Issue Date August 2, 2010 Audit Report Number 2010-LA-1014 TO: Tom Azumbrado, Director, San Francisco Multifamily Housing Hub, 9AHMLA FROM: Tanya E. Schulze, Regional Inspector General for Audit, Region IX, 9DGA SUBJECT: The Retreat at Santa Rita Springs, Green Valley, AZ, Did Not Comply With HUD Rules and Regulations and Other Federal Requirements HIGHLIGHTS What We Audited and Why We completed a review of the Retreat at Santa Rita Springs (community), a Federal Housing Administration (FHA)-insured multifamily project under Section 231 of the National Housing Act. Our audit was in response to a request for audit from Representative Gabrielle Giffords of the 8th District of Arizona. The owner defaulted on the $29.9 million U.S. Department of Housing and Urban Development (HUD)-insured mortgage in November 2009, the month after final endorsement. Our objective was to determine whether the operations of the community complied with applicable HUD rules and regulations and other Federal requirements. We plan to review the mortgage loan underwriting and approval as a separate assignment. What We Found The community did not comply with applicable Federal rules and regulations and its regulatory agreement with HUD in the operation of the project. The audit found that Resident security deposits were converted to community fees and/or commingled with operating funds and not returned and Prohibited management costs and erroneous and duplicative billings were charged to the project. Although funds were owed to the residents and the community, these violations were not material enough to be the primary cause of the project’s mortgage default. What We Recommend We recommend that the Director of HUD’s San Francisco Office of Multifamily Housing require the owner to refund $11,000 in security deposits collected from former residents and prospective residents, and require the owner to reimburse the project $19,216 for ineligible and unsupported expenses. 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 We provided our discussion draft audit report to the owner on June 11, 2010, and held an exit conference on June 16, 2010. The owner provided written comments on July 27, 2010. The owner generally agreed with our report findings. The complete text of the auditee’s response, along with our evaluation of that response, can be found in appendix B of this report. 2 TABLE OF CONTENTS Background and Objective 4 Results of Audit Finding 1: Security Deposits Were Converted to Revenue and Commingled With 5 Operating Funds Finding 2: Management Charged Ineligible and Unsupported Project Expenses 7 Scope and Methodology 9 Internal Controls 10 Appendixes A. Schedule of Questioned Costs 11 B. Auditee Comments and OIG’s Evaluation 12 C. Criteria 28 3 BACKGROUND AND OBJECTIVE The Retreat at Santa Rita Springs (community) is a 196-unit independent living facility located in Green Valley, AZ. The community’s $29.9 million mortgage was insured under Section 231 of the National Housing Act (project number 123 38033). The project was owned by the Retreat IL, LLLP, an Arizona limited liability limited partnership, a general partner of which, Retreat Fast, Inc., executed the regulatory agreement with the U.S. Department of Housing and Urban Development (HUD) on October 30, 2007. The community started operations in January 2009, HUD approved the final endorsement of the Federal Housing Administration (FHA) mortgage loan in October 2009, and the community ceased operations in November 2009. When the community opened for occupancy in February 2009, the economy and housing market were on a downturn trend. Lease-up for the community remained at 6 percent from its inception, which led to the project’s operating shortfalls. The owner’s unwillingness to contribute additional funds to the project after final endorsement then led to its default. After the community defaulted on its mortgage payment in November, Red Mortgage assigned the mortgage to HUD on December 28, 2009. The property was managed by Watermark Retirement Communities (WRC) beginning in October 2008. WRC also managed 10 other non-HUD and HUD properties in addition to the community. The owner owed WRC for back management fees from May 2009 until the contract termination on November 4, 2009. WRC has been pursuing legal action against the community’s owner. HUD’s Lender Qualification and Monitoring Division has been performing a quality assurance project default review of the community to evaluate the project’s underwriting. The results will be issued to the lender for comment before actions are taken on any potential findings. Our objective was to determine whether the operations of the community complied with applicable HUD rules and regulations and other Federal requirements. 