oversight

Prudential Huntoon Paige Associates, LTD, Did Not Underwrite and Process a $22 Million Loan in Accordance With HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2015-08-14.

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

Prudential Huntoon Paige Associates, LTD,
              Arlington, VA
Multifamily Accelerated Processing Program, Lafayette Towers
                  Apartments (Detroit, MI)




  Office of Audit, Region 4     Audit Report Number: 2015-AT-1007
  Atlanta, GA                                      August 14, 2015
To:            Nancy-Ann Bodell, Acting Director, Office of Asset Management and Portfolio
               Oversight, HTN
               Dane Narode, Associate General Counsel for Enforcement, CACC
               Craig T. Clemmensen, Director, Departmental Enforcement Center, CACB

               //signed//
From:          Nikita N. Irons, Regional Inspector General for Audit, Atlanta Region, 4AGA
Subject:       Prudential Huntoon Paige Associates, LTD, Did Not Underwrite and Process a
               $22 Million Loan in Accordance With HUD Requirements


Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of Prudential Huntoon Paige Associates’
underwriting of a 223(f) refinance loan, Lafayette Towers Apartments.
HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on
recommended corrective actions. For each recommendation without a management decision,
please respond and provide status reports in accordance with the HUD Handbook. Please furnish
us copies of any correspondence or directives issued because of the audit.
The Inspector General Act, Title 5 United States Code, section 8M, requires that OIG post its
publicly available reports on the OIG Web site. Accordingly, this report will be posted at
http://www.hudoig.gov.
If you have any questions or comments about this report, please do not hesitate to call me at
404-331-3369.
                    Audit Report Number: 2015-AT-1007
                    Date: August 14, 2015

                    Prudential Huntoon Paige Associates, LTD, Did Not Underwrite and Process
                    a $22 Million Loan in Accordance With HUD Requirements




Highlights

What We Audited and Why
We audited Prudential Huntoon Paige Associates, LTD’s underwriting of a $22.8 million
mortgage loan to refinance Lafayette Towers Apartments, a 584-unit highrise multifamily project
in Detroit, MI. We initiated the review based on the early default, assignment, and significant
amount of the project. Our objective was to determine whether Prudential underwrote and
processed the loan for Lafayette Towers according to the U.S. Department of Housing and Urban
Development’s (HUD) requirements.

What We Found
Prudential did not underwrite and process the refinance loan for Lafayette Towers in accordance
with HUD’s guidelines and regulations. Specifically, it did not ensure that the project capital
needs assessment was complete and accurate, adequately assess the borrower’s eligibility,
adequately assess the property’s financial capacity, and ensure that the appraisal report was
supported. Prudential exposed the Federal Housing Administration (FHA) insurance fund to
unnecessary risk and a loss of more than $15 million because it inappropriately submitted and
concluded that the loan for Lafayette Towers was an economically sound and acceptable risk to
HUD. Prudential recommended the project be refinanced for $22.8 million when the owner
purchased the project for only $16 million less than a year before. The refinance only showed
repairs of $1.4 million and allowed a $5 million equity take out for the owner.

What We Recommend
We recommend that the Director of the Detroit Office of Multifamily Housing Programs refer
Prudential to the Mortgagee Review Board to take appropriate action for violations that caused a
more than $15 million loss to HUD’s FHA insurance fund or other administrative action as
appropriate. We also recommend that HUD’s Office of General Counsel for Program
Enforcement pursue civil remedies, if legally sufficient, against responsible parties.
Additionally, we recommend that the Departmental Enforcement Center pursue administrative
actions, as appropriate, against the responsible party for the material underwriting deficiencies
cited in this report.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................5
         Finding: Prudential Did Not Underwrite and Process a $22 Million Loan in
         Accordance With HUD Requirements ............................................................................ 5

Scope and Methodology .........................................................................................16

Internal Controls ....................................................................................................18

Appendixes ..............................................................................................................19
         A. Schedule of Questioned Costs .................................................................................. 19

         B. Auditee Comments and OIG’s Evaluation ............................................................. 20

         C. Schedule of Borrower's Principal's Liens ............................................................... 57

         D. Schedule of Critical Repairs Contributing to Property Deterioration ................ 58

         E. Schedule of Noncritical Repairs Contributing to Property Deterioration .........59




                                                             2
Background and Objective
Prudential Huntoon Paige Associates, LTD, is one of the Nation’s leading originators of Federal
Housing Administration (FHA) multifamily and health care loans with regional offices located
throughout the United States. Prudential is a multifamily accelerated processing (MAP)-
approved lender that underwrote and processed a 223(f) refinance loan for Lafayette Towers
Apartments in Detroit, MI, which consists of 584 units.
Section 223(f) of the National Housing Act authorizes loans to be insured by FHA to facilitate
the purchase or refinancing of existing multifamily rental housing. Section 223(f) insures
lenders against loss on mortgage defaults. The program allows for long-term mortgages (up to
35 years) that can be financed with Government National Mortgage Association mortgage-
backed securities. This eligibility for purchase in the secondary mortgage market improves the
availability of loan funds and permits more favorable interest rates. These multifamily projects
may have been financed originally with conventional or FHA-insured mortgages. Properties
requiring substantial rehabilitation are not eligible for mortgage insurance under this program.
The U.S. Department of Housing and Urban Development (HUD) requires completion of critical
repairs before endorsement of the mortgage and permits the completion of noncritical repairs
after the endorsement for mortgage insurance.
By insuring mortgages, HUD encourages private lenders to enter the housing market to provide
financing that otherwise might not be available to owners. Under HUD’s MAP program,
approved lenders prepare, process, review, and submit loan applications for multifamily
mortgage insurance. In accordance with MAP guidelines, the sponsor works with the MAP-
approved lender, which submits required exhibits for the preapplication stage. After HUD
reviews the exhibits, it either invites the lender to apply for a firm commitment for mortgage
insurance or declines the application. For acceptable exhibits, the lender submits the firm
commitment application, including a full underwriting package, to HUD to determine whether
the loan is an acceptable risk. MAP Guide, Revised 2002, requires that lenders provide a
narrative analysis within the firm commitment application, describing the mortgage transaction
containing a discussion of the characteristics of the proposed loan that make it economically
sound or an acceptable risk. If HUD determines that the project meets program requirements, it
issues a firm commitment to the lender for mortgage insurance.
In accordance with MAP guidelines and Federal regulations, Prudential is responsible for
reviewing all documents submitted to HUD for insurance. Lafayette Towers’ loan was closed
and endorsed on August 20, 2009, with a mortgage amount of $22.8 million. The mortgage
amount also included a $5 million equity take out, which was disbursed to the borrower at
closing. The borrower was not required to use the equity take out for project purposes. The
project’s first notice of default was in June 2010. It was assigned to HUD in April 2011, and
HUD paid a claim of more than $21.5 million on August 22, 2011. The property was sold to the
City of Detroit for $5.8 million on November 5, 2012, which resulted in a loss of more than $15
million.



                                                3
HUD’s Office of Multifamily Housing Programs is responsible for the overall management,
development, direction, and administration of HUD’s multifamily housing programs. The Office
of Multifamily Housing Development provides direction and oversight for FHA mortgage
insurance loan origination, including the implementation of the MAP program.
HUD’s Office of Multifamily Housing Programs required Prudential to obtain a project default
review of Lafayette Towers from a third-party source. Its purpose was to determine what caused
the early default and whether the MAP lender complied with program requirements. Prudential
hired a third-party contractor, which reviewed the loan documents and submitted its report on
January 9, 2014. However, our audit was separate from this review.

Our objective was to determine whether Prudential underwrote and processed the loan for
Lafayette Towers according to HUD’s requirements.




