U.S. Department of Housing and Urban Development
Office of Inspector General for Audit
Great Plains District, 7AGA
Gateway Tower II - 5th Floor
400 State Avenue
Kansas City, Kansas 66101-2406
AUDIT MEMORANDUM
2001-KC-1803
September 28, 2001
MEMORANDUM FOR: Herman Ransom, Director, Kansas City Multifamily HUB, 7AHM
FROM: Roger E. Niesen, District Inspector General for Audit, 7AGA
SUBJECT: Review of Oak Tree Park Apartments
Overland, Missouri
Project No. 085-11052
We have completed a review of the operations of Oak Tree Park Apartments for the period from
November 1998 until the transfer of physical assets on August 28, 2000. We performed this
review at the request of your office. We reviewed Oak Tree Apartment’s use of project funds to
determine if the owners complied with the terms of their Regulatory Agreement. We did not
review any other operations of the property.
We determined that the owners, G & K Properties, used $222,012 in violation of the Regulatory
Agreement during the audit period. This includes tenant rental payments that were never
deposited to the project bank account and disbursements for uses that were ineligible or not
documented. Although the owners were also the HUD-approved management agent, they never
accrued or paid themselves a management fee. As the management agent, they earned a
management fee of $57,299 during our audit period that they should have paid themselves but
did not. We offset the $57,299 against the $222,012 and determined the net diversion was
$164,713. This memorandum contains two recommendations.
Within 60 days please provide us, for each recommendation in this memorandum, a status report
on: (1) the corrective action taken; (2) the proposed corrective action and the 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.
Should you or your staff have any questions, please contact me at (913) 551-5870.
Telephone: (913) 551-5870 www.hudoig.gov Fax: (913) 551-5877
Background
Under the 223(f) program, HUD insured a $2,720,000 mortgage refinance for Oak Tree
Apartments. Oak Tree Apartments is located in Overland, Missouri and consists of 140 two-
bedroom units in 35 buildings. G & K Properties, a profit-motivated partnership, was the owner
of Oak Tree during our audit period. On May 28, 1997, HUD endorsed the mortgage for
insurance upon completion of repairs and G & K signed its Regulatory Agreement. After
completing required repairs, the owners submitted the certificate of actual cost in October 1998.
We received a referral from HUD’s staff on July 31, 2000 regarding diversion of funds by the
owners of Oak Tree Apartments. According to the referral, G & K Properties diverted funds
from the project. The diversion came to HUD’s attention after HUD reviewed audited financial
statements submitted by the project as part of a transfer of physical assets application. As a
result, HUD required the owners to escrow $200,000 for correction of potential deficiencies as a
condition of the transfer. HUD’s Kansas City Office of Housing referred this matter to HUD’s
Enforcement Center and requested an OIG review. On August 28, 2000, Gundaker Commercial
Group, as Oak Tree Associates, L.P., assumed ownership of the property. Our audit covered the
period between the cost certification and the transfer of physical assets.
Objectives, Scope and Methodology
The overall audit objective was to determine whether project officials used project funds for
purposes other than reasonable operating expenses and necessary repairs, except for allowable
distributions from surplus cash. To achieve our objective, we reviewed the project’s bank
statements, canceled checks, and invoices. We reviewed tenant records maintained by the new
owners at the project office. We interviewed the prior owners. We also reviewed HUD
guidelines deemed appropriate to accomplish our objective. The audit covered the period from
November 1, 1998 through August 28, 2000.
Audit Results
We found that the owners, G & K Properties, used $222,012 in violation of the terms of their
Regulatory Agreement. This includes tenant rental payments that were never deposited to the
project bank account and disbursements of funds for uses that were ineligible or not documented.
Although the owners were also the HUD-approved management agent, they never accrued or
paid themselves a management fee. As the management agent, they earned a management fee of
$57,299 during our audit period that they should have paid themselves but did not. As a result,
we offset the $57,299 against the $222,012 spent in violation of the Regulatory Agreement to
arrive at a net diversion of $164,713.
