Lakeside Apartments, Auburn, AL

Published by the Department of Housing and Urban Development, Office of Inspector General on 1996-02-21.

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

                                                                    Issue Date

                                                                         February 21, 1996
                                                                    Audit Case Number


TO:           Herman S. Ranson, Director, Multifamily Division, Birmingham, Alabama State
              Office, 4CHM

FROM:         Kathryn Kuhl-Inclan
              District Inspector General for Audit-Southeast/Caribbean, 4AGA

SUBJECT:      Development Fees Claimed by General Contractor
              The Village at Lakeside (Lakeside Apartments)
              Auburn, Alabama

In response to the Assistant General Counsel's (4AC) request, we have reviewed $564,318 in
development fees included as part of the $8,088,560 construction-development costs for Lakeside
Apartments. The property owners/mortgagor are Lakeside Apartments Limited Partnership; the
developer is Winn Development Company of Boston.

The report presents one finding: the costs included $564,318 in ineligible development fees,
which were paid to an affiliate of the mortgagor. As a result, the owners did not contribute
$239,187 needed to meet the Housing Development Grant (HDG) minimum equity investment.

If you have any questions, please call me or Ted E. Drucker, Assistant District Inspector General
for Audit (404-331-3369). We are providing copies of the report to the mortgagor, the general
contractor, and the City of Auburn.

                                         *   *    *   *

Within 60 days please give us, for each recommendation made in this report, a status report on:
(1) the corrective action taken, (2) the proposed corrective action and the date to be completed;
or (3) why action is considered unnecessary. Also, please furnish us copies of any
correspondence or directives issued because of the audit.
Management Memorandum

                        This Page Left Blank Intentionally

96-AT-219-1002                        Page ii
Executive Summary
We audited the records of Theodore N. Freeman, the general contractor (GC), at Columbus, Ga
relating to $564,318 in development fees claimed as project costs. We conducted the limited
review at the request of Department of Housing and Urban Development's (HUD) Assistant
General Counsel (4AC) to determine the basis for these fees, and whether they were allowable
costs. Mr. Freeman also is president of Freeman & Associates, Inc. (F&A); Columbus, Ga.

The $564,318 were ineligible costs paid to the mortgagor's identity-of-interest (IOI) affiliate,
Construction Alliance, Ltd. (CA), because the fees were either for customary duties of the owner
or for usual responsibilities of GCs under a construction contract. Also, the owners should
contribute an additional $239,187 to meet the minimum HDG equity requirement. The GC stated
that he did not know the costs violated HUD's requirements.

We are recommending that you have the mortgagor both disgorge the ineligible fees, and reduce
project costs on the Lakeside entity's books and records by that amount. We also recommend that
HUD encourage the City of Auburn to have the mortgagor make the additional equity-investment
in the Lakeside entity.

We discussed matters presented in the finding with the GC and HUD officials during the course
of the audit. On December 4, 1995, we sent the draft finding to the mortgagor and requested
written comments, which were dated January 19, 1996. The Mortgagor written comments are
included as Appendix D1 mortgagor in general disagreed with us. Although our conclusions on
the nature of the fees, and their ineligibility as project costs remain the same, we made some
clarifications in our presentation.

The chart on the next page is based without audit on the developer's statement of development
costs by financing source. The sources primarily are tax-exempt or subsidized; the related
percentages (rounded) of each category are compared to the total.

    We added Office of Inspector General (OIG) Notes at the bottom of some pages of the auditee comments to
clarify possible auditee misunderstandings on our finding presentation. The absence of such notes, however, does
not imply or connote OIG agreement, as in repeated statements or matters which in our opinion were outside the
crux of our finding development and conclusions.

