oversight

Housing Finance: Procedures and Costs for Developing San Diego Project Were Reasonable

Published by the Government Accountability Office on 1997-07-25.

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

                  United States General Accounting Office

GAO               Report to Congressional Requesters




July 1997
                  HOUSING FINANCE
                  Procedures and Costs
                  for Developing San
                  Diego Project Were
                  Reasonable




GAO/RCED-97-190
                   United States
GAO                General Accounting Office
                   Washington, D.C. 20548

                   Resources, Community, and
                   Economic Development Division

                   B-277297

                   July 25, 1997

                   The Honorable Brian P. Bilbray
                   The Honorable Duncan Hunter
                   The Honorable Randy “Duke” Cunningham
                   House of Representatives

                   In response to allegations of mismanagement and excessive spending, you
                   asked us to evaluate the San Diego Housing Commission’s role in
                   developing Knox Glen Apartments, a 54-unit project consisting mainly of
                   three- and four-bedroom town houses located on Logan Avenue in
                   southeastern San Diego. The project, which replaced an abandoned,
                   partially completed 116-unit complex, was financed with funds from a
                   variety of sources, including the federal HOME and Low-Income Housing
                   Tax Credit programs. Specifically, you asked us to evaluate (1) the process
                   the Commission followed to develop the project, (2) the reasonableness of
                   the project’s costs compared with the costs of other new and existing
                   multifamily projects in the area, and (3) the impact of the project on the
                   area’s rental housing market and supply of affordable housing. You also
                   asked us to summarize the results of other governmental investigations of
                   the Knox Glen project.


                   The process that the San Diego Housing Commission followed to develop
Results in Brief   Knox Glen Apartments was dictated, in large part, by its decision to
                   revitalize the Logan Avenue site and by federal funding and local
                   requirements. After purchasing the property and determining that the
                   existing structures could not be salvaged, the Commission used HOME
                   funds to demolish these structures and constructed new affordable
                   housing on the site. From the start, the Commission met with
                   neighborhood representatives, securing their approval of the project’s
                   design and ensuring that this design met the requirements of the city and
                   of the Low-Income Housing Tax Credit program. In addition, the
                   Commission designated a nonprofit corporation to manage the project’s
                   development and financing. The president of the nonprofit corporation is
                   the Commission’s executive director, and the nonprofit corporation is
                   staffed by Commission personnel on a cost-reimbursable basis.

                   Overall, the costs of developing Knox Glen Apartments were reasonable.
                   The project’s site-specific costs were high but necessary to revitalize the
                   Logan Avenue site. Because these costs (for acquiring the land,
                   demolishing the existing structures, and complying with local design and




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             zoning requirements) were high and because the project consisted mainly
             of large (three- and four-bedroom) units, the average per-unit cost was
             about $149,000. The project’s per-square-foot costs above the foundation
             ($39.55) were about average for new construction in San Diego at the time,
             and the project’s per-bedroom costs (about $40,300) were relatively low
             for the California projects that received tax credits at the same time.

             The construction of Knox Glen Apartments increased the supply of
             affordable housing in the neighborhood without adversely affecting other
             rental properties in the area. All of the units at Knox Glen were rented
             within 2 weeks after the project was completed. An owner of three
             sizeable low-income properties in the area said that he lost about six
             families to Knox Glen, but his vacant units were quickly filled. Also, since
             Knox Glen was completed, a private developer began to construct 23
             single-family homes for first-time home buyers across the street.
             According to the developer, he would not have built the project, and his
             bank would probably not have lent him the money for its construction, if
             the structures that formerly stood on the Knox Glen site had not been
             demolished.

             Investigations by a San Diego County Grand Jury, a Select Committee of
             the San Diego City Council, and the Department of Housing and Urban
             Development’s Inspector General found no abnormalities, malfeasance, or
             incompetence in the financing or construction of Knox Glen as a
             low-income housing project.


             The HOME program, created under title II of the National Affordable
Background   Housing Act of 1990, makes funding available to state and local
             governments to develop and support affordable housing for low- and very
             low income households.1 Eligible activities include assistance to qualified
             tenants, home buyers, and homeowners; property acquisition; new
             construction; rehabilitation; demolition; loan guarantees; and other
             expenses related to the development of nonluxury housing. The program’s
             funding—an account with a line of credit—is allocated by formula to
             participating jurisdictions.

             The Low-Income Housing Tax Credit program, created under the Tax
             Reform Act of 1986, substituted tax credits for existing tax incentives for
             the construction of low-income housing, such as accelerated depreciation.

             1
              “Low-income” is generally defined as 80 percent or less of the median income for the area. “Very low
             income” is defined as 50 percent or less of the area’s median income, adjusted for family size.



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Under this program, an agency in each state administers the state’s tax
credit allocation, and for-profit or nonprofit developers build affordable
housing projects. The California Tax Credit Allocation Committee
administers California’s tax credit allocation.

The Internal Revenue Code requires each state tax credit allocating agency
to evaluate proposed projects against a qualified allocation plan that
establishes a procedure for ranking the projects on the basis of how well
they meet the state’s identified housing priorities and are appropriate to
local conditions. The Code further directs each state agency to consider
the reasonableness of a project’s development and operating costs.

