Issue Date December 21, 2004 Audit Report Number 2005-PH-1003 TO: Sean G. Cassidy, General Deputy Assistant Secretary for Housing, H FROM: Daniel G. Temme, Regional Inspector General for Audit, Mid-Atlantic Region, 3AGA SUBJECT: The Town of Clifton, VA’s, Participation in the Single Family Property Disposition Discount Sales Program HIGHLIGHTS What We Audited and Why In response to a congressional and departmental request, we audited the Town of Clifton’s participation in the U.S. Department of Housing and Urban Development’s (HUD) Single Family Property Disposition Discount Sales Program (Sales Program). Our objective was to determine whether the Town of Clifton (Town) complied with HUD's rules and regulations in administering the Sales Program. Specifically, we wanted to determine whether the Town appropriately participated under the Sales Program using the competitive sales method, re-sold rehabilitated properties at prices less than 110 percent of their net development cost, and re-sold the properties only to income-eligible homebuyers. What We Found The Town of Clifton did not fully comply with HUD's rules and regulations in administering its Sales Program. Specifically, the Town of Clifton could not adequately support property rehabilitation costs it claimed it made to the properties it sold under the program, and it sold several properties at sale prices 1 above the amount allowed by HUD requirements. However, we did find the Town of Clifton participated under the program using the competitive sales process and it did meet the requirements in selling the homes to income-qualified buyers. Focusing on properties with the highest dollar repair costs, we selected and reviewed 10 of the 89 properties the Town had purchased and re-sold under the program to see if sales were made to income-qualified buyers and that net development costs met the requirements of Mortgagee Letter 2001-30. The home inspection repair invoices the Town of Clifton provided us to support each property’s repair costs did not have sufficient detail to permit us to determine if the claimed costs were reasonable nor to verify contractor or vendor expenditures. However, our on-site physical home inspections of the 10 properties confirmed that some of the work itemized on the home inspection repair invoices had not been performed. In total, we identified $9,380 of charges for repairs that did not exist in seven homes and thus were ineligible. Also, for many other repairs we were not able verify if the work was necessary, reasonable or had actually been completed because the home inspection repair invoices lacked sufficient detail. Since we found the process used to identify and pay for repair costs was neither accurate nor reliable, we also question the remaining $205,615 in repair costs for the 10 homes we inspected. Further, since the rehabilitation costs are used in calculating the sale price of the homes, we determined the Town of Clifton exceeded the 110 percent of the net development costs requirement for at least five of the properties. By exceeding the allowable sales percentage, the homeowner’s mortgage was overstated and in turn the discounts received by the Town were not passed along to the homeowners. Since we could not verify the repair costs associated with the 10 properties we reviewed, and in 7 cases we found evidence that repairs were paid for that were not actually completed, we question the full amount of the discounts ($140,475) the Town received when it purchased these 10 properties. What We Recommend We recommend the Department require the Town of Clifton schedule an independent inspection of the 79 remaining homes it has processed under the discount Sales Program to verify that all work was satisfactorily completed. If work has not been done, the Town should pay down the homeowners’ mortgage by the appropriate amount. Additionally, the Department should review the deficiencies noted in this report and determine if the Town of Clifton should be reinstated to participate in the Sales Program. If the Town is reinstated, prior to reinstatement, require the Town of Clifton to set up controls and procedures that fully document and verify the claimed net development costs. 2 For each recommendation without a management decision, please respond and provide status reports in accordance with HUD Handbook 2000.06, REV-3. Please furnish us copies of any correspondence or directives issued because of the audit. Auditee’s Response The complete text of the Town of Clifton’s response, along with our evaluation of that response, can be found in Appendix B of this report. 3 TABLE OF CONTENTS Background and Objectives 5 Results of Audit Finding 1: Support Documentation for Property Rehabilitation Costs Was 7 Inadequate and Unreliable Scope and Methodology 13 Internal Controls 14 Appendixes A. Schedule of Questioned Costs 15 B. Auditee Comments and OIG’s Evaluation 16 4 BACKGROUND AND OBJECTIVES The purpose of HUD’s Single Family Property Disposition Sales Program is to dispose of properties in a manner that expands homeownership opportunities, strengthens neighborhoods and communities, and ensures a maximum return to the mortgage insurance funds. In an attempt to provide increased affordable housing opportunities to low- and moderate-income homebuyers, HUD permits non-profits and government entities to purchase HUD Real Estate Owned properties at a discount. These discounts range from 10 to 30 percent off the “as is” appraised value of the property. The entity must pass along the discounts received in order to increase homeownership opportunities for low- and moderate-income families and individuals. To sell the properties HUD uses several