[Federal Register Volume 71, Number 54 (Tuesday, March 21, 2006)]
[Rules and Regulations]
[Pages 14328-14353]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-2621]



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Part III





Department of Housing and Urban Development





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24 CFR Part 972



Conversion of Developments From Public Housing Stock; Methodology for 
Comparing Costs of Public Housing and Tenant-Based Assistance; Final 
Rule

  Federal Register / Vol. 71, No. 54 / Tuesday, March 21, 2006 / Rules 
and Regulations  

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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 972

[Docket No. FR-4718-F-02]
RIN 2577-AC33


Conversion of Developments From Public Housing Stock; Methodology 
for Comparing Costs of Public Housing and Tenant-Based Assistance

AGENCY: Office of the Assistant Secretary for Public and Indian 
Housing, HUD.

ACTION: Final rule.

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SUMMARY: This final rule provides the cost methodology that public 
housing agencies (PHAs) are required to use under HUD's regulations 
governing required and voluntary conversion of public housing 
developments to tenant-based assistance. Both programs require PHAs, 
before undertaking any conversion activity, to compare the cost of 
providing tenant-based assistance with the cost of continuing to 
operate the development as public housing.

DATES: Effective Date: April 20, 2006.

FOR FURTHER INFORMATION CONTACT: Bessy Kong, Deputy Assistant Secretary 
for Policy, Program, and Legislative Initiatives, Department of Housing 
and Urban Development, Office of Public and Indian Housing, 451 Seventh 
Street, SW., Room 4116, Washington, DC 20410-5000; telephone (202) 708-
0713 (this is not a toll-free telephone number). Persons with hearing 
or speech impairments may access this number via TTY by calling the 
toll-free Federal Information Relay Service at 1-800-877-8339.

SUPPLEMENTARY INFORMATION:

I. Background

    On September 17, 2003, HUD published a proposed rule (68 FR 54624) 
to establish the cost methodology that public housing agencies (PHAs) 
must use under HUD's programs for the required and voluntary conversion 
of public housing developments to tenant-based assistance. The Quality 
Housing and Work Responsibility Act of 1998 (title V of the Fiscal Year 
1999 HUD Appropriations Act; Pub. L. 105-276, approved October 21, 
1998) (QHWRA) authorized the two conversion programs. Both programs 
require that PHAs, before undertaking any conversion activity, compare 
the cost of providing tenant-based assistance with the cost of 
continuing to operate the development as public housing. The 
methodology would be codified as an appendix to 24 CFR part 972, which 
contains the regulations for the required and voluntary conversion 
programs.
    The required conversion program is authorized under section 537 of 
QHWRA, which added a new section 33 to the United States Housing Act of 
1937 (42 U.S.C. 1437 et seq.) (1937 Act). Section 33 requires PHAs to 
annually review their public housing inventory and identify distressed 
developments that must be removed from the public housing inventory. If 
it would be more expensive to modernize and operate a distressed 
development for its remaining useful life than to provide tenant-based 
assistance to all residents, or the PHA cannot assure the long-term 
viability of a distressed development, then it must develop and carry 
out a plan to remove the development from its public housing inventory 
and convert it to tenant-based assistance. The regulations for the 
required conversion program are located in subpart A of 24 CFR part 
972.
    The voluntary conversion program is authorized under section 533 of 
QHWRA, which amended section 22 of the 1937 Act. As amended, section 22 
authorizes PHAs to voluntarily convert a development to tenant-based 
assistance by removing the development or a portion of a development 
from its public housing inventory and providing for relocation of the 
residents or provision of tenant-based assistance to them. This action 
is permitted only when that change would be cost effective, principally 
benefits residents of the development and the surrounding area, and not 
have an adverse impact on the availability of affordable housing. The 
regulations for the voluntary program are located in subpart B of 24 
CFR part 972.
    In tandem with the September 17, 2003, proposed cost methodology 
rule, HUD released a Web-based cost comparison calculator that was 
posted on the HUD Web site (http://www.hud.gov/offices/pih/costcalculator.cfm) to aid PHAs in conducting the required cost 
comparisons. The downloadable spreadsheet calculator is designed to 
walk PHAs through the required calculations and comparisons and permits 
PHAs to enter the relevant data for their PHA and the development being 
assessed.

II. This Final Rule; Significant Changes to September 17, 2003, 
Proposed Rule

    This final rule follows publication of the September 17, 2003, 
proposed rule and takes into consideration the public comments received 
on it. The most significant differences between this final rule and the 
September 17, 2003, proposed rule are listed below. The changes, and 
HUD's rationale for making the revisions, are discussed more fully in 
section IV of this preamble:
    1. Remaining useful life time period. The final rule establishes 
uniform time periods for estimating the remaining useful life of 
developments for the voluntary and required conversion programs. In 
addition to the physical condition of a property, there are three key 
assumptions that guide how PHAs prepare modernization estimates that 
affect remaining useful life and determine whether a 20, 30, or 40-year 
remaining useful life evaluation period will be used for the cost-test. 
When calculating the public housing revitalization, operating, and 
accrual costs for estimating the remaining useful life and viability of 
a development, PHAs will use a 30-year period if the level of 
modernization addresses all accumulated backlog needs and the planned 
redesign ensures long-term viability. If the modernization is 
equivalent to new construction or the renovation achieves as-new 
conditions, a 40-year remaining useful life test is used. When light or 
moderate rehabilitation is undertaken that does not cover all 
accumulated backlog, but it is compliant with the International 
Existing Building Codes (ICC) or Public Housing Modernization Standards 
in the absence of a local rehabilitation code, the 20-year remaining 
useful life evaluation period must be used. The final rule does not 
adopt the proposed 15-year evaluation period for voluntary conversions.
    2. Inclusion of net proceeds from the sale or lease of a property 
for voluntary conversions. The final rule requires that a PHA include 
in the cost-test calculations the residual value (or net sales 
proceeds) from the sale or lease of a property that is to be 
voluntarily converted to tenant-based voucher assistance. The PHA will 
be required to hire an appraiser to estimate the market value of the 
property using the comparable sale, tax-assessment, or revenue-based 
appraisal methods. HUD will permit PHAs to incorporate the appraised 
market value or estimated amount of any residual value or net sales 
proceeds that would result from the sale or lease of the property in 
the cost-test. PHAs must incorporate this market or residual value 
estimate into the cost-test depending on whether a PHA will sell a 
property and pay for demolition and remediation costs to prepare the 
site for sale.
    The market value of the property is determined using one or more of 
the

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appraisal methods identified above to obtain an accurate estimate of 
the actual market value. The residual value is derived by calculating 
the estimated market value for the property based on the appraisal, 
minus any costs required for demolition and remediation. Residual value 
must be incorporated into the cost-test instead of the actual market 
value only when any demolition, site remediation, and clearance costs 
that are necessary are covered by the selling PHA. The market value or 
estimated amount of any residual value or net sales proceeds that would 
result from the sale or lease of the property must be included in the 
cost-test as an additional cost (a foregone opportunity cost) of 
keeping the development as a public property, and it will be added to 
the public housing cost side of the ledger before a comparison is made 
to voucher costs.
    As noted, this revision would apply solely to voluntary 
conversions. Demolition and remediation costs would now apply only in 
the computation of net residual value for voluntary conversion and 
would no longer be added to either the modernization or voucher costs 
for the public housing and voucher cost-comparison for voluntary or 
required conversion.
    3. Vacant units. Under the cost-test, the vacancy adjustment factor 
is a 20 percent representation of long-term vacant units used to 
determine the total unit count used to estimate operating costs for a 
property. All funded occupied and vacant units are factored into the 
calculations to determine per-unit costs for respective developments. 
Using this vacancy adjustment factor, the cost-test distinguishes 
partially funded vacant units from fully funded vacant units. When 
calculating an estimate of operating costs per occupied unit, this 
final rule provides that 20 percent of long-term vacant units will be 
counted rather than 50 percent. This factor excludes only a limited 20 
percent fraction of the unit costs associated with these partially 
funded vacant units instead of 50 percent. As development-level 
estimates become more accurate and as vacant units beyond 3 percent are 
not funded under the new operating fund formula, this provision will 
lose even its current minor impact.
    4. Payment standard used to calculate voucher costs for conversion 
determinations. The final rule requires PHAs to use the payment 
standard of recent movers for the Fair Market Rent Area or sub-area for 
properties proposed for voluntary or required conversion to estimate 
voucher costs. HUD has revised the cost-test factor used to calculate 
Housing Choice Voucher tenant-based assistance. This factor is used 
instead of the proposed rule requirement for a PHA to use the higher of 
the average cost (gross rents) for voucher units occupied by recent 
movers, or the applicable Section 8 payment standard to calculate the 
voucher costs required to provide housing assistance instead of public 
housing.