                                               4
Results of Audit

Finding: Prudential Did Not Underwrite and Process a $22 Million
Loan in Accordance With HUD Requirements
Prudential did not underwrite and process the FHA-insured mortgage loan for Lafayette Towers
in accordance with HUD’s guidelines and regulations. We identified several underwriting
deficiencies related to (1) the project capital needs assessment, (2) the borrower’s eligibility, (3)
the property’s financial capacity, and (4) the property’s appraisal. This condition was caused by
Prudential’s failure to conduct due diligence, practice prudent underwriting, and conduct a
sufficient review of related documents and third-party reports, which HUD relied on. As a result,
Prudential exposed the FHA insurance fund to unnecessary risk and a loss of more than $15
million.

Prudential Did Not Perform an Adequate Review of the Project Capital Needs Assessment
Prudential did not ensure that the project capital needs assessment used during underwriting was
complete and accurate. MAP Guide, Revised 2002, chapter 5-25(A) and (B) provides that
lenders are required to provide HUD with a complete project capital needs assessment and
reserve for replacement report, and is required to provide HUD with its review of the project
capital needs assessment. Critical repairs are any individual or combination of repairs required
to correct conditions that (a) endanger the safety or well-being of residents, patients, visitors or
passers-by, (b) endanger the physical security of the property, (c) adversely affect project or
unit(s) ingress or egress; and (d) prevent the project from reaching sustaining occupancy. MAP
Guide, Revised 2002, chapter 11-1.B provides that the lender must provide a narrative analysis
describing the mortgage transaction containing a discussion of the characteristics of the proposed
loan that make it economically sound or an acceptable risk. The 2009 report used during
underwriting listed the general condition of the building as “good,” while the 2010 report 1 listed
the condition as “fair.” The 2009 report listed critical repairs estimated at $99,445, while the
2010 report listed them at $125,295 (a $25,850 increase) (see appendix D). The 2010 report also
listed 14 additional noncritical repairs totaling more than $1 million that were not listed in the
2009 report (see appendix E). In response to the 2010 needs assessment, on November 18, 2010,
HUD’s Detroit field office sent a letter to Prudential and the engineering firm that conducted the
needs assessment and noted that the additional repairs could not be explained solely by natural
deterioration. HUD requested an alternative explanation for the variance in the two needs
assessments. Neither HUD nor Prudential’s files contained a reply.




1
 The 2010 project capital needs assessment was ordered by Prudential after it was contacted by the property’s
management agent, which informed it that tenants had complained about the condition of the property.



                                                         5
In addition, item number 7 2 in the critical repairs for the 2010 needs assessment report was an
improper omission from the 2009 report. Specifically, the 2009 report required the same repair
for only two units, while the 2010 report required the same repair for 292 units, or 50 percent of
the building. It would be reasonable to assume that if the bathroom light fixtures had issues in
two units; the inspector would verify whether all bathroom light fixtures required similar repairs
or at least inspect them and certify that they were properly working. The improper omission
resulted in a health and safety issue. The item involved a non-ground-fault circuit, which was a
shocking hazard, considering that it was close to water. Critical repairs are any individual or
combination of repairs required to correct conditions that (1) endanger the safety or well-being of
residents, patients, visitors, or passers-by; (2) endanger the physical security of the property; (3)
adversely affect project or unit(s) ingress or egress; and (4) prevent the project from reaching and
sustaining occupancy. In addition, the owner improperly certified that critical repairs were
completed before closing. 3 MAP Guide, Revised 2002, chapter 13-17(A)(1), provides that
critical repairs must be completed before closing due to safety and security hazards. The needs
assessment completed in 2010 showed that 8 of the 10 critical repairs listed in the 2009 needs
assessment had not been completed.

A clear understanding of the physical condition of the property was of the utmost importance to
HUD’s underwriting determination because HUD relies on the third-party report to provide an
accurate accounting of the conditions, required repairs, and reserves. As a MAP-approved
lender, Prudential was responsible for hiring third-party contractors, such as inspectors and
engineers; therefore, it was also responsible for ensuring that the inspector was prudent and the
needs assessment report included supported and verifiable information. Prudential signed
certifications stating that all in-house, third-party forms, reports, and reviews were reviewed by
Prudential in accordance with HUD guidelines. MAP Guide, Revised 2002, chapter 11-1(B),
provides that the lender must provide a narrative analysis describing the mortgage transaction,
containing a discussion of the characteristics of the proposed loan that make it economically
sound or an acceptable risk.

The incomplete critical and noncritical repairs contributed to the property’s deteriorating
condition (see appendixes D and E), which contributed to the loan’s default. Specifically, HUD
determined that the property’s vacant units were not turned over in a timely manner due to a lack
of rental revenue to purchase supplies to complete the units for occupancy. Prudential’s files
included documentation supporting the same conclusion. Specifically, the default report
requested by Prudential showed that the overall condition of the property was unsatisfactory and
did not reflect the $1 million investment in noncritical repairs that had been approved for
payment by Prudential and HUD between September 2009 and January 2010.




2
  Item number 7 was to remove or disconnect the receptacle in bathroom lighting fixtures in the dwelling units.
3
  Principal B signed a certification, dated August 6, 2009, which stated that the borrower certified that the critical
repairs had been completed. MAP Guide, Revised 2002, chapter 13-17(A)(1)



                                                            6
   Prudential Did Not Adequately Assess the Eligibility of the Principals
   Prudential did not adequately assess the background and eligibility of the borrower and its
   principals before approving them for the FHA mortgage. 4 Specifically, one principal’s résumé
   did not adequately outline her multifamily experience. Further, the résumé did not address the
   type and size of the multifamily developments in which she had experience. It did not specify
   what her role was in the property developments and the length of time she served in the unstated
   capacity. MAP Guide, Revised 2002, chapter 8-3(J), provides that the lender’s underwriter is to
   evaluate the résumé of the principal(s). In doing so, the underwriter will look for experience in
   developing, owning, or building similar multifamily properties. It also explains that the
   underwriter should pay particular attention to the type and size of previous projects, the
   geographic area of business involvement, the length of time served in this capacity, and past
   roles in multifamily business.

   Prudential’s files also revealed that it did not asses the eligibility of two additional principals that
   were not listed in the underwriter narrative and the firm commitment loan application. The
   underwriter narrative listed one sole principal in the borrower’s Mortgage Development Team.
   However, Prudential’s files included limited liability company (LLC) formation documents for
   the borrower, dated February 8, 2008, which included principal A, who was originally listed as
   the sole principal on the underwriter narrative; principal B; and principal C (see table 1). The
   document showed that the “authorized principals” were principal B and principal C, and it
   approved them to conduct business related to Lafayette Towers. Prudential was aware of the
   additional principals; however, it did not assess their eligibility to participate and did not notify
   HUD of the additional principals during underwriting. Prudential’s files also included an
   amendment to the February 2008 LLC document, dated August 12, 2009, which excluded
   principal C and revised principal B’s title to authorized signatory. The HUD MAP underwriter
   who reviewed the firm commitment loan application explained that HUD was unaware that the
   borrower had additional principals beyond principal A (see table 1).
                                 Table 1: Listing of the borrower’s principals
                                                     Did Prudential assess the eligibility
Principals                  Position
                                                              of this principal?                 Relationship
    A              Owner - managing member           Yes (inadequate review of eligibility)   Mother of principal B
                     Managing member -
    B                authorized principal                             No                       Son of principal A
                    Chief financial officer -
    C                authorized principal                             No                              N/A




   4
       MAP Guide, Revised 2002, chapter 8-1(B)(1)(a)(1)



                                                           7
           Prudential’s failure to assess the additional principals’ eligibility was significant because
           principal B had significant financial issues. We identified two news articles, which showed that
           principal A and principal B were principals in another company that owned four additional
           multifamily highrise properties in Detroit, which had significant financial and creditworthiness
           issues. The articles explained that the issues ranged from outstanding liens totaling $2.2 million
           filed by contractors, civil suits, mortgage defaults, and foreclosures. The articles also discussed
           the background and status of four failed multifamily endeavors. In three of the transactions,
           principal B purchased the property with cash and then refinanced for a higher amount within a
           short time, similar to the Lafayette Towers transactions (see table 2).

