oversight

Multifamily Project Deficiencies Resulted in More Than $2.8 million in Cost Exceptions for Windham Heights Apartments, Windham, Connecticut

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-02-05.

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

                                                                Issue Date
                                                                         February 5, 2008
                                                                Audit Report Number
                                                                         2008-BO-1005




TO:         James Barnes, Acting New England Hub Director, Multifamily Housing, Boston
              Regional Office, 1AHMLA

            Henry S. Czauski, Deputy Director, Departmental Enforcement Center, CV


FROM:       John A. Dvorak, Regional Inspector General for Audit, Region 1, 1AGA

SUBJECT: Multifamily Project Deficiencies Resulted in More Than $2.8 million in Cost
           Exceptions for Windham Heights Apartments, Windham, Connecticut

                                   HIGHLIGHTS

 What We Audited and Why

             We audited Vesta Windham Heights, LLC (Windham Heights), after completing
             an audit of the owners’ related project, Vesta Moosup, LLC (Moosup Gardens).
             The Moosup Gardens audit (OIG Audit Report Number 2007-BO-1006) disclosed
             cost exceptions totaling more than $700,000 related to unauthorized distributions
             and repayments of owner advances while in a non-surplus-cash position and
             unreasonable payments to identity-of-interest (related) companies. Our audit
             objective was to determine whether the owners and/or management agent used
             project funds in accordance with the regulatory agreement.


 What We Found
             The owners did not use project funds in accordance with the regulatory
             agreement. We identified questioned costs and opportunities for funds to be put
             to better use totaling more than $2.8 million (see appendix A). These cost
             exceptions were due to weak internal controls, a lack of policies for related
             company transactions, and inadequate accounting procedures. Specifically, the
           owners and management agent (1) used more than $171,000 for services that were
           unnecessary and unreasonable to operate and maintain the project and when the
           project was in a non-surplus-cash position; (2) included unreasonable and
           unnecessary costs in their cost certification, causing the U.S. Department of
           Housing and Urban Development (HUD) to overinsure the mortgage by more
           than $598,000; and (3) repaid more than $800,000 in advances when the project
           was in a non-surplus-cash position. These violations, which included charging
           the project more than $1.3 million for unreasonable relocation services when the
           project was in a non-surplus-cash position, may subject the owners to monetary
           penalties.

What We Recommend

            We recommend that the Acting New England Hub Director for Multifamily
            Housing require the owners to (1) repay the project for ineligible use of operating
            funds for unreasonable and unnecessary costs charged to the project, (2) make a
            principal payment or establish an escrow with the lender from nonproject funds
            to pay down the amount of overinsurance, and (3) repay the project for ineligible
            repayments to their related companies.

           Further, we recommend that HUD pursue sanctions as appropriate against the
           responsible parties for the unreasonable disbursements cited in this report.

           For each recommendation in the body of the report 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


           We provided the draft audit report to the auditee on December 20, 2007, and
           requested a response by January 16, 2008. We discussed the draft audit report at
           an exit conference on December 21, 2007, and received the auditee’s written
           comments on January 16, 2008. The auditee generally disagreed with the report.

           The text of the auditee’s response, along with our evaluation of that response, can
           be found in appendix B of this report. Please note that the referenced attachments
           were not included in the report because of their size, but are available upon
           request.




                                             2
                            TABLE OF CONTENTS

Background and Objectives                                                          4

Results of Audit
      Finding 1: The Owners Charged More Than $171,000 for Services That Were
                 Unnecessary and Unreasonable for Operating and Maintaining the    5
                 Project
      Finding 2: The Owners Included Unreasonable and Unnecessary Costs in Their
                 HUD-Insured Mortgage Cost Certification
                                                                                   8
      Finding 3: The Owners Repaid More Than $800,000 in Advances When the
                 Project Was in a Non-Surplus-Cash Position
                                                                                   13

Scope and Methodology                                                              15

Internal Controls                                                                  16

Appendixes
   A. Schedule of Questioned Costs and Funds to Be Put to Better Use               18
   B. Auditee Comments and OIG’s Evaluation                                        19
   C. Summary of Related Companies                                                 33




                                            3
                       BACKGROUND AND OBJECTIVES

Windham Heights (project) is a multifamily 350-unit apartment complex located on 22 acres in
Windham, Connecticut, with 345 project-based Section 8 units and five units supported with
housing choice vouchers.

