Housing Preservation: Policies and Administrative Problems Increase Costs
and Hinder Program Operations (Letter Report, 07/18/97, GAO/RCED-97-169).

Congress created the preservation program 10 years ago to keep
multifamily housing affordable for low-income households because the
owners of several thousand federally insured multifamily properties were
reaching a point at which they were eligible to pay off their mortgages.
Prepayment would enable these owners to terminate the existing
affordability restrictions, such as limits on the income levels of
residents and the rents that can be charged. The program offers
incentives to owners and purchasers of federally insured multifamily
properties who agree to maintain their properties for low-income
occupancy. This report reviews the (1) funding provided for preservation
properties as compared with the properties' values, (2) levels of
rehabilitation grants provided to properties compared with their
physical needs, and (3) administrative and other problems that have
arisen under the program. GAO also identifies lessons from the
preservation program that can be applied to portfolio reengineering, a
program designed to address long-standing problems plaguing the Federal
Housing Administration's insured portfolio of multifamily properties.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-97-169
     TITLE:  Housing Preservation: Policies and Administrative Problems 
             Increase Costs and Hinder Program Operations
      DATE:  07/18/97
   SUBJECT:  Low income housing
             Federal aid for housing
             Housing programs
             Housing repairs
             Rental housing
             Internal controls
             Program abuses
             Comparative analysis
             Formula grants
             Fair market value
IDENTIFIER:  HUD Low Income Housing Preservation Program
             
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Cover
================================================================ COVER


Report to Congressional Committees

July 1997

HOUSING PRESERVATION - POLICIES
AND ADMINISTRATIVE PROBLEMS
INCREASE COSTS AND HINDER PROGRAM
OPERATIONS

GAO/RCED-97-169

Housing Preservation

(385657)


Abbreviations
=============================================================== ABBREV

  ELIHPA - Emergency Low-Income Housing and Preservation Act
  FHA - Federal Housing Administration
  GAO - General Accounting Office
  HUD - Department of Housing and Urban Development
  LIHPRHA - Low-Income Housing Preservation and Resident
     Homeownership Act
  PCNA - preservation capital needs assessment
  POA - plan of action

Letter
=============================================================== LETTER


B-276544

July 18, 1997

The Honorable Christopher S.  Bond
Chairman
The Honorable Barbara A.  Mikulski
Ranking Minority Member
Subcommittee on VA, HUD,
 and Independent Agencies
Committee on Appropriations
United States Senate

The Honorable Jerry Lewis
Chairman
The Honorable Louis Stokes
Ranking Minority Member
Subcommittee on VA, HUD,
 and Independent Agencies
Committee on Appropriations
House of Representatives

The Congress created the preservation program 10 years ago to keep
existing multifamily housing affordable for lower-income households
as the owners of several thousand federally insured multifamily
properties were approaching eligibility to prepay (pay off) their
mortgages.  Prepayment would allow these owners to terminate the
existing affordability restrictions, such as the limits on the income
levels of residents and the rents that can be charged.  The program,
which offers incentives to owners and purchasers of federally insured
multifamily properties who agree to maintain their properties for
low-income occupancy, has been amended frequently.  Currently, the
financial incentives are provided through grants or loans and
primarily cover a payment to (1) the existing owner for equity in the
property--essentially an amount derived from the appraised value of
the property less the unpaid principal balance on the loan insured by
the Federal Housing Administration (FHA) and (2) the owner or
purchaser to rehabilitate the property.  The preservation program has
proven to be costly and complex. 

This report was prepared to comply with the requirements of House
Conference Report 104-812, accompanying the fiscal year 1997
appropriations act for the Departments of Veterans Affairs, Housing
and Urban Development (HUD), and Independent Agencies (P.L. 
104-204), which requested a GAO study of the preservation program. 
As requested, we reviewed (1) the funding provided for preservation
properties as compared with the properties' values, (2) the levels of
rehabilitation grants provided to properties compared with their
physical needs, and (3) the administrative and other problems that
have arisen under the program.  In addition, we identified lessons
from the preservation program that can be applied to portfolio
reengineering, a program designed to address long-standing problems
affecting FHA's insured portfolio of multifamily properties which is
being tested on a limited scale.  These lessons are discussed in
appendix I. 

To respond to the first two objectives, we obtained information on 40
properties that were processed by four of HUD's field offices.  At
each field office, the properties that we selected for review were
those that were closest to the top of HUD's preservation "funding
queue"--a list of properties with approved incentives that are
awaiting funding.  As of October 1996, 477 properties were on the
funding queue.  Twenty-seven of the 40 properties we reviewed
represented sales to new owners, and 13 represented extensions of
affordability restrictions by current owners.  Because the properties
we reviewed were not randomly selected, information about them cannot
be projected to all of the properties on HUD's funding queue.  Also,
the property values that we used in addressing the first objective
reflect the values of the properties that HUD and the property owners
agreed to in establishing the properties' preservation funding. 
Essentially, these values reflect the "as is" fair market values of
the properties based on their highest and best use as unsubsidized
market-rate residential properties.  As such, these values do not
reflect any increases in property values that may result from
improvements funded under the preservation program.  We did not
conduct our own independent assessments of property values. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

For the 40 properties that we reviewed, HUD approved $239 million for
preservation grants or loans, which averages about $6 million per
property.  The approved funding ranged from about $580,000 to $27
million per property or from about $8,000 to $120,000 per unit. 
Overall, there were wide variations between the amounts of approved
preservation funding and the values of the 40 properties we reviewed. 
The approved funding ranged from one-fourth of a property's value to
more than 3 times its value.  For 22 of the 40 properties, the
approved funding exceeded the property's value by an average of 62
percent. 

As part of the preservation funding for the 27 sales transactions we
reviewed, HUD approved a total of $111.9 million for rehabilitation
funding that owners or purchasers had requested.  This amount was 568
percent higher than the $16.7 million that HUD contractors had
identified as needed to cover repairs that would return the
properties to good condition.  The approval of a higher funding level
is largely attributable to HUD's broad criteria for funding
rehabilitation costs presented in a 1994 HUD preservation policy
notice.  The policy on eligible rehabilitation costs is aimed at
facilitating sales to nonprofit purchasers and maximizing the
remaining life and quality of preservation properties.  While HUD is
likely to reduce rehabilitation funding for some of these properties
in order to comply with fiscal year 1997 funding caps that the
Congress established, the overall rehabilitation funding for the 27
properties will still be substantial. 

HUD's administration of the preservation program is hampered by a
number of factors that collectively limit the Department's ability to
ensure that the program is being managed effectively and efficiently,
that federal funds are being spent wisely, and that preservation
operations are consistent with program requirements.  These factors
include the program's complexity, frequent changes in program
requirements, the tight time frames under which approval and funding
decisions are often made, program guidance that is fragmented and
sometimes ambiguous or incomplete, and HUD's limited oversight of its
field office operations.  For example, we found these factors
contributed to two cases in which HUD erroneously funded and in a
third case planned to provide preservation funding that exceeded
legislatively mandated funding caps by a total of $1.5 million. 
After we notified HUD of these situations, it took action to recover
the excess funds.  We also found two cases in which the Department
used its waiver authority to provide preservation funds to properties
whose operations were already governed by use agreements requiring
the owners to maintain them as affordable housing for extended
periods even if they prepaid their mortgages. 


   BACKGROUND
------------------------------------------------------------ Letter :2

The private owners of more than 3,600 multifamily housing projects
(with about 397,000 units) developed during the 1960s and 1970s under
sections 221(d)(3) and 236 of the National Housing Act have the
option to prepay their federally subsidized 40-year mortgages after
20 years.  In many cases, such prepayment could remove the
restrictions that reserve these units for lower-income households. 
Concerned about the possible loss of these units from the affordable
housing stock and the potential displacement of the residents, the
Congress enacted the Emergency Low-Income Housing and Preservation
Act of 1987 (also known as title II or ELIHPA) as a temporary measure
until a permanent program to preserve the units could be enacted. 
Title II authorized incentives to owners to continue low-income use
restrictions through the life of the existing financing (generally 20
years or less) while effectively prohibiting prepayments unless HUD
determined that there would be no adverse effect on the availability
of affordable housing. 

In 1990, title II was effectively replaced by the Low-Income Housing
Preservation and Resident Homeownership Act (also known as title VI
or LIHPRHA), which was aimed at ensuring that property units remained
available and affordable to lower-income families and that the
current owners were fairly compensated if they agreed to maintain
affordability restrictions.  Under title VI, limitations on the right
to prepay were continued, but the amount of time that low-income use
restrictions would be required was generally increased from the life
of the existing mortgage to the remaining useful life of the
property, or at least 50 years. 

Under both preservation laws, owners may choose to receive incentives
to continue low-income use restrictions at their properties without a
change of property ownership (referred to as "extensions") or they
may sell their properties to new owners who agree to extend the
low-income use restrictions (referred to as "sales" or "transfers"). 

In fiscal year 1996, the Congress made further revisions to the
preservation program.  Most notably, it restored the right of owners
to prepay their mortgages and to terminate affordability restrictions
at their properties provided they agreed not to raise the rents for
60 days.  During that year, HUD also revised the way it provided
incentives.  Specifically, most of the sales transactions funded in
that year provided incentives to the buyer and the seller in the form
of a grant.  Subsequently, in the fiscal year 1997 appropriations
law, the Congress required that all preservation transactions be
provided in the form of grants or loans.  For sales, the incentives
go to the buyer and the seller in the form of a grant.\1 Grants may
cover owner equity take-outs, rehabilitation (repairs, a repair
contingency, and replacement reserves\2 ), and transaction costs. 
For extensions, the owners receive the financial incentives in the
form of a loan payable upon the sale of the property or the
termination of the FHA-insured mortgage.  Loans may cover equity
take-outs and rehabilitation but not transaction costs.  See appendix
II. 

The fiscal year 1997 appropriations law also modified the program. 
For example, new funding caps on the amount of incentives that may be
provided for individual transactions were established.  The 1997 law
also reduced the overall federal funding from $624 million to $350
million, including $100 million specifically designated for residents
of properties whose owners prepay the mortgages and end the
low-income use restrictions.\3

The remaining $250 million may be used for preservation incentives. 
In 1996 and 1997, the Congress placed a funding priority on sales to
priority purchasers--resident groups and several categories of
nonprofit organizations that agree to extend affordability
restrictions at the properties.  However, in 1997, $75 million of the
$350 million provided for the program was designated for three
categories of properties, referred to as "carve-outs." The carve-out
properties, discussed further in appendix III, include those where
outside factors, such as earthquakes, delayed preservation funding
requests.  Carve-outs include both extensions and sales to priority
purchasers. 

The 1997 appropriations law established caps that limit the amount of
funding that HUD can provide to preserve individual properties. 
Essentially, these caps limit grants to 7 times the annual fair
market rent for the area in which the property is located and loans
to the lesser of 6 times the annual fair market rent for that area or
65 percent of equity plus the funds to pay for needed repairs.\4


--------------------
\1 Prior to the use of grants and loans, HUD had provided incentives
with increased levels of Section 8 project-based rental assistance
and FHA-insured Section 241 (f) loans covering equity take-outs and
repairs.  These incentives were terminated by the fiscal year 1997
appropriations law to reduce excessive program costs. 

\2 Replacement reserves are escrow funds established to ensure that
funds are available for needed repair and replacement costs. 

\3 Unused portions of the $100 million that are not needed for
resident protection may be used to provide preservation funding. 

\4 HUD establishes fair market rents annually for geographic areas
and uses them as limits for the rents that HUD can subsidize under
its tenant-based Section 8 certificate program.  The caps used to
establish funding limits for each preservation grant or loan take
into account the mix of unit sizes in each project. 


      THE PRESERVATION FUNDING
      PROCESS
---------------------------------------------------------- Letter :2.1

The funding process begins when an owner files a notice of intent to
participate in the preservation program.  HUD then has 9 months to
provide the owner with, among other things, the results of an
independent appraisal of the property.  As part of the appraisal
process, the Department also contracts for an assessment of the
property's capital needs, which is used in the determination of
preservation value.  Within 6 months of receiving this information
from HUD, the owner or purchaser is required to file a plan of action
describing how they intend to continue the affordability
restrictions.  This plan must include, among other things, a
description of the federal incentives needed and an analysis of how
any financial or physical deficiencies connected with the property
will be addressed.  The field office then reviews the plan of action
and, for approved plans, submits summary funding information to HUD's
preservation office at headquarters, which places the property on a
funding queue.  Subject to the availability of funds and the
program's rules, the approved properties are funded in the order in
which HUD placed them on the funding queue. 


      STATUS OF THE PRESERVATION
      PROGRAM
---------------------------------------------------------- Letter :2.2

According to HUD's data, through fiscal year 1996, 751 properties
with more than 90,000 units have received preservation funding.  In
addition, as of October 1996, another 477 properties with about
56,000 units were on HUD's preservation funding queue.  The
HUD-approved funding for the 477 properties totaled approximately
$1.6 billion.  As of June 1997, HUD anticipated funding at least 69
of these properties in fiscal year 1997. 

In 1996, the Congress restored the right of owners to prepay the
mortgages on preservation properties and terminate use restrictions. 
According to HUD, as of March 5, 1997, the Department had received
notices from the owners of 247 properties indicating their intent to
prepay their mortgages, and the owners of 109 properties had done so. 
Appendix IV provides additional information on prepayments and
legislative provisions to protect tenants from being displaced when
property owners prepay. 


   PRESERVATION FUNDING OFTEN
   EXCEEDS HUD'S APPRAISAL VALUES
------------------------------------------------------------ Letter :3

For 22 of the 40 properties that we reviewed, the preservation
funding approved by the Department exceeded the HUD-approved values
of the properties.  The approved funding is contingent upon the
availability of appropriations and compliance with program rules,
such as the funding caps mandated by the fiscal year 1997
appropriations law. 


      PRESERVATION FUNDING VARIES
---------------------------------------------------------- Letter :3.1

HUD approved a total of $239 million to fund plans of action for the
40 properties that we reviewed, which averages $6 million per
property or about $35,000 per unit.\5 The approved funding ranges
from about $580,000 to $27 million per property or about $8,000 to
$120,000 per unit.  Overall, 41 percent of the funding covers equity
take-outs, 52 percent covers rehabilitation needs (e.g., repairs, a
repair contingency, and replacement reserves), and 7 percent of the
incentives covers transactions costs.\6 The funding for the 40
properties reflects the caps mandated by the fiscal year 1997
appropriations law, except for 2 properties that had waiver requests
pending as of May 15, 1997. 