                            Table 2: Listing of principal B’s failed multifamily projects
            Cash purchase    Cash purchase      Refinance
Property       amount            year            amount                               Comments
                                                             The property had been in default since April 2008. Principal
                                                             B’s company was ordered to pay the refinancing lender $14
   1          $4,200,000          2005         $15,000,000   million in September 2009.
                                                             No mortgage payments had been made to the lender since April
                                                             2009. A new receiver of the building was assigned in October
   2         $19,000,000          2005         $25,000,000   2009.
   3         $15,000,000          2005         $15,000,000   A new receiver was appointed in September 2009.
   4         $15,400,000          2003         $17,500,000   The property had been in default since February 2009.

           We conducted a lien search for the borrower and the additional principals and found that
           principal B and the same company mentioned in the articles had 11 liens totaling more than $2.4
           million that were filed against him before the loan’s firm commitment in July 2009. MAP
           Guide, Revised 2002, chapter 8-1(B)(1)(a)(1), provides that one of the major duties and
           responsibilities is to determine the acceptability of the borrower, if formed, and its key principals
           through a thorough analysis of their credit, character, financial condition, motivation for
           ownership, availability of assets for closing, and adequacy of income for total obligations (see
           appendix C). HUD’s MAP underwriter stated that if Prudential had submitted the loan
           application with the additional principals and it discovered that principal B had more than $2
           million in liens during processing, she would have been identified as a credit or financial risk.
           HUD’s MAP underwriter added that HUD would have considered ways to mitigate the risk,
           which could have included removing that principal from participation in the transaction.

           Prudential essentially allowed the borrower to circumvent HUD MAP requirements. It should
           have practiced due diligence and conducted a complete review of the borrower’s financial
           capacity and eligibility. MAP Guide, Revised 2002, chapter 11-1(B), also provides that the
           narrative analysis submitted by the lender must describe the mortgage transaction and evaluate
           the financial capacity of the principals of the borrower and its ability to repay the loan. In
           addition, Prudential’s failure to properly assess the background and eligibility of each principal
           resulted in the approval of a borrower that contributed to the project’s default. Specifically,




                                                             8
        Improper Property Management
        The borrower improperly took over the property’s management function without prior
        HUD knowledge. HUD’s records showed that the approved management agent notified
        it that it had chosen to resign as agent due to the borrower’s continued interference with
        the management of the property. 5 HUD determined that the borrower’s interference
        jeopardized the performance of the FHA-insured mortgage. Prudential also identified the
        inappropriate management interference and recommended that HUD exercise its right to
        require the borrower to immediately stop self-managing the property. 6 HUD further
        determined that when the borrower inappropriately took over the management function, it
        admitted several residents who were credit risks. HUD determined that the property’s
        tenants’ accounts receivable 7 total had accumulated to an excessive amount of $314,319
        because rents were not collected in a timely manner

        We reviewed HUD’s correspondence, which identified many examples of the improper
        and inadequate management of project funds, including but not limited to a
        misappropriation of $15,275 in unauthorized distributions to an affiliated company for
        asset management fees, unsupported costs totaling $13,240, unnecessary costs totaling
        $1,189, 8 a failure to document or obtain required bids, improperly encumbered property
        with liabilities totaling more than $600,000, and more than $39,000 in accounts payable
        for inappropriate management fees to be paid to an affiliated company with a name
        similar that of the borrower. 9
Prudential Did Not Adequtely Assess the Property’s Financial History
Prudential did not adequately assess the property’s financial history. Specifically, it did not
obtain all of the required financial statements on the property for the previous 3 years.
Prudential explained that during underwriting, the borrower stated that it could not obtain the
required financial statements because the previous management agent no longer managed the
property. Prudential also explained that the property’s last 3 years’ financial statements were not
required because the property was recently purchased; however, the MAP Guide does not
exclude recently purchased properties from the requirement. MAP Guide, Revised 2002, chapter
11-1(B), provides that a narrative analysis must be submitted by the lender to describe the
mortgage transaction and contain a discussion of the property’s financial analysis. MAP Guide,
Revised 2002, chapter 8-4(B) (3), provides that the borrower must submit the last 3 fiscal years’
financial statements on the facility. It also provides that there may be circumstances beyond the
borrower’s control under which the financial statements cannot be obtained. In these instances,
the borrower must submit evidence satisfactory to the lender that the financial statements were




5
  HUD Handbook 4381.5, section 2.12
6
  On May 12, 2010, HUD conducted a management occupancy review of the property and allowed Prudential to
accompany it during the review. Prudential’s recommendation to HUD was based on the results of the review.
7
  HUD Handbook 4370.1, exhibit 2.14.G
8
  HUD determined that these expenses were inappropriately disbursed from the operating account for the borrower’s
travel expenses. HUD Handbook 4381.5, section 3.1
9
  Paragraph 6 of the regulatory agreement, page 4



                                                        9
not obtainable. The MAP Guide provides that the lender’s case file must contain (1) a written
statement by the borrower explaining why the records were not obtainable and (2) a
memorandum from the lender stating that it evaluated the borrower’s statement and agreed that
the information was unattainable. Prudential’s and HUD’s files should have included the
required documentation. The intent of the financial statement requirements in the MAP Guide is
for the lender to document and analyze the property’s financial capacity to enable the lender and
HUD to make a sound economic decision regarding risk associated with approving a refinance
mortgage. Prudential’s failure to obtain the required financial statements resulted in HUD’s
inability to completely assess the property’s financial position and potentially unreliable income
and expense data used during the appraisal. HUD’s records included notes from the reviewing
MAP underwriter, which stated that the financial information provided in the application was
limited and not thorough.
The Appraisal Report Was Unsupported
Prudential did not ensure that the appraisal report was supported and allowed the value to be
overstated by more than $11 million. As a MAP-approved lender, Prudential was responsible for
hiring third-party contractors, such as an appraiser; therefore, it was also responsible for ensuring
that the appraiser was prudent and the appraisal included supported and verifiable information.
Prudential signed certifications stating that all in-house, third-party forms, reports, and reviews
were reviewed by Prudential in accordance with HUD guidelines. Prudential’s appraiser
determined that the value was $28.6 million. Based on information also available at the time of
Prudential’s appraiser review, we recalculated the value to be $17.5 million, more than $11
million less than Prudential’s appraised value (see table 3). MAP Guide, Revised 2002, chapter
11-1(B), provides that the lender must review in-house and third-party reports and determine that
the processing of the loan is in accordance with the requirements of the Guide and that the
proposed loan represents an acceptable risk or is economically sound.

We reviewed the MAP loan default review conducted by a third party, which included a desk
review of the appraisal. The reviewer’s methodology relied on the appraiser’s conclusions, and
it did not verify the data used in the appraisal. We also identified discrepancies in the review,
including a failure to identify that the subject property had sold within the past 3 years.




                                                  10
                                  Table 3: Valuation approach
                   Valuation approach               Land value                              Difference
                                                            Office of
                                              Prudential    Inspector
                                                             General
                                                              (OIG)
                   Market approach 10                   $28,600,000        $17,520,000      11,080,000
             Income capitalization approach 11          $28,600,000        $18,000,000      10,600,000
                    Cost approach 12                    $28,600,000        $15,900,000      12,700,000
                   Value conclusion                     $28,600,000        $17,520,000      $11,080,000

We reviewed the appraisal and identified several deficiencies that contributed to the
overstatement of the value. The deficiencies included inappropriate comparable sales,
inappropriate market data adjustments, unreasonable operating expenses, and unsupported
capitalization rates 13.