The San Diego Housing Commission (Commission) is an independent,
tax-exempt public organization created by the San Diego City Council in
1979 to advise the city on housing issues and to administer affordable
housing programs. The City Council, which serves as the city’s Housing
Authority, reviews and approves all of the Commission’s activities and
programs. In 1990, the Commission created the San Diego Housing
Development Corporation (Corporation), a nonprofit organization
authorized to act as the general partner for tax credit projects. The
executive director of the Commission is the president of the Corporation,
and the same general counsel served both entities through the project’s
construction. The Commission provides staff and services to the
Corporation on a cost-reimbursable basis.

The Commission became involved in the Knox Glen project in late 1992,
after the mayor and a city council member asked the Commission to
purchase the abandoned property on Logan Avenue known as Greentree
Plaza. This 3.2-acre property included 116 apartment units in six buildings
that were 65 percent complete when the builder declared bankruptcy in
1987. In 1988, the Federal Deposit Insurance Corporation (FDIC) took over
the property, boarded up the abandoned buildings, constructed security
fences, and periodically provided security guards. Despite these
precautions, the property became an “eyesore” and a hangout for gangs,
and was plagued with arson, trespassing, and vandalism. (See fig. 1.)




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Figure 1: Greentree Plaza




                            Greentree Plaza was located in the Lincoln Park section of southeastern
                            San Diego, which an appraiser described in August 1995 as one of the
                            “least desirable neighborhoods in the city.” The average household income
                            in the neighborhood is two-thirds of the citywide average, and the rate of
                            violent crime is nearly twice the citywide rate. The Lincoln Park
                            neighborhood is also the most densely populated in southeastern San
                            Diego, averaging about 17 dwelling units per acre.




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                      The neighborhood had opposed Greentree Plaza from the start, because of
                      its density and appearance. After the developer declared bankruptcy, the
                      city responded to these concerns by issuing new zoning and design
                      regulations for an area that it designated at this time as the Southeast San
                      Diego Planned District. The new zoning regulations, adopted in July 1987,
                      lowered the allowable number of units per acre for the property from
                      29.04 to 17.42. The new design regulations, which applied to everything
                      from parking to facade design, set standards for constructing or altering
                      residential, commercial, and industrial property in the planned district.
                      Added in August 1987, the new design regulations increased the San Diego
                      municipal code by 42 pages.


                      The process that the Commission followed to develop Knox Glen
Development Process   Apartments was largely dictated by its decision to revitalize the Logan
Was Reasonable        Avenue site and by federal funding and local planning requirements. The
Given Commission’s    Commission’s involvement in the process consisted primarily of meeting
                      with neighborhood representatives to develop a plan for the project and
Decisions             using the nonprofit Corporation to manage the project. Figure 2 identifies
                      the principal steps in the development process.




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Figure 2: Stages in Knox Glen’s Development



                                                                             Dec.
 Jan.           Mar.          Sept.                            Sept.                                   Oct.
                                                                              Construction begins
 First          Greentree     Tax credit                       City issues                             First units
                                                                              Title transferred to
 neighborhood   Plaza torn    reservation                      building                                placed in
                                                                              Logan Partnership
 meeting on     down          awarded                          permit                                  service
 development
 held

                1994                                    1995                                    1996


    Feb.                 Aug.                            Aug.                                                        Dec.
    Property             Tax credit                      Neighborhood                                                Project
    purchased            application                     gives final                                                 fully
    from FDIC            submitted                       approval                                                    rented
                                                                      Oct.
                                                                        Title transferred
                                                                        to Corporation


Commission Designed                         The Commission first met with neighborhood representatives after the
Project With Neighborhood                   Mayor’s June 1992 press conference to discuss whether Greentree Plaza
Input                                       should be completed or demolished. The meetings confirmed the
                                            neighborhood’s opposition to completing the development.

                                            According to the Commission’s executive director, FDIC had maintained
                                            that Greentree Plaza could be completed and rented and was asking
                                            $2.45 million for the property. However, several developers had inspected
                                            the development and concluded that it was beyond repair. Eventually, the
                                            Commission negotiated a purchase price of $700,000 with FDIC and bought
                                            the property in February 1994. The Commission first met with
                                            neighborhood representatives to discuss the development of a new project
                                            in January 1994.

                                            In March 1994, the Commission demolished Greentree Plaza. To do so, it
                                            used HOME funds, the only funds available for demolition, according to
                                            the Commission. Because the HOME program provides funding only for
                                            activities related to the development of nonluxury housing, the
                                            Commission’s use of HOME funds for demolition was consistent with its
                                            commitment to construct new affordable housing at the site.



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Through additional meetings with community groups and in-house
discussions, the Commission produced a development plan for the Logan
Avenue site. This plan served as the basis of the application for tax credits.
The plan provided for 55 units, primarily with three or four bedrooms to
accommodate larger households. (See app. I, tables I.1 and I.2.) The plan
also included recreation areas, space for community activities, and other
amenities desired by the neighborhood.

To finance the project, the development plan proposed to combine tax
credits with HOME funds, a low-interest community development loan, a
commercial loan, and a deferred loan from the developer (see app. I, table
I.3). On August 1, 1994, the Commission submitted its application for tax
credits to the California Tax Credit Allocation Committee. The Committee
evaluated this application against the Low-Income Housing Tax Credit
program’s criteria, determined that the project was eligible for tax credits,
and awarded points for specific features. In total, the project received 105
points—ultimately the cut-off score required to qualify it for tax credits at
the time. The project received 35 points for targeting lower-income
households (see app. I, table I.4), 25 points for agreeing to serve these
households for 55 years, 15 points for serving large families, 25 points for
the amount of equity invested by owners in the project, and 5 points for
providing special amenities, including a community center. In
September 1994, the California Tax Credit Allocation Committee approved
the Commission’s application for tax credits and reserved tax credits for
the project.