In comparison, according to HUD's data, the average amount of funding
for the 58 properties that HUD had scheduled for fiscal year 1997
funding as of March 21, 1997, was approximately $4.3 million per
property or about $26,000 per unit.  However, because this amount
does not reflect the effect of the 1997 funding caps for all
properties, it is likely to be somewhat overstated.  Twenty-four of
the 40 properties we reviewed are included in these 58 properties.\7

The amount of incentives approved for the 40 properties we reviewed
varied considerably depending upon whether the transaction
represented (1) a grant that reflected a sale to a priority purchaser
or (2) a loan that reflected an extension where the current owner
retains ownership.  For instance, the amount of funding for the 27
sales we reviewed ranged from about $1 million to $27 million per
property or an average of about $50,000 per unit.  In contrast, the
13 loans ranged from about $580,000 to $9.8 million per property,
averaging about $13,000 per unit.  This variance in financial
incentives is due to the significantly higher rehabilitation costs
associated with sales.  For example, the average per-unit
rehabilitation cost for sales was over $31,000, while the cost to
rehabilitate properties whose ownership was extended was about $2,600
per unit. 


--------------------
\5 This approved funding reflects the fiscal year 1997 funding caps. 
Without the caps, the approved funding would be $256 million.  The
percentages of funding by category are based on the unadjusted amount
of $256 million because, as of May 1997, for a number of properties,
it was not clear how the cuts would be allocated among the categories
(i.e., equity, rehabilitation, and transaction costs). 

\6 See appendix V for a list of the incentives in the approved plans
of action for each of the 40 properties we examined. 

\7 In June 1997, HUD indicated it would fund an additional 11
properties with fiscal year 1997 funding, for a total of 69
properties.  As of June 1997, 32 of the 40 properties we reviewed
have either been funded or are scheduled for funding in fiscal year
1997. 


      PRESERVATION FUNDING OFTEN
      EXCEEDED PROPERTY VALUES
---------------------------------------------------------- Letter :3.2

We found the HUD-approved preservation funding exceeded property
values for 22 of the 40 properties we reviewed.  For these 22
properties, the funding approved was on average about 62 percent
higher than the property values.  The property values that we used in
our analysis reflect the values of the properties that HUD agreed to
in determining the amount of equity take-out to which the owners
would be entitled.\8 The values are based on appraisals of the
property conducted on behalf of HUD and the property owner. 
Essentially, these values reflect each property's "as is" fair market
value based on its highest and best use as an unsubsidized
market-rate residential property.  As such, the values do not reflect
any increases in property values that may derive from improvements
funded under the preservation program.  We did not conduct our own
independent assessments of property values. 

The HUD-approved funding varied considerably compared to property
values--ranging from about one-fourth of the value to more than 3
times the value of a property (see app.  VI).  As shown in table 1,
the preservation funding for transactions involving sales under the
title VI program totaled $200.7 million, compared with property
values totaling $148 million.  HUD officials said the primary reason
that preservation funding exceeds property values is a 1994 policy
decision that broadened the scope of rehabilitation work that may be
funded under the program.  This policy is discussed more fully in the
next section of our report. 



                                Table 1
                
                Preservation Funding and Property Values
                           for 40 Properties

                          (Dollar in millions)

                                   Total            Differen  Ratio of
                                preserva                  ce   funding
                        Number      tion            (funding  to value
Type of preservation        of  funding\  Property     minus  (percent
funding               projects         a   value\b    value)      age)
--------------------  --------  --------  --------  --------  --------
TitleVI
----------------------------------------------------------------------
Sales                       27    $200.7    $148.0     $52.6       136
Extensions                   3       8.0      18.8    (10.8)        43
======================================================================
Subtotal                    30     208.7     166.8      41.8       125

Title II
----------------------------------------------------------------------
======================================================================
Extensions                  10      30.3      73.4    (43.1)        41
======================================================================
Total                       40    $238.9    $240.2    $(1.3)        99
----------------------------------------------------------------------
Note:  Totals may not add due to rounding. 

\a Preservation funding represents amounts in approved plans of
action, adjusted for funding caps unless HUD had waiver requests
pending (as of May 15, 1997). 

\b Property value represents the value of the property that HUD
agreed to in determining the amount of equity to which the owner
would be entitled--essentially, the "as is" fair market value based
on the property's highest and best use as an unsubsidized market-rate
residential property, reflecting the deduction of all improvements as
well as the repair and the conversion costs to transition the
property from subsidized to market-rate housing. 


--------------------
\8 HUD refers to these values as preservation values.  In this
report, we refer to the preservation values as property values. 


   FUNDING FOR REHABILITATION HAS
   GROWN SUBSTANTIALLY
------------------------------------------------------------ Letter :4

As a result of a 1994 policy decision by HUD, preservation funding
for property rehabilitation has increased substantially, particularly
for title VI sales transactions.  This policy allows property owners
and purchasers to receive preservation funding for a broad category
of property improvements, including improvements that "enhance the
economic life of the project and its livability for the tenants."


      HUD'S PROCESSES FOR
      IDENTIFYING AND FUNDING
      REHABILITATION
---------------------------------------------------------- Letter :4.1

HUD usually determines the rehabilitation needs of preservation
properties and the funding to address these needs at two stages of
the preservation process.  Early in this process, HUD contracts for
preservation capital needs assessments to determine the repairs that
are needed at properties whose owners have applied to participate in
HUD's preservation program.  Later, owners or purchasers may request
additional funding for repairs and improvements when they file plans
of action under the program. 

Preservation capital needs assessments are used to determine the
"required" repairs, including corrections and replacements, needed to
restore a property back to its original physical standards and their
associated costs.  As such, the costs reflect work needed to bring
the property to "good" physical condition, which generally means that
the property meets local codes and HUD's housing quality standards. 
In addition, the required repairs may include operational or energy
upgrades that will increase the efficiency of how a property
functions and/or its energy usage, such as new windows.  Under most
circumstances, required repairs may not include new amenities,
facilities, and equipment for the property, nor replacement of items
that are operational and functional, unless items are
inconsistent--such as mismatched kitchen appliances.  When HUD
promulgated procedures and standards in 1992 for implementing title
VI, the Department noted that the repairs identified in the initial
capital needs assessments represent a beginning basis for estimating
the rehabilitation needs and costs.  However, the Department
explained that the amounts would not be binding for purposes of
funding rehabilitation under a plan of action because (1) the limited
scope of some assessments may not have identified all of the costs
associated with repairing the properties to meet HUD's housing
quality standards and (2) the costs identified may be outdated by the
time the plan of action is approved.  Thus, these two exceptions seek
to address shortcomings in some capital needs assessments and changed
physical needs between the time of the assessment and the plan of
action. 

In 1994, HUD revised its policies on rehabilitation needs that may be
funded under the preservation program to allow owners and purchasers
to request funding for additional repairs as well as improvements
that go far beyond those items covered in the capital needs
assessments.  Specifically, HUD determined that it would fund
improvements that would enhance the economic life of the property
and/or its livability for the residents.  Examples of the types of
repairs HUD indicated it would fund include new amenities; replacing
items that are near the end of their useful life; upgrading items
that currently exist at the property, such as lighting to enhance
security; modernization of unit space (e.g., common areas, kitchens,
bathrooms, and new flooring) and energy upgrades not proposed as a
required repair, such as utility conversions or energy-efficient
windows.  However, the policy specifically disallows certain items,
such as swimming pools, saunas, bowling alleys, decks, dishwashers,
and washers and dryers in individual units. 

In its 1994 policy decision, the Department also indicated it would
fund a 10-percent contingency for all repairs and improvements for
sales of properties to priority purchasers under title VI.  According
to HUD preservation officials, this 10-percent contingency is now
available for all preservation transactions being funded in 1997,
including extensions to current profit-motivated owners.  While
unused repair contingencies are to be deposited in replacement
reserve accounts for properties that are sold, any unused
contingencies for extensions are to be used to reduce the balance of
the capital loan provided under the preservation program. 


      REHABILITATION FUNDING HAS
      SUBSTANTIALLY INCREASED
---------------------------------------------------------- Letter :4.2

For the 27 transactions involving sales to resident or nonprofit
entities that we reviewed, purchasers requested and received approval
for rehabilitation funding that greatly exceeded the needs that had
been identified in HUD's preservation capital needs assessments (see
table 2).  Overall, the plans of action that HUD has approved for the
sales transactions have provided funding for repairs (which include
improvements) and repair contingencies that is 568 percent higher
than the repairs identified in the preservation capital needs
assessments.\9 That is, the Department initially identified about
$16.7 million in needed repairs but agreed to provide about $111.9
million in funding (not including funding for replacement reserves). 
The average approved repair funding for the 27 properties was about
$28,066 per unit.  In comparison, according to HUD's data, the
average approved repair funding for 37 sales transactions scheduled
for funding in fiscal year 1997 as of March 21, 1997, was about
$11,168 per unit.\10

The cost growth for preserving the 27 properties is largely
attributable to funding improvements requested by nonprofit
purchasers.  Other factors that contribute to the growth, but to a
far lesser extent, include (1) HUD's decision to include a 10-percent
contingency for repairs and improvements in the plan-of-action
funding and (2) inflation in the cases where the capital needs
assessments are several years old. 



                                         Table 2
                         
                         Repair Needs Identified in HUD's Capital
                            Needs Assessments and Funding for
                          Repairs in Plans of Action Approved by
                                  HUD for 40 Properties

                         Repair needs      Per unit   Funding for
                           identified  repair needs    repairs in
                             in HUD's      in HUD's      plans of    Per unit
Title/                        capital       capital        action     plan of
transaction   Number of         needs         needs   approved by      action     Percent
type           projects   assessments   assessments         HUD\a     repairs    increase
-----------  ----------  ------------  ------------  ------------  ----------  ----------
Title VI             27   $16,735,548        $4,199  $111,871,201     $28,066         568
 Sales
Title VI              3     1,013,364         1,675     1,001,653       1,656         (1)
 Extensions
=========================================================================================
Subtotal-            30    17,748,912         3,866   112,872,854      24,586         536
 Title VI
Title II             10     4,907,387         2,169     6,486,630       2,866          32
 Extensions
=========================================================================================
TOTAL                40   $22,656,299        $3,306  $119,359,484     $17,415         427
-----------------------------------------------------------------------------------------
\a Includes funding for repairs and the repair contingencies and
excludes funding for replacement reserve accounts.  Reserves are
included in the total rehabilitation funding for the 40 properties
reported in appendix V. 

In contrast, the funding increased by only 32 percent for the 10
transactions covering extensions funded or approved for funding with
title II incentives through capital loans.  The increases in
rehabilitation costs for these properties generally stem from HUD's
decision to fund a 10-percent repair contingency and, according to
preservation guidance issued in January 1997, repairs that correct
unsafe or life-threatening conditions that may have developed since
the approval of the plan of action, and an inspection fee. 
Similarly, for the three extensions funded under title VI, only one
owner requested a minor increase.  According to a HUD official,
because owners receive their incentives as a loan for extensions as
opposed to a grant, they are motivated to minimize rehabilitation
costs to the extent they want to minimize the debt they carry. 


--------------------
\9 These amounts do not fully reflect the impact of the fiscal year
1997 funding caps.  As of May 1997, it was not clear how the funding
cuts needed for a number of properties to comply with the funding
caps would be allocated among equity, rehabilitation, and transaction
costs.  We note that if all of the approved funding in excess of the
caps was taken from rehabilitation costs, these costs would still be
465 percent higher than the repairs identified in the capital needs
assessments. 

\10 As shown in appendix V, when funding for initial deposits to
replacement reserves is included, the average approved amount of
rehabilitation funding for the 27 properties was $31,230 per unit. 
In comparison, according to HUD's data, the average approved
rehabilitation cost was $14,313 per unit for 37 sales scheduled for
funding in fiscal year 1997 as of March 21, 1997.  This average does
not include the additional 11 properties (8 of which are included in
our sample of 40 properties) that HUD approved for fiscal year 1997
funding in June 1997.  Also, according to HUD's data, the average
amount of approved rehabilitation funding for the 313 sales on HUD's
November 1996 funding queue was $12,921 per unit (including initial
deposits to replacement reserves). 


      COST GROWTH STEMS FROM BROAD
      CRITERIA AND GOAL TO
      TRANSFER PROPERTIES TO
      NONPROFITS
---------------------------------------------------------- Letter :4.3

The significant growth in funds for rehabilitation needs that we
identified at the properties we reviewed is largely attributable to
the broad criteria for funding capital needs, as contained in HUD's
1994 policy decision, and HUD's desire to facilitate sales of
properties to nonprofit owners. 

In 1994, HUD established broad criteria for rehabilitation work
eligible for preservation funding.  Allowable rehabilitation includes
items that enhance living conditions, make a property more
marketable, extend the life of material, enhance security, or reduce
maintenance costs or other operating expenses.  As a result, the
scope of rehabilitation work eligible for preservation funding
shifted from a narrowly prescribed standard focused on restoring
properties to good condition to a broad standard, with few specific
limitations, that generally supports rehabilitation proposals as long
as they increase the life of the property or its livability for the
residents. 

According to HUD, this policy was established to encourage additional
repairs to facilitate sales to nonprofit purchasers and to maximize
the remaining life and quality of the affordable housing stock.  HUD
officials also cited other benefits of the policy, such as reducing
properties' operating expenses, enhancing property values, and
preventing the short-sighted, "band-aid" type solutions that have
historically plagued the Department. 

The rehabilitation funding requested in plans of action is based on
assessments carried out for the owners or the purchasers and
incorporates input from the tenants.\11 Each funding request is to be
reviewed and approved by HUD field office architectural, engineering,
and cost-processing staff on the basis of eligibility; benefit to the
project, tenants, and HUD; cost-effectiveness; and availability of
funds.  For the 27 title VI sales we reviewed, we found that HUD
often approved the rehabilitation funding requested by nonprofit
buyers with little or no change, other than in some cases increasing
funding for replacement reserves.  For example, we reviewed 14 sales
handled by HUD's Massachusetts and Connecticut state offices.  In
these cases, the amounts requested by the owners or buyers were
essentially approved without any downward adjustment.  In the only
case in which HUD reduced the request for repairs (which includes
improvements), it also increased the funding for replacement
reserves, approving a total amount higher than the request. 
Furthermore, in five of these cases, the HUD field offices increased
the funding incentives provided for replacement reserves with no
downward adjustments for repairs.  These 14 cases accounted for 58
percent of the funding approved for the 40 properties we examined. 

For the three title VI sales we reviewed that were handled by HUD's
Illinois state office, this office increased the repair funding
requested in all cases by between about $300,000 and $394,000.  In
contrast, HUD's Los Angeles area office reduced the repair funding
requested for seven properties by amounts ranging from about $30,000
to $1,274,000.  It increased funding for repairs at the other three
properties by amounts ranging from about $101,000 to $150,000. 

