Multifamily Housing
Physical and Financial Condition of Mark-to-Market At-Risk Properties Gao ID: GAO-02-953 September 6, 2002In 1997, Congress established the mark-to-market program to help preserve the availability and affordability of low-income rental housing while also reducing the cost to the federal government of rental assistance provided to low-income households. The mark-to-market program was developed for multifamily properties that are both insured by the Federal Housing Administration (FHA) in the Department of Housing and Urban Development (HUD) and aided through the project-based Section 8 program. Under the mark-to-market program, at the time of the assisted properties' section 8 contract renewal, HUD resets rents to prevailing market levels and restructures a property's mortgage debt, if necessary, to permit a positive cash flow. This process is designed to ensure that properties whose rents are reduced to market level still have sufficient income to meet the mortgage payments and operating expenses on the property. The Office of Multifamily Housing Assistance Restructuring (OMHAR) was established within HUD to administer the mark-to-market program. OMHAR places federally assisted, FHA-insured properties on the watch list when their rents have been reduced to market level under the mark-to-market program but their mortgages have not been restructured. Two-hundred and eleven properties have been placed on the watch list, for one of three reasons: (1) the property owners elected not to enter into or complete the mortgage restructuring process; (2) OMHAR determined that the property was not financially viable for restructuring; or (3) the property owners were disqualified from the mortgage restructuring process because of certain actions by the owner, such as financial or managerial improprieties. Eighty-seven percent of OMHAR's watch list properties received HUD inspections that indicated they were in satisfactory physical condition, but some of these inspections occurred before the properties were placed in the watch list. The timing of HUD's inspection cycle depends on the results of each property's most recent inspection. As a result, a watch list property that received a high score on its previous physical inspection may not be reinspected for up to 3 years from the last inspection. While OMHAR believes that all properties on the watch list are potentially at financial risk, HUD's Financial Assessment Subsystem--which contains information on property owners' audited annual financial statements--indicates that 62 percent of the watch list properties show signs of potential financial risk. HUD established guidance for monitoring the watch list properties 10 months ago, but it is too early to assess how effective the monitoring will be.
GAO-02-953, Multifamily Housing: Physical and Financial Condition of Mark-to-Market At-Risk Properties
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Report to Congressional Requesters:
United States General Accounting Office:
GAO:
September 2002:
Multifamily Housing:
Physical and Financial Condition of Mark-to-Market At-Risk Properties:
Multifamily Housing:
GAO-02-953:
Contents:
Letter:
Results in Brief:
Background:
Properties Are on the Watch List for One of Three Reasons:
Most Watch-List Properties Received Satisfactory Physical Inspection
Scores:
Financial Assessment Scores Suggest Many Watch-List Properties Are
Experiencing Financial Problems:
HUD Has Targeted Watch-List Properties with Monitoring Procedures:
Agency Comments:
Appendix I: Williams Apartments - Titusville, Florida:
Background:
Reason for Placement on Watch List:
Physical and Financial Condition:
HUD Monitoring:
Appendix II: Parkside Terrace Apartments - Washington, D.C.
Background:
Reason for Placement on Watch List:
Physical and Financial Condition:
HUD Monitoring:
Appendix III: The Colony - Providence, Rhode Island:
Background:
Reason for Placement on Watch List:
Physical and Financial Condition:
HUD Monitoring:
Appendix IV: Parkside Apartments - Gillette, Wyoming:
Background:
Reason for Placement on Watch List:
Physical and Financial Condition:
HUD Monitoring:
Appendix V: New Haven Apartments - Athens, Texas:
Background:
Reason for Placement on Watch List:
Physical and Financial Condition:
HUD Monitoring:
Appendix VI: Miyako Gardens Apartments - Los Angeles,
California:
Background:
Reason for Placement on Watch List:
Physical and Financial Condition:
HUD Monitoring:
Appendix VII: Scope and Methodology:
Appendix VIII: Comments from the Department of Housing and Urban
Development:
Appendix IX: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Acknowledgments:
Figures:
Figure 1: Reasons the 211 Properties Were Placed on the Watch List:
Figure 2: Percentage of Watch-List Properties Sorted By Scoring Range:
Figure 3: Percentage of Watch-List Properties, By Annual Financial
Score:
Figure 4: Photograph of Williams Apartments:
Figure 5: Photograph of Parkside Terrace Apartments:
Figure 6: Photograph of The Colony Apartments:
Figure 7: Photograph of Parkside Apartments:
Figure 8: Photograph of New Haven Apartments:
Figure 9: Photograph of Miyako Gardens Apartments:
Abbreviations:
DECDepartmental Enforcement Center
FASSFinancial Assessment Subsystem
FHAFederal Housing Administration
HUDDepartment of Housing and Urban Development
OMHAROffice of Multifamily Housing Assistance Restructuring
PAEParticipating Administrative Entity
REACReal Estate Assessment Center:
United States General Accounting Office:
Washington, DC 20548:
September 6, 2002:
The Honorable Paul Sarbanes
Chairman, Committee on Banking,
Housing and Urban Affairs
United States Senate:
The Honorable Jack Reed
Chairman, Subcommittee on Housing
and Transportation
United States Senate:
The Honorable Wayne Allard
Ranking Member, Subcommittee on Housing
and Transportation
United States Senate:
In 1997, Congress established the mark-to-market program to help
preserve the availability and affordability of low-income rental
housing while also reducing the cost to the federal government of
rental assistance provided to low-income households. There is a
shortage of affordable housing in the United States, particularly in
tight housing markets. The mark-to-market program was developed for
multifamily properties[Footnote 1] that are both insured by the Federal
Housing Administration (FHA)[Footnote 2] in the Department of Housing
and Urban Development (HUD) and aided through the project-based Section
8 program.[Footnote 3] HUD‘s project-based Section 8 program provides
rental subsidies to participating property owners to supplement rent
paid by eligible low-income families for units in those properties. The
impetus for the mark-to-market program was the determination that unit
rents in many of these properties exceeded those prevailing in the
market, resulting in higher federal subsidies to property owners.
Under the mark-to-market program, at the time of the assisted
properties‘ section 8 contract renewal, HUD ’marks“ (i.e., resets)
rents to prevailing market levels and restructures a property‘s
mortgage debt,[Footnote 4] if necessary, to permit a positive cash
flow. This process is designed to ensure that properties whose rents
are reduced to market level still have sufficient income to meet the
mortgage payments and operating expenses on the property. The Office of
Multifamily Housing Assistance Restructuring (OMHAR) was established
within HUD to administer the mark-to-market program.
Property owners receiving above market rents are eligible to enter the
mark-to-market process when their current Section 8 contracts are about
to expire.[Footnote 5] Once a property owner decides to enter the mark-
to-market process, OMHAR determines how much the property‘s rents will
be reduced and whether the property needs mortgage restructuring. OMHAR
assigns each property that needs a mortgage restructuring to a
contractor who works with the owner to develop a restructuring plan
that would permit a positive cash flow in light of the reduced rents.
Since the inception of the mark-to-market program, over 2,000
properties have entered the restructuring process. Of these, over 200
properties that needed a mortgage restructuring have not completed the
process. These properties represent 15,301 units and approximately $207
million in outstanding mortgage principle. OMHAR believes these
properties are at risk of physical and financial problems because,
according to the contractors‘ financial analyses, the properties will
not have sufficient cash flow to meet their mortgage payments and
operating expenses without restructuring. Moreover, because these
properties are insured by FHA, if any of the properties should go into
default, FHA will likely be responsible for paying the lender‘s claim.
In order to closely monitor these properties, OMHAR placed them on a
watch list and, in concert with HUD‘s Office of Multifamily Housing,
developed and implemented new monitoring procedures for them.[Footnote
6]
Because of your concerns about the possible problems associated with
the watch-list properties, you asked us to examine HUD‘s oversight of
these properties. As agreed with your offices, this report examines (1)
the reasons OMHAR places Section 8 properties on the watch list, (2)
the physical condition of the properties, (3) the financial condition
of the properties, and (4) HUD‘s monitoring procedures for the
properties.
To assess the reasons that Section 8 properties were placed on the
watch list, we analyzed available data from OMHAR. We also conducted
telephone interviews with contractors responsible for developing the
restructuring plans for a random sample of these properties. To
determine the physical and financial condition of the watch-list
properties, we analyzed data on the results of HUD‘s physical
inspections and assessments of annual financial statements submitted by
property owners. To examine the procedures that HUD uses to monitor the
watch-list properties, we (1) reviewed HUD guidelines for monitoring
properties and (2) discussed the implementation of the guidelines at
selected HUD field offices. We also conducted case studies for six
watch-list properties to obtain detailed information on the reasons
they were placed on the watch list, the implications of their rents
being reduced to market levels, the physical and financial condition of
the properties, and HUD‘s role in monitoring them. For detailed
descriptions of the properties included in our case studies, see
appendixes I through VI. Data are current as of April 2002, unless
otherwise noted. We conducted our review from October 2001 to July
2002, in accordance with generally accepted government auditing
standards. (See app. VII for additional discussion of our scope and
methodology.):
Results in Brief:
OMHAR places federally assisted, FHA-insured properties on the watch
list when their rents have been reduced to market level under the mark-
to-market program, but they have not had their mortgages restructured.
