oversight

The Owner of Laurentian Hall Apartments, Pittsburgh, PA, Did Not Always Manage Its HUD-Mortgaged Project in Accordance With HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2017-03-24.

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

            Laurentian Hall Apartments,
                  Pittsburgh, PA
                        Mark-to-Market Program




Office of Audit, Region 3            Audit Report Number: 2017-PH-1002
Philadelphia, PA                                         March 24, 2017
To:            Brenda Brown, Director, Asset Management Division, Baltimore Multifamily
               Hub, 3BHMLAP
               //signed//
From:          David E. Kasperowicz, Regional Inspector General for Audit, Philadelphia
               Region, 3AGA
Subject:       The Owner of Laurentian Hall Apartments, Pittsburgh, PA, Did Not Always
               Manage Its HUD-Mortgaged Project 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 the Mark-to-Market-mortgaged Laurentian Hall
Apartments multifamily project.
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 215-
430-6734.
                    Audit Report Number: 2017-PH-1002
                    Date: March 24, 2017

                    The Owner of Laurentian Hall Apartments, Pittsburgh, PA, Did Not Always
                    Manage Its HUD-Mortgaged Project in Accordance With HUD
                    Requirements



Highlights

What We Audited and Why
We audited Laurentian Hall Apartments (project) because of its failure to submit financial
statements in a timely manner and because we had never audited the project before. Our audit
objective was to determine whether the project’s owner managed the project in accordance with
its U.S. Department of Housing and Urban Development (HUD)-held mortgage and other HUD
requirements.

What We Found
The owner of Laurentian Hall Apartments did not always manage its multifamily project in
accordance with HUD requirements. Specifically, the owner (1) did not submit financial
statements and mortgage payments as required, (2) improperly leased commercial space without
HUD’s consent to a related party at below market rent, (3) disbursed funds for building
improvements without HUD’s approval, (4) did not properly procure products and services, (5)
created a lien on the property in violation of its mortgage terms, and (6) incurred costs that were
not eligible for the project’s operations. As a result, the project was in default of its HUD-held
mortgage and it incurred more than $71,000 in unsupported costs from unapproved building
improvements and improper procurement of products and services, and nearly $9,000 in
ineligible expenditures. The project also lost the opportunity to increase surplus cash available
to pay its mortgage by $282,578 because it didn’t collect fair market rent on its commercial
space, and it exposed project assets to risk from creditor claims of up to $25,000.

What We Recommend
We recommend that HUD require the owner to (1) pay the project $282,578 from non-project
funds for the commercial rent not collected because the lease charged less than fair market rent,
and (2) request approval from HUD to lease the commercial space and if HUD approves the
request, then execute a lease at fair market rent. We also recommend that the Director of HUD’s
Asset Management Division, Baltimore Multifamily Hub (1) recalculate the project’s annual
surplus cash balances to determine whether the project should make additional payments from
surplus cash toward its mortgage beyond the $13,740 that it paid during the audit, and (2)
provide training and technical assistance to the owner and its management agent to ensure
compliance with the terms of its mortgage and other applicable HUD requirements.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................5
         Finding: Laurentian Hall Apartments’ Owner Did Not Always Manage Its HUD-
         Mortgaged Project in Accordance With HUD Requirements ...................................... 5

Scope and Methodology .........................................................................................12

Internal Controls ....................................................................................................14

Appendixes ..............................................................................................................15
         A. Schedule of Questioned Costs and Funds To Be Put to Better Use ...................... 15

         B. Auditee Comments and OIG’s Evaluation ............................................................. 17




                                                            2
Background and Objective
Laurentian Hall Apartments (project) is a 36-unit building located in Pittsburgh, PA, owned by a
nonprofit corporation, Laurentian Hall Associates, Inc.. It receives project-based Section 8
assistance through its housing assistance payments contract with the U.S. Department of Housing
and Urban Development (HUD). The building has 35 Section 8 rental units available to eligible
families of low to moderate incomes. The project has a management agent agreement with RSI
Property Management Corporation and is governed by the owner’s board of directors.

The project’s Federal Housing Administration mortgage was initially insured under the Section
221(d)(3) program. 1 On July 8, 1998, the owner restructured its mortgage during HUD’s Mark-to-
Market demonstration program. 2 HUD paid off the first mortgage and replaced it with a
nonperforming,3 HUD-held mortgage of $978,870. The mortgage documents required the owner
to submit certified financial statements that identified surplus cash 2 months after the end of each
year, accompanied by a payment of $36,300 toward principal and interest. The payment due
could be higher or lower depending on the surplus cash balance.