In some cases we reviewed, it was questionable whether the reviews
performed by HUD's field office staff were sufficient to ensure that
the cost of items requested and approved for funding were prudent and
represented the best use of preservation funds.  For example, we
found that the HUD-approved plan of action for Chauncy House
Apartments in Boston, Massachusetts, included about $455,000 to
replace the storm windows in all units within the first year, even
though, according to a property official, the existing double-pane
windows had been replaced between 3 and 4 years earlier.  The plan of
action indicated that the windows had to be replaced because of
"structural inadequacies and moisture conditions between the prime
windows and the interior storm windows," but it did not indicate the
existing windows had been recently installed.  While HUD officials
believe that funding this item is appropriate, we question whether
HUD's review was sufficient to determine whether there were less
costly maintenance and repair tasks that could have been taken to
correct moisture problems rather than replacing all of the windows
again.  Furthermore, the purchaser's plan of action for Chauncy
House, which was approved by HUD without change, also includes about
$536,000 for painting and caulking in its justification for
replacement reserves.  HUD's policies do not authorize the inclusion
of painting and caulking for replacement reserve funding.\12 However,
according to HUD preservation officials, while such items are not
acceptable replacement reserve items, HUD state and area offices can
waive this requirement because it does not represent a statutory or
regulatory prohibition. 

In addition, at one property we noted substantial differences in the
estimates for replacing items in HUD's capital needs assessment
compared with those in the plan of action.  For Alewife Parkway
Apartments in Cambridge, Massachusetts, a new refrigerator was
estimated to cost $430 in the replacement reserve analysis included
in HUD's April 1995 preservation capital needs assessment, while the
purchaser's estimate in the June 1996 plan of action was $653.  The
preservation capital needs assessment per-unit estimate for
oven/ranges was $330 compared with $547 in the plan of action, which
also included an additional estimate of $429 for oven hoods. 
Similarly, the estimates for kitchen counters was $282 versus $435. 

According to HUD field office staff, a key factor that has
contributed to the increase in funding for rehabilitation is HUD's
desire to facilitate sales to nonprofits.  Several of these staff
with responsibility for reviewing costs in the plan of action
requests said that they interpreted headquarter's guidance on
rehabilitation funding as directing them to give the tenants and
nonprofits what they want.  Furthermore, some of them view these
requests for repairs as "wish lists," but they have approved the
funding requests because of HUD's broad criteria and informal
guidance.  When we discussed our preliminary findings with the
Department, HUD's General Deputy Assistant Secretary for Housing and
other HUD officials acknowledged that the criteria for improvements
were too broad given the limits of the staff's capacity to process
cases and monitor the program.  They also acknowledged the need to
emphasize that the additional repairs are not intended to be a "wish
list" in which nonprofits are given what they ask for without
attention to the costs and benefits.  Nonetheless, they believed that
this weakness did not result in widespread excessive costs for
improvements and repairs. 


--------------------
\11 In contrast, the repair needs in preservation capital needs
assessments are based on reviews carried out by contractors on HUD's
behalf. 

\12 The approved funding for Chauncy House is about $1.5 million in
excess of the fiscal year 1997 funding cap.  HUD's Massachusetts
state office requested a waiver for this property on the basis that
the funds were needed to renovate and repair the property and because
the fair market rents for fiscal year 1997 "are not an accurate
reflection of the market rents in Boston." On May 30, 1997, the
Deputy Assistant Secretary for Multifamily Housing denied the waiver
request. 


      EQUITY AMOUNTS NOT ADJUSTED
      TO REFLECT INCREASED CAPITAL
      NEEDS FUNDING
---------------------------------------------------------- Letter :4.4

In HUD's preservation program, there is a direct link between a
property's repair needs and the funding for equity an owner receives. 
Specifically, repairs required to restore the property to good
condition (as well as upgrades and conversion costs associated with
changing the property from subsidized housing to a market-rate
property) reduce the equity HUD may provide to owners (see table 3). 



                                Table 3
                
                 Hypothetical Example of Computation to
                  Determine Owner's Equity Under HUD's
                          Preservation Program

----------------------------------------  ----------------------------
Property's appraised value                                 $12,000,000
Less required repairs (to restore                          (1,000,000)
 property to good condition in
 compliance with local codes and HUD's
 housing quality standards as identified
 in preservation capital needs
 assessments)
Less upgrades and conversion costs                         (1,000,000)
 (identified in appraisals)
"As is" preservation value                                  10,000,000
Less unpaid mortgage principal balance                     (6,000,000)
Owner's equity                                              $4,000,000
----------------------------------------------------------------------
HUD's 1994 policy on funding repairs and improvements acknowledged
the link between repairs, improvements, and an owner's equity
funding.  That is, the policy noted that similar to the treatment of
additional required repairs identified by HUD staff as a result of a
time lapse between the preservation capital needs assessment and the
plan of action, repairs approved at the plan-of-action stage that
bring a property to a "good condition" would have the effect of
decreasing the "as is" preservation value.  Accordingly, an increase
in required repair costs would decrease the amount of equity to which
the owner would be entitled.  In 1995, however, the Department
determined that such downward adjustments of equity would be limited
to instances where the owner had been fully aware of a required
repair condition during the preservation capital needs assessment
process and had not divulged it intentionally.  This decision
increases program costs to the extent additional repairs are funded
but the equity payments to owners are not correspondingly reduced. 
Also, according to HUD's guidance, approved improvements are not
considered in calculating the "as is" preservation value because the
improvements would not be required to bring the property to a good
condition or would not be encountered in the process of converting
the property to an unsubsidized use.  Thus, by definition, equity is
not reduced for improvements the Department agrees to fund at the
plan-of-action stage.  According to program officials at
headquarters, this policy stems from the Department's goal to
encourage owners of these properties to sell them to resident groups
and nonprofits and to maximize the remaining life and quality of its
affordable housing stock. 

At most of the 40 properties we reviewed, while HUD has approved
significantly larger amounts of funding for rehabilitation than the
amounts identified in HUD's capital needs assessments, we did not
identify any reductions in equity that had been made because of
increased rehabilitation funding.  In one case, we noted that HUD did
reduce the owner's equity, but we were unable to determine from the
information available whether this adjustment was made to reflect
increased repair costs.  Also, reductions in equity were made for a
number of properties to meet the funding caps mandated by HUD's
fiscal year 1997 appropriations act.\13


--------------------
\13 For some extension properties, equity reductions were also made
for transaction costs and deposits to the replacement reserve
accounts. 


      FUNDING FOR REPLACEMENT
      RESERVES MAY BE EXCESSIVE
---------------------------------------------------------- Letter :4.5

Under HUD's preservation program, purchasers are eligible to receive
funding for reserves to replace capital items, such as roofs and
appliances, that will need to be replaced in future years.  For the
27 properties we reviewed that involved sales, HUD approved about
$12.6 million for deposits to replacement reserves, or about 10
percent of the rehabilitation needs the Department had approved.  We
believe that the amounts approved by HUD may be excessive for two
reasons. 

First, HUD allows the property owners to retain existing replacement
reserve balances when selling properties under the preservation
program and then provides funding to the purchasers to replenish
those reserves.  This policy can substantially add to the costs of
the preservation program.  For example, the owner of Alewife Parkway
Apartments in Cambridge, Massachusetts, was allowed to retain the
$539,659 replacement reserve balance when the preservation funding
was provided in January 1997.  HUD then included $900,000 in the
capital grant given to the purchaser of the property to fund
replacement reserves.  However, if the existing replacement reserve
balance had stayed with the property, HUD's replacement reserve
funding would have been reduced to about $360,000. 

A 1996 HUD preservation letter stated that for sales transactions the
Department no longer requires that the existing account for
replacement reserves remain with the property in most cases.  The
letter indicated that owners are entitled to keep the money in the
reserve accounts because the appraisals did not reflect these amounts
in establishing the values of the properties.  HUD program staff told
us that, upon request, HUD will allow owners who are selling
properties under the program to retain the replacement reserve
balances.  However, the preservation staff also told us that there
was considerable debate within HUD regarding the merits of this
policy because replacement reserves were funded in large part from
mortgage interest subsidies and project-based Section 8 rental
assistance provided by the government. 

When we discussed our preliminary findings with the Department, HUD's
General Deputy Assistant Secretary for Housing and other HUD
officials told us that it is the Department's position that it is
never appropriate to allow owners receiving preservation funding to
withdraw replacement reserve funds when an initial deposit is
required to meet the property's future capital needs.  They added
that the Department's policy allowing such withdrawals is intended to
reflect the intent of the Congress.  To support this belief, the
Department cited language from a 1992 House Banking Committee report
that discusses the need for an amendment to the preservation law
regarding replacement reserves.  However, the proposed
amendment--which would have included the amount of the reserve for
replacement account in the preservation value of the property-- was
not enacted.\14

Second, we found that HUD's process to determine the amount of
replacement reserves funded at one property we reviewed--Alewife
Parkway Apartments--did not ensure that all of the funding was
actually needed.\15 Essentially, HUD determines the amount of initial
deposits to replacement reserves that can be included in the
preservation funding on the basis of the highest of three
computations specified in the Department's preservation-processing
instructions.  HUD officials believed that this approach is
appropriate because of the uncertainty in estimating replacement
reserve needs and the sensitivity of the account as a resource in
averting troubled-project situations. 

For Alewife Parkway Apartments, the highest of the three required
computations reflected the amount needed to replace items whose
remaining useful life was expected to expire in the first 5 years
after preservation funding as well as items whose replacement costs
might be considered "weighty" in years 6 through 10.  HUD determined
that replacement reserve funding of about $1.2 million was needed. 
However, this calculation did not consider all of the appliances and
other items that HUD was funding with the $5.5 million grant for
property repairs.  Instead, HUD's analysis was based on the earlier
capital needs assessment that had assumed that the replacement of
kitchen and bath appliances and other items would be funded over time
from the replacement reserve account. 

We also found that the documentation provided by the purchaser to
support the initial request of $750,000 for the deposit to
replacement reserves included several items, such as painting walls
and ceilings and caulking, that are not acceptable replacement
reserve items under HUD policies.  As stated earlier, HUD officials
said that state and area offices can waive the prohibition against
including such items in replacement reserves.  Furthermore, when the
purchaser requested an additional $150,000 for replacement reserves,
raising the total cost to $900,000, a mistake in its earlier analysis
was cited, but information on the items that were erroneously
excluded was not provided.  Nonetheless, HUD approved the increase. 


--------------------
\14 The House Banking Committee report accompanying the proposed
amendment stated that the replacement reserves, which the report
described as the rightful property of the owners, should be included
in the appraised value of preservation projects, even though this may
increase the cost of the program and the compensation to the owners. 

\15 Our review of the documentation supporting preservation funding
for replacement reserves and the reserve balance provided to owners
was limited to Alewife Parkway Apartments, the one sales transaction
in our sample that had received fiscal year 1997 funds as of February
1, 1997. 


   ADMINISTRATIVE AND OTHER
   PROBLEMS LIMIT EFFECTIVE AND
   EFFICIENT PROGRAM MANAGEMENT
------------------------------------------------------------ Letter :5

A variety of factors have hampered HUD's ability to administer the
preservation program effectively and to ensure that federal funds are
being spent wisely and in accordance with program requirements.  We
identified instances in which these factors contributed to errors and
other problems in HUD's processing of preservation cases and also
noted other questionable practices relating to HUD's awards of
preservation funding.  In addition, HUD continues to face
difficulties in (1) targeting the program to only those properties
whose owners will actually prepay and (2) ensuring that property
owners that receive preservation funding comply with the
affordability restrictions placed on the properties. 


      PROGRAM ADMINISTRATION IS
      HAMPERED BY VARIOUS FACTORS
---------------------------------------------------------- Letter :5.1

The preservation program has been described by some HUD officials,
including HUD's General Deputy Assistant Secretary for Housing, as
the Department's most complex multifamily housing program--a program
that is very difficult for HUD to administer.  On the basis of our
review of the program's requirements, HUD's processing of individual
preservation cases, and discussions with HUD preservation officials,
we believe that program implementation is hampered by a variety of
factors, including the following: 

Frequent program changes and fragmented program guidance complicate
identifying and complying with current policies and procedures.  From
its inception in 1987, the preservation program has been very
complex, and it has been amended seven times.  Preservation rules are
contained in HUD's numerous handbook transmittals, notices, and
memoranda and--since April 1996--15 preservation letters that
describe the changing program rules and provide numerous policy
clarifications and changes.  We found that it was difficult to get a
clear understanding from program staff of HUD's current requirements
in some cases, and that sometimes the program guidance was ambiguous
or incomplete.  One field office official characterized the program's
criteria as "one big blur."

Staff responsible for processing the cases frequently change.  Staff
generally do not specialize only in preservation, and there is
frequent turnover among staff familiar with the program because of
other priorities and heavy workloads in the Department.  Given the
program's complexity and its fragmented guidance, these frequent
staff changes increase the potential for error.  In addition, some
HUD staff who process preservation transactions expressed strong
negative opinions about the program for various reasons.  For
example, some staff were troubled that it has provided substantial
benefits to some owners who, as discussed in the next section, have
not complied with HUD's policies; others questioned the substantial
amount of funds being provided for rehabilitation needs. 

Approval and funding decisions are often made under tight time
frames.  Frequently, new rules and requirements have had to be
implemented in conjunction with program funding.  Field staff were
required to process their cases under the new rules to get them
funded, often within tight time frames, thus limiting their review of
funding requests.  For example, transactions relating to the $75
million set-aside for "carve-out" properties in the fiscal year 1997
appropriations law had to be processed in about 5 weeks. 

Data are aging and files are in poor condition.  Many properties
awaiting funding began the preservation process 3 or more years ago. 
Consequently, the data on which decisions are based have become more
and more out of date.  Furthermore, the files, upon which the funding
amounts are based, can be voluminous and disorganized.  We found that
tracking case activity and final decisions was very difficult in some
cases and that documentation supporting staff decisions was missing
in others. 

Program operations are decentralized and headquarters oversight is
limited.  Six preservation staff at headquarters provide the overall
program guidance and rules and maintain a database of properties
eligible for preservation funding and the transactions that have been
funded.  However, the headquarters preservation office does not
conduct systematic reviews of field offices that process preservation
transactions.  The information on the properties approved for funding
that headquarters examines is generally limited to aggregate dollar
amounts of the incentives approved by the field offices. 
Headquarters staff indicated that they obtain information about
specific cases when they respond to questions from the field offices
and that they also raise questions about some cases.  However, the
information that is routinely submitted to and reviewed by
headquarters staff is insufficient, in our view, to allow them to
identify many of the issues and problems that arise. 

When we discussed our preliminary findings with the Department, HUD
multifamily housing officials told us that they believed a number of
the fundamental problems with the preservation program were the
result of overly prescriptive legislative requirements, which they
believed added administrative burden and complexity to the program
and increased the potential for error.  The officials also noted,
however, that improvements could be made in program oversight.  For
example, they noted that if the program continues to be funded,
ideally, preservation staff at headquarters should periodically visit
all field offices to monitor transactions, provide technical
assistance, and facilitate input from staff on programmatic issues. 
They also believed that the availability of sophisticated, real-time
data management capability could greatly improve HUD's ability to
manage the preservation program. 


      ADMINISTRATIVE PROBLEMS
      IMPAIR OVERSIGHT OF
      PRESERVATION PROGRAM FUNDING
---------------------------------------------------------- Letter :5.2

The administrative weaknesses noted above have reduced HUD's ability
to effectively oversee the use of preservation program funding.  In
our view, they have limited the Department's ability to ensure that
the program is managed effectively and efficiently, that federal
funds are being spent wisely, and that the program is carried out in
a manner that is consistent with program requirements.  For example,
as we discussed above, HUD's oversight was not sufficient, in our
view, to ensure that rehabilitation funding was provided in the most
prudent and cost-effective manner. 

