Issue Date March 26, 2004 Audit Case Number 2004-SE-1003 TO: Philip Head, Acting Director, Region X Multifamily Hub, 0AHM FROM: Frank E. Baca, Regional Inspector General for Audit, 0AGA SUBJECT: Uptown Towers Apartments, Portland, Oregon HAP Contract No. OR160039003 Master ACC Contract No. S-0029 INTRODUCTION At the request of your office, we have completed an audit of Uptown Towers Apartments (Project), a HUD-subsidized project in Portland, Oregon. The purpose of our audit was to determine if: • The Project owner received repayment of ineligible construction loans and capital contributions from Project funds; • Commercial space income has been treated as Project income or owner's contribution; • Commercial income has been paid out to the Project owner; • The management agent has been receiving excessive management fees; and • Certain Project expenses were eligible and benefited the Project. To achieve our objectives, we performed audit procedures that included: Obtaining and reviewing: • Federal Regulations, the Annual Contributions Contract between HUD and Oregon Housing and Community Services Department (OHCSD) and the Housing Assistance Payments (HAP) Contract between Uptown Towers Apartments and OHCSD to determine the terms and conditions under which OHCSD monitors the Project and under which the Project should operate. • OHCSD and Guardian Management files and records related to Uptown Towers Apartments to obtain information relevant to the Project’s operations. Interviewing: • HUD program staff to confirm our understanding of the request received; • OHCSD staff to determine how they monitor the operations of the Project; and • Guardian Management and Project employees to understand the operations of the Project. Our audit covered the period from January 1998 through July 2003. We performed our audit work from June 2003 through January 2004 at the offices of: Oregon Housing and Community Services Department in Salem, Oregon; Guardian Management and Uptown Towers Apartments in Portland, Oregon; Dwyer Pemberton and Coulson P.C., in Tacoma, Washington; and HUD Seattle Multifamily Hub and OIG Office of Audit in Seattle, Washington. We conducted the audit in accordance with generally accepted government auditing standards. In accordance with HUD Handbook 2000.06 REV-3, within 60 days please provide us, for each recommendation without a management decision, 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. Additional status reports are required at 90 days and 120 days after report issuance for any recommendations without a management decision. 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 Oregon Housing and Community Services Department, Guardian Management, and Uptown Towers Apartments. Should you or your staff have any questions, please contact me at (206) 220-5360. SUMMARY Our audit found no repayments of construction loans. We determined that repayments of capital contributions from Project surplus cash to the owners were eligible. We also found that the Project’s commercial income was properly treated as owner contributions or income, and that payments to the owner from the commercial income are allowable. However, the management agent received excessive management fees paid from residential income for the management of the Project’s commercial income. Further, ineligible partnership expenses were paid from Project funds and some of those expenses 2 were paid without supporting documents in sufficient detail to show whether they were partnership or Project expenses. BACKGROUND Uptown Towers Apartments (Project) is a 72 unit elderly housing project located in Portland, Oregon. Each unit contains one bedroom, a living room, a kitchen, and a bathroom. Uptown Associates, Ltd., owns the property. It was built in 1983 using bond financing from OHCSD. The property was refinanced in 1992 through OHCSD under a Financing Adjustment Factor (FAF) Agreement between HUD and OHCSD. The property is not insured or financed by HUD. However, the Project owner entered into a Housing Assistance Payments (HAP) contract with OHCSD, dated July 19, 1983 under which HUD provides a monthly project-based rental subsidy (Section 8) for 71 of the Project’s 72 units. One unit is a rent-free management unit. Project operations are monitored by OHCSD under terms of its Annual Contributions Contract with HUD. Guardian Management manages Uptown Towers Apartments. In this capacity, Guardian Management is responsible for overseeing the day-to-day operations and maintenance of the property as well as all financial aspects of the property. To compensate for these services, Guardian Management receives a management fee expressed as a percentage of collections. A convenience store and parking area associated with the store occupies the lower portion of one side of the Project’s building. The store generates lease income of $3,000 per month, which flows through the books and records of the Project and is paid to the Project owner. Additionally, in September 1998 the owner entered into a contract to lease the side of the building as advertising space. This contract was terminated due to a city ordinance in 2001. However, while the contract was in effect, the income generated by this lease of about $2,500 per month also flowed through the Project’s books and records and was paid to the owner. The Project’s residential operations do not benefit in any way from either of these commercial leases. FINDING 1 PROJECT FUNDS WERE USED TO PAY FOR NON-PROJECT EXPENSES We found that $55,907 in Project funds were inappropriately used to pay $14,720 in management fees on commercial income as well as $41,187 in partnership expenses. Consequently, these funds were not available to reduce subsidy payments or to fund the residual receipts account, which reverts to HUD at the termination of the HAP contract. These ineligible expenditures of Project funds allowed the owners to receive distributions in excess of the limited distribution provided for in the Federal regulations. This occurred because controls were not in place to prevent or detect unauthorized use or disposition of Project resources. 