The Section 8 program was authorized by Congress in 1974 and developed by HUD to provide
rental subsidies for eligible tenant families residing in newly constructed, rehabilitated, existing
rental, or cooperative apartment projects. Laurentian Hall received the following payments under
its housing assistance payments contract:

                                                    Section 8 funds authorized
                                   Year
                                                          and disbursed
                                   2015                        $135,382
                                   2014                         120,947
                                   2013                         101,060
                                   Total                        357,389




1
    The Section 221(d)(3) program insures mortgage loans to facilitate the new construction or substantial
    rehabilitation of nonprofit multifamily rental or cooperative housing for moderate-income families, the elderly,
    and the handicapped.
2
    In 1997, Congress established the Mark-to-Market program to help preserve the availability and affordability of
    low-income rental housing while reducing the cost to the Federal Government of rental assistance provided to
    low-income households using project-based Section 8 funds. Under this program, HUD resets the rents to the
    prevailing market level and restructures the property’s mortgage debt, if needed, to permit a positive cash flow.
    As a result, the restructured project is subject to long-term use and affordability restrictions.
3
    Mortgage payment requirements on a “nonperforming mortgage” are determined at the end of the project’s fiscal
    year and are based on the amount of surplus cash reported by the owner in the project’s annual financial
    statements.




                                                          3
The project’s use agreement, housing assistance payments contract, mortgage restructuring
mortgage and its rider, mortgage restructuring mortgage note, and HUD multifamily project
handbooks require the owner to manage its project in accordance with its mortgage terms and
applicable HUD requirements.

Our objective was to determine whether the project’s owner managed the project in accordance
with its HUD-held mortgage and other HUD requirements.




                                               4
Results of Audit

Finding: Laurentian Hall Apartments’ Owner Did Not Always
Manage Its HUD-Mortgaged Project in Accordance With HUD
Requirements
The owner of Laurentian Hall Apartments did not always manage its multifamily project in
accordance with HUD requirements. Specifically, the owner (1) did not submit financial
statements and mortgage payments as required, (2) improperly leased commercial space without
HUD’s consent to a related party at below market rent, (3) disbursed funds for building
improvements without HUD’s approval, (4) did not properly procure products and services, (5)
created a lien on the property in violation of its mortgage terms, and (6) incurred costs that were
not eligible for the project’s operations. These conditions occurred because the owner generally
disregarded the terms of the mortgage and HUD’s requirements and lacked an understanding of
applicable HUD regulations. In addition, the owner did not have controls to ensure that the
project was managed in accordance with HUD requirements. As a result, the project was in
default of its HUD-held mortgage and it incurred more than $71,689 in unsupported costs from
unapproved building improvements and improper procurement of products and services, and
$8,597 in ineligible expenditures. The project also lost the opportunity to increase surplus cash
available to pay its mortgage by $282,578 because it didn’t collect fair market rent on its
commercial space, and it exposed project assets to risk from creditor claims of up to $25,000.

The Owner Did Not File Financial Statements and Make Mortgage Payments as Required
The owner did not file financial statements in a timely manner and pay annual surplus cash
balances to HUD on its mortgage. The mortgage documents required the owner to submit
certified financial statements, either audited or unaudited, that identified surplus cash 2 months
after the end of each year, 4 accompanied by a payment of $36,300 toward principal and interest.
Depending on the amount of the surplus cash balance, the payment due could be less, or the
project could be required to pay additional surplus cash toward the mortgage. 5 However,
although the owner timely filed certified financial statements for the period ending December 31,
2013, it did not pay the related surplus cash balance of $10,676 to HUD on its mortgage. The
owner filed financial statements almost a year late for 2014 6 and more than 4 months late for



4
    By the end of February of the following year.
5
    Section B.1 of the mortgage restructuring note states that the annual mortgage payment amount was $36,300.
    Section C.1 of the note states that the annual mortgage payment varies based on the amount of surplus cash. If
    the surplus cash balance was greater than the annual mortgage payment, the project was required to make an
    additional payment on the mortgage. If the surplus cash balance was not sufficient to make the full annual
    mortgage payment, the project was required to pay only the surplus cash balance to HUD as its annual payment.
    If the surplus cash balance was negative, the project was not required to remit an annual payment.
6
    Filed on February 14, 2016.