After receiving the tax credit reservation, the Commission continued to
meet with neighborhood representatives to secure their approval of the
project’s design. The city of San Diego requires proof of the
neighborhood’s approval before it will issue a permit for a project’s
development. In addition, the Low-Income Housing Tax Credit program
requires certification that a project has obtained all necessary state and
local approvals before construction can begin. In August 1995, a task force
of volunteers representing key neighborhood organizations approved the
project’s design, and in September 1995, the city approved a permit for the
project’s development.

The meetings with neighborhood representatives to obtain their approval
took about 4 months longer than planned. These meetings were
time-consuming because the Lincoln Park neighborhood did not want a
repeat of its experiences with the Greentree Plaza development. For the
new development, the neighborhood wanted the least dense, most



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                          aesthetically pleasing complex possible. For example, the neighborhood
                          held the Commission to a strict interpretation of the 1987 zoning limits,
                          negotiating a 1-unit reduction in the original plan for 55 units. At times, the
                          neighborhood also emphasized aesthetics over costs. For example, the
                          neighborhood insisted that barrel-vaulted roofs be designed into the
                          structure in order to vary the roof lines. Community leaders believed that
                          such a visually pleasing design would make the development stand out as
                          well as eliminate any reference in appearance to Greentree Plaza.


Commission Chose to       In October 1995, the Commission transferred the title to the Logan Avenue
Designate the Project’s   property, along with the tax credit allocation and the project’s debt, to the
Developer                 San Diego Housing Development Corporation. To create the legal entity
                          necessary to develop the project and obtain the necessary financing, the
                          Corporation created the Logan Development Limited Partnership
                          (Partnership) and transferred the project’s title to the Partnership on
                          December 1, 1995. The Corporation acts as the general partner and holds a
                          1-percent ownership share. Under this arrangement, the Corporation
                          retains control of the project, and the other partners provide the equity
                          funds to develop the project.

                          Instead of transferring the project’s title to the Corporation and creating
                          the Partnership, the Commission could have solicited proposals from
                          existing nonprofit developers and awarded the project to the most
                          qualified bidder. According to the agendas for the Commission’s August
                          and September 1995 meetings, the Commission considered this alternative.
                          However, according to the agendas, a solicitation could have caused a
                          delay that could have resulted in the loss of tax credits and required a
                          reapplication in December 1995.

                          The directors of two San Diego community development corporations
                          with experience in developing tax credit projects agreed that a delay could
                          have resulted from soliciting bids in August 1995. They added, however,
                          that the Commission could have solicited bids before the tax credits were
                          awarded, and the chosen developer would then have negotiated the
                          project’s design with the neighborhood and finalized the development
                          plan. According to both directors and the executive director of the San
                          Diego County Apartment Association, the underlying issue is one of
                          policy—whether a corporation established by a government entity with




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ties to that entity should be in the development business and whether such
a corporation can build as efficiently as the private sector.2

The directors of the two San Diego community development corporations
also expressed concern about the organizational links between the
Commission and the Corporation. The directors noted that if the
Commission were to solicit bids in the future, their organizations would
have difficulty competing with the Corporation because the Corporation
has direct ties to the Commission.

The first residents moved to Knox Glen in late October 1996, and all of the
units were rented before the end of the year. (See fig. 3.) Forty percent of
the residents moved from within 2 miles of the project, and the average
distance moved was 4 miles. As of March 1997, 88 adults, 123 minors, and
a resident manager were living in the 54 units, paying monthly rents
ranging from $486 to $753 (see app. I, table I.5).




2
 A reference to the San Diego Housing Development Corporation’s role in the project’s development,
appearing in the agenda for the Commission’s July 18, 1994, meeting, seems to confirm the directors’
position that the Corporation’s participation was more a matter of policy than an action required to
avoid delays. According to the agenda, the development plan recommended as the basis for the
application for tax credits provides for ownership of the project “by a limited partnership, of which the
San Diego Housing Development Corporation (SDHDC) would serve as general partner, . . . with
development by the Commission on behalf of SDHDC.”



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Figure 3: Knox Glen




                        The costs of developing Knox Glen Apartments were reasonable, given the
Costs of Project Were   Commission’s decision to revitalize the Logan Avenue site. This decision
Reasonable, Given Its   entailed high site-specific costs; however, when these costs are excluded,
Location                the project’s costs are reasonable compared with those of other San Diego
                        properties constructed at the time and of other California properties that
                        received tax credits at the time. The Commission could have saved money
                        by building new housing or rehabilitating existing housing elsewhere in
                        the city, but it could not then have revitalized the Logan Avenue site.




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Site-Specific Requirements           A project’s development costs are usually closely linked to the project’s
Increased Project’s Costs            location. Knox Glen’s location—in an area affected by a community plan
                                     and a planned district ordinance with strict controls over the design of
                                     amenities—contributed substantially to its costs. Moreover, the costs of
                                     construction in San Diego are among the highest in California, and the
                                     costs of construction in California are among the highest in the nation.