The owners, HDASH, Limited Liability Corporation (LLC), and its related company Vesta
Equity 2003, LCC, purchased the property in December of 2003 and embarked on substantial
rehabilitations. The owners financed the purchase and renovations, and the U.S. Department of
Housing and Urban Development (HUD) insured the mortgage through Section 221(d)4 of the
National Housing Act (Act). The Act authorizes HUD to insure lenders against loss on mortgage
defaults and assists owners in the construction or rehabilitation of housing for eligible families
by making capital more readily available.

The project remained operational during the rehabilitation, and the $13 million in renovations
completed in July of 2005 included gutting and reconstruction of 92 termite-damaged units.
Interior work included new doors, kitchen and bathroom cabinets, bathroom accessories, new
appliances and fixtures, drywall, electrical fixtures, and paint. The heating and hot water
systems were also segregated for more efficient operation. Exterior work included new
sidewalks, sealing the parking lot, landscaping, site lighting, and upgrading the closed circuit
television monitoring system.

The owners submitted a “Mortgagor’s Certificate of Actual Cost” (form HUD-92330) to HUD
on March 28, 2006, to determine the amount of mortgage insurance HUD would provide. HUD
insured the project’s mortgage for $17.1 million based on the documentation provided.

Our audit objective was to determine whether the owners and/or management agent used project
funds in accordance with the regulatory agreement. Specifically, we wanted to determine whether
the owners/management agent (1) obtained goods and services that were reasonable and necessary
project expenses and were costs properly supported, (2) included only reasonable and adequately
supported costs on the “Mortgagor’s Certificate of Actual Cost,” and (3) repaid any advances or
loans to their related companies when the project was in a non-surplus-cash position.

The issues identified in our report deal with administrative and internal control activities that we feel
are necessary to bring to the owners’ attention now. Other matters regarding the owners’
management may remain of interest to our office as well as other federal agencies. Release of this
report does not immunize any individual or entity from future civil, criminal, or administrative
liability or claim resulting from future action by HUD and or other federal agencies.




                                                   4
                                   RESULTS OF AUDIT

Finding 1: The Owners Charged More Than $171,000 for Services That
Were Unnecessary and Unreasonable for Operating and Maintaining the
Project
The owners charged the project more than $171,000 for services that were unnecessary and
unreasonable for operating and maintaining the project. This amount included charges of
$67,326 for unnecessary Internet service provided to all tenant units, $66,015 for unnecessary
social activities, and $38,160 to pay their related management company for unreasonable
temporary employee services when the project was in a non-surplus-cash condition. These
unnecessary and unreasonable charges occurred due to inadequate accounting procedures and
management controls. These charges contributed to operating losses and the project’s non-
surplus-cash position and may subject the owners to sanctions under the federal equity skimming
statutes.



    Owners Charged $67,326 for
    Unnecessary Internet Services


                The owners paid a vendor $67,326 in project operating funds to provide Internet
                services to the project’s 350 housing units. They paid $5,292 during construction1
                and $62,034 after normal operations began.2 The services were provided as an
                additional amenity to attract new tenants and to further the goals of the project’s
                learning center, which also provided Internet access and educational opportunities
                to residents. The service agreement with the vendor also provided no-cost local
                phone and cable service for the property’s exercise and social rooms and no-cost
                local phone, fax, and Internet service for the property’s main office. Although the
                project obtained some no-cost benefits, Internet service at the unit level was not
                necessary for operating or maintaining the project. Therefore, the costs were not
                eligible project costs and must be repaid to the project because the owners’
                regulatory agreement with HUD requires that HUD-insured project funds be used
                only for reasonable expenses necessary for the operation and maintenance of the
                project. 3




1
  December 23, 2003, through September 4, 2005.
2
  September 5, 2005, through August 31, 2007
3
  “Regulatory Agreement,” form HUD-92466, paragraph 6b.




                                                    5
    Owners Charged $66,015 for
    Unnecessary Food/Entertainment


                 The owners charged the project $66,015 for trips to an amusement park, bus
                 transportation, snacks, and disc jockeys. They charged $30,259 during
                 construction and $35,756 after normal operations began. The costs were incurred
                 because the owners continued several community programs and activities that the
                 previous owners had established. However, these costs were not necessary for the
                 operation or maintenance of the project.


    The Owners Charged $38,160
    for Unreasonable Temporary
    Employee Services



                 The owners’ related management company also charged the project $38,160 for
                 unreasonable and temporary employee services. It charged $14,310 during
                 construction and $23,850 after normal operations began.4 The costs were
                 unreasonable because they were already paid for as part of the management
                 agent’s fee.5 In addition, the owners did not maintain records to show who
                 provided the services or whether the services were actually provided. This
                 condition occurred due to inadequate accounting procedures and weak
                 management controls.