Two-hundred and eleven properties have been placed on the watch list,
for one of three reasons: (1) the property owners elected not to enter
into or complete the mortgage restructuring process, even though OMHAR
has determined that such a restructuring is needed to allow the
property to have sufficient cash flow to meet its mortgage payments and
operating expenses (177 properties, or 84 percent); (2) OMHAR
determined that the property was not financially viable for
restructuring (31 properties, or 15 percent); and (3) the property
owners were disqualified from the mortgage restructuring process
because of certain actions by the owner, such as financial or
managerial improprieties (3 properties, or less than 1 percent).
According to contractors who worked with property owners to develop
restructuring plans, owners most commonly opted out of the
restructuring process because they did not want to accept certain HUD
requirements related to the mortgage restructuring or because they
believed that their property could operate sufficiently at the reduced
rents.
Eighty-seven percent of OMHAR‘s watch-list properties received HUD
inspections that indicated they were in satisfactory physical
condition, but some of these inspections occurred before the properties
were placed on the watch list. Specifically, 182 of the 211 properties
received satisfactory physical inspection results. However, 75 of these
182 properties have not had a physical inspection since being placed on
the watch list. The timing of HUD‘s inspection cycle depends on the
results of each property‘s most recent inspection. As a result, a
watch-list property that received a high score on its previous physical
inspection may not be reinspected for up to 3 years from the last
inspection. Twelve percent (26) of the watch-list properties received
inspection scores indicating that they were in substandard condition,
and about 1 percent received scores indicating they were in severe
condition.
While OMHAR believes that all properties on the watch list are
potentially at financial risk, HUD‘s Financial Assessment Subsystem--
which contains information on property owners‘ audited annual financial
statements--indicates that 62 percent of the watch-list properties show
signs of potential financial risk. Moreover, 46 percent of the watch-
list properties have financial indicators that suggest that they do not
have sufficient income to cover their mortgage payments. HUD officials
said these data should be used in conjunction with other information to
assess a property‘s overall financial condition.
HUD established guidance for monitoring the watch-list properties 10
months ago, but it is too early to assess how effective the monitoring
will be. Implementation of this guidance has been slow and inconsistent
among the field offices we visited. HUD‘s watch-list guidance, which
was issued in September 2001, is based on the premise that such
properties should be closely monitored because they are at risk of
developing physical and financial problems. However, HUD only recently
developed the format for a quarterly report required by the guidance,
and we observed that the guidance was not being consistently
implemented across the HUD field offices we visited.
In commenting on a draft of this report, HUD stated that we provided it
with valuable advice and guidance during our review, but provided some
clarifying comments and suggested technical modifications, which we
have incorporated into this report as appropriate. For example, in
response to our assessment that implementation of the watch-list
procedures has been slow and inconsistent at the field offices we
visited, HUD commented that new procedures disseminated to Multifamily
HUB Directors in July 2002, such as guidance on quarterly reporting,
will ensure more consistent oversight of these properties. Moreover,
HUD stated that it was taking other measures to improve oversight, such
as using Real Estate Assessment Center (REAC) real estate financial
specialists to analyze watch-list properties‘ financial statements and
providing this information to field office managers to assist in their
monitoring of such properties.
Background:
To date, over 800,000 units in approximately 8,500 multifamily housing
projects have been financed with mortgages insured by FHA and supported
by project-based Section 8 housing assistance payments contracts. Many
of these contracts set rents at amounts higher than those of the local
market. As these housing subsidy contracts expire, Congress has
mandated that the rents on these privately owned multifamily properties
be lowered to market levels.
For those properties identified by HUD as having above-market rents,
Congress created the mark-to-market program in 1997 to reduce rents to
market levels and restructure existing mortgage debt to levels
supportable by these rents. The goals of the mark-to-market program
include preserving the affordability and the availability of low-income
rental housing, while reducing the long-term costs of Section 8
project-based assistance. The restructuring generally involves
resetting rents to market levels and reducing mortgage debt, if
necessary, to permit a positive cash flow. To facilitate the
restructurings, Congress provided OMHAR with certain tools, such as the
ability to reduce an owner‘s mortgage payments by creating a new first
mortgage and, where necessary, deferring some of the debt to a second
mortgage, which is only required to be repaid if sufficient cash flow
is available.
The mark-to-market process begins when a property‘s existing Section 8
project contract is nearing expiration and the owner decides to remain
in the program. Before a new Section 8 contract is awarded, these
property owners are required to submit to HUD a market study that
contains information on market rents for comparable properties located
within the subject property‘s geographic area. Local HUD field offices
review these market studies and, where studies show a property owner‘s
rents are not above market, have the option and authority to award the
owner with a new Section 8 contract. HUD field offices forward cases to
OMHAR when a market study submitted by an owner shows their rents are
above market. OMHAR, in turn, provides these cases to contractors,
known as participating administrative entities (PAE),[Footnote 7] who
also conduct market studies, carry out the analysis necessary for
restructurings, and prepare restructuring plans and documentation.
Under the mark-to-market program, properties whose rents are above
market levels undergo one of two types of restructuring. Mortgage
restructurings generally involve resetting rents to market levels and
reducing mortgage debt to permit an acceptable, positive cash flow. For
this type of restructuring, the PAE develops restructuring plans based
on a reduction in rents and mortgage debt and submits the plans to
OMHAR for review and approval. Before the restructuring plans can be
implemented, owners are required to enter into a new 20-year Section 8
contract and to sign an affordability and use agreement promising to
maintain restrictions aimed at preserving the designated units as
affordable housing for at least 30 years--10 years beyond the Section 8
contract period. Property owners must agree to contribute 20 percent of
the total cost of rehabilitation needs of the property. The remaining
rehabilitation costs are included in the second mortgage that is
created during the restructuring process. Rent restructuring also
involves the PAEs developing restructuring plans that must be approved
by OMHAR. However, these plans are based only on a reduction in the
rents, not the mortgage debt. Rent restructurings are only permitted
for properties that can demonstrate the ability to have acceptable,
positive cash flow with a rent reduction but without a mortgage
restructuring. There are no affordability and use restrictions on
properties that receive rent restructuring, and the Section 8 contracts
are usually renewed for 5 years.
Approximately 211 properties have not completed the mortgage
restructuring process, even though, as a result of having their rents
reduced to market level, OMHAR determined that such a restructuring is
necessary for the properties to have acceptable, positive cash
flows.[Footnote 8] OMHAR places properties that it believes should have
had a mortgage restructuring on the watch list because it believes such
properties are at risk of developing physical and financial problems
stemming from insufficient cash flow. These property owners receive a
1-year renewal watch-list contract.
After OMHAR places these properties on its watch list, it becomes the
responsibility of HUD field offices to monitor them as part of their
asset management duties. Guidance issued by HUD in September 2001
requires HUD field offices to monitor watch properties for signs of
physical, financial, and management deterioration. Based on the
guidance, field office staff should review available data on the
properties‘ physical and financial condition, and conduct periodic
management reviews and site visits for properties showing signs of
impending default. If a field office observes a decline in the
properties‘ physical or financial condition, it can refer the property
to HUD‘s Departmental Enforcement Center (DEC) for analysis and a
potential corrective action plan. In cases where owners fail to comply,
DEC can resort to enforcement actions, such as the issuance of civil
money penalties, taking debarment and suspension actions, and
recommending foreclosure.
HUD‘s REAC conducts physical inspections of all HUD multifamily
properties, including watch-list properties. One of the key monitoring
responsibilities of HUD project managers is to monitor the results of
these physical inspections, which are captured in HUD‘s Guidance for
Oversight of Multifamily Physical Inspections. HUD‘s monitoring
guidelines direct project managers to pay special attention to
properties receiving a substandard or severe physical inspection score
of 59 or below, including follow-up with the property owners to ensure
that all exigent deficiencies (health and safety issues) are corrected
in 3 business days.
