oversight

Review of Housing Activities in FHA Single Family Insurance Programs, Brothers Redevelopment, Inc., Denver, Colorado

Published by the Department of Housing and Urban Development, Office of Inspector General on 2001-09-28.

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

                                  Audit Report
                                  District Inspector General for Audit
                                  Rocky Mountain District




  Brothers Redevelopment, Inc.
                           Denver, Colorado


    Review of Housing Activities
      In FHA Single Family
       Insurance Programs

                                2001-DE-1002
                              September 28, 2001

Department of Housing and Urban Development
District Office of Inspector General For Audit
633 17th Street, 14th Floor
Denver, CO 80202-3607
                                           2001-DE-1002




                                      Audit Report
                                      District Inspector General for Audit
                                      Rocky Mountain District
                                      Report: 2001-DE-1002            Issued: September 28, 2001



TO: Ronald C. Bailey, Director, Denver Homeownership Center, 8AHH




FROM: Robert C. Gwin, District Inspector General for Audit, 8AGA

SUBJECT: Review of Housing Activities in FHA Single Family Insurance Programs
         Brothers Redevelopment, Inc.
         Denver, Colorado

We have completed a review of Brothers Redevelopment, Inc. (Brothers Redevelopment),
Denver, Colorado, of their housing activities in the Federal Housing Administration (FHA) Single
Family Insurance Programs. This review was done as part of a nationwide audit of nonprofit
organizations’ participation in the FHA Single Family Insurance Programs. The objective of our
review was to determine whether Brothers Redevelopment is legitimate and independent (not
under the influence, control or direction) of other parties and is passing on the benefits of
discounts received on the purchase of HUD homes to low- and moderate-income homebuyers.

This audit report contains one audit finding dealing with Brothers Redevelopment not carrying
out its housing activities in conformity with its Affordable Housing Program and HUD
requirements.

At the start of our site work, your staff also initiated a monitoring visit to review the FHA Single
Family Insurance Program activities at Brothers Redevelopment. Their review results parallel
ours.

Within 60 days please furnish to this office, for each recommendation contained in the finding in
this report, a status report on: (1) the corrective action, (2) the proposed corrective action and the
corrective date to be completed, or (3) why action is considered unnecessary. Also, please
furnish us copies of any correspondence or directives issued because of the audit.

We appreciate the courtesies and assistance extended by the management and staff of Brothers
Redevelopment and their related contract parties and the Denver Homeownership Center.




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                                        2001-DE-1002

Should you have any questions, please contact Ernest Kite, Assistant District Inspector General
for Audit, at (303) 672-5452.




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                iii
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Executive Summary
We have completed a review of Brothers Redevelopment, Inc. (Brothers Redevelopment),
Denver, Colorado, of their housing activities in the Federal Housing Administration (FHA) Single
Family Insurance Programs. This review was done as part of a nationwide audit of nonprofit
organizations’ participation in the FHA Single Family Insurance Programs.

Brothers Redevelopment is a nonprofit organization that has been approved by HUD to
participate in the FHA Single Family Insurance Programs. Brothers Redevelopment was
authorized by HUD to carryout the program in conformity with its Affordable Housing Program.
Under this program, Brothers Redevelopment purchased HUD properties at a discount,
rehabilitated the structures as needed and resold the houses at market value to qualifying
homebuyers. Brothers Redevelopment did not pass on any benefits realized from the discounted
property purchases from HUD to the low- and moderate-income homebuyer as intended by HUD.

We found that Brothers Redevelopment was not carrying out its Affordable Housing Program in
conformity with HUD requirements. Brothers Redevelopment allowed an outside independent
Contract Developer to administer all phases of its Affordable Housing Program. The Contract
Developer operated the program to realize the maximum profit possible. The realized profits
were shared by Brothers Redevelopment, the Contract Developer and a conflict of interest
program lender. As a result, no discounts were passed on to the ultimate homebuyer as intended
by the program. Basically, Brothers Redevelopment served as a strawbuyer for a fee for the
purchase of HUD properties while the Contract Developer functioned as an investor.

Members of the Denver Homeownership Center initiated a site review of Brothers
Redevelopment’s program activities at the same time we began our site audit. The results of our
review parallel the findings of the Denver Homeownership Center.


                                Nonprofit organizations can participate in the FHA’s Single
   Nonprofit entities can
                                Family Insurance Programs. HUD approves the nonprofit
   participate in FHA’s
                                organizations and authorizes them to carry out their Affordable
   Single Family Insurance
                                Housing Program. Under HUD’s program, the nonprofits are
   Programs                     allowed to purchase HUD properties at a discount ranging
                                primarily from 10 to 30 percent.

                                The nonprofits rehabilitate the discounted properties and then are
                                to sell the properties to low- and moderate-income homebuyers.
                                The primary intent of the HUD program is to pass on the
                                discounts from the purchase of HUD discounted properties to the
                                purchasing homebuyer. HUD has issued various HUD
                                mortgagee letters and notices setting out the parameters for
                                implementing the HUD programs by the nonprofit organizations.

                                The objectives of our audit were to determine whether Brothers
   Audit objectives             Redevelopment is:




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                                  2001-DE-1002

                              •   Legitimate and independent (not under the influence,
                                  control or direction) of other parties; and

                              •   Passing on the benefits of discounts received on the
                                  purchase of HUD homes to low- and moderate-income
                                  homebuyers.

                          Brothers Redevelopment did not administer or carryout its
Affordable Housing        Affordable Housing Program as approved by HUD or in
Program not carried out   conformity with HUD requirements. Furthermore, intended
in accordance with        savings realized from the discount purchase of properties from
HUD requirements          HUD were not passed on to the low- and moderate-income
                          homebuyer.

                          Specifically, Brothers Redevelopment allowed an independent
                          Contract Developer to administer and control all aspects of its
                          Affordable Housing Program with very limited participation by
                          Brothers Redevelopment. In addition, the Contract Developer
                          maintained a conflict of interest relationship with the primary
                          lender for the Affordable Housing Program. The program was
                          administered by the Contract Developer to realize the maximum
                          possible profit that was distributed to the Contract Developer, a
                          conflict of interest lender and Brothers Redevelopment. The
                          discounted properties acquired from HUD were resold at market
                          value to a qualifying homebuyer. As such, any benefits realized
                          from the discounted acquired properties were not passed on to
                          the homebuyer as required by HUD.

                          Brothers Redevelopment implemented its affordable housing
                          program by allowing an outside independent contract developer
                          to administer the program. The Contract Developer operated the
                          program under a verbal agreement with Brothers Redevelopment
                          and controlled all aspects of the program. The Contract
                          Developer had a vested interest in the program in that the
                          Contract Developer received 40 percent of the profits realized
                          from the sale of the properties. In addition, the Contract
                          Developer secured financing for the acquisition and
                          rehabilitation of the properties from an identity of interest lender
                          who also realized 20 percent of the profits from the property
                          sales. Furthermore, Brothers Redevelopment received 40
                          percent of the net profits from the resale of the properties. In
                          actual practice, the Contract Developer used Brothers
                          Redevelopment as a strawbuyer for a fee and functioned as an
                          investor of HUD acquired properties.

                          In our opinion, deficiencies associated with Brothers
                          Redevelopment’s affordable housing program stem from
                          Brothers Redevelopment:

                          1) Not having a clear understanding of the intent of HUD
                             requirements to participate in FHA’s Single Family


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                       Insurance Programs, to create homeownership opportunities
                       for low- and moderate-income persons ; and

                   2) Not wanting to take part in the risk associated with the
                      purchase, rehabilitation, and resale of the properties.

                   As a result, Brothers Redevelopment did not administer their
                   affordable housing program to target low- and moderate-income
                   homebuyers and allowed excessive profits from the market sale
                   of the properties to be ultimately funded by the homebuyers.
                   This violated the intent of the program whereby benefits from
                   the discounted acquired properties from HUD were to be passed
                   on to the homebuyer rather than being absorbed by the nonprofit
                   and its contract developer and lender.

                   The results of the audit were discussed with officials of Brothers
Auditee Comments   Redevelopment during the course of the audit. The draft audit
                   finding was submitted to Brothers Redevelopment on August 10,
                   2001 for their review and comments. On August 30, 2001,
                   Brothers Redevelopment provided us with their written response
                   to the draft finding. At that time, officials discussed the draft
                   finding and their written response. The officials disagreed with
                   our audit finding. At the meeting the draft audit report was
                   provided to Brothers Redevelopment who elected to not provide
                   any additional written comments. We have incorporated their
                   comments into the report as applicable and their complete
                   written response is included in Appendix 1.