We did not attempt to assess the extent to which each of the 40
transactions we examined was processed in accordance with
preservation program requirements.  However, in carrying out our work
to address this report's objectives, we did note some errors and
problems that appear to have resulted from the changing preservation
program rules, tight processing time frames, and limited headquarters
oversight of field offices, among other factors. 

In particular, we found that HUD was not aware that it had approved
incentives for three transactions that were $1.5 million over the
program's fiscal year 1997 funding caps.  For various reasons, errors
totalling $1.5 million were made by field staff in determining
whether the approved financial incentives exceeded the new fiscal
year 1997 funding caps.  At two properties processed by the Los
Angeles office, Villa St.  Andrews Apartments and Mountclef
Apartments, the Department completed the transactions and provided
excess amounts totalling $1.2 million to the owners.  Specifically,
HUD provided fiscal year 1997 funding for two of the carve-out
properties that exceeded the 1997 caps by $731,283 and $499,123. 
These errors occurred because the field office staff used the
incorrect number of apartment units in the funding limit formula for
the Villa St.  Andrews Apartments and did not calculate the funding
limit for the Mountclef Apartments.  These errors were not identified
when the cases were reviewed by the field office or headquarters. 
After we brought the errors to HUD's attention, the Department
recovered the excess funding from the new owners principally by
reducing the funds that will be provided for rehabilitation work.\16
In the third case, the Connecticut state office was unaware that the
approved incentives for the Tariffville Apartments were about
$347,000 higher than the funding limits established in the 1997
appropriations law because the staff used an incorrect formula
relating to a different preservation requirement to calculate the
funding limit.  According to HUD, the Connecticut state office
requested a waiver from headquarters to fund the amount in excess of
the cap, but it was denied. 

We also found that HUD added projects to the preservation funding
queue before the plans of action were received and approved.  To
allocate limited preservation funding, program staff told us that
properties are placed on the preservation funding queue after field
offices approve their plans of action.  The properties then receive
funding in the same order in which they are listed on the queue.  We
note that on July 12, 1996, HUD placed Bayview Towers, located in
Stamford, Connecticut, on the preservation funding queue.  However,
the Bayview plan-of-action request for about $12.9 million (about
$64,000 per unit) in preservation funding was not received in HUD's
Connecticut state office until July 15, 1996, and was not approved
until August 15, 1996.  HUD made no adjustments to the funding
requested in the plan of action.  As a result of being placed on the
queue in July before its plan of action was received and approved,
this property is receiving fiscal year 1997 funding, whereas a number
of properties that were added to the funding queue later in July 1996
will not be funded this year.  We also noted that Tariffville
Apartments, also located in Connecticut, and six properties processed
by HUD's Massachusetts state office were placed on the queue about a
month before their plans of action were approved. 

We also noted that, in one case we reviewed, HUD increased the
preservation value of Alewife Parkway Apartments in Cambridge,
Massachusetts, by about $5 million on the basis of its internal
appraisal, resulting in a value that more closely coincided with the
owner's appraisal.  The preservation program generally requires that
the preservation values are to be based on independent appraisals,
with HUD having limited authority to make adjustments to the values. 
This approach provides some protection to the Department in terms of
limiting the potential for fraud, waste, and abuse in establishing
preservation values.  However, in 1995, the Department's guidance
indicated that negotiations could be used in cases where HUD's review
appraiser believes that market data will support a value greater than
110 percent of the HUD appraisal in lieu of contracting for a third
independent appraisal that would be binding.  In this case, the
Massachusetts state office indicated that there was not sufficient
time to contract for a third independent appraisal.  However, 9
months elapsed between the time that the owner raised questions about
HUD's contract appraisal and the internal appraisal prepared by the
Department.  HUD officials acknowledged that, ideally, a third party
appraiser would have been engaged in this case, but that because of
timing issues and competing workload demands, they believed the field
office's action was appropriate. 

In discussing our tentative findings with the Department, HUD
officials noted that it was inevitable that we would find some
mistakes in the program given the number of transactions funded and
the complex nature of the program.  Nevertheless, they believed that,
considering the numerous obstacles, HUD's administration of the
program has been effective. 


--------------------
\16 When a grant is provided under the preservation program, the
equity take-out and replacement reserve funding is provided up-front,
while the funding for rehabilitation (repairs and repair contingency)
is provided after the rehabilitation work is completed. 


      SOME USES OF PROGRAM FUNDS
      APPEAR QUESTIONABLE
---------------------------------------------------------- Letter :5.3

In several instances HUD has provided funding to preserve properties
that were already bound by affordability restrictions.  The
Department's preservation rules state that properties with use
restrictions that would continue after prepayment, such as those
which have received flexible subsidies,\17 are not eligible for
preservation funding.  Nonetheless, the Department has granted
waivers of this policy.  During our review, we identified two such
cases.\18 In one case, the Department provided $7.7 million in fiscal
year 1996 preservation funding for Northwest Towers Apartments in
Chicago, Illinois, which had a flexible subsidy contract requiring
use restrictions until 2012.  A primary argument made in the waiver
request by the Deputy Assistant Secretary for Multifamily Housing was
that it would be less expensive to preserve this property now rather
than in 2012 because the appraisal value now--and the related equity
payment--would be based on regulated rents that would be lower than
the unregulated market rents that would apply in 2012.  Given the
limited resources available to the preservation program, we question
whether providing preservation incentives to properties that will
already be preserved as affordable housing for extended periods
represents the best use of scarce federal resources.  In addition, we
noted that the appraisal value used to determine the equity payment
to the owner was based on a rent structure from a property in another
state rather than the property's existing rent structure.  The rent
structure used was derived from a use agreement for a property in St. 
Louis, Missouri, that had also received flexible subsidy funding and
later had its mortgage prepaid.  This rent structure was used after
an appraisal using the property's actual rents showed that its
preservation value was less than the outstanding balance on the
property's mortgage, which prevented the property from moving forward
in the preservation process.  HUD determined that using the rent
structure from the St.  Louis property represented a "more reasonable
basis for determining the rent levels and still maintaining a rent
structure which would be considered affordable." HUD paid the owner
about $2.5 million for equity. 

HUD officials told us that the Department has approved preservation
funding for three or four properties that had received flexible
subsidies "on a trial basis" after the Congress had proposed language
in an authorization bill that would have made one such
property--Northwest Towers--eligible to receive preservation
incentives.  The officials stated that those approvals were given
because HUD believed that allowing only a particular project to
receive preservation incentives would inappropriately benefit one
owner.  However, they stated that HUD subsequently concluded that
providing incentives to such properties was not an effective use of
preservation funds and HUD has stopped granting such waivers. 

We also found that the Department has provided preservation funding
to owners who HUD believed had violated its regulations.  In 1994,
HUD used preservation funding as a tool to negotiate a settlement
agreement with an owner who, among other things, HUD believed had
diverted funds from HUD-insured properties in violation of the
regulatory agreements.  HUD agreed not only to provide preservation
funding for 8 of this owner's properties--the proceeds of which were
to be used to repay the diverted funds and HUD-imposed fines--but for
26 other properties as well.  Eight of the properties were funded in
1995, and funding for seven of the owner's other properties was
provided with fiscal year 1997 funds under the carve-out category
(see app.  III).  HUD officials told us that other than the funding
provided to that owner under the carve-out category established in
the 1997 appropriations act, the only preservation funding the
Department had previously provided to that owner was an amount
sufficient to cover the owner's obligations to repay the diverted
funds and associated fines.\19 We found that HUD used preservation
funding as a tool to reach settlement agreements covering two other
properties in Connecticut in 1995 and 1996.  Under the agreement, the
owners were required to repay HUD about $4.5 million that had been
diverted from the HUD-insured properties in violation of the
regulatory agreements, along with a $500,000 fine. 


--------------------
\17 Under the flexible subsidy program, loans were provided for
capital needs in exchange for use agreements extending the
affordability restrictions for the term of the original mortgage. 

\18 We did not review previously completed preservation transactions
to determine how many involved flexible subsidies.  However, in
examining a completed case in one office, we found the Department had
previously provided flexible subsidies to that property.  This file
also identified one other such case. 

\19 As discussed further in appendix III, in 1994 HUD and the owner
entered into an agreement to settle allegations in a HUD Office of
Inspector General report that the owner had violated several
regulatory agreements.  The owner agreed to pay an $11.1 million
settlement that included penalties.  In 1995, HUD provided about
$26.7 million in preservation funding, of which $22.2 million was for
the owner's equity. 


      DIFFICULTIES EXIST IN
      TARGETING PROGRAM FUNDING
      AND MONITORING COMPLIANCE
---------------------------------------------------------- Letter :5.4

In addition to the administrative problems discussed earlier, HUD
also faces two other issues in administering the preservation
program:  (1) how to target the program to properties whose owners
will actually prepay and (2) how to ensure that property owners
comply with affordability restrictions. 

One of the problems that has existed under the preservation program
throughout much of its history is how to target funds to only those
properties whose owners would actually prepay their mortgages.  The
1990 revisions to the preservation program addressed this problem by
permitting HUD to limit incentive payments to property sales or
extensions in rental markets that had an inadequate supply of decent
and affordable housing.  This provision, called the windfall profits
test, was included in the law in response to the administration's
concerns that the preservation program should not be used to provide
incentives to owners who would not have prepaid because of local
market conditions. 

However, the windfall profits test was controversial and repealed by
the Congress in 1992 before HUD implemented it because of concerns
that a test designed to distinguish between properties with future
value and eligible to receive incentives and those without value was
imprecise, unfair, and unnecessary.  The House Banking Committee
considered the preservation program's appraisal system sufficient for
determining if incentives should be made available to property owners
and purchasers.  The Committee expected that the appraisals and HUD's
review of plans of action would protect against owners' receiving
windfall profits. 

Questions continue, however, concerning the extent to which the
program provides incentives to owners of projects who are unlikely to
prepay.  HUD preservation staff in the field offices in which our
work was performed had mixed views on the extent that owners would
prepay if incentives were not available.  Due to one area's bad
economy, staff in that field office said it was unlikely that any of
the owners who received incentives would have actually prepaid. 
Similarly, staff in another office told us that even though the
Congress has restored the right of owners to prepay, they did not
believe that most owners in their area were planning to prepay.  On
the other hand, staff in two other field offices felt very strongly
that owners would prepay if the preservation program was
discontinued.  Due to the strong market in the area, one office is
processing 40 prepayment applications.  The other office is currently
processing eight prepayment applications; and for the 10 projects
that received incentives in fiscal year 1996, the preservation
coordinator told us that most of those owners would have prepaid if
incentives had not been offered to them. 

Targeting preservation incentives to the owners that are most likely
to prepay is difficult because there are no criteria that HUD can use
to clearly identify such owners.  According to HUD and industry
officials, the appraisal process serves as a test for prepayment
because a property's market value is a key factor in whether an owner
will prepay.  However, according to these officials, business
considerations and the availability of financing also influence
whether an owner actually decides to prepay. 

According to some housing industry officials, however, one option
that could potentially improve the targeting of preservation funding
would be to have the states or the localities in which properties are
located contribute a portion of the preservation funding--either from
their own funding or from other housing-related federal funding that
they receive.  These officials stated that states or localities would
only be willing to provide funding to preserve properties that they
believed were likely to prepay and truly needed to be preserved as
affordable housing. 

Concerns also exist about HUD's ability to monitor the properties
that have received preservation funds to ensure that the long-term
use agreements are adhered to by property owners.  Without oversight,
neither the Congress nor the Department can be assurred that the
long-term affordability promised in exchange for financial incentives
will be achieved.  At the present time, HUD does not have a
departmentwide system in place to identify and monitor owners'
compliance with its various regulatory obligations, including the
low-income affordability restrictions that owners agreed to extend in
exchange for receiving preservation funds.  The program's monitoring
guidance in HUD's preservation handbook was prepared in 1993 and does
not address the numerous, substantial changes that have occurred in
the program since then. 

Officials at three field offices expressed concerns over tracking all
of the different use agreements for preservation properties, which
vary in terms of the affordability restrictions depending upon when
the properties were funded.  In general, officials we contacted were
most concerned about the lack of guidance on monitoring projects that
no longer have mortgage insurance or existing Section 8 contracts. 
According to a HUD asset management chief, preservation projects can
easily "fall off HUD's radar screen," particularly when the loan is
paid off and Section 8 assistance is not renewed.  This official said
that due to limited resources, properties without mortgage insurance
or Section 8 assistance were generally low priority in the field
offices. 


   CONCLUSIONS
------------------------------------------------------------ Letter :6

HUD's administration of the preservation program is hampered by a
number of problems that, when taken together, seriously limit the
Department's ability to ensure that the program is being managed
effectively and efficiently, that federal funds are being spent
wisely, and that the program is being carried out in accordance with
program requirements. 

We recognize that some of the problems affecting the program are due
to its inherent complexity, the numerous programmatic changes that
have taken place, and the compressed time frames under which
decisions must be made.  In our view, however, these problems are
compounded by questionable HUD policies and internal control
weaknesses.  In particular, we believe that HUD's broad criteria for
funding rehabilitation costs, its policy of limiting downward
adjustments in owners' equity when additional repair needs are
identified to only those cases in which owners were previously aware
of the needed repairs and intentionally did not divulge them, its
limited oversight of field office activities, and its process for
determining initial deposits to replacement reserves have not only
increased preservation costs, but are also insufficient to ensure
that federal funds are being used wisely, particularly in a
budget-constrained environment.  Also, HUD's lack of a uniform
up-to-date system to monitor owners' compliance with preservation
program requirements limits HUD's ability to ensure that owners are
adhering to the long-term affordability restrictions placed on their
properties. 

Furthermore, we believe that HUD's use of waivers to provide funding
to properties that would have already been required to continue to
provide affordable housing, HUD's policy allowing owners to retain
balances in replacement reserve accounts and then providing funding
to purchasers to replenish those reserves, and HUD's use of the
preservation program to resolve enforcement actions do not represent
the best use of the program's limited funds. 


   RECOMMENDATIONS
------------------------------------------------------------ Letter :7

To strengthen HUD's administration of the preservation program, we
recommend that the Secretary of Housing and Urban Development
undertake a systematic reassessment of the policies and internal
controls governing the preservation program to ensure that they
provide adequate assurance that the program's funds are being spent
prudently and in accordance with legislative requirements.  This
assessment should focus, in particular, on policies and controls
governing (1) the types of improvements eligible for rehabilitation
funding and HUD's reviews of requests for such funding, (2) HUD's
assessment of the effects of increases in rehabilitation funding on
owners' equity, (3) HUD's determination of funds needed for initial
deposits to replacement reserves, (4) HUD's oversight of field office
activities, and (5) HUD's monitoring of the owners' compliance with
affordability restrictions placed on their properties. 