Each year HUD requires property owners to submit audited financial
statements for all multifamily housing properties it insures and/or
subsidizes. Using its Financial Assessment Subsystem (FASS), HUD
develops a score that indicates the level of financial health
associated with such properties. This financial score represents a
single aggregate financial measure that synthesizes data from five
different financial ratios. For example, the debt service coverage
ratio compares a property‘s net operating income to its mortgage amount
and demonstrates whether the property has sufficient cash flow to meet
its debt service obligations. If a property‘s income is equal to its
debt service, the debt service coverage ratio is 1.0. Generally, HUD
expects a property‘s income to be at least 120 percent of its debt, or
have a debt service coverage ratio of 1.2 or higher.
Properties Are on the Watch List for One of Three Reasons:
OMHAR places properties on the watch list when a property‘s rents are
reduced to market level but its mortgage is not restructured. As of
April 15, 2002, OMHAR had placed 211 properties on the watch list for
one of three reasons. OMHAR assigned the majority of these properties
to the watch list because the property owners elected not to enter into
or complete the mortgage restructuring process, even though OMHAR had
determined that the mortgage needed to be restructured. In addition,
OMHAR placed some properties on the watch list because it decided that
restructuring the mortgage was not financially feasible under OMHAR‘s
guidelines. Finally, OMHAR placed a few properties on the watch list
because the owner‘s actions, such as financial or managerial
improprieties, resulted in the owner‘s ineligibility for a mortgage
restructuring. Figure 1 below shows the percentage and number of
properties placed on the watch list by reason.
Figure 1: Reasons the 211 Properties Were Placed on the Watch List:
[See PDF for image]
Source: GAO analysis of OMHAR data.
[End of figure]
Owners‘ Refusal to Restructure Mortgage Is Most Common Reason OMHAR
Placed Properties on the Watch List:
According to HUD data, most owners on the watch list refused to enter
into or complete the restructuring process. OMHAR considers these
owners ’uncooperative.“ According to OMHAR, uncooperative owners
include those who (1) fail at any point during the process to supply
information needed to complete the restructuring process, (2) fail to
respond in a timely manner to the PAE‘s proposed restructuring plan,
(3) fail to address critical repair needs in a timely manner, and (4)
fail to close on a viable transaction.
OMHAR officials told us that property owners did not restructure their
mortgages for several different reasons. OMHAR and PAEs, who work
closely with owners while developing restructuring plans, agreed that
the most common reasons owners refuse to enter into or complete the
restructuring process are (1) the required out-of-pocket funds for
rehabilitation and repairs and (2) the owners‘ perception that
properties could operate sufficiently at the reduced rents. Under mark-
to-market program regulations, each owner who is participating in a
mortgage restructuring is required to contribute 20 percent of the
total cost of rehabilitation of the property. For example, the owner of
one of the properties we visited for a case study did not complete the
restructuring because he refused to pay approximately $26,000 for
contributions toward rehabilitation and escrow costs. OMHAR determined
that with restructuring, the property would have an acceptable cash
flow. However, because of the owner‘s refusal to complete the
restructuring process, OMHAR believes the property does not have
sufficient income to cover its debt and operating expenses. See
appendix V for more information on this case study property.
Some owners chose not to have their mortgages restructured because,
despite OMHAR‘s determination that a restructuring was necessary to
provide for an acceptable cash flow, the owners felt that they could
successfully operate the property at reduced cash flow. According to
one housing industry representative, some owners disagree with OMHAR‘s
conclusion that their property‘s mortgage needed to be restructured.
The housing industry official stated that she believes that some owners
have valid arguments against OMHAR‘s conclusion and that their
properties could operate successfully at reduced cash flow. According
to OMHAR, there are some properties on the watch list that may operate
successfully at reduced rents until they have a major capital repair
need that will affect their cash flow because they do not have
sufficient reserves to cover the repair.
Another reason some property owners have not restructured their
mortgages is their reluctance to enter into a 30-year affordability and
use agreement, as required in the act.[Footnote 9] This agreement
requires that a certain percentage of units must be leased to families
whose incomes do not exceed a certain percentage of the area median
income. According to a PAE, some owners are concerned about entering
into a 30-year affordability and use agreement when the contract HUD
has established for a mortgage restructuring is only for a 20-year
period, which leaves 10 years when the owner will have to provide
affordable housing without the guarantee of a Section 8 contract. Also,
an industry official representing owners noted that some owners are
also concerned about agreeing to a 30-year affordability and use
agreement when their property is already 20 to 30 years old and they
are uncertain about the viability of their property in 30 years.
According to HUD‘s database, most properties on the watch list are at
least 20 years old.
According to OMHAR, some property owners have not restructured their
mortgages because they are planning to opt out of the project-based
Section 8 program. When an owner chooses to opt out of the project-
based Section 8 program, eligible tenants are offered assistance in the
form of tenant-based vouchers, which they may use at the same property.
According to OMHAR, some owners may be able to obtain higher subsidies
through tenant-based assistance because the market rents established
for tenant-based assistance may be higher than the market rents
established for the property through the mark-to-market
process.[Footnote 10]
Secondly, OMHAR also places properties on the watch list if it
determines that because of economic conditions in the market and/or a
property‘s financial and/or physical condition, restructuring the
property is not financially viable. According to OMHAR, the majority of
the 31 watch-list properties that were determined to be financially
nonviable were nonviable due to a combination of the economic
conditions in the market and the property‘s financial and/or physical
condition. Two of the properties we visited for case studies were
declared by OMHAR to be financially not viable for restructuring. For
example, one property we visited in Washington, D.C., required over $4
million in rehabilitation and had an outstanding mortgage balance of
about $1.3 million. OMHAR determined that, given the market rents in
the area, the property could not generate enough income to finance the
mortgage and rehabilitation costs. The other property that we visited
that OMHAR declared financially nonviable was located in Rhode Island.
OMHAR determined that restructuring was not viable for this property
because it had an unpaid mortgage balance of $421,280 but appraised at
only $217,000 and required $200,000 in rehabilitation costs. See
appendixes II and III for more information on these properties.
Third, OMHAR places properties on the watch list because of an owner‘s
actions. Under the act, owners who engage in financial or managerial
improprieties may be declared ineligible for mortgage
restructuring.[Footnote 11]
Properties Can Be Removed from the Watch List for Several Reasons:
Properties can be removed from the watch list for several reasons. Thus
far, 70 properties that were at one time on the watch list have been
removed. Under watch-list monitoring guidelines, properties can remain
on the watch list for 3 or more years. According to OMHAR, a property
can be removed if, after 3 years on the watch list, it has maintained
its physical and financial condition. No properties have been removed
from the watch list for this reason. In addition, properties can be
removed from the watch list if the owners prepay their FHA-insured
mortgage. Property owners who prepay their FHA-insured mortgages may
continue to have Section 8 contracts but no longer represent a
financial risk to the FHA insurance fund. Thirty-two properties have
been removed from the watch list for this reason. Properties are also
removed from the watch list if the owner decides to reenter the
mortgage restructuring process, as has occurred with 32 properties. In
addition, properties are removed from the watch list if the owner opts
out of the Section 8 program, as has occurred with six properties.
Most Watch-List Properties Received Satisfactory Physical Inspection
Scores:
According to HUD‘s latest physical inspection results, the majority of
watch-list properties are in satisfactory physical condition. HUD data
show that 182 of the 211 watch-list properties, or 87 percent, scored
60 or higher on their most recent physical inspection--which HUD
considers to be satisfactory. However, 75 of these properties have not
been inspected since being placed on the watch list.
HUD uses the same criteria for determining the timing of inspections
for watch-list properties as it does for other multifamily properties.
Under HUD‘s guidelines, properties that receive a physical inspection
score between 90 and 100 are to be reinspected in 3 years, properties
that receive a score between 80 and 89 are to be reinspected in 2
years, and properties that receive a score of less than 80 are to be
reinspected in 1 year. HUD data indicate that 131 of the watch-list
properties received scores between 80 and 100 on their most recent
inspection and therefore are not required to be reinspected for 2 or 3
years. According to HUD and industry officials, watch-list properties
are at risk of developing physical problems because, in response to
reduced cash flow, some owners are likely to cut back on routine
maintenance, major improvements, and contributions to replacement
reserves.
Twenty-six of the watch-list properties, or 12 percent, received a
substandard physical inspection score between 31 and 59 on their most
recent inspection. Properties with scores in this range may exhibit a
variety of significant problems. For example, a property we reviewed in
Florida for our case studies that received a score of 33 had a wide
range of deficiencies, including health and safety issues, such as
inoperable smoke detectors and missing or broken electrical outlets.
See appendix I for more information on this case study.
Three watch-list properties, or about 1 percent of the total, received
a physical inspection score of 30 or less--which HUD considers severely
distressed. Severely distressed properties are likely to have major
problems. One of our case study properties received a score of 21. Its
roof and boilers required replacement, and there was water damage
throughout the building. (See app. II for more information on this case
study). Figure 2 shows the watch-list inventory sorted by the
percentage of properties whose physical inspection score fell into each
category.[Footnote 12]
Figure 2: Percentage of Watch-List Properties Sorted By Scoring Range:
[See PDF for image]
Source: HUD‘s Real Estate Management System database.