                                     Knox Glen incurred site-specific costs that accounted for over 25 percent
                                     of its total development costs of about $149,000 per unit. These included
                                     the costs of acquiring land and demolishing Greentree Plaza, of meeting
                                     the planned district’s special design requirements, and of complying with
                                     the municipal building code and other city requirements. For example, the
                                     planned district requires covered off-street parking for at least 50 percent
                                     of a project’s parking spaces and at least 200 square feet of exterior usable
                                     open space for each unit. For aesthetic reasons, the district also requires
                                     that structures be built with offsetting variations in a minimum of three
                                     vertical or horizontal planes. These requirements added substantially to
                                     Knox Glen’s costs, as table 1 indicates.

Table 1: Knox Glen’s Site-Specific
Costs                                                                                         Site-specific costs
                                     Cost category                                    Total             Per unit         Per bedroom
                                     Land acquisition                             $807,800               $14,960                   $4,840
                                     Demolition                                   $155,600                $2,880                    $930
                                     Off-street parking and                       $793,800               $14,700                   $4,750
                                     accessa
                                     Exterior usable open                          $38,850                  $720                    $230
                                     areasa
                                     Offsetting planes                            $154,000                $2,850                    $920
                                     requirementa
                                     Off-site workc                                $69,900                $1,290                    $420
                                                       b
                                     Fire protection                               $65,650                $1,220                    $390
                                     One-time school feed                         $109,520                $2,030                    $660
                                     Total                                       $2,195,120              $40,650               $13,140
                                     a
                                     San Diego Municipal Code requirement for planned district.
                                     b
                                         Uniform Fire Code and the City of San Diego Fire Department requirements and ordinances
                                     c
                                      San Diego Uniform Building Code, Uniform Fire Code, City of San Diego Municipal Code,
                                     Metropolitan Transit District Board Requirements, and Southeast Planned District Ordinance.
                                     d
                                         San Diego school district assessment.



                                     Source: San Diego Housing Commission.




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                                   We compared Knox Glen’s site-specific costs with those of the Mercado
                                   Apartments, another family-oriented San Diego tax credit project that
                                   opened in June 1994, about 2-1/2 years before Knox Glen. This
                                   project—consisting of 18 one-bedroom, 60 two-bedroom, and 66
                                   three-bedroom apartments; a community room; and a playground
                                   area—won a number of awards and has been cited as the tax credit
                                   project with the lowest per-unit costs in the city (about $92,000 per unit).
                                   (See fig. 4.)


Figure 4: The Mercado Apartments




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                                       Although the Mercado incurred substantial site-specific costs, it was
                                       generally subject to less restrictive and less costly requirements than Knox
                                       Glen. Located in a different section of San Diego, the Mercado’s site was
                                       zoned to allow denser, less costly development. Additionally, the Mercado
                                       did not have to comply with the planned district’s special design
                                       requirements. And because the Mercado is situated close to a trolley line,
                                       it did not have to provide covered parking spaces or as many parking
                                       spaces per unit as Knox Glen. However, the Mercado incurred its own
                                       costs for off-site improvements and for environmental remediation, which
                                       alone amounted to about $200,000. Overall, Knox Glen’s site-specific costs
                                       were higher than the Mercado’s—a difference that accounts for a
                                       significant portion of the difference in the two projects’ per-unit costs.


Construction Costs Were                Because the costs of development often vary from site to site, much as the
About Average                          costs of developing Knox Glen and the Mercado varied, developers do not
                                       consider projects’ total development costs comparable. Instead, they
                                       compare the per-square-foot costs of construction above the foundation.
                                       The specialist assigned by the Commission to oversee Knox Glen’s
                                       construction for the Corporation surveyed a number of San Diego real
                                       estate developers in August 1996 to compare Knox Glen’s estimated costs
                                       with those of other multifamily housing projects under construction at the
                                       same time. His survey revealed that Knox Glen’s above-foundation
                                       construction cost of $39.55 per square foot was just below the average for
                                       nine projects, whose above-foundation construction costs ranged from $34
                                       to $45 per square foot. (See table 2.)

Table 2: Above-Foundation Costs Per
Square Foot for Attached Multifamily                                                             Cost per square foot
Housing in San Diego, August 1996      Location of development             Number of units        (above foundation)
                                       South County                                   230                     $45.00
                                       Poway                                          249                     $42.50
                                                                                          a
                                       Rancho San Diego                                                       $41.00
                                       Chula Vista                                    135                     $40.00
                                       Middletown                                      36                     $40.00
                                       Southeast San Diego                             15                     $40.00
                                       East County                                     15                     $40.00
                                       Knox Glen                                       54                     $39.55
                                       North County                                   344                     $34.00
                                       a
                                       Not available.




                                       Page 13                                        GAO/RCED-97-190 Housing Finance
                           Source: San Diego Housing Commission.


                           The Mercado’s above-foundation cost of about $37 per square foot is not
                           significantly lower than Knox Glen’s, given that the Mercado was
                           constructed about 2-1/2 years earlier. In 1997, the same community
                           development corporation that built the Mercado proposed a new 138-unit
                           tax credit project, to be designed along the same lines as the Mercado. The
                           estimated cost of this project is about $39.50 per square foot above the
                           foundation.