    Conclusion


                 The owners charged the project $171,501 for services that were unnecessary and
                 unreasonable to operate and maintain the project. This condition occurred due to
                 inadequate accounting procedures and management controls, weakened the
                 project’s financial position, and contributed to operating losses of more than
                 $275,0006 during 2004 and 2005. The $121,640 charged after normal operations
                 began should be repaid to the project operating account, and the $49,861 charged
                 during construction should be repaid to reduce the HUD-insured mortgage (see
                 finding 2). Since the owners charged these unreasonable costs when the project
                 was in a non-surplus-cash condition, they are subject to sanctions under the
                 federal equity skimming statutes.


4
  The project paid $7,950 and accrued $15,900 in payables to the owner's related company during operations.
5
  “The Management Agent Handbook,” HUD Handbook 4381.5, paragraph 6.39b (9).
6
  $298,091 in losses in 2004 + $22,680 in profits in 2005 = $275,411 in losses.


                                                        6
    Recommendations



                 We recommend that the Acting New England Hub Director for Multifamily
                 Housing require the owners to

                 1A.      Repay the project $105,7407 from nonproject fund sources and remove the
                          $15,9008 in payables for temporary employee services from its accounting
                          records for the unnecessary and unreasonable operating costs. The
                          repayment should be deposited into the project’s replacement reserve
                          account or another restricted account that requires HUD approval for the
                          release of funds.

                 1B.      Implement adequate written procedures and controls to ensure that future
                          disbursements for project expenses comply with the regulatory agreement
                          and HUD’s requirements.

                 1C.      Obtain an unrelated management agent to manage the project.9

                 We also recommend that the Director of the Departmental Enforcement Center

                 1D.      Pursue all administrative and/or civil monetary penalties for the regulatory
                          agreement violations disclosed in this report.10




7
  $62,034+35,756+$7,950.
8
   Accrued for temporary employee services.
9
  In implementing this recommendation, HUD should consider all of the issues discussed in this report.
10
   In implementing this recommendation, the Deputy Director should consider all of the issues discussed in this
report.


                                                         7
                                      RESULTS OF AUDIT

Finding 2: The Owners Included Unreasonable and Unnecessary Costs
in Their HUD-Insured Mortgage Cost Certification

The owners included more than $1.3 million in unreasonable relocation costs in their cost
certification. The costs were unreasonable because the owners

      •   Exceeded the amount that HUD initially approved for relocation services,
      •   Did not show that their related company incurred costs, and
      •   Failed to show that the amount paid did not exceed what would have been paid on the
          open market.

The owners failed to maintain adequate records for the amounts charged to their related
companies. In addition, the owners included more than $364,000 in unreasonable operating
costs, including unpaid and unnecessary interest payments and excessive salary costs, in their
operating statement. This condition occurred due to weak accounting controls over cash
disbursements and related party transactions.

HUD disallowed some of the relocation costs during its final cost certification; however, these
costs caused HUD to overinsure the mortgage by more than $598,000, contributed to
unnecessary operating losses, and subjects the owners to sanctions under the federal equity
skimming statutes.




     Related Company Costs Were
     Unreasonable


                 The $1,301,123 charged for related company relocation services11 was unreasonable.
                 The costs were unreasonable because they exceeded the $425,769 HUD approved.12
                 HUD initially approved the owners to charge the project an average of $3,108 per
                 tenant to move 137 tenants. However, the owners charged the project an average of
                 $8,243 per tenant to move 214 tenants, an increase of more than 150 percent and a
                 cost increase of more than 400 percent, with no credible explanation for the cost
                 disparity. The costs were also unreasonable because one related company incurred
                 no costs, yet it billed the project $635,756. In addition, the owners could not show
                 that the costs paid to their companies were comparable to costs that would have been

11
   On their “Mortgagor’s Certificate of Actual Cost,” form HUD-92330, signed March 28, 2006, in support of their
HUD-insured mortgage.
12
   “Multifamily Summary Appraisal Report,” form HUD-92264, approved on December 3, 2003.


                                                        8
                   paid on the open market as required by their regulatory agreement and certification
                   to HUD.13

                   In addition, the $1,301,123 in improper relocation costs was capitalized as part of
                   the building improvements, and should be removed from the project’s balance sheet.
                   The $999,348 paid to the owners’ related companies must be returned to the project
                   and the $301,775 recorded as an account payable must be removed from the
                   project’s books.

