhill.”
Another change owners experienced was the increase in tenants with disabilities, primarily mental illness. This shift caused changes within the dynamics of the properties. One interviewee reported:
One of the biggest changes over the forty years I've been around the program is the growth of handicapped and disabled individuals who are part of the property. You know, it used to be about four or five percent of the tenants would be classified or declare themselves handicapped or disabled and now it's up to a third.
One advocate reported that people with companion animals have been harassed. Owners reported concern over the need to connect residents with proper resources or recovery programs. This need has increased property managers’ workload, requiring them to become familiar with resources and de-escalating tensions between tenants that previously were unnecessary. Owners also reported needing to make physical changes in projects to make some units accessible according to American Disabilities Act (ADA) requirements.
Although interviewees did not indicate the racial or ethnic composition of their properties, one interviewee discussed concerns about equality for residents of color. She perceived that management culture and unpleasant interactions with other tenants led residents of color to leave, indicating one Black woman left a Section 515 property in just under three months and one Hispanic woman left within two months. Filings had been made with legal advocacy groups in order for some tenants to keep their housing. An advocate stated, “I think that there is something else going on...that it gives the illusion that it's equal opportunity housing, but people of color are not able to sustain their housing.”
Impact of COVID
The largest impacts of the COVID-19 pandemic have been in property management. Because the impacts of COVID-19 were unforeseeable, RD allowed owners to forego their mortgage payments and reserve deposits for three months. Interviewees mentioned these concessions and indicated how it helped maintain their cash flow. However, most interviewees indicated they had no problems collecting rents. They attributed this to the deep subsidy associated with these properties and the support provided by Social Security and other federal safety net programs. The rental assistance adjusted as incomes changed. If a tenant lost their job, this subsidy paid for rent and utilities when the income reached zero. The subsidized portion of rent payment was sent directly from the county offices to property management – although there was a period at the beginning of the pandemic when even these subsidized amounts were not being sent by the USDA, worrying some property owners.
Adjustments to policies and activities were made by management in response to the needs of tenants or to follow the Center for Disease Control and Prevention (CDC) recommendations. A nonprofit owner managing a large portfolio noted, “we've had to adjust policies and how we collect payments and how we connect with residents.” For example, an improved dropbox was installed with more frequent checking, different cleaning methods were launched, and common spaces were closed. Property owners and managers rearranged budgets to account for new expenses on sanitation and PPE for staff. In addition, maintenance and building inspections were delayed as outside individuals were prevented from entering the buildings or units for safety reasons. Turnover rates were lower than normal, so upgrades and refreshing units after a tenant moved were reduced. And previously deferred maintenance created unique issues: a for-profit property manager discussed how individuals experiencing homelessness found their way into their older properties without secured entrances and were squatting in the hallways. Although some of these changes saved money in the short term, there was concern that at the end of the pandemic, some of these older properties would be in poorer quality, construction costs would remain high and contractors would be stretched to accommodate the increased maintenance demands. Additionally, owners anticipated an increased turnover as tenants felt safer moving, creating a deluge of costs associated with unit turnover, including advertising for and screening new tenants and refurbishing units to prepare them for a new tenant.
Though it was rarely a prominent issue described by property owners we interviewed, some owners reported having trouble collecting rent from a few tenants. They surmised that the eviction moratorium gave tenants “permission” to not pay, without fear of losing their housing. A for-profit owner with a large portfolio expressed how the pandemic has affected their rent collections:
We started off with two percent of the people not paying and we went to five percent of the people not paying, and right now we're at about 12 percent of the tenants don't pay us any rent. And we can't do anything about it...they never pay you back, you lose the money, you can't collect it and even if you could win, if you could go to court and win - which you can[‘t] - we can't collect it…he owes us $12,880 right now…There’s no chance of him paying that.
The quality and availability of housing stock was primarily influenced by property age and USDA capital reserve requirements. Many stakeholders discussed numerous strategies to preserve cases of buildings experiencing obsolescence.
