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. i 2001-DE-1002 Should you have any questions, please contact Ernest Kite, Assistant District Inspector General for Audit, at (303) 672-5452. ii 2001-DE-1002 THIS PAGE LEFT BLANK INTENTIONALLY iii 2001-DE-1002 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: iv 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 v 2001-DE-1002 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. vi 2001-DE-1002 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 vii 2001-DE-1002 Abbreviations: FHA Federal Housing Administration HUD Department of Housing and Urban Development viii 2001-DE-1002 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. 1 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 2 2001-DE-1002 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 3 2001-DE-1002 THIS PAGE LEFT BLANK INTENTIONALLY 4 2001-DE-1002 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 5 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 6 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 8 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. 9 2001-DE-1002 • 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. 10 2001-DE-1002 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 24 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. 25 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 26 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. 28 2001-DE-1002 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 29 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. 31 2001-DE-1002 THIS PAGE LEFT BLANK INTENTIONALLY 32 2001-DE-1002 Appendices Appendix 1 - Auditee Comments 33 2001-DE-1002 34 2001-DE-1002 35 2001-DE-1002 36 2001-DE-1002 37 2001-DE-1002 38 2001-DE-1002 39 2001-DE-1002 40 2001-DE-1002 41 2001-DE-1002 42 2001-DE-1002 43 2001-DE-1002 44 2001-DE-1002 45 2001-DE-1002 46 2001-DE-1002 THIS PAGE LEFT BLANK INTENTIONALLY 47 2001-DE-1002 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 48 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 49
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)