                   The unreasonable relocation costs were due to weak internal controls for accounting
                   and related party transactions. For example, the related companies did not enter into
                   a contract to establish the scope and cost of work to be performed. In addition, they
                   did not maintain adequate records to support the costs they incurred. The owners’
                   related companies did not show which employees provided services, what services
                   they provided, or the number of hours they spent providing these services. The
                   project maintained invoices for some of the costs charged; however, invoices were
                   missing for $307,435 in charges.


 Owners Charged the Project
 $364,110 in Unreasonable and
 Unnecessary Operating Costs


                   The owners also included $364,110 in unreasonable and unnecessary charges on
                   the “Statement of Project Operations” they certified and submitted to HUD in
                   support of their HUD-insured mortgage as follows:

                     Description                                                           Amount
                       Loan interest to related company                                           $138,995
                       Salary costs for manager                                                   $115,254
                       Learning center startup costs                                                $60,000
                       Entertainment and food                                                      $ 30,259
                       Related company temporary employee costs                                    $ 14,310
                       Internet service for all housing units                                        $ 5,292
                       Total                                                                      $364,110

                       •    The $138,995 in loan interest was not recorded on the project’s records
                            and was not paid.

                       •    The $115,254 in manager salary was already paid for as part of the
                            management fee. The manager’s costs were also unnecessary because the
                            project maintained and paid for an on-site manager during the construction
13
     “Project Owner’s/ Management Agent’s Certification,” form HUD-9839-B, signed July 29, 2003


                                                         9
                             period to manage the day-to-day operations of the project. In addition, the
                             owners charged this project and two other HUD-insured projects $200,546
                             on their cost certifications for the same employee’s salary, an overbilling
                             of $84,239.

                         •   The $60,000 in learning center startup costs was not entered in the
                             project’s books and records and was not paid.

                    The inappropriate entertainment and food, Internet, and temporary employee costs
                    were discussed in finding 1.


     The Mortgage Was
     Overinsured by $598,700

                    The owners included more than $1.3 million in unreasonable relocation costs on
                    the cost certification they submitted to HUD. HUD disallowed $999,907 in
                    relocation expenses and $9,211 in other costs during final cost certification. Our
                    audit identified $665,32614 in additional unreasonable and unnecessary costs that
                    increased the mortgage amount HUD insured by $598,700, calculated as follows:

                       Description                                                       Amount
                      Total land and improvements                                        $20,066,948
                      Less HUD-disallowed unreasonable relocation costs                   $(999,907)
                      Less other HUD-disallowed costs                                        $(9,211)
                      Less unreasonable and unnecessary costs                             $(665,326)
                      Audited adjusted total land and improvements                       $18,392,504
                      Statutory percentage (90% of line 6)                               $16,553,254
                      Audited maximum insurable mortgage (in multiples of $100)          $16,553,300
                      HUD-approved maximum insurable mortgage                            $17,152,000
                      Overinsured amount                                                    $598,700


     The Project Was in a Non-
     Surplus-Cash Position


                    The project incurred more than $275,00015 in operating losses during the
                    construction period. The more than $1.3 million in unreasonable relocation costs
                    paid to the owner’s related companies and reduced occupancy rates during
                    construction contributed significantly to these operating losses. Federal statutes
                    prohibit HUD-insured multifamily project owners from using project funds for

14
     $1,301,123 - $999,907 = $301,216 + $364,110 = $665,326.
15
     $298,091 in losses in 2004 + $22,680 in profits in 2005 = $275,411 in losses.


                                                           10
          unreasonable expenses when the project is in a non-surplus-cash position. A
          major concern of HUD’s mortgage insurance programs is the inappropriate use of
          project funds, which can contribute to mortgage defaults, the need for additional
          financial assistance from HUD, and losses to HUD through the sale of devalued
          foreclosed properties. Also, an inappropriate and willful use may be subject to
          civil money penalties. Since the owners paid their related companies
          unreasonable amounts for relocation services when the project was in a non-
          surplus-cash position, they may be subject to these penalties.


 Conclusion


          The owners included more than $1.3 million in unreasonable costs paid to their
          related companies for relocation services in their cost certification as building
          improvements when the project was in a non-surplus-cash position. In addition,
          the owners included more than $364,000 in unreasonable operating costs in their
          cost certification. These conditions were caused by weak internal controls over
          related party transactions and accounting. In addition, these costs contributed to
          unnecessary operating losses and caused HUD to overinsure the mortgage by
          $598,700.


