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entitled 'Multifamily Housing: Physical and Financial Condition of 
Mark-to-Market At-Risk Properties' which was released on September 06, 
2002.



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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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