California’s Costs Are     High land and construction costs, stringent seismic standards, and other
Among the Highest in the   factors make California’s tax credit projects among the costliest in the
Nation                     nation. In addition, in 1994, when the Commission applied for tax credits,
                           the California Tax Credit Allocation Committee had not yet adopted the
                           per-unit cost limits established by the Department of Housing and Urban
                           Development (HUD) for nonluxury multifamily housing projects
                           participating in its 221(d)(3) mortgage insurance program.3 Before the
                           Committee adopted HUD’s 221(d)(3) limits in 1996, the costs for
                           construction financing and various fees had escalated throughout the
                           state. After the Committee adopted HUD’s limits, these costs reportedly
                           declined by 12 percent. Knox Glen received tax credits 2 years before the
                           Committee adopted HUD’s limits.

                           Compared with the costs of the other California properties that received
                           tax credits at the same time, Knox Glen’s costs were reasonable. Of the 30
                           projects—most of which were located in San Francisco, Los Angeles, or
                           Sacramento—Knox Glen was the tenth lowest in eligible costs per
                           bedroom. Eligible costs, computed on the eligible basis for tax credit
                           projects, include the costs of new construction, the developer’s costs, and
                           various fees; they exclude the costs of land, permanent financing, rent
                           reserves, syndication, and marketing (see app. I, table I.6). Knox Glen’s
                           eligible costs per bedroom were about $40,300.


Commission Implemented     While reasonable, Knox Glen’s costs were not as low as they might have
Some but Not All           been. As noted, the project’s design included certain features desired by
Cost-Saving Measures       the neighborhood, and the Commission retained these features to secure

                           3
                            This program is designed to establish maximum per-unit cost limits equivalent to the costs of
                           constructing nonluxury multifamily housing projects for different areas within each state. Initially set
                           by the Congress in legislation, the limits are adjusted annually by HUD to reflect changes in
                           construction costs. The limits also reflect differences in housing characteristics, such as the presence
                           or absence of elevators.



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the neighborhood’s approval of the project’s design. In addition, the
project included some amenities that were not required to satisfy code
requirements but were necessary to enable the project to compete for tax
credits.

To accommodate the neighborhood’s preference for a low-density
development, the Commission did not take advantage of a density waiver
for affordable housing that would have allowed 69 units to be built on the
property.4 The waiver would have reduced the project’s per-unit costs by
spreading some general costs over more units, but it would not have
permitted the construction of the town houses desired by the
neighborhood.

Before starting to construct the project, the Corporation, architect, and
contractor performed a value engineering study, which recommended a
number of design changes to control costs. The Corporation chose to
implement most of the study’s recommendations. For example, the
Corporation deleted skylights and glass from garage doors and installed
less expensive doors, door hinges, drainage systems, and landscaping. The
Corporation did not, however, substitute lower-cost roof facades or
traditional pitched roofs with asphalt shingles for the barrel-vaulted roofs
preferred by the neighborhood.

According to the project’s construction specialist, the Corporation would
have saved over $1,000 per unit if it had chosen the traditional pitched
roofs with asphalt shingles, but the community insisted on “a design that
would be more reflective of a single-family home with an evident quality of
design.” He said that the community chose the barrel-vaulted design to
make the development stand out visually and aesthetically, as well as to
eliminate any reference in appearance to Greentree Plaza. He added,
however, that the final barrel-vaulted design represented a compromise
with the local housing groups, which had originally advocated even larger
and costlier vaulted roofs. In addition, he noted that the barrel-vaulted
roofs are expected to last for the full 55 years that California tax credit
projects are required to operate under restricted rents to serve low-income
residents, whereas traditional shingle roofs require replacement every 10
to 12 years, making the ultimate cost differential negligible.

Another design feature that was not required by the tax credit program’s
or by state or local regulations but was requested by the neighborhood for

4
 The city of San Diego had already maintained that the new zoning limit of 17.42 units per acre should
be rounded down to 17 before being multiplied by the project’s acreage (3.2 acres)—an interpretation
of the zoning ordinance that limited the project to 54.4 units rather than 55.7 units.



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                                   security reasons was a gated enclosure, which added almost $1,300 per
                                   unit to the project’s costs. In addition, according to the project’s
                                   construction specialist, the project received upgraded plumbing fixtures
                                   and flooring material to reduce its long-term maintenance costs.

                                   The inclusion of a community center (see fig. 5) added to the project’s
                                   costs. However, according to Commission officials, the project would not
                                   have qualified for tax credits without the points awarded for the center,
                                   and without tax credits, the project could not have been built.


Figure 5: Knox Glen Neighborhood
Center




Other Options Might Have           Purchasing an existing apartment complex would likely have been cheaper
Lowered Costs but Not              than building Knox Glen Apartments. Other apartment complexes were
Revitalized Neighborhood           available in the San Diego area when the Knox Glen project was being
                                   planned. Because many owners of multifamily properties were unable to
                                   refinance mortgage loans with high interest rates or to increase rents to
                                   cover costs, a number of properties were liquidated at very low prices.
                                   According to the San Diego County Apartment Association, some sold for
                                   as little as 40 to 70 percent of their replacement costs. But few of these
                                   apartment complexes consisted primarily of three- and four-bedroom
                                   units. Converting these properties would have increased the city’s supply
                                   of affordable housing at less cost per unit than constructing Knox Glen;
                                   however, it would have provided fewer three- and four-bedroom units, and
                                   it would not have helped to revitalize the Lincoln Park neighborhood.