Recommendations

          We recommend that the Acting New England Hub Director for Multifamily
          Housing require the owners to

          2A.     Repay the project $999,348 paid to the owners’ related companies from
                  nonproject funds, with the amounts reimbursed placed in the project’s
                  reserve for replacement or a restricted capital account that requires HUD
                  approval for release of the funds, and reduce the building improvements
                  account for the same amount.

          2B.     Remove the $301,775 accounts payable for relocation costs to the owners’
                  related companies from the project’s books and reduce the building
                  improvements account for the same amount.

          2C.     Make a $598,700 principal payment or establish an escrow with the lender
                  from nonproject funds to pay down the amount of overinsurance, with the
                  amounts reimbursed placed in the project’s reserve for replacement or a
                  restricted capital account that requires HUD approval for the release of the
                  funds due to unreasonable costs during construction.




                                            11
2D.   Implement adequate written procedures and controls to ensure that future
      disbursements for project expenses comply with the regulatory agreement
      and HUD’s requirements.




                               12
                                       RESULTS OF AUDIT

Finding 3: The Owners Repaid More Than $800,000 in Advances When
the Project Was in a Non-Surplus-Cash Position
The owners repaid more than $800,000 in advances when the project was in a non-surplus-cash
position16 and without HUD approval. The owners paid expenses directly on the project's behalf
and also advanced other cash to the project’s accounts to cover operating shortfalls. However,
owners can only repay the advances from available surplus cash. The improper repayments of
the advances were due to weak internal controls and a lack of policies for related company
transactions. The repayments negatively influenced the project’s precarious financial condition.
In addition, these violations reduced the availability of cash needed for project operations and
may jeopardize the future financial operations and physical condition of the project.


     Owners Improperly Repaid
     Member Advances

                  During the period December 23, 2003 (the project’s inception), through
                  December 31, 2006, the owners improperly repaid $806,530 for member
                  advances. The owners paid expenses on the project's behalf and advanced other
                  funds during this period to cover operating shortfalls. However, the project was
                  in a non-surplus-cash position during this period. Owners can only repay the
                  advances made for reasonable and necessary operating expenses from surplus
                  cash at the end of the annual or semiannual period unless otherwise approved by
                  HUD.17 Repayment of owner advances when the project is in a non-surplus-cash
                  position or without HUD approval is a violation of the regulatory agreement and
                  may subject the owner to criminal and civil monetary penalties.


     Project Financial Performance
     Was Rated High Risk

                  HUD’s Real Estate Assessment Center (REAC) rated the project’s financial
                  performance as a high risk to HUD. The REAC review of the underlying
                  financial ratios for the last two years of annual financial statements, which
                  measures a project’s performance based on standards that are objective, uniform,
                  and verifiable, indicated significant deficiencies. HUD had also notified the
                  owners of serious compliance issues including unauthorized repayments of owner

16
   “Surplus cash” is the cash remaining after all necessary and reasonable expenses of the project have been paid or
funds have been set aside for such payment.
17
   HUD Handbook 4370.2, REV-1, CHG-1, “Financial Operations and Accounting Procedures for Insured
Multifamily Projects,” paragraphs 2-6.E and 2-11.A.


                                                         13
             advances, unauthorized management fees, and late submission of their 2006
             financial statements. The high risk is of concern to HUD, which must maintain
             public trust in the management of assets funded with HUD financial assistance.



Conclusion


             The project owners improperly repaid their related companies $806,530 for
             advances when the project was in a non-surplus-cash position. This repayment
             violated the owners’ regulatory agreement with HUD. These actions occurred
             due to weak internal controls and the lack of policies regarding related company
             transactions. As a result, these funds were not available for normal project
             operations and contributed to the high risk rating by REAC. This condition may
             also jeopardize the future financial operations and physical condition of the
             project.


Recommendations



             We recommend that the Acting New England Hub Director for Multifamily
             Housing require the owners to

             3A.    Reimburse the project $806,530 from nonproject fund sources for the
                    ineligible member advance repayments. The reimbursement should be
                    deposited into the project’s replacement reserve account or another restricted
                    account that requires HUD approval for the release of funds.




                                              14
                         SCOPE AND METHODOLOGY

Our audit generally covered the period December 23, 2003, through December 31, 2006, but we
expanded it when necessary. We conducted our fieldwork from April through November 2007.
We carried out our audit work at the management agent’s office in Weatogue, Connecticut, and the
local HUD Hartford (Connecticut) field office.

To accomplish our audit objectives, we

   •   Reviewed federal laws and regulations and the owners’ regulatory agreement with HUD and
       obtained an understanding of the owners’ corporate structure as it relates to the project.

   •   Reviewed the project management files at the local HUD field office.

