HUD issues Reserve for Replacement guidance for Mark-to-Market properties

by Richard Michael Price on Oct 26, 2011

This article is reprinted with the permission of Nixon Peabody LLP

Late last week HUD distributed copies of its October 19, 2011, dated Notice H-2011-30 instructing HUD staff and project owners on how to use Reserve for Replacement Accounts in restructured Mark-to-Market properties. The genesis of this Notice was the ongoing discussion about the proper use of Reserve for Replacement accounts when HUD asset managers emphasize spending operating funds on project upkeep, while the Office of Assisted Housing Preservation (“OAHP”) staff have been optimizing surplus cash distributions.

The Notice generally discusses the Mark-to-Market transaction structure and underwriting, noting that the underwriting anticipated certain expenses to be paid from the Reserve for Replacement account. In essence, failure or delay in paying underwritten activities from the Reserve for Replacement account leads to more operating funds used for those purposes, and that in turn leads to less surplus cash. The Mortgage Restructuring Mortgages (“MRM”), or the “soft second loans,” generated by the Mark-to-Market process are paid based on surplus cash. The Notice discusses IRS Revenue Ruling 98-34 and notes that the MRM needs to be reasonably prepayable to be considered “real debt.” This discussion ignores prior OAHP policy that the MRM is considered new debt and not replacement debt.

The Notice also contains an appeal process if an owner believes there is insufficient Reserve for Replacement funding. Specifically, an owner can ask the local HUD office to use operating income to pay for specific capital improvements. An owner can also request an increase in the monthly deposit to the Reserve for Replacement account to pay for costs not previously taken into account in the underwriting. These requests would have to be prospective and for the same fiscal year so as not to affect surplus cash in other years.

If you have any questions about this Alert, please contact Richard Michael Price at 202-585-8716 or, or your regular Nixon Peabody LLP attorney.

The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

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