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Table of Contents
Management Memorandum........................................................................ i

Executive Summary ................................................................................. iv

Table of Contents.....................................................................................vii

Abbreviations ........................................................................................viii

Introduction.............................................................................................. 1

Finding and Recommendations

        1. Affordable Housing Program Not Carried Out in Conformity
           With HUD Requirements............................................................ 5

Management Controls ............................................................................. 29

Follow-up on Prior Audits ....................................................................... 31

Appendices

        1. Auditee Comments ................................................................... 33
        2. Distribution.............................................................................. 48




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Abbreviations:

FHA              Federal Housing Administration
HUD              Department of Housing and Urban Development




                                      viii
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Introduction
Brothers Redevelopment was established on May 10, 1971, as a Colorado nonprofit corporation.
A Board of Directors made up of volunteers who represent a cross section of professions and
ethnic groups governs Brothers Redevelopment. One of Brothers Redevelopment’s primary
objectives is:

    •   To build, repair, remodel and refurbish houses and other dwelling units, and to finance
        construction, reconstruction, remodeling and refurbishment of houses and other dwellings
        units through various financial institutions for moderate and low income, elderly,
        handicapped and minority people to help them improve their standard of living. The
        welfare of the elderly and handicapped are high priority for these services.

The Purchase Repair Resale program at Brothers Redevelopment began in early 1995. Brothers
Redevelopment entered into a verbal agreement with an outside independent Contract Developer,
AmReal Companies, with the purpose to purchase and rehabilitate HUD homes for resale.
AmReal Companies was responsible for the selection, inspection, and submission of bids to
HUD, obtaining financing for purchase and rehabilitation, accomplishing the rehabilitation work,
marketing the properties for resale, and providing information to the title company, while
Brothers Redevelopment limited its involvement to providing HUD program approval to
purchase homes from HUD at a discount.

From March 1995 to March 2001, Brothers Redevelopment obtained financing for the purchase
and rehabilitation of acquired properties from various lenders in the form of recourse and
nonrecourse1 loans. Brothers Redevelopment’s primary le nder during the above mentioned time
period was US Capital, Inc. and business entities associated with the principal staff of US Capital,
Inc. The Board of Directors for US Capital, Inc. consists of three members: the President, Vice-
President and Brothers Redevelopment’s Contract Developer. Financing provided by US Capital,
Inc. is in the form of a nonrecourse loan at an interest rate of 19.5 percent.

Brothers Redevelopment entered into a verbal agreement with the outside independent Contract
Developer and its primary lender whereby proceeds from the subsequent resale of properties is
divided as follows:

    •   40 percent to Brothers Redevelopment

    •   40 percent to AmReal Companies

    •   20 percent to US Capital, Inc.

On March 3, 2000, HUD issued Mortgagee Letter 00-8 requiring current and prospective
nonprofit entities to submit a recertification package to their local HUD Homeownership Center
to gain approval to participate in FHA Single Family Insurance Programs. Brothers

1
 Nonrecourse financing is a type of debt whereby the borrower is not personally liable. If the borrower
defaults on the nonrecourse loan, the lender recovers the amount owed through foreclosure on the property,
which secures the loan.


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                                          2001-DE-1002

Redevelopment requested and was approved by the Denver Homeownership Center on May 30,
2000, to participate in the following activities:

   •     Participate as a mortgagor to obtain FHA-insured financing at the same attractive terms
         as owner occupants.

   •     Purchase HUD foreclosed properties, in certain cases, at a discounted price.

   •     Provide down payment, closing cost or rehabilitation assistance with a secondary lien.

During the period from January 1, 1998 through January 31, 2001, Brothers Redevelopment had
purchased 92 discounted properties from HUD at a total cost of $8,055,378. The total discount
awarded to Brothers Redevelopment for these 92 properties was $1,123,405. Brothers
Redevelopment has used these properties in their Purchase Repair Resale program.

On May 1, 2001, members of the Denver Homeownership Center initiated a site review on
Brothers Redevelopment’s compliance with HUD requirements under HUD’s FHA Single Family
Insurance Programs. On June 5, 2001, the Homeownership Center temporarily suspended
Brothers Redevelopment’s authority to purchase HUD homes at a discount due to irregularities in
their affordable housing program. This suspension is to continue until the Homeownership
Center receives our final audit report.


                                 The objectives of the audit were to determine whether Brothers
 Audit Objectives and            Redevelopment is:
 Methodology
                                 •    Legitimate and independent (not under the influence,
                                      control or direction) of other parties; and

                                 •    Passing on the benefits of discounts received on the
                                      purchase of HUD homes to low- and moderate-income
                                      homebuyers.

                                 Our audit approach was to identify and evaluate the management
                                 controls in place over the key areas of operations of Brothers
                                 Redevelopment’s affordable housing program and within HUD’s
                                 FHA Single Family Insurance Programs requirements. During
                                 the review, we examined program records and related documents
                                 of Brothers Redevelopment and other parties of their program
                                 including their Contract Developer, primary lender, and loan
                                 closing agent. We also reviewed applicable HUD records
                                 relating to Brothers Redevelopment’s program. We conducted
                                 interviews with officials and employees of these organizations.
                                 Furthermore we conducted inspections of selected program
                                 properties and interviewed the individual homebuyers.

                                 Our audit generally covered the period of January 1, 1998
 Scope                           through January 31, 2001. However, this period was expanded
                                 to include the most current data available while performing our
                                 site review. Therefore, where applicable, the audit period was



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                      expanded to include current data through June 30, 2001. We
                      conducted our field work from March through June 2001.

                      Our review was performed in accordance with generally
Generally Accepted    accepted government auditing standards.
Government Auditing
Standards




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Finding
Affordable Housing Program Not Carried Out in
Conformity with HUD Requirements
Brothers Redevelopment did not administer or carryout its Affordable Housing Program as
approved by HUD or in conformity with HUD requirements. Furthermore, intended savings
realized from the discount purchase of properties from HUD were not passed on to the low- and
moderate-income homebuyer.

Specifically, Brothers Redevelopment allowed an outside independent Contract Developer to
administer and control all aspects of its Affordable Housing Program with very limited
participation by Brothers Redevelopment. In addition, the Contract Developer maintained a
conflict of interest relationship with the primary lender for the Affordable Housing Program. The
program was administered by the Contract Developer to realize the maximum possible profit that
was distributed to the Contract Developer, conflict of interest lender and Brothers
Redevelopment. Because Brothers Redevelopment resold its HUD acquired discounted
properties at market value to realize the maximum profit for themselves, the Contract Developer
and the program financing lender, any realized benefits from the discounted purchases were not
passed on to the low- and moderate-income homebuyer as intended by HUD.

Brothers Redevelopment’s implementation of HUD’s FHA Single Family Insurance Programs
was designed to pass on all risks under the program to the Contract Developer and the program
lender. By doing so, the Contract Developer used Brothers Redevelopment as a strawbuyer for a
fee and functioned as an investor of HUD acquired properties.

In our opinion, deficiencies associated with Brothers Redevelopment’s affordable housing
program stem from Brothers Redevelopment:

        1) Not having a clear understanding of HUD requirements to participate in FHA’s
           Single Family Insurance Programs, to create homeownership opportunities for low-
           and moderate-income persons; and

        2) Not wanting to take part in the risk associated with the purchase, rehabilitation, and
           resale of the properties.

As a result, Brothers Redevelopment allowed an outside independent contract developer to
administer their affordable housing program and resold their HUD discounted acquired properties
at market value without any realized benefit from the discount purchase being passed on to the
homebuyer as specified and intended by HUD.


HUD requirements                 Under HUD’s FHA Single Family Insurance Programs,
                                 nonprofits are eligible if certain qualifications are met to acquire
                                 HUD owned properties at a discount, rehabilitate them and then
                                 to sell them to low- to moderate-income buyers who are to
                                 receive any benefit realized by the nonprofit acquisition of


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                               2001-DE-1002

                       discounted properties. The program is governed by various
                       HUD Regulations, Handbooks, Notices and Mortgagee Letters.

                       HUD Regulation Section 291.110 of Title 24 of the Code of
                       Federal Regulations authorizes HUD to sell “as-is” valued HUD
                       properties to approved nonprofit organizations at a discount of
                       no less than 10 percent. HUD Handbook 4310.5 REV-2, Section
                       10-20 supplements the HUD Regulations and specifies the nature
                       and extent of discounts that can be granted to nonprofit property
                       purchases. In HUD approved revitalization areas, the discount to
                       nonprofits and government entities is 30 percent off the list
                       price. In non-revitalization areas, the discounts to nonprofits and
                       government entities is 10 percent off of the list price. An
                       additional 5 percent discount may be added to the 10 percent
                       discount if five or more properties are purchased simultaneously
                       by the nonprofit or government entity.

                       HUD in accordance with Mortgagee Letter 00-8, dated March 3,
                       2000, required each nonprofit organization to resubmit its
                       application and related Affordable Housing Program to HUD for
                       review and approval. HUD approval letters to the nonprofits
                       identified previously issued HUD issuances that related to
                       HUD’s FHA Single Family Insurance Programs. The listing
                       included some issuances that had previously expired expiration
                       dates.