   •   Interviewed and held meetings with the project owners, controller, selected project staff, and
       HUD personnel and officials.

   •   Reviewed the project’s financial statements and independent public accountant’s reports.

   •   Reviewed supporting documentation for related company loans and advances to ensure
       compliance with HUD’s requirements.

   •   Reviewed supporting documentation for the owners’ cost certification, form HUD-92330, to
       determine whether HUD overinsured the project’s mortgage.

   •   Reviewed supporting documentation for selected project costs to ensure that they were
       reasonable, necessary, and properly supported.

We conducted this performance audit in accordance with generally accepted government
auditing standards. Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions
based on our audit objectives. We believe that the evidence obtained provides a reasonable basis
for our findings and conclusions based on our audit objectives.




                                                15
                             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:

                      •   Controls over payments to vendors and related companies for
                          operating costs.
                      •   Controls over accounting and maintaining adequate support for
                          development costs.
                      •   Controls over the repayment of owner advances and related party
                          transactions.

              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:

                      •   Accounting procedures did not ensure that operating costs were
                          reasonable, necessary, and properly supported (see findings 1 and 2).



                                               16
•   Accounting procedures did not ensure that development costs were
    reasonable, properly classified, and adequately supported (see finding
    2).
•   Accounting procedures did not ensure that transfers of owner funds to
    the project were properly supported, classified, and approved by HUD
    before transfer and repayment (see finding 3).




                         17
                                   APPENDIXES

Appendix A

               SCHEDULE OF QUESTIONED COSTS
              AND FUNDS TO BE PUT TO BETTER USE

 Recommendation          Ineligible 1/ Unreasonable or    Funds to be put to               Total
        number                          unnecessary 2/         better use 3/
      1A                                      $105,740              $15,900            $121,640
      2A                                      $999,348                                 $999,348
      2B                                                           $301,775            $301,775
      2C                                      $598,700                                 $598,700
      3A                    $806,530                                                   $806,530
     Totals                 $806,530        $1,703,788             $317,675          $2,827,993


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/   Unreasonable/unnecessary costs are those costs not generally recognized as ordinary,
     prudent, relevant, and/or necessary within established practices. Unreasonable costs
     exceed the costs that would be incurred by a prudent person in conducting a competitive
     business.

3/   Recommendations that funds be put to better use are estimates of amounts that could be
     used more efficiently if an Office of Inspector General (OIG) recommendation is
     implemented. This includes reductions in outlays, deobligation of funds, withdrawal of
     interest subsidy costs not incurred by implementing recommended improvements,
     avoidance of unnecessary expenditures noted in preaward reviews, and any other savings,
     which are specifically identified. For recommendations 1A and 2B, if our
     recommendations are implemented, the project will not repay its management agent for
     unreasonable and unnecessary accrued temporary employee services, or repay its
     members for unreasonable accrued relocation costs once the project realizes surplus cash.




                                            18
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         19
Comment 1




            20
Comment 2




            21
Comment 3




Comment 4




            22
Comment 5




Comment 6


Comment 7




            23
Comment 8




Comment 9




            24
Comment 10




Comment 11


Comment 12




Comment 13




             25
Comment 14

Comment 15




Comment 16




Comment 17


Comment 18




             26
Comment 19




Comment 20


Comment 21




             27
OIG Evaluation of Auditee Comments

Comment 1   We do not dispute the owners’ comments that HUD’s policy is to promote
            providing tenant services that provide a wholesome environment. However, the
            costs must still meet the test of necessity and reasonableness. Further, the owners
            stated that HUD was advised that the owner would be providing Internet access to
            the residents during the application process. HUD program officials advised us
            that they were only aware of and approved Internet access for residents through
            the computers located in the new learning center. HUD program officials were
            not made aware of nor did they approve subsidizing Internet access to individual
            units. We coordinated this issue with HUD program officials throughout the
            audit, and continue to maintain our position that Internet costs to individual units
            were not a necessary/reasonable project cost.

            We concur that amount of unreasonable Internet costs requiring repayment may
            be reduced by the value of the services provided at no cost. However, the
            owner’s response provided no documentation to support the value of these
            services. In addition, the contract between the owners and Internet provider
            provides for both parties to share in the profits obtained related to the sale or use
            of names of residents for purposes of third party vendor marketing. Therefore, if
            the owners received any income from the sales of these services the income
            received should be returned to the project or used to offset the amount requiring
            repayment.

            We continue to question the costs as unreasonable in the report and
            recommendation 1A.