                                                         5
2015. 7 Although the financial statements, which were audited, showed that the project had
$8,994 in surplus cash for 2014 and $8,259 in surplus cash for 2015, the owner did not make a
mortgage payment by paying its annual surplus cash to HUD. Additionally, note G in the 2015
financial statements reported cumulative surplus cash totaling $27,929, which is the sum of the
surplus cash balances reported for 2013, 2014 and 2015. During the audit, an owner official
stated that the project would make a mortgage payment if he was contacted by HUD. HUD
informed us that the project made a payment of $13,740 toward its mortgage on January 31,
2017.

Section 3.3 of HUD’s Real Estate Assessment Center’s financial reporting and auditing guidance
for multifamily program participants, required the project to submit audited financial statements
within 9 months after the end of the fiscal year. The Center reviews the audited financial
statements and determines the final amount of the required mortgage payment. The Center may
adjust the surplus cash balance reported as a result of its review. The mortgage note stated that if
HUD determined that the amount of surplus cash exceeded the actual amount paid by the owner,
the owner was required to pay the shortfall within 30 days or provide a detailed explanation to
HUD for not doing so. However, the owner did not file the project’s audited financial statements
for 2013 and it filed audited financial statements for 2014 late. The statements were due by the
end of September 2015, but the owner filed them in February 2016.
The conditions described above occurred because the owner did not fully understand the
mortgage terms and believed it could wait until HUD notified it that payments were due before
making mortgage payments. The owner stated that it did not have the mortgage documents and
was unaware of the terms. Further, although the Center emailed delinquency notices to the
management agent, the agent claimed that he did not receive them because he had begun using a
new e-mail address and failed to update it in HUD’s system. As a result, the owner defaulted on
the mortgage because it did not pay its surplus cash due as mortgage payments. 8

The Owner Leased Commercial Space without HUD’s Consent to a Related Party at Rent
Below Market Rate
Contrary to its use agreement, the project’s owner leased the project’s commercial space to a
related party at a price below market rate without HUD’s approval. In May 2009, the project’s
owner executed a rental agreement with two parties to lease commercial space in the property for
$1,250 per month. The president of the project’s owner entity is also the director of one of the
lessees, creating a related party transaction. Further, this lessee manages the other lessee. The
use agreement required the property to be used only for rental housing unless another use was
approved by HUD. However, the project’s owner did not seek HUD’s approval to rent the
commercial space. Further, when the lease ended in 2012, the owner continued to rent the
commercial space to the lessees for the same rental amount without seeking HUD approval. The
owner also failed to report on the project owner’s and management agent’s certifications and on


7
    Filed on July 21, 2016.
8
    According to the restructuring note, if the borrower fails to pay installments of principal and interest due, the
    mortgage will be in default.




                                                            6
rent schedule forms the potential increased rental income value and that the lease was with a
related party.

The commercial space was leased for below fair market rent, even though the project owner’s
and management agent’s certification required the management agent to make a reasonable effort
to maximize project income. As described in HUD Handbook 4350.1, by improperly leasing its
commercial space for less than market rate, the owner reduced the funds available for the
project’s operating expenses. This failure weakened its financial position, including its ability to
make mortgage payments from surplus cash.

According to a 2003 appraisal, the project had 5,762 square feet of commercial space. The
owner estimated that the fair market value for the commercial space was approximately $6 to $7
per square foot per year when the lease was signed in 2009 and $12 per square foot in 2017.
Based on a comparison of the rent listed in the lease to the estimated fair market value calculated
by using the square footage listed in the appraisal and an average of the owner’s estimates, 9 the
project lost $36,858 10 in potential rental income per year.

The conditions described above occurred because the owner did not fully understand HUD
requirements and disregarded the information required on HUD forms. As a result, HUD was
not aware of the lease, and the project lost $282,578 11 in potential rental revenue for the
commercial space between May 2009 and December 2016. If this is not corrected, it could
potentially lose $36,858 in rental revenue over the next year.