Section 515 rents targeted very low to moderate income tenants. To ensure rents remained low, USDA placed requirements on the level of capital reserves allowed, writing this level into the mortgage documents. Many respondents highlighted the capital reserve requirements as a crucially flawed part of the program. A long-time housing advocate argued “…the reserves that owners are required to maintain in order to invest in their properties are pretty low, and lower probably than what you would want to have to run a good multifamily property. So that can lead to serious issues.” A long-time Section 515 consultant noted that owners were “supposed to build the reserves up to 10 percent of the initial project cost,” but primarily due to low rents, “owners never could build a decent reserve.” A small-scale, mission-driven owner offered, seemingly the only solution as an owner: “You have to amend your mortgage in order to put more money into your replacement reserve.” Due to these highly restrictive deposit requirements, a large-scale for-profit property manager speculated “[USDA] didn't want the project to have any money because then it was raising how much rental assistance the government would have to put back in the building.”
Other capital reserve deposit requirements resulted in negative consequences for properties and owners. At one point during the life of the program, the USDA forced owners to spend down the reserve account, leaving owners with large, unexpected expenditures and depleted reserves. Owners lent their own money to their management companies so large repairs could be made. Additionally, USDA did not include an inflation factor on the reserves deposit calculations. Owners who tried to mitigate these issues by placing more money in the reserve account recounted how they were faced with penalties for doing so. Current owners’ potential solutions to the inadequate capital reserve problem include applying for grant money, removing properties from the program, and seeking bank loans for refurbishing the building, resulting in the property entering the middle market and replacing existing tenants with higher earning residents. Healthier reserve amounts have been received when properties enter the transfer process. This is a result of these properties undergoing a required capital needs assessment (CNA) that requires higher underwriting standards than RD had in place. For example, the CNA ensured that ADA standards were met and replacements for appliances/furnaces/etc. were placed on faster schedules.
The poor quality and condition of 515 properties was discussed by many interviewees. Some seemed resolved that this is the nature of the properties; one government official mentioned, “we're just going into this assuming that the properties are old and that they need…pretty significant repairs.” Other stakeholders, disturbed by the lack of funding to help with upkeep, reached out to state representatives. A small-scale, for-profit owner invited his representative to take a tour; “it was at the point where I brought the state person down to [one of my properties]...I mean it [the quality] was disturbing.” Another respondent mentioned one city considering demolition for the two Section 515 properties in their community. A large-scale, for-profit owner summarized the opinions of many: “[Section 515 properties] are really not much value. They’re not something that appreciates in reality.”
Several factors have contributed to the deteriorating quality of properties. Minnesota was one of the first states to really engage with the Section 515 program in the 1970s. A long-time Section 515 advocate stated “it is to a considerable extent a function of the age of the housing…Minnesota was a leader in building the first 515 housing projects so it's got some of the oldest in the country.” In addition, some respondents pointed out the initial construction was not of high quality. Standards, including the quality of the classic USDA T1-11 production materials, were lower than market rate projects. A Section 515 advocate mentioned other housing organizations held stricter architectural standards than USDA. As a result, Section 515 property designs were unique and unusual materials were used in the initial construction--a mission-driven owner who had acquired properties from original developers cited metal windows as one of these non-standard items they were now contending with for repairs. The rising costs of building materials and labor, especially prevalent during COVID, increased maintenance budgets substantially. Likewise, the availability of labor was problematic. In these rural areas, acquiring a maintenance person with a range of skills and willingness to travel among scattered sites proved challenging for some property managers.
Other factors associated with the high level of perceived obsolescence of Section 515 properties included low capital reserve requirements, a perception that USDA staff was not monitoring physical conditions of Section 515 properties, and a lack of timely capital needs assessments at Section 515 properties. Both a consultant and a mission-driven owner acknowledged that long-term owners were part of the reason that buildings were not kept up. Many of these owners were no longer interested in actively managing or maintaining them and instead just wanted to get out of the program. One small-scale, mission driven owner summed up property obsolescence succinctly: “Not enough people, not enough money, not enough anything.”