Inappropriate Comparable Sales
Improved sale 14 4 was not comparable due to the property style. Specifically, improved sale 4
consisted of townhomes and duplexes, while the subject property was a 22-story highrise (see
table 4). Prudential’s appraisal also showed that improved sale 5 had 184 apartments; however,
the building consisted of only 65 apartments at the time it was sold. Therefore, the price per unit
calculation and any analysis related to sale 5 would not be reliable. In addition, the appraiser
failed to use the previous April 22, 2008 (less than 1 year from the effective date of the
appraisal), sale of the subject property as a comparable sale, although it was most representative
of the subject. The subject property previously sold for $16 million, and the appraiser valued the
property at $28.6 million less than 1 year later with only $1.4 million in repairs. Prudential’s
appraiser documented the sale in the appraisal but did not document an analysis to determine
whether the sale was an arms-length transaction or below market. MAP Guide 7-11(A), requires
that the firm commitment application includes evidence of the last arm’s length transaction and
price. The previous April 2008 sale was considered a market value sale and would have been
one of the best indicators of the subject property’s value. The appraisal did not document why
the previous sale was not included as a comparable. MAP Guide, Revised 2002, chapter 7-1(A),




10
   A method of determining the value based on the selling price of similar items. A property’s value can be
estimated by reviewing comparables that are similar in size and features that are located near the subject property.
11
   A method that considers the income-generating potential of a property based on projections of income and
expenses that could be realized if the property were used to generate income into a value conclusion
12
   A method that assumes that the price someone should pay for a property should not exceed what someone would
pay to build an equivalent building. In this approach, the market price of the property is equivalent to the cost of
land plus cost of construction less depreciation. It is often most accurate for market value when the property is new.
13
   A rate of return on a real estate investment property based on the expected income that the property will generate.
Capitalization rate is used to estimate the investor's potential return on his or her investment.
14
   Improved property is land that has some improvements or land that has been partially or fully developed for use.
An improved sale is a comparable used to support the highest and best value of a particular property.



                                                           11
     provides that the valuation analysis is made to evaluate the existing or proposed property as
     security for a long-term HUD-insured mortgage. Section 7-4 states that an appraisal must
     adequately describe the geographic area, neighborhood, rental competition, sales comparable,
     site, and improvements. Uniform Standards of Professional Appraisal Practice (USPAP)
     Standard Rule 1-5 and Standard Rule 2-2(viii) require that appraisers analyze and report all sales
     of the subject property that occurred within the 3 years before the effective date of the appraisal.

           Table 4: Land sales used by Prudential’s appraiser and OIG’s determination
                Price per Distance
Improved sales                           Style       OIG determined appropriate comparable (yes-no)
                   unit     (miles)
Subject property*      $27,397            0            Highrise        Yes*
        1              $29,788           2.3           Midrise         Yes
        2              $24,809           1.7           Highrise        Yes (inappropriate adjustments)
        3              $26,150           10.9          Highrise        Yes (inappropriate adjustments)
        4              $45,662           16.2         Townhome         No – property style incomparable (inappropriate adjustments)
                                                                       Yes (inappropriate adjustments, unverified sale, overstated unit
       5               $17,120             1.5          Highrise       amounts, inaccurate price per unit, superior location)
     * The subject property previously sold in April 2008 and should have been used as a comparable sale.

              Inappropriate Market Data Adjustments
              Prudential’s appraiser made two sets of adjustments to the comparable sales. The first set
              of adjustments was made in the original report, and it showed that a positive net operating
              income adjustment was made to each of the comparable sales, indicating that each sale
              was inferior to the subject based on its income-producing capabilities. HUD reviewed
              the appraisal and required the appraiser to amend the market value conclusion because it
              was unsupported. The appraiser revised the analysis; however, it yielded a similar value
              conclusion, with positive overall adjustments ranging from 10 to 65 percent with
              inadequate support to justify why the adjustments were made. The 10 percent adjustment
              to improved sale 4, which was previously discussed, consisted of townhomes and
              duplexes and was not comparable to the subject property. The other improved sales had
              positive overall adjustments ranging from 45 to 65 percent (see table 5). The adjustments
              were excessive and indicated that the improved sales were not comparable to the subject
              property or the adjustments were made to support an unsupported value conclusion. The
              USPAP Standard Rule 1-4 requires the appraiser to collect, verify, and analyze all
              information necessary for creditable assignment results. Standard Rule 2-2(viii) requires
              the appraiser to describe the information analyzed; the appraisal methods and techniques
              employed; and the reasoning that supports the analysis, opinions, and conclusions.




                                                                    12
                               Table 5: Unsupported market data adjustments

       Improved sale        Price per     Adjustment          Adjusted price    Price per unit increase
                               unit       percentage             per unit          after adjustment
               1             $29,788       65 percent             49,150                 19,362
               2             $24,809        55 percent           $38,454                 13,645
               3             $26,150        55 percent           $40,533                 14,383
               4             $45,662        10 percent           $50,605                  4,943
               5             $17,120        45 percent           $25,010                  7,890


        Unsupported Operating Expense
        Prudential’s appraiser understated the property’s operating expenses. We reviewed form
        HUD-92264, HUD Multifamily Appraisal Report, and the property budget comparison
        report and determined that the property’s operating expenses from 2005 through 2007
        were within a stable range with an average of $5,860 per unit. The budget comparison
        report showed that expenses were only $4,326 per unit in 2008. Prudential’s appraiser
        determined that expenses before reserves and management fees were $5,122 per unit.
        The expense per unit before reserves and management fees should have been $5,604 per
        unit based on historical levels. The appraiser’s estimate considered activity from 2005
        through 2008; however, the lower expenditures in 2008 skewed the estimate. The
        reduced expenses were not consistent with the appraiser market conclusion. Specifically,
        the modest expense estimate was not commensurate with the appraiser’s conclusion of a
        stressed financial time and high unemployment period in the area. It would have been
        reasonable to estimate that the expenses would remain at or above the historical levels in
        2005 through 2007. The understated expenses placed the property at a disadvantage in its
        ability to pay the mortgage and increased the risk of default. MAP Guide, Revised 2002,
        chapter 7-7, provides that a determination is made of the portion of gross income, which
        must be used to maintain, operate, and repair the property and to defray the costs of
        ownership arising from it.
        Unsupported Capitalization Rates
        Prudential’s appraiser failed to properly analyze improved sales to arrive at the
        capitalization rate and failed to evaluate the risk associated with properties in the Detroit
        market in 2008 and early 2009. The appraiser calculated a capitalization rate of 8.5
        percent by applying four different capitalization methods used to capitalize the subject
        property’s net operating income for the income approach. 15 The appraiser’s review of the
        market painted a negative picture of the market, which indicated that investors would be
        more reluctant to invest in real estate in the Detroit area and would want a greater return
        on capital when they did. This review indicated that a higher capitalization rate would be




15
  A method that considers the income-generating potential of a property based on projections of income and
expenses that could be realized if the property were used to generate income into a value conclusion



                                                         13
            more representative of the subject property. However, the lender’s appraiser determined
            that the capitalization rate was only 8.5 percent, which yielded a value of $28.6 million.
            We determined that the capitalization rate for the property should have been 9.9 percent,
            which yielded a value of only $18 million under the income approach. 16 We made our
            determination using data that were available to the appraiser at the time of his review.
            MAP Guide, Revised 2002, chapter 7-7, provides that a determination is made of the
            portion of gross income, which must be used to maintain, operate, and repair the property
            and defray the costs of ownership arising from it. USPAP Standard Rule 1-4(c)(iii)
            requires appraisers to analyze comparable data as is available to estimate rates of
            capitalization and rates of discount. We determined that each of the following methods
            was flawed and unsupported (see table 6).