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                    Since it was placed in service, Knox Glen has not adversely affected other
Project Has Had a   rental properties in the area, and it has stimulated new development.
Positive Impact
                    The demand for affordable rental housing in San Diego is so great that new
                    construction in almost any neighborhood is unlikely to harm existing
                    rental properties. According to the city’s consolidated plan for fiscal year
                    1997,5 San Diego will need approximately 17,520 new housing units for
                    additional low-income households during the next 5 years. Because the
                    city’s housing costs have increased much more rapidly than incomes, the
                    report says, San Diego is now among the least affordable cities in the
                    nation. Nearly 107,000 households with very low and low incomes pay
                    30 percent or more of their incomes for rent, and over 31,000 families are
                    on the Commission’s waiting list for rental assistance.

                    Given these figures, it is not surprising that Knox Glen’s units were rented
                    within days after they were completed. According to the property’s rental
                    agent, over 950 applications were received and about half of the applicants
                    met the project’s income guidelines. At the time of our visit, over 200
                    families were on the waiting list to apply for apartments that might
                    become vacant.

                    We asked the owner of three sizeable low-income properties in the area
                    whether he was concerned about the impact of Knox Glen on his business.
                    He said he lost about six families to Knox Glen because it is new, has
                    garages, and has somewhat lower rents. He added that he is not concerned
                    because he had no difficulty replacing the families he lost.

                    Knox Glen’s construction has already stimulated new development.
                    Directly across the street, a private subdivision of 23 single-family
                    detached homes is being built. According to the developer, the project’s
                    goal is to help revitalize the neighborhood by building affordable homes
                    for first-time home buyers. The developer emphasized that he would not
                    have built the project—and his bank would probably not have lent him the
                    money for its construction—if the partially completed property that once
                    stood on Knox Glen’s site had not been removed.



                    5
                     The consolidated plan is produced annually by an interagency working committee led by the San
                    Diego Housing Commission. The plan replaces HUD’s prior planning and application requirements
                    with a single submission and satisfies the regulatory requirements for HUD’s four formula programs:
                    Community Development Block Grants (CDBG), HOME Investment Partnership (HOME), Emergency
                    Shelter Grant, and Housing Opportunities for Persons With AIDS. Developing the plan gives the city an
                    opportunity to shape its publicly supported programs into a coordinated housing and community
                    development strategy.



                    Page 17                                                       GAO/RCED-97-190 Housing Finance
                        B-277297




                        A 1994-95 grand jury investigation, a 1996 report by a housing
Prior Studies Did Not   subcommittee of the Select Committee on Government Efficiency and
Find Serious            Fiscal Reform, and a 1997 report by HUD’s Inspector General examined
Problems at Knox        different aspects of the Commission’s affordable housing portfolio. None
                        of these reports found any abnormalities, malfeasance, or incompetence in
Glen                    the financing or construction of Knox Glen as a low-income housing
                        project.

                        After examining the Commission’s management and lending practices, the
                        grand jury reported 18 findings and recommendations in 1995. It did not
                        mention Knox Glen specifically in the report, although two of the
                        management recommendations address issues raised by critics of Knox
                        Glen’s development.

                        The first recommendation called for a “total project” feasibility study to be
                        submitted with the request to approve the funding for a housing project’s
                        development or rehabilitation. The Low-Income Housing Tax Credit
                        program already requires three feasibility analyses for most tax credit
                        projects—the first at the time of the preliminary reservation, the second if
                        a carryover allocation is made, and the third when the project is placed in
                        service. These three feasibility analyses were performed for Knox Glen.

                        The second recommendation called for the Commission to amend its
                        underwriting criteria so that the allocation of funds or financing does not
                        exceed a total of 90 percent of a property’s appraised or market value.
                        Under such amended criteria, the Commission would not have been able
                        to fund Knox Glen—or to participate in most low-income housing tax
                        credit deals. Under the Low-Income Housing Tax Credit program, the
                        appraisal calculates the market value of a property using the restricted
                        rents required for low-income households; therefore, the appraised value
                        will typically be lower than the cost of construction.

                        The housing subcommittee followed up on the grand jury’s work and
                        examined Knox Glen as a case study. The subcommittee’s report, released
                        in October 1996, did not include the Knox Glen case study. Our review of
                        the unpublished case study showed that the cost figures obtained by the
                        subcommittee were very similar to the project’s preliminary cost
                        estimates.

                        In January 1997, HUD’s Inspector General investigated allegations of
                        possible noncompliance with HUD’s regulations as well as excessive costs
                        in developing Knox Glen. The Inspector General found no evidence of



                        Page 18                                        GAO/RCED-97-190 Housing Finance
                  B-277297




                  illegal acts or violations of HUD’s regulations. Furthermore, the Inspector
                  General concluded that the reasons for the project’s costs appeared to be
                  valid.


                  We provided copies of a draft of this report to the San Diego Housing
Agency Comments   Commission for its review and comment. We spoke with Commission
                  officials, including the assistant to the executive director, the senior
                  housing construction specialist, and the financial specialist for the Knox
                  Glen project. The Commission commented that the draft was a
                  well-researched and balanced presentation of the facts, and it agreed with
                  the overall conclusions.

                  The Commission also further clarified its decision not to solicit bids from
                  existing nonprofit developers. The Commission commented that the
                  qualified nonprofit organizations were fully occupied with other projects
                  in early 1994 when the property was purchased from FDIC and the
                  negotiations with community groups began. According to the Commission,
                  this factor weighed heavily in its decision to have the Corporation act as
                  the general partner in the development of Knox Glen Apartments. We
                  agree that the qualified nonprofit organizations were busy completing tax
                  credit projects at the time the property was purchased. However, the
                  question whether a nonprofit corporation established by a government
                  entity with ties to that entity should be in the development business
                  remains an open issue. The Commission also provided technical
                  comments to improve the accuracy of the report, which we incorporated
                  where appropriate.


