Propriety of Rental Increases Authorized by HUD

Published by the Government Accountability Office on 1971-04-16.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

       In accordance with your request of November 9, 1970, and subsequent
discussions    with your office,  we have examined into the propriety of rental
increases authorized    by the Department of Housing and Urban Development    (HUD)
at the Xashington    Towers Apartments in Union City, New Jersey, and the
Park Hudson Apartments in North Bergen, New Jersey*

     HUD regulations  provide in general that the rental     income of a project
which has a mortgage loan insured pursuant to the National        Housing Act, as
amended (12 U.S.C, 17011, be established     at a level which will maintain    the
economic soundness of the project    and which will provide    the owner with a reason-
able return on his investment   consistent   with reasonable   rents to the tenants.

       HUD regulations      do not provide    for the establishment      of maximum rents
for each type of apartment in a project           but instead provide        for establishment      of
a maximum gross rental          income for the project.      Generally,    increases     in the
maximum gross rental         income requested by a project      owner mav be authorized         only
to compensate the owner for increases in operating              costs,     In reviewing     requests
for increases,      HUD determines whether the operating          cost increases are bona fide,
HUD also requires       the project    owner to submit annual financial          statements which
HUD reviews to ensure that the gross rental             income of the project        does not
exceed the maximum gross rental income which it had authorized.                     When the
reported   rental income exceeds the approved rental            income, HUD is required         to
take appropriate       action to obtain necessary adjustments,          including     the refund
of any excess rental         charges to tenants,

       Our review was made principally          at HUD headquarters;     at its Newark,
New Jersey, insuring       office;     and at the management offices       of the projects.
Our review included an examination            of the applicable    laws and regulations        and
the project     owners' accounting       records and financial     statements,      We also com-
pared the authorized       rental    incomes for the two projects       with the rental      incomes
reported    by the project      owners and with those authorized        for similar    projects
in neighboring     areas.

       Rental increases at the two projects      were not uniformly  applied  to all
tenants nor made at the same time; therefore,        we could not determine precisely
the rental    increases applicable   to the various   sizes of apartment units without
a considerable      amount of work, which would have delayed our reporting      to you,
Further,    we did not think such determinations     were necessary to respond to
your request,

        The mortgage loan for the YWashington Towers project   is insured pur-
suant to section 220 of the National      Housing Act, which authorizes   mortgage
insurance    for housing in urban renewal areas.    The section 220 program is
similar    to the program authorized  by section 207 of the act, in that it is
an unsubsidized     program for the general public rather than for any specific
income group0

        Our review showed that HUD authorized        increases in the rental   income
in accordance with applicable        regulations   and that HUD based the increases
upon increased operating       costs reported    by the project  owner,   The rents
charged by the project       owner were within    the authorized   maximum amounts for
the project,      and the authorized    amounts compared favorably    with those for
similar    projects   in the area*

      Although HUD had authorized  two increases in the maximum gross rental
income since the project   began operating   in 1965, our review did not show,
as the tenants alleged to you, that ther.e were three rent increases    to the
tenants within a 14-month period.

     The maximum gross rental      incomes authorized       by HUD for   the project
wece, as L't~ilows~

     Date    of                                Authorized      monthly   rental  income
   authori,zation                                Total                   Per room

     November 1965 (initial)                      $52,741                 $37.13
     July 1969                                     57,175                  40,26
     December 1970                                 64,595                  45.48
      With respect to the contention      of the tenants that rent increases were
caused, in part, by HUD's refusal       to extend the mortgage period when owner-
ship of the project    was transferred,    we noted that the project  had a 40-year
mortgage loan which was the maximum period prescribed        by HUD, and the factor
for amortization    of the mortgage loan used in the rent formula was as iow as
possible   under HUD regulations,


      The mortgage   loan for the Park Hudson project  is insured pursuant to s-I
section 221(d)(4)    of the act.  At the time HUD approved the project    for

    1   I   .


                mortgage loan insurance,        HUDUs criterion       for approval       of a 221(d)(4)    project
                was that the initial      rental rates necessary to make the project                 economically
                sound should generally       be above those for projects             insured pursuant to the
                section 2211d)C3)--the       below-market-interest-rate             program--and   below those
                for projects   insured pursuant to the section 207 program--an                   unsubsidized
                program intended for the general public.                The initial      monthly gross rental
                income authorized     for the project      and the subsequent increases are shown

                      Date of                                          Authorized     monthly    rental income
                  authorization                                          Total                  Per room

                      November 1968 (initial.1                            $42,OOQ                $47038
                      February 1970                                        54,525                 61.51
                      July 1970                                            64,366                 72.61

