oversight

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)

                                                                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