Deer Creek Apartments', Houston, Texas, Previous Management Agent Paid Itself Unsupported Fees

Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-05-11.

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

                                                               Issue Date
                                                                            May 11, 2006
                                                               Audit Report Number

TO:        Raynold Richardson
           Director, Multifamily Housing Program Center, 6EHM


           Frank E. Baca
           Regional Inspector General for Audit, Fort Worth Region, 6AGA

SUBJECT: Deer Creek Apartments’, Houston, Texas, Previous Management Agent Paid
         Itself Unsupported Fees


 What We Audited and Why

             We conducted a review of Deer Creek Apartments (project), a Section 221(d)(4)-
             insured multifamily housing project, to determine whether the project’s owner
             complied with the regulatory agreement and U.S. Department of Housing and
             Urban Development (HUD) regulations.

 What We Found

             The project’s owner generally complied with the regulatory agreement and HUD
             regulations; however, the previous management agent paid itself $24,312 for
             unsupported expenses due to weak procurement procedures.
What We Recommend

           We recommend that the director of HUD’s Multifamily Housing Program Center
           require the owner or its prior management agent to either provide documentation
           to show the charges were for actual work performed and that the fees charged
           were reasonable and necessary or repay the expenses to Deer Creek Apartments.
           We further recommend that HUD determine whether the prior management agent
           charged other HUD-insured projects for these unsupported fees and if so, require
           that the same documentation be provided or the fees be repaid for these projects
           as well.

           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

Auditee’s Response

           We provided a draft to the auditee on April 5, 2006. The auditee’s comments
           were due on April 21, 2006. On April 20, 2006, the auditee requested an
           extension to respond until May 12, 2006. We approved an extension to April 28,
           2006, since we had previously discussed the finding with the auditee during the
           audit. The auditee responded on April 28, 2006, and disagreed with the
           conclusions in the report. We stand by our finding. Further, HUD’s Office of
           Multifamily Housing agrees with our position and has taken steps to seek
           recovery of the funds. However, we made a clarification in the background
           section of the report. The complete text of the auditee’s response, along with our
           evaluation of that response, can be found in appendix B of this report.

                          TABLE OF CONTENTS

Background and Objectives                                                       4

Results of Audit
      Finding: The Previous Management Agent Paid Itself $24,312 for Unsupported 5
               Engineering Services

Scope and Methodology                                                           7

Internal Controls                                                               8

   A. Schedule of Questioned Costs                                              10
   B. Auditee Comments and OIG’s Evaluation                                     11

                     BACKGROUND AND OBJECTIVES

The Deer Creek Apartments (project) are located at 16303 Imperial Valley Drive in Houston, Texas.
PH Deer Creek, LLC, owns the project. Pleasant Hill Community Development Corporation is the
nonprofit corporation that owns PH Deer Creek, LLC. In April 2002, PH Deer Creek, LLC
(owner), purchased and began renovating the apartment projects with more than $7.4 million in
financing provided by Davis-Penn Mortgage Company and insured by the Federal Housing
Administration of the U.S. Department of Housing and Urban Development (HUD) under Section
221(d)(4) of the National Housing Act.

In November 2001, HUD approved Coach Realty Services (Coach) as the management agent for
the project. The owner signed a management agent agreement with Coach to operate the project,
and Coach served as the management agent until December 2004. In 2004, while Coach was the
management agent, the project became delinquent in its mortgage payments. The independent
public accountant’s report for the fiscal year ending December 31, 2004, cited the owners for
several violations of the regulatory agreement and HUD regulations and poor financial

In January 2005, the owner hired Creative Property Management (Creative) as the management
agent. Creative maintains its office and records at 8323 Southwest Freeway, Suite 330, Houston,
Texas. The mortgage loan has been in default since October 2004. The objective of this review
was to determine whether the project’s owner complied with the regulatory agreement and HUD

                               RESULTS OF AUDIT

Finding: The Previous Management Agent Paid Itself $24,312 for
Unsupported Engineering Services
Although the project’s owner generally complied with the regulatory agreement and HUD
regulations, Coach, the previous management agent, paid itself $24,312 for unsupported
engineering services. Coach made the unsupported payments because it was unaware of HUD’s
requirements. As a result, the project may have spent at least $24,312 for unreasonable or
unnecessary services obtained on less than advantageous terms.

 Unsupported Engineering Fees

              Coach paid itself a $1,013 monthly fee from the Deer Creek operating account for
              engineering services that it could not support and which it improperly procured.
              The engineering services consisted of using the specialized knowledge of a Coach
              employee and purchasing major equipment necessary to reduce major
              maintenance costs at several projects owned by the parent company of the owner.
              Over the two-year review period, these unsupported services totaled $24,312.
              Coach agreed in its management agent certification to HUD to ensure that all
              expenses of the project were reasonable and necessary, on terms most
              advantageous to the project, and to obtain cost estimates and maintain copies of
              such documentation. However, it could not provide documentation to show that
              actual services were provided or that the fees charged were reasonable and
              necessary. Further, HUD’s Management Agent Handbook required Coach to
              procure services after “soliciting written cost estimates from at least three
              contractors or suppliers for any contract, ongoing supply, or service which is
              expected to exceed $10,000 per year.” HUD’s handbook also required Coach to
              retain documentation of all bids for three years following the completion of the
              services. However, Coach could not provide bids or a written contract with the
              apartment owner for the engineering services performed; nor did it have time
              sheets, work orders, or written job descriptions to support these charges. As a
              result, Deer Creek Apartments may have spent at least $24,312 for unreasonable
              or unnecessary services obtained on less than advantageous terms.