[End of figure]
Financial Assessment Scores Suggest Many Watch-List Properties Are
Experiencing Financial Problems:
Based on information from FASS,[Footnote 13] which contains information
from property owners‘ audited annual financial statements, 131 of the
211 watch-list properties, or 62 percent, show signs of potential
financial risk. FASS generates a score that places properties in one of
three risk categories--acceptable risk, cautionary risk, and high risk.
FASS indicates that the overall financial condition for 95 watch list
properties is ’high risk,“ while another 36 properties are
’cautionary.“ Figure 3 shows the percentage of watch-list properties in
each of HUD‘s three risk categories based on their 2001 FASS scores.
Figure 3: Percentage of Watch-List Properties, By Annual Financial
Score:
[See PDF for image]
Source: HUD‘s Real Estate Management System database.
[End of figure]
In generating a FASS score, FASS uses a formula that analyzes such
factors as whether a property has sufficient cash to meet its mortgage
payments, operating expenses, vacancy rates, and contributions to the
replacement reserve account. According to HUD officials, the overall
FASS score is meant to provide HUD with information on the financial
condition of its aggregate portfolio and highlight properties that
warrant further investigation by spotting potential financial problems
before they occur. These officials also told us that these data should
be used in conjunction with other available information to assess a
property‘s overall financial condition.
One of the indicators that are included in the FASS score is the debt
service coverage ratio, which shows how much revenue is available to
pay mortgage payments. We found that 97 of the 211 watch-list
properties, or about 46 percent, had debt service coverage ratios below
1.0. Specifically, 73 of the 95 high-risk properties, 18 of the 36
cautionary properties, and 6 of the 66 acceptable properties had debt
service coverage ratios below 1.0. This suggests that even some
properties in the acceptable and cautionary risk categories may
experience difficulty meeting their mortgage payments.[Footnote 14]
HUD Has Targeted Watch-List Properties with Monitoring Procedures:
HUD recently developed monitoring procedures specifically for watch-
list properties, but it is too early to tell whether the guidance will
be effective in monitoring the watch-list properties. HUD‘s
implementation of these procedures has been slow and inconsistent at
the field offices we visited.
New Watch-List Oversight Procedures Supplement Monitoring Guidelines
Applicable to All Section 8 Properties:
Believing that mark-to-market rent reductions in the absence of a
corresponding mortgage restructuring may place the physical and
financial condition of watch-list properties at risk, HUD developed
oversight procedures specifically designed to protect the long-term
viability of watch-list properties. The procedures, introduced in
September 2001, include HUD requirements that:
* all properties be assigned to experienced project managers who are
responsible for documenting properties‘ current condition as well as
performing ongoing monitoring activities.[Footnote 15]
* all property owners on the watch list are to submit monthly
accounting reports for a minimum of 1 year after rent reduction. These
reports are to itemize receipts and disbursements and are intended to
aid project managers‘ analysis of financial performance.
* HUD project managers review properties‘ monthly accounting reports,
prepare and submit quarterly status reports on all properties to HUD
and OMHAR directors, and handle and resolve compliance and performance
problems if revealed by the FASS review.
In addition to the above requirements, the new watch-list guidelines
provide monitoring guidance to ensure field offices closely track any
changes in a property‘s condition. In particular, the guidance states
that the project managers should pay close attention to the physical
and financial condition of the watch-list properties that are assigned
to them. In terms of the physical condition, the HUD guidance states
that the project manager should follow-up with the owner to ensure that
deficiencies are corrected. HUD also suggests that its representatives
make site visits to monitor repairs, and consider requesting interim
physical inspections where there are indications of diminished property
viability.
The new guidelines also specify that watch-list properties are subject
to existing asset management, project servicing and physical inspection
guidelines applicable to all multifamily properties.[Footnote 16] These
include the detailed REAC physical inspections and annual financial
reporting requirements. Other monitoring suggestions applicable to all
multifamily properties include on-site management reviews when there
are indicators of potential problems, and informal drive-by
observations. Properties can also be referred to DEC for further
actions when there are signs of potential or existing diminished
property viability. DEC works with owners to correct deficiencies and
can resort to actions such as levying civil money penalties, taking
debarment and suspension actions, and recommending foreclosure.
HUD‘s Implementation of the Watch-List Guidance Has Been Slow and
Inconsistent Across Field Offices We Visited:
HUD has only recently--in July 2002--developed the format that field
offices should use in developing quarterly reports for the watch-list
properties--10 months after saying it would do so ’shortly“ in its
September 2001 guidance. As a result, until now, field offices have not
been able to implement this aspect of the guidance. Furthermore, during
our review, we visited selected HUD field offices and found differing
levels of compliance with other aspects of the watch-list monitoring
guidance, specifically the experienced project manager and monthly
accounting report requirements. In the six field offices we visited to
review sample watch-list cases, implementation--as characterized by HUD
officials--ranged from none to exceeding the minimum guidelines. At one
office, officials had not assigned our sample case to an experienced
project manager and were not collecting monthly accounting reports at
the time of our visit in April 2002; officials at another office did
not introduce the guidelines until our visit in October 2001; three
offices had assigned watch-list properties to experienced project
managers and were requiring monthly accounting reports; and one office
was assigning monitoring responsibility to a single experienced project
manager, was receiving monthly accounting reports, and had gone beyond
the minimal requirements by creating a computer spreadsheet to
facilitate trend analysis of the monthly financial data.
Agency Comments:
We provided a draft copy of this report to HUD for its review and
comment. In its written comments, HUD‘s Assistant Secretary for
Housing-Federal Housing Commissioner stated that we provided valuable
advice and guidance during our review, but provided some clarifying
comments and technical modifications, which we have incorporated into
this report as appropriate. In addition, the Assistant Secretary stated
that, with respect to our assessment that the implementation of the
watch-list procedures was slow and inconsistent at the offices we
visited, additional guidance has been sent to HUD Multifamily HUB
directors that should lead to more consistent oversight. The Assistant
Secretary also stated that other measures are being taken to monitor
the watch-list properties, including an analysis of these properties‘
financial statements by REAC financial specialists and sharing the
results of the analyses with project managers in the field. The full
text of HUD‘s comments can be found in appendix VIII.
We will send copies of this report to the Secretary of Housing and
Urban Development. We will also make copies available to others on
request. In addition, this report will be available at no charge on the
GAO Web site at http://www.gao.gov.
If you or your staff have any questions about this report, please call
me at (202) 512-7631. Key contributors to this report are listed in
appendix IX.
Stanley J. Czerwinski
Director, Physical Infrastructure Team:
[End of section]
Appendix I: Williams Apartments - Titusville, Florida:
Background:
Williams Apartments is a 37-unit Florida complex, constructed in 1969
and has been owned by the same sole proprietor since that date. The
property is located in Titusville, a small town of approximately 30,000
people. There are 5 residence buildings composed of 37 units (18 2-
bedroom and 19
3-bedroom). All units receive Section 8 subsidies.
The managing agent for the complex is currently the owner. He also
managed the property from 1969 until 1995 and two independent
management companies managed from 1995 until 2000.
The property‘s rents were reduced in March 2001. Based on full
occupancy, the total annual rental income was reduced approximately 36
percent. The monthly rents on the two-bedroom units were reduced from
$568 to $345, and the three-bedroom units were reduced from $656 to
$440 (see fig. 4 below).
Figure 4: Photograph of Williams Apartments:
[See PDF for image]
Source: HUD.
[End of figure]
Reason for Placement on Watch List:
The property was placed on the watch list in March 2001. The owner, who
is of advanced age, refused to sign the restructuring agreement after
it was completed in November 2000, and he would not provide us specific
reasons for his refusal. The owner‘s cash contributions were set at
$25,594, including approximately $21,000 for rehabilitation escrow. The
restructured mortgage would mature in 21 years and 8 months and would
provide a 1.2 debt service coverage ratio, making the property
financially viable to operate.
The existing mortgage had an unpaid balance of $205,657 as of October
2001 and will mature in October 2010.
Physical and Financial Condition:
The Williams Apartments received a score of 33 (based on a 100-point
system) on its most recent Real Estate Assessment Center (REAC)
physical inspection, which was conducted in December 2001. The
inspection report cited a wide range of life threatening deficiencies,
including missing/inoperable electrical cover plates and blocked
emergency exits. The property had received a similar low score of 36 on
its prior physical inspection. HUD considers these scores to indicate
that the property was in substandard condition.