III. Transition to Project-Based Accounting and Asset Management

    On April 14, 2005, HUD published a proposed rule (70 FR 19858) to 
revise the Public Housing Operating Fund Program. This proposed rule 
would require PHAs to manage properties in their inventory in 
accordance with an asset management model, consistent with practices in 
the multifamily-assisted housing industry. Under this model, PHAs would 
be required to adopt project-based accounting and project-based 
budgeting and management practices that are essential components of 
asset management. Under an asset management approach, HUD and PHAs will 
work to improve efficiency in managing properties; assess the 
performance of properties; consider alternatives to preserve 
properties; make long-term decisions regarding re-investment of viable 
properties; or reposition assets of non-viable properties that are 
performing at a sub-par level.
    Required and voluntary conversion assessments are two existing 
tools available for PHAs to assess the cost-effectiveness and viability 
of public housing properties by comparing voucher costs to the costs to 
continue operating a development. As HUD transforms its monitoring 
practices to a property-centric focus and the public housing program 
adopts property-based accounting, budgeting, and asset management 
practices, and as lessons are learned in regard to public housing 
properties that are converted to tenant-based assistance, it is likely 
the Department will need to revise the cost-test methodology in the 
future.

IV. Discussion of Public Comments

    The public comment period on the September 17, 2003, proposed rule 
closed on November 17, 2003. HUD received 14 public comments. Comments 
were submitted by PHAs, a private citizen, a consulting firm, three of 
the main national organizations representing PHAs, and several national 
legal aid and low-income advocacy organizations. This section of the 
preamble presents a summary of the significant issues raised by the 
public commenters and HUD's responses to these issues.
    Comment: Support for Internet cost calculator. Several commenters 
wrote that the Internet calculator posted on HUD's Web site is very 
useful. They congratulated HUD on developing the spreadsheet calculator 
to help make conversion calculations easier.
    HUD Response. HUD appreciates the comments received from PHAs 
regarding the usefulness of the spreadsheet calculator. HUD believes 
the cost methodology is a sound approach to determine the viability and 
ongoing useful life of public housing properties compared with 
providing vouchers in a local rental market. The methodology and 
associated spreadsheet calculator are tools developed to facilitate the 
comparisons of programmatic costs. The cost methodology and cost 
spreadsheet outline the methodology and procedures for PHAs to 
uniformly conduct conversion determinations using PHA-derived cost data 
to identify non-viable properties with costs that exceed vouchers.
    Comment: HUD should use a simplified cost test for small PHAs to 
determine cost-effectiveness of conversion. Several commenters made 
this suggestion. The commenters wrote that the simplified test should 
be based on the housing construction cost limits applicable to the 
developments divided by an assumed useful life of the property (e.g., 
50 years), multiplied by the project age in years to determine the 
presumed modernization cost. The commenters wrote that this methodology 
should recognize that a project has an ultimate life span without 
requiring the calculation of repair costs for all deficiencies.
    HUD Response. HUD has not adopted the suggestion of these 
commenters. This suggestion does not adequately address the statutory 
intent of the cost methodology to assess the viability of properties 
based on the physical conditions of specific developments. HUD has 
developed the cost spreadsheet calculator to ease the administrative 
efforts of all PHAs. This cost-test and cost-calculator are designed 
for PHAs to accurately estimate public housing costs, including 
estimated revitalization (modernization) costs for properties based on 
the unique conditions and characteristics of individual properties 
instead of a one-size-fits-all approach as proposed by this commenter. 
HUD is applying an amortization life cycle of 30 years (with 20- or 40-
year options) that is based upon an accrual model that assumes all new 
physical need is met annually and

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that all or most of the accumulated backlog and redesign necessary for 
viability is also addressed.
    Comment: HUD should institute an annual review process, including a 
formal comment period to adjust the methodology periodically or when 
necessary. The commenters wrote that this is necessary to legitimize 
the methodology and prevent it from being error prone and irrelevant 
over time.
    HUD Response. HUD believes the cost methodology is a sound approach 
for PHAs to conduct conversion determinations. These cost comparisons 
use cost-data provided by PHAs in accordance with the unique conditions 
and characteristics of properties within a PHA's inventory and voucher 
costs in the local rental market. HUD believes this cost-test and 
calculator spreadsheet are accurate tools for PHAs to use to assess the 
viability of properties compared with vouchers and whether properties 
should be re-invested in or removed from the inventory in tandem with 
the HUD approval process.
    No later than 5 years following the effective date of this final 
rule, HUD will review the cost test, to determine whether it is 
necessary to update or revise the methodology to reflect new policy or 
more up-to-date methodologies. Should HUD determine that revisions to 
the cost methodology are necessary, it will implement such changes 
through rulemaking, Federal Register notice, PIH notice, or other 
means, as it determines appropriate based on the specific nature of the 
changes.
    Comment: Adequate operating and capital funding would eliminate the 
need for the conversion programs. One commenter wrote that conversion 
actions are an appropriate step to rid public housing of non-viable 
developments, while protecting developments that are viable in the long 
term. However, the commenter also wrote that limited appropriations to 
preserve public housing would increase the need for conversion. The 
commenter wrote that adequate operating and capital funding would 
eliminate the need for this cost-test and mandatory and voluntary 
conversions.
    HUD Response. The purpose of the conversion programs is to enable 
PHAs to identify non-viable developments whose costs, relative to 
vouchers, merit permanent removal from the public housing inventory. 
The cost test determines the most cost-effective method for a 
particular property, either to modernize it or replace the property 
with housing vouchers. The comparison is necessary for proper selection 
of the alternatives, regardless of the level of appropriation.
    PHAs may supplement capital and operating funding by seeking state 
and local funding or private financing. PHAs are authorized to leverage 
additional resources under section 30 of the 1937 Act. These are 
additional financing options available for PHAs to modernize 
appropriate developments.
    Comment: The final rule should provide for construction of 
replacement developments after conversion. One commenter recommended 
that the final rule should clarify that a PHA may build replacement 
housing following the removal of housing deemed to be distressed as a 
result of the cost test. Additionally, the commenter wrote that HUD 
should prohibit conversion if this replacement option is more cost-
effective than conversion to tenant-based rental assistance.
    HUD Response. Under the regulations for the required and voluntary 
conversion programs, PHAs are permitted to determine the most feasible 
and cost-effective options for providing relocation and permanent 
replacement housing for families impacted by the conversion and removal 
of developments from the inventory (see Sec. Sec.  972.130 and 
972.230). PHAs must provide such families with either a comparable 
assisted unit or a housing choice voucher. Further, under Sec.  972.127 
of the required conversion program, a PHA must identify and demonstrate 
that funding sources are available to revitalize a development. Section 
972.218 of the voluntary conversion program regulations provide that a 
PHA must describe the future use of a property after conversion and may 
include the means and timetable to complete these activities.
    The applicable sections of the required and voluntary conversion 
program regulations cited above demonstrate that PHAs are permitted to 
build replacement housing. However, the statutes authorizing the 
programs do not direct HUD to use this cost-test to assess whether or 
not it is cost-effective to rebuild replacement housing. Section 9 of 
the 1937 Act contains a provision indicating the limitations on new 
construction and building new public housing units. PHAs are only 
permitted to build new public housing units if they are mixed-finance 
developments that leverage significant financing and the PHA's total 
inventory will not exceed the number of units owned, operated, or 
assisted as of October 1, 1999, except if the new units to be built are 
cheaper than Section 8 for the useful life of the property for the same 
period of time (40 years or as determined under the required conversion 
regulation). Further, these units must be built in accordance with the 
Total Development Cost (TDC) limits for the applicable jurisdiction. 
HUD does not believe it would be appropriate to restrict the authority 
of a PHA to determine how to provide replacement housing to impacted 
families because this cost-test was not intended to assess construction 
costs for building replacement housing.
    Comment: Support for the inclusion of net proceeds. A commenter 
strongly encouraged HUD to include net proceeds in the cost-test.
    HUD Response. Upon further consideration, HUD agrees with the 
commenter and has revised the rule accordingly for voluntary 
conversions. HUD believes that the inclusion of market or residual 
value will help to ensure that PHAs more fully consider the cost-
effectiveness of voluntary conversions and whether such conversions are 
warranted. This final rule requires that a PHA include in the cost-test 
calculations the market or residual value (or net sales proceeds) from 
the sale or lease of a property that is to be voluntarily converted to 
tenant-based voucher assistance. The PHA will be required to hire an 
appraiser to estimate the market value of the property using the 
comparable sale, tax-assessment, or revenue-based appraisal methods. 
HUD will issue additional guidance on the required appraisals, 
including information regarding the HUD protocols for reviewing and 
assessing the accuracy of the appraisals.
    The estimated amount of any market value, residual value, or net 
sales proceeds that would result from the sale or lease of the property 
must be included in the cost-test as an additional foregone opportunity 
cost of maintaining the property as public housing. The residual value 
is to be determined by calculating the estimated market value for the 
property based on the appraisal, minus any costs required for 
demolition or remediation deletion (with such costs capped at the sales 
value so that the residual value will not equal a negative amount).
    This revision is consistent with the policies and procedures 
contained in Office of Management and Budget (OMB) Circular A-94, which 
provides guidance on conducting cost-effective analyses for determining 
the optimum use of Federal resources.
    Comment: Opposition to including net proceeds from the sale or 
lease of a development or land to offset voucher costs. Several 
commenters on this issue objected to the inclusion of net proceeds; 
however, the reasons for this opposition varied. Several of the