The owners did not keep adequate records of the income received by the project. Based on the
limited information available to us, $100,767 in rents should have been deposited to the project’s
bank account, but was not. The owners only provided receipts evidencing $971 in cash
payments. Therefore, the difference of $99,796 is unaccounted for.
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The Regulatory Agreement requires that all rents and other receipts of the project must be
deposited in the project bank account. HUD guidelines require that all disbursements must be
supported by approved invoices/bills and that appropriate controls must be in place over receipts
and disbursements.
The owners did not have an appropriate control over cash receipts. The only evidence that
collections were received was a handwritten list of amounts received with a deposit ticket stapled
to the back. The amount on the list frequently exceeded the amount deposited. Sometimes,
notes were made on the handwritten list that indicated cash payments were made, but there were
not receipts or other records to support the payments. The owners said they had to hold out cash
from their deposits because it was the only way they could get cleaning people. A review of the
amounts on the handwritten list versus the amounts deposited showed the owners retained
$35,537 in cash. In addition, there was no control to ensure rent collections were not omitted or
understated on the list and not deposited in the account. By reviewing information available in
the tenant files and from the housing authority, we identified $65,230 in tenant rents that should
have been collected and deposited, but were not. As previously mentioned, the owners
improperly retained $99,796 in project funds and either used the funds for ineligible purposes or
could not support how the funds were used.
Further, the owners spent project funds that were deposited to the project account for purposes
other than reasonable operating expenses and necessary repairs of the project. These unallowable
and unsupported disbursements totaled $122,216.
The owners spent $36,301 for ineligible purchases, including payments related to a Ford
Explorer for one owner, payments for invoices not billed to Oak Tree, payments on a $50,000
loan taken out for project improvements but not approved by HUD, and payments for other
ineligible purposes. The owners said the payments on invoices not billed to Oak Tree were in
fact used for the project, but they could not provide documentation to support the connection. In
addition, the owners spent $165,212 for expenses that they could not support. Of this amount,
$132,549 was paid to CERJ, a related company of the owners’ that was also used to pay the Oak
Tree payroll. Although the individual checks were not supported by documentation tying them to
specific payroll and other reimbursements, a review of the CERJ bank account revealed that
$79,297 was spent by CERJ to pay Oak Tree payroll and other expenses. Therefore, we
subtracted this amount from the unsupported expenses.
The owners said that all the money that was disbursed from the operating account was solely for
the benefit of the project. They said that all expenses were paid upon receipt of an invoice from a
company or supplier, and if invoices were missing, they did not know what happened to them.
The owners said that they did not follow HUD’s rules and regulations because they were not
aware of them. They said HUD should have taught them.
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The following table summarizes the information described above:
Unallowable Expenses $36,301
Unsupported Expenses $165,212
Less: Total for Oak Tree paid out of CERJ $79,297
Total Amount Unallowable and Unsupported $122,216
Undeposited Rent Collections $100,767
Less: Receipts for Cash Purchases $971
Total Amount Unaccounted for $99,796
Total Amount Unallowable, Unsupported, and Unaccounted for $222,012
Less: Management Fee that the Project was Allowed $57,299
Total Amount due from Owners $164,713
In August 2000, the owners escrowed $200,000 to guarantee payment for the correction of
deficiencies identified by the financial statement auditors. Of this amount, $39,277 was
immediately transferred to the new owners to cover under funded security deposits. The balance
of $160,723 was kept in the escrow fund to be paid to the project should HUD determine
reimbursement is necessary. This escrow balance is insufficient to cover the total amount we
determined was inappropriately used by the owners. In addition to the escrow amount, another
$3,990 is required from the owners to cover the deficiencies.
Auditee Comments
Excerpts from G & K Properties’ comments on our draft finding follow. Appendix A contains
the complete text of the comments.
G & K believes that upon the sale of the project to the new owners, all accounts related to the
project were funded at appropriate levels from investment returns to the owners of the Company
and according to agreements reached with a division of HUD in connection with the preliminary
approval for the sale of the project. The project, has been made whole by the owners of the
project from the proceeds of the return on their investment in the project. Since the project has
been made whole from the personal resources of the owners of the Company, HUD, in essence,
is requesting that the owners now make the project whole from their own personal resources an
inappropriate second time.