                                                     Page iii                                      96-AT-219-1002
Executive Summary

96-AT-219-1002      Page iv
Table of Contents

Management Memorandum                                             i

Executive Summary                                                iii

Introduction                                                      1


          The GC Claimed and Received Ineligible
          Development Fees, and Paid Them to an IOI
          Affiliate of the Mortgagor                              3

Internal Controls                                               13


    A     Schedule of Ineligible Payments to Mortgagor's
          IOI Affiliate, Construction Alliance, Ltd.            15

    B     Interim Computation of Additional
          Investment Requirement                                17

    C     Schedule of Ineligible Costs                          19

    D     Auditee Comments                                      21

    E     Distribution                                          29

                              Page v                  96-AT-219-1002
Table of Contents

CA        Construction Alliance, Ltd.
CFR       Code of Federal Regulations
F&A       Freeman & Associates, Inc.
FNMA      Federal National Mortgage Association
GAS       Government Auditing Standards
GC        General Contractor
HDG       Housing Development Grant
HUD       Dept. of Housing and Urban Development
IOI       Identity-of-Interest
JV        Joint Venture
OIG       Office of Inspector General

96-AT-219-1002                            Page vi

                       The property (Project AL 001HG403) has 200 units located
                       in Auburn, Alabama. The property owners/mortgagor are
                       Lakeside Apartments Limited Partnership. The Developer,
                       Winn Development Company on April 20, 1993, stated that
                       the following financing sources were used for development

                          Tax-exempt bonds                  $ 6,000,000
                          HDG                                    3,670,000
                          Tax credit sale proceeds from FNMA*     1,120,000
                          Additional capital (loan by Winn)

                                    Total                         $ 11,143,417

                       On November 20, 1987, the General Contractor (GC)
                       agreed with Construction Alliance, Ltd. (CA) for CA to be
                       a subcontractor for Lakeside. Arthur M. Winn is the general
                       partner of the mortgagor and the President of CA.

                       The tax-exempt bond financing and HDG loan were closed
                       on December 28, 1987. Project construction began in
                       December 1987 and was completed in April 1989. Project
                       rent-up commenced in September 1988.

                       The Housing Authority of Auburn issued the bonds which
                       are secured by a first lien on the project. The City of
                       Auburn obtained the HDG funds and provided them to the
                       mortgagors as a low interest loan secured by a second lien
                       on the project. HUD completed its HDG settlement process
                       in September 1990.

                       We performed a special-purpose audit of the GC's records
Objectives and Scope
                       plus related City and HUD records solely for $564,318 in
                       other development fees claimed as project costs. We
                       examined 100 percent of these fees due to HUD's concern
                       about their eligibility. Our objectives were to determine
                       eligibility of these fees as project costs, and if ineligible,
                       their impact on HDG calculations.

                                Page 1                                   96-AT-219-1002

* Federal National Mortgage Association

96-AT-219-1002                            Page 2

The examined costs are about seven percent of the
$8,088,560 construction contract sum. We did not audit the
project's other costs, which generally approximated HUD's
estimated costs, due to the elapsed period since construction
activities were completed (as of April 30, 1989), and the
limited scope for our audit.

During our limited audit, we: (a) examined various records
and files obtained from the GC, City of Auburn, Housing
Authority of Auburn, and HUD; and, (b) interviewed
various GC, HUD, and City of Auburn officials. We
performed our work at the City of Auburn, and at the GC
and HUD offices.

This is our initial audit of any aspect of the Auburn project.
We previously audited two LaGrange, Georgia
developments involving the same GC and Winn-interests
(Audit Report 94-AT-219-1024, dated August 25, 1994,
which continues to have an unresolved audit

We conducted this work between August and October
1995, mainly covering the period from project inception
through its completion. Our limited audit was conducted in
accordance with generally accepted government auditing
standards (GAS) as qualified below (also see the report
section on internal controls):

   Subsequent Events - Although we requested through
   Counsel that the owners provide us the Lakeside
   development's financial statements for periods
   subsequent to completion of its construction, they
   declined to do so. In our opinion, there was no resulting
   material effect on our limited audit's primary objectives.