3 Federal and OHCSD Requirements Federal regulations at 24 CFR 883.702(e) and Section 2.6(c)(1) of the Project’s HAP contract state that project funds must be used for the benefit of the project to: (1) make mortgage payments, (2) pay operating expenses, (3) make required deposits to the replacement reserve, and (4) provide limited distributions to the owner. Funds in excess of those needed for these purposes must be deposited into a separate account (residual receipts), from which withdrawal may only be made with OHCSD approval for project purposes including the reduction of HAP payments. Upon termination of the HAP contract, any funds in the residual receipts account must be remitted to HUD. Distributions to the Project owner are limited to six percent of equity. Project Residential Income Was Used to Pay Ineligible Fees for Management of the Project’s Commercial Income During our audit period, Guardian Management received a fee of eight percent of the monthly rent paid for the space leased by the convenience store located within the Project. Guardian Management also received a fee of eight percent of the payments for the lease of the advertising space on the side of the Project’s building. The following table illustrates the amount of commercial income generated by these leases and the fees paid to Guardian to manage this commercial income: FY1999* FY2000 FY2001 FY2002* Total Advertising Income $30,000 $10,000 Convenience Store Income $36,000 36,000 36,000 $36,000 Total Commercial Income $36,000 $66,000 $46,000 $36,000 Management Fee Percentage 0.08 0.08 0.08 0.08 Management Fee Paid on Commercial Income $ 2,880 $ 5,280 $ 3,680 $ 2,880 $14,720 *A management fee was not paid on advertising income in 1999 and there was no advertising income in 2002 We found that this commercial income did not in any way benefit the Project’s residential operations as it flowed through the Project’s books and records and was paid out in its entirety to the Project’s owner. Because all of the commercial income was paid out, the $14,720 paid out for the commercial income management fee came from the Project’s residential income. The entire $14,720 is an ineligible Project expense since it only covers expenses related to the generation of commercial income paid to the owner. Project Funds Were Used to Pay Ineligible Partnership Expenses We reviewed all Project checks written for accounting, auditing, bookkeeping, legal fees, and tax services from January 1, 1999 through July 31, 2003. We also reviewed all checks in excess of $50 written to the general partner of the ownership entity or to his wife for miscellaneous expenses, software, or supplies. Our review disclosed $41,187 of ineligible expenses relating to the operation of the Uptown Associates, Ltd. partnership. 4 We also found $2,042 in unsupported expenses. The ineligible payments were not for legitimate Project expenses since they were not: (1) part of the mortgage payments; (2) for Project operating expenditures; (3) for payments to the reserves for replacement; or (4) authorized distributions to the owners. Supplies and Miscellaneous Expenses We reviewed $4,406 in supplies and miscellaneous expenses reimbursed to the general partner, of which $1,702 (38.6 percent) was ineligible and $1,804 (40.9 percent) was unsupported. These expenses included reimbursements to the general partner for his purchases of computer software and office supplies such as toner, binders, and paper. The general partner of the ownership entity resides in a different state from that in which the Project is run and he purchased these items for use in his home office. The management agent reimbursed these expenses using Project funds even though the items were not used for the benefit of the Project. Further, the management agent did not require the general partner to submit itemized invoices that would show if the expenses were for the partnership or the Project. Consequently, many of the supporting documents we received from the general partner through the management agent did not support the costs in question. Bookkeeping Expenses We reviewed $59,781 of expenses classified as auditing, bookkeeping, and tax services and found that $13,790 (23.1 percent) was for ineligible partnership expenses. The general partner’s wife typically invoiced the Project $450 for bookkeeping services once every three months. These expenditures were categorized as either auditing or bookkeeping fees. The management agent has been paying these invoices from Project funds for at least as far back as 1990. However, the management agent did not know when or what auditing or bookkeeping services the general partner’s wife performed. Since all of the Project’s bookkeeping and auditing functions are performed and managed by the management agent, any auditing or bookkeeping performed by the General Partner’s wife is not reflected in the Project’s accounting system and did not benefit the Project. We also found costs relating to the purchase of filing cabinets and furniture on some of these bookkeeping invoices. As discussed above, the furniture and file cabinets are used in the general partner’s home office and are not for the benefit of the Project. Further, we identified expenses categorized as accounting and tax fees that related to the sale of the property. These are asset management services that benefit the partnership, not the Project as discussed below. Legal Fees We reviewed $38,144 in legal expenses and found $25,695 (67.4 percent) was ineligible. Expenses categorized as legal fees included