The Owner Made Unapproved Project Improvements Using Operating Funds
The project’s owner improperly used $71,689 in operating funds for project improvements.
Section 2-6 of HUD Handbook 4370.2, REV-1, states that operating funds should be used only
to make mortgage payments, make required deposits to the reserve for replacements, or pay for
reasonable expenses necessary for the operation and maintenance of the project. The use
agreement states that the project’s reserve for replacements fund could be used for project
improvements and mechanical equipment and disbursements but only after consent was received
in writing from HUD. Additionally, the restructuring mortgage required that the project obtain
consent from HUD for alterations, additions, or improvements to the property. However, in
2014 and 2015, the owner used operating funds, without HUD approval, to make $71,689 in
project improvements, shown in the following chart.




9
     The average of the owner’s estimates was $9 per square foot per year. This is the average of the $6 lower
     estimate provided for the beginning of the lease and the $12 estimate in 2017.
10
     $36,858 = ($9 per square foot per year x 5,762 square feet) - ($1,250 monthly rent amount x 12 months)
11
     $282,578 = ($9 per square foot per year x 5,762 square feet x 7 years and 8 months) - ($1,250 monthly rent
     amount x 7 years and 8 months)




                                                           7
             Year                           Description                        Amount

            2015               Air conditioning system replacement              $39,920
          2014-2015                    New security panel                         7,995
            2015                          Floor coverings                         7,359
            2015                         Electrical retrofit                      7,000
            2015                    Exterior and interior work                    5,115
            2015                 Parking lot and sidewalk repair                  4 ,300
                                               Total                             71,689

During this period, the project did not disburse funds from its reserve for replacement account,
which had a balance of $73,706 as of May 2016. This condition occurred because the owner
disregarded requirements. The owner believed that it knew more about project improvements
than HUD and that HUD would not approve its requests to use the reserve for replacement funds.
As a result, improvements totaling $71,689 were not supported. Additionally, because the owner
used operating funds instead of reserve for replacement funds for the improvements, it reduced
the surplus cash balance, resulting in the project having fewer funds available to make mortgage
payments to HUD.

The Owner Did Not Ensure That Cost Estimates Were Obtained
The owner did not ensure that the management agent obtained the required number of cost
estimates before spending $39,920 to replace an air conditioning system. HUD Handbook
4381.5, paragraph 6.50(a), requires management agents to obtain written cost estimates from at
least three contractors for any contract, supply, or service that is expected to exceed $10,000 per
year. Section 4(b) of the project owner’s and management agent’s certification also stated that
the management agent agreed to obtain the required cost estimates and ensure that all expenses
of the project were reasonable and necessary. In 2015, the management agent obtained only one
cost estimate before paying $39,920 to replace an air conditioning system.

This condition occurred because the owner believed it was an emergency and that additional
estimates were not required. However, the purchase was made 29 days after the cost estimate,
which indicates that it was not an emergency. Further, the owner lacked controls to ensure the
required cost estimates were obtained. For example, the owner’s agreement with the
management agent prohibited the agent from incurring an expense for maintenance, alteration,
refurbishing, or repair greater than $3,000 unless (1) the expense was specifically authorized by
the owner or was for an emergency repair immediately necessary for the preservation and safety
of the premises; (2) the repair was needed to avoid danger to life and property; or (3) the repair
was needed to comply with Federal, State, or local law, but it did not discuss cost estimates. As
a result, HUD and the project did not have assurance that the $39,920 paid to replace the air
conditioning system was fair and reasonable.




                                                 8
Unauthorized Lien on the Project’s Property
The owner allowed a $25,000 increase to an existing lien on the property which is prohibited by
the restructured mortgage. At the time the mortgage was restructured, a $714,542 lien existed on
the property for loans made to the owner by the Urban Redevelopment Authority of Pittsburgh.
However, in 2011, the owner secured an additional $25,000 loan from the Authority, which
resulted in an increase to the existing lien on the property. This condition occurred because an
owner official stated he was not familiar with the terms of the mortgage and believed HUD
would not allow him to use project funds for improvements. As a result, project assets were
exposed to risk from potential creditor claims.

The Project Incurred Ineligible Expenses Related to Its Leased Commercial Space
The owner improperly used $8,597 in project funds to pay for expenses related to the lease of the
project’s commercial space, including $2,205 for undisclosed management fees and $6,392 for
natural gas expenses. According to Section 3.14 of HUD Handbook 4381.5, management fees
can be paid only from project income after the owner submits its management certification to
HUD. In addition, the project must submit a new management certification before changing the
management fee. When the owner signed the lease for the commercial space in 2009, the owner
and management agent failed to disclose that the monthly management fee had increased by
$73.50 per month for services performed related to the commercial space. In the most recent
management certification, which was signed in 2013, the owner and management agent again
failed to disclose the additional $73.50 management agent fee per month. As a result, during the
period July 2013 to December 2015, the project incurred ineligible management fees totaling
$2,205, 12 because they were not approved by HUD, as required.