         Page 3                                   96-AT-219-1002

     The GC Claimed and Received Ineligible
    Development Fees, and Paid them to an IOI
           Affiliate of the Mortgagor
The GC, Theodore N. Freeman as an individual, claimed and paid development fees totaling
$564,318 to the mortgagors' identity-of-interest (IOI) affiliate, CA. These fees were not eligible
or needed to construct the project. Also, the owners did not contribute $239,187 needed to meet
the HDG minimum equity investment.

                                     Generally to be allowable, costs must be necessary, and
                                     reasonable as well as related directly to the grant or
                                     contract, and conform to limitations or exclusions for costs.
                                     (Office of Management and Budget Circular A-87, Cost
                                     Principles for State and Local Governments, Section C.)

                                     Section 2.01 of the HDG Agreement defined eligible costs
                                     for Grantee activities and non-Grantee activities to include
                                     that such costs: (1) not be incurred in connection with
                                     activities which, under 24 CFR part 850, are ineligible
                                     under the HDG program; and (2) conform, as applicable, to
                                     the requirements of OMB Circular A-87.

                                     Developer/sponsor fees or risk allowance may not be
                                     considered in the grant amount, project costs, or owners'
                                     equity to be contributed in excess of an amount that HUD
                                     determines to be reasonable [24 Code of Federal
                                     Regulations (CFR) 850.37(d), dated June 14, 1984, and
                                     later 1986 and 1987 revisions].

                                     We reviewed $564,318 of development fees the GC
 Summary of work done
                                     claimed and paid to CA (Appendix A), which are not
 and results
                                     reasonable or necessary project costs. We did not audit the
                                     project's other construction costs, which generally
                                     approximated HUD's estimated costs. We accepted HUD's
                                     prior adjustment to reduce claimed legal costs by $53,777.
                                     As a result of these reductions in costs claimed for
                                     ineligible costs, the mortgagor needs to contribute an

96-AT-219-1002                                Page 4

                            additional $239,187 to meet the HDG minimum required
                            equity investment of $1,098,118 (See Appendix B).

                            The mortgagor provided the City of Auburn as HDG
Details on the ineligible
                            Grantee, and ultimately HUD, with a Project Financial
                            Settlement Statement as of April 30, 1989. This statement
                            included the figure of $8,088,560 as the construction
                            contract sum. Included were $564,318 for development
                            fees paid to CA. The GC did not incur these fees for labor,
                            materials, equipment or related services necessary and
                            reasonable for project development.

                            The GC, Mr. Freeman individually, is also the President of
                            F&A. The GC and mortgagor signed a Standard Form of
                            Agreement Between Owner and Contractor on November
                            19, 1987. On November 20, 1987, the GC and CA signed
                            a Standard Form of Agreement Between Contractor and
                            Subcontractor. Arthur M. Winn's name appears on both
                            agreements. He is a general partner in the Lakeside
                            mortgagor and also the President of CA, which made CA an
                            IOI entity.

                            Prior to the Lakeside project, F&A and CA formed
                            Freeman/ Alliance Company, a Joint Venture. The parties
                            signed a Joint Venture Agreement dated December 5, 1986,
                            prior to the construction of Meadow Terrace Apartments in
                            LaGrange, GA. The agreement's first amendment, at May
                            2, 1988, added the Greenwood Park Apartments, also in
                            LaGrange. The GC joined with CA on the Lakeside
                            project. However, documentation showed CA as a
                            subcontractor, not as part of a Joint Venture. Although no
                            Joint Venture Agreement for the Lakeside project existed,
                            the Joint Venture bank account was used to disburse all
                            payments except one to CA. This same account was used
                            for construction payments for the LaGrange projects.