In February 2001, a HUD manager stated that as a result of the owner
allowing the physical condition of the property to deteriorate, the
complex had been ’on and off“ HUD‘s highest risk list for the last 15
years. A contractor for HUD‘s Departmental Enforcement Center (DEC),
where the property was referred because of physical and financial
problems, stated that since 1994, the property has consistently
received below average ratings on maintenance policies and procedures.
The contractor visited the property in April 2001 and reported many
physical problems that were cited in previous inspections. In March
2002, the HUD senior project manager received a list of complaints
signed by 20 tenants. They complained of ceilings falling down, the
absence of hot water, electrical outages, and plumbing problems.
Deficiencies identified by the November 2000 and December 2001
inspections have not been addressed, and the owner has not submitted
the required plan of corrective actions to HUD.
The property received a financial assessment score of 65 in 1999. HUD
considers this score to indicate that the property is in ’cautionary“
financial condition. A more current financial analysis is not available
because the owner failed to submit annual financial statements for
calendar year 2000. Also, a June 2001 HUD record indicated that the
owner had repeatedly been delinquent on his mortgage payments.
HUD Monitoring:
HUD devoted considerable monitoring attention to this property before
and after its placement on the watch list and has well documented the
property‘s physical and financial condition. The owner has shown his
refusal to address the problems identified by HUD oversight, and
tenants have complained that living conditions are deteriorating.
Prior to entering the watch list, the property was referred to DEC, in
February 2001, because the owner failed to resolve deficiencies
identified in the November 2000 inspection and repeatedly violated his
regulatory agreement by collecting funds for self-management of the
property. The HUD field office had required that a new management agent
be appointed due to the poor management and needed physical repairs. In
April 2001, the owner‘s attorney expressed the opinion that the owner
should return the property to HUD because the mortgage and necessary
rehabilitation costs far exceeded its appraised value, and the rent
reduction would result in further deterioration.
In August 2001, HUD refused to grant a request that the mortgage be
forgiven as part of the owner‘s attempt to donate the property to a
nonprofit corporation. HUD specified repairs as the number-one priority
and authorized the owner to begin addressing these maintenance items
with funds normally reserved for capital replacements.
In October 2001, HUD notified the owner of his failure to submit
complete and correct monthly accounting reports, as required by watch-
list monitoring guidelines. In December 2001, DEC mailed the owner a
certified letter notifying him that he was in default on his HUD
housing assistance contract and regulatory agreement. Cited violations
were (1) failure to properly maintain property and respond to HUD
physical inspection reports, (2) failure to file and late filing of
annual financial statements, and (3) late mortgage payments. He was
given 30 days to take corrective action. In January 2002, the owner met
with HUD and DEC officials and left with the understanding that he must
respond to all REAC inspections and provide annual financial statements
and monthly accounting reports.
In March 2002, HUD again notified the owner of problems with the
monthly accounting reports and requested that he reimburse the project
operating account $1,673 paid to himself as manager.
The smaller income stream, resulting from reduced rental rates, has
increased the potential risk for this property. A HUD manager was of
the opinion that the property would have ’made it“ if restructuring had
been completed, but the owner had not responded to DEC‘s demand for
corrective action as of April 2002. Foreclosure is the next course of
action. If that occurs, then the tenants will be given relocation
vouchers.
[End of section]
Appendix II: Parkside Terrace Apartments - Washington, D.C.
Background:
Parkside Terrace Apartments is a 291-unit apartment building located in
the Southeast quadrant of Washington, D.C. It was built in 1966. A
managing agent oversees the operations for the owner, Parkside Terrace
Company Limited Partnership. The managing agent assigned an on-site
manager to Parkside, which is a 12-story building consisting of 12
efficiencies, 54 1-bedroom units, 162 2-bedroom units, and 63 3-bedroom
units.
The area surrounding Parkside Terrace Apartments has improved during
the 1990s, but overcrowding, unemployment and poverty are still
problems. Two of the three public housing developments in the area have
been demolished and replaced by a new development; the third was also
demolished and is now a vacant lot. The area has also experienced a
drop in crime. The overcrowded rate for occupied units in the area is
above 25 percent. As of February 2002, only 30 percent of Parkside
Terrace Apartments‘ households reported having a working adult, and the
median household income for all the households in the property is
$15,700.
Rents for 142 of Parkside Terrace Apartments‘ 291 units were reduced on
April 1, 2001. The rents for these units were reduced between 13 and 26
percent. Sixty-nine units are still governed by a project-based Section
8 contract that does not expire until October 2003 and will continue to
receive above market rents until that time. The remaining 80 units are
not receiving Section 8 subsidies (see fig. 5).
Figure 5: Photograph of Parkside Terrace Apartments:
[See PDF for image]
Source: GAO.
[End of figure]
Reason for Placement on Watch List:
On October 23, 2000, HUD‘s Office of Multifamily Housing Assistance
Restructuring (OMHAR) determined that Parkside Terrace Apartments was
not financially viable; thus, it was ineligible for mortgage
restructuring. As a result, on April 1, 2001, the property was placed
on the watch list. OMHAR made this determination because the property‘s
physical condition assessment report, prepared by a contractor for the
participating administrative entity (PAE), includes a 20-year repair
plan and recommends major capital replacements and repairs that would
cost more than $4.4 million in the first year. Major capital
improvements have never been performed on the property. Parkside
Terrace Apartments‘ roof, boilers, and over 500 of its windows need to
be replaced. According to OMHAR, the total cost of the needed
improvements to the property is too high for OMHAR to finance under the
mark-to-market program.
Before OMHAR determined the property to be financially not viable, the
PAE recommended that the property receive a mortgage restructuring
since a rent reduction alone would leave the property with inadequate
cash flow to meet its mortgage payments and finance the property‘s
rehabilitation cost. A representative of the PAE told us that it might
have been possible to restructure the property‘s debt despite the large
rehabilitation cost, based on the assumption that tax credits and tax-
exempt bond financing would be made available. However, the PAE did not
perform any analysis to assess the feasibility of using tax credits and
tax-exempt bonds for this purpose.
Physical and Financial Condition:
According to HUD‘s physical inspection scores, the property is in poor
physical condition. Its physical inspection scores have declined over
time. It received a physical inspection score of 43 on February 5,
1999, and a score of 38 on December 1, 2000, both of which HUD
considers to indicate poor condition. On October 30, 2001--
approximately 6 months after being placed on the watch list--Parkside
Terrace Apartments‘ received a physical inspection score of 21. Water
damage was discovered in some of the property‘s units and hallways
during the October 30, 2001, physical inspection.
Since the property received a score less than 30, it was referred to
DEC. DEC‘s contractor inspected the property in April 2002 and
discovered severe water damage, caused by leaking copper pipes
throughout the building. Several balconies needed to be repaired as
well.
Based on HUD‘s Financial Assessment Subsystem (FASS), Parkside Terrace
Apartments‘ financial condition is cautionary. Prior to the rent
reduction, the property received a financial assessment score of 69,
had a debt service coverage ratio of 1.2, and a vacancy rate of about
20 percent. For the fiscal year ending December 31, 2001 (during which
time the rents were reduced), Parkside Terrace Apartments received a
financial assessment score of 65 and had a debt service coverage ratio
of 0.7 percent (which suggests the property did not have sufficient
cash flow to meet its mortgage payments) and a vacancy rate of above 22
percent. The vacancy rate has been above 14 percent since 1996.
According to the managing agent, the mark-to-market rent reduction has
further contributed to Parkside‘s declining financial condition.
According to the managing agent, the property‘s expenses increased
substantially in 2001. The natural gas and electricity costs increased
by 300 percent and 150 percent, respectively. Parkside Terrace
Apartments also experienced an increase in insurance costs as a result
of the event on September 11, 2001.
HUD has approved several suspensions of replacement reserve deposits
and changes in the replacement reserve deposit requirements since 1994.
Property owners are required to deposit money into reserve for
replacement accounts, which are intended to be used to pay for capital
improvements such as roofs, boilers, and windows. In 1994, HUD required
that Parkside increase its replacement reserve deposit amount from
$4,000 to $20,000 per month. HUD approved several consecutive
suspensions to its replacement reserve, as requested by the managing
agent, from July 1996 to June 1999. The managing agent used these funds
to renovate 30 vacant units. In September 2001, HUD‘s project manager
assigned to Parkside approved a reduction of the deposit requirement
from $20,000 to $3,000 per month because (1) the property experienced a
significant reduction in rent under the mark-to-market program, and (2)
the HUD field office determined that the existing deposit amount was
too high in light of a proposal to demolish the property.
