Background

Established in 1993, HUD’s Discount Sales Program seeks to expand  affordable housing opportunities, help revitalize neighborhoods, and  reduce the agency’s inventory of single-family properties in a timely,  efficient, and cost-effective manner. Under the program, approved  nonprofit organizations receive a discount when purchasing HUD-owned  single-family properties and are required to rehabilitate and resell them to  low- or moderate-income homebuyers. As of August 2003, 423 nonprofits  were approved to participate in the program, down from more than 2,000  nonprofits 3 years earlier. HUD attributed the reduction to changes in the  program, such as stricter approval standards and increased reporting  requirements, and to the agency’s efforts to remove nonprofits that violate  program rules.
HUD acquires properties through foreclosures of homes with FHA-insured  mortgages. FHA provides federally backed mortgage insurance primarily to  low-income and first-time homebuyers who might otherwise have difficulty  obtaining a mortgage. In calendar year 2002, HUD acquired more than  67,000 properties through foreclosures and sold approximately 65,000  properties from its inventory. At the end of calendar year 2002, HUD had an  inventory of 32,018 single-family properties.
HUD sells the properties in its inventory in as-is condition through a  number of different programs. Table 1 shows the primary programs HUD  uses to sell properties and the number of properties sold under each during  calendar year 2002. Most HUD-owned properties are eligible for price  reductions under the Discount Sales Program. The program accounted for  approximately 2 percent of HUD’s overall property sales in calendar year  2002.
HUD offers discounts of 10, 15, and 30 percent to nonprofit organizations.  The size of the discount depends on several factors: whether a property in  as-is condition is eligible for FHA insurance, whether it is located in a  revitalization area, and whether it is sold individually or in a package of  five or more homes. HUD inspects and appraises all foreclosed properties  to determine whether they are again eligible for FHA mortgage insurance.  FHA will insure mortgages only on properties that meet HUD’s minimum  property standards and local building codes or that need less than $5,000 in  repairs in order to meet these standards. Properties needing more than  $5,000 in repairs are considered uninsurable. For purposes of the Discount  Sales Program, HUD then differentiates properties by location. All  insurable properties receive a 10 or 15 percent discount whether or not  they are located in a revitalization zone. The 15 percent discount is only  applied if the property is part of a group of five or more properties  purchased in a single transaction. Uninsurable properties lying outside  revitalization areas also receive these discounts, but those located within  revitalization areas are eligible for the steepest discount—30 percent.
Under the Discount Sales Program, HUD has two methods of selling  properties to nonprofits: competitive bidding and noncompetitive sales.  Both methods allow discounts for nonprofits. Under the competitive  process, HUD establishes a list price for the properties but will accept bids  that are lower. HUD posts the properties, with their list prices, on the  Internet in its general listings and accepts bids from prospective owner- occupants and nonprofits, but not investors, for a priority period of 10 to 30  days, depending on the geographic area. HUD awards the property to the  owner-occupant or nonprofit with the highest bid. If the highest bidder is a  nonprofit, HUD grants a 10 or 15 percent discount off the bid price when it  closes on the home. For properties that fail to sell during this priority  period, HUD then accepts bids from the general public, including investors.
The noncompetitive sales method applies only to uninsurable properties.  HUD lists these properties separately from its general listings and makes  them available to nonprofits through a HUD contractor’s Web site.  Nonprofits have a priority period of 5 days to express interest in the  properties at HUD’s list price. If more than one nonprofit expresses interest  in a property, HUD selects the buyer by lottery. As with competitive sales,  the discount is applied at closing. Properties that are not sold  noncompetitively are placed in HUD’s general listings and made available  for sale on a competitive basis.
Nonprofits that purchase properties under the Discount Sales Program are  responsible for rehabilitating them as needed to meet HUD’s minimum  property standards and local building codes. Nonprofits are required to  limit their resale price to no more than 110 percent of their “net  development cost,” or the sum of their allowable costs for acquiring,  rehabilitating, and reselling the properties. Nonprofits must also sell the  homes to buyers whose incomes do not exceed 115 percent of their area’s  median income, adjusted for family size.
HUD’s four HOCs administer the Discount Sales Program and oversee the  participating nonprofits. The HOCs process nonprofits’ applications to  participate in the program and monitor nonprofits for compliance once  they begin purchasing, rehabilitating, and reselling homes. To help monitor  the program, HUD requires nonprofits to submit annual reports to the  appropriate HOC by February 1 of each year. The reports must provide  information on properties the nonprofits have bought, rehabilitated, and  resold, including repair costs, prices to homebuyers, and homebuyers’  incomes. HOC staff also conduct on-site visits to nonprofits and properties  to review files and inspect repairs, among other things. When a nonprofit  fails to follow the program’s requirements, HOCs may remove the nonprofit  from the program.
In recent years, HUD has changed some of its program requirements to  increase its oversight of nonprofits. For example, in 2000 HUD issued  guidance establishing uniform standards for nonprofits applying to  participate in the program. The guidance outlines specific information  nonprofits must submit in applying for the program, mandates that  nonprofits recertify with HUD every 2 years, and requires that nonprofits  answer detailed questions about their ability to carry out affordable  housing programs.
To address concerns raised in the HUD Inspector General’s 2001 report on  the program, HUD issued additional guidance in December 2001 designed  to strengthen the program’s reporting and accountability requirements.  Until this guidance was issued, nonprofits needed to meet HUD’s annual  reporting and net development cost requirements only for properties  purchased at a 30 percent discount. The guidance expanded annual  reporting and resale price requirements to all properties, regardless of  discount level, and clarified HUD’s net development cost calculation by  providing a detailed list of allowable and unallowable costs.
Also in response to the Inspector General’s report, HUD issued guidance in  January 2002 designed to tighten eligibility requirements for nonprofits.  Among other things, the guidance described circumstances that could  create a conflict of interest between nonprofits and their business partners.  In addition, it required that nonprofits be incorporated as 501(c)(3)  organizations for at least 2 years and have a minimum of 2 consecutive  years of affordable housing experience within the last 5 years. Finally, to  accommodate HUD’s on-site reviews, the guidance required nonprofits to  maintain property records in a specified format.
HUD did not implement all of the Inspector General’s recommendations.  Specifically, the Inspector General’s report recommended that HUD  suspend the program and evaluate it to determine whether the program  was viable or should be discontinued. HUD Office of Housing officials told  us they developed a proposal for a contractor study of the program but that  the proposal was never funded. HUD officials said they did not suspend the  program because they felt the improvements made following the Inspector  General’s review would prevent further problems.

	In 2002, the Discount Sales Program Cost HUD at Least $18.8 Million

We estimate that the Discount Sales Program cost HUD between $18.8 and  $23.9 million in calendar year 2002. Most of this cost, between $15.1 and  $20.2 million, was a reduction in net revenue resulting from HUD’s selling  properties through the program rather than through its regular sales  process. Personnel expenses for administering the program accounted for  the remaining $3.7 million of HUD’s cost.

