HUD Needs to Make a Final Determination on Whether San Diego Square Subleased Property is HUD Insured Under Section 202 of the Housing Act of 1959

Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-10-01.

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

                                                      U.S. Department of Housing and Urban Development
                                                                    Office of Inspector General
                                                                                                 Region IX
                                                                         611 West Sixth Street, Suite 1160
                                                                       Los Angeles, California 90017-3101
                                                                                     Voice (213) 894-8016
                                                                                      Fax (213) 894-8115

                                                                  Issue Date

                                                                           October 1, 2009
                                                                  Audit Memorandum Number


MEMORANDUM FOR:              Kelly Boyer, Multifamily Housing Director, 9DHML

FROM:                        Joan S. Hobbs, Regional Inspector General for Audit, 9DGA

SUBJECT:                     HUD Needs to Make a Final Determination on Whether San Diego
                             Square Subleased Property is HUD Insured Under
                             Section 202 of the Housing Act of 1959
                             San Diego, California


We performed a review of the San Diego Square (Square) project in response to a hotline
complaint. The complainant stated that San Diego Kind Corporation (Corporation)
misappropriated a lease prepayment of $480,060 and the U.S. Department of Housing and Urban
Development (HUD) failed to enforce program rules and regulations after detecting the
misappropriation. Our objective was to determine whether the complaint was valid.

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 review.

                              SCOPE AND METHODOLOGY

The scope of our review was limited to addressing the hotline complaint by determining whether
the Corporation misappropriated the lease prepayment and whether HUD failed to enforce
program requirements. To accomplish our review objective, we

       Obtained an understanding of the Section 202 program by reviewing the regulatory
       agreement, applicable HUD handbooks, and other program requirements;
       Interviewed the former HUD employee who initiated the complaint;
       Corresponded with the Corporation’s owner, chief financial officer, management agent,
       and attorney;
       Examined relevant records provided by the Corporation, Office of Multifamily Housing,
       and Departmental Enforcement Center;
       Interviewed the San Diego Senior Community Center’s (Community Center) president;
       Performed a site visit to the project and the City of San Diego’s (City) recorder’s office.

Our review generally covered the period July 20, 1978, through July 9, 2009. We conducted our
review from March 17 through July 24, 2009.


The Corporation was formed as a nonprofit entity in October of 1972 to provide assistance to the
elderly. In 1979, it entered into an agreement with HUD to construct and operate the Square, a
156-unit high-rise apartment complex for San Diego’s elderly located at Tenth and “C” Streets in
downtown San Diego, California. The Corporation received a loan of more than $7.4 million
from HUD under Section 202 of the National Housing Act of 1959 to construct the complex.
The 2007 and 2008 audited financial statements reported that there was a remaining balance of
more than $4.7 million on the loan, which will mature in May 2021. In addition, a Section 8 new
construction housing assistance payments contract was to provide affordable housing for elderly
and handicapped residents in 154 units at the complex. The Square was built on leased land
from the City for an annual rent of $1 through the term of the lease ending in 2029. On March
30, 1988, the Corporation entered into an agreement with the Community Center to sublease for
a period of 20 years a portion of the Square’s premises, also known as the Broadway Center,
located at 928 Broadway. The Corporation received a $480,060 prepayment for the entire term
of the sublease, which it recognized as its own entity’s income, as opposed to the Square’s

The complainant (a former HUD employee) contended that the regulatory agreement between
HUD and the Corporation defined the $480,060 lease payment as project income. Therefore, the
complainant stated that HUD accounting regulations required that the lease payment be
amortized and reported in the annual financial statements, which the Corporation failed to do
from 1986 to 2005. HUD became aware of the lease and lease payment in 2005 and allowed the
Corporation to resubmit its 2006 annual financial statements to disclose the proper information.
However, HUD decided not to pursue reimbursement because the payment was received in 1988,
which was determined to be “legally and administratively well outside an appropriate time frame
to secure recovery.” The complainant believed that HUD improperly failed to enforce program
requirements by not seeking reimbursement of the prepayment funds, which could be used to
fund the Section 8 contract and would reduce the cost of providing affordable housing.

                                    RESULTS OF REVIEW

We were unable to determine whether the allegations were valid. The sublease transaction
occurred over 20 years ago, so many of the project records could not be located or are no longer
available. As a result, we only reviewed documents that were retained by the Los Angeles
Office of Multifamily and Departmental Enforcement Center such as the regulatory, master, and
sublease agreements. In addition, we performed a site visit to obtain a better understanding of
the project’s layout. We also went to the City recorder’s office to locate other relevant records.
Despite our efforts, there does not appear to be sufficient evidence to show exactly what the
Section 202 loan went to pay for and whether HUD intended the Center to be part of the Section
202 insured project. Therefore, we could not make a final determination as to whether the
hotline complaint was valid. As a result, it is incumbent upon HUD to resolve this matter by
making a final determination on whether the subleased area was or was not built and insured
under the Section 202 loan.

Present Situation at the Square

According to the Community Center’ president, the Corporation refused to negotiate with the
Community Center after the sublease expired on March 30, 2008. Therefore, the Community
Center had been mailing the Corporation monthly rental checks in the amount of $3,506 from
May 2008 through July 2009. It will continue to mail the checks through January 2010, at which
time, it will move its operation to another facility. Because the checks were sent by registered
mail, the Community Center was aware that the checks, for a total of $52,586, covering the
period May of 2008 through July 2009, had not been cashed by the Corporation. Given that the
Corporation believed the subleased portion of the property was distinct from the project, it was
probable that it would not recognize the $73,621 (sum of $52,586 for the period May of 2008
through July of 2009 and $21,035 for the projected period August of 2009 through January of
2010) in rental income as part of the project’s residual receipts account once it cashed the
checks. The Corporation had not responded to our query regarding its reason for not cashing the

In consultation with our general counsel, we concluded that HUD could not pursue other actions
with regard to the $480,060 lease prepayment because the statute of limitations had passed,
despite discovery of the issue only a few years ago. However, if HUD makes a final
determination that the subleased area of the Square is considered part of the Section 202-insured
project, the rental income from May 2008 to the present should be recognized as project income.


We recommend that the Director of the Los Angeles Office of Multifamily Housing

   1A.     Make a final determination and provide official written notification to the
           Corporation as to whether the subleased area of the Square is considered part of the
           Section 202-insured project and, therefore, rental revenue it received for use of space
           on the project must be recognized as project income.

   1B.     If HUD determines the subleased area to be part of the project, require the
           Corporation to cash the checks and record more than $73,621 in rental income for the
           Community Center’s occupancy of the Square’s premises between May 2008 and
           January 2010 as part of the project’s residual receipts account. This measure will
           ensure that these funds will be put to better use in the future.

                                  AUDITEE’S RESPONSE

We provided a discussion draft report to the auditee on August 26, 2009, and held an exit
conference on August 28, 2009. The auditee declined to provide written comments, but
informed us that it agreed with the results and recommendations.


Appendix A


                           Recommendation         Funds to be put to
                               number               better use 1/
                                   1B                  $73,621

1/   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. These amounts include reductions in outlays, deobligation of funds,
     withdrawal of interest, costs not incurred by implementing recommended improvements,
     avoidance of unnecessary expenditures noted in preaward reviews, and any other savings
     that are specifically identified. In this instance, if HUD determines the subleased area to
     be part of the project, it will ensure that the Corporation recognizes program funds in
     accordance with HUD rules and regulations. These funds may be expended to fund the
     Section 8 contract and would reduce the cost of providing affordable housing.