different formats. Our review concentrated on two of them: the direct sales method and the competitive sales method. Under the direct sales method a non-profit or government entity must be pre-approved by HUD to participate in the Sales Program. Once they are approved, they are provided the first opportunity to purchase the homes. Any homes not purchased by an approved non-profit or government entity will be offered for sale under the competitive sales method. Under the competitive sales method, HUD offers to sell the properties to the general public. Both non-profits and government entities can participate in the competitive sales method; however, they do not have to be “pre-approved” by the Department to participate in the program. Under the competitive sales method, HUD sells the properties on an "as-is" basis, without repairs or warranties. Non-profits and government agencies, which bid competitively during this period, and are the successful bidder without any discount being considered, are then given the applicable discount off the gross sale price for that property. Homes purchased under HUD’s Sales Program must be sold to an eligible purchaser, whose income does not exceed 115 percent of the median income of the locality of the home. In addition to selling the home to an eligible homebuyer, the program participants must pass on the discount received from HUD to increase homeownership opportunities. In order to do this HUD limits the net development costs allowed. The net development costs is composed of the allowable property acquisition costs plus allowable rehabilitation, holding, and various other selling costs entities incur when purchasing a HUD home at discount prices. The Department limits the eligible costs and prohibits the entity from reselling the repaired properties at prices in excess of 110 percent of the net development cost calculation. Appendix A of Mortgagee Letter 2001-30 identifies costs allowed in calculating net development costs which states costs passed along must be “reasonable and customary.” In addition, rehabilitation costs are to be “verifiable contractor and vendor expenditures.” The Town of Clifton used HUD’s Single Family Property Disposition Sales Program as a means to raise revenue. The Town entered into an agreement on November 19, 2002, with a “for- profit” entity, Commercial Lending Corporation (Commercial Lending), to handle all aspects of the purchase, rehabilitation, and sale of the properties. The contractor paid for all purchase and rehabilitation costs; or the Town would borrow funds from the contractor to cover these expenditures. 5 Using the competitive sales method under the program, over a 2-year period the Town of Clifton purchased 98 homes across the State of Virginia for a total purchase price of $9,451,301. None of the homes purchased were within the Town of Clifton’s geographic boundary, nor are they required to be under the competitive sales program. In purchasing these homes, the Town received $1,417,695 in discounts from HUD. During our audit period, 89 of the 98 properties were re-sold for $10,581,823. Using the Town’s “government” status to purchase the properties, the contractor divided approximately $721,164 in profits with the Town. Commercial Lending received $322,337 in management fees and the Town received $399,305 in net income. Our overall objective was to determine whether the Town of Clifton and its agent, Commercial Lending Corporation, followed HUD's rules and regulations in administering HUD's Single Family Property Disposition Discount Sales Program. To accomplish this, we wanted to determine whether the Town appropriately participated under the Sales Program using the competitive sales method, re-sold rehabilitated properties at prices less than 110 percent of their net development cost, and re-sold the properties only to income-eligible homebuyers. 6 RESULTS OF AUDIT Finding 1: Support Documentation for Property Rehabilitation Costs Was Inadequate and Unreliable The files maintained by Commercial Lending on behalf of the Town of Clifton did not provide adequate documentation to support the repair costs it claimed it made on the properties it re-sold under the program. In fact, from our review of a sample of 10 of the 89 properties the Town of Clifton re-sold under the program, we found Commercial Lending paid for repairs for items that did not exist in 7 of the homes. Thus, the net development costs used for calculating the sale prices of the homes was not accurate and homeowners paid for repairs through their mortgages that were not made. This occurred because the Town did not provide adequate oversight over Commercial Lending to ensure it properly administered the program according to HUD regulations. Further, Commercial Lending provided limited monitoring of its repair contractors, which caused it to pay its repair contractors for repairs that were not performed. Consequently, both entities delegated oversight functions in a manner that does not provide assurance low- and moderate-income buyers received full value for the amounts paid. Documentation To Support Home Repair Cost Was Limited The only document Commercial Lending could provide us to support the repair costs it claimed that it incurred for each property was the home inspection repair invoice it had generated. No detailed documentation, such as invoices from its repair contractors, supported this document. Further, we noted several discrepancies with this document. Dollar values were missing in the “owners estimate” or “contractor estimate” columns, and start and completion dates were left blank. In addition, the description of the work performed was not sufficient enough to determine exactly what work was performed. For example, an inspection report stated a roof repair was made for $4,000; however, no information was provided to detail exactly what was done (i.e., replacing shingles, fixing leak, etc.). Thus, based on the documentation in the file, it is impossible to determine if the work claimed on the home inspection repair invoice had actually been completed and if the price paid was reasonable. 