In addition, we recommend that the Secretary no longer fund
preservation properties that are already bound by use agreements
preserving the properties' affordability for extended periods or use
preservation funds to resolve enforcement actions against the owners
of multifamily properties and reconsider HUD's policy allowing owners
to retain replacement reserve account balances when transferring
properties to new owners. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :8

We provided a draft of this report to HUD for its review and comment. 
In commenting on the report, HUD did not disagree with the facts we
presented in the report.  However, while HUD accepted our view that
internal controls and procedures for preservation program
administration need to be strengthened, the Department believed that
our conclusions unfairly characterized its overall administration of
the preservation program.  HUD stated that it believes its overall
administration of the program has been effective and has resulted in
the preservation of over 100,000 affordable housing units.  HUD's
comments do not change our view that this program is hampered by a
number of factors--including frequent program changes, fragmented
program guidance, frequent staff changes, and limited oversight--and
that these factors collectively limit HUD's ability to ensure that
the program is being managed effectively and efficiently, that
federal funds are being spent wisely, and that the program is being
carried out in accordance with program requirements. 

In addition, HUD took exception to several aspects of our methodology
and analysis:  the sample of properties that we reviewed and our
analyses of property values compared with preservation funding and
replacement reserve funding.  HUD asserts that our report is
misleading because the properties in the sample were not randomly
selected and thus overstates average program costs.  The sample we
used was not intended to estimate funding costs, but rather to
respond to the report's objectives.  As the Department acknowledges,
our report clearly states that the 40 properties reviewed were not
randomly selected and cannot be used to draw conclusions about all
properties on HUD's funding queue.  Instead, we focused our work on
four field offices with substantial preservation workloads and
properties at those offices that were likely to receive funding in
fiscal year 1997 or 1998 (if the program is continued).  The fact
that our results cannot be statistically projected to the universe of
preservation properties awaiting funding in no way invalidates our
findings that the incentives provided for a substantial number of
properties are high--in many cases far exceeding their preservation
values--and that improvements are needed in HUD's controls over
preservation funding.  We also note that in fiscal year 1997, the
Department has funded or plans to fund 32 of the 40 properties that
we reviewed. 

In addition, the Department states that preservation value is an
inappropriate basis of comparison with program cost because it is not
comparable to the value of a property after improvements funded by
the preservation program have been made.  We continue to believe that
a property's preservation value was the best available measure that
could have been used to respond to the House Conference Report's
request that we compare the funding provided to preservation
properties to the properties' values.  Our report recognizes that
preservation values do not take into account any increases in
property values that may result from improvements funded under the
preservation program; however, as HUD officials have acknowledged,
HUD does not require that an appraisal be performed to determine
property value after improvements have been made.  Furthermore,
performing appraisals to determine a property's value after repairs
and improvements are completed would have been difficult, if not
impossible, at the properties we analyzed because they have either
only recently received preservation funding or are still awaiting
funding. 

Regarding the analysis of replacement reserves, while the Department
states that it has taken action to prevent overfunding of replacement
reserves, it did not present any new information that alters the
analysis in our report.  We continue to believe that the Department's
current methodology for determining the amount of reserves to fund
and its oversight of the process for determining the reserves are
insufficient to prevent overfunding. 

The two recommendations in our report address eight specific issues. 
HUD did not take exception to the recommendations on five of the
issues, but disagreed with three.  Specifically, HUD indicated that
its policy allowing owners selling their properties to keep the
existing replacement reserve balances reflects congressional intent. 
However, we believe the information presented by HUD is insufficient
to support this assertion.  We continue to believe that HUD should
reassess this policy that provides owners with replacement reserve
balances that had been generally funded by federal subsidies and then
replenishes these amounts with preservation funding provided to the
new owners.  In addition, the Department indicated that its existing
procedures are adequate to avoid overfunding replacement reserves. 
As discussed above, we disagree and believe the Department should
reassess the policies and internal controls governing replacement
reserves. 

Finally, the Department did not agree to reassess the effects of
increases in rehabilitation funding on owner's equity.  However, we
believe that HUD misstates its current policy covering equity
adjustments (reductions) for repairs that bring the property to
marketable ("good") condition and thus does not address the issue
raised in our report.  Specifically, HUD's comments do not reflect
the Department's current policy, promulgated in 1995, which limits
the deduction for repairs being funded at the plan-of-action stage
that exceed the repairs identified in the capital needs assessments
to only those instances where owners had intentionally concealed
required repairs during the capital needs assessment process.  As
discussed in our report, this policy increases program costs to the
extent that additional repairs are funded but the equity payments to
owners are not correspondingly reduced.  We continue to believe this
policy should be reassessed.  (The complete text of HUD's comments
and our evaluation of them are provided in appendix VIII.)


---------------------------------------------------------- Letter :8.1

We conducted our review from November 1996 through June 1997 in
accordance with generally accepted government auditing standards. 
(See app.  VII for a discussion of our scope and methodology.) We are
sending copies of this report to appropriate congressional
committees; the Secretary of HUD; the Director, Office of Management
and Budget; and other interested parties.  We will also make copies
available to others on request. 

Please contact me at (202) 512-7631 if you or your staff have any
questions.  Major contributors to this report are listed in appendix
IX. 

Judy A.  England-Joseph
Director, Housing and
 Community Development Issues


LESSONS FROM HUD'S PRESERVATION
PROGRAM THAT ARE APPLICABLE TO ITS
PORTFOLIO REENGINEERING PROGRAM
=========================================================== Appendix I

While the purposes of the Department of Housing and Urban
Development's (HUD) preservation and portfolio reengineering programs
differ, a number of important similarities exist in terms of their
data needs, administrative processes, and program structures.  As
such, a variety of learning experiences pertaining to the operations
of the preservation program appear relevant to the effective
development and management of HUD's portfolio reengineering program. 
These experiences include lessons relating to controlling program
costs, screening owners, maximizing long-term housing affordability,
ensuring sufficient time for evaluating and negotiating reengineering
agreements, and avoiding frequent program changes. 


      HUD'S PORTFOLIO
      REENGINEERING PROGRAM
------------------------------------------------------- Appendix I:0.1

HUD initially proposed its portfolio reengineering program (then
called "mark-to-market") in 1995 as a way to address the
long-standing problems it faces in managing its insured Section 8
multifamily loan portfolio of about 8,600 properties.  This portfolio
of assets has been affected by three basic problems--high Section 8
subsidy costs, high exposure to defaults and losses to the Federal
Housing Administration's (FHA) insurance fund, and the poor physical
condition of some properties.  HUD's portfolio reengineering proposal
assumes that long-term cost savings can be achieved by adjusting a
property's rents to market levels and writing down its mortgage as
needed to allow operations to continue at a sustainable level. 
Initially, HUD also proposed to terminate FHA mortgage insurance on
the properties and replace project-based Section 8 subsidies with
portable tenant-based subsidies.  HUD believed that these actions
would help address the problems affecting the portfolio by subjecting
properties to the forces and disciplines of the commercial market. 

In April 1997, HUD and the Treasury Department jointly proposed the
latest version of portfolio reengineering--a legislative package
that, for the first time, would provide several forms of relief for
owners with federal tax obligations resulting from reengineering. 
The proposed legislation's principal provisions would authorize HUD
to adjust above-market Section 8 contract rents to local market
conditions; restructure existing debt to projected cash flow levels
while allowing owners to choose whether or not to retain FHA
insurance on restructured debt; substitute tenant-based rental
assistance, such as portable vouchers or certificates, for
project-based Section 8 assistance in soft market areas unless the
properties are targeted to elderly or disabled residents; and help
ensure rehabilitation needs are met through the use of project
reserves, restructured financing, or grants from HUD.  The proposed
tax changes would allow the amortization of tax liabilities,
resulting from debt forgiveness (in the case of mortgage write downs)
and capital gains on sales to nonprofit organizations, over periods
of up to 10 and 7 years respectively.  With these tax changes, HUD
hopes to remove a deterrent to owner participation in the portfolio
reengineering effort and also make it easier for nonprofit
organizations to purchase properties. 

HUD is also administering two portfolio reengineering demonstration
programs that were authorized in the appropriations acts for fiscal
years 1996 and 1997.  These programs were designed to test the
portfolio reengineering concept.\1


--------------------
\1 The 1996 program was available to owners whose Section 8 contract
rent levels exceeded the fair market rents in the geographical area
in which their properties were located.  Through April 1997, two
restructuring agreements were finalized with as many as 10 still
under consideration.  The 1997 program is limited to owners having
expiring Section 8 contracts with aggregate rents exceeding 120
percent of the fair market rents in their local market areas.  For
Section 8 contracts lapsing in 1997, owners have the option of
extending their contracts for 1 year at 120 percent of the fair
market rents or volunteering for portfolio reengineering.  By
mid-April 1997, 34 owners out of approximately 370 having properties
with 1997 Section 8 expirations had notified HUD that they desired to
participate in the program. 


      CONTROLLING PROGRAM COSTS
------------------------------------------------------- Appendix I:0.2

Both the preservation program and portfolio reengineering rely on the
accumulation, analysis, and review of property-specific information,
such as market values, operating income and expenses, and deferred
maintenance and rehabilitation requirements.  Inaccurate or
unreliable information on HUD properties can lead to increased
program costs, hinder HUD in its negotiating position with property
owners, and delay specific program agreements.  To reduce program
risks and accurately assess the effects of portfolio reengineering on
individual properties, housing experts we spoke with emphasized the
need for HUD to include systematic and reliable approaches to
determine property values, assess market income potential, and
determine the levels and the costs of required physical improvements. 
In addition, they said that clear and reasonable rehabilitation
standards and procedures for overseeing the development of
rehabilitation assessments and cost estimates will also be important
to holding down overall rehabilitation expenses and minimizing
federal costs in the reengineering process.  Moreover, to avoid the
complications and problems experienced in the preservation program,
it will be important that HUD has the capacity to administer and
provide for the central oversight and controls needed to minimize
exposure to waste, fraud, and abuse; adequate mechanisms to
administer third-party technical service contracts for reengineering
functions, such as negotiating agreements and executing due diligence
work; and reliable information systems to track the progress and the
status of reengineering proposals and transactions.  HUD multifamily
officials noted that the complexity of administering about 700
preservation program transactions pales in comparison to the scope of
negotiating 5,000 or more potential portfolio reengineering deals. 


      SCREENING OWNERS
------------------------------------------------------- Appendix I:0.3

Numerous HUD-subsidized properties have deteriorated financially and
physically due to the mismanagement and neglect of owners.  HUD's
Secretary recently noted that serious problems continue to exist and,
accordingly, has proposed several new initiatives and legislation to
help the Department strengthen its efforts to identify problem
owners; take enforcement actions, such as criminal or civil actions;
and prevent the misuse of federal resources.  Housing experts we
interviewed agreed with the Secretary's assessment of its ownership
problems and cited the need for HUD to screen out problem owners as
part of its portfolio reengineering process. 

Because of HUD's past ownership problems, housing experts believed
that examining the background and management record of participating
owners and taking appropriate steps to resolve specific ownership
problems are important steps needed in the design of the portfolio
reengineering process.  Some housing experts also believed that the
preservation program has provided effective models for transferring
properties from existing owners to resident ownership and
resident-endorsed nonprofit ownership.  They believed that these
models could successfully be adapted to portfolio reengineering.\2


--------------------
\2 Recent work by HUD's Office of Inspector General has, however, led
to some concerns about the extent to which the targeting of funding
to sales transactions to priority purchasers (i.e., resident and
nonprofit groups) increases the potential for the establishment of
"sham" nonprofits.  (Audit-Related Memorandum 97-BO-114-0801, Oct. 
24, 1996). 


      MAINTAINING LONG-TERM
      HOUSING AFFORDABILITY
------------------------------------------------------- Appendix I:0.4

To ensure that subsidized multifamily properties are retained as
affordable housing for low-income households, HUD uses legally
binding agreements with owners that specify the length of time the
properties must be affordable and preserved for low-income
households.  Determining the appropriate terms of long-term
affordability use agreements is an issue in both the preservation and
the portfolio reengineering programs.  For example, while the title
II preservation program established use restrictions for the
remaining life of a property's financing, the length of the
restrictions was substantially increased under title VI to the
remaining useful life of a property. 

Housing experts we spoke with believed that, for portfolio
reengineering, careful consideration also needs to be given to
designing use agreements that will help ensure the availability of
affordable housing into the future.  They emphasized the importance
of balancing the benefits of portfolio reengineering with a continued
commitment to preserving housing for low-income households. 
According to those we interviewed, a number of factors relevant to
these determinations include establishing an acceptable length of
time that housing properties are to remain under federal use
restrictions, ensuring that properties remain available to
tenant-based Section 8 residents, adequately providing rent and
relocation protection for current residents, and ensuring that rents
actually remain affordable to the range of households being targeted. 


      ENSURING SUFFICIENT TIME FOR
      EVALUATING AND NEGOTIATING
      REENGINEERING AGREEMENTS
------------------------------------------------------- Appendix I:0.5

Interviews with housing experts, as well as our discussions with HUD
staff during this review, indicated that HUD's field office staff
were often under tight time frames and pressures to approve
preservation applications.  Similar concerns about compressed
processing time frames were expressed about HUD's portfolio
reengineering program.  For example, during the fiscal year 1997
portfolio reengineering demonstration program, 180 days are allowed
to perform the essential reengineering functions dealing with the
application, due diligence, and negotiation processes.  During this
time frame, HUD and the owner must reach agreement on a wide variety
of issues ranging from rent levels, operating expense budgets, and
rehabilitation needs, to the most acceptable restructuring approach
and financing needs.  Each of these steps could encompass a number of
time-consuming obstacles that HUD and its designated processors
and/or contractors may be under pressure to address and find
difficult to control.  In general, housing experts believed that the
180-day time frame may not allow HUD the flexibility to adequately
address the broad range of issues involved in the reengineering
process.  Accordingly, they believed that HUD's ability to administer
the program within these time frames needs to be closely monitored
and the time frames potentially reexamined. 


      AVOIDING FREQUENT PROGRAM
      CHANGES
------------------------------------------------------- Appendix I:0.6

Other concerns that surfaced during our interviews, as well during
our review at HUD field offices, were the frequent program changes
and modifications to program operations and delivery mechanisms that
were characteristic of the preservation program.  Housing experts
believed that deficiencies comparable to those that have plagued the
preservation program can be minimized in reengineering if key areas
of concern are resolved early and prior to implementation of a
full-scale reengineering effort.  In general, they favored testing
specific portfolio reengineering design concepts and methods of
program administration.  They believed that the demonstration effort,
if properly administered, can be an advantageous tool in providing
vital information and data on the range of questions and issues that
will be assessed in reaching final agreement on the appropriate
approach to resolve the multifamily portfolio problems. 