Comment 2   We do not dispute the owners’ comments that HUD’s policy is to promote
            providing tenant services that provide a wholesome environment. However, the
            costs must still meet the test of necessity and reasonableness. Further, the owners
            provided no evidence to support their claim that entertainment and food costs
            were necessary and in fact reduced vandalism and increased occupancy rates. If
            the owners are concerned about vandalism they may consider additional security
            costs that are allowable project expenses. Therefore, we continue to question the
            costs as unnecessary/unreasonable in the report and recommendation 1A.

Comment 3   The owners’ response provided no evidence to show which employees provided
            these services, the services they provided, the amount of time they spent, or the
            associated costs. The owners’ books and records clearly showed that the
            temporary employee costs were for “… additional staff to cover sick time, special
            projects, and vacation” and the amount charged was “an estimated amount upon
            which sales tax is charged” which were paid for as part of the management fee.
            We do not understand how the owners could make the statement that “these
            charges were for additional employees required at the project during the audit
            period” when they do not know who the employees were, what services they


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                    provided, and how much time they worked for the project. In addition, the
                    owners provided no evidence they established adequate controls to account for
                    and charge for their employees’ time. Therefore, our audit position remains
                    unchanged.

Comment 4           We concur that reduced occupancy rates during construction reduced project
                    income and contributed to operating losses. However, we continue to maintain
                    that the project would not have incurred losses if the owners did not charge the
                    project more than $1.3 million for unreasonable relocation services.

                    We also concur the project had an operating profit of $22,680 before depreciation
                    in 2005. We do not concur the project had a net operating loss before
                    depreciation of $309,203 in 2004. We maintain the operating loss was $298,091
                    as reported on their audited profit and loss statement.

                    Therefore, we adjusted the report to read, “The project incurred more than
                    $275,00018 in operating losses during the construction period. The more than 1.3
                    million in unreasonable relocation costs paid to the owner’s related companies
                    and reduced occupancy rates during construction contributed significantly to these
                    operating losses.”

Comment 5           We continue to question the costs as unreasonable in the report and
                    recommendation 1A (see comments 1 and 2). We concur that if the owners
                    provide verifiable evidence to support a reasonable cost for the free business
                    phone, facsimile, and Internet services currently being provided to the project,
                    they could be considered an offset to our questioned costs. However, if the
                    owners received any income from the sales of services provided to Mohegan
                    Common tenants because of the profit sharing provisions of the contract between
                    the owners and Internet provider, the amount requiring repayment may be reduced
                    accordingly.

Comment 6           The owners’ response provided no support to show they implemented adequate
                    written procures and controls. Therefore, we maintain our recommendation 1B.

Comment 7           Based on the nature of the related party relocation costs questioned, and the
                    totality of the deficiencies in this report, our recommendation remains unchanged.

Comment 8           We do not concur with the owners’ reasoning that based on the amount HUD
                    approved they should have been allowed to charge $665,112 to the project for
                    relocation services. The owners’ related companies should have charged the
                    project only for the costs they actually incurred, could support, and HUD
                    approved. During our audit and in their written comments the owners did not
                    provide documentation to support the more than $1.3 million dollars their related
                    companies charged the project for relocation services nor justify why their related
                    company charged the project more than $635,000 dollars when it did not have any
18
     $298,091 in losses in 2004 + $22,680 in profits in 2005 = $275,411 in losses.


                                                           29
                   employee costs. Nonetheless, the owners maintain that their companies should
                   have been paid for relocation services. We cited the owners’ lack of internal
                   controls because they failed to maintain adequate records to support their charges.
                   For example, the owners’ related companies did not show which employees
                   provided services, what services they provided, or the number of hours they spent
                   providing these services. In addition, the project maintained invoices for some of
                   the costs charged; however, invoices were missing for $307,435 in charges.
                   Therefore, we continue to maintain the related company relocation costs were
                   unreasonable and the owners’ internal controls require improvement.

Comment 9          The owners signed and certified the cost certification19 for costs incurred prior to
                   September 4, 2005, the cost certification date. The owners included $60,000 for
                   “Learning center start-up costs incurred as of the cost certification date.” The
                   invoices provided in the owners’ response for 2006 and 2007 are for costs
                   incurred after the cost certification date and thus, are not eligible for inclusion in
                   the cost certification and should not have been included in the mortgage amount
                   that HUD insured. The 2004 and 2005 invoices to transport students from
                   the learning center to a park and a school were not learning center start-up
                   costs; and were not eligible to be included as a capitalized item on the cost
                   certification. Therefore, our conclusion and recommendations remain
                   unchanged.