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commenters wrote that assessing net proceeds would be outside the scope 
of the cost test for determining the viability of public housing. One 
commenter wrote that if the market value of property were to be 
considered, it would be more appropriate to add this value to the 
voucher costs or deduct the value from public housing revitalization 
costs. Another commenter suggested that if net proceeds were included, 
they should be offset by the estimated remaining value of a development 
if the property is to be operated for an additional 20-or 30-year 
period.
    HUD Response. HUD does not agree with the commenters. As noted 
above, this final rule requires that a PHA include in the cost-test 
calculations the market or residual value (or net sales proceeds) from 
the sale or lease of a property that is to be voluntarily converted to 
tenant-based assistance. HUD has determined that the inclusion of 
residual value will help to ensure that PHAs more fully consider the 
cost-effectiveness of voluntary conversions and whether such 
conversions are warranted.
    Comment: The cost methodology should provide for greater 
consideration of local community issues and other non-quantitative 
factors. Several commenters suggested that certain qualitative, social, 
economic, and community factors should be considered by PHAs in making 
conversion decisions. The commenters wrote that HUD should consider the 
impact of a conversion on a community, including estimated changes in 
housing demand, rents, and neighborhood characteristics, such as the 
willingness of landlords to accept voucher holders. The commenters also 
wrote that the cost comparisons should be considered in reference to 
and consistent with PHA Plan and local planning processes.
    HUD Response. HUD believes the conversion program planning 
requirements and HUD approval process address these concerns. HUD 
believes quantitative, non-financial, and social factors that impact 
the conversion of developments, residents, and the surrounding 
neighborhoods are adequately addressed in the regulations for the 
required and voluntary conversion programs. PHAs must consult with 
residents and develop relocation plans under both conversion programs. 
Families are provided relocation counseling and assistance to help them 
successfully relocate to other project-based units or to lease quality 
units.
    Voluntary conversions are permitted and approved by HUD only if the 
conversion principally benefits residents and does not adversely affect 
the availability of affordable housing in the community. When making a 
determination of whether a conversion principally benefits residents, 
the PHA, and the community, the PHA must consider such factors as the 
availability of landlords providing tenant-based assistance, as well as 
access to schools, jobs, and transportation.
    Under the HUD review and approval process, PHAs are required to 
evaluate the supply of quality units compared with the number of 
voucher holders that will need rental units. PHAs must demonstrate that 
voucher holders will be able to successfully find affordable units in 
the local rental market. The voluntary conversion program regulations 
at Sec.  972.218 require PHAs to analyze the local rental market 
conditions as part of a conversion assessment required for HUD approval 
of conversion plans. This analysis must include an assessment of the 
availability of decent and safe units that can be rented at or below 
the payment standard set for providing housing choice voucher 
assistance.
    Comment: For required conversions, the cost test should only be 
used to make a presumptive finding that conversion is cost-effective. 
One commenter made this suggestion. The commenter wrote PHAs should be 
permitted to rebut the findings of the cost-test using direct or 
indirect financial and social cost information.
    HUD Response. HUD has not made any changes to the rule based on 
this comment; however, Sec.  972.127 of the required conversion 
regulations addresses the concerns of this commenter. Under the 
required conversion program, more than the cost-test is used by PHAs to 
identify distressed developments with more than 250 units that have 
excessive vacancy rates over a 3-year period and which are subject to 
required conversion determinations. Once a PHA identifies a distressed 
development with costs that exceed vouchers, the PHA is still able to 
demonstrate the long-term viability of a development and avoid 
mandatory removal. A PHA must meet four regulatory factors in order for 
a development to satisfy this long-term viability test. HUD believes 
the resident advisory board consultation and relocation requirements, 
in addition to the conversion and PHA planning and reporting 
requirements, which provide that the relocation plan must be consistent 
with the local Consolidated Plan and be made available for inspection 
prior to public hearings, work together to adequately ensure that that 
PHA conversion plans are meaningful and beneficial for the interests 
for a local community, as well as the Federal government.
    Comment: Post-conversion financing for rehabilitation. Several PHAs 
submitting comments indicated an interest in removing developments from 
their inventory and applying for tax credits, site-based vouchers, or 
other financing to use equity and debt to cover debt service to 
rehabilitate properties.
    HUD Response. HUD believes the regulations regarding HUD's review 
and approval of conversion assessments already address the concerns 
expressed by these commenters. Under Sec.  972.218 of the voluntary 
conversion regulations, PHAs are permitted to remove non-viable 
developments with operating and revitalization costs that exceed 
vouchers. Properties are determined to be non-viable using a pre- and 
post-rehabilitation market analysis. These two market analyses are 
designed for PHAs and HUD to evaluate the feasibility of redeveloping 
and operating the property as public housing versus providing low-
income, unassisted, or market rate housing. The conversion assessment 
must describe the planned future use of the converted developments, as 
well as the means and timeframes for completing these conversion and 
redevelopment activities. PHAs are required to identify available 
financing and describe the future use of properties proposed for 
conversion and redevelopment.
    Comment: HUD should award PHAs for leveraging financing for 
conversions. One commenter made this suggestion. However, the commenter 
wrote that non-federal sources should not count against conversion 
through the cost-test methodology.
    HUD Response. HUD declines to evaluate a PHA's efforts at 
leveraging financing for revitalization activities associated with 
voluntary or required conversion actions. HUD's approval relative to a 
PHA securing financing for revitalization activities is limited to the 
long-term viability test for required conversion (see Sec.  972.139) 
and a description of the future use of a property for voluntary 
conversion (see Sec. Sec.  972.218 and 972.224). HUD believes this 
level of review is adequate.
    Comment: HUD should allow PHAs the flexibility to use short- and 
long-term direct and indirect costs to demonstrate the appropriateness 
of voluntary conversion. The commenters wrote that the proposed 
methodology's exclusion of local data and other relevant factors may 
lead to the denial of PHA requests for voluntary conversions that are 
cost-effective.