The lease agreement provided that the lessees would pay for the natural gas it used. However,
the project paid for the gas used by the lessees. The owner admitted that the lessees should
reimburse the project. Based on square footage, we determined that the lessees should have paid
$6,392 for natural gas that it used from January 2013 to December 2015. 13 However, since the
project paid for the gas, the gas expenses totaling $6,392 were ineligible.

These conditions occurred because the owner disregarded applicable requirements. As a result,
the project paid $8,597 for ineligible expenses related to its commercial space. Additionally,
because the owner used the project’s operating funds for these expenses, surplus cash was
reduced, resulting in fewer funds available to make mortgage payments to HUD.

Conclusion
The owner of Laurentian Hall Apartments did not always manage its multifamily project in
accordance with HUD requirements. The conditions identified above occurred because the

12
     $2,205 = $73.50 x 30 months (July 2013 to December 2015)
13
     $6,392 = prorated amount of natural gas used by the lessees based on square footage. The total square footage
     for the project was 34,574 square feet, and the square footage of the commercial space was 5,762 square feet.
     Therefore, the commercial space occupied 16.7 percent of the total square footage of the project (5,762 / 34,574
     = 16.7 percent rounded). The total payments made by the project for natural gas during the period January 2013
     to December 2015 were $38,274 ($38,274 x 16.7 percent = $6,392 (rounded)).




                                                           9
owner generally disregarded the terms of the mortgage and HUD’s requirements and lacked an
understanding of applicable HUD regulations. In addition, the owner did not have controls to
ensure that the project was managed in accordance with HUD requirements. As a result, the
project was in default of its HUD-held mortgage and it incurred more than $71,689 in
unsupported costs from unapproved building improvements and improper procurement of
products and services, and $8,597 in ineligible expenditures. The project also lost the
opportunity to increase surplus cash available to pay its mortgage by $282,578 because it didn’t
collect fair market rent on its commercial space, and it exposed project assets to risk from
creditor claims of up to $25,000.

Recommendations
We recommend that the Director, Asset Management Division, Baltimore Multifamily Hub,
direct the owner of the Laurentian Hall Apartments to

         1A.      Pay the project $282,578 from non-project funds for the fair value of the
                  commercial rent not collected from the lessees.

         1B.      Request approval from HUD to lease the commercial space. If HUD approves the
                  request, then execute a lease at fair market rent thereby increasing the project’s
                  rent revenue by at least $36,858 per year.

         1C.      Request approval from HUD for the $31,769 14 in project operating funds spent on
                  building improvements or repay the project from nonproject funds for any amount
                  not approved.

         1D.      Provide documentation to show that the $39,920 paid to replace an air
                  conditioning system was fair and reasonable or repay the project from nonproject
                  funds any amount determined not to be fair and reasonable (excluding any amount
                  repaid as a result of recommendation 1C).

         1E.      Remove the $25,000 lien on the project property.

         1F.      Repay the project $8,597 from nonproject funds for the ineligible expenses it
                  incurred for management fee and gas utility expenses that were identified by the
                  audit and any additional management fee and gas utility expenses improperly paid
                  outside of our review period.

         1G.      Develop and implement controls to ensure that financial statements are submitted
                  to HUD in a timely manner, including paying the correct amount of annual
                  payments according to the terms of the mortgage.


14
     To avoid double-counting, we reduced the amount shown as unsupported for recommendation 1C by the amount
     discussed in recommendation 1D. The $31,769 is the full amount of unsupported expenditures of operating
     funds ($71,689) less the amount cited in recommendation 1D ($39,920).




                                                       10
      1H.    Develop and implement controls to ensure that the project complies with
             applicable HUD requirements.

We recommend that the Director, Asset Management Division, Baltimore Multifamily Hub

      1I.    Recalculate the project’s annual surplus cash balances for 2013, 2014, and 2015
             after resolution of recommendations 1A, 1C, 1D, and 1F to determine whether the
             project should make additional payment to HUD from surplus cash toward its
             mortgage beyond the $13,740 that it paid during the audit.