4 RESULTS OF AUDIT Finding 1: Security Deposits Were Converted to Revenue and Comingled With Operating Funds Security deposits were collected from prospective residents to guarantee a place in the community. The owner and management agent deemed the security deposits as nonrefundable and converted them to ineligible community fees upon residents’ move-in. The security deposits were also commingled with the project’s other cash in the operating bank account. In addition, we identified a $1,000 tenant deposit in November 2009, the source of which could not be confirmed. These issues occurred because the owner and management agent had insufficient knowledge of HUD requirements for the Section 231 program and disregarded the owner’s regulatory agreement with HUD. As a result, residents who moved into the community were charged ineligible fees, and prospective residents were not refunded their security deposits. Security Deposits Were Converted to Revenue The owner and management agent deemed the security deposits as nonrefundable, and they were converted to community fees upon residents’ move-in. This practice violated the HUD-approved regulatory agreement, which states that the owners shall not require, as a condition of the occupancy or leasing of any unit, any consideration or deposit other than the prepayment of the first month’s rent plus a security deposit in an amount not in excess of 1 month’s rent, and any funds collected must be kept in a separate trust account (see appendix C). The security deposits inappropriately credited toward community fees totaled $6,500 for the 13 residents who moved into the community. Security Deposits Were Commingled With Project Funds The owner and management agent commingled the security deposit cash in the community’s operating bank account with the project’s other funds. Security deposits were posted under the priority reservation general ledger account. Other miscellaneous collections were also posted in this account, including pet and bank fees. In April 2009, another general ledger account, called resident security deposits, was created with an initial amount of $500; however, no cash collection supported this entry. The account balance was then reclassified to the priority reservation and nonrefundable fees accounts in July 2009. 5 In November 2009, an additional $1,000 was posted under the priority reservation account for a prospective resident; however, the source of the funds could not be confirmed due to inadequate records, and the balance of the priority reservation account may have been overstated. According to the community’s former executive director, this transaction could have been a rental payment from another resident, so the funds may be owed to a former resident. The security deposit is a liability account that should be safeguarded for the protection of residents of the community. The project’s regulatory agreement, therefore, requires funds collected as security deposits to be kept separate from other funds in a trust account. When the security deposits were not deposited into a separate bank account, the owner and management agent put the security deposits at risk of being used for other, unintended purposes. When operations ceased in November 2009, the operating bank account was depleted and closed. At that time, the project owed security deposits of $4,500 to former prospective residents, who had not been refunded. Conclusion The owner and agent’s practice of commingling resident security deposits and converting them to revenue violated HUD requirements. This violation occurred because the owner and management agent had insufficient knowledge of the Section 231 program and HUD regulations. As a result, resident funds were used for other, inappropriate purposes, and former residents and prospective residents were not refunded their security deposits. Recommendations We recommend that the Director of the San Francisco Office of Multifamily Housing 1A. Require the owner to reimburse the residents for ineligible community fees totaling $6,500. 1B. Require the owner to refund security deposits collected from prospective residents totaling $4,500. 1C. Require the owner and/or management agent to provide documentation that the $1,000 is not a security deposit or repay that individual. 6 Finding 2: Management Charged Ineligible and Unsupported Project Expenses The management agent charged the project for travel of non-front-line staff and markups on marketing and advertising vendor invoices. Additionally, the agent charged erroneous, duplicative, and unsupported expenses to the project. These violations occurred because the owner and management agent lacked knowledge of the HUD requirements for the Section 231 program and the management agent did not properly account for project disbursements. As a result, operating expenses were overstated, thus fewer funds were available to pay for eligible project expenses. Costs Already Covered by the Management Fee Were Charged to the Project HUD regulations require that expenses for services that are not front-line activities be paid from management fee funds (see appendix C). The project was charged for ineligible travel expenses of non-front-line management staff amounting to $1,126 that were already covered under the management fees. In addition, the agent added markups on advertising invoices totaling $6,281 although surcharges over actual costs are specifically disallowed under HUD Handbook 4381.5 (see appendix C). Poor Accounting Resulted in Ineligible and Unsupported Expenses The management agent administers retirement facilities other than the community. Non - front-line functions such as accounting and marketing for several properties are performed by management agent staff operating out of a single office. Due to an accounting error, the agent charged an erroneous advertising expense of $7,267 to the community that was attributable to one of its other projects. The agent also charged the project for an erroneous duplicative posting of $1,725, and unsupported expenses totaling $1,817 that were not supported by valid vendor receipts. 