                       Housing Notice 94-74 and Mortgagee Letter 97-5
                       established resale restrictions on properties sold to
                       nonprofit agencies at a 30 percent discount. Mortgagee
                       Letter 96-52 established program requirements concerning
                       acceptable affordable housing programs, in addition to
                       other programmatic changes. In addition, Mortgagee Letter
                       00-8 required current and prospective nonprofit agencies to
                       submit a recertification package to HUD for approval to
                       participate in FHA Single Family Insurance Program
                       activities.

Housing Notice 94-74   Housing Notice 94-74 and Mortgagee Letter 97-5
and Mortgagee Letter   established resale restrictions on properties sold to non-
97-5                   profit agencies at a 30 percent discount. HUD Housing
                       Notice 94-74 provides that properties purchased at a 30
                       percent discount are to be sold to individuals who intend to
                       occupy the property as their principal address and whose
                       income is at or below 115 percent of the median income in
                       the area when adjusted for family size.

                       Mortgagee Letter 97-5, further delineates requirements of
                       nonprofits that are participating in HUD’s FHA Single Family
                       Insurance Programs, which is referred to as HUD’s Real Estate


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                                 2001-DE-1002

                         Owned Discount Sales Program. Specifically, the Mortagee
                         Letter states:

                             “Under HUD's REO [Real Estate Owned] Discount Sales
                             Program, it is possible under certain circumstances for a
                             non-profit or government entity to receive up to a 30 percent
                             discount on the sales price of a property. HUD's intent is for
                             those buyers receiving a discount off the sales price in
                             excess of 15 percent to perform necessary repairs and resell
                             the property to individuals/families who intend to occupy
                             and whose income does not exceed 115 percent of the
                             median income for the area, when adjusted for family size.
                             The resale price of the property cannot exceed 110 percent
                             of the net development cost.”

                             “The net development cost is defined as the total cost of
                             the project, including items such as acquisition cost,
                             architectural fees, permits and survey expenses,
                             insurance, rehabilitation, and taxes (for a 203(k) loan,
                             use lines A-1 and B-14 of the 203(k) Maximum
                             Mortgage Worksheet, form HUD 92700). Total costs
                             incurred by the purchaser, including those for
                             acquisition financing, management fees and selling
                             expenses related to the project can also be included, but
                             are expected to be reasonable and customary for the
                             area in which the property is located. The purchaser
                             can also include up to three months' mortgage
                             payments (principal and interest only), less all rents
                             received. The net development cost cannot include gifts
                             to the eventual purchaser for the down payment,
                             financing or closing costs, nor any other related
                             expenses associated with that buyer's purchase of the
                             property.”

                 00-08
Mortgagee Letter 96-52   Mortgagee Letter 96-52 established program requirements
                         concerning acceptable affordable housing programs, in addition
                         to other programmatic changes. The affordable housing program
                         must be viable, well-run operation that successfully serves the
                         housing needs of low- and moderate-income individuals and
                         families. The affordable housing program is approved for a two-
                         year period. An acceptable affordable housing program is
                         defined as one in which the ultimate goal is the attainment of
                         affordable housing. Nonprofits are expected to fulfill their
                         commitment to low- and moderate-income families.

                         Also, there are certain elements in an affordable housing
                         program that make it successful. One element is remaining
                         affordable. The principal, interest, tax and insurance for
                         properties “should remain in the affordable range for


                                        7
                                 2001-DE-1002

                         homebuyers/assumptors, i.e., the end product will be within the
                         financial reach of those families it was designed to serve”. This
                         would mean low- and moderate-income families.

                         This mortgagee letter relates to the Affordable Housing
                         Programs of nonprofits in connection with their implementation
                         of HUD’s FHA Single Family Insurance Programs. The
                         requirements would be applicable to all HUD acquired properties
                         of the nonprofit. Accordingly, this would include 10, 15 and 30
                         percent discounted HUD properties.

                         In addition, the nonprofit agency is to demonstrate in its
                         affordable housing program that it is acting on its own behalf
                         and is not under the influence, control or direction of any outside
                         party seeking to derive profit or gain from the proposed project,
                         such as a landowner, real estate broker, contractor, builder,
                         lender, or consultant. Beneficiaries of the affordable housing
                         program itself may not be members of its board, employees or
                         others with an identity of interest to the nonprofit.

Mortgagee Letter 00-8
                 00-08   HUD issued Mortgagee Letter 00-8 in March 2000 detailing
                         provisions for nonprofit agencies participation in HUD’s FHA
                         Single Family activities. This letter stated that all nonprofit
                         agencies must follow the uniform standards for participation and
                         recertification in HUD activities. Further, this would ensure
                         nonprofits work to fulfill HUD’s goal of creating
                         homeownership opportunities for low- and moderate-income
                         persons.

                         Under the recertification process of Mortgagee Letter 00-8,
                         nonprofit agencies applied for participation in the following
                         three activities:

                             •   The HUD Homes Program which allows nonprofit
                                 agencies to purchase HUD homes at a discount.

                             •   Nonprofit Agencies as Mortgagors which allows
                                 nonprofit agencies to obtain FHA financing as an owner
                                 occupant.

                             •   Secondary Financing which allows nonprofit agencies to
                                 provide secondary financing in the form of second
                                 mortgages, forgivable second mortgages or “soft”
                                 second mortgages.

                         Mortgagee Letter 00-8 also reiterated HUD’s stance regarding
                         conflicts of interest. Specifically:

                             “No person who is an employee, agent, consultant, officer,
                             or elected or appointed official of the lessee or purchaser of
                             property or who is in a position to participate in a decision


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        2001-DE-1002

    making process pursuant to the affordable housing plan or
    gain inside information with regard to the lease or purchase
    of the property pursuant to the affordable housing plan, may
    obtain a personal or financial interest or benefit from the
    purchase of the property, or have an interest in any contract,
    subcontract, or agreement with respect thereto, of the
    proceeds there under, either for himself or herself or for
    those with whom he or she has family or business ties,
    during his or her tenure or for one year thereafter.”

This Mortgagee Letter established the minimum standards for
recertification. This included the ability of the nonprofit to meet
HUD’s and the nonprofit’s goal to expand affordable housing
opportunities for low- and moderate-income individuals and to
complete the rehabilitation of acquired properties from HUD
within set time frames. In addition, the nonprofit must follow
HUD’s resale requirements and maintain an acceptable
accounting system to report on property purchases,
rehabilitations, rentals and resales.

In the recertification process, the nonprofits are to detail in their
Affordable Housing Program how low- and moderate-income
persons benefit from their program. In addition the Affordable
Housing Program is to be designed to pass along to low-income
persons any savings the nonprofit may receive from the
discounted purchase of a HUD-owned property. Since no
distinction is made about the amount of the discount, the
Affordable Housing Plan is to be designed to pass on benefits
from all discount properties to low- and moderate-income
persons. This would include 10, 15 and 30 percent discounted
HUD property purchases.

Mortgagee Letter 00-8 also established conditions for removing
a nonprofit agency from the FHA approval list. These included
the following:

    •   Properties purchased under the HUD Homes Program
        are not resold to persons who are at or below 115% of
        median income for their area when adjusted for family
        size.

    •   Discounts received by the nonprofit agency in
        purchasing HUD Homes are not adequately passed on to
        the homeowner.

    •   The nonprofit agency does not achieve the majority of
        the goals as outlined in their affordable housing plan.




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                                 •   The nonprofit agency acts to further objectives not
                                     described in the affordable housing plan, or participates
                                     in activities or actions detrimental to the Department,
                                     etc.

Brothers Redevelopment       Prior to the implementation of Mortgagee Letter 00-8, Brothers
approved to participate in   Redevelopment was approved to purchase HUD homes at a
FHA Single Family            discount. On March 3, 2000, HUD issued Mortgagee Letter 00-
Insurance Program            8 requiring all current and prospective nonprofit agencies to
activities                   submit a recertification or approval package to their local
                             Homeownership Center. Accordingly, Brothers Redevelopment
                             submitted their recertification package and was approved on
                             May 30, 2000 by the Denver Homeownership Center to
                             participate in these FHA Single Family Insurance Program
                             activities:

                                 •   Participate as a mortgagor to obtain FHA-insured
                                     financing at the same attractive terms as owner
                                     occupants.

                                 •   Purchase HUD foreclosed properties, in certain cases, at
                                     a discounted price.

                                 •   Provide down payment, closing costs or rehabilitation
                                     assistance with a secondary lien.

Verbal agreement with        In early 1995, Brothers Redevelopment entered into a verbal
Contract Developer,          agreement with an outside independent Contract Developer and
AmReal Companies             at-risk Investor, AmReal Companies, for a multitude of services
                             relating to the purchase, rehabilitation and subsequent resale of
                             HUD homes purchased at a discount. The Contract Developer
                             responsibilities entailed, but were not limited to the following:

                                 •   Selection and inspection of available HUD homes for
                                     purchase.

