Report 2011-120 Summary - August 2012

California Department of Transportation:

Its Poor Management of State Route 710 Extension Project Properties Costs the State Millions of Dollars Annually, Yet State Law Limits the Potential Income From Selling the Properties

HIGHLIGHTS

Our review of the State's management of state property along the proposed State Route 710 (SR 710) extension project highlighted the following:

  • The California Department of Transportation (Caltrans) passed up roughly $22 million in rental income for these properties between July 1, 2007, and December 31, 2011, because of poor management.
  • Caltrans failed to charge rents at the market rate for the majority of the 404 properties it rents.
    • It charged rents for 345 of these properties that were, on average, 57 percent of the rents in its market rent determinations that were prepared nearly four years ago.
    • Rental of these properties at below-market values constitutes a prohibited gift of public funds, unless such rentals serve a public purpose.
    • For state employees renting these properties, the difference between the market rental value of the properties and the rent paid by these employees should be included in their gross income.
  • Caltrans' affordable rent program for certain low-income tenants—who in 1981 qualified for affordable rent—is costing the State more than $940,000 per year because the rent they pay is much lower than the fair market rental value.
    • Caltrans has not been verifying income eligibility annually for the tenants in this program as required.
    • For those tenants who no longer qualify, the difference between the fair market rental value of the property and the rent they pay would be considered a gift of public funds.
  • Although Caltrans collected net rental income of $12.8 million, it spent $22.5 million to repair the properties from July 1, 2008, through December 31, 2011.
    • It spent an average of $6.4 million per year on repairs to these properties, but could not demonstrate that repairs for 18 of the 30 projects we reviewed were reasonable or necessary.
    • It did not always perform annual inspections and often authorized repairs that far exceeded the properties' potential rental income.
  • Since fiscal year 2005-06, Caltrans has transferred an average of $4.7 million each year to the Department of General Services (General Services) to maintain the properties. However, the departments have operated without an interagency agreement for over a decade.
    • Caltrans has not monitored General Services to ensure funds are properly spent.
    • General Services has limited justification for the fees it charges clients such as Caltrans.
    • General Services' construction unit does not properly monitor its labor charges—we identified roughly 330 hours that may have been inappropriately charged to projects related to the SR 710 properties.
    • General Services did not follow state law and policies governing purchases from small businesses.
    • Caltrans has not sufficiently evaluated options to having General Services perform the repairs.
  • Because of legislation enacted in 1979 known as the Roberti Bill, selling these properties may require the State to offer the properties at significantly reduced prices to any current tenants who have low or moderate incomes, and have not owned real property in the three years prior to the sale.

RESULTS IN BRIEF

The California Department of Transportation (Caltrans) is responsible for constructing, operating, administering, and maintaining the State's comprehensive transportation system. For decades, Caltrans has proposed the State Route 710 extension project (SR 710 extension project) to close a roughly 4.5-mile unconstructed gap in the freeway just north of State Route 10 in Los Angeles and State Route 210 in Pasadena. This gap affects the cities of Alhambra, Pasadena, South Pasadena, and a portion of Los Angeles. However, the project has been in the planning stage since 1953 for a variety of reasons related to the federal environmental review process. Caltrans is currently considering several options for moving forward, including either building a tunnel instead of a freeway or not building anything at all. By 2014 Caltrans hopes to have identified how it intends to proceed, but in the meantime the right-of-way division of Caltrans' District 7 office, which is located in the city of Los Angeles, is responsible for managing the hundreds of SR 710 extension project parcels and property units (SR 710 properties), ranging from residential to commercial properties to vacant land, that it purchased beginning in 1954 for use as land on which to build the project.

Because of Caltrans' poor management, we estimate that it missed the opportunity to generate roughly $22 million in rental income for the SR 710 properties between July 1, 2007, and December 31, 2011. In addition, the State spent millions of dollars more maintaining the SR 710 properties than it received in rental income. Although Caltrans collected net rental income of $12.8 million, it spent $22.5 million to repair the SR 710 properties from July 1, 2008, through December 31, 2011. A primary reason for this shortfall is that Caltrans failed to charge rents at the market rate for the majority of the 404 SR 710 properties it rents. Our review found that Caltrans charged rents for 345 of these properties that were, on average, 57 percent of the rents it identified in its market rent determinations. Moreover, because Caltrans' market rent determinations for the 345 properties are, on average, nearly four years old, the discrepancy between the rents it is charging and current market rates is likely even larger. Caltrans asserted that it recently completed market rent determinations for all of the SR 710 properties; however, these determinations were completed subsequent to the end of our fieldwork.