OIG Evaluation of Auditee Comments
As a condition for approving the sale of the property, HUD required G & K to establish a
$200,000 escrow account to guarantee payment for correction of deficiencies that HUD
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determines occurred under the Regulatory Agreement. The escrowed funds were to be used to
reimburse the buyer for under funded security deposits and to reimburse the project for
disbursements of project funds that were not for reasonable and necessary project expenses and
exceeded the amount of surplus cash that was available. Funds to reimburse under funded
security deposits were immediately transferred to the new owner upon closing. Our audit
determined $164,713 is needed to satisfy the inappropriate disbursements when surplus cash was
not available. Transferring the funds out of the escrow account according to the escrow
agreement is not requiring the owners to repay the project a second time.
Auditee Comments
G & K disputes our finding that they could not account for $99,796 in rent receipts. They claim
that substantial portions of this amount (at least $35,573) relates to them having to pay cleaning
personnel in cash. G & K said they retained residents of the project to perform maintenance
services. The workers were paid in cash. The payments were small in nature, and the Company
does not believe that any one person was paid more than $600 in any one year. The Company
indicated that it attempted to make notations of the cash paid to individuals on calendar year
1999 reports. G & K said since this issue was brought to their attention, cash amounts paid
were documented and reconciled from total amounts collected and compared to amounts
deposited in the bank. The Company believes that the balance of the amounts questioned by
HUD in this category relate to scheduled rent payments that were not actually received by the
Company.
OIG Evaluation of Auditee Comments
The Regulatory Agreement requires that all project funds must be promptly deposited in the
project bank account. Therefore, holding cash out of the deposits is improper. G & K was not
able to provide us with proof of cash payments. They did not have receipts and could not give us
dates, payment amounts, or even the names of workers. The only documentation available to
support the payments was notations made on the deposit tickets, such as “1100 cleaning people”.
There were 15 such notations made from May 1999 through August 2000 totaling $14,857.
These are not adequate evidence of proper project expenses.
G & K said the balance of the amounts questioned were rent payments not actually received by
the Company. We were not able to substantiate whether the collections were actually made
because G & K did not have, or destroyed applicable rent receipts. However, in the one case
where we had a tenant’s rent receipt and G & K records, we found the tenant paid her full rent,
but only a portion of it was recorded as received on G & K records. If tenants were in fact not
paying rent, as G & K said, G & K files should have contained delinquency notices, bad debt
expenses should have been recorded, and tenants should not have been permitted to continue
occupancy. For example, one tenant occupied her unit until the sale in August 2000, although G
& K did not record any rent collections after June 1999. Owners of projects have a responsibility
to operate projects efficiently. Additionally, HUD requires owners to maintain proper accounting
records to support their operations.
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Auditee Comments
G & K has no objection to HUD’s request for reimbursement for the automobile expenses, but
the company disputes reimbursing other items. G & K said project funds were only used to
purchase items for the project. G & K admits to using accounts from related entities, but only
for the purpose of taking advantage of preferred customer credit and pricing and for
administrative expediency and economy. For example, it was not possible for G & K to obtain
“good-customer” pricing and credit from vendors while using the name of the recently formed
company with no operating history or financial background. These financial advantages that G
& K provided to the project caused record-keeping challenges that have been identified by HUD.
The financial record-keeping challenges should not cause HUD to overlook the intent of G & K
to advance the financial well-being of the project. At the time in question, G & K and related
affiliates owned only two properties – the project (a residential facility) and a commercial
building. The receipts for the purchases show the purchase of materials for a residential facility.
The owners of the G & K are willing to provide sworn statements from them and vendors as to
the use of the products purchased by the Company directly and through an affiliate.
OIG Evaluation of Auditee Comments
The Regulatory Agreement required G & K to maintain its documents in reasonable condition for
proper audit and that books and accounts shall be kept in accordance with the Secretary’s
requirements. HUD Handbooks require that all disbursements must be supported by approved
invoices/bills or other supporting documents. G & K’s records were not properly maintained.