7 Commercial Lending Claims It Conducts Site Inspections To Ensure Only Needed Repairs Are Made and Paid For According to Commercial Lending, once a home is purchased from HUD, Commercial Lending inspects each home to identify what repairs it will need to make before the property is re-sold. The Commercial Lending inspector documents the results of the inspection by completing a home inspection repair invoice, which includes a cost estimate for each identified repair item. Commercial Lending uses the home inspection document to negotiate a final price with primarily four repair contractors that it uses to make the home repairs. After the repair contractor completes the repairs, Commercial Lending inspects the property and then disburses payment based on the agreed price on the home inspection repair invoice. Commercial Lending does not require the repair contractors to support the repair costs with any other form of documentation. Instead, Commercial Lending requests that the repair contractor sign and date a certification form stating that all repairs specified on the home inspection repair invoice were completed in a workmanlike manner. Our review of Commercial Lending’s property files found that the certifications were sometimes signed 9 to 12 months after the work was performed or the date was left blank. On-Site Home Inspections Showed Not All Repairs Were Completed, Valid or Verifiable Since we could not determine the repairs reported on Commercial Lending’s home inspection repair invoice were actually necessary or completed by the repair contractor, we decided to complete on-site home inspections for a sample of the properties. We selected 10 of the 89 properties the Town had acquired during our review period, with the highest claimed repair costs. The repair costs for these 10 properties totaled $214,9951. A HUD housing inspector accompanied us on the inspections. In completing our physical inspections, we walked through each house and compared Commercial Lending’s home inspection repair invoice to the work we could see had actually been completed. In addition we interviewed the homeowners. Since Commercial Lending’s home inspection repair invoices lacked specific detail, for many items we were not able to determine if the repair was necessary or had actually been completed. However, in 7 of the 10 homes inspected we were able to identify a number of repairs listed on the home inspection repair invoices that either did not exist or were not completed by the repair contractor before the homeowners moved in. In total, we identified $9,380 of ineligible charges for repairs to items in the homes that did not exist. 1 The total repair costs for the 89 properties totaled $1,054,723. 8 For example, • Three home inspection repair invoices noted that repairs were made to powder rooms that did not exist. • Three home inspection repair invoices noted that refrigerators were provided to the homeowners; however, the homeowners provided receipts showing that they had purchased the refrigerators themselves. • One home inspection repair invoice claimed a sliding glass door was replaced in the family room of the home when there was no sliding glass door in the home. • One home inspection repair invoice indicated a hot water heater had been replaced. However, when we looked at the picture of the hot water heater on the Federal Housing Administration appraisal (before the Town acquired the property), we noted it had the same marks and tape on it as the current “replacement” hot water heater. Although these repairs and replacements were not completed, Commercial Lending paid the vendors. In addition, the home inspection repair invoices for the 10 homes we inspected had “soft cost”2 items, totaling $52,935. We could not determine whether these costs were justified or had actually been made because the home inspection repair invoices lacked sufficient detail to describe the specific nature of the repair(s). Further, the repair contractors were not required to provide detailed documentation to support the repair costs, i.e., nature of repair, labor, parts, etc. These included line items such as “repair air conditioner,” “dumping fees,” “fence repair,” and “ceiling/wall repair.” Thus, since we found the process Commercial Lending used to identify and pay for repair costs to be inaccurate and unreliable, we question the remaining $205,615 in repair costs for the 10 homes we inspected. Repair Costs Should Be Reasonable and Verifiable According to Mortgagee Letter 2001-30, in reference to determining the allowable net development costs, rehabilitation costs are the total verifiable contractor and vendor expenditures incurred in the actual reconstruction, repair, restoration and physical improvement of the property. The Town of Clifton and Commercial Lending were aware of Mortgagee Letter 2001-30; however, contractors were paid for repairs that were not actually performed. Commercial Lending and the Town could have verified the costs by completing proper inspections of the property and by obtaining appropriate work orders from the repair contractors. 2 For purposes of this audit, a soft cost is defined as the price of a repair item that we could not determine whether it was completed or necessary. 