The context in which the Section 515 properties exist has been molded not only by the economic and population changes over time, but also by the USDA rules and regulations that govern the program. Most stakeholders interviewed expressed some level of frustration with the amount of USDA bureaucracy embedded in the Section 515 program, with a specific focus on rules concerning the exit/transfer process, rental assistance, interfacing with other affordable housing programs. There was a great deal of concern expressed with the new RD reorganization within USDA, moving from a local-state structure to a regional structure. This new reorganization only compounded the frustrations respondents already had with the USDA regulations.
Program Exit/Transfer Rules
“Exiting the program is easier said than done.” Long-time Section 515 Consultant
“The best way out of an RD property is to die.” Large-Scale, For-Profit, Portfolio Property Manager
Withdrawing from the USDA Section 515 program lacks a straightforward, easy to understand process. This contributed to lengthy transaction times, substantial frustration and anger among participants, and owners finding easier ways out, often resulting in removing affordability from the property. A small-scale, mission-driven owner surmised that the reason for this cumbersome process was due to the USDA not wanting owners to sell their properties, as no new units are being built and the USDA does not know where to place these tenants.
Much of the frustration voiced by stakeholders in the Section 515 program focused on the unwieldy nature of the property transfer process. To begin a transfer, sellers are required to submit a lengthy application indicating intent to transfer so USDA can determine if the property is eligible to exit the program. Sellers must have a capital needs assessment (CNA) completed by an RD-approved assessor, enumerate capital needs for the next 20 years, and submit a 20 year budget indicating how these capital needs will be paid for. Three separate appraisals are required: one at market rate and two done post-rehab – one that assumes tenants will be low-income and the other that assumes tenants will be at market incomes. Another USDA rule requires a seller to offer the 515 property first to a nonprofit buyer, limiting the amount the nonprofit is allowed to pay for the property. A small-scale, mission driven owner was frustrated by these restrictions, “How can they [USDA] force you to sell it to somebody and then limit them on what they can pay?” Buyers are also subject to USDA rules. They must indicate to USDA their interest in a property, described as an application with 40 separate documents, each of which has multiple attachments. Respondents on both sides of the sale indicated that signatures, interpreting emails, and application review all required legal counsel, adding to the cost. Every step of the transfer process takes one to two months to complete and is most often a cost to the seller.
The length of time to execute a transfer makes the process unwieldy and expensive. A Section 515 advocate noted that “there's a timeline that we've developed that suggests that the average time to go from start to finish on one of these transfers is about 24 months.” This two-year period was confirmed by many respondents who had been involved with a transfer. Although exceptions were provided, none of the exceptions indicated shorter timeframes. In some cases, interviewees described delays in the transfer process they found particularly egregious. For example, a long-time Section 515 consultant shared the story of one owner calling to complain about the lengthy process of trying to transfer one of her properties; her application had been sitting in the USDA’s inbox for six years due to a capital improvement issue. As another interviewee related:
I mean it's so far from the normal real estate transactions. And I think…that's on RD too, because they have these crazy rules…specifically around the transfer process and how long it takes and all that stuff. And people don't understand it until they are knee deep into it and realize…holy crap, this is two and a half years and we still haven't closed.
Timing affected original assessments on capital needs. For example, due to the rising costs of construction, especially during the pandemic, owners had to go back to their contractors for updated estimates. The revised rehab costs often required more investment than what was noted a year earlier, complicating transfer processes. A long-time Section 515 consultant pointed out the consequences of not receiving funding: “If you don't have it [additional funding]...the transfer just stops.”