                                 •   Bid submission for selected HUD properties using
                                     Brothers Redevelopments assigned name address
                                     identifier.

                                 •   Obtain financing for the purchase and rehabilitation of
                                     awarded HUD properties.

                                 •   Coordination of rehabilitation work.

                                 •   Marketing of properties for resale.

                                 •   Provider of information on properties to Title Company.




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                        Brothers Redevelopment’s basic participation in the HUD FHA
                        Single Family Insurance Programs is limited to the signing of the
                        sales contract submitted for the acquisition of a HUD property
                        and the HUD-1 Settlement Statements for the initial purchase
                        and subsequent resale of a property. The Contract Developer is
                        responsible for the selection, inspection, and submission of bids
                        to HUD, obtaining financing for purchase and rehabilitation,
                        accomplishing the rehabilitation work, marketing the properties
                        for resale, and providing information to the title company.
                        Brothers Redevelopment does not review the rehabilitation work
                        accomplished by the outside independent Contract Developer
                        nor require the Contract Developer to submit a summary report
                        disclosing the type and amount of rehabilitation work performed.

                        The Contract Developer receives 40 percent of the net proceeds
                        from the subsequent resale of a property. Brothers
                        Redevelopment receives the same amount of proceeds as the
                        Contract Developer. However, in some cases the split of
                        proceeds may deviate from the set agreement, if for example
                        Brothers Redevelopment pays the $500 earnest money deposit to
                        HUD for a property. In this case, the Contract Developer’s
                        portion of the proceeds would be reduced by $500 while
                        Brothers Redevelopment’s portion would increase by $500.
                        During our audit period, January 1, 1998 through January 31,
                        2001, Brothers Redevelopment received a total of $379,682 in
                        net proceeds from the subsequent resale of properties. If funds
                        are not used from the rehabilitation of a property, the Contract
                        Developer keeps the monies for use on other properties.

Verbal agreement        Brothers Redevelopment entered into a verbal agreement with its
                        primary lender, US Capital, Inc. Under the agreement, US
with primary lender,
                        Capital, Inc. provides funds in the form of nonrecourse loans at
US Capital, Inc.        an excessive interest rate of 19.5 percent to Brothers
                        Redevelopment, for use in the purchase and rehabilitation of
                        properties. Additionally, as an incentive for providing the loans,
                        the two primary principals of US Capital, Inc. receive directly 20
                        percent of the net proceeds from the subsequent resale of a
                        property. The Contract Developer, with the acknowledgement of
                        Brothers Redevelopment, negotiated the agreement.

Relinquished control    During our review, we found that Brothers Redevelopment’s
                        affordable housing program was actually administered by an
of affordable housing
                        independent Contract Developer, a for-profit entity, with very
program to for-profit   limited involvement and participation by Brothers
entity                  Redevelopment. In its recertification package, Brothers
                        Redevelopment made the following certification:

                            “BRI [Brothers Redevelopment, Inc.] is acting on its own
                            behalf, and is not operating under the influence, control, or
                            direction of any outside party seeking to derive a profit or



                                       11
                                  2001-DE-1002

                              gain from the proposed project such as a landowner, real
                              estate broker, contractor, builder, lender or consultant.”

                          Our review disclosed that Brothers Redevelopment was not
                          acting on its own behalf in connection with implementing its
                          affordable housing program, but was under the influence,
                          control, and direction of the outside independent Contract
                          Developer, AmReal Companies, a for-profit entity. The
                          Contract Developer selected, inspected and placed bids for
                          discount properties. In addition to coordination of rehabilitation
                          work, the Contract Developer was responsible for maintaining
                          all financial records concerning rehabilitated properties and
                          payment of subcontractors and laborers. The Contract
                          Developer did not report or substantiate any of these costs to
                          Brothers Redevelopment.

                          The Contract Developer was responsible for determining the
                          marketability of rehabilitated properties. Discounted properties
                          were sold at market value of the properties to homebuyers. The
                          Contract Developer also signed as liable on five loans for
                          properties recently purchased at a discount from HUD. Brothers
                          Redevelopment’s involvement was limited to providing their
                          name address identifier for use by the Contract Developer in
                          bidding for properties and execution of the sales contracts for the
                          purchase of HUD properties and the HUD-1 Settlement
                          Statements.

                          We identified two conflict of interest issues in our review of
  Conflicts of interest
                          Brothers Redevelopment’s affordable housing program:

                              •   The Contract Developer’s financial interest in the
                                  purchase, rehabilitation and resale of properties; and

                              •   The Contract Developer’s relationship with the primary
                                  lender, US Capital, Inc.

                          Under HUD requirements, the nonprofit agency is to
                          demonstrate in its affordable housing program that it is acting on
                          its own behalf and is not under the influence, control or direction
                          of any outside party seeking to derive profit or gain from the
                          proposed project, such as a landowner, real estate broker,
                          contractor, builder, lender, or consultant. Beneficiaries of the
                          affordable housing program itself may not be members of its
                          board, employees, others with an identity of interest to the
                          nonprofit.

Contract Developer        During our review we found that the Contract Developer is in a
                          position to make decisions pursuant to the affordable housing
has financial interest    program and has a financial interest in the purchase, rehabilitation
                          and resale of properties purchased at a discount from HUD.



                                         12
                                2001-DE-1002

                        The Contract Developer inspects the properties being sold by
                        HUD at a discount and determines if they should be purchased.
                        If the properties are found to be a good investment based on
                        assessment of rehabilitation costs and marketability, the Contract
                        Developer submits a bid for the HUD property using Brothers
                        Redevelopment’s name address identifier. The Contract
                        Developer bids on five properties at a time, as HUD increases
                        the discount given on 10 percent properties to 15 percent if 5 or
                        more properties are sold and closed the same day. The Contract
                        Developer does not coordinate (no prior approval) bids with
                        Brothers Redevelopment.

                        Upon completion of rehabilitation work, the Contract Developer
                        requests information from realtors concerning the market value
                        of homes in the area. The Contract Developer uses this
                        information to determine the sales price of the property.
                        Brothers Redevelopment has no involvement in this process.

                        In a response to a draft on-site review report issued by the
                        Denver Homeownership Center, Brothers Redevelopment stated:

                            “The only way [the Contract Developer] makes money is to
                            assure the sales close on time and under budget. [The
                            Contract Developer] has time and financial investment at
                            risk in order to assure this happens.”

                        It is evident that the Contract Developer has a vested financial
                        interest in the resale of each property. Furthermore, Brothers
                        Redevelopment had limited participation in HUD’s FHA Single
                        Family Insurance Programs and allowed an independent outside
                        contract developer and at-risk investor to operate the HUD
                        program on its behalf. The Contract Developer influenced,
                        controlled and directed Brothers Redevelopment’s program for a
                        fee of 40 percent of net market sales proceeds, contrary to
                        HUD’s program requirements and Brothers Redevelopment’s
                        own certification to HUD in its Affordable Housing Program.

Contract Developer is   In addition, we found that the Contract Developer maintained a
member of Board of      conflict of interest relationship with Brothers Redevelopment’s
Directors of primary    primary lender. Specifically, the Contract Developer sits on the
lender                  Board of Directors for US Capital, Inc. The Contract Developer
                        introduced Brothers Redevelopment to US Capital, Inc. and
                        participated in the negotiation of the loan terms (e.g., interest
                        rate of 19.5 percent) and the 20 percent of net proceeds received
                        by US Capital, Inc. from the subsequent resale of properties.
                        The 20 percent of net proceeds from the sale of properties is
                        disbursed directly to the two principal staff of US Capital, Inc. as
                        it is more advantageous tax wise to realize the disbursements as
                        personal income.




                                       13
                                  2001-DE-1002

                          Since 1997, US Capital, Inc. has provided a total of 126 loans
                          with a total original loan amount of $12,830,605 to Brothers
                          Redevelopment, Inc. In a discussion with US Capital, Inc.
                          officials, they indicated they would consider severing their
                          relationship with Brothers Redevelopment if they no longer
                          received the 20 percent of net proceeds. Even though they
                          charged an interest rate of 19.5 percent to offset their risk. US
                          Capital, Inc. feels they are taking all the risk involved with the
                          loans and they need to be compensated for that risk.

Savings not passed on     Brothers Redevelopment has not passed the savings it received
to the low- and           from the purchase of discount properties through the HUD FHA
moderate-income           Single Family Insurance Programs to the low- and moderate-
homebuyer                 income homebuyers. Instead, Brothers Redevelopment
                          distributes the net profit from the sale of the properties to the
                          outside independent contract developer, the primary lender, and
                          itself. This is discussed in the following two main sections
                          dealing with properties purchased from HUD at a 30 percent
                          discount and those purchased at a 10 or 15 percent discount.

                          Thirty Percent Discounted Acquired Properties

                          During the audit period, Brothers Redevelopment purchased nine
                          30 percent discounted properties from HUD at a combined price
                          of $533,793. We reviewed records and files for all of these
                          properties that were subsequently resold.