		The Discount Sales Program Reduced HUD’s Net Revenue

The net revenue HUD receives from each property it sells is less than the  property’s selling price because HUD incurs certain holding and selling  costs.  Some of these costs are common to both discounted and regular  HUD property sales, while others are not. For example, on a regular sale,  HUD pays the homebuyer’s closing and financing costs and the sales  commission of the successful selling broker, within certain guidelines.  HUD does not pay either of these costs for properties sold through the  Discount Sales Program. HUD does not require a selling broker for the  properties nonprofits purchase through the program; consequently, there is  generally no selling broker’s commission for these transactions. HUD  incurs other types of costs for all properties whether or not they are part of  the program. These costs include (1) the fees and reimbursable expenses it  pays to management and marketing contractors responsible for inspecting,  appraising, securing, maintaining, and selling HUD-owned properties; (2)  sales incentives in the form of cash allowances that HUD periodically  offers to homebuyers—including nonprofits—that close relatively quickly  on executed sales contracts; (3) the listing broker’s fee; and (4) the  property taxes for the period when HUD owned the home.
To determine the impact of the Discount Sales Program on HUD’s net  revenues (i.e., the selling price minus holding and selling costs) we  compared the estimated net revenues HUD received for the discounted  properties with the estimated net revenues HUD would have received if it  had sold the properties through its regular sales process. Using data from  HUD’s SAMS and the U.S. Census Bureau, we made this determination for 1,194 properties that HUD sold through the program in calendar year  2002. We used a statistical model that included data for these properties  and approximately 4,000 properties HUD sold through its regular process  during the same year. We found that by selling the 1,194 properties  through the Discount Sales Program instead of its regular sales process,  HUD reduced the net revenue it received in calendar year 2002.  Specifically, we estimate that the total reduction in HUD’s net revenue was  between $15.1 and $20.2 million, an average of between $12,672 and  $16,945 per property. (See app. II for a detailed discussion of our statistical  analysis.)  Without the program, and with all other things remaining equal,  cash flows into HUD’s insurance fund would have increased by that  amount.
As shown in table 2, the overall and average reductions in net revenue  varied according to the discount level. The properties sold with 10 percent  discounts accounted for about two-thirds of the homes that HUD sold  through the program in calendar year 2002, but for less than half the total  estimated reduction in net revenue. In contrast, the properties sold with 30  percent discounts represented less than one-third of the total properties  sold but more than 40 percent of the overall reduction in net revenue.  Finally, the properties with 15 percent discounts accounted for about 9  percent of the total properties and between 7 and 10 percent of the overall  reduction in HUD’s net revenue.
According to HUD officials, the agency’s database somewhat overstates the  number of properties sold with a 10 percent discount (the most common  type) and somewhat understates the number sold with a 15 percent  discount (the least common type). The officials said this overstatement  occurs because HUD does not always update its database to reflect the fact  that a property, indicated in the database as being sold with a 10 percent  discount, may actually have been sold at a 15 percent discount if it was part  of a group of five or more properties bought in a single transaction. As a  result, our analysis may overestimate the reduction in net revenue for  properties discounted by 10 percent and underestimate it for those  discounted by 15 percent.
As shown in table 3, the overall and average reductions in net revenues also  varied by HOC. A major reason for this variance was differences among the  centers in the proportion of their properties sold with 30 percent discounts.  Because 30 percent discount properties cost HUD more in net revenue than  properties at the other discount levels, the HOC with the highest  proportion of 30 percent properties—Santa Ana—had the greatest  reduction in net revenue. The HOC with the lowest proportion—Denver— had the smallest reduction in net revenue.
HUD officials told us they were aware that the program reduced the  agency’s net revenue from property sales. However, HUD has not evaluated  whether the program is reducing HUD’s property inventory in a timely,  efficient, and cost-effective manner, as intended.

		HUD Incurred Administrative Costs Operating the Discount Sales Program

To determine the impact of the Discount Sales Program on HUD’s  administrative costs in calendar year 2002, we compared the administrative  costs HUD incurred under the program to what HUD would have incurred  had the discounted properties been sold through HUD’s regular process.  According to HUD, in administering the Discount Sales Program, HOC staff  perform tasks that are not part of HUD’s regular home-selling process. For  example, for the Discount Sales Program, center staff approve and recertify  participating nonprofit organizations and monitor the nonprofits’  compliance with program requirements—tasks they do not perform for the  regular sales process. As a result, HUD’s administrative cost per property is  lower for its regular sales process than it is for the Discount Sales Program.  HUD officials told us that for this reason and the small volume of  properties sold through the Discount Sales Program, selling the discounted  properties through HUD’s regular process would have had no measurable  effect on the administrative costs for the regular sales process.
The bulk of HUD’s administrative costs for the Discount Sales Program are  the salaries and benefits of staff who work on the program. According to  HUD officials, most of these staff split their time among several programs,  but HUD’s time and attendance system does not record the time they spend  on each one. Therefore, we relied on estimates from HUD to determine  how many staff years were spent on the program in calendar year 2002 and  the associated costs. Although HUD incurred other types of costs to  administer the program, such as mailing costs and travel expenses for  visiting nonprofit offices, these were minor compared with the personnel  costs and were not included in HUD’s estimate.
HUD estimates that its personnel costs for the Discount Sales Program  were approximately $3.7 million in calendar year 2002. (See table 4.)  HUD’s estimate was based on information provided by its HOCs and Office  of Housing, which showed that their staffs devoted a total of 45 staff years  to the program. The number of staff years and the associated cost varied  across offices, however. Among the HOCs, the Atlanta center had the most  staff years and highest personnel costs and the Denver center the fewest  staff years and lowest personnel costs. HUD’s Office of Housing devoted  the equivalent of about one staff year to the program. HUD headquarters  and HOC officials told us that in the absence of the Discount Sales  Program, these staff years would have been dedicated to administering  other HUD programs, so that HUD would have incurred the personnel  costs with or without the program.

	The Discount Sales Program Is Not Likely to Benefit Most Homebuyers Financially but Can Help Them Access Homeownership Services and Assistance

Our analysis of 238 properties sold under the Discount Sales Program in  calendar year 2002 indicates it is likely that most homebuyers did not  benefit financially from the program. Specifically, assuming that nonprofits  and homebuyers had the same rehab costs, we estimate that 76 percent of  the homebuyers would have spent less if they had purchased the properties  through HUD’s regular sales process and paid for the rehab work  themselves. In part, the lack of financial benefit to homebuyers is  attributable to the program’s rules, which authorize nonprofits to pass on  costs that homebuyers would likely not incur using the regular sales  process. Despite the program’s limited financial benefits, it may help  homebuyers access a range of services and assistance—such as  homeownership counseling, down payment assistance, and home  maintenance courses—that are beneficial but also available from other  sources. The program may also help improve neighborhood conditions by  rehabbing and putting back on the market homes that might otherwise  remain vacant or in disrepair.

		The Financial Benefit of the Program to Most Homebuyers is Doubtful

To determine the extent to which homebuyers benefited financially from  purchasing a rehabilitated home through the Discount Sales Program, we  performed a statistical analysis comparing what the homebuyers actually  paid for these homes with our estimate of what they would have spent had  they purchased the homes under HUD’s regular process and paid for the  rehab work themselves. Our analysis assumed that in the absence of the  Discount Sales Program, a homebuyer would be able to (1) purchase the  same home and rehabilitate it to the same extent as the nonprofit and (2)  incur the same rehab costs as the nonprofit. We also assumed that the  homebuyer would inhabit the home during the rehabilitation and therefore  would not incur housing expenses for two residences during that period.  We performed this analysis on 238 properties that nonprofits purchased  and resold between February 1 and December 31, 2002.  These properties  were the only ones for which HUD could provide the rehab costs and  selling prices to homebuyers at the time of our review. (See app. II for a  detailed discussion of our statistical analysis.)
Assuming equal rehab costs for nonprofits and homebuyers, we estimate  that 182 of the 238 homebuyers, or 76 percent, did not benefit financially by  purchasing a rehabbed property from a nonprofit that bought the property  through the Discount Sales Program. That is, the buyers would have spent  less had they purchased the property through HUD’s regular sales process  and paid for the rehab work themselves. Under the assumptions of our  analysis, we estimate that these purchasers spent an average of $9,200  more buying the house through the program than they would have spent  otherwise. Our analysis indicated that the other 24 percent of the  homebuyers benefited financially from the program, because purchasing  the homes through HUD’s regular sales process and rehabbing them would  have been more expensive. We estimate that these homebuyers saved  $9,200, on average, by purchasing through the Discount Sales Program.  Because nonprofits may, in some circumstances, be able to rehab a home  more cheaply than an individual homebuyer, we also performed the  analysis assuming that a homebuyer would pay 25 percent more than a  nonprofit for the same rehab work. Even under that assumption, we  estimate that 59 percent of the homebuyers would not have benefited  financially from the program. More specifically, we estimate these  purchasers spent an average of $8,000 more buying the house through the  program than they would have spent otherwise. We estimate that the  remaining 41 percent of homebuyers saved $10,100, on average, by  purchasing a home through the program.
Our estimates of the extent to which homebuyers did or did not benefit  varied according to the discount level of the property purchased. Assuming  equal rehab costs for nonprofits and homebuyers, we estimate that 79  percent of the homebuyers purchasing houses that had been discounted 10  percent saw no financial benefit. For the properties with 15 percent  discounts, we estimate that more than 90 percent did not benefit. However,  for the properties with 30 percent discounts, we estimate that one-half of  the homebuyers saw some financial benefit. (See table 5.)
One reason homebuyers did not benefit financially, according to our  analysis, was that nonprofits sometimes resold the properties for more  than the program allowed.  This finding was especially strong for  purchases in the 15 and 30 percent discount categories. Had the nonprofits  not overcharged the homebuyers in these cases, we estimate that more  than one-third of the homebuyers who bought properties with a 15 percent  discount and more than three-quarters of those who bought properties with  a 30 percent discount would have benefited financially.
Our analysis did not take into account certain factors that are difficult to  quantify but may make the program either more or less beneficial from a  homebuyer’s perspective. For example, some homebuyers may be willing  to incur significant costs to avoid the time, difficulty, and inconvenience  involved in selecting materials, obtaining and evaluating contractor bids,  residing in a property undergoing rehab work, and possibly obtaining a  separate loan to finance the rehab work.  Conversely, some homebuyers  may not view these tasks as major obstacles and may see significant  benefits to controlling the rehab process themselves, such as the ability to  select the materials used and the ability to oversee the rehab work as it  progresses.