      1J.    Provide training and technical assistance to the owner and its management agent
             to ensure compliance with the terms of its mortgage and other applicable HUD
             requirements.




                                             11
Scope and Methodology
We conducted the audit work from June 2016 through February 2017 at the Laurentian Hall
Apartments located at 5321 Penn Avenue in Pittsburgh, PA, RSI Property Management
Corporation offices located at 3702 Allendale Circle in Pittsburgh, PA, Bloomfield-Garfield
Corporation offices located at 5149 Penn Avenue in Pittsburgh, PA, and our offices located in
Philadelphia and Pittsburgh, PA. The audit covered the period January 1, 2013, through
December 31, 2015, but was expanded when necessary.
To accomplish our objective, we reviewed
   •   HUD’s files for the project, including a management agent certification, management
       reviews, monitoring reports, the use agreement, mortgage restructuring mortgage,
       mortgage restructuring mortgage note, and rider to the mortgage restructuring mortgage;
   •   The owner’s corporate bylaws, board meeting minutes, 2013 owner-certified financial
       statements and 2014 and 2015 audited financial statements;
   •   The management agent’s agreement with the owner, project budgets, general ledger, cash
       disbursements journal, check listing and invoices;
   •   Applicable HUD regulations, handbooks, and guidance;
   •   The owner’s lease and rent comparability study;
   •   Allegheny County real estate records; and
   •   Commercial leasing trends for the City of Pittsburgh obtained via Internet queries.

To achieve our audit objective, we relied in part on computer-processed data from the management
agent’s computer system. Although we did not perform a detailed assessment of the reliability of
the data, we did perform a minimal level of testing and found the data to be adequate for our
purposes. The tests for reliability included but were not limited to comparing computer-processed
data to invoices, checks and the commercial lease agreement rental income terms.

In addition, we interviewed employees of RSI Property Management Corporation and
Bloomfield-Garfield Corporation (one of the project lessees), tenants of the project, former and
present property managers, and HUD staff. We also conducted a physical inspection of the
project’s common areas and the leased commercial space.

To determine whether the owner managed the project in accordance with HUD requirements, we
nonstatistically selected a sample of expenditures to review from the project’s expense summary
by vendor report from the period July 2013, through December 31, 2015, totaling $730,101. We
selected 112 disbursements totaling $116,734 from 9 vendors for our sample. We used a
nonstatistical design because it allowed us to select management fee, natural gas, and building
improvement expenditures for review because they represented the highest risk to HUD based on
specific requirements in the use agreement, the mortgage documents, the commercial lease


                                                12
agreement and HUD handbooks. Although this approach did not allow us to make a projection
to the entire population, it was sufficient to meet the audit objective.

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




                                                13
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:

•   Effectiveness and efficiency of operations – Policies and procedures that management has
    implemented to reasonably ensure that a program meets its objectives.
•   Reliability of financial information – Policies and procedures that management has
    implemented to reasonably ensure that it obtains relevant, reliable information to adequately
    support program expenditures and discloses that information in the required reports.
•   Compliance with laws and regulations – Policies and procedures that management has
    implemented to reasonably ensure that program expenses are supported and comply with
    program funding guidelines and restrictions.
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 Deficiencies
Based on our review, we believe that the following items are significant deficiencies:

•   The owner generally disregarded the terms of the mortgage and HUD’s requirements and
    lacked an understanding of applicable HUD regulations.

•   The owner did not have controls to ensure that the project was managed in accordance with
    HUD requirements.



                                                  14
Appendixes

Appendix A


               Schedule of Questioned Costs and Funds To Be Put to Better Use
             Recommendation                                    Funds to be put
                               Ineligible 1/ Unsupported 2/     to better use 3/
                 number
                       1A                                                  $282,578
                       1B                                                    36,858
                       1C                               $31,769 15
                       1D                                39,920
                       1E                                                    25,000
                       1F             $8,597
                       1I                                                    13,740

                    Totals             8,597             71,689             358,176



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.
3/        Recommendations that funds be put to better use are estimates of amounts that could be
          used more efficiently if an Office of Inspector General (OIG) recommendation is
          implemented. These amounts include reductions in outlays, deobligation of funds,
          withdrawal of interest, costs not incurred by implementing recommended improvements,
          avoidance of unnecessary expenditures noted in preaward reviews, and any other savings


15
     See footnote 14 on page 10.




                                                   15
that are specifically identified. In this instance, if the owner implements our
recommendations, the project will increase the project’s rent revenue; protect project
assets from creditor claims; and make payments toward its mortgage from surplus cash
for calendar years 2013, 2014, and 2015.