Caltrans also stated that it does not charge market rates for many of the SR 710 properties because in 2002 the former Caltrans director instructed the District 7 office not to increase rents to market rates. However, our legal counsel advised us that Caltrans' rental of the SR 710 properties at below-market values constitutes a gift of public funds, which is prohibited by the California Constitution unless such rentals serve a public purpose. If it charged market rents for the 345 SR 710 properties, Caltrans could potentially generate as much as $3.8 million more per year in rental income.1 These are public funds that Caltrans is, in effect, giving to its tenants. Moreover, in performing our analyses of the rent Caltrans charges its SR 710 property tenants, we identified 15 state employees to whom Caltrans was renting properties at below-market rates as of February 2012. The difference between the market rental value of the properties and the rent paid by these employees constitutes either income in the form of compensation from a fringe benefit or a gift of public funds. As such, the State should be including the difference in the employees' gross income that is reported for federal and state income tax purposes.

Caltrans also rents 58 of the SR 710 properties units under an affordable rent program for certain low-income tenants who originally qualified for affordable rent before March 3, 1981, in order not to impose hardship on them. Our review found that Caltrans charged rents for these 58 properties that were, on average, 26 percent of the rents it identified in its market rent determinations. Based on our comparison of Caltrans' market rates and the rates it actually charges these tenants, we estimate that this program is costing the State more than $940,000 per year. However, Caltrans has not been performing income eligibility verifications annually for the tenants in the affordable rent program, as its own policies require. Consequently, it cannot be sure that all of the tenants continue to qualify for the program. For those tenants who no longer qualify, the difference between the fair market rental value of the property and the rent they pay—an average of $16,200 per year per property—would be considered a gift of public funds.

Caltrans has spent an average of $6.4 million per year on repairs to SR 710 properties; however, it could not demonstrate that the repairs for 18 of the 30 projects we reviewed were reasonable or necessary. Caltrans maintains the SR 710 properties by either contracting directly with service providers or—more frequently—by requesting that the Department of General Services (General Services) complete specific repairs. However, Caltrans did not always perform annual inspections to determine whether repairs were necessary. Moreover, Caltrans often authorized repairs that far exceeded the properties' potential rental income. In fact, for 20 of the 30 properties we reviewed, Caltrans authorized repairs for which it will take more than three years' worth of rental income to recover the costs.

To maintain the SR 710 properties, Caltrans has transferred an average of $4.7 million each year to General Services since fiscal year 2005-06. However, Caltrans does not provide proper oversight of the repairs General Services performs. Caltrans and General Services had no interagency agreement in place for over a decade, and it has not monitored General Services to ensure that it spends the transferred funds properly. For example, in some instances Caltrans was unable to provide us with records to substantiate its approval of General Services' work either before or after the work was performed. Moreover, Caltrans has not sufficiently evaluated alternatives to having General Services perform the work, which might be resulting in Caltrans spending more state funds than needed to perform the repairs on these properties. For example, General Services has limited justification for the fees it charges clients such as Caltrans. Specifically, General Services was unable to substantiate the $50 hourly rate it charges to clients for its Direct Construction Unit's (construction unit) operational costs that include the salaries and benefits for its permanent employees, known as its hourly burden rate, and its direct administration fees for each project.

Further, General Services exerts insufficient oversight over several project cost areas. In particular, General Services' construction unit does not properly monitor the labor charges of its temporary employees, known as casual trades or day laborers. For example, we identified roughly 330 hours that may have been inappropriately charged by the casual laborers to projects related to the SR 710 properties. General Services also did not follow state law and policies governing purchases from small businesses. Specifically, General Services made purchases for amounts under $5,000 without using competing bidders or justifying that the price was fair and reasonable. For the purchases for which General Services did solicit competitive bids, we found that the owner of a small business that does a large amount of business with General Services is related to the owners of two other small businesses that General Services made purchases from, and these companies with related owners bid against each other. Consequently, other qualified suppliers may not have had a fair opportunity to participate in the competitive solicitation process. We also reviewed invoices for five small businesses to which the construction unit paid a total of more than $300,000 between July 2011 and May 2012 and found in some instances that the businesses do not appear to serve a commercially useful function. For example, our review found that two of the small businesses obtained goods either from The Home Depot or online vendors at retail prices and charged the State an average markup of 35 percent for the goods, instead of the construction unit purchasing the goods directly from the suppliers.

Once Caltrans completes the necessary reviews and plans for the SR 710 extension project, it can determine if it requires all of the properties that it currently owns. It can then proceed with selling surplus properties. However, the sale of these properties will be restricted by legislation enacted in 1979 known as the Roberti Bill, which requires the State to offer the properties at significantly reduced prices to any current tenants who have low or moderate incomes and have not owned real property in the three years prior to the sale. As of March 1, 2012, Caltrans estimated that the market value of the SR 710 parcels was $279 million.2 However, as a result of the Roberti Bill, the actual sale price for many or potentially all of the residential SR 710 parcels could be roughly 80 percent less than Caltrans' estimated market value. These discounted prices would have long-term ramifications because the properties would generate only a fraction of the property tax revenues that they would generate if sold at market price. Because state law requires Caltrans to restrict the use of these properties exclusively as affordable housing, and Caltrans plans to implement these restrictions for 45 to 55 years, the reduction in property tax revenues would likely exceed many millions of dollars.