                  We met with officials of the California Tax Credit Allocation Committee,
Scope and         the San Diego Housing Commission, the San Diego Housing Development
Methodology       Corporation, and the County Apartment Association. We also interviewed
                  officials from HUD’s San Diego office and from local community
                  development corporations, as well as private developers and interested
                  members of the public. In addition, we reviewed federal, state, and local
                  program regulations and ordinances; files on the Knox Glen project; and
                  reports of the grand jury, the San Diego housing subcommittee, and HUD’s
                  Inspector General. We conducted our review from March through
                  June 1997 in accordance with generally accepted government auditing
                  standards.




                  Page 19                                        GAO/RCED-97-190 Housing Finance
B-277297




We are sending copies of this report to the appropriate congressional
committees; the Executive Director, San Diego Housing Commission; the
Director, Office of Management and Budget; and other interested parties.
We will make copies available to others upon request.

Please call me at (202) 512-7632 if you or your staff have any questions.
Major contributors to this report are listed in appendix II.




Judy A. England-Joseph
Director, Housing and Community
  Development Issues




Page 20                                        GAO/RCED-97-190 Housing Finance
Page 21   GAO/RCED-97-190 Housing Finance
Contents



Letter                                                                                             1


Appendix I                                                                                        24

Project’s
Characteristics and
Funding
Appendix II                                                                                       28

Major Contributors to
This Report
Tables                  Table 1: Knox Glen’s Site-Specific Costs                                  11
                        Table 2: Above-Foundation Costs per Square Foot for Attached              13
                          Multifamily Housing in San Diego, August 1996
                        Table I.1: Size of Knox Glen’s Units, by Number of Bedrooms               24
                        Table I.2: Characteristics of Knox Glen’s Units, by Number of             24
                          Bedrooms, Type of Unit, and Square Footage
                        Table I.3: Sources of Funds Used to Finance Knox Glen’s                   25
                          Development
                        Table I.4: Household Income Levels Targeted at Knox Glen                  25
                        Table I.5: Comparison of Knox Glen’s Rents With the Maximum               26
                          Rents Allowed Under HUD’s Section 8 Program
                        Table I.6: Total Development Costs and Tax Credit Eligible Basis          27
                          for Knox Glen Apartments, by Major Cost Categories

Figures                 Figure 1: Greentree Plaza                                                  4
                        Figure 2: Stages in Knox Glen’s Development                                6
                        Figure 3: Knox Glen                                                       10
                        Figure 4: The Mercado Apartments                                          12
                        Figure 5: Knox Glen Neighborhood Center                                   16




                        Abbreviations

                        FDIC       Federal Deposit Insurance Corporation
                        SDHDC      San Diego Housing Development Corporation
                        HUD        Department of Housing and Urban Development
                        CDBG       Community Development Block Grants


                        Page 22                                       GAO/RCED-97-190 Housing Finance
Page 23   GAO/RCED-97-190 Housing Finance
Appendix I

Project’s Characteristics and Funding


                                           Knox Glen is a 54-unit complex consisting mainly of two-story town
                                           houses. It includes 9 two-bedroom units, 31 three-bedroom units, and 14
                                           four-bedroom units. The average number of bedrooms is three. (see table
                                           I.1.)

Table I.1: Size of Knox Glen’s Units, by
Number of Bedrooms                         Size of unit, by number of
                                           bedrooms                                       Number of units Total number of bedrooms
                                           Two-bedroom                                                       9                            18
                                           Three-bedroom                                                     31                           93
                                           Four-bedroom                                                      14                           56
                                           Total                                                             54                          167

                                           Source: Rent roll for Knox Glen Apartments, dated Mar. 7, 1997.


                                           In addition to three- and four-bedroom town house units, Knox Glen
                                           contains 12 apartment flats. The six ground floor units are fully accessible
                                           for persons with impaired physical mobility. The size of the units varies
                                           from 678 square feet for a two-bedroom apartment flat to 1,383 square feet
                                           for a four-bedroom town house. (See table I.2.)

Table I.2: Characteristics of Knox
Glen’s Units, by Number of Bedrooms,       Size of unit, by                                             Number of
Type of Unit, and Square Footage           number of                                      Number of square feet per           Total square
                                           bedrooms             Type of unit                  units            unit                footage
                                           Two-bedroom
                                                                Flat                                 4               678               2,712
                                                                Flat                                 5               711               3,555
                                           Three-bedroom
                                                                Flat                                 3               855               2,565
                                                                Town house                         14              1,197             16,758
                                                                Town house                         14              1,214             16,996
                                           Four-bedroom
                                                                Town house                         14              1,383             19,362


                                           Total                                                   54                                61,948

                                           Source: Rent roll for Knox Glen Apartments, dated Mar. 7, 1997, and Independent Auditor’s Report,
                                           Dec. 23, 1996.




                                           Page 24                                                       GAO/RCED-97-190 Housing Finance
                                      Appendix I
                                      Project’s Characteristics and Funding




                                      Knox Glen’s development was financed with funds from a number of
                                      private and public sources. The first mortgage accounted for less than
                                      25 percent of the total funding, while the proceeds from the syndication of
                                      the tax credits accounted for approximately 50 percent of the total
                                      funding. The public subsidies enable the development to charge rents that
                                      are comparatively affordable to low-income tenants. (See table I.3.)