		The Discount Sales Program’s Rules Reduce the Likelihood That Buyers Will Benefit Financially

Some of the Discount Sales Program’s rules make it unlikely that  purchasing a property from a nonprofit that purchased the property from  HUD at a 10 or 15 percent discount will benefit homebuyers more than  purchasing the same property from HUD through the regular sales process.  For example, HUD allows nonprofits to resell discounted properties for up  to 110 percent of the “net development cost,” or the cost of buying the  property plus allowable rehab, holding, and selling costs. The 10 percent  markup helps nonprofits to cover the overhead expenses they incur by  participating in the program. However, taking a 10 percent markup on a  property purchased at a 10 or 15 percent discount effectively cancels out all  or most of the discount. As a result, the price of the home to the eventual  homebuyer reflects little, if any, of HUD’s discount to the nonprofit.
Furthermore, program rules authorize nonprofits to include in their  calculations of net development cost certain “allowable” financing and  closing costs they incur in buying discounted HUD properties. As a result, a  homebuyer who purchases a property from a nonprofit pays not only his or  her own financing and closing costs but—through the sales price—the  nonprofit’s as well. In contrast, when a homebuyer purchases a property  using HUD’s regular sales process, HUD pays allowable financing and  closing costs on the buyer’s behalf. Also, a nonprofit’s net development cost  may include the principal and interest payments for the mortgage on the  property while the property is being renovated for up to 6 months. Raising  the nonprofit’s net development cost effectively raises the price for the  eventual homebuyer, who could have avoided some of these expenses by  purchasing the house directly from HUD and, if possible, inhabiting it  during the renovation.

		The Discount Sales Program May Help Homebuyers Access Certain Services and Assistance and Improve Neighborhood Conditions

According to HUD and nonprofit officials, many of the families who  purchase properties through the program are first-time homebuyers.  Accordingly, HUD strongly encourages nonprofits to provide  homeownership counseling services and requires participants to submit  “affordable housing plans” detailing, among other things, the services and  assistance that low- and moderate-income homebuyers using the program  can expect to receive. During our visits to HUD’s homeownership centers,  we reviewed the affordable housing plans for a judgmental sample of 17  nonprofits. The plans showed that the nonprofits offered a wide range of  services and assistance to homebuyers, either directly or through referrals  to other agencies. The services included mortgage credit counseling,  “hotlines” homebuyers could call with questions, and courses on budgeting  and home maintenance. Some nonprofits also offered assistance with  down payments and closing costs. HOC staff told us that these services and  assistance were typical of those provided by most participating nonprofits.
Both HUD and nonprofit officials told us they believed that providing such  services to new homebuyers facilitated homeownership among low-income  families that might otherwise have a hard time purchasing a home. These  officials also said that the services helped minimize the likelihood of  default by preparing families for the responsibilities of homeownership.  However, we found that similar services were widely available outside the  Discount Sales Program. For example, HUD itself provides financial  support to hundreds of housing counseling agencies across the country.  Any prospective homebuyer can access these services at no cost.
According to HUD, the Discount Sales Program also generates benefits and  serves policy objectives, such as neighborhood revitalization and stability,  that extend beyond the individual households that purchase properties.  Some HUD and nonprofit officials told us they believe that the Discount  Sales Program may help to improve neighborhood conditions by  supporting the rehabilitation and sale of properties that would otherwise  be vacant and in disrepair, reducing surrounding property values, and  becoming magnets for vandalism and trespassing. For example, one  nonprofit official told us that by purchasing and rehabbing multiple  properties over a period of several years, the organization had not only  improved the housing stock of one community but also helped create an  environment that encouraged economic development and social service  opportunities nearby. HUD officials also told us that many prospective  owner-occupants are not willing to purchase homes requiring significant  rehab work because of the difficulty and risks of undertaking a rehab  project. They said that even if owner-occupants were to purchase these  properties, they might do less rehab work than a nonprofit would or not  rehab them at all. Finally, HUD believes that by promoting homeownership  and property rehabilitation, the program has stabilizing effects on  neighborhoods and contributes to property values—factors that reduce the  risk of foreclosure and losses to FHA’s insurance fund. Although expansion  of homeownership opportunities and neighborhood revitalization are  objectives and potential benefits of the program, HUD has not studied the  extent to which the program is serving these ends.

	Limited Monitoring Efforts Have Uncovered Numerous Violations, but Effective Enforcement Has Been Difficult

The HOCs use two monitoring tools to assess nonprofits’ compliance with  program requirements:  desk reviews of annual reports and on-site  evaluations. However, the HOCs had trouble conducting desk reviews  because many program participants turned their reports in late or not at all,  and many reports were incomplete. In addition, the HOCs’ use of on-site  reviews was uneven, with two centers conducting them routinely and the  other two doing few or none. Even with these problems, the HOCs’  monitoring efforts uncovered numerous violations of program rules, such  as making excess profits by reselling discounted properties for more than  the program allowed. The HOCs have removed many nonprofits for  noncompliance but lack an effective mechanism for enforcing  requirements concerning excess profits.