                        Our review showed that (1) the rents charged by the project                owner
                exceeded the authorized        limits during the initial       14 months of operation,
                (2) procedures     followed    by the Newark insuring     office     in approving    the proj-
                ect owner's first       request for an increased-rent      authorization       were not in
                accordance with HUD's regulations,          and (3) rental. rates euthcrizcr? fcr the
                project    in July 1970 exceeded the rents authorized            for neighboring     section 2Q7

                Authorized     rental   limits   exceeded

                       During the initial  14 months of operation  (January 1969 through
                February 19701, the rents established    by the project    owner would have resulted
                in, at full occupancy, monthly gross rental income of about $47,000 or about
                $5,1oOO in excess of the monthly income authorized      by HUD in November 1968,
                The average rent for a room, based on the rents established       by the project
                owner, was $53 compared with the average of $47 a room under the maximum gross
                rental   income authorized  by HUD.

                        apparently    the Newark insuring     office    failed    to detect the excess rental
                charges because it compared the reported             rental    income for 1969 with the
                increased-rent      authorization   approved in February 1970 rather than with the
                initial     gross rental income approved in November 1968, HUD headquarters"
                officials      have informed us that the mortgagor may be required             to refund all
                excess rental charges collected         during the 14-month period.

Rent increase not authorized     in
accordance with HUD rem.d.ations

       Generally,  increases in rental    income can be authorized       only for
increases   in operating    costs0 In   February   1970,  however,    HUD authorized    an,
increase from $42,000 TV $54,525 a month,        an  average   increase   of  $14  a room.
The increase was achieved primarily       by increasing     the factors   used in the
rent authorization     formula for replacement     cost of the project      and amortiza-
tion of the mortgage loan.

      About $10 of the $24 increase was attributable             to an increase of about
$1 million   in the replacement      cost and an increase of one half of one per-
cent in the amortization      factor   for repayment of the mortgage loan.            The
increase in the replacement        cost represented     an overrun of construction
costs which were not allowed by HUD in the original              rent authorization.      The
remaining   portion    of the increased-rent     authorization      ($4) was principally
for increased     operating  costs.

       It should be noted that, although the authorized     rent increase was
greater    than it should have been, the gross rental   income of the project
during the period from March to July 1970 was below the maximum amount
authorized     in February 1970,

     The increase in July 1970 in the authorized             maximum gross rental   income
was approved by HUD to offset increased operating             costs of the project.

Comparison of authorized     rental      rates
with those of other projects

       As requested by your office,  we compared the most recent authorized
rental   rates for the Park Hudson project     with those of nearby similar   projects*
There were no other section 221(d5(4)      projects   in the area, therefore  the
comparison was made with neighboring    projects    insured pursuant to section 207
of the act0

      Although HUD's       criterion     for approval   of a section 221iCdlC43 project
was that the initial        rental   rates should generally       be lower than those for
section 207 projects,          this criterion    is not applicable     in the approval  of sub-
sequent increases in        rental   rate authorizations.       The average rent, $73 a
room, authorized     for    the Park Hudson project       in July 1970 exceeded the most
recent average rent,         $56 to $65 a room, for the section 207 projects,

Rent escalation     clause

        One of the conditions         that apparently     contributed  to tenant dis-
satisfaction       was the rent adjustment made by the project            owner in accordance
with an escalation        clause contained in the lease agreements, which provided
that rents could be increased retroactively                to cover increased property    taxes.
During 1970, property         taxes increased by $44,441, to $140,291, and the project
owner imposed this increase on the tenants in three stages during an 8-month
period.      The resulting      increased rental      income, however, remained within      the
limits     authorized    by HUD for the project,

Agency actions

        We discussed the rental. rates charged by the project             owner during the
initial     14 months of operation        with HUD headquarters'   officials    who stated
that the project         owner was not entitled      to any rental income which exceeded
the amount authorized         by HUD, With respect to the rent increase approved in
February 1978, these officials            stated that the increase     in the replacement
value and amortization         factor for repayment of the mortgage was contrary           to
existing     regulations,      HUD officials     advised us that, as a result      of our
inquiries,      HUD had initiated     a review of these matters with a view toward
requiring      the refunding    of rental overcharges      and the rescinding    of any
unwam-anted       increases in rental authorizations,

      We did not obtain formal written  comments from HUD officials   or from
the project  owners concerning the matters discussed in this report,    and this
fact should be taken into consideration   in any use made of the information

       In accordance with      our agreement with you, we are sending a copy of this
letter   to the Secretary,      D'epartment of Housing and Urban Development, We
plan to make no further        distribution  of this report,

      We trust    that   the information    furnished   will   serve   the purpose   of your

                                                Comptroller  General
                                                of the United States

The Honorable Dominick       V, Daniels
House of Representatives