This minimum two-year process led to a lot of ambiguity for all parties. A Section 515 consultant noted that “there is a reluctance from the buyers to even meet with the tenants, because it feels like, you know if this thing takes two years, there's a really high chance that it could fall apart.” Several respondents told stories of how owners withdrew from the transfer process either due to impatience that the sale was not finalized or due to uneasiness with the numerous requirements needing to be fulfilled. For example, the USDA requires owners to notify tenants of the “intent to sell.” Long-term owners, ready to get out of the program immediately, have been stymied, not just by this notice, but by the requirement that it be issued a year in advance. Interviewees also noted that some property owners, given the rigid rules governing Section 515 sales, chose to sell their properties at market rate as an easier alternative. One interviewee succinctly stated what many alluded to, saying “[USDA has] got to streamline the process and make it easier or owners are going to walk away.”
In addition to transferring a Section 515 project, another way owners exit the Section 515 program is through the prepayment process. Prepayment can be a threat to maintaining low rents for tenants, depending how an owner chooses to prepay: with use restrictions or without use restrictions. “With use restrictions” allow tenants to maintain assistance for rent by replacing their rental assistance with a voucher. These vouchers may be used with their current unit, or a tenant may move to a different building accepting these vouchers. “Without use restrictions” leaves a tenant with no rental assistance. Other regulations must be satisfied before prepayment can be approved. For example, a racial minority impact analysis must be conducted to determine if units lost through prepayment will have a detrimental impact on racial minorities within the community. If the analysis determines there will be an impact, the owner is required to offer the building for sale first to a nonprofit.
Although still a viable option, prepayment does not seem as attractive as more mortgages on Section 515 properties reach maturity. Another reason owners may not opt for prepayment may be due to the agreement made during the lawsuit, Franconia Associates v. United States, 536 U.S. 129, 19 (2002). If the owner agreed to a cash settlement, they forfeited their ability to opt out early via prepayment. And yet another reason for diminishing numbers of prepayments was given by one for-profit owner, “you cannot prepay them - there's no market, nobody wants to buy ‘em anymore either.”
Rental Assistance Rules
Although Section 515 properties are structured to provide subsidized rents, units within these properties can have rents further reduced through rental assistance provided by USDA. This subsidy is based on tenant’s income, making up the difference between thirty percent of the tenant’s income and the rent amount. The benefit of this rental assistance for the owner is guaranteed revenue. Tenants benefit by avoiding hardships if their income is reduced.
The high demand for rental assistance units has resulted in lengthy waitlists. An added complication for low-income individuals waiting to access Section 515 housing is the USDA rule requiring open rental assistance units be offered first to existing tenants. In practice, this means that if a rental assistance (RA) unit becomes available, a tenant in a non-RA unit who is paying more than thirty percent of their income on rent is offered the unit before someone on the waitlist. As a result, the units that tend to get rented out are those without rental assistance, where rent is set at an RD market rate somewhere between basic rate and note rate rent. It is harder to rent these units because there is no associated subsidy.
Unlike Section 8 vouchers which are determined by market rate rents, USDA rental assistance is based on a budget determined by the structure of the mortgage. Thus, when the mortgage ends, so does the rental assistance. Currently, there is an effort in Congress to separate, or “decouple,” rental assistance from Section 515 properties, allowing rental assistance to remain with a project after the life of the mortgage. A Section 515 advocate promoted this idea, noting that “decoupling the RD rental assistance from…the 515 mortgage would help a lot, especially if the state had control of where that rental assistance goes.” At the same time, the advocate warned that rules about what happens to tenants after a prepayment could complicate this decoupling process and potentially leave tenants in a bad situation.
When properties exit the program due to a mature mortgage, transferring the property or re-amortizing the mortgage are the primary options to keep it within the Section 515 program, ensuring rental assistance will not be lost. Many respondents were concerned with the fact that large numbers of properties are due to mature and this rental assistance may leave, not only the property, but the state. Some fear it will be harder to keep RA in Minnesota now that USDA has regionalized its offices and processes. When properties exit the program due to prepayment or foreclosure, tenants have some protections. Tenants receiving rental assistance are offered vouchers, though the voucher amount is established at the time of prepayment or foreclosure and remains a fixed amount. Thus, as rents increase over time, the voucher amount does not, creating potential affordability problems for households with employment and income in flux.