While Caltrans is determining whether it will proceed with the SR 710 extension project, the State could consider certain alternatives that would allow it to retain access to the SR 710 properties for right-of-way purposes while eliminating its need to directly manage the properties. One possibility is that Caltrans could contract with one or more private contractors to provide property management services to maintain the SR 710 properties. Another option the Legislature could consider would be the establishment of a joint powers authority (JPA) that would include Caltrans and the cities of Pasadena, South Pasadena, and Los Angeles to manage the SR 710 properties. This option would allow the affected cities an opportunity to have an equal voice in the management of the properties.

RECOMMENDATIONS

To ensure that it collects fair market rents for the SR 710 properties on the State's behalf, Caltrans should do the following:

  • Using the fair market rent determinations for all SR 710 properties it recently prepared, excluding those in its affordable rent program, adjust the tenants' rents to fair market after providing them with proper notice.
  • Make only limited exceptions to charging fair market rent and document the specific public purpose that is served in any case where it does not charge fair market rent.

To ensure that all taxable fringe benefits or gifts state employees receive are appropriately included in their gross income, Caltrans should take the following actions:

  • Establish procedures to notify state employees who rent SR 710 properties that they may be subject to tax implications.
  • Work with the State Controller's Office (state controller) to identify the difference between the fair market rental value of the SR 710 housing and the rent the state employees paid for that housing during the applicable calendar years within the federal and state statute of limitations.
  • Work with the state controller to identify the statute of limitations for employers to report adjustments to employee gross income to the federal Internal Revenue Service and the Franchise Tax Board.

To ensure that only eligible tenants receive the benefit of the affordable rent policy, Caltrans should annually review the tenants' household incomes and document their incomes using income certification forms. If tenants no longer qualify for the program because their income exceeds the income requirement or one of the income-producing tenants in the household has been replaced by a new tenant, it should increase their rent to fair market rates after giving proper notice.

To ensure that the repairs it makes to the SR 710 properties are necessary and reasonable, Caltrans should do the following:

  • Conduct annual field inspections of the properties.
  • Develop a written policy to ensure that it considers the cost-effectiveness of repair costs in relation to the potential rental income for a property.
  • Establish a process to ensure that it evaluates the cost-effectiveness of any repair before authorizing it.
  • Retain in its project files evidence to support the necessity and reasonableness of repairs, such as change orders, annual field inspections, and analyses of the cost-effectiveness.

To ensure that the State achieves cost savings for the repairs made to the SR 710 properties, Caltrans should periodically perform more comprehensive analyses of viable options for repairing the properties. If Caltrans determines that General Services is the best option, it should ensure that it properly executes an interagency agreement in accordance with the State Contracting Manual.

To ensure that it charges its clients appropriately for the work it performs, General Services should reassess its methodologies for determining the hourly burden rate and direct administration fees.

To ensure that the construction unit complies with the State's procurement laws and policies, General Services should do the following:

  • Provide training to its construction unit employees regarding the State's procurement laws and policies.
  • Conduct an investigation of the small businesses we discuss in this report to determine if they are performing a commercially useful function.

To ensure that casual laborers charge only for their actual hours worked on projects, General Services should ensure that the daily time reports for casual laborers contain the appropriate task codes, the laborer's signature, and the approval of a civil service supervisor.

To pursue alternatives to its management of the SR 710 properties, Caltrans should:

  • Prepare a cost-benefit analysis to determine if the State would save money by hiring a private vendor to manage the properties.
  • Perform an analysis to compare the cost of establishing a JPA to its current costs of managing the properties.

To pursue alternatives to the State's management of the SR 710 properties that would preserve its access to the right-of-way needed for the SR 710 extension project, to the extent that Caltrans has determined it to be cost-beneficial to do so, the Legislature should consider the establishment of a JPA that would allow Caltrans and the affected cities to jointly manage the SR 710 properties.

AGENCY COMMENTS

The Business, Transportation and Housing Agency (BTH) stated that it appreciates the identification of opportunities for improvement and recommendations for best practices that Caltrans can follow. In addition, Caltrans stated that it has implemented recommendations, is in the process of implementing recommendations, or will work with BTH to determine how best to address the issues raised in our report.

General Services stated that it agrees that additional actions need to be taken to improve the construction unit's administrative processes. General Services also stated that, in general, the recommendations have merit and that it will promptly address them.


1 One of the 404 SR 710 properties Caltrans rents did not have a market rent determination.

2 A parcel is a plot of land that can contain more than one single-family or multifamily residential property unit.


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