                            The mortgagor increased the GC's Lakeside total contract
                            sum for the development fees paid to CA. F&A's 1987
                            Financial Statements showed the estimated total contract
                            amount for Lakeside was $7,524,242. The owner's
                            Application for Multifamily Housing Project of September
                            18, 1986 also included a builder's estimated costs of
                            $7,524,242. This amount was increased $564,318 in the
                            construction contract sum of $8,088,560. According to the

                                    Page 5                                 96-AT-219-1002

                 final cost summary, the development fees totaled $564,318.
                 Of this amount, CA received $556,811 by checks issued on
                 the Joint Venture bank account, and F&A paid CA the
                 remaining $7,507 from its general account.

                 The Joint Venture Agreement, dated December 5, 1986,
                 stipulated in part that CA would:

                     "expedite the processing of requisitions, contribute its
                     financial experience and expertise; assure timely
                     decision-making by Owner in connection with all
                     special requirements of          the Project, including
                     compliance with... HoDAG administration; and
                     generally to coordinate finishes (sic), delivery schedules
                     and communications between Contractor, Owner and
                     the Lenders for the Project."

                 Excluding an omitted reference to the Georgia Department
                 of      Transportation          requirements,          t he
                 contractor/subcontractor agreement for the Lakeside
                 (Alabama) project had almost identical wording as the Joint
                 Venture Agreement concerning what CA would do. The
                 subcontractor was not required "to devote any specific
                 amount of time or effort."

                 Mr. Freeman, representing his and his firm's interests, stated
 GC views

                 •   he did not believe there was anything wrong with the
                     arrangements, including the development fees paid.

                 •   his name individually was used on the Lakeside
                     construction contract due to a poor previous financial
                     year (for F&A), which caused insurance-bond

                 •   CA functioned as a subcontractor.

                 The GC's former Controller and present consultant stated

                 •   The GC and CA agreed to, and CA received, a specific
                     amount of $564,318 for the developer's fees.

96-AT-219-1002            Page 6

                 •   Although the developer's fees and F&A's profit were
                     spread to the various work category items, the GC
                     viewed each interim application for payment as an
                     indication of completion percentage and not as a
                     certification of specific incurred costs.

                 As set forth on Page 3 (See Criteria), to be allowable, HDG
OIG conclusion
                 costs must be necessary and reasonable, as well as related
                 directly to the project. The Lakeside Financial Settlement
                 Statement correctly stated that one of the significant
                 accounting policies affecting development costs is that costs
                 are to be exclusive of kickbacks, rebates, or trade discounts.
                 In our opinion, the GC effectively made kickbacks or
                 rebates to CA, who thereby received a windfall.

                 CA's services either overlapped those allowed for
                 organizational or other costs, or were not necessary because
                 the GC did not incur them for project labor, materials,
                 equipment or related services essential to produce the
                 project.     Most services provided by CA were GC
                 responsibilities; thus, if CA performed instead, the GC
                 should have similarly offset its contract revenues rather than
                 increasing total costs for the fees paid to CA.

                 The $564,318 in fees were not bona fide project costs
                 because they were unnecessary; they resulted in the
                 mortgagor's affiliate receiving a windfall, and in the
                 mortgagor not contributing $239,187 to meet the HDG
                 required minimum equity. Footnotes 2 and 3 of Appendix
                 B of this audit report should be considered in a final
                 determination of the amounts of adverse effects to the HDG

                 The relationships and payments among the GC, mortgagor,
                 and the IOI entity should not result in added project costs or
                 benefits to the IOI parties. The reasonable and prudent
                 standard for persons and entities in IOI relationships is: no
                 added project costs should occur, as compared to arms-
                 length competitive transactions. This is to lessen the
                 inherent potential of IOI self-dealing. Both added project
                 costs, a detriment to the mortgagor entity, and benefits to
                 the IOI entity did occur. Neither the mortgagor nor the GC
                 adequately disclosed these facts to HUD and to the City.