When rental assistance is unused for over six months, USDA reserves the right to remove that assistance and assign it to another property with the greatest need. Because federal funds are limited for rental assistance, owners fear they will never be able to gain back subsidies once they are removed. A large-scale, for-profit property manager stated that “when we get notified that they're going to take it away, you can request an appeal. We always appeal them because that buys us a couple more months and hopefully we can get somebody's name on that rental assistance unit.” Respondents indicated various reasons why rental assistance may go unused. For example, an RD unit may not utilize both rental assistance and a voucher. A tenant moving in with a voucher is more likely to maintain the voucher subsidy as this is transferable to other properties, including non-RD properties. Another reason given was the cyclical nature of some small communities. During the down cycle, Section 515 properties are more at risk for losing their rental assistance. A for-profit property manager of a large portfolio expressed frustration with USDA’s rule: “If you're in a down time and you're not using your RA, and so you're already struggling, and then they take their rental assistance away, I mean they're just driving the stake in the coffin.” However, respondents did understand the reasoning behind USDA’s action of RA re-assignment, as a for-profit owner indicated “I see the other side of it too, you know. If we have rental assistance we’re sitting on and they have to reassign it to somebody that can use it right away, I mean that's a good thing too for the person that needs it.”
Interfacing with Other Affordable Housing Programs
RD’s rental assistance does not allow layering of numerous subsidy programs within a unit. Nevertheless, two other rent subsidy programs, Section 8 vouchers and Section 811 subsidies, were highlighted as programs that had desirable characteristics. Several respondents discussed the desire to see Section 515 vouchers become structured similarly to HUD’s Section 8 vouchers to allow flexibility and mobility for tenants, but also recognized that not all communities had units accepting Section 8 vouchers and those areas that did accept them had very long waitlists. Some stakeholders also pointed toward the tiered rent structure allowed by Section 811 rental assistance as a desirable change in the Section 515 program. In general, Section 811 requires rents even lower than Section 515 rents. In non-515 properties, some units are set at Section 811 rent rates while other units are set at higher rents. Because Section 515 properties require the same rent rate per unit type within a property, this tiered rent schedule is not allowed.
The Section 515 program is not sufficient on its own to support the capital needs of the properties. Searching out and applying for other sources of funding led to an additional layer of complexity as owners had to learn and abide by these sources’ rules and regulations and then coordinate this funding within the Section 515 regulations. One Section 515 consultant expressed what an owner might experience when seeking additional funding to support capital needs in their properties:
I'm an owner that's doing my own property management or maybe working with a local realtor or smaller firm, I'm not going to understand the complexity of some of those programs. And let's be honest, like every application takes time in terms of all those pieces, it doesn't happen quickly, you know you're talking a couple year process [with] applications...And even too, you can apply for the funds and then you get them, then you can go through a closing process with more documentation, and so it is not, by any means, easy.
There were many alternative sources of funding respondents knew about or had accessed. These included the Rural Guarantee Program, Home Rental Rehab Program (later called Rental Rehabilitation Deferred Loan or RRDL), DEED (Small Cities), HOME, Minnesota Housing, and Greater Minnesota Housing Fund. Other sources included Community Action Agencies, Community Facilities Program, weatherization applying to multifamily properties, and utility companies’ programs.
Navigating these multiple sources of funding was not without issues. As these funds are limited, owners must compete to access this money. Additionally, a local realtor or smaller company may not have the understanding or resources to navigate the complexities of these programs. Organizations working with a property management company had an advantage over others, as property management companies have the time and resources to dedicate to this funding application process. One small-scale, mission-driven owner cautioned the success of accessing those RRDL dollars: “the downfall to that, though, is that you have a 515 with now three mortgages on it. Three sometimes four mortgages…well gosh, are we ever going to pay that back?”
