Single-Family Housing: Stronger Measures Needed to Encourage Better
Performance by Management and Marketing Contractors (Testimony,
05/16/2000, GAO/T-RCED-00-180).

Pursuant to a congressional request, GAO discussed the Department of
Housing and Urban Development's (HUD)-single family housing, focusing on
the implementation of its management and marketing contracts.

GAO noted that: (1) HUD has experienced widespread problems with the
management and marketing contracts since they started in April 1999; (2)
property maintenance and security, which was a problem under HUD's
previous property disposition approach, remains a significant problem;
(3) although monitoring improvements have aided HUD's ability to detect
such problems, these improvements have not had a sufficient impact in
remedying them; (4) in addition, older properties have accumulated in
inventory as the contractors have focused their sales efforts on the
newly acquired, more saleable properties; and (5) also, while HUD
encourages contractors to sell properties quickly, it does not provide
incentives for the contractors to focus on properties that have been in
inventory for a long period of time.

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

 REPORTNUM:  T-RCED-00-180
     TITLE:  Single-Family Housing: Stronger Measures Needed to
	     Encourage Better Performance by Management and Marketing
	     Contractors
      DATE:  05/16/2000
   SUBJECT:  Housing programs
	     Contract administration
	     Marketing
	     Federal property management
	     Internal controls
	     Mortgage programs
	     Property disposal
IDENTIFIER:  HUD Good Neighbor Program

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Testimony

Before the Subcommittee on Housing and Transportation, Committee on Banking,
Housing, and Urban Affairs, U.S. Senate

For Release on Delivery
Expected at 9:30 a.m., EDT,
Tuesday
May 16, 2000

SINGLE-FAMILY HOUSING

Stronger Measures Needed to Encourage Better Performance by Management and
Marketing Contractors

Statement of Stanley J. Czerwinski, Associate Director,
Housing and Community Development Issues,
Resources, Community, and Economic Development Division

GAO/T-RCED-00-180

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here to discuss our report that you are releasing today
on the Department of Housing and Urban Development's (HUD) implementation of
its management and marketing contracts. HUD introduced these contracts
nationwide last year as a means of disposing of the inventory of
single-family properties that the Department acquires through foreclosures.
The contractors are responsible for all management and marketing activities,
ranging from inspecting the properties to ensure that they are presentable
to listing and selling the properties.

In summary, our work showed that HUD has experienced widespread problems
with the management and marketing contracts since they started in April
1999. Property maintenance and security, which was a problem under HUD's
previous property disposition approach, remains a significant problem.
Although monitoring improvements have aided HUD's ability to detect such
problems, these improvements have not had a sufficient impact in remedying
them. In addition, older properties have accumulated in inventory as the
contractors have focused their sales efforts on the newly acquired, more
saleable properties. Also, while HUD encourages contractors to sell
properties quickly, it does not provide incentives for the contractors to
focus on properties that have been in inventory for a long period of time.

Background

HUD, through its Federal Housing Administration, helps finance home
purchases by insuring private lenders against losses on mortgages for
single-family homes. If a borrower defaults on a loan and the loan is
subsequently foreclosed, the lender may file a claim for most of its losses
with HUD. The lender transfers the title to the home to HUD after the claim
is paid. HUD manages and sells the property through its property disposition
program. The property disposition program's mission is to sell these
properties in a manner that expands homeownership opportunities, strengthens
neighborhoods and communities, and ensures a maximum return to the fund.

As part of an effort to streamline operations and reduce costs, HUD began a
pilot program in 1996 to test the feasibility of contracting out the
management and sales functions of its property disposition program. HUD
determined that the pilot was successful and in March 1999, began
contracting out the management and marketing of its single-family property
inventory when it awarded 7 companies a total of 16 contracts. The
contractors are responsible for all activities associated with managing and
marketing the properties which includes having the properties appraised,
securing the properties to prevent unauthorized entry, inspecting the
properties to ensure that they are clean and in presentable condition,
listing the properties for sale, and selling them. For these services, HUD
pays the contractors a fee that is based on a percentage of the property's
selling price. Each contract covers a different geographic area under the
jurisdiction of one of HUD's four homeownership centers.