                          Page 7                                   96-AT-219-1002

                        Lakeside Limited Partnership, the developer disagrees with
 Mortgagor's comments
                        the OIG's analysis, including the interpretation of the
                        applicable regulations, and its understanding of HUD
                        practices and precedent on other HDG new construction

                        Criteria- The OIG relies upon Office of Management and
                        Budget Circular No. A-87, Section C ("Circular A-87") for
                        the proposition: "[t]o be allowable, costs must be necessary,
                        reasonable and directly related to the grant program, and
                        conform to limitations or exclusions for cost." Later, the
                        OIG applies this statement to mean that costs, to be eligible,
                        must be incurred "for labor, materials, equipment or
                        services reasonable or necessary to construct the project,"
                        or more restrictively that HDG costs must be reasonable
                        and necessary and "directly" related. These are inaccurate
                        interpretations of Circular A-87.

                        The purpose of Circular A-87 is "to provide that federally-
                        assisted programs bear their fair share of costs recognized
                        under [Circular A-87] principles." The principles do not
                        express a view, one way or the other, regarding the payment
                        of profits or other increments above costs. (Circular A-87,
                        Section A). Section C of Circular A-87--the section cited
                        in the Draft--provides that allowable costs must meet the
                        following criteria: "Be necessary and reasonable for proper
                        and efficient administration of the grant programs, be
                        allocable thereto under these principles and...not be a
                        general expense required to carry out the overall
                        responsibilities of State, local or federal-recognized Indian
                        tribal governments." Circular A-87 is not meant to dictate,
                        prohibit, or limit the profit or amount to be paid above
                        costs in connection with any federal project to which
                        Circular A-87 may apply. The Circular is consistent with
                        the Federal Regulations. Section 850.17 of Title 24 of the
                        code of Federal Regulations provides that grant funds "may
                        be used to provide grants or loans to defray project costs."
                        The Section cites several nonexclusive examples of the
                        types of costs for which grants or loans may be made and
                        specifically includes "related soft costs."

                        The OIG here misapplied the general principle of Circular
                        A-87 by failing to consider the particular facts and
                        circumstances of the Lakeside project. A proper application

96-AT-219-1002                   Page 8

would allow the amount called ineligible (amount hereafter)
to be paid to CA consistent with the proper administration
and goals of the HDG program, even if deemed an amount
above costs traditionally incurred on a construction project.
The OIG failed to acknowledge that the regulations and
Circular A-87 provide that grant funds could be used for
broad purposes, including soft costs. Instead, it elected to
require that the costs be for "labor, materials, equipment or
services" actually provided, which also were reasonable or

In the circumstances here (and in the Meadow Terrace and
Greenwood Park projects mentioned by the OIG in the
Draft), the General Contractor entered into a contractual
relationship with CA to meet the demands of the financing
entity because the General Contractor was not able to
satisfy the requirements for use of the bond proceeds for
construction financing. The fact was that the General
Contractor had experienced financial difficulty and was
unable to provide a surety bond. Without a bond, the credit
enhancer would not permit the bonds to be used to finance
construction, necessitating an alternative construction
financing arrangement to allow the project or proceed. That
arrangement was for a construction loan to be obtained
from a lending institution. A principal condition of the
construction loan was that it be personally guaranteed. Mr.
Winn guaranteed the loan himself, putting himself at risk
for any default by the General Contractor.

The payment of the amount to CA for assuming the risk of
the General Contractor's default was reasonable and
necessary under the circumstances and a "soft cost" that
should have been considered for payment. It was a cost
directly related to the project. Circular A-87 envisions
payments of this kind. For example, Circular A-87,
Attachment B, Section C(4) provides for the payment of
various costs associated with insurance and indemnification
of grantees. The amount paid to CA permitted the project
to go forward. It allowed the credit enhancer to enhance the
bond rating, all because Mr. Winn agreed personally to
assume the risk of default by the General contractor. The
arrangement, in the end, enhanced the viability of and
contributed substantially to the project, promoting the

         Page 9                                  96-AT-219-1002

                 "proper and efficient administration" of the Lakeside grant
                 and enabling the project to be constructed.