IRS Section 42 (more well-known as the low-income housing tax credit, LIHTC) was approved in 1986 to encourage development of low-income housing. LIHTC was discussed by many respondents with three ways emerging in which tax credits were used: (1) to develop properties, (2) to rehab properties being acquired through transfer/sale, or (3) to help finance a new loan when the mortgage expires. Many recognized LIHTC as a way to secure funds for capital needs, but the deep subsidy was not provided. LIHTC was advantageous for large-scale, for-profit developers. One of these successful developers described how this program worked:
So if I built a project that cost a million dollars, million dollar mortgage, I would sell that project…the day I opened it…I sold 99 percent of it to investors under tax credit law Section 42 of the US tax code. And those investors could use the tax code to show an interest in that. So they would pay me, you know, over a million dollars. And then…I was the general partner with 1 percent interest in the project and the limited partnership had 99 percent interest. But you need to understand limited partnership law for me to go very far into this. But that's how we developed 30, 40, 50 projects, because we know how to do accelerated depreciation prior to ‘87 and tax credit development after ’87…it wasn't our money…it was federal tax policy.
One owner felt that USDA never understood the tax credit funding and syndication: “The people at USDA, when I talk about syndicating properties, they don't really understand… whereas Minnesota Housing Finance understands what I'm talking about when I go into syndication - but USDA never figured it out.” He continued, “MHFA…wanted to have a voice in rural Minnesota…they would award tax credits, they would award it to any project that USDA was giving money to for new construction. MHFA would set that aside for rural development projects. And so…we took advantage of it.”
Implementing LIHTC at the time of development led to some owners' success on their investment. Today, however, applying LIHTC for rehab purposes has posed some challenges. RD properties typically have upper limits on income between 80 and 115 percent AMI, but LIHTC reduced that to 60 percent. In addition, some interviewees described tension between Minnesota Housing, which wanted to maximize the number of units offered to households at 30 percent AMI and Rural Development Minnesota, which was uncomfortable with too many units for households at such a low level of income.
Other Section 515 Rules and Regulations
“Anytime a request is made about something, the response is tied to some explicit regulation or rule.” Small-scale, for-profit owner
Small and large-scale owners who were mission-driven and for-profit alike recognized the difficulty of understanding and interpreting the voluminous rules and regulations of the Section 515 program. Small-scale owners in particular reported confusion and substantial amounts of time required to find and interpret information. In addition to the complexity, owners complained about the inflexibility of the rules. As one large-scale, mission-driven owner stated, “There really wasn't any thinking outside of the box on RD’s side, you know, they're very much a ‘this is our manual, this is our handbook, we will quote the handbook any chance we get, and this is how you have to follow our rules.’” A small-scale, for-profit owner alluded to this issue driving owners away from this program: “[USDA] need[s] to be careful on how much regulatory action they take on these private owners. Because I know a lot of them that don't want to continue to be in the affordable housing business any longer.”
In addition to the complexity and rigidity, owners discussed a variety of other challenges related to the Section 515 rules and regulations. Integral to the regulations are the level of restrictions placed on owners. Owners perceived that these restrictions, which include restrictions on rent levels, limits on capital reserve deposits, and a cap on the annual distribution an owner can receive that has not changed since the program began, made it difficult to maintain properties. Respondents also complained about the amount of paperwork that was required for any type of regulation. One example provided was the ubiquitous documentation required to certify tenants’ eligibility to live at the property; this paperwork is required every year or when a tenant’s income changes. A for-profit owner who had developed a large number of properties since the 1960s expressed this frustration: “I dislike all the rules that they have. Every time you want to do something - so much paperwork and so much time - takes up so much time.” A long-time advocate of the program observed:
There's just been an enormous frustration on the part of owners in dealing with the bureaucracy and the regulatory scheme that they have to address…many of these owners are very small nonprofits or simply mom and pop small enterprises. You know, at a fairly unsophisticated level and they just want to be done with the government.