                                        16
Appendix B
             Auditee Comments and OIG’s Evaluation



Ref to OIG    Auditee Comments
Evaluation




Comment 1


Comment 2




                               17
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




Comment 3




Comment 4




Comment 5




                               18
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




Comment 6
Comment 7




Comment 8



Comment 9




                               19
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




Comment 10




Comment 11




Comment 12




                               20
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




                               21
                         OIG Evaluation of Auditee Comments


Comment 1   The owner stated that it believed that most financial statements were submitted on
            time. The audit covered the period January 1, 2013, through December 31, 2015.
            As stated in the audit report, the owner filed its financial statements, due with the
            mortgage payments, almost a year late for 2014 and more than 4 months late for
            2015. Additionally, it did not file audited financial statements for 2013 and filed
            them late for 2014.

Comment 2   The owner stated that it did not make mortgage payments because it was waiting
            for HUD to review the financial statements and inform it of the amount that was
            due. However, the mortgage documents required the owner to submit certified
            financial statements that identified surplus cash 2 months after the end of each
            year, accompanied by a payment of $36,300 toward principal and interest.
            Although the financial statements for the project showed surplus cash of $10,676
            for 2013, $8,994 for 2014, and $8,259 for 2015, the owner did not pay the surplus
            cash to HUD.

Comment 3   The owner stated that the correct square footage of the leased space was 1,750
            square feet rather than the 5,762 square feet cited in the audit report. The owner
            asserted that the figure cited in the audit report included the entire basement, most
            of which is not leasable. According to a 2003 appraisal, the project had 5,762
            square feet of commercial space. While onsite, we toured the space. We
            observed that the space had a single entry door with a lobby area and hallways
            that had offices on each side. It appeared that the entire finished area of the
            basement was being used. Based on the appraisal and our observation, we believe
            that 5,762 square feet was a reliable estimate of the leased space. As part of the
            audit resolution process, HUD will evaluate the owner’s assessment and
            determine the amount of space occupied by the lessees.

Comment 4   The owner stated that the correct rent per square foot for the leased space,
            considering the market conditions, was $6 per year for the period 2012 through
            2017. However, during the audit the owner estimated that the fair market value
            for the commercial space was approximately $6 to $7 per square foot per year
            when the lease was signed in 2009 and $12 per square foot in 2017. As part of
            the audit resolution process, HUD will evaluate the owner’s estimation and
            determine a reasonable amount per square foot for the rental of the commercial
            space.

Comment 5   The owner stated that it considers itself fortunate to have a tenant since 2007 that
            can accept occasional flooding and live with water leakage from condensate lines
            above the space during periods of heavy air-conditioning usage. Most other
            commercial tenants would likely find alternate space rather than endure these
            problems or would require the landlord to spend tens of thousands of dollars to



                                              22
            correct the problems. The flooding and water leakage is a concern. By signing
            the use agreement, the owner agreed to maintain the project in good repair and
            condition. Water infiltration inside a building can lead to problems with mold
            that can present a health hazard to humans. If the commercial space was in
            disrepair, resulting in a lower rent, the owner should have made the necessary
            repairs.

Comment 6   The owner stated that it believed that our findings cannot go back more than 5
            years. The owner’s belief is inaccurate. The scope of our audit work and the
            related findings are not limited. In this case, contrary to its use agreement, the
            owner leased the project’s commercial space to a related party in May 2009 at a
            price below market rate without HUD’s approval. When the lease ended in 2012,
            the owner continued the arrangement without creating a new lease and again
            without HUD approval. The arrangement is ongoing. Therefore, we questioned
            the arrangement from its origin.

Comment 7   The owner asserts that non-HUD funds were used to build out the commercial
            space and therefore all commercial rent should benefit the operation of the
            building and not be used for debt service. However, the use agreement required
            the property to be used only for rental housing unless another use was approved
            by HUD. The owner did not seek HUD’s approval to rent the commercial space.
            The project owner’s and management agent’s certification required the
            management agent to make a reasonable effort to maximize project income. The
            project correctly recorded the commercial rent that it collected as revenue in its
            accounting records and financial statements. It included the commercial rent that
            it collected in the calculation of surplus cash balances available for mortgage
            payments for 2013, 2014 and 2015.