PRESERVATION FUNDING PROVIDED FOR
SALES AND EXTENSIONS
========================================================== Appendix II

Currently, preservation funding is provided through capital grants to
owners and purchasers for sales to nonprofit owners who agree to
extend affordability restrictions at the property.  As shown in table
II.1, these grants may cover owner equity take-outs, rehabilitation
(i.e., repairs, a repair contingency, and replacement reserves), and
transaction costs.\1



                               Table II.1
                
                     Funding Provided to Owners and
                 Purchasers Through Capital Grants for
                      Sales to Priority Purchasers

----------------------------------------  ----------------------------
Equity                                    Recipient: Owner selling
                                          property
                                          Amount funded: The
                                          preservation value minus
                                          outstanding mortgage debt.
                                          Essentially, the
                                          preservation value
                                          represents 100 percent of
                                          the "as is" fair market
                                          value of the property based
                                          on its highest and best use
                                          as an unsubsidized market-
                                          rate residential property,
                                          reflecting the deduction of
                                          all improvements, repair and
                                          conversion costs needed to
                                          transition the property from
                                          subsidized to market-rate
                                          housing.\a

Repairs                                   Recipient: Purchaser
                                          Amount funded: Repairs to
                                          restore property to original
                                          condition and improvements
                                          that extend the life of the
                                          property or enhance the
                                          livability for residents.


Repair contingency                        Recipient: Purchaser
                                          Amount funded: 10 percent of
                                          repair and improvement
                                          amount.

Replacement reserves                      Recipient: Purchaser
                                          Amount funded: 100 percent
                                          of capital needs for 5 years
                                          and any shortfall for major
                                          capital needs in years 6-10
                                          that will not be covered by
                                          required annual replacement
                                          reserve deposits.


Transaction costs                         Recipient: Purchaser
                                          Amount funded: Costs include
                                          expenses incurred by
                                          purchasers associated with
                                          the acquisition, loan
                                          closing, and implementation
                                          of the plan of action. These
                                          costs may include such items
                                          as consultant fees,
                                          mortgagee retainer fees,
                                          training fees, and
                                          relocation allowances.

----------------------------------------------------------------------
Note:  Priority purchasers are defined by HUD as resident councils,
community-based nonprofit organizations with the support of a
majority of the tenants, and any nonprofit organization or state or
local agency that agrees to maintain low-income affordability.  A
priority purchaser may not be a related party to the owner. 

\a For sales, the value is based on the property's highest and best
use, which may include something besides multifamily rental housing,
such as a condominium.  None of the 40 properties we examined has a
highest and best use for something other than a residential
market-rate rental property.  In general, the preservation value
agreed to represents either (1) the owner's appraisal value or 110
percent of HUD's appraisal if lower than the owner's, (2) an amount
negotiated between HUD and the property owner based on an appraisal
prepared by HUD, or (3) a value derived from a third, independent
appraisal. 

Owners who retain the properties and agree to extend the
affordability restrictions receive fewer incentives than the
incentives provided to owners and purchasers as part of preservation
sales transactions (see table II.2).  Rather than receiving a grant,
extension owners receive a nonamortizing, noninterest-bearing loan
that is due and payable when the mortgage is paid off, although the
Department may defer payment of the loan under certain conditions. 
In addition, the loan does not cover 100 percent of the equity, as is
available for sales.  Instead, the maximum equity amount available is
65 percent of equity.\2 Also, with extensions, the owner must fund
any amounts needed to meet HUD's reserve requirements.  Finally,
owner transaction costs are not funded for extensions, whereas with
sales, new owners may receive funding to cover transaction costs. 



                               Table II.2
                
                 Funding Provided Through Capital Loans
                             for Extensions

----------------------------------  ----------------------------------
Equity                              Recipient: Owner
                                    Amount funded: Up to 65 percent of
                                    the preservation value minus
                                    outstanding mortgage debt.
                                    Essentially, the preservation
                                    value represents the "as is" fair
                                    market value of the property based
                                    on its highest and best use as an
                                    unsubsidized market-rate
                                    residential property, reflecting
                                    the deduction of all improvements,
                                    repair and conversion costs needed
                                    to transition the property from
                                    subsidized to market-rate housing.

Repairs                             Recipient: Owner
                                    Amount funded: Repairs to restore
                                    property to original condition and
                                    improvements that extend the life
                                    of the property or enhance the
                                    livability to residents.


Repair contingency                  Recipient: Owner
                                    Amount funded: 10 percent of
                                    repair and improvement amount.
----------------------------------------------------------------------
Note:  With extensions, the current owner retains the proprerty and
agrees to retain affordability restrictions. 

In addition to the funding provided by the preservation program and
the balances in replacement reserve accounts, owners selling their
properties may also receive the balances in residual receipt
accounts.  Purchasers may be authorized to use excess rental income
for specified purposes.  Also, preservation properties would continue
to receive project-based rental assistance from HUD for units covered
by Section 8 rental assistance contracts.  HUD estimates that, on
average, about 40-45 percent of the units in preservation projects
are covered by such contracts.  Finally, most preservation properties
would also continue to receive mortgage interest subsidies from HUD
that reduce interest payments to as little as 1 percent. 


--------------------
\1 Replacement reserves are escrow funds established to ensure that
funds are available for needed repair and replacement costs. 

\2 The maximum capital loan is the lower of 65 percent of the owner's
equity plus the total approved costs for repairs or rehabilitation or
six times the most recently published annual existing fair market
rent using the appropriate apartment sizes and mix in the eligible
project. 


CARVE-OUT FUNDING
========================================================= Appendix III

The fiscal year 1997 Department of Veterans Affairs, HUD, and
Independent Agencies appropriations act (P.L.  104-204) requires HUD
to set aside $75 million of the $350 million in preservation program
funding for three special categories of properties, commonly referred
to by HUD and others as "carve-out" projects.  Essentially, this
provision gave properties falling within these categories priority
over other properties that were awaiting preservation funding.  The
three carve-out categories are as follows: 

  -- Properties that are subject to a repayment or settlement
     agreement that was executed between the owner and the Secretary
     of HUD before September 1, 1995. 

  -- Properties whose submissions for funding were delayed because of
     their location in an area that was designated as a federal
     disaster area in a Presidential Disaster Declaration. 

  -- Properties for which processing was suspended, deferred, or
     interrupted for a period of 12 months or more because of
     differing interpretations, by the Secretary of HUD and an owner
     or by the Secretary and a state or local rent regulatory agency,
     concerning the timing of filing eligibility or the effect of a
     presumptively applicable state or local rent control law or
     regulation on the determination of preservation value under
     section 213 of the Low Income Housing Preservation and Resident
     Homeownership Act (LIHPHRA) if the owner of such project filed a
     notice of intent to extend the low-income affordability
     restrictions of the housing or transfer it to a qualified
     purchaser who would extend such restrictions, on or before
     November 1, 1993. 

While the legislation did not specify how the $75 million was to be
allocated among the three categories, HUD decided to divide the $75
million equally among them.  This resulted in 21 properties being
funded as carve-outs, including 6 in Connecticut, 1 in Massachusetts,
9 in California, and 5 in New York. 

The first carve-out category was used to provide preservation funding
to seven properties in Connecticut and Massachusetts.  These seven
properties were owned by a person who had entered into an agreement
with HUD in 1994 to settle allegations in a 1993 HUD Office of
Inspector General report that the owner had violated several of the
Department's regulatory agreements.  More specifically, the Inspector
General determined that the owner had violated HUD's regulatory
agreements by diverting funds from the properties for personal and
other business use.  Specific violations included diverting $5.2
million, not forwarding $1.1 million of section 236 excess income to
the Department, and not timely forwarding $383,000 of Housing and
Urban-Rural Recovery Act rent refunds to tenants.  Additionally, the
Inspector General found that the owner could not support $232,100 of
accounting services and did not maintain the project's accounting
systems entirely in accordance with HUD's requirements.  The
Inspector General's report also questioned the independence of a
certified public accountant who performed project audits. 

After the Inspector General identified these problems, the owner
agreed with the Secretary of HUD to an $11.1 million settlement that
included penalties.  As part of the settlement agreement, the
Department allowed the owner to apply for preservation funding on 34
of his projects and to use his equity to help defray the penalty
costs. 

In 1995, HUD provided about $26.7 million in preservation funding for
eight of this owner's projects, of which $22.2 million was for owner
equity.  The $25 million the owner received in April 1997 included
about $18 million for equity.  Thus, while the owner's violations and
penalties amounted to $11.1 million, the owner received a total of
about about $51.7 million in preservation funding.\1 All of the
properties were funded as extensions under Title II of the
preservation program, thus allowing the owner to continue ownership
of the properties.\2

Under the second carve-out category, HUD provided about $25 million
in funding to nine California properties whose applications were
processed by HUD's Los Angeles field office.  HUD determined that the
submissions on these properties had been delayed by the 1994
earthquake in California. 

Under the third carve-out category, HUD provided about $25 million in
funding to five properties.  Each of these properties' applications
was handled by HUD's New York field office. 


--------------------
\1 Reflecting program changes discussed in the report, the funding
was provided with FHA-insured Section 241(f) loans in 1995 and with
nonamortizing, noninterest- bearing loans in 1997 that are due and
payable when the mortgages are paid off (although the Department may
defer payment of the loan under certain conditions). 

\2 In addition to the properties already funded, the owner has nine
more properties awaiting preservation funding.  We also noted that at
one of the other properties we examined, Mishawum Park Apartments in
Charlestown, Massachusetts, the owner had entered into an agreement
with HUD to settle alleged violations identified by HUD's Inspector
General.  The Inspector General determined that the owner had
diverted funds and charged higher than normal legal fees for work at
the property.  The preservation plan of action HUD has approved would
provide about $29.7 million to that property. 


PREPAYMENT OF INSURED MORTGAGES ON
PRESERVATION-ELIGIBLE PROJECTS
========================================================== Appendix IV

In the fiscal year 1996 HUD appropriations act (P.L.  104-134), the
Congress restored the right of owners to prepay their mortgages and
to terminate affordability restrictions at their properties provided
the owners agreed not to raise the rents for 60 days.  This
legislation also provided certain protections for tenants living in
properties whose owners decide to prepay.  The fiscal year 1997 HUD
appropriations act (P.L.  104-204) also authorized protections for
tenants living in properties whose owners prepay, although the
specific protections available to certain classes of tenants were
modified.  While owners are no longer required to request HUD
approval prior to prepayment, HUD has emphasized that they must
notify the Department if they intend to prepay so that steps may be
taken to provide affected tenants with the statutory protections. 

This appendix provides information about the prepayments that have
occurred since the 1996 legislation, the protections available to
affected tenants, and outstanding issues related to the potential
impacts of prepayments on the tenants.  Because prepayment rights
were restored relatively recently, it is too soon to tell what the
effects on tenants will actually be. 


      EXTENT OF PREPAYMENTS
------------------------------------------------------ Appendix IV:0.1

According to data from HUD's preservation office, as of March 5,
1997, owners had filed notices of intent to prepay the mortgages on
247 projects with about 23,000 units; of these, 131 notices were
filed for prepayment in fiscal year 1996 and 116 were filed for
prepayment in fiscal year 1997. 

These notices covered projects located in 37 states.\1 About 23
percent, or 58 notices, were filed for projects located in
California.  However, the majority of states have had no more than 5
notices of intent filed, and only four (Oregon, New Mexico,
Washington, and California) have had more than 15 notices. 

Of the 247 notices filed at the time of our review, owners had
actually prepaid the mortgages on 109 of the projects with about
9,800 units.  There were at least one prepayment in each of 35 states
and no more than five prepayments in most states.  There were 12 and
10 prepayments in California and Maryland, respectively.  In March,
HUD's preservation office initiated a survey of owners to estimate
the volume of prepayments likely to occur in the remainder of fiscal
year 1997. 


--------------------
\1 Data on the extent of prepayments by state include Washington, D. 
C. 


      TENANT PROTECTIONS
------------------------------------------------------ Appendix IV:0.2

Several pieces of legislation have set forth provisions to help
protect tenants from being displaced when property owners prepay. 
Although the Low Income Housing Preservation and Resident
Homeownership Act (LIHPRHA) of 1990 (P.L.  101-625) placed
substantial restrictions on owners' ability to prepay the mortgages
on their properties, the legislation also included protections for
tenants in case an owner did prepay.  Depending on the type of
tenant, LIHPRHA generally allows eligible tenants to receive
tenant-based Section 8 assistance or to remain in their current unit
for 3 years with no rent increases (except for increases necessary
for increased operating costs).  These protections are generally
available to tenants who are not already receiving project-based or
tenant-based Section 8 assistance at the time of prepayment. 
According to HUD guidance, tenants who are already receiving
assistance at the time of prepayment continue to receive the
assistance under its existing terms.  The amount that they contribute
to rent is not affected, and the assistance remains in place until it
expires or is terminated under regular program rules. 

The fiscal year 1996 HUD appropriations legislation restored the
right of owners to prepay the mortgages on preservation-eligible
housing, so long as they agreed not to raise the rents for 60 days
after prepayment.\2 The law also further defined some of the tenant
protections authorized by LIHPRHA.  For example, it more specifically
identified those eligible for tenant-based Section 8 assistance as
unassisted low-income tenants residing in the housing on the date of
prepayment whose rent, as a result of an increase occurring no later
than 1 year after the date of prepayment, exceeds 30 percent of
adjusted income.\3 The law also added that these tenants may not pay
less for rent than they were paying at the time of mortgage
prepayment.  Under the statute, any tenant receiving this
tenant-based assistance may elect to (1) remain in the housing unit
and if the new rent exceeds the normal Section 8 limit, the new rent
will be considered the applicable limit,\4 or (2) move from the
housing and the rent will be subject to the normal Section 8 limits. 
Because this special Section 8 assistance will subsidize rents higher
than the normal Section 8 limits so that tenants can remain in their
current units if they wish, it is referred to as "sticky" Section 8
assistance. 

The fiscal year 1997 HUD appropriations legislation continued the
right of owners to prepay, with the 60-day restriction on rent
increases, but somewhat modified the protections available to tenants
affected by a prepayment.  Specifically, the law expanded the
category of tenants eligible to receive the "sticky" Section 8
assistance to include moderate-income tenants who are elderly,
disabled, or residing in a low-vacancy area.  Before the 1997
legislation, these classes of tenants were eligible for the 3-year
continued occupancy protection of LIHPRHA.  However, under the 1997
statute, the "sticky" tenant-based Section 8 assistance is given in
lieu of the protections (relocation assistance, 3-year continued
occupancy, and required acceptance of Section 8 tenants) provided
under LIHPRHA.  According to HUD guidance, during fiscal year 1997,
as long as sufficient appropriations are available to provide
tenant-based assistance, the LIHPRHA protections are not applicable. 
For projects that had filed notices of intent to prepay as of March
5, 1997, HUD estimates that the 1-year cost of "sticky" tenant-based
Section 8 assistance provided under the fiscal year 1996 and fiscal
year 1997 statutes will be about $24 million.  For projects that had
actually prepaid as of the March date, the 1-year cost of
tenant-based assistance is expected to be about $14 million. 