                          We conducted a detailed review for three of the nine properties
                          to ascertain whether the costs incurred for the rehabilitation were
                          accounted for and supported. We interviewed the homebuyers
                          and inspected the properties to ensure claimed rehabilitation
                          work had been performed. In addition, we calculated the net
                          development costs for the properties, to determine whether
                          profits made by Brothers Redevelopment were in line with HUD
                          requirements and stipulated savings under the HUD’s FHA
                          Single Family Insurance Programs were passed on to a low- and
                          moderate-income buyer.

                          The results of our review of the sample properties are:

  Rehabilitation costs    We found not all of the rehabilitation costs were accounted for
  neither accounted for   nor supported. For example, rehabilitation costs for one property
  nor supported           were erroneously charged to another property. Also, proceeds
                          from the subsequent resale of one property were used to pay
                          down the financing costs of another property.




                                         14
                               2001-DE-1002

                       The following table provides the cost of rehabilitation reported
                       by Brothers Redevelopment and by the outside Contract
                       Developer, AmReal Companies, for the three properties
                       reviewed.

                                               30 Percent Discount
                                       Reported Rehabilitation Costs
                        Properties             A         B        C               Totals
                        Brothers                $16,000     $9,800    $19,300       $45,100
                        Redevelopment
                        AmReal                   10,744      3,156     18,641        32,541
                        Companies
                        Difference               $5,256     $6,644      $659        $12,559

                       The amount reported by Brothers Redevelopment represents the
                       amount of the loan allocated to rehabilitation and the amount
                       reported to HUD. The amount reported by AmReal Companies
                       represents the amount of actual rehabilitation costs. The
                       difference of $12,559 in reported rehabilitation costs is the
                       amount of loan funds kept by AmReal Companies to be used
                       towards the rehabilitation of other acquired properties.

                       The following table provides our calculation of rehabilitation
                       cost and unsupported rehabilitation costs based on our review of
                       supporting documentation maintained by the Contract
                       Developer. We adjusted the cost reported by the Contract
                       Developer for costs not associated with the rehabilitation of the
                       property. The adjustments included such items as rehabilitation
                       expenditures that were improperly charged to the wrong
                       properties.

                                             30 Percent Discount
                                   Rehabilitation Costs – Adjusted
                        Properties            A       B        C                Totals
                        Rehabilitation      $11,781  $2,119  $18,591            $32,491
                        Cost
                        Supported             8,286   1,756   18,109             28,151
                        Unsupported          $3,495    $363     $482             $4,340

                       For the three properties, the Contract Developer was unable to
                       support $4,340 in claimed rehabilitation costs.

Homebuyer interviews   Interviews of the homebuyers and inspections of the three
and property           properties indicated that the rehabilitation work claimed by the
inspections            Contract Developer had been accomplished. However, during a
                       property inspection on June 21, 2001, a homebuyer informed us
                       that the brand new furnace did not work. The homebuyer had
                       moved into the property in November 2000 and went without
                       heat through the winter months. A repairman hired by the
                       homebuyer was unable to repair the furnace. We inquired as to


                                      15
                                   2001-DE-1002

                           whether the homebuyer had been provided with a warranty for
                           the furnace. The homebuyer had been provided with a warranty,
                           but did not understand how a warranty worked.

                           In their affordable housing program, Brothers Redevelopment
                           claimed to provide homeownership counseling. However, in our
                           review of a sample of 14 properties purchased and rehabilitated
                           by Brothers Redevelopment, only one of the homebuyers
                           received a certificate that they had received homeownership
                           counseling from Brothers Redevelopment. It is evident the
                           homebuyer, whose furnace did not work, did not receive any
                           homeownership counseling from Brothers Redevelopment.

Profits in excess of 110   For the three properties purchased at a 30 percent discount, we
percent of net             found that Brothers Redevelopment received profits in excess of
development cost           110 percent of the net development cost, contrary to HUD
                           program requirements. This was due in part to the excessive
                           interest rate charged by US Capital, Inc. of 19.5 percent, the split
                           of proceeds from the subsequent resale of the properties, and the
                           use of unallowable costs in the net development cost calculation,
                           as defined by Housing Notice 94-74, Mortgagee Letter 97-5 and
                           the land use restriction addendum.

                           The following table provides Brothers Redevelopment’s
                           calculation of profit on the subsequent resale of the three
                           properties reviewed.

                                                     30 Percent Discount
                            Properties             A          B          C               Totals
                            Sales Price          $119,900      $93,000     $119,900      $332,800
                            Net                   113,538       87,829      110,259       311,626
                            Development
                            Cost
                            Profit                 $6,362       $5,171       $9,641       $21,174

                           The following table depicts our calculation of net development
                           cost and the excess profits made. Amounts were rounded to the
                           nearest dollar.

                                                       30 Percent Discount
                            Properties             A            B          C             Totals
                            Sales Price          $119,900      $93,000     $119,900      $332,800
                            Net                    93,231       72,069       81,648       246,948
                            Development
                            Cost
                            110% of Net           102,555       79,275       89,813       271,643
                            Development
                            Cost
                            Excess Profit         $17,345      $13,725      $30,087       $61,157




                                          16
        2001-DE-1002

For these three 30 percent discounted properties, Brothers should
have sold the properties to the buyer at the 110 percent of the net
development costs value as required by HUD. Instead, Brothers
Redevelopment sold the properties at market value. For
example, the buyer for property C shown above should have
purchased the home from Brothers Redevelopment for $89,813.
However, Brothers Redevelopment sold the property at market
value of $119,900. This means the buyer had to incur an
additional indebtedness of $30,087 for the house. In other
words, the buyer had to pay 33.5 percent more for the property
than the buyer should have.

The net profit realized by Brothers Redevelopment on the sale of
the 30 percent discounted properties exceeded the amount
stipulated by HUD. Under Mortgagee Letter 97-5 the resale of a
30 percent discounted property cannot exceed 110 percent of the
net development cost. Net development cost is defined as the
total cost of the project, including items such as acquisition cost,
architectural fees, permits and survey expenses, insurance
rehabilitation and taxes as well as selling expenses.
This same requirement was specifically stated in HUD’s May 30,
2000 approval letter of Brothers Redevelopment’s recertification
package. Even with these requirements, Brothers
Redevelopment has developed their Affordable Housing
Program to sell all of their 30 percent discounted properties at
the market value of the properties in order to maximize their
profits.

In selling properties at a 30 percent discount to nonprofit
organizations, HUD has intended to include in the sales
documents a land use restriction addendum that placed
restrictions on the resale of 30 percent discounted properties by
the nonprofit. For example, the 30 percent discounted property
B discussed above contained this addendum to the sales
documents.

The addendum sets out certain conditions for the resale of the
property. One condition was that the property is to be sold to a
buyer whose income is not to be more than 115 percent of the
median income in the area. This would be to low- and moderate-
income persons. A second condition was that the nonprofit was
not to sell the property for more than 110 percent of the net
development costs. Net development cost is defined in the
addendum as the total cost of the project including items as
acquisition costs, architectural fees, permits and survey
expenses, insurance, rehabilitation and selling expenses.




               17
        2001-DE-1002

Brothers Redevelopment has not complied with the sales
restriction placed on the property by the land use restriction
addendum to sell the property at no more than 110 percent
of the net development cost. Instead, Brothers
Redevelopment elected to sell the 30 percent discounted
property at market value. The buyer of the property was an
individual who could afford to purchase the home. By doing
so, Brothers Redevelopment was not providing an
opportunity for the purchase of the property at the 110
percent above the net development cost value to a low- and
moderate-income person.

Ten and Fifteen Percent Discounted Acquired Properties

During the audit period, Brothers Redevelopment acquired 83
properties at 10 or 15 percent discount from HUD at a combined
price of $7,521,586. We reviewed records and files for nine of
these properties. For selected property acquisitions, we verified
whether the costs incurred for the rehabilitation were accounted
for and supported. In addition, we evaluated whether benefits
realized from the discount acquisition of the properties were
passed on to the low- and moderate-income homebuyer as
intended by HUD requirements.

From our review, we found that Brothers Redevelopment
process for acquiring, rehabilitating, and selling its 10 and 15
percent discounted properties followed the same procedures as
for its 30 percent discounted properties. We noted that not all of
the rehabilitation costs for its 10 and 15 percent discounted
properties were accounted for nor supported. Proceeds from the
subsequent resale on one property were used to pay down the
financing costs of another property. The sale of 10 and 15
percent discounted properties at market value prevents Brothers
Redevelopment from passing on any realized savings to low- and
moderate-income buyers as intended by HUD requirements.

To illustrate, Brothers Redevelopment acquired a 15 percent
discounted property from HUD at a cost of $74,550 performed
the needed rehabilitation repairs, which was funded at $12,700,
and resold the property at the market value of $114,900 to a
qualifying buyer.