HUD Monitoring:
HUD‘s District of Columbia field office (responsible for monitoring
Parkside Terrace Apartments) has partially implemented the September
2001 monitoring guidance for watch-list properties. The Parkside
Terrace Apartments managing agent has submitted monthly accounting
reports, and an experienced project manager has been assigned to the
property. However, because HUD headquarters has not provided a format
to be used for watch-list properties‘ quarterly reports, the field
office has not prepared them.
Currently, the managing agent is attempting to purchase Parkside
Terrace Apartments for demolition and planning construction of a mid-
rise building for the elderly and townhouses. The townhouse portion of
the proposal contains a plan for both market rate and subsidized rental
townhouses.
[End of section]
Appendix III: The Colony - Providence, Rhode Island:
Background:
The Colony is a 17-unit apartment complex located in Providence, Rhode
Island. The building, consisting of efficiencies and one-and two-
bedroom units, is a former rooming house that underwent substantial
rehabilitation and became part of the Section 8 elderly housing program
in 1981. In 1984, the complex received a waiver from HUD to admit non-
elderly residents; the complex currently has no elderly residents. The
majority of residents are single females with children. All the units
are currently subsidized by HUD‘s Section 8 program.
The Colony is in a neighborhood of Providence (South Providence) that
has a history of drug and crime problems. According to the management
agent, the Colony did not house elderly residents in the early 1980s
because the elderly were afraid to live in this area. While the
surrounding neighborhood has improved somewhat in recent years, the
immediate neighborhood continues to have significant drug and crime
activity, and some nearby houses are in poor physical condition.
The watch-list contract took effect in October 2001. Under this
contract, the rents were reduced by an average of 34 percent, and the
total monthly maximum Section 8 payment from HUD decreased from $12,708
to $8,370. The owners appealed OMHAR‘s rent determination; subsequently
the rents were increased slightly, and the total monthly maximum
payment also increased to $9,415. Ultimately, the new rents were set at
25 percent below the pre-mark-to-market levels.
The rents for the Colony were reduced in October 2001. The rents on the
efficiencies were reduced from $635 to $475; the rents on the 1-bedroom
units were reduced from $771 to $560; and the rents on the 2-bedroom
units were reduced from $910 to $695 (see fig.6).
Figure 6: Photograph of The Colony Apartments:
[See PDF for image]
Source: GAO.
[End of figure]
Reason for Placement on Watch List:
OMHAR placed the Colony on the watch list on November 2, 2001, because
it determined that the property was not financially viable; thus, it
was ineligible for mortgage restructuring. OMHAR made this
determination primarily because the property was appraised at $267,000
but had a mortgage balance of $415,675. In addition, according to HUD
and the management agent, the Colony also required approximately
$200,000 in physical rehabilitation costs.
Physical and Financial Condition:
The Colony received a score of 80 on its most recent physical
inspection, which was conducted in September 2001 (2 months prior to
placement on the watch list). This represents a marked improvement from
its previous scores of 24 and 66 in 1999 and 2000, respectively. The 80
score indicated that the Colony was in satisfactory physical condition.
However, according to HUD and the management agent, this property had
significant problems that needed substantial rehabilitation costs.
Because of the previous score of 80, the Colony is not scheduled for
another physical inspection for 2 years, in September 2003.
The Colony‘s financial condition continues to decline. The property
received financial scores of 69 in 1998, 60 in 1999, and 39 in 2000.
Also, since the Colony had a debt service coverage ratio of 0.7 in
2000, there is evidence that the Colony has had difficulty meeting its
financial obligations even before its rents were reduced. After the
rent reduction, the Colony was experiencing greater difficulty meeting
its mortgage payments and have frequently been 30 to 60 days
delinquent.
HUD Monitoring:
The HUD field office has monitored this property in accordance with
current HUD guidance. Specifically, the field office has assigned the
Colony to an experienced project manager, who receives and reviews
monthly accounting reports. In addition, the project manager conducts
regular management reviews of the property, which include site visits
and reviews of the property‘s physical, financial, and managerial
condition.
The current owners of the Colony have entered into discussions with a
nonprofit group to purchase the Colony. This nonprofit group has
experience in successfully rehabilitating Section 8 properties in the
Providence area and is interested in rehabilitating the property and
using it to house elderly tenants.
According to the project manager, it would be best for the Colony to be
sold to owners who are willing to contribute significant financial
resources to refurbishing the property. If the property cannot be sold
in the near future to an owner who is willing to pay for the
substantial repairs that are needed, the project manager said he is
planning to request that the tenants receive vouchers and the property
be discontinued as a Section 8 property. Moreover, he said that it
would not be difficult for the 17 households to find other Section 8
units in the area.
[End of section]
Appendix IV: Parkside Apartments - Gillette, Wyoming:
Background:
Parkside Apartments is a 94-unit complex located in Gillette, Wyoming.
The complex consists of 4 buildings with 24 1-bedroom units and 70 2-
bedroom units. All of the units are currently subsidized by HUD‘s
Section 8 program. The property was initially occupied as a Section 8
property in February 1980, with its initial Section 8 contract expiring
on February 28, 2001. The population of Gillette is approximately
19,000. There is very little alternative housing in Gillette, and the
closest town is 75 miles away.
The owners of this apartment complex also have other Section 8
properties-Acadian Manor in Lafayette, Louisiana and Mountain View
Apartments in San Jose, California. In addition, the owners previously
owned the Pittsburgh Plaza Apartments in Pittsburgh, California. The
owners of Parkside Apartments have been charged and convicted on
several counts, including fraud and conspiracy at each of the HUD
subsidized properties they own.
OMHAR reduced the monthly rents for Parkside Apartments in March 1,
2001, by approximately 28 percent. The rents were reduced from $568 to
$405 for the 1-bedroom units; $666 to $485 for the 2-bedroom (1
bathroom) units; and $705 to $495 for the 2-bedroom (2 bathrooms) units
(see fig. 7).
Figure 7: Photograph of Parkside Apartments:
[See PDF for image]
Source HUD.
[End of figure]
Reason for Placement on Watch List:
OMHAR placed Parkside Apartments on the watch list in April 2001
because the owners were indicted on criminal charges and suspended from
conducting further transactions with HUD.
The owners of Parkside Apartments have a criminal history dating back
to 1992. They were charged in 1996 by a California municipal court for
crimes committed in 1992, including filing a false insurance claim,
grand theft, and falsely reporting a crime. While one of the owners was
still on bail in March 1999, the owners were indicted by the State of
California for welfare fraud, health care fraud, conspiracy, and six
counts of grand theft. Some of the charges resulted from the owners
receiving subsidy payments for apartments that were vacant in the
owners‘ California Section 8 property, and the owners were subsequently
suspended from further government contracting in October 1999. After
receiving a tenant complaint that the owners were also billing HUD for
vacant units at Parkside Apartments, HUD investigators raided the
owner‘s home and Parkside‘s office in July 2000. The investigation
revealed that the owners were receiving subsidy payments for empty
apartments, just as they had in their California property. As part of
the owners‘ plea agreement, the owners paid over $1.4 million in
restitution.
Physical and Financial Condition:
REAC inspected Parkside Apartments in October 1999 and gave it a score
of 90. HUD considers this score to indicate that the property is in
satisfactory condition. Based on HUD‘s guidance, the property should
have had a physical inspection in June 2002. As of late July 2002, the
inspection had not been done.
The property‘s financial scores have increased annually since 1999,
with all of the scores in HUD‘s highest performance category. The
financial scores received were 73, 78, and 93 in 1999, 2000, and 2001,
respectively.
HUD Monitoring:
The HUD field office has monitored this property in accordance with
current HUD guidance. The last management review was conducted in June
1999, and the property received an overall rating of unsatisfactory
because the owners had not submitted annual financial statements for
fiscal years 1997 and 1998. The management review also disclosed that
the owners have serious unresolved internal control deficiencies in its
accounting systems. In November 1998, the HUD project manager noted in
the property‘s file that the owner was diverting funds from Parkside
Apartments to his other properties. As a result, the project manager
suggested pursuing sanctions against the owner if he was not indicted
by the end of January 1999. The owner was indicted in March 1999.
In October 2001, the owner of Parkside Apartments entered into a
settlement agreement with HUD. In this agreement, the owner agreed to
be permanently disbarred from participating in any activities with the
federal government. The owner also agreed to divest himself from any
interest in HUD properties within 24 months from the date of the
agreement. HUD‘s project manager stated that the owner will most likely
opt out of the Section 8 program at the end of the 24 months and
compete in the private rental market. Due to the tight housing market
in Gillette, the property has a possibility of succeeding in the
private rental market. According to HUD officials, however, the tight
housing market will make it very difficult to relocate the existing
tenants if the owners sell the property or opt out of the program.