When invoices indicated that a purchase through an affiliate was in fact for the project, due to the
shipping address or customer name being listed as that of Oak Tree or G & K, we accepted those
payments. But, in the absence of documents indicating the products purchased were for Oak
Tree, we cannot assume that because the payments were to a plumbing company or a building
supply company, that the payments were for allowable expenses of the project.
Auditee Comments
G & K argued that with respect to the funds used to repay a loan from Enterprise Bank in the
amount of $50,000, the Company began conducting negotiations with Enterprise Bank prior to
HUD’s approval of the project. The loan discussions were prompted by the need to raise
required capital to respond to HUD’s and the City of Overland, Missouri directives as a
precondition to obtaining occupancy permits. Accordingly, the Company believed in good faith
that the already contemplated loan was essential to the viability of the project, the loan was
effectively grand fathered, and it was proper to repay the loan from project receipts. This
assumption was based, in part, on the fact that the need for the loan was dictated by
governmental requirements, including requirements of HUD. Even if HUD takes the position
that the Enterprise Bank loan was not grand fathered since the transaction was clearly
contemplated prior to the closing, it is inconceivable that HUD would require expenditures to
make repairs and then not allow the owners to repay the loan that produced the repairs.
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OIG Evaluation of Auditee Comments
HUD’s Commitment to Insure Upon Completion, dated April 11, 1997 and revised April 23,
1997, does require that repairs must be completed as a condition of receiving mortgage insurance
from HUD. However, it also requires in the Special Conditions that the Second Deed of Trust
and Line of Credit borrowing must be paid off, and neither may be reestablished in a manner that
encumbers the property. Oak Tree Apartments did not secure the Enterprise Loan, dated
September 8, 1997, and the loan should not have been repaid out of project funds. The
Regulatory Agreement prohibits paying project funds for other than reasonable operating
expenses and necessary repairs, except from Surplus Cash. Development costs are neither
operating expenses nor repairs. Therefore, repayment of this loan, even if it was used toward
development costs, is not allowed from project funds.
Recommendations
We recommend the Director, Office of Kansas City Multifamily Housing HUB:
1A. Take appropriate steps to recover the $164,713 in project funds that were used for
ineligible expenses or for which the use is unsupported. Any funds transferred to
project accounts should be put in a reserve account over which HUD has control
to ensure they are used to benefit the project and its tenants.
1B. Take appropriate administrative actions against G & K Properties for their
mismanagement of Oak Tree funds.
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Appendix A
Auditee Comments
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Appendix A
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Appendix A
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Appendix A
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Appendix B
Distribution
Ranking Member, Committee on Governmental Affairs, 340 Dirksen Senate Office Building,
United States, Senate, Washington, DC 20510
Chairman, Committee on Governmental Affairs, 706 Hart Senate Office Building,
United States, Senate, Washington, DC 20510
Chairman, Committee on Government Reform, 2185 Rayburn Building, House of
Representatives, Washington, DC 20515
Ranking Member, Committee on Government Reform, 2204 Rayburn Building
House of Representatives, Washington DC 20515
Subcommittee on Oversight and Investigations, Room 212 O’Neil House Office Building
Washington, DC 20515
Associate Director, Housing and Telecommunications Issues, United States General
Accounting Office, 441 G Street, NW, Room 2T23, Washington, DC 20548
Subcommittee on Oversight and Investigations, Room 212, O’Neil House Office Bldg,
Washington, DC 20515
Chief, Housing Branch, Office of Management and Budget, 725 17th Street, NW,
Room 9226, New Executive Office Building, Washington, DC 20503
Senior Advisor, Subcommittee on Criminal Justice, Drug Policy and Human Resources,
B373 Rayburn House Office Building, Washington, DC 20515
House Committee on Financial Services, 2129 Rayburn House Office Building,
Washington, DC 20515
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Review of Oak Tree Park Apartments, Overland, Missouri, Project No. 085-11052
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)