Comment 10 We interviewed the employee during our audit and confirmed that a significant
           amount of her duties required payment from the management fee. The duties that
           required payment as part of the management fee included preparing budgets,
           recruiting, hiring, and supervising project personnel, and training project
           personnel, monitoring project performance and operations, analyzing and solving
           project problems, and keeping the owner abreast of project operations. In
           addition, the project already maintained and paid for an on-site manager during
           the construction period. Thus, paying for an additional manager's salary, the
           entertainment and food, and internet services from operating funds was
           unreasonable and unnecessary project cost. Therefore, our conclusion and
           recommendation remain unchanged.

Comment 11 We maintain the mortgage was overinsured by $598,700. See comments 1, 2, 3,
           8, 9, and 10 for the reasons that including this amount results in the mortgage
           being overinsured.

Comment 12 We concur the project’s mortgage was current. However, the project also was in
           a non-surplus-cash position and incurred more than one million dollars in losses
           after deprecation20 and more than $275,000 before depreciation during 2004 and
           2005.


19
     Certificate of Actual Construction Costs HUD form 92330
20
     $606,015 in 2004 + $475,921 in 2005 = $1,081,936


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Comment 13 We maintain the Mortgage was overinsured by $598,700. See comments 1, 2, 3,
           8, 9, and 10 for the reasons that including this amount results in the mortgage
           being overinsured.

Comment 14 We maintain our recommendation, and renumbered it from 2A to 2C. See
           comments 1, 2, 3, 8, 9, and 10 that supports the basis for this recommendation.

Comment 15 The owners’ response provided no support to show they implemented adequate
           written procures and controls. Therefore, we maintain our recommendation and
           renumbered it from 2B to 2D.

Comment 16 We reviewed the development costs cited in the owners’ attachment. We concur
           that advances repaid from the project’s development account for supported pre-
           acquisition costs are eligible. We reduced the total amount questioned
           accordingly. However, all advances repaid from the project’s operating account
           are ineligible and must be reimbursed. In addition, the $110,000 repayment on
           November 14, 2005, from the project’s development account was not supported
           and must be reimbursed. Because the development account is closed, the
           remaining balance to be repaid for pre-acquisition costs can only be repaid from
           surplus cash at the end of the fiscal period. Furthermore, since the owners did not
           request HUD approval to repay member advances for the late Section 8 payments,
           the related repayments are ineligible.

Comment 17 We maintain that relocation costs charged by the owners’ related companies were
           unreasonable. See comment 8 for basis that costs were unreasonable.

Comment 18 The project’s financial performance was analyzed and rated by HUD’s Real
           Estate Assessment Center division. The review is based on an analysis of the
           underlying financial ratios for the last two years of annual financial statements,
           which measures a project’s performance based on standards that are objective,
           uniform, and verifiable, indicated significant deficiencies.

Comment 19 We reduced the total amount of questioned costs accordingly (see comment 16).
           However, we maintain the significance of our finding.

Comment 20 We reduced the total amount of questioned costs accordingly (see comment 16).

Comment 21 We disagree with the owners’ reasoning that based on the amount HUD approved,
           they should have been allowed to charge $665,112 to the project for relocation
           services. The owners’ related companies should have charged the project only for
           the costs they actually incurred, could support, and HUD approved. See comment
           8 for the basis that this cost should not have been charged.

              In addition, we moved this recommendation to remove the account payable to
              from Finding 3, Recommendation 3B to Finding 2, Recommendation 2B.




                                              31
We also added related Recommendation 2A requiring the owners to repay the
project $343,939 and reduce the building improvements account for the same
amount.




                              32
Appendix C
                  SUMMARY OF RELATED COMPANIES

Windham Heights (the project), also known as Windham Heights, LLC, is owned by HDASH,
LLC (99 percent), and Vesta Equity 2003, LLC (1 percent). HDASH is owned by two members,
“the owners.”

Vesta Corporation performs no functions for the project and is the parent holding company for
its wholly owned subsidiaries, Vesta Equity Corporation and Vesta Management Corporation.
RFD Acquisition Corporation owns Vesta Corporation. J&Z Investment Company owns RFD
Corporation. J&Z Investment Company’s shareholders are the project owners’ family members
(70 percent) and nonrelated investors (30 percent).

Vesta Equity Corporation performs no functions for the project but owns Vesta Equity 2003,
LLC. Vesta Equity 2003, LLC, was created to perform management functions on behalf of the
project.

Vesta Management Corporation is the legal entity that manages the project’s day-to-day
operations such as renting apartments, collecting rents, maintenance, and other daily property
operational tasks.




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