             Table 6: Prudential’s appraiser capitalization rate method conclusions
Capitalization rate method Rate Cause of unsupported capitalization rate
        Market extraction           8.50    Incomparable sale and failure to apply subject property’s previous sale
        Korpacz survey              8.00    Rate not supported by data included in the report
       Debt coverage ratio          8.98    Inaccurate mortgage constant
       Band of investment           8.71    Inaccurate mortgage constant and no support for equity dividend rate
        Rate conclusion             8.50


  Conclusion
  Prudential certified that the MAP application for the FHA-insured multifamily loan for Lafayette
  Towers was prepared and reviewed in accordance with HUD requirements. However, it did not
  properly analyze (1) the project capital needs assessment appraisal, (2) the experience and
  financial capacity of the borrower, (3) the financial history of the property, and (4) the appraisal.
  In addition, Prudential did not conduct due diligence, practice prudent underwriting, and conduct
  a sufficient review of related documents and third-party reports, which HUD relied on for
  insuring Lafayette Towers.

  HUD placed confidence in Prudential’s integrity and competence to properly implement the
  MAP Guide and other relevant guidance during the underwriting process; however, Prudential
  did not comply with HUD requirements, which resulted in HUD’s approval of a loan with
  significant financial risk. The owner defaulted on the mortgage loan in less than 10 months,
  resulting in a loss to HUD of more than $15 million.




  16
    Our capitalization rate determination included the previous 2008 sale of the property, which contributed to our
  higher 9.9 percent rate. Prudential’s appraiser did not include the sale in his analysis.



                                                            14
Recommendations
We recommend that the Director of HUD’s Detroit Office of Multifamily Housing Programs

      1A.    Refer Prudential to the Mortgagee Review Board to take appropriate action for
             violations that caused $15,727,529 in unnecessary or unreasonable cost to HUD’s
             FHA insurance fund or other administrative action as appropriate.

We also recommend that HUD’s Associate General Counsel for Program Enforcement

      1B.    Determine legal sufficiency and if legally sufficient, pursue remedies under the
             Program Fraud Civil Remedies Act against the borrower, its principals, or both
             for incorrectly certifying that the property’s critical repairs were completed
             before loan closing.

We further recommend that the Director of HUD’s Departmental Enforcement Center

      1C.    Pursue administrative actions, as appropriate, against the responsible party for the
             material underwriting deficiencies cited in this report.




                                               15
Scope and Methodology
We conducted the audit from October 2014 to June 2015 at the HUD Office of Multifamily
Development in Detroit, MI, and the Atlanta, GA, HUD OIG regional office. The audit covered
the period April 2008 through March 2012 and was adjusted as necessary.

The review was conducted based on information contained in Prudential’s project files with no
reliance on systems used and maintained by Prudential. The records obtained from Prudential
and reviewed for audit evidence are not computer generated or based; therefore, we did not
conduct an assessment of data reliability.

To accomplish our objective, we reviewed

•   Organizational charts effective from August 1, 2008, to December 31, 2012;

•   Applicable laws, regulations, and relevant HUD program requirements and HUD’s MAP
    Guide;

•   Prudential’s policies and procedures that govern the MAP program related to preparing,
    processing, and submitting the subject application;

•   A list of current and past employees, including job function, date of hire, and date of
    termination, if applicable, who were directly or indirectly involved with the processing or
    approval of the loan;

•   The appraisal conducted during loan origination;

•   The capital needs assessments conducted during loan origination and after loan default; and

•   Prudential’s and HUD’s project files related to Lafayette Towers, including but not limited to
    correspondence files, emails, processing and underwriting files, firm applications, repairs,
    and default activity.

We conducted interviews with management agents, Prudential’s employees, and HUD
employees. We also conducted a site visit of Lafayette Towers in March of 2015. We
determined the loss to the FHA fund to be more than $15 million (the amount of the claim paid,
$21,576,859, minus the amount of the sale for $5,849,330 equals $15,727,529).

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




                                                 16
objective(s). We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




                                                17
Internal Controls
Internal control is a process adopted 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:

•   Policies, procedures, and other management controls implemented to ensure that Prudential
    underwrote and processed the mortgage for Lafayette Towers in accordance with HUD’s
    MAP requirements.

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.
We evaluated internal controls related to the audit objective in accordance with generally
accepted government auditing standards. Our evaluation of internal controls was not designed to
provide assurance regarding the effectiveness of the internal control structure as whole.
Accordingly, we do not express an opinion on the effectiveness of Prudential’s internal control.




                                                  18
Appendixes

Appendix A


                          Schedule of Questioned Costs
                                              Unreasonable or
                  Recommendation number        unnecessary 1/
                              1A                     $15,727,529
                            Totals


1/   Unreasonable or unnecessary costs are those costs not generally recognized as ordinary,
     prudent, relevant, or necessary within established practices. Unreasonable costs exceed
     the costs that would be incurred by a prudent person in conducting a competitive
     business. We determined the unreasonable cost to be the loss to the FHA fund. We
     determined the loss to the FHA fund to be more than $15 million (the amount of the
     claim paid, $21,576,859, minus the amount of the sale for $5,849,330 equals
     $15,727,529).