After shrinking visibility of the USDA in Minnesota due to a transition to a district office system within the state, the USDA completed a new round of reorganization in October 2020 that implemented a regional structure for the U.S. overall. This most recent reorganization was necessitated by reduced staffing during the last couple of federal administrations. Respondents felt the recent reorganization was rushed, as USDA seemingly wanted to get it in place before the most recent presidential election. The new regional arrangement serves Minnesota properties primarily through offices in neighboring states, but sometimes in more distant states, such as New York.
Some interviewees viewed the USDA reorganization to regional offices as problematic because it failed to preserve institutional memory. Previously, staff at USDA had a local presence and established relationships with owners in the Section 515 program. They understood the local housing market and what resources were available in specific communities. They knew who the potential buyers were and specific information about loans. This knowledge was lost in the reorganization, when links between USDA staff and specific areas and locations were severed. As stated by a Section 515 consultant, “The weakness is that they changed everything that gave [the Section 515 program] the strengths.”
A government official explained that the reorganization aligned offices to work on specific tasks and functions, which should theoretically lead to efficiencies in workflow and increases in productivity as staff members gain insights and experience working on a more narrow set of tasks. This government official pointed out that only a few transfers happened in a year and the relevant staff had to fit those “front to back” transfer processes into their other responsibilities. The reorganization plan included retraining staff so that procedures would be consistent across offices and staff would conduct supervisory visits to the properties every three years. The potential advantages gained from this reorganization were recognized by a Section 515 consultant: “the pros will build more efficiencies…[transfers] will be kind of their focus and getting them through the system faster and being able to get this done quicker.” At the same time, many large-scale, for-profit owners were skeptical of the promises of consistency across offices and establishing more efficiencies, with one large-scale, for-profit owner commenting, “It's just [an] absolutely outlandish system that's in place right now. It’s unworkable.” Two small-scale, mission-driven owners also addressed the promise of consistency among staff: “People have a different concept of how things should be done. So it's subject to interpretation…the rule should kind of be the same from person to person. So that's a little frustrating.” Her partner added, “And a little scary…who are we going to get next time, right? What is their style going to be?”
One of the biggest impacts owners felt was the interruption to their transfer or budget approval transactions. Recent changes to the transfer process resulted in the perception among owners that the transfer process has slowed considerably. For example, new underwriting groups were assigned in the middle of transfers and different requirements or priorities were being set. A large-scale, for-profit owner shared their frustration related to the transfer process:
‘Oh, your property switched’ and so, even during budgeting this year, there was a lot of confusion…and not just a different person in the same office but we got transferred to a different office somewhere else…as soon as you have someone else look at your budget, they might not approve what [a different staff member] approved last year.
Inexperience of agents also contributed to the slowdown as they learned the program, in particular, the transfer and budget processes. Many respondents were aggravated with the inexperience new staff demonstrated with the program and perceived that “nobody really knows what they're doing.” Not every respondent’s experience was frustrating. A large-scale, mission-driven owner expressed her positive experience, but with a caveat: “My experience, thus far, with our new person since the reorg has been pretty positive but, again, we had pretty much everything done…almost by the time we got to him.”
An even more extreme potential reorganization proposal was raised by several interviewees: transferring the Section 515 program from USDA to HUD. An advantage of remaining under USDA is that Section 515 would potentially receive more attention as one of USDA’s few housing programs, relative to joining HUD where it would become a small housing program among many larger housing programs. As one interviewee related:
We've had Congressional staffers who wanted to combine [Section 515] with HUD for years and years and years, but that's never been a good solution, because…[it would] move over there, and [it would] be the 14th stovepipe and [it would] never get any attention and nothing would happen.
On the other hand, an advantage of moving the program to HUD is that this agency is perceived as a better organization to manage housing programs. HUD has different sources of funding owners can access, potentially allowing better upkeep of properties.