7 The Owner and Agent Lacked Knowledge of HUD Regulations The owner and management agent of the community were charged with protecting the financial viability of the HUD-insured multifamily project and were required to comply with HUD regulations, requirements, and guidelines. Financial compliance requires adequate internal controls and procedures for reporting and accounting to prevent misappropriation of project funds and claims and losses against the FHA insurance fund. The owner and agent’s lack of knowledge of HUD regulations and poor accountability for project funds resulted in questionable costs being charged to the project. Conclusion The owner and agent’s charging of ineligible management cost and erroneous/unsupported expenses to the project resulted in fewer funds being available to pay for eligible project expenses. Although this violation contributed to the operating shortfalls experienced by the community, these questioned costs were not significant enough to cause the project’s default. The community’s inability to lease up (see the Background and Objective section) was the primary cause of the continued operating shortfalls that led to the project’s default. Recommendations We recommend that the Director of the San Francisco Office of Multifamily Housing 2A. Require the owner to reimburse the project $16,399 for ineligible expenses. 2B. Require the owner to provide documentation to support $1,817 for undocumented disbursements cited in this report or reimburse the project. 8 SCOPE AND METHODOLOGY The audit covered the use of project funds for the period December 1, 2008, through November 30, 2009. Our audit was performed at the owner’s business office located in Tucson, AZ. We performed our audit work from January 19 through April 2, 2010. To accomplish our objective, we Reviewed applicable laws, regulations, and guidance issued by HUD (see criteria in appendix C); Reviewed pertinent financial records maintained by the project at the owner’s business office; Interviewed staff from the project, the owner, and the management agent; Reviewed HUD files and interviewed HUD officials in the Phoenix Office of Multifamily Housing; and Performed site visits to the property Specifically, our audit included the review of the community’s financial records and the management agent’s accounting system, policies, and procedures. We reviewed transactions from the start of the project’s operations in January 2009 until it ceased operations in November 2009 and tested a nonstatistical sample of receipts and disbursements for support, accuracy, and compliance with HUD rules and regulations. We did not project our results to the universe of transactions in our audit scope. In addition, we reviewed the HUD Lender Qualification and Monitoring Division’s draft report on its quality assurance project default review results. We plan to review the mortgage loan underwriting and approval as a separate assignment. We conducted the 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 objective. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective. 9 INTERNAL CONTROLS Internal control is a process adapted by those charged with governance and management, designed to provide reasonable assurance about the achievement of the organization’s mission, goals, and objectives with regard to: Effectiveness and efficiency of operations Reliability of financial reporting, and Compliance with applicable laws and regulations. Internal controls comprise the plans, policies, methods, and procedures used to meet the organization’s mission, goals and objectives. Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations as well as the systems for measuring, reporting, and monitoring program performance. Relevant Internal Controls We determined that the following internal controls were relevant to our audit objective: Administering the project’s operations in compliance with applicable laws and regulations, Maintaining complete and accurate records, and Safeguarding the project’s resources. We assessed the relevant controls identified above. . A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, the reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or efficiency of operations, (2) misstatements in financial or performance information, or (3) violations of laws and regulations on a timely basis. Significant Weaknesses Based on our review, we believe that the following items are significant deficiencies: The project did not have adequate controls in place to ensure that Tenant security deposits were adequately safeguarded (finding 1). Project financial transactions were eligible and supported (finding 2). 10 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS Recommendation Ineligible 1/ Unsupported 2/ number 1A $6,500 1B $4,500 1C $1,000 2A $16,399 2B $1,817 Total $27,399 $2,817 1/ Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity that the auditor believes are not allowable by law; contract; or Federal, State, or local policies or regulations. 2/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program or activity when we cannot determine eligibility at the time of the 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. 11 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 Comment 2 12 Comment 2 Comment 3 13 Comment 4 Comment 4 14 15 16 Comment 4 Comment 5 17 Comment 6 Comment 4 Comment 4 Comment 7 Comment 8 18 Comment 9 Comment 4 Comment 10 Comment 11 19 Comment 11 20 21 22 Comment 9 23 The names were redacted for privacy reasons. 