              Coach stated it was not aware of HUD’s requirements for bids and a written
              contract. Further, Coach said it believed it was providing a service that was cost
              advantageous to the apartment complex, and that it had the verbal permission of
              the owner to provide the services. Coach should either provide documentation to

             show the $24,312 it received was for actual services performed or repay those
             fees to the Deer Creek Apartments. Because Coach also managed several other
             apartment complexes owned by Pleasant Hill Community Development
             Corporation, it may have unsupported fees at the other projects as well. We did
             not recommend that Coach modify its procurement procedures because Coach no
             longer manages HUD properties in the Houston field office portfolio.


             Except for the unsupported engineering services, our review did not disclose any
             evidence of regulatory violations, unauthorized distributions not previously
             disclosed by the independent public accountants, or loans to other properties. We
             also determined that the apartments were in generally good condition, needing
             only minor routine repairs.


             We recommend that the director of HUD’s Multifamily Housing Center

             1A. Require the owner or its prior management agent, Coach, to either provide
                 documentation that shows that engineering services were provided and fees
                 charged were reasonable and necessary, or repay the $24,312 fees Coach
                 paid itself to the Deer Creek Apartments’ operating account.

             1B. Determine what other HUD-insured projects this management agent has
                 operated and whether those projects were charged for unsupported
                 engineering fees. If the management agent charged other projects for
                 unsupported engineering fees, HUD should require the owner or Coach to
                 either provide documentation to support the engineering fees paid or repay
                 the fees to the projects’ operating accounts.

                         SCOPE AND METHODOLOGY

We conducted the review at the offices of the current and previous management agents and the local
HUD office in Houston, Texas. Our review period was from January 1, 2003, to December 31,
2005. We expanded the review period to 2002 to review payments made to an identity-of-interest
construction company. During the review, we performed the following steps:

   •   Reviewed background information and the criteria that control the insured multifamily
       housing project.
   •   Reviewed various reports, databases, and documents to determine existing conditions at
       Deer Creek Apartments. The data included independent public accountant reports for
       fiscal years 2003 and 2004, information contained in HUD’s Real Estate Management
       System, and documents maintained by the multifamily project manager assigned to
       monitor the project.
   •   Physically inspected a sample of apartment units and the common areas in the apartment
       complex to determine the project’s overall physical condition.
   •   Reviewed disbursements and deposits in the accounting records and their supporting
       documentation to determine whether they appeared appropriate and whether potentially
       fraudulent activity existed.
   •   Reviewed the identity-of-interest construction company’s contract and the cost certification
       audits for the contractor and lender to determine whether payments appeared to be
   •   Conducted interviews with staff of the current and previous management agents, the owner,
       and HUD.

We performed the review at the offices of the current and previous management agents during
January and February 2006. We performed our review in accordance with generally accepted
government auditing standards.

                             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:

                  •   Those policies and procedures that the owner/management agent has put
                      into place to reasonably assure that its accounting system accurately
                      classifies revenues and expenses.

                  •   Those policies and procedures that the owner/management agent has put
                      into place to reasonably protect the owner’s equity in the Deer Creek

                  •   Those policies and procedures that the owner/management agent has put
                      into place to reasonably protect HUD’s interest in the Deer Creek
                      Apartments through compliance with the terms of the various agreements
                      between HUD and the owner and/or the management agents.

              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

           We noted no significant weaknesses in the current management agent’s internal
           controls. However, based on our review, we believe the following item is a
           significant weakness in the previous management agent’s internal controls:

               •   Coach did not have policies and procedures to ensure it complied with
                   HUD requirements related to procurement and maintenance of supporting


Appendix A


                           Recommendation        Unsupported 1/

                                  1A                $24,312

1/   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.

Appendix B


Ref to OIG Evaluation   Auditee Comments

Comment 1

Comment 1

Comment 2

Comment 3

Comment 1

Comment 4

Comment 1

Comment 4

                         OIG Evaluation of Auditee Comments

Comment 1   The response disputed the charges were for unsupported payments and indicated
            the charges were for direct reimbursement of payroll expenses of a salaried
            employee. The response provided backup documentation for the employee’s
            position. We disagree with the response and stand by our original conclusions.
            Further, the additional information provided indicates that the employee was a
            supervisory employee whose salary should not have been paid from the project’s
            operating funds, but should have been covered by the management agent’s fee.

Comment 2   The response asserted the public accountant’s report did not state that Coach had
            violated the regulatory agreement nor was it responsible for the project’s poor
            financial performance. We clarified in our report that the owner, PH Deer Creek,
            LLC, and its sole member, Pleasant Hill CDC, were the entities the independent
            auditor’s report cited for violations of the regulatory agreement and poor financial
            performance. However, Coach, as the management agent, was responsible for the
            daily management and maintenance of the project during the period when the
            findings occurred.

Comment 3   The response stated Coach had never provided “Engineering Services.” The term
            “Engineering Services” is the name that Coach used in its general ledger account
            for the $1,013 monthly charge. Coach also used the terms “Engineering fees” and
            “ENG FEE” to describe the individual transactions in the general ledgers and
            “Engineering Services” as a vendor account label in its check register.

Comment 4   The response stated the auditee did not have sufficient time to gather and review
            all documentation to respond to the audit. We originally presented our finding to
            Coach on February 16, 2006, and gave it a chance to provide information to refute
            our conclusion. Since Coach was previously unable to provide documentation to
            support the fees and the response included information dated April 25, 2006, to
            support expenses paid by the project in 2003 and 2004, we question whether any
            contemporaneous documentation exists.