Research findings in this report reveal that there are good reasons to be concerned about the future of the Section 515 program. As properties age, they may be subject to greater maintenance needs and given the age of most properties they often lack amenities that tenants have come to expect from contemporary housing. The large proportion of Section 515 mortgages due to mature and widespread agreement that the policies and procedures governing the Section 515 program are cumbersome and difficult to navigate suggest that maintaining the stock of subsidized housing in rural areas of Minnesota may be an increasing challenge in the future. Fortunately, local, state and federal leaders still have time to address concerns voiced by stakeholders in the Section 515 program to preserve this important resource for rural communities in Minnesota and beyond.
Appendix: Data and Methodology
This report is based on a content analysis of interviews with 32 stakeholders in the Section 515 program in Minnesota.
Participants included 17 Section 515 property owners and 15 non-owner stakeholders, including housing advocates and government officials. Section 515 property owners were identified as nonprofit, mission-driven owners and for-profit owners. Where appropriate, Section 515 property owners were further identified as having either a large or small portfolio of properties and housing units. An application was submitted and approved by the University’s Institutional Review Board (IRB) before recruitment of property owners. The remaining stakeholders were considered housing experts with specific knowledge of the Section 515 program and therefore were not considered part of this IRB process.
We recruited property owners to participate in an interview after randomly selecting property owners from a list of 515 properties with mortgages scheduled to expire within the next ten years supplied by the USDA. Letters describing the research, interview procedures, voluntary nature of participation and ensured confidentiality, contact information for questions/concerns, and a request for an interview were mailed to a total of 80 randomly selected property owners. If property owners had not responded to our invitation letter after one week, we placed follow up phone calls to those with available contact information. About 20 percent of property owners that we contacted agreed to participate in an interview.
Non-owner stakeholders were recruited in partnership with Minnesota Housing Partnership (MHP) and Minnesota Housing Justice Center. We sent emails to individuals who had participated in workshops or forums hosted by MHP, and individuals who were involved with the Section 515 program currently or formerly inviting them to participate in an interview. An explanation of the research, interview procedures, and voluntary nature of participation was included in this communication.
Participants had the option to be interviewed via a phone call or Zoom video conferencing. They were reminded that the interview would be recorded and would later be deleted after transcribing and de-identifying the interview. Interviews typically lasted between 30 and 60 minutes.
We established two sets of interview questions, one for property owners and another for non-owner stakeholders. The questions for property owners focused on their interaction with the Section 515 program – their motivations for entering the program, whether their expectations were met, and their future involvement with the program given their maturing mortgage. The non-owner stakeholders were asked how they were involved with the Section 515 program, and their perspectives on the advantages / disadvantages of the program, quality of housing stock, motivations of property investors, and tenant well-being.
Various topics emerged from these interviews and were identified as “high-level themes.” Researchers skimmed several transcripts for applicability and appropriateness of these themes, while also listing other ideas previously not identified. The initial theme list was modified and sub-themes added before actual coding began. The final five themes were Evolution of the Section 515 Program, Context Changes, Tenants, Housing Stock, and USDA Bureaucracy. Each theme had three to five associated sub-themes. Transcripts were then coded using Atlas.ti, a qualitative data analysis software program.
An important limitation of this research is tenants were not included in the stakeholder interviews. Due to COVID-19 restrictions during data collection that required working from home, in-person recruitment and interviews were not possible. Conducting tenant interviews in a virtual format was challenging given the need for computers and a strong internet connection, which many Section 515 tenants may not have. Telephone interviews of tenants were possible, but this approach was complicated by difficulty recruiting tenants due to the absence of publicly available contact information for Section 515 tenants. As would be true with any research that relies on qualitative data, we do not claim that our research findings are representative of experiences of all property owners and other stakeholders in the Section 515 program.
Sources and Endnotes
 Consult the Appendix for more detail on recruitment practices, a description of the interviewee sample, and other data and methodological questions.
 USDA, Rural Development. (2013). Housing Vouchers. Washington, DC. https://www.rd.usda.gov/sites/default/files/fact-sheet/RHSHousingVouchers_1873.pdf