24 OIG Evaluation of Auditee Comments Comment 1 The statement “The owners owed WRC for back management fees from May 2009 until it terminated its contract in November 2, 2009” was changed to “The owners owed WRC for back management fees from May 2009 until the contract termination in November 4, 2009.” Comment 2 Based on our review of the books of account, there were 13 residents/families (some have their spouses as secondary occupants) that moved in the community. The security deposits of $500 were converted into ineligible community fees. The auditee submitted no documentation to show that the security deposits were credited towards rent for the referenced tenants. Below is a list of residents that moved in the community and should be refunded their security deposits less fees for damages (if any) upon move out. Resident Apt/Bed Admit Date Amount No. 1 108202 January 31, 2009 $500 2 108205 February 2, 2009 $500 3 101102 March 31, 2009 $500 4 108207 March 31, 2009 $500 5 101201 April 11, /2009 $500 6 108203 April 17, /2009 $500 7 108209 April 30, 2009 $500 8 108210 April 15, 2009 $500 9 112102 April 22, 2009 $500 10 106210 May 26, 2009 $500 11 108201 May 28, 2009 $500 12 106208 August 3, 2009 $500 13 106110 August 9, 2009 $500 Total $6,500 Note: Residents’ names were not disclosed to protect their privacy. The community had been collecting security deposits of $500 since it started operation. However, starting October 2009, the security deposit was increased to $1,000. Below is a table listing the prospective residents who paid security deposit but did not move in the community and therefore should be refunded their security deposits. Note that prospective resident No. 6 paid $1,000 in two installments of $500 each dated October 27, 2009 and October 30, 2009 respectively. 25 Potential Date Security Resident No. Deposit Received Amount 1 December 1, 2008 $500 2 March 11, 2009 $500 3 September 8, 2009 $500 4 September 14, 2009 $500 5 October 21, 2009 $500 6 October 27, 2009 $500 October 30, 2009 $500 7 November 2, 2009 $1,000 Total $4,500 Note: Potential residents’ names were not disclosed to protect their privacy. Comment 3 The owners are responsible for the management agent’s actions. As stated in finding one of the report, the project’s regulatory agreement required security deposit funds to be kept separate from other funds at all times. Comment 4 The resolution to the recommendation will be between HUD and the auditee. Comment 5 WRC managing director stated that it was WRC's procedure to add 15 percent mark-up to advertising invoice cost as a charge for managing the activity. As a qualified agency to the various advertising companies, WRC claimed to get a discount whenever it did business with these companies. However, no documentation was provided to support any discount was received and the claimed savings did not benefit the project because of the additional 15 percent surcharge. Comment 6 We reviewed the additional information submitted by WRC and removed the questioned cost from the report. Comment 7 In the February 2009 Media Placement general ledger account postings, the accrual for KGVY expense was posted three times under JE 1-00, JE10-00, and JE14-00, each amounting to $800. The two duplicates (JE 1-00 and JE 14-00) were reversed in April 2009. However, in March 2009, the same amount was posted under JE 6-00, not reversed, and no invoice was provided to support the entry. Although we continue to question the item, we have re-categorized the questioned cost to unsupported. Comment 8 The KGVY expense for $330 was posted three times under JE 1-00, JE10-00, and JE14-00 in February 2009. We agree two of the postings were for two KGVY invoices of the same amount (09010203 and 09010214). However, the KGVY invoice 09010203 was also included as part of WRC invoice # SM209RSR under JE 10-00, resulting in a duplicate expense that was never reversed. In March 26 2009, the same amount was posted under JE 8-00 but no KGVY invoice was provided to support the entry, and it was not reversed. Therefore, we continue to question the costs; however, we have re-categorized them as unsupported expenses. Comment 9 Although WRC’s response indicates we categorized this expense as “ineligible” it was actually listed in our report as unsupported due to the lack of documentation provided. The document provided in the auditee’s response, listing the expenses, appears to be an internally generated WRC document and not original vendor documentation. The agent subsequently provided additional documentation from the vendor to support $800 of the Career Builder expense for the recruiting of 8 onsite staff at $100 each. However, insufficient documentation was submitted for the remaining $40 charged per employee, so the remaining $320 remains unsupported. Comment 10 Green Valley expense was first accrued in September 2009. Since the invoice had not been received, the entry was reversed and reaccrued in October 2009. In November 2009, the invoice still was not received, the October entry was reversed and reaccrued. There were two debit entries in November for the same amount, the reaccrual for the September expense and a new accrual for November expense. If the invoices for September and November were received, the accruals should be reversed and the correct expense amounts entered. However, since the amounts were merely accruals and not paid from project funds, we have removed the amounts from our questioned costs. Comment 11 If the invoices for November 2009 were received, the accruals should be reversed and the correct expense amounts entered. However, since the amounts were merely accruals and not paid from project funds, we have removed the amounts from our questioned costs. 