[[Page 14332]]

    HUD Response. HUD disagrees with this comment. The required cost 
test calculations are derived from locally based cost data entered into 
the spreadsheet calculator by PHAs. The cost-test and review process 
permits HUD to consider local data on quantitative costs and other 
factors that affect the feasibility of a proposed conversion, such as: 
(1) The likelihood that impacted families would be successfully 
relocated; (2) the neighborhood's supply of affordable housing; and (3) 
whether the conversion primarily benefits residents of the impacted 
development and surrounding area. PHAs must demonstrate that impacted 
tenants are relocated or provided quality replacement housing 
assistance and that the local community's affordable housing supply 
will not be adversely impacted by the proposed conversion of a 
particular development (see Sec.  972.224).
    Comment: HUD should issue guidance regarding how it will use 
appraisal results to approve the conversion proposals. One commenter 
made this suggestion.
    HUD Response. PIH is developing protocols regarding the review of 
appraisal results contained in conversion proposals. HUD will use these 
property appraisals to evaluate the pre- and post-rehabilitation market 
analyses for the property and to assess the feasibility of the proposed 
revitalization and redevelopment activities using the criteria 
necessary for HUD approval at Sec.  972.224.
    Comment: Reference to national fire protection and safety code. Two 
commenters suggested that the final rule should incorporate a reference 
to the Model Building Code (``Building Construction and Safety Code'') 
in addition to the Public Housing Modernization Standards Handbook 
(7485.2) and the International Existing Building Code (ICC) 2003 
Edition.
    HUD Response. HUD has not revised the rule in response to these 
comments. The final rule continues to provide that, for purposes of the 
cost methodology, the viability of new housing construction or 
rehabilitation will be determined by reference to either the applicable 
local housing code or (in the absence of a local code) PIH Handbook 
7485.2 or the ICC. The Department believes that these two housing codes 
are sufficient to ensure that housing meets acceptable viability 
standards, and that the change requested by the commenters is, 
therefore, unnecessary.
    Comment: Concerns regarding the use of a national inflation factor. 
Several commenters wrote that the methodology incorrectly uses the 
national rate of inflation to assess costs driven by local market 
conditions. The commenters wrote that this procedure both overstates 
and understates certain public housing and voucher costs and fails to 
derive the best estimate of the value of future public housing and 
voucher costs. The commenters wrote that cost increases for public 
housing and vouchers are tied to different HUD regulatory requirements 
and to cost changes in particular segments of the overall economy. For 
example, public housing operating costs (aside from utilities) are 
determined by a formula that increases estimated costs annually based 
primarily on a local inflation factor. The commenters presented varied 
options to address this perceived problem with the methodology, all of 
them focusing on the need to adjust the national inflation rate by 
local factors.
    HUD Response. HUD has not made changes to the rule based on these 
recommendations. In accordance with OMB Circular A-94, the cost 
methodology uses the national inflation and real discount rates 
specified by OMB.
    This net, present value method is a constant dollar method, which 
calculates the stream of public housing costs and voucher costs 
adjusted exponentially, for a fixed discount rate, by using initial 
year costs for vouchers and estimated public housing costs amortized 
over the remaining useful life of the development (20, 30, or 40 
years). These cost streams are discounted using the OMB-specified real 
discount rate to account for program cost increases and decreases in 
the future to compare the net present value of both programs.
    Future program costs are unknown and may fluctuate. Therefore, HUD 
believes it is appropriate to use national inflation measures to 
estimate future costs and account for program costs that may vary due 
to program differences and market dynamics. In response to the comments 
regarding understating and overstating certain public housing and 
voucher costs, HUD has adjusted the vacancy adjustment factor used to 
estimate public housing operating costs and basing the calculation of 
voucher costs on actual program costs as reflected in the Section 8 
payment standard for the Fair Market Rent Area or sub-area.
    Comment: Adjustment of discount rates to calculate net present 
value. Several commenters wrote that voucher rents are more market-
driven and increase more rapidly than public housing rents that are 
supported by a grant formula allocation system. The commenters wrote 
that, over time, public housing rents are more stable and affordable 
because they do not spike up when the market tightens. The commenters 
wrote the discount rates under this cost methodology should reflect 
these differences.
    HUD Response. HUD believes the constant dollar method is 
appropriate to evaluate the stream of costs for both the public housing 
and voucher programs, considering that upward and downward cost 
fluctuations are possible in the future. HUD believes the net present 
value methodology is a sound method for making voluntary and required 
conversion determinations in tandem with the HUD review process. Under 
this constant dollar approach, the cost calculator determines the net 
present value of public housing compared with vouchers based on future 
cash flow projections for the respective programs.
    Future program costs are unknown and may increase and decrease 
subject to market forces and other program or policy changes. For 
instance, even though payment standards (and other measures of voucher 
costs) rose more rapidly from 1999 to 2004 than underlying measures of 
Fair Market Rents (FMR) and average rental costs, this rate of increase 
is expected to be curtailed due to the budget reforms in the voucher 
program (particularly the transition to the dollar-based method for 
calculating voucher renewal costs). Within the current program 
parameters, HUD believes this will cause local PHAs to manage their 
program budgets more prudently. PHAs will adjust payment standards to 
more closely reflect local rental trends.
    Comment: Cost methodology should address future budget authority 
for tenant-based assistance. Several commenters wrote that the cost 
methodology fails to address the future budget authority needed to 
provide tenant-based assistance to families residing in converted 
developments.
    HUD Response. HUD has not revised the rule in response to these 
comments. The Department is committed to the successful implementation 
of the required and voluntary conversion programs. HUD will make 
necessary funding available for tenant-based assistance provided in 
connection with public housing conversions, consistent with 
congressionally appropriated amounts and HUD's other programmatic 
responsibilities.
    Comment: Operating cost estimates should be adjusted for outliers. 
Several commenters wrote that the cost methodology should exclude 
projected operating cost data that is not statistically representative 
of a PHA's properties. The commenters wrote that PHAs might incur 
excessive non-

[[Page 14333]]

recurring expenditures for large properties that have undergone major 
rehabilitation, or have a small number of well-managed projects and 
several under-performing properties.
    HUD Response. HUD has not made this change. Under the cost 
methodology, PHAs are permitted to use either the development-level or 
the PHA-level method to calculate operating costs. The PHA-level method 
is permitted when the PHA does not have accurate property-level 
operating cost information or a vacancy rate at or above 20 percent. To 
the extent accurate property or development-level operating cost data 
exists, PHAs should use this data to ensure that projected operating 
costs are tied to particular developments targeted for conversion. The 
asset-level approach and project-based accounting and budgeting 
requirements associated with the revised public housing operating fund 
program should accelerate the ability of PHAs to collect accurate and 
sound development-level data.
    Comment: Use of development-level method to estimate operating 
costs. One commenter suggested that PHAs should be authorized to use 
development level costs or PHA-wide costs if accurate data is 
available.
    HUD Response. HUD has not accepted this recommendation. However, 
HUD agrees with the commenter regarding the need to use development-
level costs if accurate data is available. When a PHA has accurate and 
reliable operating cost data and the overall vacancy rate is less than 
20 percent, then the development-based method must be used to determine 
the projected operating costs. The PHA-wide method is permitted only in 
the event a PHA does not have reliable cost data for a development or 
the property has a vacancy rate at or above 20 percent.
    Comment: Concerns regarding modernization estimates. Several 
commenters wrote that in the cost methodology, use of the housing 
construction cost component of the total development cost limit for 
calculating modernization costs overestimates accruing capital needs 
for public housing developments. The commenters cited several studies 
in support of their position, including the 2000 HUD Capital Needs 
Study and the Harvard Public Housing Operating Cost Study. The 
commenters recommended that the methodology should contain a more 
realistic measure of accruing modernization needs for public housing 
that is consistent with HUD and independent estimates.
    HUD Response. It is true that the physical-based accrual model used 
in this final rule has higher costs than a financial model of accrual 
that includes partial funding by refinancing. In recognition that the 
accrual model assumes that each year a development's ongoing capital 
needs are met and in proposing a realistic estimate of modernization 
that meets accumulated backlog and such redesign needs as required to 
ensure viability, this rule is recognizing a 30-year amortization model 
as the norm with 20 years as a possibility when not all backlog need is 
met (but local code and viability standards are met) and 40 years is a 
possibility when accumulated backlog and necessary redesign bring the 
development to physical condition equivalent to new construction.
    Comment: Backlog capital repair costs should be excluded from the 
cost methodology. One commenter wrote that, in light of limited 
appropriations for public housing capital funding that has not 
addressed a backlog in capital repairs, the cost comparison analysis 
for bringing developments up to a viable standard should not include 
the cost of long-term neglect.
    HUD Response. HUD disagrees with this recommendation. The statutory 
purpose of the cost methodology and conversion determination procedures 
is to assess the viability and remaining useful life of public housing 
developments and, in the case of required conversion, to determine 
whether proposed modernization investments are cost effective. By 
amortizing these costs over a realistic time period, consistent with an 
accrual model that assumes all ongoing needs are met, the rule gives 
modernization the appropriate yearly and cumulative impact.
    Comment: HUD should increase the $1,000 per unit relocation expense 
factor. Several commenters wrote that this amount does not accurately 
estimate relocation and counseling expenses based on historic costs and 
local market conditions. The commenters wrote that HOPE VI data on 
relocation and counseling activities indicate that $3,000 per household 
is a generally more accurate per-household cost for similar voucher 
relocation activities.
    HUD Response. HUD believes that $1,000 per unit is a reasonable 
benchmark for estimating relocation expenses. Under the existing 
policy, HUD permits a PHA to demonstrate if a higher relocation expense 
level is warranted based on local market conditions. HUD may approve a 
higher amount if justified by the PHA.
    Comment: The estimation of voucher costs must include the estimated 
community impact, including changes in housing demand and availability 
of affordable housing and other neighborhood demographics. One 
commenter made this suggestion.
    HUD Response. HUD believes that quantitative, demographic, and 
social factors, such as access to schools, jobs, and transportation, 
are adequately addressed in the regulations for the required and 
voluntary conversion programs. PHAs are required to evaluate such 
factors when considering the impact of conversion on residents and the 
surrounding neighborhoods. PHAs must consult with residents and develop 
relocation plans under both conversion programs. Families must be 
provided relocation counseling and assistance to help them successfully 
relocate to other project-based units or use voucher assistance to 
lease a quality unit.
    The voluntary conversion program regulations require that PHAs 
assess social and economic factors related to the conversion, including 
whether the conversion would adversely impact the affordable housing 
supply. PHAs must demonstrate that a conversion principally benefits 
residents and does not adversely impact the availability of affordable 
housing in the community. When determining whether a conversion 
principally benefits residents, the PHA, and the community, the PHA 
must consider such factors as the availability of landlords providing 
tenant-based assistance, as well as access to schools, jobs, and 
transportation.
    In addition, PHAs must evaluate the supply of quality units 
compared with the number of voucher holders that will need rental 
units. PHAs must demonstrate that voucher holders will be able to 
successfully find affordable units in the local rental market. This 
evaluation of local rental market conditions is a part of the 
conversion assessment required for HUD approval of conversion plans. 
This analysis must include an assessment of the availability of decent 
and safe units that can be rented at or below the payment standard set 
for providing voucher assistance.
    Comment: HUD should ensure that converted properties are used to 
provide low-income housing. One commenter wrote that the conversion 
program regulations do not provide guidance on the post-conversion sale 
of former public housing properties. The commenter wrote that if a 
converted property is developed as housing in the future, a portion 
should be reserved for low-income families.
    HUD Response. Under both the required and voluntary conversion