[End of section]
Appendix V: New Haven Apartments - Athens, Texas:
Background:
New Haven Apartments is a 50-unit complex located in Athens, Texas. It
was constructed in 1974. A managing agent oversees operations for the
owner and an on-site manager maintains the units and collects rent. The
complex consists of 8 1-bedroom, 26 2-bedroom, and 16 3-bedroom units.
All of the properties‘ units have Section 8 project-based assistance.
There is no tenant organization, and the managing agent said he has not
been aware of any tenant concerns during the mark-to-market process.
However, the HUD file contains a letter to the PAE signed by 14 tenants
that identifies a variety of problems, including sewage back-ups,
defective air conditioners, and leaking ceilings. The occupancy rate is
approximately 90 percent.
Rents were reduced for New Haven Apartments on August 1, 2001. Annual
rental income, based on full occupancy, was reduced approximately 7
percent. Rents on the one-bedroom units were reduced from $427 to $350;
rents on the two-bedroom units were reduced from $443 to $420; and
rents on the three-bedroom units were reduced from $496 to $475 (see
fig. 8).
Figure 8: Photograph of New Haven Apartments:
[See PDF for image]
Source: GAO.
[End of figure]
Reason for Placement on Watch List:
OMHAR placed New Haven Apartments on the watch list because the owner
rejected the mortgage restructuring plan. The management agent stated
that the owner did not accept the plan because of the 25-year term
mortgage agreement. Due to the age of the property (also 25 years) and
the declining conditions of the neighborhood, the owner did not want to
sign another 25-year term mortgage agreement. The unpaid balance on the
current mortgage is approximately $475,000, with maturity scheduled for
the year 2015. However, if the mortgage was restructured, the new
$408,026 mortgage would not mature until the year 2026. In the absence
of a mortgage restructuring, OMHAR predicts the property will
experience a negative cash flow of approximately $4,200 annually and a
debt service coverage ratio of 0.9.
Physical and Financial Condition:
The managing agent stated that he was uncertain whether the August 1,
2001, rent reduction has had a negative impact; but as of April 2002,
New Haven Apartments has been able to maintain a positive cash flow.
The on-site manager said the maintenance budget has not changed and no
major maintenance problems have occurred since rent reduction. REAC‘s
physical inspection score dropped from 81 in October 1999 to 68 in
November 2001, but HUD‘s project manager said he was doubtful that the
rent reduction contributed to the decline in the property‘s physical
condition. He bases his statements on the fact that the November 2001
inspection occurred only 3 months after the rent was reduced. HUD
considers a score of 68 to indicate that the property is in
satisfactory condition and should be inspected on an annual basis.
New Haven‘s financial scores for the past 4 years have not varied
significantly and were consistently in HUD‘s acceptable category. The
financial score for the period ending in December 31, 2001, was 78--
which represents only a 3-point drop from the previous 81 score given
in December 2000. In 1998 and in 1999, the scores were 87 and 78,
respectively.
HUD Monitoring:
Representatives from HUD‘s Fort Worth field office (responsible for
monitoring New Haven Apartments) stated that they did not implement the
watch-list monitoring guidelines until we made our visit to the field
office in October 2001. As required by the guidance, the managing agent
has submitted the monthly accounting reports. The managing agent began
submitting monthly accounting reports in October 2001, and reports
through January 2002 have been submitted. The project manager stated
that there has been ’little or no change“ in the indicators (e.g.,
income and vacancy rates) that HUD looks at to determine financial
’health“ of the property.
[End of section]
Appendix VI: Miyako Gardens Apartments - Los Angeles, California:
Background:
Miyako Gardens Apartments is a 100-unit complex located in Los Angeles,
California. Developed in 1981 by a limited partnership, Miyako Gardens
provides affordable housing to low-and moderate-income tenants. A
managing agent oversees operations at Miyako Gardens for the limited
partnership. The complex consists of 90 1-bedroom and 10 2-bedroom
units, all of which are subsidized by HUD‘s Section 8 program. Although
not established as a property for the elderly, all of the tenants are
senior citizens. According to the property manager, the complex is
currently operating at 100-percent occupancy and has few vacancies each
year. The complex has a waiting list of approximately 3 years.
Miyako Gardens is located in the ’Japan Town“ area east of the Central
Business District in downtown Los Angeles. The immediate area has good
appeal, consisting of a privately owned condominium, two subsidized
apartment complexes, a Buddhist temple, and several restaurants.
According to OMHAR‘s rent comparison study and the property manager,
there are no significant negative influences, and the immediate area is
relatively safe, quiet, and drug free. Income and employment levels are
average to above average in the area. In addition, property values and
rents have increased over the past 2 years.
Prior to the mark-to-market program, rents at Miyako Gardens were set
at $907 for a 1-bedroom unit, and $967 for a 2-bedroom unit. As a
result of restructuring, rents for Miyako Gardens were reduced to $745
and $930, respectively. This represents a decrease of 18 percent of
revenues for the 1-bedroom units, and 4 percent for the 2-bedroom units
(see fig. 9).
Figure 9: Photograph of Miyako Gardens Apartments:
[See PDF for image]
Source: GAO.
[End of section]
Reason for Placement on Watch List:
Miyako Gardens was placed on the watch list in August 2001, but OMHAR
later determined that the property should not be on the watch list
because the owner decided to opt out of the Section 8 program. Since
originally deciding to opt out of the Section 8 program, the owners
have now indicated that they wish to remain in the program and OMHAR
will determine whether the property requires a mortgage restructuring.
Physical and Financial Condition:
The property received a score of 99 on its most recent physical
inspection, which took place in August 1999 (2 years before the
property was placed on the watch list). HUD considers this score to
indicate that the property was in satisfactory physical condition. The
next inspection is scheduled in August 2002. Based on our site visit,
testimony from the property manager, and the rent comparison study, the
property has been well managed and maintained and is in good market
condition. The rent comparison study noted only very minor deferred
maintenance, consisting of cosmetic touch-up items, and the property‘s
curb appeal was rated as better than the typical property of its
generation. Miyako Gardens received a financial score of 91 for 2001.
This represents an increase from its two previous scores of 82 for
1999, and 84 for 2000.
HUD Monitoring:
HUD‘s project manager assigned to the Miyako Gardens Apartments has not
visited the complex since it was placed on the watch list. The project
manager stated that, based on the high physical and financial scores
and the absence of any ’red flags,“ there has not been an urgency to
inspect the property. HUD‘s new guidance on monitoring watch-list
properties requires, among other things, that watch-list properties be
assigned to an experienced project manager who monitors the property by
requesting and analyzing monthly accounting reports provided by the
managing agent. To date, the HUD field office has not met these
requirements. The office supervisor stated that the office is short-
staffed and is currently undergoing a reorganization. An experienced
project manager will be assigned in the future, and the office will
begin to request the monthly accounting reports.
[End of section]
Appendix VII: Scope and Methodology:
Our objectives were to answer the following questions: (1) What are the
reasons properties have been placed on HUD‘s watch list? (2) What is
the physical condition of properties on the watch list? (3) What is the
financial condition of properties on the watch list? (4) What are HUD‘s
procedures for monitoring watch-list properties?
To assess the reasons that OMHAR places Section 8 properties on the
watch list, we obtained a database extract from OMHAR‘s Management
Information System (MIS) as of April 15, 2002. This extract contained
information on over 2,000 properties that had entered OMHAR‘s portfolio
since late 1998, including properties OMHAR assigned to its watch list.
We focused on the reasons why OMHAR assigns properties to the watch
list and summarized the various results for each cause. We also
conducted telephone interviews with the agents[Footnote 17] responsible
for developing the restructuring plans for a random sample of the
properties on the watch list to determine why the owners of the
properties did not complete the restructuring process.
To determine the physical and financial condition of the watch list
properties, we used OMHAR‘s April 15, 2002, database extract and
obtained a second database extract from HUD‘s Real Estate Management
System (REMS) as of June 2002. This system contained the latest
complete information on watch-list properties‘ physical and financial
scores. We also used demographic data found in REMS to select our six
case studies. To assess the physical and financial conditions of watch-
list properties, we sorted this inventory into various scoring ranges
and computed aggregate average physical and financial scores for
OMHAR‘s watch-list inventory. We compared these results with similar
data for all properties that have gone through the mark-to-market
program, of which there are over 2,000 properties, to determine if the
physical and financial conditions of each inventory is similar. To
assess the reliability of OMHAR‘s data, we (1) performed electronic
testing (specifically for accuracy, reasonableness, and completeness);
(2) reviewed related documentation from HUD; and (3) worked closely
with OMHAR officials to identify any data problems. Where we found
discrepancies (such as nonpopulated fields or data-entry errors) we
brought them to OMHAR‘s attention and worked with these individuals to
correct the discrepancies before conducting our analyses. We determined
the data we used were reliable for purposes of this report.