                 The payment of the amount--even if designated simply as
                 a payment to the Developer--is not expressly prohibited by
                 Circular A-87 or applicable regulations. Section 850.37(d),
                 Title 24 of the Code of Federal Regulations, which the OIG
                 cites as its second "criteria of eligibility," anticipates that
                 developer/sponsor fees and risk allowance are permitted on
                 HDG projects in reasonable amounts. We note the
                 following acknowledgment by the OIG in the audit of funds
                 (similar in nature to the amount) paid on the meadow
                 Terrace and Greewood Park projects. "We recognize that
                 the regulations that accompanied the 1984 application
                 package do not prohibit the inclusion of developer/sponsor
                 fees or risk allowance." (Audit Report 94-AT-219-1024,
                 dated August 25, 1994, at p. 7). Accordingly, the issue, if
                 any, should not be the eligibility of the amount, but whether
                 any part of it is unreasonable.

                 HUD Practices on other HDG new Construction - In
                 reaching its draft findings, the OIG also has not addressed
                 HUD's precedent and practice of allowing funds, like the
                 amount, on other HDG new construction projects. By
                 1988, HUD began considering various financial issues
                 relating to costs and financing on HDG new construction
                 projects. In various instances, developers complained that
                 these projects were not profitable under strictly construed
                 HDG regulations. Specifically, developers argued that
                 HUD should interpret existing HDG regulations in a
                 manner that would allow the payment of a fee to developers
                 and which would reduce the amount of hard equity required
                 to be contributed by developers. HUD's practice was to
                 allow a fee equal to 7% of hard costs (approximately the
                 same percentage of total contract costs the amount
                 represents). which HUD permitted to be waived to allow
                 the developer to avoid a further equity contribution. That
                 is, HUD recommended that the actual cost of the project be
                 increased after all work was completed and all costs
                 incurred, and that this supplemental amount be added to the
                 actual cost which then would be waived to permit the
                 developers to avoid having to make further contributions to
                 the project. This mechanism, developed and approved by
                 HUD officials, reflects the flexibility HUD actually

96-AT-219-1002           Page 10

                 employed to insure that developers made fair profits on
                 HDG new construction projects. More importantly, it
                 illustrates HUD's recognition that the payment, to
                 developers, of amounts in excess of incurred costs were
                 allowable in various instances without regard to whether the
                 amount paid related to services actually performed, because
                 the payments promoted the "proper and efficient"
                 administration of grant funds. HUD's policies and practices
                 provide a precedent for the allowance of the amount paid to

                 We and the mortgagor disagree about eligibility of the
OIG evaluation
                 $564,318 in payments to the mortgagor's IOI affiliate, CA.
                 As set forth above under OIG conclusion, these payments
                 did not add value --only charges -- to the Lakeside project.

                 The mortgagor, in our opinion, is incorrect in interpreting
                 A-87 as "not meant to dictate, prohibit, or limit the profit or
                 amount to be paid above costs." Actual project costs and
                 justifiable portions of allocable charges which actually
                 benefit the grant program are acceptable. Although the
                 parties may contractually provide for profit, "No provision
                 for profit or other increment above cost is intended" (as
                 quoted from A-87 by the mortgagor in its footnote on page
                 3 of Appendix D). Thus a mark-up to increase actual or
                 indirect costs is not acceptable, and the ineligible payments
                 of $564,318 are not bona fide project costs.

                 Known facts indicate that the earlier GC financial problems
                 should not affect the Lakeside development. If the GC's
                 actual performance was less than specified by the contract,
                 the mortgagor had contractual remedies. In any event, GC
                 financial problems do not justify increasing total project
                 costs, and neither do vague references to precedent.
                 Fundamentally these payments of $564,318 fail the
                 necessary and reasonable concept, and should not burden
                 the Lakeside project or the taxpayers who provided its HDG

                         Page 11                                   96-AT-219-1002

Recommendations   So that costs and related consequences are accurate (not
                  inflated), and to protect taxpayer and other stakeholder
                  interests, we recommend that you:

                  1A.   Have the mortgagor and/or its IOI affiliate disgorge
                        the ineligible fees, and accordingly reduce project
                        costs on Lakeside's books and records. (The
                        objective is to put all parties in the same positions as
                        if the ineligible fees were never claimed.)