[[Page 14334]]

programs, all residents living in impacted developments are provided 
relocation assistance to a comparable assisted unit or replacement 
housing assistance. Under the voluntary conversion program, in the 
event a PHA opts to not demolish a non-viable property that is removed 
from the inventory because the development's costs for its remaining 
useful life exceed the costs to provide vouchers during the same 
period, the low-income housing use restriction associated with the 
annual contributions contract is repealed. Under the HUD review and 
approval process, PHAs are required to describe the future use for the 
property, and resale proceeds must be used for low-income housing 
purposes as required by section 18 of the 1937 Act.
    Comment: The cost-methodology should require that PHAs conduct an 
impact assessment to identify the residual value of a converted 
development. One commenter wrote that there are four possible 
activities to which converted properties will be subjected: (1) 
Demolition and remediation to secure the site; (2) demolition and 
remediation as a prelude to sale for redevelopment; (3) continued use 
of a property as affordable housing through retention or sale of the 
property to a local affordable housing provider; and (4) gradual 
conversion to market-rate housing. The commenter wrote that in the 
event any of the last three options are chosen, it is probable the 
property sale will result in a financial gain for the PHA.
    HUD Response. For required conversions, residual value will not be 
included within the cost-test and an impact assessment is not needed 
because PHAs are already required to assess the local rental market and 
ensure there is an adequate supply of units for the relocation of 
families impacted by the removal of the property from inventory. 
Further, PHAs are required to estimate the market or residual value of 
a property in accordance with the proposed use, redevelopment, or sale.
    Under the voluntary conversion approval process, HUD will review 
the proposed future use for the property, as well as the pre- and post-
rehabilitation market analyses to determine the feasibility of the 
conversion. Additionally, PHAs must demonstrate the voluntary 
conversion is feasible by showing there is an adequate supply of rental 
units at or below the payment standard for impacted families to 
successfully ``lease-up'' using vouchers, and by showing that the 
conversion will not adversely impact the local supply of rental 
housing. These demonstrations and approval procedures address the 
recommendations offered by this commenter.
    HUD believes it is not feasible to include the unrealized residual 
property value of a property within the mandatory cost methodology. HUD 
is more interested in focusing the required conversion cost-test on 
assessing what are reasonable modernization costs to rehabilitate or 
redevelop a distressed property, more so than assessing the market 
value of a property and its impact on PHA decision-making in regard to 
exploring various asset management alternatives, including 
preservation, sale, demolition, or other re-capitalization strategies 
after its conversion and removal from the inventory.
    Comment: The final rule should not cap demolition, remediation, and 
relocation costs at 10 percent of the Total Development Cost limit. The 
commenter wrote that this threshold should be based on real cost 
projections. The commenter wrote that demolition and remediation costs 
may be extensive and that in tight markets relocation costs will be 
higher than the allowable limit (under 10 percent).
    HUD Response. HUD has not adopted this recommendation. HUD 
continues to believe that it is necessary to establish a reasonable 
limit on demolition, remediation, and relocation costs associated with 
preparing cost conversion estimates.
    Based on a review of 2002 data from the HOPE VI program, average 
demolition costs are $5,500 per unit. However, there are cases where 
per-unit demolition costs are higher due to the location, size, and 
type of development that is being demolished. Typically, demolition 
costs are higher in certain high-cost areas and for larger-scale 
complexes that require special demolition and remediation procedures 
due to their special infrastructure, deep basements, environmental 
hazards, or in close proximity to other buildings. Further, under the 
HOPE VI program, which contains extensive relocation requirements, 
relocation costs have averaged $3,000 per unit, including supportive 
services. HUD expects relocation expenses to be less extensive under 
the voluntary and required conversion programs.
    Based on HUD's experience with demolition in the overall public 
housing program, demolition, remediation, and relocation costs have 
typically been within the 10 percent of TDC threshold established by 
this final rule. However, in the event a property has extremely high 
demolition or remediation costs associated with a severe site hazard 
within a development, the PHA should indicate this in its proposal for 
required or voluntary conversion. Demolition and remediation costs do 
not play a role in the cost-test for required conversion. Local rental 
market conditions and needs for remediation of environmental factors 
are issues that affect the feasibility of a conversion. These 
programmatic issues should be addressed within a conversion assessment 
and proposal.
    Comment: HUD should clarify the ``remaining useful life'' time 
period for public housing developments. Several commenters wrote that 
the final rule should contain clearer guidance on ``remaining useful 
life.'' One commenter suggested that HUD use a flat 30-year life for 
comparing public housing and voucher costs. The commenters wrote that 
other programs that involve preservation or triage decisions for 
multifamily-assisted properties provide statutory and regulatory 
determinations regarding the applicable ``remaining useful life'' 
period. The commenters wrote that in practice, any property could be 
maintained indefinitely if given large enough funding to cover 
maintenance and repair.
    HUD Response. This final rule provides additional guidance 
regarding remaining useful life estimates to determine physical 
viability. The final rule retains the 20- and 30-year remaining useful 
life periods, but, if justified, the final rule permits extending the 
period to up to 40 years. There are two key assumptions built into the 
cost-test regarding the degree of modernization that may include 
redesign undertaken to preserve the viability of a property. For 
modernization that meets accumulated backlog and redesign needs that 
ensure viability, in tandem with accrual that meets yearly ongoing 
capital needs, HUD believes that 30 years is a useful starting point 
for the amortization period for the cost-test that determines whether 
reinvestment relative to public housing versus voucher costs is cost-
effective, but if the modernization clearly brings the property to as-
new condition in an easily maintained location, a 40-year amortization 
and remaining useful life period may be warranted. On the other hand, 
when the modernization falls short of meeting all backlog needs, though 
it meets many of these needs and also local code and viability 
standards, then a 20-year amortization period is more appropriate. 
Because of its realistic standards for accrual and modernization 
estimates and its addition of sales value to public housing costs in 
voluntary conversion, HUD has decided to eliminate the 15-

