Common Housing and Urban Development (HUD) Multi-Family Housing Findings
As a result of having a HUD-insured mortgage loan, there are rules and regulations that need to be followed to remain in compliance. When certain requirements are violated, the result can be a finding in the annual audit to be filed with Real Estate Assessment Center (REAC) within the Financial Subsystem Assessment (FASSUB).
No one likes dealing with the ramifications of a finding on the annual audit. To sum it up simply, findings equate to more work for everyone involved. As auditors, there are certain findings that we see more often than others. Eliminating the chances of future findings is the goal! Putting preventative measures in place is key to finding avoidance. Below we will outline five common HUD findings accompanied with solutions to help avoid them.
Common Finding #1: Unauthorized Distributions
The HUD regulatory agreement is what governs a property’s operations. Within the agreement it states that distributions are required to be made based on available surplus cash that is calculated at 06/30 and 12/31 each year, or at the property’s yearend and six months after yearend if a non-calendar yearend. Owners will want to ensure that management is properly calculating their surplus cash based on the specific details of their regulatory agreement. For additional information and a template on surplus cash calculations, please refer to our HUD For-Profit Surplus Cash Calculation Blog.
To avoid an unauthorized distribution finding, management should monitor surplus cash distributions closely and ensure they are using the proper calculation. Owners should wait to take distribution until after the audit is complete to ensure there is no overdistribution.
Common Finding #2: Unauthorized Loans
There are often unexpected repairs, purchases, or operating shortfalls that can arise causing a strain on a property’s finances. When extra funds are needed to help with operations, HUD does not permit properties to enter into additional debt agreements such as a bank loan, line of credit, or owner advances. HUD does this because they want available property funds going to pay off their insured mortgage instead of other debt.
To avoid an unauthorized loan finding, properties should not enter any contract or arrangement to borrow funds, or finance a purchase without appropriate approval from HUD. If funds are necessary, properties have the option seek approval from HUD to withdrawal funds from replacement reserves or residual receipts (if they are a Not-For-Profit property).
Common Finding #3: Failure to Make Replacement Reserve Deposits
HUD regulatory agreements require properties to maintain a replacement reserve in a separate account to save for any major structural repairs and mechanical replacements that may occur. This allows available funds for capital improvement or repairs during the course of the HUD insured mortgage. The regulatory agreement explains that properties will fund the replacement reserve account with monthly deposits at an amount that is determined by HUD. All disbursements from the replacement reserve account must be approved by HUD in advance.
To avoid this finding, management must make monthly deposits to the replacement reserve account at the exact amount determined by HUD. A helpful tip would be to double check that the replacement reserve deposit was made during the bank reconciliation process. As a rule of thumb, all disbursements from the replacement reserve account must be approved by HUD before funds are removed.
Common Finding #4: Underfunded Tenant Security Deposits
To protect tenant security deposits, HUD requires deposits from tenants to be kept in a separate bank account from other project funds. These funds are restricted and should not be borrowed or used for operating purposes. When a tenant leaves the property, these funds need to be available for reimbursement unless the tenant has past due rent, damages, or other charges. It is important to remember that the tenant security deposit account balance must be equal to or exceed the tenant security deposit liability at all times.
To avoid an underfunded tenant security deposit finding, the tenant security deposit bank account should be compared to the liability monthly. If you find that the bank account is underfunded, then management should deposit funds into the bank account so that the balance is equal to the security deposit liability. As a value add, many HUD properties typically overfund the tenant security bank account to avoid this potential finding.
Common Finding #5: REAC Inspection
REAC inspections are a HUD requirement to ensure the property is being well maintained and that there are no Health and Safety issues for tenants. HUD wants to avoid Health and Safety risks that could potentially harm a tenant. HUD insures property mortgages and has an inherent interest for the property’s physical condition, wanting it to be well maintained.
HUD performs a Real Estate Assessment Center (REAC) inspection of all HUD projects either annually, every two, or every three years based on the previous score. HUD gives a score with numbers and letters:
- The number determines when the next REAC inspection will occur. A score of 90 to 100 usually indicates REAC will return three years, a score of 80 to 89 usually indicates REAC will return in two years, and a score below 79 usually indicates that REAC will return next year.
- The letters indicate whether Health and Safety deficiencies were observed. The letter “a” is given if no Health and Safety deficiencies were observed, excluding smoke detectors. The letter “b” is given if one or more non-life-threatening Health and Safety deficiencies were observed. The letter “c” is given if one or more fire safety or Health and Safety deficiencies were observed which calls for immediate attention or remedy.
To avoid a REAC inspection finding, properties should be vigilant in their maintenance to keep things up to date and avoid receiving a Health and Safety violation (score with a “c”). Some violations might be unavoidable; however, all precautions should be taken to avoid them. As a value add, many management companies have maintenance staff from other properties walk through the current property for insights and suggestions to acquire an outside perspective.
While we gave you five common findings to keep an eye out for, there is one more piece of information we want you to have. Though not as common, owners may miss their required deadlines to file financial statements with HUD. A missed deadline occurs if financial statements are not filed 90 days after yearend. If this were to occur, HUD could fine the ownership group up to $27,500. We’ve seen owners affected in the past by this and believe it is important to have an auditing firm that specializes in HUD serving you. Firms that specialize in HUD will remain aware of important deadlines such as this one and ensure that you meet them.
Friendly Auditors here to serve!
If you have any questions about how to further prevent potential findings, or on how to navigate a particular finding, please contact us. We are always happy to serve and offer any assistance that would make your audit experience truly enjoyable!