		Effectiveness of Desk Reviews is Hampered by Missing or Incomplete Information

Nonprofits participating in the Discount Sales Program are required to  submit annual reports to the HOCs each February 1 that provide  information on the properties purchased under the program the previous  calendar year. The required information includes the status of the  property (i.e., whether it has been rehabbed and resold), the rehab costs,  and the selling price to the homebuyer. Nonprofits must also provide  documentation, such as settlement statements, giving detailed financial  information on the purchase and resale of the properties.
Desk reviews of these reports are HUD’s primary method of determining  whether nonprofits comply with key program requirements, such as those  restricting the resale prices of rehabilitated homes and the purchasers’  income levels. However, the effectiveness of desk reviews as a monitoring  tool has been limited because many nonprofits have not submitted annual  reports on time, and others have provided incomplete information.  Specifically, as of July 2003—more than 5 months after the annual reports  were due—HUD lacked reports from nonprofits accounting for more than  half of the 626 properties it estimates were bought, rehabbed, and resold in  calendar year 2002. The HOCs had reports for properties resold to  homebuyers from only 44 of the 166 nonprofits that purchased discounted  properties in calendar year 2002. Other nonprofits submitted reports that  lacked all of the data the HOCs needed to assess the participants’  compliance with program requirements. For example, as of April 2003,  more than half of the annual reports received at the Denver HOC did not  contain the information necessary to determine the nonprofits’ net  development costs for the properties. As a result, staff could not determine  whether the nonprofits had sold their properties at prices that were within  program limits. Similarly, more than one-third of the reports received by  the Atlanta HOC as of July 2003 did not contain the required certification of  the homebuyers’ income levels. Without this information, the HOC had no  assurance that the properties were sold to homebuyers with low and  moderate incomes, as required.
According to HOC officials, efforts to collect missing data and resolve  other reporting issues can take months. For example, staff at the Atlanta  HOC told us that they spent large amounts of time calling and writing  nonprofits to gather the information missing from the annual reports.  Although three of the HOCs—Atlanta, Denver, and Santa Ana---had  originally planned to complete their desk reviews by the end of April 2003,  these reviews were still under way in mid-July 2003. At that time, the  remaining HOC—Philadelphia—had completed reviews of just 16 percent  of its properties.
The reporting problems occurred despite the HOCs’ efforts to remind  nonprofits of the reporting requirements and to provide training on the  program rules. For example, all four HOCs sent reminder letters to  nonprofits several weeks before the annual reports were due. In addition,  HOC officials told us they provided either one-on-one or group training to  nonprofits on submitting annual reports and meeting other program  requirements. HOC officials speculated that a major reason for the  reporting problems was that many nonprofits lacked adequate  administrative capacity. However, they also said that carrying out in-depth  assessments of administrative capacity as part of the initial approval  process would require a costly on-site evaluation of every applicant.
In October 2003, HOC officials told us that as a result of their follow-up  efforts, they had made significant progress in obtaining annual reports  from nonprofits that had not reported earlier in the year. However, during  the long time it takes the HOCs to obtain and review annual reports,  nonprofits may continue to purchase more homes and violate program  rules. In addition, according to HOC officials, many nonprofits that had  failed to report had either withdrawn or been removed from the program,  leaving little incentive to report. Consequently, it is unlikely that HUD will  ever know whether these nonprofits followed program requirements in  rehabbing and reselling discounted properties.

		The Number of On-Site Reviews Varied Across Homeownership Centers

HUD’s guidelines not only require that nonprofits allow on-site reviews of  their operations as a condition of program participation but also outline the  types of records participants must maintain and make available for HUD’s  on-site review. On-site reviews generally allow for a more in-depth  assessment of a nonprofit’s program activities than desk reviews. For  example, on-site reviews may include examining invoices and cancelled  checks to determine the validity of claimed rehab costs. They may also  involve inspection of rehabbed homes and interviews with homeowners.
We found that only two of the four HOCs—Atlanta and Denver—routinely  used on-site reviews as a monitoring tool in calendar year 2002. Atlanta  HOC officials told us that they tried to review each of their medium- and  high-risk nonprofits at least once every 2 years. Consistent with this  policy, the center performed 22 on-site reviews in calendar year 2002,  covering about half of the nonprofits that had purchased discounted homes  that year. The Atlanta HOC had trained staff stationed throughout the  center’s geographic jurisdiction to perform the on-site reviews and also  employed two specialists with backgrounds in home construction. The  Denver HOC performed on-site reviews of 10 of the 23 nonprofits it sold  properties to in calendar year 2002. Officials there said that they targeted  nonprofits using desk reviews, homebuyers’ complaints, and applications  to the program. The reviews were performed by staff working out of the  HOC, with assistance from other HUD staff stationed near the nonprofits.
In contrast to the Atlanta and Denver centers, the other two HOCs— Philadelphia and Santa Ana—used on-site reviews rarely or not at all. The  Philadelphia HOC, which sold properties to 48 nonprofits in calendar year  2002, conducted just two on-site reviews during that year, citing a shortage  of staff as the primary reason. Center officials told us that they plan to use a  contractor to conduct on-site reviews of nonprofits with known  performance problems and that the contractor will be required to have  construction specialists assist in these reviews. The Santa Ana HOC, which  sold properties to 52 nonprofits in calendar year 2002, did not perform any  on-site reviews.  Santa Ana HOC officials told us that the center’s large  geographic jurisdiction made it impractical for them to travel to nonprofits’  offices. To compensate for the lack of on-site reviews, the Santa Ana center  uses an in-depth version of the desk review, requiring nonprofits to submit  large amounts of supporting documentation, including invoices, with their  annual reports. A Santa Ana official said that this is the same  documentation that HOC staff examine during on-site reviews but  acknowledged that desk reviews do not include property inspections.

		Despite Monitoring Limitations, HOCs Uncovered Numerous Program Violations

The HOCs identified violations of program requirements during both desk  and on-site reviews. Primary among these were violations of the ceiling for  resale prices:  110 percent of the net development cost. The desk reviews  the HOCs had conducted as of July 2003 showed that nonprofits often did  not comply with the resale restriction. This problem occurred despite the  fact that in December 2001 HUD had issued guidance to nonprofits  clarifying net development costs and providing detailed instructions for  calculating them.
As shown in figure 1, 28 of the 44 nonprofits that had submitted annual  reports as of July 2003 overcharged homebuyers for one or more  properties. These violations occurred on about 124 (47 percent) of the 265  properties covered by the annual reports and resulted in homebuyers being  overcharged an estimated total of $704,720. The amount of the estimated  overcharges varied significantly from property to property, ranging from  under $10 to more than $40,000. For example, one nonprofit closed on a  discounted home in New York for $117,600 in October 2002 and spent  about $41,000 to rehab the property. The nonprofit subsequently resold the  property for $234,000, or $43,333 more than the program allowed.  Assuming the homebuyer had secured a 30-year loan at 6 percent interest  (the prevailing rate at the time the homebuyer made the purchase), the  overcharge increased the homebuyer’s annual mortgage payments by more  than $3,100.
The HOCs’ desk reviews also identified three cases in which nonprofits  violated program requirements by reselling discounted properties to  homebuyers whose incomes exceeded 115 percent of the area median  income. For example, the Denver HOC found that one of its nonprofits sold  a Texas home to a buyer whose income was 141 percent of the area median  income, adjusted for family size.
The HOCs’ on-site reviews also revealed instances of serious  noncompliance, underscoring the importance of these reviews as a  monitoring tool. Among these violations were a lack of auditable records,  unallowable rehabilitation costs, and conflicts of interest between  nonprofits and their rehabilitation contractors. For example, one review  disclosed that the nonprofit had made bulk purchases of the materials it  needed to rehabilitate discounted properties but, contrary to program  requirements, did not maintain records showing the costs of these  purchases or the materials that were used for each home. As a result, the  reviewers could not verify the net development cost for any of these  properties. In another on-site review, the Atlanta staff found that the  nonprofit was not in control of the day-to-day operations of its discount  property purchases. Instead, the nonprofit allowed its affiliated contractors  and realtors to control the buying, rehabbing, and selling of the properties  acquired through the Discount Sales Program and to share in the profits  from the sale.

		HOCs Have Removed Violators from the Program but Lack Effective Means to Enforce Requirements on Excess Profits

To hold nonprofits accountable for program violations, the HOCs may use  two main enforcement tools:  (1) removing participants from the program  and (2) requiring them to use excess profits to pay down overcharged  homebuyers’ mortgages. The HOCs have often exercised their authority to  remove nonprofits but lack an effective mechanism for enforcing  requirements concerning excess profits. As a result, some nonprofits that  did not comply with program requirements have retained excess profits,  and homebuyers who were overcharged have not received financial  restitution.