[[Page 14335]]

year time period for estimating remaining life under the voluntary 
conversion program.
    Comment: Concerns regarding the calculation of voucher costs. 
Several commenters wrote that the proposed methodology appears to drive 
cost comparisons toward findings that public housing will be more 
expensive than providing voucher assistance. Other commenters wrote 
that the methodology results in distortions that understate public 
housing and overstate voucher costs. For example, some of the 
commenters wrote that the methodology incorrectly assumes the adequacy 
of the local rental market to absorb voucher holders from converted 
properties. Another commenter wrote that HUD should amend the cost 
methodology to include vacant units in the voucher cost calculations. 
One commenter wrote that HUD should exclude debt service from the 
calculation of voucher costs or add these to the cost of public 
housing. One commenter suggested that the methodology should consider 
the ongoing administrative fees a PHA earns from serving individual 
voucher families and the one-time fees earned for families to more 
accurately estimate administrative fees attributable to converting 
developments to vouchers.
    HUD Response. The cost methodology already includes ongoing 
administrative costs as part of overall voucher costs, and the voucher 
cost-estimate factor has been adjusted to the payment standard a PHA 
establishes to project actual voucher costs in accordance with the 
local rental market. Aside from the revisions to the cost-test 
regarding the voucher and vacancy adjustment factor to project public 
housing operating costs, HUD has declined to make the other changes 
recommended by the comments. Some of the proposals are offsetting, and 
all are difficult to calculate. Moreover, HUD believes the final rule 
includes the appropriate adjustments and essential ingredients for a 
comprehensive cost comparison and will result in a balanced comparison 
of the cost of tenant-based assistance with the costs of continuing to 
operate developments as public housing.

V. Findings and Certifications

Impact on Small Entities

    The Regulatory Flexibility Act (RFA) (5 U.S.C. 601 et seq.) 
generally requires an agency to conduct a regulatory flexibility 
analysis of any rule subject to notice and comment rulemaking 
requirements unless the agency certifies that the rule will not have a 
significant economic impact on a substantial number of small entities. 
For the following reasons, the undersigned certifies that this rule 
will not have a significant economic impact on a substantial number of 
small entities.
    (1) A substantial number of small entities will not be affected. 
The entities that will be subject to this rule are PHAs that administer 
public housing. Under the definition of ``small governmental 
jurisdiction'' in section 601(5) of the RFA, the provisions of the RFA 
are applicable only to those PHAs that are part of a political 
jurisdiction with a population of under 50,000 persons. The number of 
entities potentially affected by this rule is therefore not 
substantial. Further, HUD anticipates that no more than 10 percent of 
all PHAs will be subject to the requirements of required conversion. 
Most PHAs with developments large enough to be subject to required 
conversion are located in larger political jurisdictions. This is a 
result of the statutory direction to identify units subject to the 
requirements based on the criteria established by the National 
Commission on Severely Distressed Public Housing, which focused on 
larger troubled agencies. For all other PHAs, conversion would be 
undertaken on a voluntary basis.
    (2) No Significant Economic Impact. The conversion plan will 
involve a one-time cost, and this cost can vary from development to 
development, depending on the scope of the assessment, location of the 
property, and other factors. A mitigating factor concerning the cost 
for PHAs whose properties are potentially subject to the requirements 
of required conversion is that they may request assistance from HUD in 
conducting the required analyses in order to offset the costs. HUD has 
provided such assistance in the past and intends to continue to do so, 
if resources are available. Therefore, the cost burden on small 
entities is not likely to be great.

Environmental Impact

    This final rule involves external administrative or fiscal 
requirements or procedures that relate to the discretionary 
establishment of cost determinations and do not constitute a 
development decision affecting the physical condition of specific 
project areas or building sites. Accordingly, under 24 CFR 50.19(c)(6), 
this final rule is categorically excluded from environmental review 
under the National Environmental Policy Act of 1969 (42 U.S.C. 4332).

Federalism Impact

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial direct compliance costs on state and local 
governments and is not required by statute, or the rule preempts state 
law, unless the agency meets the consultation and funding requirements 
of section 6 of the executive order. This rule does not have federalism 
implications and will not impose substantial direct compliance costs on 
state and local governments nor preempt state law within the meaning of 
the executive order.

Unfunded Mandates Reform Act

    Title II of the Unfunded Mandates Reform Act of 1995 (UMRA) (2 
U.S.C. 1531-1538) establishes requirements for Federal agencies to 
assess the effects of their regulatory actions on state, local, and 
tribal governments, and on the private sector. This rule does not 
impose any Federal mandates on any state, local, or tribal government, 
nor on the private sector, within the meaning of the UMRA.

Regulatory Planning and Review

    The Office of Management and Budget (OMB) reviewed this rule under 
Executive Order 12866 (entitled ``Regulatory Planning and Review''). 
OMB determined that this rule is a ``significant regulatory action'' as 
defined in section 3(f) of the Order (although not an economically 
significant regulatory action, as provided under section 3(f)(1) of the 
Order). Any changes made to the rule subsequent to its submission to 
OMB are identified in the docket file, which is available for public 
inspection in the Regulations Division, Office of General Counsel, 
Department of Housing and Urban Development, 451 Seventh Street, SW., 
Room 10276, Washington, DC 20410-0500.

Catalog of Federal Domestic Assistance Number: The Catalog of 
Federal Domestic Assistance number for the program affected by this 
rule is 14.850.

List of Subjects in 24 CFR Part 972

    Grant programs--housing and community development, Low and moderate 
income housing, Public housing.


0
For the reasons discussed in the preamble, HUD amends title 24 of the 
Code of Federal Regulations as follows:

[[Page 14336]]

PART 972--CONVERSION OF PUBLIC HOUSING TO TENANT-BASED ASSISTANCE

0
1. The authority citation for 24 CFR part 972 continues to read as 
follows:

    Authority: 42 U.S.C. 1437t, 1437z-5, and 3535(d).


0
2. Add an appendix to part 972 to read as follows:

Appendix to Part 972--Methodology of Comparing Cost of Public Housing 
with the Cost of Tenant-Based Assistance

I. Public Housing-Net Present Value

    The costs used for public housing shall be those necessary to 
produce a viable development for its projected useful life. The 
estimated cost for the continued operation of the development as public 
housing shall be calculated as the sum of total operating cost, 
modernization cost, and costs to address accrual needs. Costs will be 
calculated at the property level on an annual basis covering a period 
of 30 years (with options for 20 or 40 years). All costs expected to 
occur in future years will be discounted, using an OMB-specified real 
discount rate provided on the OMB Web site at http://www.whitehouse.gov/OMB/Budget, for each year after the initial year. 
The sum of the discounted values for each year (net present value) for 
public housing will then be compared to the net present value of the 
stream of costs associated with housing vouchers.
    Applicable information on discount rates may be found in Appendix C 
of OMB Circular A-94, ``Guidelines and Discount Rates for Benefit Cost 
Analysis of Federal Programs,'' which is updated annually, and may be 
found on OMB's Web site at http://www.whitehouse.gov/OMB. All cost 
adjustments conducted pursuant to this cost methodology must be 
performed using the real discount rates provided on the OMB Web site at 
http://www.whitehouse.gov/OMB/Budget. HUD will also provide information 
on current rates, along with guidance and instructions for completing 
the cost comparisons on the HUD Homepage (http://www.hud.gov). The 
Homepage will also include a downloadable spreadsheet calculator that 
HUD has developed to assist PHAs in completing the assessments. The 
spreadsheet calculator is designed to walk housing agencies through the 
calculations and comparisons laid out in the appendix and allows 
housing agencies to enter relevant data for their PHA and the 
development being assessed. Results, including net present values, are 
generated based on these housing agency data.