27 Appendix C CRITERIA HUD Handbook 4370.1, REV-2, paragraph 2-21, states that deposits are paid by a tenant at the time a unit is rented. The deposit is placed into an account specifically for tenant deposits and held until the tenant vacates the unit. A security deposit may be applied to pay for any damages caused by the tenant. HUD Handbook 4370.2, REV-1, paragraph 2-12, states that any funds collected as security deposits must be kept separate and apart from all other project funds in an account maintained in the name of the project. The balance of the account must not at any time be less than the aggregate of all outstanding obligations under the account for security. Regulatory agreement, paragraph 6g, states that owners shall not, without the prior written approval of the HUD Secretary, require, as a condition of the occupancy or leasing of any unit in the project, any consideration or deposit other than the prepayment of the first month’s rent plus a security deposit in an amount not in excess of 1 month’s rent to guarantee the performance of the covenants of the lease. Any funds collected as security deposits shall be kept separate and apart from all other funds of the project in a trust account, the amount of which shall at all times equal or exceed the aggregate of all outstanding obligations under said account. HUD Handbook 4381.5, REV-2, paragraph 6-34(a), Financial Compliance. Management agents are charged with protecting the financial viability of HUD-insured multifamily projects. The purpose of financial reviews is to verify that owners and management agents are in compliance with HUD Handbook 4370.2, Financial Operations and Accounting Procedures for Insured Multifamily Projects, and related HUD requirements and guidelines. HUD Handbook 4381.5, REV-2, paragraph 6-38, states: a. Front-line Costs and Day-to-Day Activities (1) Reasonable expenses incurred for front-line management activities may be charged to the project operating account. HUD Handbook 4370.2, Financial Operations and Accounting Procedures for Insured Multifamily Projects, provides a complete listing of allowable expenses. Front-line activities include: o taking applications; o screening, certifying, and recertifying residents; o maintaining the project; and o accounting for project income and expenses. Figure 6-2 provides examples of front-line management costs. 28 Figure 6-2: Examples of Costs Paid from Management Fee and Project Account ======================================================== Costs Paid from Fee Costs Paid from Project Account ======================================================== Agent's travel expenses to visit Travel expenses incurred by project and meet with owners. front-line staff’s responsibilities Training and travel expenses for (e.g., making bank deposits, meeting Agent’s supervisory staff. with contractors, attending training, etc.). (2) If front-line management functions for several properties are performed by staff of the agent operating out of a single office, the following conditions apply. (a) The agent must prorate the total associated costs among the projects served in proportion to the actual use of services. Allowable total associated costs include: (i)Salaries and fringe benefits of personnel performing front-line duties; and (ii) Actual office expenses, fees, and contract costs directly attributable to the performance of front-line duties. (b) The agent may not impose surcharges or administrative fees in addition to actual costs. (c) The cost of performing front-line management functions off-site may not exceed the total cost of performing these functions at the property. (3) The salaries of the agent’s supervisory personnel may not be charged to project accounts, with the exception of supervisory staff providing oversight for centralized accounting and computer services for the project. HUD Handbook 4381.5, REV-2, paragraph 6-39, states: a. Expenses for services that are not front-line activities must be paid out of management fee funds, except for centralized accounting and computer services. b. Salaries, fringe benefits, office expenses, fees, and contract costs for the following activities must be paid out of management fee funds. These costs include (1) Designing procedures/systems to keep the project running smoothly and in conformity with HUD requirements. (2) Preparing budgets required by the owner or HUD, exclusive of rent increase requests and MIO [management improvement and operating] Plans. (3) Recruiting, hiring, and supervising project personnel. (4) Training for project personnel that exceeds the line item budget for training expenses. (5) Monitoring project operations by visiting the project or analyzing project performance reports. (6) Analyzing and solving project problems. 29 (7) Keeping the owner abreast of project operations. (8) Overseeing investment of project funds. (9) Ensuring that project positions are covered during vacations, sickness, and vacancies. 30
The Retreat at Santa Rita Springs, Green Valley, AZ, Did Not Comply With HUD Rules and Regulations and Other Federal Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-08-02.
Below is a raw (and likely hideous) rendition of the original report. (PDF)