               18
        2001-DE-1002

The sale of this property at market value did not fulfill Brothers
Redevelopment obligation to pass on any savings from the
discounted purchase to the ultimate homebuyer. Allowing a 10
percent amount for overhead and profit, Brothers Redevelopment
could have sold the house at a price of $95,975, thereby granting
the homebuyer the benefit of the HUD discounted property sales
program. The composition of the $95,975 selling price is:

      Purchase price of home from HUD               $ 74,550
      Needed rehabilitation costs                     12,700
           Combined cost                            $ 87,250
      Overhead and profit at 10 percent of cost        8,725
           Sales Price                              $ 95,975

By selling the home at $114,900, an additional profit on the sale
in the amount of $18,925 was realized. This amount was used to
fund costs for another property, with the remaining amount
distributed to the Contract Developer at 40 percent, US Capital,
Inc. at 20 percent, and Brothers Redevelopment at 40 percent.
The true impact is that the additional profit realized by Brothers
Redevelopment and the two other contract entities is absorbed in
the market value price paid by the property buyer.

We identified two other 15 percent discounted properties
that were bought and sold by Brothers Redevelopment on
the same day. The properties were purchased at a discount from
HUD and then sold at market value. The only rehabilitation
costs we saw were $290 for appliances for one property and
$300 for heating for the other property. The profit realized from
the two property acquisitions and sales was distributed equally
between Brothers Redevelopment and the Contract Developer.
As a result, no benefit from the discounted purchase from HUD
was granted to the homebuyers, contrary to HUD requirements.

Details of these two purchases and sales are shown in the
following chart:

                              15 Percent Discount
 Properties                      A          B            Totals
 Sales Price                    $168,000      $80,000    $248,000
 Acquisition Cost from           140,372       62,899     203,271
 HUD
 Realized Gain                   $27,628      $17,101     $44,729

This table shows that Brothers Redevelopment was able to use
HUD’s discount sales program to buy and immediately sell the
properties with a realized gain of $44,729. By selling the
properties at market value, no opportunity was granted to
providing any savings from the HUD program to low- and
moderate-income homebuyers.



               19
                               2001-DE-1002

                       Allowing a 10 percent amount for overhead and profit, Brothers
                       Redevelopment could have sold the two houses at a price of
                       $154,409 and $69,189 instead of $168,000 and $80,000
                       respectively as shown in the following chart. This would have
                       enabled the savings from the discounted HUD properties to be
                       passed on to the homebuyer.

                                                    15 Percent Discount
                        Properties                     A          B           Totals
                        Sales Price                    $168,000     $80,000    $248,000
                        Acquisition Cost from           140,372      62,899     203,271
                        HUD
                        Overhead and Profit at           14,037       6,290      20,327
                        10% of Cost
                        Discounted Sales Price         $154,409     $69,189    $223,598


Overall impact of      As shown by these discussions above, Brothers Redevelopment
deficient affordable   has designed the implementation of its affordable housing
                       program by marketing its acquired discounted HUD properties to
housing program        be sold at the market value of the property in order to maximize
                       the revenue from the HUD program. According to Brothers
                       Redevelopment, profits from their affordable housing program
                       made up for losses incurred in their other programs and to help
                       finance other activities being carried out by them.

                       Brothers Redevelopment officials expressed that they have
                       received an average of $5,000 profit per property sold under the
                       HUD program. Brothers Redevelopment in their July 12, 2001
                       response to HUD’s draft report of HUD review of Brothers
                       Redevelopment program implementation stated the following:

                           “BRI [Brothers Redevelopment, Inc.] has used the proceeds
                           created from this program to leverage the purchase of
                           additional properties from HUD in order to house still more
                           modest income families and to support ongoing overhead
                           and administrative expenses for the organization.”

                           “Nevertheless BRI [Brothers Redevelopment, Inc.] earned a
                           grand total of $163,184 for its efforts in this program last
                           year. However, in Housing Counseling (also funded in part
                           by HUD) we had a short fall of $3,962 and for the Paint-A-
                           Thon project (targeted toward maintaining low income
                           seniors in their homes) we experienced a short fall of
                           $16,063. These losses were made up in part from sales
                           proceeds earned from the Purchase Repair Resale
                           Program.”

                       Clearly, Brothers Redevelopment’s participation in HUD’s FHA
                       Single Family Insurance Programs has been primarily designed
                       and implemented to generate revenues to help finance its other



                                      20
                                 2001-DE-1002

                         non-HUD related activities. This implementation process is
                         contrary to the requirements and intent of the HUD program.
                         The HUD program is designed to provide discounted properties
                         to be purchased from HUD, be rehabilitated, and then sold with
                         savings from the program being passed on to the low- and
                         moderate-income homebuyer. The HUD program was not
                         intended to generate revenue to finance activities of the nonprofit
                         entity and at the expense of the homebuyer.

Reporting to HUD not     During our audit period, we found that Brothers Redevelopment
accurate                 submitted reports to the Denver Homeownership Center that
                         were not accurate. For example, rehabilitation costs reported by
                         Brothers Redevelopment in its activity reports were not correct.
                         Brothers Redevelopment incorrectly reported the amount of the
                         loan allocated to rehabilitation as rehabilitation cost, as opposed
                         to the actual rehabilitation costs incurred by its Contract
                         Developer. Brothers Redevelopment did not require its Contract
                         Developer to provide a summation or report on the actual cost to
                         rehabilitate a property.

Brothers Redevelopment   At the time we started our site review, the Denver
suspended from           Homeownership Center also performed an on-site review of
purchasing additional    Brothers Redevelopment’s participation in the FHA Single
HUD properties           Family Insurance Program activities. Based on the deficiencies
                         they identified during the on-site review, Brothers
                         Redevelopment was placed on temporary suspension until
                         program changes were made and put in place. The draft on-site
                         review report, dated June 28, 2001, contained the following five
                         findings.

                             •   Brothers Redevelopment lack of control over the HUD
                                 Home discount purchase program.

                             •   Brothers Redevelopment exceeds the 110% net
                                 development allowed on discounted sales.

                             •   Inconsistencies in marketing to low- to moderate-income
                                 purchasers (115% and below median income).

                             •   Record keeping.

                             •   Conflict of interest.

                         These findings parallel the deficiencies we identified in Brothers
                         Redevelopment’s operation of its HUD program.




                                        21
                                   2001-DE-1002


Deficiencies in carrying   In our opinion, the deficiencies addressed above in Brothers
out Affordable Housing     Redevelopment carrying out their Affordable Housing Program
Program stem from two      stem from two primary causes. Brothers Redevelopment did not:
causes
                           1) Have a clear understanding of HUD requirements to
                              participate in FHA’s Single Family Insurance Programs, to
                              create homeownership opportunities for low- and moderate-
                              income persons, nor

                           2) Want to take part in the risk associated with the purchase,
                              rehabilitation, and resale of the properties.

Lack of understanding      First, Brothers Redevelopment has demonstrated that they did
of HUD program             not fully understand the requirements of the program. Brothers
                           Redevelopment made the following statement in their affordable
                           housing program:

                               “There is no requirement for us to pass along to low income
                               persons any savings we receive from the discounted
                               purchase of a HUD owned property. We price our
                               properties at the lower end of the market range for
                               properties in a particular market area and if we can bring
                               the property up to a level of livability within the range of our
                               available budget, we have a workable project. The buyers
                               qualify for their loans independently, and they know how
                               much home they can afford. Most of the people we help buy
                               homes through our housing counseling efforts do not buy
                               homes from BRI [Brothers Redevelopment, Inc.].”

                           This statement is in direct conflict with HUD’s stated objectives
                           of the program to provide housing opportunities and to pass on
                           the savings from the purchase of discount properties to low- to
                           moderate-income homebuyers.

                           In addition, Brothers Redevelopment lacked a proficiency of
                           HUD Requirements and was negligent in the application of
                           them. An interview with a staff member of Brothers
                           Redevelopment suggested that Brothers Redevelopment had
                           been basing their Affordable Housing Program on a HUD
                           handbook that had since been revised with the issuance of
                           various Mortgagee Letters and HUD Directives. The staff
                           member indicated that Brothers Redevelopment was not aware
                           of other program requirements, even though attached to their
                           HUD approval letter to participate in FHA’s Single Family
                           Insurance Programs was a detailed listing of applicable HUD
                           requirements and guidelines.




                                          22
                                 2001-DE-1002

Brothers Redevelopment   Secondly, Brothers Redevelopment did not want to take part in
did not want any risk    the risk associated with the purchase, rehabilitation and resale of
stemming from the HUD    properties purchased at a discount. Brothers Redevelopment
program                  indicated this in the following statement they made in their
                         response to the draft on-site review report issued by the Denver
                         Homeownership Center on June 28, 2001:

                             “In terms of oversight by BRI [Brothers Redevelopment,
                             Inc.], we have drawn the program to rely upon the
                             motivations and risk of others for their involvement in this
                             program.”