                                             19
Appendix B
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




                               20
Ref to OIG   Auditee Comments
Evaluation




Comment 1




                            21
Ref to OIG   Auditee Comments
Evaluation




Comment 1




                            22
Ref to OIG   Auditee Comments
Evaluation




Comment 1




                            23
Ref to OIG   Auditee Comments
Evaluation




Comment 1




                            24
Ref to OIG   Auditee Comments
Evaluation




Comment 1




                            25
Ref to OIG   Auditee Comments
Evaluation




Comment 1




Comment 1




                            26
Ref to OIG   Auditee Comments
Evaluation




Comment 1




                            27
Ref to OIG   Auditee Comments
Evaluation




                            28
Ref to OIG   Auditee Comments
Evaluation




Comment 1




                            29
Ref to OIG   Auditee Comments
Evaluation




Comment 2




                            30
Ref to OIG   Auditee Comments
Evaluation




Comment 3




Comment4




                            31
Ref to OIG   Auditee Comments
Evaluation




                            32
Ref to OIG   Auditee Comments
Evaluation




Comment 1




Comment 5




                            33
Ref to OIG   Auditee Comments
Evaluation




Comment 5




Comment 5



Comment 5




                            34
Ref to OIG   Auditee Comments
Evaluation




Comment 6




                            35
Ref to OIG   Auditee Comments
Evaluation




Comment 7




                            36
Ref to OIG   Auditee Comments
Evaluation




Comment 8




                            37
Ref to OIG   Auditee Comments
Evaluation




Comment 9




                            38
Ref to OIG   Auditee Comments
Evaluation




Comment 10




Comment 10




                            39
Ref to OIG   Auditee Comments
Evaluation




Comment 10




                            40
Ref to OIG   Auditee Comments
Evaluation




Comment 10




                            41
Ref to OIG   Auditee Comments
Evaluation




Comment 10




                            42
Ref to OIG   Auditee Comments
Evaluation




Comment 11




                            43
Ref to OIG   Auditee Comments
Evaluation




Comment 12




                            44
Ref to OIG   Auditee Comments
Evaluation




                            45
Ref to OIG   Auditee Comments
Evaluation




Comment 12




Comment 13




                            46
Ref to OIG   Auditee Comments
Evaluation




                            47
Ref to OIG   Auditee Comments
Evaluation




                            48
                 OIG Evaluation of Auditee Comments


Comment 1   Prudential’s outside attorney’s comments state that we ignored the
            requirements of the MAP Guide and improperly substituted its own
            judgment as to how the Lafayette Towers loan should have been
            underwritten. Prudential outside attorneys also state that we failed to
            consider the MAP Guide in relation to its audit objective and believes that
            Prudential should have second guessed the conclusions in the appraisal
            and the project capital needs assessment. In addition, Prudential’s
            comments included extensive criteria for HUD’s responsibilities in the
            underwriting process.
            We applied criteria from the MAP Guide to review the lender’s
            conclusions versus what the requirements state. We also conducted the
            audit in accordance with generally accepted government auditing
            standards. Prudential has specific responsibilities, such as conducting a
            sufficient review of all loan documents submitted to HUD for review,
            which we determined did not occur. Although HUD approved the loan,
            Prudential was responsible for reviewing the documents to ensure
            compliance with the requirements and that the loan presented an
            acceptable risk, which it did not. The MAP Guide, revised in 2002,
            paragraph 15-1(A), states that HUD places confidence in the lender’s
            integrity and competence, thus relying on the documents provided by
            Prudential. The audit objective was to determine whether the loan was
            underwritten and processed in accordance with HUD guidelines, including
            but not limited to the MAP Guide. The report cites all applicable
            requirements to support the findings in the footnotes and the narrative.
            We did not conclude that Prudential should have second guessed the
            appraiser and the project capital needs assessment engineer. Instead, we
            concluded that Prudential was required to conduct a review of the
            appraisal and the project capital needs assessment reports to ensure
            compliance with the MAP Guide and applicable USPAP requirements.
            Our review determined that the appraisal and project capital needs
            assessment submitted to HUD did not comply with the requirements and
            did not include the information required. In addition to the criteria cited in
            the report, the MAP Guide, revised in 2002, paragraph 1-4(C)(5), states
            that for the firm commitment application, the lender performs a complete
            underwriting of the application, including an architecture review, a cost
            review, and a review of the appraisal. Further, Prudential certified that
            third-party reports, including the appraisal and the project capital needs
            assessment, were reviewed to ensure compliance with requirements and
            that they were accurate and complete. Prudential should have conducted a
            review sufficient to certify that the third-party reports complied.
            Paragraph 7-9(B) also lists the responsibilities of the lender.


                                       49
Comment 2   Prudential’s outside attorney’s comments state that HUD certified to the
            accuracy and appropriateness of the judgments that we cite as evidence
            that Prudential did not properly underwrite the loan. However, Prudential
            had the responsibility to conduct a review before submitting the loan to
            HUD, including certifying that the loan was in accordance with HUD
            guidelines and presented an acceptable risk to HUD, which it did not. See
            comment 1 above.
Comment 3   Prudential’s outside attorney’s comments state that an independent
            reviewer concluded that Prudential complied with the MAP Guide
            requirements while underwriting the loan for Lafayette Towers.
            Prudential outside attorney’s also state that the independent reviewer
            generally satisfied the reporting requirements of the MAP Guide and the
            USPAP standards. However, we reviewed the independent reviewer’s
            report as part of the audit and noted its conclusions in the audit report as
            they related to the objective and findings. The audit considered the
            independent reviewer’s report; however, assessing the accuracy and
            completeness of the independent reviewer’s report was not the audit’s
            objective.
Comment 4   Prudential’s outside attorney’s comments state that we failed to consider a
            number of factors that led to the Lafayette default. Prudential’s outside
            attorney’s also state that, overall, it appeared that the unexpectedly high
            vacancy rate at the property was caused by multiple factors, including the
            misappropriation of funds, deteriorating property conditions as a result of
            incomplete construction and deferred maintenance, and inadequate
            property management.
            We acknowledge that the default was caused by those factors. However,
            we also determined that Prudential’s failure to properly underwrite and
            process the loan was directly connected to those factors. Specifically,
            OIG determined that Prudential’s (1) inadequate review of the project
            capital needs assessment contributed to the incomplete construction and
            (2) inadequate review of the principals’ eligibility resulted in the approval
            of principals that misappropriated project funds and inappropriately took
            over the property’s management function without notifying HUD.
Comment 5   Prudential’s outside attorney’s comments state that the project capital
            needs assessment was complete and accurate. Prudential’s outside
            attorney’s also state that it was known by Prudential and HUD, that the
            borrower, fired the management agent after closing and directed all project
            income to be deposited into a nonproject account without notification to or
            approval from HUD or Prudential. Repairs were not made during that
            timeframe. As a result, Lafayette Towers’ physical condition deteriorated
            in the 18 months between the two project capital needs assessments.




                                       50
We acknowledge that the borrower inappropriately diverted project funds.
However, we also determined that Prudential’s failure to adequately assess
the borrower and its principals resulted in the approval of an inappropriate
borrower, which misappropriated project funds and inappropriately took
over the property’s management function without notifying HUD.
In addition, Prudential outside attorney’s state that HUD expressed its
opinion to Dominion that “the additional repairs and increase in the
required reserves listed in the latest report cannot be fully explained solely
by natural deterioration of the building.” However, the deterioration in the
Lafayette Towers buildings was not natural. All buildings require routine
maintenance and if maintenance is withheld or lacking, the physical
condition of any building will deteriorate.

We acknowledge that some of the repairs could have resulted from
inadequate maintenance; however, some of the repairs did not occur as a
result of poor maintenance.
Further, Prudential’s outside attorney’s comments state that the report also
suggests that the project capital needs assessment inspectors must not have
inspected enough units because the first report identified only two electric
receptacles in the bathroom that needed replacement, while the second
report noted that almost 50 percent of the receptacles needed to be
replaced. During its first inspection, Dominion inspected 100 of the 584
units in Lafayette Towers. Only two of those units had receptacle
problems identified. Dominion’s conclusions, therefore, were reasonable,
and Prudential correctly relied on those conclusions.

Appendix 5M of the MAP Guide provides that lenders are required to
determine whether an adequate sampling of units has been made. It also
provides that the needs assessor must inspect enough dwelling units to be
able to formulate an accurate estimate of repair, replacement, and major
maintenance needs. We determined that the initial needs assessment
sampled only 100 of 584 units, or 17 percent, and the second needs
assessment sampled 205 of 584 units, or 35 percent. The initial needs
assessment identified an issue with the receptacles in only 2 of the units,
or 2 percent; however, the second report required the same repair for 292
units, or 50 percent of the project. The initial needs assessment included
the critical repair to install ground fault circuit receptacles in kitchens and
bathrooms. This item involved ungrounded outlets in the walls of all of
the bathrooms. The needs assessment also included the need for critical
repairs to remove or disconnect receptacles in bathroom lighting fixtures
in apartments E1813 and E2203 (the two units in question). This item
involved ungrounded outlets in the bathroom lighting fixtures.




                           51
            We determined that it was unreasonable for the needs assessment to
            require this repair for only two units, considering that the initial needs
            assessment required bathroom wall receptacles to be replaced with a
            ground fault circuit interrupter. It would have been prudent for the needs
            assessment to require the electrician to check all lighting fixture (medicine
            cabinet) receptacles while physically in the bathrooms and disconnect or
            remove them while on site. The needs assessment should have required
            the repair of all of the units, considering that it was a shocking hazard and
            both of the faulty grounds were within a close distance within the same
            room.
Comment 6   Prudential’s outside attorney’s comments state that it adequately assessed
            the eligibility of the borrower and its principal before approving them for
            the FHA mortgage. Prudential outside attorney’s state that we are
            incorrect in stating that there was more than one principal in Zulu 117,
            LLC, as the documents provided by the borrower stated that the principal
            was the 100 percent member of Zulu 117, LLC. Prudential’s outside
            attorney’s comments include details about the borrower’s experience,
            creditworthiness, and financial statements.

            We considered the details provided and determined that they were also
            outlined in the underwriter narrative submitted to HUD for review.
            However, the additional details did not comply with MAP Guide,
            paragraph 8-3(J), which provides that the lender’s underwriter is to
            evaluate the resume of the principal(s) and in doing so, the underwriter
            will look for its experience in developing, owning, or building similar
            multifamily properties. The criteria also require lenders to pay particular
            attention to (1) type and size of previous projects, (2) geographic area of
            business involvement, (3) length of time served in this capacity, and (4)
            past roles in multifamily business. Prudential did not adequately outline
            principal A’s multifamily experience, did not address the type and size of
            the multifamily developments in which she had experience, and did not
            specify her role in the property developments and how long she had served
            in the unstated capacity.
            We acknowledged that the borrower had one member with an interest in
            the company. However, we determined that the borrower had two
            additional principals whose eligibility was not assessed by Prudential.
            The MAP Guide, paragraph 8-3(D)(1)(a)(1), provides that principals of
            the borrower include all operating officers of the corporation. OIG
            determined that these additional principals were operating officers within
            the company. Specifically, the borrower’s limited liability corporation
            documents showed that principals A and B were managing members. The
            limited liability documents showed that principal C was the chief financial
            officer of the company.