                  1B.   Encourage the City of Auburn as HDG grantee to
                        have the additional mortgagor equity investment be
                        paid by the mortgagor partners to the Lakeside
                        entity. (This additional investment is owed as a
                        result of the ineligible fees and may be increased for
                        any additional amounts justified by HUD Program
                        staff and supported by legal or equitable bases for
                        disallowance at this time).

96-AT-219-1002           Page 12

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              Page 13                96-AT-219-1002
Internal Controls

Our audit scope was limited to $564,318 in development fees claimed by the GC, and paid to CA,
to construct the Auburn project. We reviewed 100 percent of these fees. Therefore, review of
internal controls was not necessary to accomplish the objectives of our limited audit.

96-AT-219-1002                              Page 14
                                     Internal Controls

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              Page 15                     96-AT-219-1002
                                                                                             Appendix A

Schedule of Ineligible Payments to Mortgagor's
IOI Affiliate, Construction Alliance, Ltd.
                      Check Date                         Amount

                      12/30/87                           $ 7,507*
                      02/08/88                             4,137
                      03/04/88                            14,276
                      04/06/88                            12,280
                      05/04/88                            32,617
                      06/02/88                            56,814
                      07/07/88                            72,797
                      08/03/88                            48,525
                      09/09/88                            58,515
                      10/10/88                            50,936
                      11/01/88                            55,455
                      11/07/88                            22,992
                      12/12/88                            62,027
                      01/27/89                            30,160
                      02/17/89                            35,280

                        Total                          $ 564,318

   * Paid from F&A's General Account; all other amounts were paid from the Freeman/Alliance Company JV ban k

96-AT-219-1002                                     Page 16
                                     Appendix A

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              Page 17                96-AT-219-1002
                                                                                                                                  Appendix B

Interim Computation of Additional Investment

Total Costs Claimed by Mortgagor                                                                                              $11,479,822
 Less: OIG Adjustments1                                                           $564,318
     HUD Adjustments2                                                            53,777
Adjusted Costs3                                                                                                               $10,861,727
 Less: Non-HDG Committed Financing                                                $6,000,000
     Minimum required equity investment                                           1,098,118
                                                                                                                   ( 7,098,118)

Tentative Eligible HDG Costs3                                                                                             $ 3,763,609
    HDG Amount Disbursed (HDG Maximum)                                                                             $ 3,670,000


Total Adjusted Costs3                                                                                              $10,861,727
 Add: Expenditure for Operating Deficit                                     $ 267,204
 Less: Operating Deficit Reserves                                               (600,000)                                       - 332,796

Total Settlement Requirements                                                                                                 $10,528,931
 Less: Non-HDG Actual Financing                                           $ 6,000,000
     HDG Funds Drawn Down                                                    3,670,000                                         - 9,670,000
Owner's Equity Invested                                                                                                       $ 858,931


Required Equity Investment                                                                                                     $ 1,098,118
 Less: Equity Currently Invested                                                                                                - 858,931
Additional Equity Investment Required3                                                                                         $ 239,187

     See Finding for details, and our limited scope.

     HUD program staff made this adjustment prior to HDG close-out for excess legal costs. Also, during September 1995, they were considering to
reduce the Mortgagor's Interest Yield Costs by $205,447 ($305,447 per Owner compared to approved amount of $100,000); we did not include that
adjustment in our interim computations due to the legal question of reopening the HDG close-out process for claimed costs which were disclosed.

    The final disposition of the HUD adjustment for interest yield costs (above Note 2) may require additional equity investment,and also affect
whether an excess HDG amount was paid.