HUD issued several memorandums in 1996 and 1997, referred to as
Preservation Letters, that provide guidance on implementing the
provisions of the preservation program, including the protections for
tenants affected by mortgage prepayment.  For instance, according to
the Preservation Letters, owners who prepay must provide HUD with
timely information necessary to ensure that those tenants who could
be displaced by a prepayment receive the appropriate assistance.\5 In
addition, the guidance for fiscal year 1996 prepayments clarifies
that the 3-year occupancy protection of LIHPRHA is also available to
unassisted low- and very low-income tenants whose rents are not
raised during the first year following prepayment and who live in a
low-vacancy area or are special needs tenants. 


--------------------
\2 For the purposes of the preservation program, the terms prepayment
and termination of mortgage insurance are used interchangeably. 
Whenever either of the terms is used, it should be taken to mean
both. 

\3 HUD guidance clarifies that the term low-income tenants includes
very low-income tenants. 

\4 The new rent will be considered the applicable standard if the
administering public housing authority deems it reasonable.  If the
rent for the unit is not reasonable, as determined by the public
housing authority, the family may either move and receive the Section
8 tenant-based assistance or elect to stay in the unit, receive the
tenant-based assistance, and pay the difference between the rental
amount that the public housing authority deems appropriate and the
actual gross rent for the unit. 

\5 The owner of a project that currently has Section 8 assistance in
100 percent of its units is exempted from the reporting requirements. 


      POTENTIAL IMPACTS OF
      PREPAYMENTS ON TENANTS
------------------------------------------------------ Appendix IV:0.3

It is not yet clear how restoring prepayment rights will affect
tenants.  While HUD does collect information from owners of
properties that prepay in order to determine the amount of Section 8
assistance that tenants will require, it has not established a system
to track what happens to tenants following prepayment.  For purposes
of estimating the amount of Section 8 assistance required, the
preservation office assumes that all tenants who receive "sticky"
Section 8 assistance will choose to remain in the project, but they
do not collect data on the extent to which this assumption is
actually true, nor the extent to which tenants choosing to relocate
have been able to find suitable, affordable housing with their
tenant-based Section 8 assistance. 

One issue that could have a substantial effect on the extent to which
prepayment leads to tenant displacement is how long the more costly
"sticky" Section 8 assistance that tenants receive will be renewed at
its enhanced level.  If the assistance reverts to normal Section 8
assistance rules, tenants in projects with rents above the normal
limit would face a choice of relocating and obtaining housing within
the regular Section 8 limits or remaining in their current residences
and paying the difference between the project rent and the normal
Section 8 limit.  Moderate-income tenants who might not qualify for
Section 8 assistance under the regular Section 8 rules could be
required to pay their unit's full rent amount or relocate to housing
that they can afford without rental assistance.  HUD officials told
us that HUD's fiscal year 1998 budget request proposes the renewal of
"sticky" Section 8 assistance at its enhanced level. 

Another issue related to the impact of prepayments on tenants is the
possibility that owners might prepay the mortgages on their projects
but wait to raise rents until more than 1 year after prepayment.  As
discussed above, tenants are only eligible for "sticky" Section 8
assistance if their rent increases within 1 year after prepayment,
causing their rent payment to exceed 30 percent of adjusted income. 
Under fiscal year 1996 rules, low- and very low-income unassisted
tenants whose rent does not increase within 1 year after prepayment
could still receive the 3-year continued occupancy protection of
LIHPRHA if they live in a low-vacancy area or are special needs
tenants.\6 However, under the fiscal year 1997 appropriations act,
unassisted low- and very low-income tenants whose rent does not
increase until after the first year could be displaced because the
3-year continued occupancy protection is not available and they were
ineligible for "sticky" Section 8 assistance at the time of
prepayment. 


--------------------
\6 HUD guidance for the fiscal year 1996 rules defines special needs
tenants as those who are elderly or disabled and large families of
five or more persons requiring units with three or more bedrooms. 


PRESERVATION FUNDING BY CATEGORY
=========================================================== Appendix V

This appendix provides a table that lists the approved preservation
funding by category (equity, rehabilitation, and transaction costs)
for the 40 properties that we reviewed.  The rehabilitation category
includes funding for repairs (including improvements), a repair
contingency, and replacement reserves.  The approved funding in this
table does not reflect the fiscal year 1997 funding caps because, as
of May 1997, it was not clear how the cuts for a number of properties
would be allocated among these categories. 



                                    Table V.1
                     
                       Approved Preservation Funding for 40
                                    Properties

                                                   Category
                                      ----------------------------------
                                                                             Per
                                                               Actual or    unit
                   Total     Owner's  Rehabilita  Transactio   estimated  fundin
Property name      units      equity        tion     n costs     funding  g cost
----------------  ------  ----------  ----------  ----------  ----------  ------
Title VI--Sales
--------------------------------------------------------------------------------
Bayview Towers       200  $7,743,847  $3,774,017  $1,335,571  $12,853,43  $64,26
                                                                       5       7
Jerome Estates       176   3,214,000   1,901,008     334,372   5,449,380  30,962
Tariffville           81   1,890,639   2,427,001     276,168   4,593,808  56,714
 Apartments
808 Memorial         301   6,722,297   7,684,287   1,262,808  15,669,392  52,058
 Drive
Alewife Parkway      274   7,126,312   6,929,151     818,368  14,873,831  54,284
 Apartments
ETC & Associates      71   1,394,769   1,665,916     469,950   3,530,635  49,727
Commonwealth         118   1,684,670   6,329,760     935,925   8,950,355  75,850
 Apartments
Glenville            117   1,426,698   6,858,878     953,510   9,239,086  78,967
 Apartments
Warren Avenue         30   1,178,757   1,775,642     652,313   3,606,712  120,22
 Apartments                                                                    4
Chauncy House         87   1,948,949   3,581,861     768,274   6,299,084  72,403
Milliken             201   2,410,771   2,044,195      67,912   4,522,878  22,502
 Apartments
Spring Meadow        270     718,859  16,013,411   1,573,781  18,306,051  67,800
 Apartments
Greenfield           201   2,641,596   6,511,954     792,371   9,945,921  49,482
 Gardens
Mishawum Park        337   6,403,590  19,573,319   3,782,924  29,759,833  88,308
 Apartments
Waukegan Terrace     140   1,631,538   3,072,120     593,398   5,297,056  37,836
Cambridge Manor      312   3,762,047   4,993,822     338,306   9,094,175  29,148
Kenmore Plaza        324   7,428,629   5,572,626     426,408  13,427,663  41,443
Villa St.             14     372,171   1,124,440     148,760   1,645,371  117,52
 Andrews                                                                       7
39th Street           46     897,009     516,650     105,662   1,519,321  33,029
 Manor
Mountclef             18     761,485     916,206     120,240   1,797,931  99,885
 Apartments
Haven 501             50     578,124     387,825     176,295   1,142,244  22,845
Haven 502            105     858,948     867,905     218,755   1,945,608  18,530
Casa Development     158     836,102   8,053,315     177,829   9,067,246  57,388
Manhattan Manor       26     612,452     506,140     183,090   1,301,682  50,065
Holiday 101-B        117   1,783,600   5,617,180     969,200   8,369,980  71,538
Los Arboles           43   2,101,866   4,089,560     676,540   6,867,966  159,72
                                                                               0
Granada Gardens      169   6,924,451   1,695,100     331,510   8,951,061  52,965
================================================================================
Total title VI     3,986  $75,054,17  $124,483,2  $18,490,24  $218,027,7
 sales                             6          89           0          05
================================================================================
Average title VI             $18,829     $31,230      $4,639              $54,69
 sales per unit                                                                8

Title VI--Extensions
--------------------------------------------------------------------------------
La Brea Gardens      185  $1,487,013    $444,658           0  $1,931,671  $10,44
 Apartments                                                                    1
Hollywood            282   2,607,540     323,355           0   2,930,895  10,393
 Knickerbocker
Green Hotel          138   2,902,258     233,640           0   3,135,898  22,724
 Apartments
================================================================================
Total title VI       605  $6,996,811  $1,001,653           0  $7,998,464
 extensions
================================================================================
Average title VI             $11,565      $1,656           0              $13,22
 extensions per                                                                1
 unit

================================================================================
Total Title VI     4,591  $82,050,98  $125,484,9  $18,490,24  $226,026,1
                                   7          42           0          69
================================================================================
Average title VI             $17,872     $27,333      $4,027              $49,23
 per unit                                                                      2


Title II--Extensions
--------------------------------------------------------------------------------
Sunset               231  $3,056,171    $173,197           0  $3,229,368  $13,98
 Apartments                                                                    0
Brookside             32     653,624      66,908           0     720,532  22,517
 Gardens
Kennedy Building     115   2,150,730     177,933           0   2,328,663  20,249
Crestwood Park       150   2,878,710     272,998           0   3,151,708  21,011
 II Apartments
Summerhill           104   1,891,061     265,438           0   2,156,499  20,736
 Apartments
Woodbury             188   3,541,218      85,673           0   3,626,891  19,292
 Apartments
Willowcrest          151   3,273,247     339,853           0   3,613,100  23,928
 Apartments
Saybrook              30     524,688      57,712           0     582,400  19,413
 Apartments
Stoneycrest           49     952,116     110,721           0   1,062,837  21,691
 Apartments
Lincoln Village     1213   4,850,141   4,936,198           0   9,786,339   8,068

================================================================================
Total title II     2,263  $23,771,70  $6,486,631           0  $30,258,33
 extensions                        6                                   7
================================================================================
Average title II             $10,505      $2,866           0              $13,37
 extensions per                                                                1
 unit

================================================================================
Grand total        6,854  $105,822,6  $131,971,5  $18,490,24  $256,284,5
                                  93          73           0          06
================================================================================
Average per unit             $15,440     $19,255      $2,698              $37,39
                                                                               2
--------------------------------------------------------------------------------
Note:  rehabilitation includes repairs and improvements, repair
contingency, and replacement reserves. 


PRESERVATION PROPERTY VALUES AND
FUNDING
========================================================== Appendix VI

This appendix provides a table that lists the property values and
preservation funding for the 40 properties that we reviewed. 
Property value represents the value of the property that HUD agreed
to in determining the amount of equity to which the property's owner
would be entitled--essentially, the "as is" fair market value based
on highest and best use as unsubsidized market-rate residential
properties, reflecting the deduction of all improvements as well as
the repair and the conversion costs to transition the property from
subsidized to market-rate housing.  Preservation funding represents
the amounts in approved plans of action, adjusted for the caps
mandated by the fiscal year 1997 appropriations law, except for the
two cases where HUD had waiver requests pending as of May 15, 1997.\1



                                    Table VI.1
                     
                      Values and Preservation Funding for 40
                                    Properties

                                                                Ratio of     Per
                    Tota                          Difference  funding to    unit
                       l               Actual or    (funding       value  fundin
                    unit    Property   estimated       minus  (percentag       g
Property name          s       value     funding      value)          e)   costs
------------------  ----  ----------  ----------  ----------  ----------  ------
Title VI--Sales
--------------------------------------------------------------------------------
Bayview Towers       200  $12,380,00  $12,853,43    $473,435         104  $64,26
                                   0           5                               7
Jerome Estates       176   5,595,813   5,449,380    -146,433          97  30,962
Tariffville           81   2,951,548   4,246,956   1,295,408         144  52,432
 Apartments
808 Memorial Drive   301  23,500,000  14,613,984           -          62  48,551
                                                   8,886,016
Alewife Parkway      274  12,300,000  14,873,831   2,573,831         121  54,284
 Apartments
ETC & Associates      71   2,324,000   3,530,635   1,206,635         152  49,727
Commonwealth         118   3,784,000   8,023,344   4,239,344         212  67,994
 Apartments
Glenville            117   2,904,000   7,257,936   4,353,936         250  62,034
 Apartments
Warren Avenue         30   1,540,000   3,606,712   2,066,712         234  120,22
 Apartments                                                                    4
Chauncy House         87   3,550,000   6,299,084   2,749,084         177  72,403
Milliken             201   5,300,000   4,522,878    -777,122          85  22,502
 Apartments
Spring Meadow        270   4,840,000  15,812,496  10,972,496         327  58,565
 Apartments
Greenfield Gardens   201   5,820,119   9,945,921   4,125,802         171  49,482
Mishawum Park        337  13,821,500  27,488,748  13,667,248         199  81,569
 Apartments
Waukegan Terrace     140   3,140,000   5,297,056   2,157,056         169  37,836
Cambridge Manor      312   7,457,800   9,094,175   1,636,375         122  29,148
Kenmore Plaza        324  12,248,500  13,427,663   1,179,163         110  41,443
Villa St. Andrews     14     582,835     914,088     331,253         157  65,292
39th Street Manor     46   1,403,495   1,519,321     115,826         108  33,029
Mountclef             18   1,150,000   1,298,808     148,808         113  72,156
 Apartments
Haven 501             50   1,039,500   1,142,244     102,744         110  22,845
Haven 502            105   2,027,725   1,945,608     -82,117          96  18,530
Casa Development     158   2,359,191   8,090,544   5,731,353         343  51,206
Manhattan Manor       26     932,800   1,301,682     368,882         140  50,065
Holiday 101-B        117   2,812,000   5,965,932   3,153,932         212  50,991
Los Arboles           43   2,897,335   3,181,248     283,913         110  73,983
Granada Gardens      169   9,364,000   8,951,061    -412,939          96  52,965
================================================================================
Total title VI      3,98  $148,026,1  $200,654,7  $52,628,60         136
 sales                 6          61          70           9
================================================================================
Average title VI             $37,137                 $13,203              $50,34
 sales per unit                                                                0

Title VI--Extensions
--------------------------------------------------------------------------------
La Brea Gardens      185  $4,512,000  $1,931,671           -          43  $10,44
 Apartments                                        2,580,329                   1
Hollywood            282   7,864,800   2,930,895           -          37  10,393
 Knickerbocker                                     4,933,905
Green Hotel          138   6,406,834   3,135,898           -          49  22,724
 Apartments                                        3,270,936
================================================================================
Total title VI       605  $18,783,63  $7,998,464           -          43
 extensions                        4              $10,785,17
                                                           0
================================================================================
Average title VI             $31,047                -$17,827              $13,22
 extensions per                                                                1
 unit

================================================================================
Total title VI      4,59  $166,809,7  $208,653,2  $41,843,43         125
                       1          95          34           9
================================================================================
Average title VI             $36,334                  $9,114              $45,44
 per unit                                                                      8


Title II--Extensions
--------------------------------------------------------------------------------
Sunset Apartments    231  $7,567,447  $3,229,368           -          43  $13,98
                                                  $4,338,079                   0
Brookside Gardens     32   1,107,538     720,532    -387,006          65  22,517
Kennedy Building     115   3,509,726   2,328,663           -          66  20,249
                                                   1,181,063
Crestwood Park II    150   5,016,199   3,151,708           -          63  21,011
 Apartments                                        1,864,491
Summerhill           104   3,582,473   2,156,499           -          60  20,736
 Apartments                                        1,425,974
Woodbury             188   7,035,941   3,626,891           -          52  19,292
 Apartments                                        3,409,050
Willowcrest          151   5,745,127   3,613,100           -          63  23,928
 Apartments                                        2,132,027
Saybrook              30   1,041,604     582,400    -459,204          56  19,413
 Apartments
Stoneycrest           49   1,840,327   1,062,837    -777,490          58  21,691
 Apartments
Lincoln Village     1,21  36,937,804   9,786,339           -          26   8,068
                       3                          27,151,465
================================================================================
Total title II      2,26  $73,384,18  $30,258,33           -          41
 extensions            3           6           7  $43,125,84
                                                           9
================================================================================
Average title II             $32,428                -$19,057              $13,37
 extensions per                                                                1
 unit

================================================================================
Grand total         6,85  $240,193,9  $238,911,5           -
                       4          81          71  $1,282,410
================================================================================
Average per unit             $35,044                   -$187              $34,85
                                                                               7
--------------------------------------------------------------------------------

--------------------
\1 HUD disapproved the waiver requests on May 30, 1997. 