A. Operating Costs

    1. Any proposed revitalization or modernization plan must indicate 
how unusually high current operating expenses (e.g., security, 
supportive services, maintenance, tenant, and PHA-paid utilities) will 
be reduced as a result of post-revitalization changes in occupancy, 
density and building configuration, income mix, and management. The 
plan must make a realistic projection of overall operating costs per 
occupied unit in the revitalized or modernized development, by relating 
those operating costs to the expected occupancy rate, tenant 
composition, physical configuration, and management structure of the 
revitalized or modernized development. The projected costs should also 
address the comparable costs of buildings or developments whose siting, 
configuration, and tenant mix is similar to that of the revitalized or 
modernized public housing development.
    2. The development's operating cost (including all overhead costs 
pro-rated to the development--including a Payment in Lieu of Taxes 
(P.I.L.O.T.) or some other comparable payment, and including utilities 
and utility allowances) shall be expressed as total operating costs per 
year. For example, if a development will have 375 units occupied by 
households and will have $112,500 monthly non-utility costs (including 
pro-rated overhead costs and appropriate P.I.L.O.T.) and $37,500 
monthly utility costs paid by the PHA, and $18,750 in monthly utility 
allowances that are deducted from tenant rental payments to the PHA 
because tenants paid some utility bills directly to the utility 
company, then the development's monthly operating cost is $168,750 (or 
$450 per unit per month) and its annual operating cost would be $5,400 
($450 times 12). Operating costs are assumed to begin in the initial 
year of the 30-year (or alternative period) calculation and will be 
incurred in each year thereafter.
    3. In justifying the operating cost estimates as realistic, the 
plan should link the cost estimates to its assumptions about the level 
and rate of occupancy, the per-unit funding of modernization, any 
physical reconfiguration that will result from modernization, any 
planned changes in the surrounding neighborhood, and security costs. 
The plan should also show whether developments or buildings in viable 
condition in similar neighborhoods have achieved the income mix and 
occupancy rate projected for the revitalized or modernized development. 
The plan should also show how the operating costs of the similar 
developments or buildings compare to the operating costs projected for 
the development.
    4. In addition to presenting evidence that the operating costs of 
the revitalized or modernized development are plausible, when the 
projected initial year per-unit operating cost of the renovated 
development is lower than the current per unit cost by more than 10 
percent, then the plan should detail how the revitalized development 
will achieve this reduction in costs. To determine the extent to which 
projected operating costs are lower than current operating costs, the 
current per-unit operating costs of the development will be estimated 
as follows:
    a. If the development has reliable operating costs and if the 
overall vacancy rate is less than 20 percent, then the development-
based method will be used to determine projected costs. The current 
costs will be divided by the sum of all occupied units and vacant units 
fully funded under the Operating Fund Program plus 20 percent of all 
units not fully funded under the Operating Fund Program. For instance, 
if the total monthly operating costs of the current development are 
$168,750 and it has 325 occupied units and 50 vacant units not fully 
funded under the Operating Fund Program (or a 13 percent overall 
vacancy rate), then the $2,250,000 is divided by 335--325 plus 20 
percent of 50--to give a per unit figure of $504 per unit month. By 
this example, the current costs per occupied unit are at least 10 
percent higher (12 percent in this example) than the projected costs 
per occupied unit of $450 for the revitalized development, and the 
reduction in costs would have to be detailed.
    b. If the development currently lacks reliable cost data or has a 
vacancy rate of 20 percent or higher, then the PHA-wide method will be 
used to determine projected costs. First, the current per unit cost of 
the entire PHA will be computed, with total costs divided by the sum of 
all occupied units and vacant units fully funded under the Operating 
Fund Program plus 20 percent of all vacant units not fully funded under 
the Operating Fund Program. For example, if the PHA's operating cost is 
$18 million, and the PHA has 4,000 units, of which 3,875 are occupied 
and 125 are vacant and not fully funded under the Operating Fund 
Program, then the PHA's vacancy adjusted operating cost is $385 per 
unit per month--$18,000,000 divided by the 3,825 (the sum of 3,800 
occupied units and 20 percent of 125 vacant units) divided by 12 
months. Second, this amount will be

[[Page 14337]]

multiplied by the ratio of the bedroom adjustment factor of the 
development to the bedroom adjustment factor of the PHA. The bedroom 
adjustment factor, which is based on national rent averages for units 
grouped by the number of bedrooms and which has been used by HUD to 
adjust for costs of units when the number of bedrooms vary, assigns to 
each unit the following factors: .70 for 0-bedroom units, .85 for 1-
bedroom units, 1.0 for 2-bedroom units, 1.25 for 3-bedroom units, 1.40 
for 4-bedroom units, 1.61 for 5-bedroom units, and 1.82 for 6 or more 
bedroom units. The bedroom adjustment factor is the unit-weighted 
average of the distribution. For instance, consider a development with 
375 occupied units that had the following under an ACC contract: 200 
two-bedroom units, 150 three-bedroom units, and 25 four-bedroom units. 
In that example, the bedroom adjustment factor would be 1.127--200 
times 1.0, plus 150 times 1.25, plus 25 times 1.4 with the sum divided 
by 375. Where necessary, HUD field offices will arrange for assistance 
in the calculation of the bedroom adjustment factors of the PHA and its 
affected developments.
    c. As an example of estimating development operating costs from 
PHA-wide operating costs, suppose that the PHA had a total monthly 
operating cost per unit of $385 and a bedroom adjustment factor of 
.928, and suppose that the development had a bedroom adjustment factor 
of 1.127. Then, the development's estimated current monthly operating 
cost per occupied unit would be $467--or $385 times 1.214 (the ratio of 
1.127 to .928). By this example, the development's current operating 
costs of $467 per unit per month are not more than 10 percent higher 
(3.8 percent in this example) than the projected costs of $450 per unit 
per month and no additional justification of the cost reduction would 
be required.

B. Modernization

    Under both the required and voluntary conversion programs, PHAs 
prepare modernization or capital repair estimates in accordance with 
the physical needs of the specific properties proposed for conversion. 
There are three key assumptions that guide how PHAs prepare 
modernization estimates that affect remaining useful life and determine 
whether the 20-, 30-, or discretionary 40-year remaining useful life 
evaluation period are used for the cost-test. When calculating public 
housing revitalization costs for a property, PHAs will use a 30-year 
period if the level of modernization addresses all accumulated backlog 
needs and the planned redesign ensures long-term viability. For 
modernization equivalent to new construction or when the renovations 
restore a property to as-new physical conditions, a 40-year remaining 
useful life test is used. When light or moderate rehabilitation that 
does not address all accumulated backlog is undertaken, but it is 
compliant with the International Existing Building Codes (ICC) or 
Public Housing Modernization Standards in the absence of a local 
rehabilitation code, the 20-year remaining useful life evaluation 
period must be used.
    Except for some voluntary conversion situations as explained in 
paragraph E below, the cost of modernization is, at a minimum, the 
initial revitalization cost to meet viability standards. In the absence 
of a local code, PHAs may refer to the Public Housing Modernization 
Standards Handbook (Handbook 7485.2) or the International Existing 
Building Codes (ICC) 2003 Edition. To justify a 40-year amortization 
cycle that increases the useful life period and time over which 
modernization costs are amortized, PHAs must demonstrate that the 
proposed modernization meets the applicable physical viability 
standards, but must also cover accumulated backlog and redesign that 
achieves as-new physical conditions to ensure long-term viability. To 
be a plausible estimate, modernization costs shall be justified by a 
newly created property-based needs assessment (a life-cycle physical 
needs assessments prepared in accordance with a PHA's Capital Fund 
annual or 5-year action plan and shall be able to be reconciled with 
standardized measures, such as components of the PHAs physical 
inspection and chronic vacancy due to physical condition and design. 
Modernization costs may be assumed to occur during years one through 
four, consistent with the level of work proposed and the PHA's proposed 
modernization schedule. For example, if the initial modernization 
outlay (excluding demolition costs) to meet viability standards is 
$21,000,000 for 375 units, a PHA might incur costs in three equal 
increments of $7,000,000 in years two, three, and four (based on the 
PHA's phased modernization plan). In comparing the net present value of 
public housing to voucher costs for required conversion, a 30-year 
amortization period will normally be used, except when revitalization 
would bring the property to as-new condition and a 40-year amortization 
would be justified. On the other hand, when the modernization falls 
short of meeting accumulated backlog and long-term redesign needs, only 
a 20-year amortization period might be justified.

C. Accrual

    Accrual projections estimate the ongoing replacement repair needs 
for public housing properties and building structures and systems 
required to maintain the physical viability of a property throughout 
its useful life as the lifecycle of building structures and systems 
expire. The cost of accrual (i.e., replacement needs) will be estimated 
with an algorithm that meets all ongoing capital needs based on systems 
that have predictable lifecycles. The algorithm starts with the area 
index of housing construction costs (HCC) that HUD publishes as a 
component of its TDC index series. Subtracted from this HCC figure is 
half the estimated modernization per unit, with a coefficient of .025 
multiplied by the result to provide an annual accrual figure per unit. 
For example, suppose that the development after modernization will 
remain a walkup structure containing 200 two-bedroom, 150 three-
bedroom, and 25 four-bedroom occupied units, and if HUD's HCC limit for 
the area is $66,700 for two-bedroom walkup structures, $93,000 for 
three-bedroom walkup structures, and $108,400 for four-bedroom walkup 
structures. Then the unit-weighted HCC cost is $80,000 per unit and .75 
of that figure is $60,000 per unit. Then, if the per unit cost of the 
modernization is $56,000, the estimated annual cost of accrual per 
occupied unit is $1,300. This is the result of multiplying .025 times 
$52,000 (the weighted HCC of $80,000) minus $28,000 (half the per-unit 
modernization cost of $56,000). The first year of total accrual for the 
development is $487,500 ($1,300 times 375 units) and should be assumed 
to begin in the year after modernization is complete. Accrual--like 
operating cost--is an annual expense and will occur in each year over 
the amortized period. Because the method assumes full physical renewal 
each year, this accrual method when combined with a modernization that 
meets past backlog and redesign needs justifies a 30- or 40-year 
amortization period, because the property is refreshed each year to as-
new or almost as-new condition.