legal services related to the advertising lease, 5 the convenience store lease, and the sale of Uptown Towers Apartments. Since the Project does not benefit from either of the commercial leases, any expenses related to these leases are ineligible non-Project expenses. Additionally, services related to the sale of the property are asset management services that benefit the owners, not the Project itself. Therefore, these expenses are partnership, not Project expenses. Further, the management agent was unable to provide support for $238 of the expenses listed as legal fees. The Owner Did Not Have Controls In Place to Prevent or Detect Unauthorized Use or Disposition of Resources. Guardian Management reimbursed the owners of Uptown Towers Apartments for partnership expenses and paid itself a management fee on commercial income from Project funds because controls were not in place to prevent or detect unauthorized use or disposition of resources. When asked why Guardian Management allowed the ineligible payments, the Portfolio Manager told us that the question had never come up before since neither HUD nor OHCSD had ever looked at expenditures in this detail before. Since Project funds were used for non-Project expenses, these funds were not available to reduce subsidy payments to the Project. Further, these funds were not available to fund the residual receipts account, which could then be used for the benefit of the Project as needed and which revert to HUD at the termination of the HAP contract. Use of Project funds in this manner also allowed the owner to receive a greater return on equity than provided for in the regulations and HAP contract. AUDITEE COMMENTS The general partner of the ownership entity responded to our draft report, in writing, on March 24, 2004. In his response, the general partner stated that: 1. He participated in major decisions involving the management of the Project, assisted in management related decision-making, worked closely with OHCSD staff on a variety of issues related to both residential and commercial operations, played a role in coordinating the annual audit from beginning to end each year to meet HUD requirements, and maintained records dating back 20 years while the management agent only kept records 7 years. 2. He agreed that management and professional fees paid in relation to the commercial portion of the Project were improperly paid with residential income, and that the partnership should reimburse the project’s residential operations for these expenses. However, he also stated that the commercial space provides a net benefit to the property as the commercial tenant pays a portion of the property taxes related to the project, and asked us to consider whether this benefit would offset the deficiency. He also explained that payment of the management fees occurred in error as the result of 6 an accounting software error following Guardian Management’s conversion to new software. 3. He has maintained files for the project’s residential and commercial activities (e.g. original submission documents, “as builts,” repair documentation, annual audits, etc.). No one else has these documents, it benefits the project for him to provide safe and secure maintenance of these records, and he has not asked for reimbursement for these costs. Because of the time, effort, and cost to store the documents, he believes the ineligible and unsupported partnership expenses should be allowed. He has also offered to provide invoices for future expenses to OHCSD for approval prior to seeking reimbursement from Guardian Management for these expenses. Additionally, his wife has stopped charging the residential operations for bookkeeping fees. 4. He believes the professional fees related to the proposed sale of the property should be allowed. OHCSD would not have allowed a sale of the property if the parties had not first agreed to extend the current use as low-income housing. This is a direct benefit to the residential segment of the project and would also mean there would be no eviction or relocation costs. In addition, OHCSD offered to forego its portion of the savings that resulted from the bond refinancing to add to the income of the project after the sale. He then stated he would be open to allocating the professional fees related to the proposed sale on the percentage basis of residential vs. commercial space in the Project. The general partner’s response is included in its entirety in Appendix B of this report. OIG EVALUATION OF AUDITEE COMMENTS 1. While it is commendable that the general partner expended much time and energy participating in the management of the Project and maintaining files and records related to the Project over the past 20 years, the services he has provided are considered a function of asset management. Asset management functions are those activities associated with managing and protecting the assets of the ownership entity and overseeing the management agent's performance. These functions include how the owner will plan for long-term operating, capital investment, rehabilitation, modernization, disposition, and other needs of the Project. In other words, asset management functions operate to protect the owner’s investment. The costs for these services are the costs of ownership and should not be borne by the Project’s operations. 2. Although the commercial tenant pays a portion of the property taxes related to the project, we do not agree that any benefit should offset the deficiency. The portion of the property taxes paid by the commercial tenant is directly related to the commercial portion of the building. 7 3. The general partner’s maintenance of files and records for the Project such as building documents and annual audits are asset management functions. These are costs related to protecting the ownership entity’s investment in the project and as such are costs of ownership. 