                         Brothers Redevelopment relied solely on an outside independent
                         Contract Developer, AmReal Companies, to make such
                         decisions as to which properties to purchase, amount of
                         rehabilitation work to be performed, and the marketability of
                         rehabilitated properties. In addition, they obtained nonrecourse
                         loans with a high interest rate of 19.5 percent from US Capital,
                         Inc. shifting all risk to the lender.

                         The use of nonrecourse loans at the high interest rate of 19.5
                         percent from US Capital, Inc. has increased the cost to each of
                         the discounted properties. A Brothers Redevelopment official
                         provided us with an analysis that they had conducted comparing
                         the cost of using a nonrecourse loan from US Capital, Inc. at a
                         19.5 percent interest rate and a recourse loan by a separate
                         mortgage company at a 10 percent interest rate. This analysis
                         showed the projected premium for using the nonrecourse loan
                         was $4,345. This increased cost is included in the total net
                         development cost for each property.

                         Brothers Redevelopment has used some recourse loans under its
                         HUD program with considerable savings in connection with
                         interest rates on property loans. During the earlier part of the
                         HUD FHA Single Family Insurance Programs participation by
                         Brothers Redevelopment, Brothers Redevelopment obtained
                         recourse loans on properties with interest rates ranging from 9.75
                         to 10 percent.

                         In the first part of their program, Brothers Redevelopment even
                         obtained a lower interest rate for nonrecourse loans. A 12
                         percent interest rate loan was obtained from WK Investments.
                         After this loan, Brothers Redevelopment started using US
                         Capital, Inc. to obtain its nonrecourse loan financing with rates at
                         19.5 percent. The two main principals for WK Investments are
                         the two main principals of US Capital, Inc.

                         The 19.5 interest rates from US Capital, Inc. were negotiated
                         with the Contract Developer, who sits on the board of US
                         Capital, Inc. In addition, the negotiated arrangement allowed US
                         Capital, Inc. to also receive 20 percent of the profit realized from


                                        23
                                 2001-DE-1002

                         the resale of the HUD discounted properties. Interestingly,
                         county records show that US Capital Inc. has provided loans to
                         the Contract Developer, AmReal Companies, for non Brothers
                         Redevelopment related properties with interest rates ranging
                         from 4.5 to 5.75 percent.

                         Brothers Redevelopment has designed the implementation of its
                         HUD program whereby the risks associated with it are passed on
                         to the outside independent Contract Developer and US Capital,
                         Inc. By doing so, the Contract Developer and lender were
                         investors taking the risk, while Brothers Redevelopment
                         functioned basically as a strawbuyer whose approval status was
                         used for a fee, 40 percent of net proceeds from the subsequent
                         resale of each property.

Participation in HUD’s   Brothers Redevelopment has not operated its Affordable
Programs needs to be     Housing Program to meet HUD’s basic requirements under the
discontinued             FHA Single Family Insurance Programs. Brothers
                         Redevelopment:

                             •   Has not controlled its’ program to ensure the minimum
                                 program requirements were being met;

                             •   Exceeded the 110 percent development allowed on
                                 discounted sales for 30 percent discounted acquired
                                 properties; and

                             •   Did not pass on the benefits of the purchase of HUD
                                 discounted properties to the ultimate homebuyer.

                         Instead, Brothers Redevelopment’s primary focus in
                         participating in the HUD programs has been to obtain the
                         maximum profit possible under the HUD programs to help
                         finance its’ other unrelated nonprofit activities and not to grant
                         any benefits realized under its’ program to the purchasing low-
                         and moderate-income homebuyer. Furthermore, Brothers
                         Redevelopment designed its program to allow it to be
                         implemented by others who would administer all phases of the
                         program and assume all risks.

                         Under this arrangement, Brothers Redevelopment did not
                         implement any major oversight or control over its Contract
                         Developer. The Contract Developer, with the knowledge and
                         acceptance of Brothers Redevelopment, was granted full
                         authority and responsibility under the program and to operate it
                         to maximize profits, not only for itself but also for an identity of
                         interest lender, and for the nonprofit. Brothers Redevelopment
                         marketed its properties at the market value for its properties in
                         order to gain the maximum profit for itself, the at-risk Contract
                         Developer, and the primary lender. and by doing so, did not pass



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                           2001-DE-1002

                   on any benefits under the program to the homebuyer as specified
                   by HUD.

                   For the 30 percent discounted properties acquired from HUD,
                   Brothers Redevelopment was required to sell these properties at
                   no more than 110 percent of the net development costs to low-
                   and moderate-income persons. This requirement was set out in
                   HUD requirements, HUD’s authorization letter for participation
                   in the HUD program, and on certain land use restriction
                   addendum to the 30 percent acquired properties from HUD.
                   HUD requirements specify that if the nonprofit does not comply
                   with the HUD provisions for the 30 percent acquired properties,
                   the nonprofit could be removed from the program.

                   Brothers Redevelopment did not carryout out its program for the
                   30 percent discount properties acquired from HUD but sold the
                   properties at market value to realize the maximum profit and did
                   not pass on any benefit from the program to the homebuyer.
                   Furthermore, the nonprofit allowed the Contract Developer to
                   function primarily as an investor under the program for a percent
                   of the net profit of the property sales and did not ensure that the
                   minimal requirements of the HUD program were met.

                   Since Brothers Redevelopment has shown through various
                   verbal and written correspondences that they do not intend to
                   change the administration of their affordable housing program to
                   conform to HUD’s FHA Single Family Insurance Program
                   requirements, further participation in the HUD program should
                   be discontinued.

                   With regards to excess profits made by Brothers Redevelopment,
                   the outside independent Contract Developer, and the primary
                   lender, the Denver Homeownership Center needs to make a
                   decision as to how the homebuyers will be compensated for the
                   excess profits that were passed on to the homebuyer in the form
                   of an increased purchase price.

Auditee Comments   Brothers Redevelopment does not agree with the finding. The
                   written response is contained in Appendix 1. Brothers
                   Redevelopment states that the report ignored certain HUD
                   directives and the findings were slanted to support a
                   predetermined outcome. The response discusses several HUD
                   handbooks and directives and often details various sections to
                   support that the nonprofit is complying with the provisions
                   relating to the purchase, rehabilitation and resale of 30 percent
                   discounted properties from HUD. Furthermore, Brothers
                   Redevelopment discusses at length the differences under the
                   program for 30 percent discounted properties and less than 30
                   percent discounted properties.




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                                2001-DE-1002

                        Brothers Redevelopment acknowledged that it did rely too much
                        upon the incentives of the Contract Developer. In addition,
                        Brothers Redevelopment states that it was acting on its own
                        behalf and not under the influence, control, or direction of
                        AmReal Corp. and was contracting for their broad experience for
                        a percentage of the net gain which was comparable to paying
                        someone a real estate commission.

                        The response to the audit finding discussed that AmReal
                        Companies brought to the attention of Brothers Redevelopment
                        the funding source from US Capital, Inc. Even though, the rates
                        were higher than previously experienced, it provided Brothers
                        Redevelopment with an increase of funding with which to
                        acquire more HUD discounted properties. This was needed
                        according to Brothers Redevelopment if they were to continue in
                        the program. Furthermore, the experience encountered by
                        Brothers Redevelopment in the 1980s whereby they found
                        themselves in financial difficulty made the financing from US
                        Capital, Inc. beneficial. Also, the availability of nonrecourse
                        loans was not readily available except from US Capital, Inc.

                        In addition, the reply to the finding points out that the schedules
                        presented in the finding are confusing and indicate that the
                        requirements for 30 percent discounted properties are the same
                        as for less than 30 percent discounted properties. The
                        requirements for the 30 percent discounted properties are to be at
                        110 percent of the net development costs but Brothers
                        Redevelopment states that the requirement is from a HUD
                        document that refers only to the Section 203(k) program for
                        which Brothers Redevelopment is not doing. Therefore, the 110
                        percent requirement does not apply to Brothers Redevelopment’s
                        program. Accordingly, the position taken in the audit finding is
                        incorrect.

Evaluation of Auditee   Brothers Redevelopment response to the draft finding stated that
Comments                the auditors ignored written program directives and slanted the
                        finding to support a predetermined outcome and intended to
                        manipulate the program for the future. Brothers Redevelopment
                        assertion is totally false. Brothers Redevelopment was selected
                        for review since they are one of the larger nonprofits
                        participating in HUD’s FHA Single Family Insurance Programs.
                        Our review focused on how Brothers Redevelopment was
                        implementing its HUD programs and whether it was within the
                        HUD requirements. In fact, the implementation of the HUD
                        property discount program by Brothers Redevelopment as
                        presented in the finding is clearly acknowledged in Brothers
                        Redevelopment’s written response to the finding.