9 The manner in which the Town of Clifton and Commercial Lending documented its claimed repair costs was consistent for the 10 properties we inspected and was consistent with the method used for the remaining 79 properties. This indicates that there are likely systemic deficiencies with the Town of Clifton’s overall administration of its discount Sales Program. Therefore, we have concerns about the reliability of documentation for claimed repair costs of $1,054,723 associated with all of the 89 properties that were in the program. However, since we only completed site inspections on 10 of the properties, we will request the Department to complete site inspections on the remaining 79 properties to determine if $839,728 in repair costs for those properties can be supported. Incorrect Net Development Costs Improperly Increased the Sale Price of Several Homes As we noted above, in 7 of the 10 properties we inspected, Commercial Lending claimed charges for a number of repairs that were not done or appliances that had not been replaced. These “non-existent” costs were used by the Town to determine the net development costs and in turn the sale price of the home. When we recalculated the sale price of these 7 homes, we found in 5 instances the Town exceeded 110 percent of the net development costs by a total of $8,378. By exceeding the allowable sales percentage, the homeowner’s mortgage was overstated and in turn the discounts received by the Town when it purchased the homes was not passed along to the homeowners. Since we could not verify the repair costs associated with the 10 properties we inspected and, in 7 cases, we found evidence that repairs were paid for, when they were not actually completed, we question the full amount of the discounts ($140,475) the Town received when it purchased these 10 properties. The Town of Clifton Provided Limited Oversight of Its Agent The Town did not adequately monitor the activities of Commercial Lending because it did not actively participate in the administration of the Sales Program. As such, the Town did not ensure proper documentation and approvals were maintained to support repair costs; and its contractor fully complied with HUD’s program requirements. The weaknesses contributed to questionable payments for repairs that were not performed. Under the Town’s agreement with Commercial Lending, the Town delegated nearly all aspects of the administration of the program to its contractor. The Town representative emphasized the Town trusts Commercial Lending with the management of the program and allows it to control all repair costs. However, the 10 agreement does not relieve the Town of its responsibility for executing the program in compliance with HUD requirements. By not requiring Commercial Lending to obtain work orders and other supporting documentation to fully support the claimed repairs, the Town of Clifton cannot guarantee that the work was completed or was completed at a reasonable cost. Our inspections confirmed that not all the repairs claimed by Commercial Lending and its repair contractors had been completed and as such the Town of Clifton cannot rely solely on Commercial Lending reports. Consequently, payments for non-existent or unnecessary repairs increase the price of the homes and undermines the mission of providing affordable housing opportunities to low- and moderate-income homebuyers. Income Eligible Recipients Purchased Homes According to Mortgagee Letter 2001-30 and the Land Use Restriction Addendum, properties in the discount Sales Program must be sold to a purchaser whose income does not exceed 115 percent of the median income, when adjusted for family size, and for the area in which the property is located. Therefore, we reviewed the income eligibility for the home purchasers of the 10 properties we inspected. We also reviewed the income eligibility for the nine homes which were purchased with Federal Housing Administration loans. Based upon the information provided in Commercial Lending's files we determined that all of the purchasers fell below the 115 percent median income limitation. Recommendations We recommend the Office of Housing: 1A. Require the Town of Clifton to support the remaining $37,350 in discounts it received when it purchased the homes within the discount Sales Program for the (3 of 10) properties that had unsupported repair costs. 1B. Require the Town of Clifton to pay down the mortgages for the properties our review showed incurred ineligible costs by $9,380. 1C. Require the Town of Clifton to support $205,615 in unsupported repairs we could not verify during our on site inspections. For costs that remain unsupported the Town of Clifton should pay down the mortgages for those properties. 1D. Require the Town of Clifton to pay the Department $103,125 in discounts it received when it purchased the homes within the Sales Program for the 11 seven properties (7 of 10) found to have non-existent repairs on its home inspection repair invoices. 1E. Require the Town of Clifton to schedule an independent inspection of the remaining 79 homes the Town of Clifton purchased under this program and verify that all stated repair work has been adequately completed. If it is found that repairs were inadequate or repairs were not made the Town of Clifton should pay down the mortgages of the homeowners by those amounts. 1F. Review the deficiencies noted in this report and determine if the Town of Clifton should be reinstated to participate in the Sales Program. If the Town is allowed to participate in the Sales Program, require it to establish and implement controls and procedures that fully document and verify claimed net development costs. 