4. As previously mentioned, the sale of the property is a function of asset management. It is the owner’s responsibility to bear the costs of disposition of the property. RECOMMENDATIONS We recommend that the Director instruct OHCSD to require the owners of Uptown Towers to: 1.A. Submit monthly accounting reports, and review the reports to ensure that only Project expenses are paid with Project funds. 1.B. Reimburse the residual receipts account $55,907 for ineligible partnership expenses and ineligible management fees paid on commercial income through July 31, 2003. Also require the owners to reimburse the residual receipts account for any ineligible partnership expenses and management fees paid on commercial income since August 1, 2003. 1.C. Provide support for the $2,042 in unsupported supplies, miscellaneous, and legal expenses or reimburse the residual receipts account if no support is provided. 1.D. Implement controls to ensure that only Project expenses are paid with Project funds. 1.E. Stop paying a management fee on the commercial space from residential income. MANAGEMENT CONTROLS In performing our review, we considered the management controls relevant to Uptown Towers Apartments' operations to determine our audit procedures, not to provide assurance on those controls. Management controls in the broadest sense include the plan of organization, methods, and procedures adopted by management to meet its missions, goals, and objectives. Management controls include the processes for planning, organizing, directing, and controlling program operations. It includes the systems for measuring, reporting, and monitoring program performance. It also serves as the first line of defense in safeguarding assets and preventing and detecting errors, fraud, and violations of laws and regulations. Officials of the audited entity are responsible for establishing effective management controls. 8 We determined the following management controls were relevant to our review objectives: • Program Operations - Policies and procedures that officials of the audited entity have implemented to reasonably ensure that a program meets its objectives and that unintended actions do not result. • Compliance with Laws and Regulations - Policies and procedures that officials of the audited entity have implemented to reasonably ensure that resources used are consistent with laws and regulations. • Safeguarding Resources - Policies and procedures that officials of the audited entity have implemented to reasonably prevent or promptly detect unauthorized acquisition, use, or disposition of resources. It is a significant weakness if management controls do not provide reasonable assurance that the process for planning, organizing, directing, and controlling program operations will meet an organization’s objectives. Based on our review, we believe the following items are significant weaknesses: We identified a significant weakness in Uptown Towers Apartments' management controls when it did not require documents in sufficient detail to support reimbursements to the general partner and others. As a result, we found during our audit that controls did not reasonably ensure that all resources were used consistent with laws and regulations. In addition, management controls did not reasonably prevent or promptly detect unauthorized use or disposition of resources. 9 Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS PUT TO BETTER USE Recommendation Type of Questioned Cost Funds Put to Number Ineligible 1/ Unsupported 2/ Better Use 3/ 1B $ 55,907 1C $ 2,042 1E $ 2,880 Totals $ 55,907 $ 2,042 $ 2,880 1/ Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity that the auditor believes are not allowable by law, contract or Federal, State or local policies or regulations. 2/ Unsupported costs are costs charged to a HUD-financed or HUD-insured program or activity and eligibility cannot be determined at the time of audit. The costs are not supported by adequate documentation or there is a need for a legal or administrative determination on the eligibility of the costs. Unsupported costs require a future decision by HUD program officials. This decision, in addition to obtaining supporting documentation, might involve a legal interpretation or clarification of Departmental policies and procedures. 3/ Funds Put to Better Use are costs that will not be expended in the future if our recommendations are implemented. Specifically, we estimate that if the owner of Uptown Towers Apartments is required to stop paying a management fee on the commercial space from residential income $2,880 will be available in the next year to reduce HUD subsidy payments or to deposit into the residual receipts account. 10 Appendix B AUDITEE COMMENTS 11 12 13 14 15 16 17 Appendix C DISTRIBUTION OUTSIDE OF HUD The Honorable Joseph Lieberman, Ranking Member, Committee on Government Affairs The Honorable Susan M. Collins, Chairman, Committee on Government Affairs The Honorable Thomas M Davis, III, Chairman, Committee on Government Reform The Honorable Henry A. Waxman, Ranking Member, Committee on Government Reform Elizabeth Meyer, Senior Advisor, Subcommittee on Criminal Justice Clinton C. Jones, Senior Counsel, Committee on Financial Services Kay Gibbs, Committee on Financial Services Mark Calabria, Committee on Banking, Housing, and Urban Affairs W. Brent Hall, U.S. General Accounting Office (HallW@GAO.GOV) Steve Redburn, Chief Housing Branch, Office of Management and Budget Linda Halliday, Department of Veterans Affairs, Office of Inspector General 18
Uptown Towers Apartments, Portland, Oregon HAP Contract No. OR160039003 Master ACC Contract No. S-0029
Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-03-26.
Below is a raw (and likely hideous) rendition of the original report. (PDF)