Table I.3: Sources of Funds Used to
Finance Knox Glen’s Development       Source of funds                                                                    Amount of funds
                                      Tax credit proceeds                                                                        $4,066,907
                                      HUD-HOME funds                                                                                 1,399,000
                                      Community Redevelopment Agency of San                                                           150,000
                                      Diego
                                      American Savings Bank, including a                                                             1,795,000
                                      $250,000 Affordable Housing Program
                                      awarda
                                      Developer fee note                                                                              619,059
                                      Total                                                                                      $8,029,966
                                      a
                                      The project received this award after the tax credit award.



                                      Source: California Tax Credit Allocation Committee, final cost certification, Dec. 23, 1996.


                                      All of Knox Glen’s units are targeted to low-income households: 22 units
                                      are targeted to households with incomes at or below 50 percent of the
                                      area’s median income (AMI), adjusted for household size, and 32 units are
                                      targeted to households with incomes at or below 60 percent of AMI,
                                      adjusted for household size. (See table I.4.)

Table I.4: Household Income Levels
Targeted at Knox Glen                                                                               Household income
                                                                                                     level targeted, by  Total
                                                                                                      number of units  number of
                                           Size of unit, by number of bedrooms                   50 percent 60 percent   units
                                                                                                    of AMIa    of AMIa
                                      Two-bedroom                                                            9               0              9
                                      Three-bedroom                                                          7             24              31
                                      Four-bedroom                                                           6               8             14
                                      Total                                                                 22             32              54
                                      a
                                      Area median income, adjusted by household size.



                                      Source: Rent roll for Knox Glen Apartments, dated Mar. 7, 1997.




                                      Page 25                                                         GAO/RCED-97-190 Housing Finance
                                       Appendix I
                                       Project’s Characteristics and Funding




                                       Knox Glen’s rents are lower than the maximum rents allowed under the
                                       section 8 rental assistance program, another program used by Department
                                       of Housing and Urban Development (HUD) to make rents more affordable
                                       to lower-income households. The primary reasons that Knox Glen can
                                       charge lower rents is the funding provided by the Low-Income Housing
                                       Tax Credit, as well as the other public and private subsidized financing
                                       provided to the Knox Glen development. (See table I.5.)

Table I.5: Comparison of Knox Glen’s
Rents With the Maximum Rents                                                                                            Fair market rent
Allowed Under HUD’s Section 8                                                                                                 ceiling for
Program                                Size of unit, by number                                       Monthly rent       section 8 rental
                                       of bedrooms                        Number of unitsa              charged              assistanceb
                                       Two-bedroom
                                                                                            9                   486                    682
                                       Three-bedroom
                                                                                            7                   558c
                                                                                           23                   678d                   947
                                       Four-bedroom
                                                                                            6                   618c
                                                                                            8                   753d                1,118
                                       a
                                        Because no rent is charged for the three-bedroom unit occupied by the resident manager, only
                                       53 units are included in this table.
                                       b
                                           Figures obtained from a San Diego Housing Commission letter dated Mar. 18, 1997.
                                       c
                                       Rents charged to households with incomes at or below 50 percent of the area’s median income.
                                       d
                                           Rents charged to households with incomes at or below 60 percent of the area’s median income.



                                       Source: Rent roll for Knox Glen Apartments, dated Mar. 7, 1997.


                                       Table I.6 identifies Knox Glen’s total development costs, by major cost
                                       category. It also indicates which of these costs are counted as part of the
                                       eligible basis for the Low-Income Housing Tax Credit program. Because of
                                       its location in a low-income neighborhood, Knox Glen was eligible to
                                       increase its tax credit eligible basis by 30 percent.




                                       Page 26                                                       GAO/RCED-97-190 Housing Finance
                                         Appendix I
                                         Project’s Characteristics and Funding




Table I.6: Total Development Costs
and Tax Credit Eligible Basis for Knox   Cost category                                  Development cost           Tax credit eligible basis
Glen Apartments, by Major Cost           Land                                                      $970,585                                   $0
Categories
                                         New construction                                         5,019,186                             5,019,186
                                         Architectural fees                                          250,914                             250,914
                                         Construction interest and fees                              115,179                             115,179
                                         Permanent financing                                          36,763                                   0
                                         Legal fees                                                    9,625                               9,625
                                         Reserves                                                    234,000                                   0
                                         Other                                                       485,456                             424,733
                                         Developer’s costsa                                          908,258                             908,258
                                         Total uses of funds                                     $8,029,966                         $6,727,895
                                         a
                                         Includes the developer’s overhead and profit, as well as fees for consultants and processing.



                                         Source: California Tax Credit Allocation Committee, final cost certification, Dec. 23, 1996.




                                         Page 27                                                         GAO/RCED-97-190 Housing Finance
Appendix II

Major Contributors to This Report


                        Dennis W. Fricke, Assistant Director
Resources,              Andrew E. Finkel, Senior Evaluator
Community, and          Patrick B. Doerning, Senior Operations Research Analyst
Economic                Elizabeth R. Eisenstadt, Communication Analyst

Development
Division, Washington,
D.C.




(385672)                Page 28                                     GAO/RCED-97-190 Housing Finance
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