                                      52
Comment 7   Prudential’s outside attorney’s comments state that it adequately assessed
            the property’s financial history. Prudential also states that it obtained 3
            years of historical operating information for Lafayette Towers from the
            borrower. Prudential outside attorney’s add that a complete financial
            history could not be provided as the prior property management firm is no
            longer employed by the new owner; however, the borrower provided a 3-
            year financial history, which was included as part of its original purchase
            transaction.
            We acknowledge that Prudential provided the property’s 3-year financial
            history. However, the financial records did not fully comply with MAP
            requirements because Prudential did not provide the required financial
            statements for the previous 3 years. Instead, it provided only a
            comparative operating statement for 2005 through 2007.
            Further, Prudential outside attorney’s state that a complete financial
            history could not be provided as the prior property management firm is no
            longer employed by the new owner; however, the borrower provided a 3-
            year financial history, which was included as part of its original purchase
            transaction.
            The MAP Guide acknowledges that there may be circumstances beyond
            the borrower’s control under which the financial statements cannot be
            obtained. In these instances, the MAP Guide provides that the borrower
            must submit evidence satisfactory to the lender that the financial
            statements were not obtainable. The MAP Guide provides that the
            lender’s case file must contain (1) a written statement by the borrower
            explaining why the records were not obtainable and (2) a memorandum
            from the lender stating that it evaluated the borrower’s statement and
            agreed that the information was unattainable. Prudential’s files did not
            include the required documentation.
Comment 8   Prudential’s outside attorney’s comments state that the appraisal report
            was adequate. Prudential’s outside attorney’s further state that the
            appraisal for the Lafayette project was conducted by an appraiser
            specifically approved by HUD and that HUD conducted a technical review
            of the appraisal and concluded that the appraisal complied with the
            requirements of the MAP Guide and USPAP. In addition, Prudential
            states that none of our findings are supported by the record. For example,
            we state that the appraiser failed to define the term “market value” in the
            appraisal report. Prudential’s outside attorney’s added that we fail to
            explain how this alleged failure had anything to do with the default. In
            any event, OIG is wrong. Market value is defined and discussed on pages
            7, 8, 54, and 68 of the appraisal. Those pages define and discuss how
            market value is calculated.




                                      53
             The audit report documented the MAP and USPAP requirements that
             Prudential did not comply with while conducting its review of the
             appraisal. Although the appraisal is a professional opinion, it must be
             supported and include verifiable information, which Prudential’s appraisal
             did not. The land value concluded by us is supported with information
             that was available to Prudential’s appraiser at the time the appraisal was
             conducted. Further, the audit report did not state that Prudential failed to
             define the term “market value” in the appraisal report.
Comment 9    Prudential’s outside attorney’s comments state that the appraisal analyzed
             the comparables appropriately. Prudential’s outside attorney’s state that
             the sale of Lafayette Towers Apartments by the seller to Zulu, Inc., was
             not used as a comparable in the appraiser’s sales approach analysis
             because it was not a comparable sale. It adds that the sale of Lafayette
             Towers Apartments was a 1031 exchange versus a “market value sale”
             based on its income-producing potential or its comparability to otherwise
             comparable sales.
             USPAP Standard Rule 1-5 provides that when the value conclusion to be
             developed is market value, an appraiser must, if such information is
             available to the appraiser in the normal course of business, omit or analyze
             all sales of the subject property that occurred within the 3 years before the
             effective date of the appraisal. Just stating that it was a 1031 exchange
             does not provide evidence that the sale was not market value and should
             not have been considered as a comparable sale. We determined that the
             previous sale of Lafayette Towers was on a per unit basis at a sale price
             that fell in the mid-range of three of the comparable sales that the
             appraiser used in the market data approach. If the appraiser had analyzed
             the Lafayette Towers sale, dated April 22, 2008, a different value
             conclusion would have been reached.
             Further, Prudential’s outside attorneys agree that the appraiser did not
             comment on this fact in the appraisal report and it would have been useful
             information. Prudential and HUD were aware that the original sale was a
             1031 exchange.
             We determined that the sale was comparable and was previously sold at
             market value. We also noted that the borrower outbid seven other offers
             by $2 million.
Comment 10   Prudential’s outside attorney’s comments state that the sales comparison
             addendum included an error with respect to comparable number 5 and
             indicated that there was no meaningful impact to the value conclusion.
             We acknowledge that the error in comparable 5 alone would not
             significantly affect the value of the property. However, when all of the
             issues identified in the appraisal were considered in conjunction with each


                                       54
             other, the value of the property was significantly overstated. The appraisal
             deficiencies included inappropriate comparable sales, inappropriate
             market data adjustments, unreasonable operating expenses, and
             unsupported capitalization rates.
             Based on the adjustments Prudential made in the chart on page 21 of its
             comments, we determined that Prudential attempted to correct issues
             related to the appraiser’s misinformation on the number of units (184 units
             versus 65 units) for comparable sale number 5 and correct the sales
             comparison grid to support the value conclusion. We questioned whether
             the comparable sales were appropriate and accurate and concluded that the
             adjustments made in the sales comparison approach were not meaningful
             and supported. Specifically, the appraiser made 50 percent adjustments
             for design and appeal to four of the five comparable sales without reliable
             analysis or support for the conclusion. Prudential failed to provide
             additional support for these adjustments. USPAP Standard Rule 2-
             2(a)(vii) requires the appraiser to describe the information analyzed; the
             appraisal methods and techniques employed; and the reasoning that
             supports the analysis, opinions, and conclusions. Standard Rule 2-2
             further states that the appraiser must provide sufficient information to
             enable the client and intended users to understand the rationale for the
             opinions and conclusions, including reconciliation of the data and
             approaches.
Comment 11   Prudential’s outside attorney’s comments state that the rent adjustments
             made were appropriate.
             We did not question the validity of the appraiser’s rent adjustments.
             Specifically, the audit report discussed only the following appraisal
             deficiencies: (1) inappropriate comparable sales, (2) inappropriate market
             data adjustments, (3) unreasonable operating expenses, and (4)
             unsupported capitalization rates.
Comment 12   Prudential’s outside attorney’s comments state that the appraisal report
             provided the required information and the underwriter included a
             summary. Prudential’s outside attorney’s also states that to determine the
             impact of applying OIG’s $5,604 per unit operating expenses, Prudential
             calculated that the debt service coverage would have been reduced from
             1.32 to 1.31 percent based on the note interest rate of 5.35 percent.

             We acknowledge that the difference in the expenses alone would not
             significantly affect the value of the property. However, when all of the
             issues identified in the appraisal were considered in conjunction with each
             other, the value of the property was significantly overstated. The appraisal
             deficiencies included inappropriate comparable sales, inappropriate
             market data adjustments, unreasonable operating expenses, and



                                       55
             unsupported capitalization rates. Prudential’s appraiser determined that
             the value was $28.6 million. Based on information available at the time of
             Prudential’s appraiser review, we recalculated the value to be $17.5
             million, more than $11 million less than Prudential’s appraised value.