The Director of the Real Estate Owned Division in each of the four centers
is responsible for monitoring contractors' performance in the respective
center's jurisdiction. Homeownership center staff manage and conduct the
monitoring and prepare monthly assessments on contractors' performance. The
homeownership centers have a number of resources upon which they can draw to
aid them in making these assessments. For instance, to assist in HUD's
oversight, third-party contractors inspect 10 percent of the properties
handled by each management and marketing contractor. Also for oversight
purposes, another national contractor follows a HUD checklist to review 10
percent of the management and marketing contractors' property case files
each month. In addition, the center's program support staff conduct
follow-up property inspections and file reviews, as well as a monthly
on-site review at the contractors' offices. As part of the analysis, the HUD
staff assign a risk rating of low, medium, or high to the contractor's
performance on each of 11 performance dimensions such as claims review,
property maintenance, and sales procedures.

Weaknesses Exist in HUD's Ability to Ensure Contractors' Better Performance

Our work on HUD's new contracts for managing and marketing its inventory of
single-family properties shows that further improvement is needed to ensure
better performance by its contractors. We found that HUD has experienced
widespread problems with the contractors since the program started in April
1999, including HUD's termination of its largest contractor--InTown
Management Group. Property maintenance and security, which was a problem
under HUD's previous property disposition approach, remains a significant
problem. While monitoring improvements have improved HUD's ability to detect
such problems, these improvements have not had a sufficient impact in
remedying them.

Although the contractors have been more aggressive at marketing
properties--for example, they use the Internet and broad-listing brokers,
and other services to publicize the properties and enhance sales--early
assessment reports prepared by the homeownership centers indicated that most
of the contractors had problems in carrying out some of their management
responsibilities. One of the areas in which most of the contractors have had
particular performance problems is that of property maintenance and
security. Contractors' failure to properly secure and maintain the
properties assigned to them may cause a decline in property values and have
a negative impact on surrounding neighborhoods. In the homeownership center
staff's' monthly assessment reports of contractors' performance for each
month from May through November 1999, the staff's assessments depict serious
performance problems in terms of property maintenance for over half of the
contracts reviewed. Even in the assessment reports for November 1999, 8
months after the initial contract start-up period, 11 of the 13 contracts
that we reviewed had serious problems in at least one of the performance
dimensions.

We corroborated our findings that these problems existed during our visits
to 16 properties. Several of the properties we visited were not properly
secured or maintained. For example, one of the homes in Washington, D.C.,
was poorly maintained (see fig. 1), had an open front window and rear door,
and had beer bottles inside; furthermore the backyard was overgrown with
brush and weeds. A property in Philadelphia that was listed for sale by the
contractor still had the previous maintenance contractor's sign on the front
door, unrepaired vandalism along the side of the house (see fig. 2), trash
in the rear courtyard, and an unsecured opening into the house.

Through experience HUD is learning that it has limited means to address poor
performance by the contractors. Although the homeownership centers have
identified performance problems, have brought them to the contractors'
attention, and have pressed for improvements, these actions have not always
yielded the improvement desired. For instance, in September 1999, the
Department issued a "letter of concern" to one of the contractors regarding
the contractor's inadequate progress in maintaining properties in
presentable condition. HUD also issued a deficiency letter regarding poor
property maintenance to another contractor. While a HUD official told us
that neither of these contractors was terminated and that their performance
has subsequently improved, the assessment reports prepared by homeownership
center staff regarding the performance of these two contractors show that as
recently as November 1999, over half of the properties reviewed for each of
these contractors were in less than satisfactory condition. Aside from
pointing out deficiencies in the monthly assessment reports, issuing letters
of concern or deficiency, or taking steps toward terminating contracts, HUD
staff do not have other tools available to address performance deficiencies.
The contracts do not provide for penalties to enforce compliance with the
contract terms. In this regard, as part of its audit of FHA's fiscal year
1999 financial statements, KPMG LLP, in a report on FHA's internal controls,
recommended that FHA devise a method of penalizing management and marketing
contractors that routinely do not comply with performance requirements. The
report noted that penalties would effectively communicate the importance of
strictly adhering to HUD's guidelines.

After 3 Years of Increases, HUD's Inventory Is Beginning to Decline, but the
Number of Older Properties in the Inventory Is Increasing

In addition to managing the acquired properties, a key component of the
contractors' responsibilities is selling these properties. After an increase
in the inventory in recent years, the number of properties is now beginning
to decline. The management and marketing contractors, hired for their real
estate sales expertise, are beginning to increase their sales of newly
acquired properties coming into the inventory. As a result, the inventory of
properties as of February 2000 is down to approximately 47,000, from a high
of 52,000 properties. However, the proportion of older properties-those in
the inventory longer than 6 months-has increased.