96-AT-219-1002                                                        Page 18
                                     Appendix B

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              Page 19                96-AT-219-1002
                                                                                                                             Appendix C

Schedule of Ineligible Costs

         Recommendation                                  Ineligible Costs1

               1A                                                   $564,3182

    Ineligible amounts are clearly not allowed by law, contract, or HUD policies or regulations.

    Other amounts mentioned in the Recommendations are related to the ineligible development fees ($564,318) and are not scheduled to avoid

96-AT-219-1002                                                       Page 20
                                     Appendix C

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              Page 21                96-AT-219-1002
                                                                                              Appendix D

Auditee Comments

 OIG Notes
 *    Our position was and is that the ineligible fees are not bona fide project costs.

 **    Our limited audit pertains only to Lakeside costs; however, as to HUD practices/precedent on other HD G
       projects, see our footnote on page 26 about any specific relevant information.

96-AT-219-1002                                          Page 22
          Appendix D

Page 23   96-AT-219-1002
Appendix D

  OIG Notes
    * The sentence in the text on this page concerning profit or amounts above costs, in our opinion, is inconsistent
      in its restatement of the last sentence of the footnote above, and also incorrect.

**     We disagree that an "amount above costs traditionally incurred" may be generally allowable, rather the usual
       disapproval should be applied against waste and abuse for programs using taxpayer-provided funds.

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                                                                                                      Appendix D

OIG Note
  * Our limited facts indicate that this earlier GC "difficulty" should not affect the Lakeside or Greenwood Par k
    projects. In any event GC problems do not justify increasing total project costs; however, the total contrac t
    amount could be apportioned if the GC actual contra ct performance was less than contractually specified. Every
    cost with a relationship to the project is not per se allowable, particularly unnecessary or unreasonable charges.

                                                      Page 25                                          96-AT-219-1002
Appendix D

  OIG Notes
    * The payment of any amount must meet the necessary, reasonable, and related stipulation of A-87.

**     Our basic point is that such fees or risk allowances, like other allowable costs, be necessary and reasonable .
       Accurate disclosure and approval, in ou r opinion, should occur so that reasonableness is determined in advance,
       instead of retroactively.

***    The essence is whether these fees in the context of total-project costs are necessary and reasonable; in ou r
       opinion the facts fully support that they are ineligible in that context.

96-AT-219-1002                                         Page 26
                                                                                                   Appendix D

OIG Note
  * As presented on page 1 of our Audit Report (See introduction), the construction contract and relate d
    arrangements for Lakeside were prior to 1988. If there is precedent for one party unilaterally increasing costs
    for such fees as the GC and CA have done, the mortgagor should provide for HUD's consideration the cases and
    specifics on their relevance to the circumstances involving Lakeside.

                                                     Page 27                                         96-AT-219-1002
Appendix D

 OIG Note
    * The Developer did not provide the requested information, as discussed in the Scope segment beginning on our
      report's page 2. We did not pursue that ora l request, which we had presented in the general context of GAS, due
      to our opinion on effect, also stated on page 2 of the audit report.

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                                     Appendix D

This Page Left Blank Intentionally

              Page 29                96-AT-219-1002
                                                                                  Appendix E

Deputy Assistant Secretary, HM
Secretary's Representative, 4AS
Assistant General Counsel, 4AC
Director, Multifamily Housing Division, 4CHM
Field Comptroller, 4AF
Director, Accounting Division, 4AFF
Field Audit Liaison Officer, 4AFI
Alabama State Coordinator, Birmingham Office, 4CS
Chief Financial Officer, F (Room 10166) (2)
Associate Director, US GAO, 820 1st St. NE Union Plaza,
Bldg. 2, Suite 150, Washington, DC 20002
Assistant to the Deputy Secretary for Field Management, SDF (Room 7106)
Director, Office of Internal Control and Audit Resolution, FOI (Room 10176) (2)
General Contractor, Theodore N. Freeman
Lakeside Apartments Limited Partnership
The City of Auburn, Alabama

96-AT-219-1002                             Page 30