Comment 13   Prudential’s outside attorney’s comments state that it strongly disputes
             OIG’s capitalization rate of 9.9 percent for the subject property in January
             2009. Prudential’s outside attorney’s also state that the five comparable
             sales reported overall rates of 8.5, 8.4, 9.6, 7.2, and 8.5 percent, averaging
             8.4 percent. Further, Prudential’s outside attorney’s state that it was not
             reasonable to impose a higher rate in 2015, more than 6 years after the
             date of the appraisal, based on factors not in place at the time of the
             appraisal. It concludes that OIG’s allegations that Prudential did not
             adequately review the appraisal are unsupported and unfounded.
             We reviewed the market abstraction of capitalization rates stated by the
             appraiser and determined that the income and expenses related to the
             comparable sales were not supported. The appraiser assumed an operating
             expense of $4,500 per unit for each of the comparable sales, and
             comparable sale number 5 had an income based on the incorrect number
             of units. Therefore, the capitalization rates derived were not supported.
             We determined a capitalization rate of 9.9 percent. Lafayette Towers sold
             for $16 million in April 2008, and according to income and expense
             reports, the complex had a net operating income of more than $1.58
             million, which yielded a capitalization rate of 9.9 percent.
             Further, while the Korpacz Survey might indicate a different capitalization
             rate according to the appraiser, the Korpacz is based on a national
             multifamily market and not on the Detroit market. As noted in the
             appraisal report and Prudential’s response, the Detroit market was in an
             extreme economic downturn in 2008 and 2009, and it would be expected
             that a capitalization rate for a property in mid-town Detroit would be
             higher than in other parts of the country.




                                        56
             Appendix C

                                              Schedule of Borrower’s Principal’s Liens


   Filing type           Original filing date     Amount        Debtor(s)                                  Comments
                                                            Company of
                                                            which principal B
                                                            was principal &
                                                            managing                 Lien filed before firm commitment date and loan
Judgments docket           March 13, 2007             $843 member 17                 closing with no release date
                                                            Company of
                                                            which principal B
                                                            was principal &          Lien filed before firm commitment date and loan
Civil new filing           August 11, 2006          $16,248 managing member          closing with no release date
                                                            Company of
                                                            which principal B
Small claims                                                was principal &          Lien filed before firm commitment date and loan
judgment                  December 5, 2005           $8,000 managing member          closing with no release date

                                                                                     Lien filed before firm commitment date and loan
State tax warrant           July 19, 2008              $853 Principal B              closing with no release date

                                                                                     Lien filed before firm commitment date and loan
Judgments docket          October 26, 2000            $5,721 Principal B             closing with no release date
                                                                                     Lien filed before firm commitment date and loan
Judgment                  December 3, 1996             $720 Principal B              closing with no release date

                                                                                     Lien filed before firm commitment date and loan
Judgment                 November 29, 1993       $1,804,635 Principal B              closing with no release date

                                                                                     Lien filed before firm commitment date and loan
Judgments docket            July 27, 1993           $17,468 Principal B              closing with no release date

                                                                                     Lien filed before firm commitment date and loan
Civil new filing           October 5, 1992         $526,415 Principal B              closing with no release date

                                                                                     Lien filed before firm commitment date and loan
Civil suit                  March 1,1991            $98,364 Principal B              closing with no release date
                                                                                     Lien filed before firm commitment date and loan
Judgments docket            March 29,1989            $3,279 Principal B              closing with no release date
     Total                                       $2,482,546




             17
                  We determined that the borrower and the above-referenced company had the same address.



                                                                      57
            Appendix D

                          Schedule of Critical Repairs Contributing to Property Deterioration
                                                                                                          Listed in 2009 project
                                2010 critical need repairs                                      Total         capital needs
                                                                                                               assessment
1. Install 7 designated handicap parking spaces & add access aisles at the current 6
                                                                                                                   yes
handicap parking spaces.                                                                         $1,950
2. Install 2 cross paths from handicap parking spaces to buildings.                                $500            yes
3. Install HUD-compliant smoke detectors in hallways and bedrooms.                               $4,095            yes
4. Install ground fault circuit receptacles in kitchens.                                        $20,440            yes
5. Replace or disconnect receptacle located within the entry foyer of the west building.       Complete            yes
6. Replace missing light fixtures globe in hallway of dwelling unit 1302-W.                    Complete            yes
7. Remove or disconnect receptacle in bathroom lighting fixtures in dwelling units 1813-E
                                                                                                                   yes
& 2203-E.                                                                                       $14,600
8. Abate friable asbestos-containing materials in parking deck area.                            $10,000            yes
9. Implement an asbestos operation and maintenance plan.                                           $500            yes
10. Repair 11th floor “B” stairway door of the east building that is not operating properly.       $100            no
11. Repair improperly working emergency lighting in stairways and hallways.                      $1,600            no
12. Repair loose door hardware on stairway doors.                                               No cost            no
13. Replace damaged outlet in common hallway outside dwelling unit 303-E.                           $35            no
14. Install self-closing hinges on dwelling units’ doors.                                       $29,200            no
15. Install National Fire Protection Association-approved exit lighting at stairway doors       $32,200            no
16. Drain water from fire hose in 12th floor stairway.                                          No cost            no
17. Cover exposed electrical wires at junction box at parking deck                                  $75            no
18. Have a licensed plumbing contractor evaluate the galvanized water supply pipe.              $10,000            no
19. Complete correction of all violations noted on building inspection.                         Pending            no
Total                                                                                          $125,295




                                                                  58
         Appendix E

                     Schedule of Noncritical Repairs Contributing to Property Deterioration
                              2010 noncritical repairs                                   Total         Comments


1. Repair damaged plaster in hallways.                                                    No cost          Completed*
2. Repair-regrout bathroom and shower ceramic tile.                                       No cost          Completed*
3. Replace door in hallway of dwelling unit 1302-W.                                         $225      Repair incomplete
4. Replace exit door onto the roof of the east building.                                    $275      Repair incomplete
5. Repair damaged brick on the north side of the west staircase in the covered parking
deck.                                                                                     No Cost     Repair incomplete
6. Repoint brick on south side of the west stair within the parking deck.                 No Cost     Repair incomplete
7. Repair damaged concrete located at the entrance into the covered parking deck and
the service entrance of the west building.                                               Complete            Completed
8. Repair damaged concrete steps on west stair case located in parking deck.             Complete            Completed
9. Repair damaged guard rail at exterior patios.                                          Pending   Repair Inadequate**
10. Repair spalling concrete on sidewalks.                                               Complete            Completed
11. Repair plaster ceiling located within community room in the west building.           Complete            Completed
12. Repair asphalt parking area located on the north side of the property.                 $1,326     Repair incomplete
13. Complete renovation of elevators.                                                    Complete            Completed
                                                                                           $1,826
14. Refurbish parking garage, including exterior brick wall, concrete rooftop,
structural columns, walls, bricks, and concrete staircase.                               $205,800       New work item
15. Replace air handler units in east and west buildings.                                 $89,460       New work item
16. Replace rooftop make-up air units.                                                    $50,554       New work item
17. Identify ground water condition and repair sink holes in parking lot.                 Pending       New work item
18. Replace damaged exterior concrete patios at north ends of east and west buildings.    $12,000       New work item
19. Perform plumbing repairs based on the recommendations of plumbing evaluation
noted in critical repairs.                                                                   Pending      New work item
20. Replace dwelling entry units 303W, 1609E, 1704E, and 313W.                                 $1,180     New work item
21. Replace dwelling entry locks on select units.                                              $1,500     New work item
22. Repair leaking butterfly valves on boilers as noted.                                       $9,600     New work item
23. Repair or replace cracked shower pans in dwelling units.                                $146,000      New work item
24. Replace master bath shower doors.                                                        $40,000      New work item
25. Replace roofs on east and west building.                                                $278,408      New work item
26. Return down units to rentable condition.                                                $224,000      New work item
27. Repair spalling concrete at select areas of parking deck.                                  $8,000     New work item
                                                                                          $1,066,502
Total                                                                                     $1,068,328
         * These repairs were completed; however, undetected water leaks continued to damage the walls.
         ** This was reportedly completed; however, during the updated project capital needs assessment 2010
         inspection, the entire parking garage structure was observed in poor condition.
         Repairs listed in 2009 project capital needs assessment, repair items1 – 13.
         New repairs not listed in 2009 project capital needs assessment, repair items 14 -27.



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