			HOCs Frequently Removed Nonprofits from the Program, but the Process Has Limitations

HUD issued regulations in June 2002 authorizing the agency to remove a  nonprofit from its roster of approved organizations for any cause HUD  judged to be detrimental to the agency or to any of its programs.  These  causes include failure to comply with HUD guidance and instructions and  failure to respond within a reasonable time to HUD inquiries, including  requests for documentation. In recent years, the HOCs frequently used  removal to hold nonprofits in the Discount Sales Program responsible for a  variety of compliance problems. In calendar year 2002, for example, the  Santa Ana HOC removed 31 nonprofits from the program, mostly for failure  to submit annual reports, conflicts of interest, selling homes for more than  program limits or to families that were not low- or moderate-income, and  lack of administrative or financial capacity. In calendar year 2003, all four  HOCs removed nonprofits that had failed to file annual reports or  committed other program violations. For example, as of October 2003, the  Atlanta HOC had removed 18 nonprofits from the program—more than  one-third of the nonprofits that had purchased discounted properties in  calendar year 2002. The other three HOCs removed a total of 63 nonprofits  that had purchased properties that year.
Despite its importance as an enforcement tool, HOC officials told us that  removing nonprofits from the program had significant limitations. First, the  process can take months to complete, allowing nonprofits to continue  purchasing properties and possibly to commit additional violations. HOC  staff must carefully document their justification for the action and must  follow due process procedures that can be lengthy, particularly if a  nonprofit appeals the removal decision. HOC officials said that once they  decide to remove a nonprofit, they often restrict the number of properties it  may purchase in an effort to reduce the potential for further  noncompliance during the due process period. Second, once a nonprofit is  removed, it has little incentive to report to HUD on the discounted  properties it resold or to surrender any of the excess profits it may have  earned. As a result, the centers may never learn whether these properties  were resold at reasonable prices to low- or moderate-income homebuyers,  and the homebuyers who were overcharged for their properties do not  receive any financial restitution.

			HOCs Had Limited Success Recovering Excess Profits

In December 2001, HUD issued instructions requiring nonprofits to sign an  addendum to every sales contract that limited the resale price of  discounted homes to 110 percent of the net development cost. The  instructions also mandated that nonprofits use the excess profits they earn  by exceeding the 110 percent limit to pay down the mortgages of the  homebuyers they overcharged.
The four HOCs have attempted to implement this requirement by  requesting mortgage “pay downs” from nonprofits that are making excess  profits. However, Philadelphia HOC officials and attorneys from HUD’s  Office of General Counsel also told us that the agency’s authority to enforce  the requirement was not specified in regulation and was therefore in  question. Furthermore, the attorneys said that as a practical matter the  requirement would be difficult to enforce, as HUD would have to refer  nonprofits that refused to comply to the Department of Justice for legal  action. The officials said they doubted whether Justice would accept these  cases because the amounts of money involved are generally relatively  small—often less than $10,000—and it would be cost-prohibitive for  Justice’s attorneys to pursue them. HUD officials added that obtaining  enough documentation to build a convincing legal case was difficult,  because many nonprofits do not keep proper financial records that  adequately document the amount of excess profits earned.
As a result of these problems, the HOCs had limited success getting  nonprofits to use excess profits to pay down homebuyers’ mortgages.  According to HOC officials, the nonprofits that have paid down mortgages  did so voluntarily because they wanted to stay in the program. As of July  2003, the HOCs’ desk reviews had identified 28 nonprofits that made an  estimated total of $704,720 in excess profits. At that time, seven of the  nonprofits had made combined mortgage pay downs of $62,002, or only  about 9 percent of the total estimated excess profits. (See table 6.)
HOC officials told us that although some of the remaining 21 nonprofits had  withdrawn or were removed from the Discount Sales Program, others were  still being evaluated by HOC staff and were continuing to purchase  discounted properties. Moreover, these nonprofits retained all of the  excess profits they had made. For example, one nonprofit still under  review as of October 2003 made an estimated $28,700 in excess profits on  five discounted properties that it resold in 2002. The nonprofit did not pay  down any mortgages, purchased 27 additional properties in 2003, and is still  in the program. HUD’s inability to enforce its requirements on excess  profits in a vigorous and timely manner not only deprives homebuyers that  have been overcharged but also puts the financial interests of other  prospective homebuyers at risk.

	Conclusions

HUD’s Discount Sales Program is intended, among other things, to help  make homes affordable for low- and moderate-income homebuyers.  However, deficiencies in the program’s design and implementation have  undermined its ability to serve this end. Our analysis suggests that the  program is of questionable benefit to most homebuyers. In addition, the  HOCs’ monitoring and enforcement efforts do not adequately ensure that  nonprofits are complying with requirements designed to protect  homebuyers’ financial interests. And despite the program’s significant cost,  HUD has not determined whether the program is meeting its objectives of  expanding affordable housing opportunities, helping to revitalize  neighborhoods, and reducing HUD’s property inventory in a timely,  efficient, and cost-effective manner.
Measures to address the cost, benefit, and compliance issues raised in this  report are likely to be expensive or have adverse effects. For example, to  reduce the cost of the program, HUD could reduce the size of its discounts,  dedicate fewer staff resources to the program, or both. However, these  actions would likely reduce the program’s financial benefit to homebuyers  and weaken HUD’s ability to oversee participating nonprofits. Conversely,  to increase financial benefits to homebuyers, HUD could increase the size  of its discounts, but doing so would effectively raise the cost of the  program.
Taken together, the program’s problems and the lack of clear solutions  raise serious questions about whether HUD should continue to operate it.  We recognize that contemplating the termination of the program involves  trade-offs. In the absence of the program, it is possible that some  individuals and families would have difficulty purchasing suitable homes  and that neighborhood conditions would suffer if HUD-owned properties  were not rehabilitated or sold as quickly. However, unless significant  changes are made to the program, it will likely continue to experience the  problems raised in this report and by HUD’s Inspector General.

	Recommendations for Executive Action

GAO recommends that the Secretary of HUD take the following two  actions:    Evaluate options to improve the program’s benefit to homebuyers, the  agency’s monitoring of nonprofits, and enforcement of excess profits  requirements.
Assess the extent to which the program is meeting its objectives.
If the Secretary determines that the current cost of the program plus the  resources needed to improve it exceed the program’s benefits, GAO  recommends that the program be terminated.

	Agency Comments and Our Evaluation

We provided HUD with a draft of this report for review and comment. In a  letter from the Assistant Secretary for Housing (see app. I), HUD agreed  with our recommendations to further assess the program and said it would  proceed accordingly. Also, HUD disagreed with some aspects of our  methodology and said that our analysis overstated the program’s costs and  understated its benefits. Lastly, HUD said that the report should  acknowledge the significance of the multiple public policy objectives the  program serves. However, HUD did not respond to our third  recommendation concerning the possible termination of the program if,  after further evaluation, HUD determines that the program’s current costs  plus the resources needed to improve it exceed its benefits.
More specifically, HUD stated that any conclusions about program costs  should be based on actual program performance rather than on  “hypothetical extrapolations.”  We designed our analysis to estimate the  effect of the Discount Sales Program while holding constant the effect of  other factors, such as neighborhood and property characteristics, that  might also influence the ratio of the net revenue HUD receives from selling  a property to the property’s appraised value. To implement this approach,  we developed a statistical model using data from actual HUD property  sales and compared (1) the net revenue our model estimated HUD would  have received for each discounted property had the property been sold  through the regular process with (2) the net revenue our model estimated  HUD would have received by selling the property through the Discount  Sales Program. Each estimated value contained an error term that captured  the effects of omitted variables unavailable for the modeling process. As  appendix II of our draft report explained, comparing two estimated values  removed the influence of the omitted variables from our comparison,  leaving the effect of the program on HUD’s net revenue. HUD said that its  own preliminary comparison of net revenues from program and  nonprogram property sales had shown that the loss in net revenue from the  program was substantially less than our estimate indicated, and that our  report significantly overstated the program’s cost. Because HUD did not  provide us details of its analysis, we cannot determine why HUD’s results  differed from ours. We continue to believe that isolating the effect of the  program from other influences, rather than making comparisons that do  not control for these factors, is the most appropriate way to estimate the  impact of the Discount Sales Program on HUD’s net revenue.
HUD also said that our conclusion that most homebuyers did not benefit  financially from the program rested on the assumption that individual  homebuyers would have access to rehab financing on terms as favorable as  nonprofits and would have the skills to oversee the construction. HUD  disagreed with this assumption and said it believes that nonprofits have  both the ability to obtain financing that is unavailable to average  homebuyers and the capacity to oversee the rehab work at a cost that “may  be less than that” charged by profit-motivated firms. As a result, HUD said  that our report significantly understated the program’s benefit to  homebuyers. Our draft report recognized the possibility that individual  homebuyers might not be able to rehab a home as cheaply as a nonprofit.  For this reason, we estimated the program’s financial benefits under two  scenarios. The first assumed equal rehab costs for nonprofits and  homebuyers; the second assumed that homebuyers would pay 25 percent  more than a nonprofit for the same rehab work. Under both scenarios, our  estimates indicated that most homebuyers did not benefit financially from  the program. Our draft report also recognized that obtaining financing for  rehab work and overseeing this work are obstacles for some homebuyers,  and that these and other factors that are difficult to quantify may make the  program either more or less beneficial from a homebuyer’s perspective.  However, it is important to note that homebuyers financing properties  purchased through the Discount Sales Program in effect pay financing  costs for the rehab work because the cost of this work is included in the  nonprofit’s selling price (i.e., the homebuyer’s purchase price) and  therefore is reflected in the homebuyer’s mortgage costs. Furthermore,  because more than half of the properties we reviewed received less than  $15,000 in rehab work—including some that received none at all—it is  unlikely that the oversight costs for these projects would be very  substantial.
Finally, HUD said that the Discount Sales Program serves several public  policy purposes and was neither conceived as nor intended to be only a  source of revenue for FHA. HUD stated that the program contributes in a  “direct and positive manner” to the promotion of homeownership and the  revitalization of neighborhoods and that our report should acknowledge  the significance of these objectives. Our draft report did not indicate that  the program was intended to be solely a source of revenue. In addition, our  draft report recognized that the goals of the program include the expansion  of affordable housing opportunities and neighborhood revitalization and  included statements from HUD and nonprofit officials about how the  program may help to improve neighborhood conditions. Furthermore,  HUD’s comments do not recognize the potential of the agency’s regular  sales process to help achieve the same goals. Nevertheless, we added  language to the final report to reflect HUD’s views about the program’s  potential benefits. As our report notes, HUD has not provided any analysis  to support its assertion that the program is contributing to the stated policy  objectives. Accordingly, we believe that HUD needs to undertake such an  analysis before making decisions about the program’s future.
We are sending copies of this report to the appropriate congressional  committees, and it will be available at no charge on GAO’s Web site at  http://www.gao.gov. If you or your staff have any questions about this  report, please call me at (202) 512-8678. Key contributors to this report are  listed in appendix IV.

