oversight

Sharps and Flats Apts., Davis, CA

Published by the Department of Housing and Urban Development, Office of Inspector General on 1995-11-21.

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

November 21, 1995

AUDIT RELATED MEMORANDUM
96-SF-212-1802


MEMO FOR: William F. Bolton, Director, Multifamily Division, Sacramento, CA.

FROM:     Mark J. Pierce, Senior Auditor

SUBJECT: Sharps and Flats Apartments
      Multifamily Mortgagor Operations
      Davis, California


We completed a survey of Sharps and Flats Apartments to identify instances
of assets used in violation of the regulatory agreement governing project
operations. Our initial work identified risk in the areas of (1)
development costs, (2) owner advances, (3) litigation, and (4) tenant
security deposits account. Subsequent work, however, identified no
material violations of the regulatory agreements or found that HUD asset
management had approved the owner's actions. Therefore, we concluded
that a detailed audit was not necessary. We noted several matters, however,
that warranted monitoring by HUD.

       BACKGROUND

Sharps and Flats (FHA project 136-35681) is a multifamily housing
development located in Davis, California. The mortgage loan is insured
by HUD under Section 221(d)(4) of the National Housing Act. Final
endorsement for insurance occurred in 1993. The project is owned by
Waggener Ranch Limited Partnership, whose general partner is Edward
MacDonald. Jon Berkley Management, also located in Davis, manages the
project. Project operations are governed by a regulatory agreement with
HUD in consideration of the mortgage insurance.

The project has severe cash flow problems because projected gross income
has not been realized. Mortgage payments and property taxes were almost
80 percent of the total revenues in 1994, leaving insufficient funds for
other operating expenses. The mortgage payments are current because: the
owner advanced funds to the project; tenant security funds and reserve for
replacement funds were used to make mortgage payments; and the management
agent reduced its fee to two percent. The project is now fully occupied
and rents are planned to be raised. Thus, the financial condition may
improve.
       PURPOSE AND METHODOLOGY OF SURVEY

We began this review to determine if project assets were used in violation
of the regulatory agreement governing project operations. To accomplish
this objective, we:

       ö     interviewed HUD staff, the owner, management agent staff,
       and the public accountant who performed the audit of the project's
       1994 financial statements.

       ö     reviewed HUD's asset management and development files,
       project records maintained by the management agent, public
       accountant's workpapers, and litigation records provided by the
       owner; and

       ö     gained an understanding of the internal control structure.
       We did not conduct tests to determine control effectiveness because
       this was not necessary for the limited objective of this review.

The review covered activities from August 1, 1993 to July 31, 1995. We did
the field work in August 1995 and conducted the review in accordance with
generally accepted government auditing standards.

       SURVEY RESULTS

Our initial work identified risk of possible asset misuse in the areas of
(1) development costs, (2) owner advances, (3) litigation, and (4) tenant
security deposits account. Subsequent work, however, identified no
material violations of the regulatory agreements or found that HUD asset
management had approved the owner's actions.

Development Costs. The 1993 statement of cash flows shows a $219,000
payment of a note payable, $119,405 repayment of advances from affiliates,
and $384,275 payment of construction costs payable. Based on our review
of project records, we concluded that nearly all of these payments were
proper. We did note that some development costs were paid from the
operating account for interest payments and service fees associated with
lines of credit used during construction; but the amount totaled less than
$6,500 during the time when the owner was advancing monies to the project.

Owner Advances. Since April 1993 the owner has advanced $474,000 to meet
the operational needs of the project. The owner has received partial
repayments of about $80,000 on these advances. The repayments generally
occurred during the same or subsequent month an advance was made. The
owner also occupies an apartment at the project rent-free with the amount
of the recorded advances being further reduced for the value of the rent.
While such repayments are violations of the regulatory agreement, the owner
has shown a commitment to keeping the mortgage current. We cautioned the
owner and management agent that repayments of advances are to be approved
by HUD.

Litigation. In 1994 an action was brought by the general contractor, Brown
Construction, against Waggener Ranch limited partnership and its general
partner, Edward MacDonald. The action seeks to recover the sums of two
promissory notes in the amounts $130,000 and $200,000. The owner
subsequently filed a cross-complaint. According to the owner, he execute
d the promissory notes in September 1992 when it appeared that there would
be a substantial construction cost savings. The notes were to be paid when
the general contractor completed another owner-related development called
Greek Court.

The $200,000 note represents cost savings to be passed on to the general
contractor. The owner stated that the cost savings never materialized,
and the general contractor is trying to enforce the notes although the
Greek Court development has not begun.

The $130,000 note represents a "good faith deposit" made to the mortgagee
by the general contractor. The general partner told us that it was his
intention to repay the deposit from additional funds requested in the
owner's application to HUD under a statutory waiver. The waiver was
denied. The general contractor agreed to include the deposit in his
limited partnership interest. The general partner explained that the
general contractor's agreement with him provided that the general
contractor would receive an ownership interest in the project in lieu of
a builders profit. Thus, the general contractor is a limited partner.

The $130,000 note represents part of the general contractor's equity
investment in the project. If the owner returns any of the general
contractor's investment, funds must not come from project resources,
except from available surplus cash. Likewise, litigation expenses
are partnership expenses. Nevertheless, we found no evidence that
significant project funds had been used to pay for litigation expenses
or to refund the contractor's investment.

Tenant Security Deposits Account. The management agent transferred funds
from the tenant security deposits account to the operating account to help
meet expenses. Only $1,200 remained in the account in mid-December 1993.
Then, on December 28, 1993 the general partner advanced $50,000 to the
account. The security account was later reduced to $1,023 by May 1994,
and refunded by another $50,000 in July. Starting in October, the
management agent began transferring funds from the security account at
the end of the month and returning it several weeks later. The security
account was only used once in 1995, and it appears that the practice has
stopped. HUD verbally approved the use of the tenant security funds to
meet the projects's operating needs. (HUD also approved the use of
$40,000 in reserve for replacement funds to be applied toward the August
1994 mortgage payment.) As of July 21, 1995, the tenant security account
held $49,280 compared to a liability of $74,301.

       CONCLUSION

We concluded that further audit work was not warranted at this time;
however, the HUD asset management branch should closely monitor this
project, particularly for the litigation, security deposit, and owner
advance matters. We are not controlling any audit recommendations as a
result of this review.

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