                        Since the response indicates that the finding omitted certain
                        HUD handbook and directives and misapplied others, we have
                        incorporated into the finding all of the HUD documents


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        2001-DE-1002

specifically discussed by Brothers Redevelopment. These
additional references further detail and/or restate other program
requirements already cited in the finding.

The response indicates that Brothers Redevelopment was not
acting under any outside influence, control or direction of its
Contract Developer. The point presented in the finding is that
the Brothers Redevelopment allowed the Contract Development
to influence, control and direct the HUD discounted acquisition
program, not to influence, control and direct Brothers
Redevelopment.

Brothers Redevelopment’s reply to the finding states that they
used the nonrecourse loans from US Capital, Inc. to finance their
property purchases from HUD so that Brothers Redevelopment
would not be in a position to encounter property losses as they
experienced in the 1980’s. The point being presented in the
finding by Brothers Redevelopment allowed the HUD
discounted acquisition program to be administered by the outside
independent Contract Developer with program financing coming
from an identity of interest relationship with the Contract
Developer and the program lender. Brothers Redevelopment
allowed this arrangement in order to pass all risk under the
program to the Contract Developer and the program financing
lender for a fee of the net proceeds from the property sales.

In order to clarify the confusion on the definition of the net
development cost not being applicable to the program being
administered by Brothers Redevelopment, we have clarified in
the finding some of the criteria applicable to the definition and
use of net development cost. We point out in the finding that
Mortgagee Letter 94-74 discusses that under HUD’s Real Estate
Owned Discount sales program, which is the one Brothers
Redevelopment is participating in, that nonprofits that purchase
30 percent discounted properties from HUD are to be resold at
no more than 110 percent of the net development cost for the
property. This same requirement is specifically stated by HUD
in their approved letter of Brothers Redevelopment
recertification package. In addition, the finding is modified to
show that some of the 30 percent discount sales documents from
HUD contained land use restriction addendums that specifically
specified the properties were to be resold at no more than 110
percent of the net development cost. The net development cost
was clearly defined in the land use restriction addendums.

Even so, Brothers Redevelopment has elected to sell their 30
percent discounted properties at the market value of the property
that has been above the amount limited by HUD. In addition, the
sale of all of its properties have been to the buyers at the market
value without any benefit from the discounted property purchase



               27
                         2001-DE-1002

                  from HUD being passed on to the homebuyer as also required
                  and intended by HUD.


RECOMMENDATIONS   We recommend that the Denver Homeownership Center:

                  1A. Disapprove Brothers Redevelopment from further
                      participation in HUD’s FHA Single Family Insurance
                      Programs.

                  1B. Determine what the actual net development cost is for each
                      30 percent property purchased and rehabilitated by Brothers
                      Redevelopment. Based on the actual net development cost,
                      calculate the excess profits. Decide how the homebuyers
                      are to be compensated for the excess profits that were
                      passed on to them in the form of an increased property
                      purchase price.




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Management Controls
In planning and performing our audit, we obtained an understanding of the management controls
that were relevant to our audit. Management is responsible for establishing effective management
controls. Management controls, in the broadest sense, include the plan of organization, methods
and procedures adopted by management to ensure that its goals are met. Management controls
include the processes for planning, organizing, directing, and controlling program operations.
They include systems for measuring, reporting, and monitoring program performance.


                                We determined the following Brothers Redevelopment
 Management controls            management controls were relevant to our audit objectives:
 assessed
                                •   Governing policies and procedures as established by
                                    Brothers Redevelopment relating to its HUD approved
                                    Affordable Housing Program;

                                •   Procedures for implementing its Affordable Housing
                                    Program granting independence from other parties; and

                                •   Procedures granting discounts from the purchase of HUD
                                    discounted properties were passed on to low- and moderate-
                                    income homebuyers.

                                The following audit procedures were used to evaluate the
 Assessment procedures
                                management controls:

                                •   Review of established procedures formulated by Brothers
                                    Redevelopment in implementing its Affordable Housing
                                    Program;

                                •   Interviews with officials and employees of Brothers
                                    Redevelopment and other related parties and entities;

                                •   Review of Brothers Redevelopment’s Affordable Housing
                                    Program records and related files;

                                •   Review of program records and files maintained by
                                    independent parties associated with Brothers
                                    Redevelopment’s Affordable Housing Program;

                                •   Review of records and files maintained by the Denver
                                    Homeownership Center in connection with the approval and
                                    oversight of the HUD FHA Single Family Insurance
                                    Program activities by the approved nonprofit Brothers
                                    Redevelopment, Inc.; and



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                                 2001-DE-1002

                         •   Interview with applicable officials and employees of the
                             Denver Homeownership Center relating to activities
                             associated with Brothers Redevelopment.

                         A significant weakness exists if management controls do not
Significant Weaknesses   give reasonable assurance that resource use is consistent with
                         laws, regulations, and policies; that resources are safeguarded
                         against waste, loss, and misuse; and that reliable data is obtained
                         and maintained, and fairly disclosed in reports. Based on our
                         audit, we identified the following significant weaknesses:

                         •   Brothers Redevelopment did not administer or carryout its
                             Affordable Housing Program as approved by HUD or in
                             conformity with HUD requirements, (Finding) and

                         •   Benefits realized from the acquisition of discounted HUD
                             properties were not passed on to the low- and moderate-
                             income homebuyer as required (Finding).




                                        30
                                         2001-DE-1002



Follow-up on Prior Audits
This is the first HUD Office of Inspector General for Audit review of activities of Brothers
Redevelopment, Inc.




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Appendices
Appendix 1 - Auditee Comments




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Appendix 2

Distribution
Secretary’s Representative, 8AS (2)
Director, Denver Homeownership Center, 8AHH (2)
Deputy Assistant Secretary for Single Family Housing, HU, Room 9282
Special Assistant for Single Family Housing, HU, Room 9278
Deputy Secretary, SD, Room 10100
Chief of Staff, S, Room 10000
Assistant Secretary for Administration, A, Room 10100
Deputy Chief of Staff, S, Room 10226
Deputy Chief of Staff for Operations, S, Room 10226
Deputy Chief of Staff for Programs and Policy, S, Room 10226
Assistant Secretary for Congressional and Intergovernmental Relations, J, Room 10120
Senior Advisor to the Secretary, Office of Public Affairs, S, Room 10132
Deputy Assistant Secretary for Public Affairs, W, Room 10222
Special Counsel to the Secretary, S, Room 10234
General Counsel, C, Room 10214
Deputy General Counsel, CB, Room 10220
Office of Policy Development and Research, R, Room 8100
Assistant Deputy Secretary for Field Policy and Management, SDF, Room 7106
Director, Office of Department Operations and Coordination, I, Room 2124
Chief Procurement Officer, N, Room 5184
Chief Information Officer, Q, Room 3152
Chief Financial Officer, F, Room 2202
Deputy Chief Financial Officer for Operations, FF, Room 10166
Director, Office of Budget, FO, Room 3270
Director, Enforcement Center, V, 200 Portals Building
Director, Real Estate Assessment Center, X, 1280 Maryland Ave., SW, Suite 800
Departmental Audit Liaison Officer, FM, Room 2206
Headquarters Audit Liaison Officer, Public and Indian Housing, PF, Room P8202
Field Audit Liaison Officer, 6AF, (2)
Director of Scheduling and Advance, AL, Room 10158
Assistant Deputy Secretary for Field Policy and Management, SDF, Room 7108 (2)
Special Assistant to the Deputy Secretary for Program Management, SD, Room 10100
Acquisitions Librarian, Library, AS, Room 8141
Inspector General, G, Room 8256
The Honorable Joseph Lieberman, Chairman, Committee on Governmental Affairs, 340 Dirksen
        Senate Office Building, United States Senate, Washington, DC 20510
The Honorable Fred Thompson, Ranking Member, Committee on Governmental Affairs, 706
        Hart Senate Office Building, United States Senate, Washington, DC 20510
The Honorable Dan Burton, Chairman, Committee on Governmental Reform, 2185 Rayburn
        Bldg., House of Representatives, Washington, DC 20515
Henry A. Waxman, Ranking Member, Committee on Governmental Reform, 2204 Rayburn
        Bldg., House of Representatives, Washington, DC 20515
Ms. Cindy Fogleman, Subcommittee on Oversight and Investigations, Room 212, O’Neil House
        Office Building, Washington, DC 20515



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                                      2001-DE-1002

Director, Housing and Community Development Issue Area, United States General Accounting
        Office, 441 G Street, NW, Room 2474, Washington, DC 20548 (Attention: Stan
        Czerwinski)
Deputy Staff Director, Counsel, Subcommittee on Criminal Justice, Drug Policy and Urban
        Resources, B373 Rayburn House Office Building, Washington, DC 20515
Steve Redburn, Chief, Housing Branch, Office of Management and Budget, 725 17th Street, NW,
        Room 9226, New Executive Office Building, Washington, DC 20503
Andy Cochran, House Committee on Financial Services, 2129 Rayburn H. O. B., Washington,
        DC 20515




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