Objectives, Scope, and Methodology

Our objectives were to assess (1) the cost of the Discount Sales Program to  HUD, (2) the benefits of the program to homebuyers, and (3) HUD’s efforts  to monitor participating nonprofits and enforce program requirements. Our  work focused on the approximately 1,200 properties HUD sold through the  program in calendar year 2002 and the monitoring and enforcement  activities the four HOCs performed in connection with those properties.
To determine the cost of the Discount Sales Program to HUD, we examined  the program’s impact on HUD’s net revenue from property sales and the  cost of administering the program. To determine the effect of the program  on HUD’s net revenue, we performed a statistical analysis of data from  HUD’s Single-Family Acquired Asset Management (SAMS) and the U.S.  Census Bureau. This analysis allowed us to estimate how much less net  revenue HUD received by selling properties through the program instead of  its regular sales process, while controlling for other factors. Appendix II  provides detailed information on our statistical model. Because HUD does  not keep records that would identify the costs to administer the program,  we asked HUD to estimate them. HUD developed its estimate by querying  HOC and Office of Housing officials about the number of staff years they  allotted to the program in calendar year 2002. HUD used this information  and salary and benefit data to derive an approximate personnel cost for the  program. HUD’s estimate of administrative costs did not include  comparatively minor expenses, such as travel and mailing costs. We did not  assess the reliability of HUD’s estimate.
To determine the benefits of the program to homebuyers, we examined the  program’s potential financial benefits and the types of homeownership  services and assistance provided by participating nonprofit organizations.  To determine the extent to which homebuyers benefited financially from  the program, we performed a statistical analysis using data from HUD’s  SAMS, the Bureau of the Census, and the four HOCs. Our analysis was  limited to 238 discounted properties that HUD sold between February 1  and December 31, 2002, that nonprofits resold to homebuyers that same  year. These were the only properties for which the HOCs had the rehab and  resale data necessary for our analysis. This analysis allowed us to compare  what homebuyers actually paid for the discounted homes to our estimate of  what they would have spent had they purchased the homes under HUD’s  regular sales process and paid for the rehab work themselves. Our analysis  assumed that in the absence of the Discount Sales Program, a homebuyer  would be able to purchase the same home and rehabilitate it to the same  extent as the nonprofit. We also assumed that a homebuyer would inhabit  the home during the rehabilitation and, therefore, would not incur housing  expenses for two residences during that period. We performed the analysis  twice using different assumptions about rehab costs each time. The first  time we assumed that a homebuyer would incur the same rehab costs as a  nonprofit; the second time we assumed that homebuyers would incur 25  percent higher rehab costs than a nonprofit. Appendix II provides detailed  information on our statistical model. In assessing the program’s financial  benefits, we also reviewed HUD’s rules and instructions for both the  Discount Sales Program and the agency’s regular sales process and  interviewed officials from HUD’s Office of Housing. To determine the types  of services and assistance provided by participating nonprofits, we visited  6 nonprofits that were actively involved in the program and interviewed  officials from these organizations. During our visits to the four HOCs, we  reviewed the affordable housing plans for a judgmental sample of 17  nonprofits and interviewed the nonprofit coordinator at each HOC. We did  not evaluate the impact of the Discount Sales Program on neighborhood  conditions. However, we discussed this issue with HUD and nonprofit  officials and visited six properties that nonprofits had either rehabbed or  were in the process of rehabbing.
To assess HUD’s efforts to monitor participating nonprofits, we reviewed  HUD’s program guidance and instructions, SAMS data on the number of  discounted properties each nonprofit purchased in calendar year 2002,  nonprofits’ annual reports on these properties, and the results of the HOCs’  desk and on-site reviews. We analyzed SAMS data, nonprofits’ annual  reports, and desk reviews to determine the extent to which (1) nonprofits  submitted required monitoring information through their annual reports  and (2) the HOCs’ monitoring efforts identified noncompliance with  requirements governing the resale price of discounted properties and the  income level of the homebuyers. From the desk review information, which  was current as of July 2003, we also determined the estimated excess  profits earned by the nonprofit organizations that submitted annual  reports. For each HOC, we used SAMS data and on-site review logs to  determine how many of the nonprofits that purchased discounted  properties were subject to an on-site visit. We also examined the results of  these reviews and discussed them with cognizant HOC officials to  determine how they were conducted and the types of problems they  uncovered. Finally, we interviewed HUD Office of Housing and HOC  officials about factors that hampered their ability to monitor nonprofits.
To assess HUD’s efforts to enforce program requirements, we reviewed the  agency’s regulations and guidance to determine the major enforcement  actions available to the HOCs. We interviewed officials from HUD’s Office  of Housing, Office of General Counsel, and the four HOCs about their  ability to take these actions. At each HOC, we collected information on  how frequently and in what situations they used these enforcement tools.  We also collected information on the amount of excess profits nonprofit  organizations used to pay down homebuyers’ mortgages as of July 2003.  Finally, we obtained data from each HOC showing the calendar year 2003  discounted home purchases of nonprofits that sold properties for more  than program limits the previous year.
We tested the data we obtained from HUD’s SAMS and the HOCs’ desk  reviews for reasonableness and completeness and found them to be  reliable for the purpose of our analyses. In addition, we reviewed existing  information about data quality and controls supporting SAMS and  discussed the data we analyzed with agency officials to ensure that we  interpreted them correctly.
We conducted this review from December 2002 through November 2003.  We performed our work in accordance with generally accepted government  auditing standards.