To assess the effectiveness of HUD‘s monitoring procedures, we reviewed
HUD‘s policies and procedures for monitoring properties and discussed
HUD‘s implementation of the policies and procedures at selected HUD
field offices. We also visited a judgmental sample of properties that
are monitored by HUD offices that are geographically distributed to
determine whether HUD‘s monitoring procedures are sufficient to quickly
detect signs of physical and/or financial deterioration of the
properties.
In conducting our review, we interviewed officials in HUD and OMHAR
headquarters in Washington, D.C., and HUD personnel in six HUD field
offices--Providence, Rhode Island; Denver, Colorado; Jacksonville,
Florida; Los Angeles, California; Washington, D.C.; and Fort Worth,
Texas. In addition, we conducted a structured telephone interview with
PAEs for a random sample of 60 watch-list properties. We also
interviewed officials in OMHAR headquarters in Washington, D.C. and
OMHAR staff in Chicago, Illinois. We performed our work from October
2001 through July 2002 in accordance with generally accepted government
auditing standards.
[End of section]
Appendix VIII: Comments from the Department of Housing and Urban
Development:
U.S. Department of Housing and Urban Development:
Washington, DC 20410-8000:
AUG 15 2002:
Mr. Stanley J. Czerwinski:
Director, Physical Infrastructure Team United States General Accounting
Office Washington, DC 20548:
Dear Mr. Czerwinski:
Thank you for the opportunity to provide comments on the General
Accounting Office (GAO) draft report: MULTIFAMILY HOUSING: Physical and
Financial Condition of Mark-to-Market At-Risk Properties (GAO-02-953).
The Department shares the concern of GAO and Members of Congress about
the preservation of low-income housing and especially about the
condition of properties with project-based Section 8 assistance that
have been through the mark-to-market process and are in need of a full
mortgage restructuring, but have elected just to have their rents
reduced to market. The Department‘s ’watch list“ approach is intended
to monitor approximately 200 properties in this situation and to ensure
that the properties remain physically acceptable for tenants and
financially viable for the long term. GAO has provided valuable advice
and guidance during this review and its related review of the Office of
Multifamily Housing Assistance Restructuring (OMHAR) completed in July
2001.
The draft report contains no findings or recommendations, noting that
it may be too early to assess the guidance the Department has developed
for monitoring the watch list properties and that to date the
implementation of the procedures has been slow and inconsistent in the
offices GAO visited. On July 25, 2002, just as the Department received
the draft report, additional direction on monitoring watch list
property was sent to the Multifamily Hub Directors in the field. The
Department believes that Headquarters oversight through this tracking
process will ensure more consistent oversight of these properties.
In addition to oversight by the field offices, the Financial Assessment
Subsystem (FASS) Lab of the Real Estate Assessment Center (REAL) is
reviewing the watch list properties. The FASS Lab has real estate
financial specialists who are analyzing these properties‘ financial
statements to determine the risk to the insurance fund. The results of
the analyses will be shared with the field project managers to assist
them in their ongoing monitoring.
The Department has reviewed the draft report and offers the following
technical corrections:
*On Page 3, where the report indicates that OMHAR developed the new
monitoring procedures for watch list properties, please include the
point that the procedures were developed in concert with and
implemented by the Office of Multifamily Housing.
*On page 4, under ’Results in Brief,“ the Department recommends
including the point that, in addition to ensuring that these properties
are closely monitored, the watch list was established to provide a
mechanism for them to re-enter the mark to-market program. As indicated
later in the report, 32 properties have re-entered the mortgage
restructuring process.
*On page 7, where the report discusses the monitoring of the watch list
properties by the HUD field offices, it is implied that conducting
periodic management reviews and site visits for each watch list
property is required. Given limited travel resources and staff, such
visits are required only if there is an indicator of impending default.
They are also encouraged to monitor repairs necessitated by a REAC
physical inspection.
*On page 8, and elsewhere, it should be noted that the Departmental
Enforcement Center has other tools than civil money penalties to assist
enforcement actions, including recommending foreclosure and abatement
of any subsidies, taking debarment and suspension actions, and
referring the matter to the Department of Justice for affirmative civil
enforcement seeking double damages.
*On Page 18, and elsewhere in reference to the term ’senior project
manager,“ the watch list guidance uses this term to mean a seasoned and
experienced project manager who would be assigned to monitor the watch
list properties. While there are staff persons with the position title
’Senior Project Manager“ (typically at the GS-13 level), the guidance
intends that watch list properties be assigned to staff that has
considerable experience in working with and monitoring troubled or
potentially troubled properties.
The Department is committed to ensuring that the cost of the Section 8
program to the taxpayer is reduced by the mark-to-market program and
that properties brought into the program continue to provide decent and
affordable units to families in need of assisted housing. GAO‘s
assistance in monitoring this program and the Department‘s performance
has been very beneficial to the achievement of these objectives.
Sincerely,
John C. Weicher:
Assistant Secretary for Housing-Federal Housing Commissioner:
Signed by John C. Weicher:
[End of section]
Appendix IX: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Stanley J. Czerwinski, (202) 512-7631
Charles E. Wilson, Jr., (202) 512-6891:
Acknowledgments:
In addition to those named above, Andy Clinton, Mark Egger, Rafe
Ellison, Reid Jones, John McGrail, Sara-Ann Moessbauer, Tinh Nguyen,
John Shumann, Rick Smith, Mark Stover, and Alwynne Wilbur made key
contributions to this report.
FOOTNOTES
[1] Multifamily properties include dwellings with five or more units,
such as apartment buildings.
[2] FHA mortgage insurance protects lenders from financial losses
stemming from borrowers‘ defaults on mortgage loans.
[3] Under the Section 8 program, the federal government pays property
owners the difference between the monthly rent on a unit and 30 percent
of a family‘s income. This assistance can be project based (i.e.,
attached to the unit) or tenant based (i.e., a voucher held by the
tenant). The mark-to-market program applies only to the project-based
Section 8 program.
[4] Restructuring mortgage debt can include lowering the total
mortgage, lowering the monthly payments, or both.
[5] Within 120 days of the date Section 8 project-based contracts are
set to expire, owners are required to notify HUD of their intentions to
opt out or remain in the program. In some cases, a property may have
multiple Section 8 contracts.
[6] Once properties are placed on the watch list by OMHAR, they become
the monitoring responsibility of local HUD field offices.
[7] OMHAR has contracts with various public and private organizations,
referred to as participating administrative entities, to carry out the
property restructurings.
[8] Of the 15,301 units represented by the 211 properties, 12,848, or
almost 84 percent, receive Section 8 project-based assistance.
[9] Section 514(e)(6) of the act requires the owner or purchaser of the
property to maintain affordability and use restrictions for a term of
not less than 30 years.
[10] Tenant-based assistance is calculated based on fair market rents,
which sets the maximum monthly subsidy for all areas of the country.
[11] Financial or managerial improprieties include, among other things,
violating federal, state, or local laws, breaching a Section 8
contract, and repeatedly failing to make mortgage payments.
[12] In general, the physical condition of the watch-list properties is
similar to all properties that have gone through the mark-to-market
process. More specifically, watch list physical inspection scores
averaged just over 79, while the average physical inspection score for
all OMHAR properties was approximately 83. This slight variance does
not reflect a significant difference in the physical condition of the
properties in the separate portfolios because both scores indicate a
’satisfactory“ physical condition.
[13] Using information from the annual financial statement, a computer
model statistically calculates five financial ratios, or indicators,
for each project and applies acceptable ranges of performance, weights,
and thresholds for each. Examples of such ratios include a property‘s
physical vacancy rate, mortgage debt service coverage, and reserves per
unit. This information is then synthesized into an overall point value,
ranging from 10 to 100, or performance risk rating, for each project.
HUD uses a property‘s risk rating to place it into a risk category or
zone.
[14] The average FASS score for watch-list properties is 57, which
places them in the high-risk category, while the average score for
OMHAR‘s overall inventory is 63, which places them in the cautionary-
risk category.
[15] The September 2001 guidance indicated that watch-list properties
are to be assigned to ’Senior Project Managers.“ However, in July 2002,
HUD issued new guidance clarifying that these properties are intended
to be assigned to ’experienced or seasoned“ project managers, which
includes staff that have considerable experience working with troubled
properties.
[16] In addition to the September 2001 watch-list guidance, other
guidance applicable to monitoring watch-list properties include
Multifamily Asset Management and Project Servicing (Handbook 4350.1)
and The Revised Guidance for Oversight of Multifamily Housing Physical
Inspections, issued May 24, 2001.
[17] OMHAR has contracts with various firms (referred to as
participating administrative entities - PAE) to carry out the property
restructurings.
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