Comment 8   The owner stated that additional information regarding the replacement of the air
            conditioning chiller was being sought. It also stated that it was very unlikely that
            it would have paid less than $39,920 to purchase and install the new chiller and
            dispose of the old one. We are encouraged that the owner is seeking additional
            information regarding the replacement of the chiller. As discussed in the audit
            report, without the required cost estimates, there was no assurance that the
            $39,920 price paid to replace the chiller was fair and reasonable. As part of the
            audit resolution process, the owner can provide documentation to HUD to show
            that $39,920 was a fair and reasonable price to replace the chiller and avoid
            having to repay the project from nonproject funds.

Comment 9   The owner stated that it could have paid for $31,769 of project improvements
            from the reserve for replacement account but at the time the account was so
            perilously low that it felt it was far more prudent not to reduce the reserve further.
            However, as stated in the report, HUD Handbook 4370.2, REV-1, states that
            operating funds should be used only to make mortgage payments, make required
            deposits to the reserve for replacement account, or pay for reasonable expenses


                                               23
                    necessary for the operation and maintenance of the project. The use agreement
                    states that the project’s reserve for replacements fund could be used for project
                    improvements and mechanical equipment and disbursements but only after
                    consent was received in writing from HUD. Additionally, the restructuring
                    mortgage required that the project obtain consent from HUD for alterations,
                    additions, or improvements to the property. However, in 2014 and 2015, the
                    owner used operating funds, without HUD approval, to make $71,689 16 in project
                    improvements. The owner made no disbursements from the reserve for
                    replacement account during 2014 and 2015 and the account balance was more
                    than $73,000 in May 2016. Because the owner used operating funds instead of
                    reserve for replacement funds for the improvements, it reduced the surplus cash
                    balance, resulting in the project having fewer funds available to make mortgage
                    payments to HUD.

Comment 10 The owner stated that it would, as we suggest, request approval from HUD for the
           $25,000 mortgage lien. It stated that such liens are permitted under HUD
           regulations and that it was much more prudent to obtain these funds than further
           deplete the anemic reserve for replacement account. It also stated that HUD’s
           interests were far better protected by this loan than they would have been by
           depleting project reserves. We did not suggest that the owner request approval
           from HUD for the $25,000 lien, rather, we recommended that the owner remove
           the lien. Also, although liens may be permitted under HUD regulations, in this
           case the restructured mortgage required the owner to keep the property free from
           liens, inferior or superior, to the lien of HUD’s mortgage. The owner’s statement
           that HUD’s interests were far better protected by this loan than they would have
           been by depleting project reserves is uncertain. The owner did not involve HUD
           in the decision to obtain the loan that created the lien. As stated in the audit
           report, the owner obtained the loan because it believed that HUD would not allow
           it to use project funds for improvements.

Comment 11 The owner stated that it is further investigating the issue of the natural gas cost
           not charged to the tenant. The owner disagrees with our estimate of $6,392 based
           on square footage and it asserts that gas heat is only used for part of the premises
           and electric baseboard heat is used for the rest. The owner stated that the gas cost
           is relatively negligible and that there is only one gas line and one gas meter for the
           building making the determination of this cost challenging. We are encouraged
           that the owner is investigating this issue. The lease agreement provided that the
           lessees would pay for the natural gas it used. Based on square footage, we
           determined that the lessees should have paid $6,392 for natural gas that it used
           from January 2013 to December 2015. As part of the audit resolution process, the



16
     This figure includes the $39,920 that the owner spent to replace the air conditioner chiller that was discussed in
     Comment 8 ($31,769 + $39,920 = $71,689).




                                                             24
              owner can provide documentation to HUD to show that it has a more accurate
              methodology to estimate the amount of natural gas used by the lessees.

Comment 12 The owner stated that it will, as we suggest, request that HUD approve the
           increase in the management fee as reasonable. We did not suggest that the owner
           request approval from HUD for the management fees totaling $2,205, rather, we
           recommend that the owner repay the project that amount from nonproject funds
           because the owner and management agent failed to disclose the fee increase on its
           management certifications and obtain approval from HUD.




                                              25