Statistical Models Used to Estimate Program Costs and Benefits

Two objectives of the study were to determine (1) the cost of the Discount  Sales Program to HUD and (2) the benefits of the program to homebuyers.  For the cost objective, the scope of the study included properties that HUD  sold to nonprofit organizations in calendar year 2002. For the benefits  objective, the scope included the properties that HUD sold to nonprofits  between February 1 and December 31, 2002, that nonprofits rehabilitated  and resold to homebuyers during the same year. The empirical analysis  used to address these objectives was based upon two procedures. The first  procedure was the estimation of a model for which the dependent variable  is the fraction of the appraised value that HUD recovers for each property  after taking the agency’s selling costs into account. Controlling for a  number of factors discussed below, the difference between the estimated  net revenue HUD would have received by selling the properties at a  discount versus an estimate of what HUD have would received if the  property had been sold under HUD’s regular sales process represented the  cost of the Discount Sales Program to HUD. The second procedure was an  estimate of the financial benefits a homeowner received from purchasing a  rehabilitated Discounted Sales Program property from a nonprofit  organization rather than purchasing the property through HUD’s regular  sales process and paying for the rehab work personally.
This appendix is organized in the following manner. First, there is a brief  discussion of the data. Second, there is an explanation of the specification  of the two econometric models that differ only in their dependent  variables, as mentioned above. Next, there is a discussion of the estimation  results of the two models. Finally, these results are used to calculate  estimates of the costs and benefits of the Discount Sales Program.

	Data

For our analysis, we obtained from HUD’s Single-Family Acquired Asset  Management System (SAMS) computerized files for the 65,039 properties  sold by the agency during calendar year 2002. Each record provided  financial information, such as selling price, appraised value, and various  transactions costs. Each record also contained information on the  structural characteristics of the property, such as the number of bedrooms  and bathrooms. To describe the impact of neighborhood characteristics,  we obtained data at the census tract level on the percent of the population  living within an urbanized area, median household income in 1999, and  median real estate taxes. The source of these data was the Census 2000  Summary File 3 prepared by the U.S. Census Bureau.
A review of the data identified a number of outliers and missing values.  These observations were replaced using the means from the overall data  set minus these observations. In addition, 3,776 observations were lost  during the merger of the Census data because of the inability to identify the  census tract in which they were located. As a result, these observations  were not included in our analysis. In order to make the properties more  comparable, we also restricted the set of properties to only those  properties in census tracts in which at least one discount sale was made.  Finally, we excluded some observations with extreme values for the  dependent variable in our first model, which resulted in 5,189 observations  being used in the regression analysis.
Specification of the Models We developed two econometric models possessing the same set of  explanatory variables. We used the first model to estimate the cost of the  Discount Sales Program to HUD. In this model, the dependent variable is  HUD’s net revenue from the sale of a property divided by the property’s  appraised value. Net revenue equals HUD’s selling price minus property  taxes paid by HUD, management and marketing contractor costs, financing  and closing costs (including discounts) paid by HUD, the listing broker fee,  and the cost of any HUD sales incentives. We used the second model to  estimate the benefits of the program to homebuyers. In this model, the  dependent variable is simply HUD’s selling price for a property divided by  its appraised value. The explanatory variables used in both models are of  four types:  dummy variables identifying the homeownership center (HOC)  that administered the sale; dummy variables describing a combination of  HOC and discount level, for those properties sold through the Discount  Sales Program; characteristics of the property; and characteristics of the  neighborhood. We chose the final specification of the models to obtain a  good fit while avoiding problems with multicollinearity.
We chose the property and neighborhood characteristics based on a review  of the specifications employed in hedonic housing models. Such models  treat the housing market as an integrated series of submarkets for various  housing characteristics such as house size and neighborhood quality. A set  of housing and neighborhood characteristics can serve to describe a  product like housing because individual housing units can be differentiated  from one another in many ways.
Selling price is the amount paid to HUD by either the nonprofit or the  private individual purchasing the property. Property taxes are the annual  property tax multiplied by the number of days the property was owned by  HUD divided by 365. Management and marketing contractor costs  encompass all fees and reimbursable costs HUD pays to these contractors.  Financing and closing costs paid by HUD include any discount granted to a  nonprofit organization. The selling fee is the commission that HUD paid to  the selling broker. This fee is generally zero for properties sold to  nonprofits. All HUD properties are placed with a listing broker, so this  generates a listing broker fee. Incentives are cash back allowances that  HUD periodically pays to homebuyers who close on an executed sales  contract relatively quickly—for example, within 30 to 60 days. Appraised  value is the amount at which the property was appraised before the sale.
The explanatory variables belong to one of four groups of variables:  those  identifying the HOC that administered the sale; those describing a  combination of HOC and discount level, for those properties sold through  the Discount Sales Program; those describing characteristics of the house;  and those describing characteristics of the neighborhood. This  specification allows the net revenue as a fraction of the appraised value for  properties sold through the regular program to vary by HOC, and it allows  the effect of the Discount Sales Program on HUD’s net revenue to vary by  HOC and by discount level. We defined a set of HOC dummy variables that  take on a value of 1 for all sales (discounted and not discounted)  administered by that HOC, with Atlanta as the omitted category, and 0  otherwise. We then defined a set of dummy variables that represented  combinations of HOC and discount program level. For example, there is a  dummy variable that takes on a value of 1 for all sales with a 10 percent  discount made by the Atlanta HOC and 0 otherwise, etc. In this way, the  coefficient on that variable represents the difference in the fraction of the  appraised value obtained on property sales with a 10 percent discount and  made by the Atlanta HOC, compared with the fraction obtained by the  Atlanta HOC on sales made through the regular program. Similarly, the  coefficient on the dummy variable that takes on a value of 1 for all sales  with a discount level of 30 percent made by the Santa Ana HOC represents  the difference in the fraction of the appraised value obtained on property  sales made at a 30 percent discount and made by the Santa Ana HOC,  compared with the fraction obtained by the Santa Ana HOC on sales made  through the regular program.
There are three variables that provide characteristics for each property.  These variables measure the property’s number of bedrooms, bathrooms,  and stories. Although the likely association between those variables and  HUD’s net revenue from a property sale relative to the property’s appraised  value is not clear-cut, we anticipated that there may be a positive  association for the number of bedrooms and bathrooms. HUD’s costs  associated with property management and sale include a fixed cost  component not related to property value as well as a component that varies  with selling price. Accordingly, if properties with more bedrooms and  bathrooms tend to be valued more, increasing both their selling prices and  appraised values, then HUD’s net revenue relative to the appraised value  will be higher for higher-valued properties because HUD’s fixed costs will  be lower relative to the appraised value. Because the relationship between  number of stories and market value is less clear, we had no clear  expectation for the sign of the coefficient for that variable. Because any  effect of these variables on market value is likely to similarly affect both  selling price and appraised value, for the equation with selling price divided  by appraised value as the dependent variable we had no clear expectation  of the signs of the coefficients of these variables. However, we included  them to keep our equations consistent and because these variables may  exhibit statistically significant effects if HUD is able to obtain more  accurate appraisals for certain types of properties.
Finally, there are four variables for neighborhood characteristics:  the  percent of the population in the census tract living within an urbanized  area, median household income in 1999, median real estate taxes, and  whether the property is located in a revitalization area. As for the property  characteristics, we anticipated that to the extent that these neighborhood  characteristics are associated with higher (lower) property values, they  would be positively (negatively) associated with HUD’s net revenue from a  property sale relative to that property’s appraised value because for higher-  (lower-) valued properties HUD’s fixed costs will be lower (higher) relative  to appraised values. Accordingly, we anticipated positive coefficients in the  equation for which the dependent variable is HUD’s net revenue relative to  appraised value for the percentage of the population living within an  urbanized area, median income, and median real estate because all of these  variables are likely to be positively associated with property value. In  contrast, we anticipated a negative coefficient for location in a  revitalization area because that variable may indicate lower property  values that would raise the ratio of HUD’s fixed costs to a property’s  appraised value and because HUD may also incur additional costs to  maintain properties in those areas. Again, similar to the property  characteristics, we had no clear expectations for the signs of the  neighborhood characteristics in the equation in which the dependent  variable is HUD’s selling price relative to the appraised value because any  effect of these variables on property value is likely to similarly affect selling  price and appraised value. But, for the reasons cited above, we included  them in the equation.
Table 7 presents the variable names and descriptions, along with mean  values of the explanatory variables. In a previous version of the model that  we estimated using a data set representing all usable observations of HUD  property sales, rather than the data set containing only sales made in  census tracts in which discount sales were made, we included as variables  the year in which the structure was built and the average age of homes in  the census tract. These variables were significant at that time, but they  became insignificant in the final model when we limited our data set, so we  dropped them from the analysis. Although the rate of change in house  prices is another variable that may have some predictive value, we did not  include it in our models because information on the rate of house price  change was not available at the census tract level. Also, according to HUD  officials, the average time between the appraisal and the sale of a property  is about 3 months, so in most cases we did not anticipate that there would  be much price appreciation or depreciation resulting from market  conditions.