D. Residual Value (Voluntary Conversion Only)

    Under the voluntary conversion program, PHAs are required to 
prepare market appraisals based on the ``as-is'' and post-
rehabilitation condition of properties, assuming the buildings are 
operated as public or assisted,

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unassisted, or market-rate housing. Section 972.218 requires PHAs to 
describe the future use for a property proposed for conversion and to 
describe the means and timetable to complete these activities. HUD will 
permit a PHA to enter the appraised market value of a property into the 
cost-test in Years 1 through 5 when a PHA anticipates selling a 
property or receiving income generated from the sale or lease of a 
property.
    As a separate line item to be added to total public costs as a 
foregone opportunity cost, a PHA shall include in the voluntary cost-
test calculations the appraised market or residual value (or net sales 
proceeds) from the sale or lease of a property that is to be 
voluntarily converted to tenant-based voucher assistance. The PHA must 
hire an appraiser to estimate the market value of the property using 
the comparable sale, tax-assessment, or revenue-based appraisal 
methods. PHAs are advised to select one or more of these appraisal 
methods to accurately determine the actual or potential market value of 
a property, particularly the comparable sales or revenue-based methods. 
The market or residual value is to be determined by calculating the 
estimated market value for the property based on the appraisal, minus 
any costs required for demolition and remediation. The residual value 
must be incorporated into the cost-test instead of the actual market 
value only when any demolition, site remediation, and clearance costs 
that are necessary are covered by the selling PHA. However, if the sum 
of the estimated per unit cost of demolition and remediation exceeds 10 
percent of the average Total Development Cost (TDC) for the units, the 
lower of the PHA estimate or a figure based on 10 percent of TDC must 
be used. Suppose the estimated remediation and demolition costs 
necessary for conversion sale are $7,000 per unit. Also, suppose the 
TDC limits are $115,000 for a two-bedroom unit, $161,000 for a three-
bedroom unit, and $184,000 for a four-bedroom unit. Then the average 
TDC of a development with 200 two-bedroom units, 150 three-bedroom 
units, and 25 four-bedroom units is $138,000 (200 times $115,000, plus 
150 times $161,000, plus 25 times $184,000, the sum divided by 375) and 
10 percent of TDC is $13,800. In this example, the estimated $7,000 per 
unit costs for demolition and remediation is less than 10 percent of 
TDC for the development, and the PHA estimate of $7,000 is used. If 
estimated expenses had exceeded 10 percent of TDC ($13,800 in this 
example), demolition and remediation expenses must be capped at the 
lower amount.

E. Accumulated Discounted Cost: Public Housing

    The overall cost for continuing to operate the development as 
public housing is the sum of the discounted values of the yearly stream 
of costs up for the amortization period, which can range from 20 to 30 
to 40 years, depending on the extent of modernization relative to the 
current physical and redesign needs of the development. In calculating 
net present value for required conversion, the sum of all costs in each 
future year is discounted back to the current year using the OMB-
specified real discount rate. For voluntary conversion, the discount 
rate is applied forward as a direct inflation factor. To assist PHAs in 
completing the net present value comparison and to ensure consistency 
in the calculations, HUD has developed a spreadsheet calculator that is 
available for downloading from the HUD Internet site. Using PHA data 
and property specific inputs (to be entered by the housing agency), the 
spreadsheet will discount costs as described above and will generate 
net present values for amortization periods of 20, 30, and 40 years.

II. Tenant-Based Assistance

    The estimated cost of providing tenant-based assistance under 
Section 8 for all households in occupancy shall be calculated as the 
unit-weighted average of recent movers in the local area; plus the 
administrative fee for providing such vouchers; plus $1,000 per unit 
(or a higher amount allowed by HUD) for relocation assistance costs, 
including counseling. However, if the sum of the estimated per unit 
cost of demolition, remediation, and relocation exceeds 10 percent of 
the average Total Development Cost (TDC) for the units, the lower of 
the PHA estimate or a figure based on 10 percent of TDC must be used.
    For example, if the development has 200 occupied two-bedroom units, 
150 occupied three-bedroom units, and 25 occupied four-bedroom units, 
and if the monthly payment standard for voucher units occupied by 
recent movers is $550 for two-bedroom units, $650 for three-bedroom 
units, and $750 for four-bedroom units, the unit-weighted monthly 
payment standard is $603.33. If the administrative fee comes to $46 per 
unit, then the monthly per unit operating voucher costs are $649.33, 
which rounds to an annual total of $2,922,000 for 375 occupied units of 
the same bedroom size as those being demolished in public housing. To 
these operating voucher costs, a first-year relocation is added on the 
voucher side. For per-unit relocation costs of $1,000 per unit for 
relocation, then $375,000 for 375 units is placed on the voucher cost 
side of the first year.

Accumulated Discounted Cost: Vouchers

    The overall cost for vouchers is the sum of the discounted values 
of the yearly stream of costs up for the amortization period, which can 
range from 20 to 30 to 40 years, depending on the extent of 
modernization relative to the current physical and redesign needs of 
the development. The amortization period chosen is the one that was 
appropriate for discounting public housing costs. In calculating net 
present value for required conversion, the sum of all costs in each 
future year is discounted back to the current year using the OMB-
specified real discount rate. For voluntary conversion, the discount 
rate is applied forward as a direct inflation factor.
    To assist PHAs in completing the net present value comparison and 
to ensure consistency in the calculations, HUD has developed a 
spreadsheet calculator that will be available for downloading from the 
HUD Internet site.

III. Results of the Example

    With the hypothetical data used in the examples, under an 
amortization period of 30 years, the discounted public housing costs 
under required conversion sums to $69,633,225, and the discounted 
voucher cost under required conversions totals $60,438,698. The ratio 
is 1.15, which means that public housing is 15 percent more costly than 
vouchers. With this amortization and this data, the PHA would be 
required to convert the development under the requirements of subpart A 
of this part, except in a situation where a PHA can demonstrate a 
distressed property that has failed the cost-test can be redeveloped by 
meeting each of the four factors that compose the long-term physical 
viability test to avoid removal from the inventory. With the same data, 
but a 40-year amortization period, public housing is still 11 percent 
costlier than vouchers, and with a 20-year amortization, public housing 
is 25 percent costlier than vouchers. In voluntary conversion, with the 
same hypothetical data, but a slightly different methodology (use of 
residual value as a public housing cost, inflating forward the discount 
numbers), the ratio of public housing costs to voucher costs would be 
1.16 for the 20-year amortization period, 1.03 for the 30-year

[[Page 14339]]

amortization period, and .97 for the 20-year amortization period. Thus, 
in voluntary conversion, the appropriate amortization period would 
decide whether public housing is more costly or is slightly more 
costly, or less than vouchers. Under a 20-year amortization assumption 
and possibly under a 30-year amortization period, the PHA would have 
the option of preparing a conversion plan for the development under 
subpart B of this part. Different sets of data would yield different 
conclusions for required and voluntary conversion determinations.

    Dated: December 28, 2005.
Orlando Cabrera,
Assistant Secretary for Public and Indian Housing.

    Note: The following sample pages will not be codified in the 
Code of Federal Regulations.

Sample Pages from Spreadsheet Calculator

    As noted above in the preamble to this final rule, HUD has 
developed a spreadsheet calculator to assist PHAs in the calculations 
and comparisons required for the conversion analysis. The spreadsheet 
calculator will be available for PHAs to download from the HUD Internet 
site (http://www.hud.gov). The following sample pages from the 
spreadsheet calculator illustrate the cost comparison methodology 
contained in this final rule.
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[FR Doc. 06-2621 Filed 3-20-06; 8:45 am]
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