HUD's Inventory of Properties Has Grown in Recent Years but Is Now Beginning
to Decline

HUD's inventory of foreclosed properties steadily increased during fiscal
years 1996 through 1999. (See fig. 3.) However, the inventory began to
decline in fiscal year 2000. In the first 3 months following the
implementation of the management and marketing contracts (Apr. through June
of 1999), the number of properties in HUD's inventory increased, reaching
approximately 52,000 properties by the end of fiscal year 1999. Within a
month, however, the contractors had increased their sales, which, by that
time, were outpacing acquisitions. (See fig. 4.) As of February 2000, the
inventory was down to about 47,000 properties. The structure of HUD's
contracts, which provide full payment to the contractors only after a
property is sold, provides an incentive for good sales performance.

Contractors Are Not Effectively Reducing the Number of Properties That Have
Been in the Inventory for 6 Months or Longer

Although the contractors have increased their sales of HUD properties, the
inventory of older properties, or those that have remained in the inventory
for 6 months or longer, has increased. The contractors are selling more of
the newer properties coming into the inventory. Properties that were in the
inventory for 6 months or longer accounted for 42 percent of the total
inventory at the end of February 2000--up from 30 percent in April 1999. The
properties in the inventory for 1 year or longer increased from 10 to 17
percent of the total inventory for this same time period. (See fig. 5.)
According to a HUD contracted study, in the real estate industry, only about
2 to 3 percent of the properties remain in inventory for over a year. In
1995, we reported that properties in the inventory for longer periods of
time are sold for proportionately less. In addition to the potential for
deterioration of the properties, which can reduce their value, HUD also
incurs some costs as the properties remain in the inventory, such as
property taxes, utility costs and lost sale revenue.

HUD is aware of the problems with older properties in the inventory and
encourages the contractors, through frequent telephone calls, to focus on
the older properties. In addition, on March 1, 2000, HUD announced a new
Good Neighbor Program whereby it will sell properties that have been listed
for over 6 months to local communities for $1. The program is too new for us
to know what effect it may have on HUD's inventory of older properties or on
the fund.

Furthermore, while HUD has an extensive monitoring system to oversee
contractors' performance, the system does not specifically address
contractors' performance in selling aging properties. Thus, there are no
specific incentives for the contractors to give attention to the older,
potentially more-difficult-to-sell properties, or penalties if they do not.
In contrast, the fee structure of the contracts provides an incentive for
the contractors to sell properties quickly, which could lead the contractors
to sell the newer, more marketable properties first.

Conclusion

Improvements are still needed to ensure that HUD's contractors perform the
full range of functions required to manage and sell the single-family
properties it acquires given the continuing problems that HUD, KPMG, and we
have identified with property maintenance and security. HUD's available
incentives and enforcement methods, short of contract termination, are not
strong enough to ensure that the contractors are meeting their
responsibilities in this area. In its internal control report as a part of
its fiscal year 1999 audit of FHA's financial statements, KPMG recommended
that HUD devise a method of penalizing management and marketing contractors
that routinely do not comply with contract performance requirements. We
agree that a more effective mix of incentives and penalties is needed.

HUD's contracts provide incentives for the contractors to sell properties
quickly, and consequently, the inventory of properties has begun to decline.
But HUD does not provide incentives to sell properties that have been in the
inventory for a long period of time. These properties tend to worsen the
longer they remain unsold and could possibly sell at a lower price than
other properties in the inventory. As a result, our report recommended that
HUD develop more effective methods, such as specific incentives or
penalties, to encourage contractors to reduce the number of properties that
are in the inventory longer than 6 months.

Mr. Chairman, this concludes our statement. We would be pleased to respond
to any questions that you or Members of the Subcommittee may have.

For further information regarding this testimony, please contact Stanley J.
Czerwinski at (202) 512-7631. Individuals making key contributions to this
testimony included Jacqueline Garza, Stan Ritchick, Paul Schmidt, Stewart
Seman, Leigh Ward, and Steve Westley.

Figure 1: Unmaintained Washington, D.C., Property

Figure 4: Number of New Acquisitions Into the Inventory Compared With Sales
by Month Since the Implementation of Management and Marketing Contracts

Figure 5: Percentage of Properties by Length of Time in HUD's Inventory in
April 1999 Compared With Percentage in February 2000

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