12 SCOPE AND METHODOLOGY To accomplish the audit objectives, we • Reviewed applicable HUD regulations relating to the Town’s participation in the Single Family Property Disposition Discount Sales Program. • Conducted interviews with officials and employees of the Town of Clifton, Commercial Lending and HUD’s Single Family Division. • Reviewed established procedures formulated by the Town of Clifton and Commercial Lending in administering the Sales Program. • Reviewed home inspection repair invoices for 10 of the 89 properties that were sold during our audit period. The 10 homes selected for our sample were chosen because they had the highest amount of repair costs expended per home. • Reviewed the income verification documents for the 10 homebuyers sampled during our inspection, to ensure income eligibility. • Reviewed the income verification documents of the nine homebuyers that obtained Federal Housing Administration loans, to ensure income eligibility thereby ensuring that no risk was placed upon the Federal Housing Administration insurance fund. • Examined records and related documents for the properties purchased and closed by the Town from HUD’s inventory of foreclosed properties. We performed the majority of our fieldwork between June and September 2004 at the offices of Commercial Lending Corporation, located at 7603 Maple Branch Road, Clifton, VA. The audit generally covered the period of November 1, 2002, through May 31, 2004, but was expanded when necessary. We performed our review in accordance with generally accepted government auditing standards. 13 INTERNAL CONTROLS Internal Control is an integral component of an organization’s management that provides reasonable assurance that the following objectives are being achieved: • Effectiveness and efficiency of operations, • Reliability of financial reporting, and • Compliance with applicable laws and regulations. Internal controls relate to management’s plans, methods, and procedures used to meet its mission, goals, and objectives. Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations. They include the systems for measuring, reporting, and monitoring program performance. Relevant Internal Controls We determined the following internal controls were relevant to our audit objectives: • Management Oversight Processes - Policies and Procedures that management has in place to reasonably ensure that improper payments would not be made or would be detected in the normal course of business. • Monitoring of Contractor Performance - Policies and Procedures that management has in place to ensure that adequate supporting documentation substantiates the validity of the work performed. We assessed the relevant controls identified above. A significant weakness exists if management controls do not provide reasonable assurance that the process for planning, organizing, directing, and controlling program operations will meet the organization’s objectives. Significant Weaknesses Based on our review, we believe the following items are significant weaknesses: • Lack of management oversight. • Lack of adequate supporting documentation for repairs performed. 14 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS Recommendation Ineligible 1/ Unsupported Number 2/ 1A $ 37,350 1B $ 9,380 1C $205,615 1D $103,125 Total $112,505 $242,965 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 polices or regulations. 2/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program or activity when we cannot determine eligibility at the time of audit. Unsupported costs require a 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. 15 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments 16 Ref to OIG Evaluation Auditee Comments Comment 1 17 Ref to OIG Evaluation Auditee Comments Comment 2 Comment 1 Comment 3 18 Ref to OIG Evaluation Auditee Comments Comment 1 19 OIG Evaluation of Auditee Comments Comment 1 We are encouraged by actions the Town plans to implement to move forward in resolving the outstanding issues, including the reimbursement of several questioned costs to the homeowners. However, it will be HUD’s decision as to whether these proposed actions are acceptable or an alternative course of action is warranted. Consequently, we have not removed any of the questioned costs from the report. Comment 2 As stated in the report, we only looked at a limited number of homes purchased by the Town to determine if the work that was paid for was actually completed and to determine if the net development costs were properly accounted for. Based upon our testing, we noted discrepancies in 70% of the homes we visited. This high percentage should lead an objective observer to conclude that the questioned costs are more than just an oversight by the Town or its agent. The entire process used by the Town and its agent to document the work completed created an environment where repair items could easily be added without any accountability. However, we did adjust the report to take out the word “fraudulent”. Comment 3 As explained at the exit conference, the OIG makes recommendations based upon what we believe will correct the problems. The Department will then take those recommendations and determine if they should be implemented or not. Since the Town did violate the 110 percent net development requirement in the homes we reviewed, it will be HUD’s decision to determine if the proposed corrective action by the Town will be enough to disregard this recommendation. 20
The Town of Clifton, VA's, Participation in the Single Family Property Disposition Discount Sales Program
Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-12-21.
Below is a raw (and likely hideous) rendition of the original report. (PDF)