OBJECTIVES, SCOPE, AND METHODOLOGY
========================================================= Appendix VII

The House Conference Report 104-812 accompanying the fiscal year 1997
appropriations act (P.L.  104-204) included a request for a GAO study
on the preservation program to assist the Congress in making a
determination of whether the program is the most cost-effective way
to provide affordable housing opportunities to low-income families. 
As requested, we reviewed (1) the funding provided to preservation
properties as compared with their values, (2) the levels of
rehabilitation grants provided to properties compared with their
physical needs, and (3) the administrative and other problems that
have arisen under the program.  In addition, we identified lessons
from the preservation program that can be applied to portfolio
reengineering, a program currently being tested on a limited scale
designed to address long-standing problems affecting FHA's insured
portfolio of multifamily properties. 

To respond to the first two objectives, we obtained and reviewed
information on 40 properties at four HUD field offices located in
Boston, Massachusetts; Chicago, Illinois; Hartford, Connecticut; and
Los Angeles, California.  Each of these offices had a substantial
preservation workload in terms of the cases and/or dollars for which
it was responsible.  The properties we selected for review at each
field office were those that were the highest on HUD's November 1996
"funding queue"---the list of properties with approved incentives
that were awaiting funding as of that time.  As of June 1997, 32 of
the 40 cases we reviewed have either been funded or are scheduled for
funding in fiscal year 1997.  The properties we reviewed accounted
for about 19 percent of the funding for all sales to priority
purchasers and carve-outs on HUD's November 1996 funding queue. 

To provide information on the funding provided to preservation
properties as compared with their values, we used the HUD-approved
preservation values, which are generally based on independent
appraisals and physical inspections of the properties.  We did not
conduct our own independent assessments of property values for the 40
properties we examined.  Essentially, the values we used represent
"as is" fair market values of the properties based on their highest
and best use as unsubsidized market-rate rental properties,
reflecting the deduction of all improvements, repair and conversion
costs needed to transition from subsidized to market-rate housing. 
It is important to note that these values do not take into account
increases in property values that may result from improvements funded
under the preservation program. 

We compared the HUD-approved values with the HUD-approved financial
incentives.  The financial incentives were taken from HUD's final
approved funding queue for fiscal year 1997, dated March 21, 1997,
for the 24 properties HUD identified for funding at that time and
from HUD's November 20, 1996, funding queue for the other 16
properties that had not yet been identified for funding as of March
21, 1997.  We lowered the approved financial incentives on these
listings, however, for the cases in which the incentives shown on the
funding queue exceeded the fiscal year 1997 funding caps, except in
the two cases for which HUD had waivers pending as of May 15, 1997. 

To provide information on the levels of rehabilitation grants
provided to properties compared with their physical needs, we
reviewed HUD's files for the 40 cases and obtained the physical needs
identified in the preservation capital needs assessments performed by
HUD's contractors.  We compared the repair needs identified in the
preservation capital needs assessments with the amounts for repairs
and the repair contingency in HUD-approved plans of action for the
properties.  As discussed in the report, the rehabilitation costs in
the approved plans of action do not fully reflect the impact of the
fiscal year 1997 funding caps.  As of May 1997 it was not clear how
the funding cuts needed at some properties to meet the fiscal year
1997 funding caps would be allocated among equity, rehabilitation,
and transaction costs.  We also interviewed HUD officials in
headquarters and in the field and reviewed HUD's regulations and
guidance to determine the basis for the approval of rehabilitation
requests. 

To determine what administrative and other problems have arisen under
the preservation program, we obtained information from our file
reviews of the 40 cases we examined.  We did not attempt to assess
the extent to which each of the 40 transactions we examined was
processed in accordance with preservation program requirements.  We
also interviewed HUD officials at headquarters and six field offices
(located in Boston, Chicago, Hartford, Los Angeles, Jacksonville, and
Seattle) and industry officials including representatives from the
National Housing Trust, the Institute for Responsible Housing
Preservation, and the Mid-City Financial Corporation.  In addition,
we reviewed past HUD Inspector General reports and held discussions
with Office of the Inspector General officials to identify problems
associated with the program and the status of any recommendations to
correct them. 

To identify lessons learned from the preservation program that can be
applied in the development of HUD's portfolio reengineering program,
we obtained comments and opinions from a wide range of officials
having experience with HUD's multifamily housing programs.  These
included officials in HUD's Office of Multifamily Housing Programs at
headquarters and representatives from the four HUD field offices
where we performed our work.  We also interviewed a range of
representatives from the private and public sector who were familiar
with affordable housing programs.  This included officials from the
National Housing Trust; the National Housing Conference; the National
Housing Law Project; the National Low Income Housing Coalition; the
National Housing Partnership; Recapitalization Advisors Inc., Boston,
Massachusetts; On-Site Insight, Boston, Massachusetts; the Community
Economic Development Assistance Corporation, Boston, Massachusetts;
the California Housing Partnership Corporation, Oakland, California;
Emily Achtenberg, consultant, Boston, Massachusetts; the Kerry
Company, Washington, D.C.; and the Chicago Community Development
Corporation, Chicago, Illinois.  In addition, we reviewed portfolio
reengineering legislation and regulations pertaining to HUD's
demonstration program and discussed the program with demonstration
program officials at headquarters and its demonstration contractor
group, the Ernst & Young Kenneth Leventhal Real Estate Group. 

In addition, we obtained information about prepayments by analyzing
spreadsheets compiled by HUD's preservation office which contained
data for fiscal years 1996 and 1997 on properties for which owners
had filed notices of intent to prepay as of March 5, 1997.  We
generally used data from HUD's multifamily housing data systems to
identify the locations of these properties.  We did not verify the
accuracy of the location data in these systems.  For information on
the protections available to tenants affected by prepayments, we
reviewed the statutory requirements of LIHPRHA (P.L.  101-625) and of
the fiscal year 1996 and fiscal year 1997 HUD appropriations
legislation (P.L.  104-134 and P.L.  104-204, respectively).  We also
reviewed HUD's written regulations and guidance for implementing the
legislative provisions and discussed them with preservation office
staff. 




(See figure in printed edition.)Appendix VIII
COMMENTS FROM THE DEPARTMENT OF
HOUSING AND URBAN DEVELOPMENT AND
GAO'S EVALUATION
========================================================= Appendix VII



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on the Department of Housing and
Urban Development's (HUD) letter, received on July 10, 1997. 

1.  We continue to believe that the administrative weaknesses
discussed in the report while not based on a random sample of HUD's
properties nevertheless have hampered HUD's ability to ensure that
the program is managed effectively and efficiently, that federal
funds are being spent wisely, and that program requirements are
complied with.  Furthermore, the Department's comments on this report
recognize that improvements in internal controls and procedures for
program administration are needed. 

2.  We continue to believe that our methodology was appropriate to
address the report's objectives.  While, ideally, it may have been
desirable to examine all of the properties scheduled for funding in
fiscal year 1997, this would have involved our carrying out work in
16 HUD field offices.  Such an approach was not practical given the
time frames we had to perform our work and current budget realities. 
Instead, we focused our work on field offices with substantial
preservation workloads and properties at those field offices that
were likely to receive funding in fiscal year 1997 or 1998 (if the
program is continued).  The fact that our results cannot be
statistically projected to the universe of preservation properties
awaiting funding in no way invalidates our findings that the
incentives provided to a substantial number of properties are high,
in many cases far exceeding the properties' preservation values, and
that improvements are needed in HUD controls over preservation
funding.  As of June 1997, in fiscal year 1997 the Department
expected to fund 32 of the 40 properties we reviewed. 

3.  Our report shows that the rehabilitation costs funded by HUD were
568 percent higher than the repairs identified in the Department's
preservation capital needs assessments which were to identify, among
other things, the repairs needed to return the properties to good
condition.  Our review of rehabilitation costs was not intended to
determine the extent to which repairs funded were appropriate and
cost effective but was to provide information on the levels of
rehabilitation grants provided to properties compared with their
physical needs.  It does not conclude that these rehabilitation costs
were higher than what was needed to cover necessary repairs.  Rather,
our point, with which HUD also agreed, was that the criteria for
improvements that may be funded under preservation is too broad in
light of the limits on HUD staff's ability to process preservation
funding requests and monitor the program. 

4.  We continue to believe that a property's preservation value was
the best available measure of property value that could have been
used to respond to the House Conference Report's request that we
compare the funding provided to preservation properties to the
properties' values.  Our report recognizes that the preservation
value, which is based on its "as is" fair market value as an
unsubsidized market-rate rental property, does not take into account
any increases in property value that may result from improvements
funded under the preservation program.  However, as HUD's General
Deputy Assistant Secretary-FHA recognized in a memorandum commenting
on the facts contained in our report, no appraisals are required that
would determine a property's value after repairs and improvements are
completed.  Also, performing such appraisals would have been
difficult, if not impossible, at the properties we analyzed, because
they have either only recently received preservation funding or are
still awaiting funding.  Furthermore, while we in no way assert that
preservation funding should never exceed a property's preservation
value, we believe that it is reasonable for both HUD and the Congress
to carefully examine the merits of preserving properties that require
funding far in excess of their preservation value. 

5.  Our report already indicates that the significant growth in funds
for rehabilitation needs that we identified is largely attributable
to the Department's 1994 policy decision to fund improvements above
those identified in the preservation capital needs assessments and
HUD's desire to facilitate sales of properties to nonprofit owners. 

6.  The Department states that GAO is short-sighted for criticizing
HUD's policy on funding improvements while at the same time agreeing
that more stringent criteria are needed to document the cost
effectiveness of proposed repairs.  As noted earlier, our point was
that the criteria for improvements that may be funded under
preservation is too broad in light of the limits on HUD staff's
ability to process preservation funding requests and monitor the
program. 

7.  We believe the information presented by HUD is insufficient to
support its assertion that the Department's policy decision to allow
owners to keep the balances in replacement reserves reflects
congressional intent. 

8.  The information presented by HUD does not cause us to change our
view that the Department's policy and methodology for determining the
initial deposits to replacement reserves are not sufficient to
prevent funding excess amounts.  HUD's revised policy for determining
the adequacy of replacement reserves, cited as the action taken to
prevent overfunding of reserves, was put in place in 1995.  We
continue to believe that HUD's policies and controls over replacement
reserve funding are not sufficient to prevent overfunding. 

9.  We believe that the Department's comments misstate its current
policy covering equity adjustments (reductions) for repairs that
bring a property to marketable ("good") condition.  Specifically,
HUD's comments do not reflect the Department's current policy,
promulgated in 1995, which limits the deduction for repairs being
funded at the plan-of-action stage that are in excess of repairs
identified in the capital needs assessments to only those instances
where owners had intentionally concealed required repairs during the
preservation capital needs assessment process.  As discussed in the
report, this policy increases program costs to the extent that
additional repairs are funded but the equity payments to owners are
not correspondingly reduced.  In addition, we are unaware of any
provision in LIHPRHA that would preclude HUD from deducting from
equity improvements funded at the plan of action stage that are also
relevant to converting the property to an unsubsidized use. 

10.  In our report, we noted that headquarters did not conduct
systematic reviews of field offices that process preservation
transactions and concluded that the information reviewed by
headquarters staff is insufficient to allow them to identify many of
the issues and problems that arise.  Therefore, the Department's
commitment to make more frequent visits to its field offices to,
among other things, monitor transactions if preservation funding is
provided in the future is appropriate.  Our report did not indicate
that HUD should review all preservation funding transactions. 
However, we note that such reviews should provide sufficient coverage
of preservation transactions to assure the Department that the
program is being carried out consistent with program requirements, is
being managed efficiently and effectively, and that preservation
funds are being spent wisely. 

11.  While the Department commented that it had stopped funding
properties with long-term use agreements 4 years ago, the property
discussed in our report was funded in 1996.  In addition, HUD's
comments indicate that it was necessary to use preservation funds to
resolve enforcement activities because of inadequate enforcement
capacity.  However, we question whether enforcement capacity was so
inadequate that it required the Department to use preservation
funding for this purpose. 

12.  As discussed in our report, HUD officials acknowledged that,
ideally, a third party appraiser would have been engaged in this
case, but that because of timing issues and competing workload
demands, they believed the field office's action was appropriate. 
However, we note that there was sufficient time for HUD to contract
for the third appraisal as 9 months elapsed between the time that the
owner raised questions about the HUD contract appraisal and HUD's
internal appraisal.  It is not clear why a third appraisal was not
requested at the time the large discrepancy between the owner's and
HUD's appraisal was identified and the owner questioned HUD's
appraisal. 

13.  HUD states that approval of the plan of action was not required
to estimate the funding or to place a project on the funding queue so
long as the office had evaluated the financial structure of the
transaction and the repair costs.  However, during the review,
program staff told us that properties are to be placed on the
preservation funding queue after field offices had approved their
plans of action.  The properties then receive funding in the same
order in which they are listed on the queue.  The fact that HUD did
not consistently apply this rule allowed a few offices to obtain
funds ahead of most of the other offices which submitted their
properties for funding after they had approved the plans of action. 
In the case cited in our report, the property was placed on the
funding queue on July 12, 1996, but the plan of action was not
received by the field office until July 15, 1996.  This raises
questions about how the office would have evaluated the proposal. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IX


      HOUSING AND COMMUNITY
      DEVELOPMENT ISSUE AREA
------------------------------------------------------ Appendix IX:0.1

Mark H.  Egger
Christine M.B.  Fishkin
Diana Gilman
Richard A.  Hale
Richard C.  LaMore
Joseph M.  Raple
Rose M.  Schuville
Leigh K.  Ward


      DESIGN, METHODOLOGY, AND
      TECHNICAL ASSISTANCE GROUP
------------------------------------------------------ Appendix IX:0.2

Luann M.  Moy


      ECONOMIC ANALYSIS GROUP
------------------------------------------------------ Appendix IX:0.3

Austin J.  Kelly


      OFFICE OF THE GENERAL
      COUNSEL
------------------------------------------------------ Appendix IX:0.4

John T.  McGrail


*** End of document. ***