	Estimation Results

We estimated the two models using ordinary least squares due to its ease of  calculation and interpretation. Table 8 presents the estimated coefficients,  their standard errors, and the summary statistics.
In general, both models were consistent with our expectations. In the  model for net revenue relative to appraised value, the coefficients on the  Discount Sales Program category showed the expected pattern. That is, for  each HOC, coefficients became more negative at higher discount levels.
In both models the coefficients for the characteristics for the property  possessed the same sign. In general, a higher fraction of the appraised  value was obtained from larger homes, as measured by more bedrooms and  bathrooms, as well as homes with fewer floors. The fraction of the  appraised value obtained by HUD tended to be higher for properties  located in more urban areas and where median real estate taxes were  higher. In the model for selling price relative to appraised value, the  coefficient for median household income was negative and statistically  significant at less than the 0.01 percent level. However, in the model for net  revenue relative to appraised value, the coefficient on this variable was  statistically insignificant.

	Program Costs

We used the estimated coefficients for the Discount Sales Program  variables from the model for net revenue relative to appraised value to  estimate the cost of the program to HUD. We made this estimate by  comparing the (1) net revenue that our model predicted HUD would have  received for each discounted property had it been sold through the regular  sales process with (2) net revenue our model predicted HUD would have  received by selling it through the Discount Sales Program. Even though we  knew the actual amount HUD received by selling the property through the  Discount Sales Program, we compared two estimated values in order to be  consistent. Each estimated value contained an error term that captured the  effects of omitted variables unavailable for the modeling process. By  comparing two estimated values, we removed the influence of the omitted  variables from our comparison, leaving the effect of the Discounted Sales  Program.
This analysis was conducted using 1,194 discounted properties that were  sold during calendar year 2002. The values of the Discount Sales Program  dummy variables reflect the estimate of the difference in the fraction of  appraised value obtained by HUD for each combination of discount level  and HOC. That is, for a given property’s program characteristics—discount  level and HOC—these estimates represent the difference in value HUD  obtains compared to the case in which that property had been sold through  the regular program. Because we included HOC dummies to capture  otherwise unmeasured factors that might vary by region, the program  characteristic dummy variables describe incremental revenue differences  associated with each discount level as compared to the level of  nondiscount sales in each HOC. For example, if a property was sold by the  Philadelphia HOC at a 15 percent discount, the estimated difference in the  net revenue value would be about –13 percent of appraised value. The  relevant coefficient in table 8 is –0.1267. Similarly, if a property was sold by  the Santa Ana HOC at a 15 percent discount, the estimated difference in the  net revenue value would be about 20 percent of appraised value. The  relevant coefficient in table 8 is –0.1959.
We also estimated a range of costs using confidence intervals around the  estimates for the sales category dummy variables. We did this by  multiplying each coefficient estimate by 1.645 times its associated standard  error. We then added and subtracted this amount from the coefficient  estimate to create a 90 percent confidence interval around each estimate.  We then recalculated program costs assuming that the estimates associated  with the lower and upper bounds of the confidence interval reflected the  difference between the value HUD obtains through the Discount Sales  Program as compared to the value obtained through the regular sales  process.

	Benefits to Homebuyers

In the model for selling price relative to appraised value, the benefit to the  homebuyer of purchasing a property from a nonprofit organization was  taken to be the estimated price a homeowner would have paid to buy the  house through HUD’s regular sales process, minus the estimated financing  and closing costs that HUD would have paid in that situation, plus the  rehabilitation costs, minus the actual sales price paid to the nonprofit. This  analysis was conducted using 238 observations for discounted properties  purchased by nonprofits between February 1 and December 31, 2002, and  resold to homebuyers that same year. These were the only properties for  which data on the nonprofits’ rehabilitation costs and the selling price to  the final homeowners were available. We performed the analysis twice  using different scenarios. In the first scenario, we assumed that the  rehabilitation costs incurred by a homebuyer operating outside of the  Discount Sales Program would be the same as the rehabilitation costs  actually incurred by the nonprofit. In the second scenario, we assumed that  a homebuyer’s rehabilitation costs would be 25 percent higher than those  incurred by the nonprofit. Under both scenarios, we assumed that the  financing and closing costs HUD would pay for under its regular sales  process were equal to 3 percent of the estimated selling price.
Because these properties were originally bought from HUD by a nonprofit  organization, we needed to estimate the prices homebuyers would have  paid to purchase the properties directly from HUD through the regular  sales process to calculate the difference in price paid by homeowners  purchasing a property after it had been rehabilitated under the Discount  Sales Program. In a manner parallel to our estimate of net revenue  described earlier, we used the values of the estimated Discount Sales  Program dummy variables from our second model to make this calculation.

Comments From the Department of Housing and Urban Development

GAO Contacts and Staff Acknowledgments

	GAO Contacts

	Acknowledgments

In addition to those named above, Kimberly Berry, Gwenetta Blackwell,  Stephen Brown, Emily Chalmers, Rudy Chatlos, Jay Cherlow, David  Dornisch, John McGrail, John Mingus, Mark Molino, David Pittman, Steve  Ruszczyk, Stewart Seman, and Mark Stover made key contributions to this  report.

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Summary:
Why GAO Did This Study

In 2001, the Department of Housing and Urban Development's (HUD) Inspector General reported on serious problems in HUD's Discount Sales Program, under which nonprofit organizations purchase HUD-owned properties at a discount, rehabilitate them, and resell them to low- and moderate-income homebuyers. The objectives of the program are to expand affordable housing opportunities, help revitalize neighborhoods, and reduce HUD's property inventory in a timely, efficient, and cost-effective manner. Although the Inspector General recommended that the agency suspend the program and evaluate its viability, HUD did neither. GAO was asked to assess (1) the costs of the program to HUD, (2) the benefits of the program to homebuyers, and (3) HUD's efforts to monitor participating nonprofits and enforce program requirements.

What GAO Found

GAO found that the Discount Sales Program poses significant costs to HUD, is of questionable benefit to homebuyers, and has serious monitoring and compliance problems. GAO estimates that the program cost HUD between $18.8 and $23.9 million in calendar year 2002. Between $15.1 and $20.2 million was a reduction in net revenue resulting from HUD's selling approximately 1,200 properties through the program instead of through its regular sales process. Personnel expenses for administering the program accounted for the remaining $3.7 million. GAO's analysis of 238 properties sold under the program in 2002 suggests that most of the homebuyers did not benefit financially. Assuming that nonprofits and homebuyers would incur the same rehabilitation costs, GAO estimates that 76 percent of the homebuyers would have spent less purchasing the properties through HUD's regular process and paying for the rehabilitation work themselves. And while the program can help homebuyers access a range of homeownership services, these services are also available from other sources. GAO did not evaluate the extent to which the program generated other benefits, such as neighborhood revitalization. While uncovering numerous program violations, HUD's monitoring efforts have faced challenges. For example, HUD monitors nonprofits through desk reviews of the annual reports it requires nonprofits to submit each February. However, as of July 2003, HUD's four homeownership centers, which administer the program, had not received reports for more than half of the properties the agency estimates were purchased and resold under the program in 2002. Even with this problem, the desk reviews found that 28 of the 44 nonprofits that submitted reports violated resale limits, earning an estimated total of $704,720 in excess profits. HUD requires that nonprofits use their excess profits to pay down the mortgages of the homebuyers they overcharged, but the agency's ability to enforce this requirement is extremely limited. As of July 2003, nonprofits had made only $62,000 in payments on mortgages.