GRACE TOWER F.H.A. PROJECT NO A PROJECT OF GRACE TOWER, INC. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION DECEMBER 31, 2016 L &

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1 FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION DECEMBER 31, 2016 L & C Leaf & Cole, LLP Certified Public Accountants

2 L & C Leaf & Cole, LLP Certified Public Accountants A Partnership of Professional Corporations To the Board of Directors Grace Tower Attached is the financial report of Grace Tower, a project of Grace Tower, Inc. for the year ended December 31, 2016: Audit Partner Information Name: Steven W. Northcote Address: 2810 Camino Del Rio South, Suite 200 San Diego, CA Phone No.: (619) Firm s Federal Employer Identification Number Leaf & Cole, LLP: San Diego, California May 10, Camino Del Rio South, Suite 200, San Diego, California , fax, leafcole@leaf-cole.com

3 FINANCIAL STATEMENTS DECEMBER 31, 2016 TABLE OF CONTENTS Independent Auditor s Report 1-2 Statement of Financial Position 3 Statement of Activities 4 Statement of Cash Flows 5 Notes to Financial Statements 6-13 Supplementary Information: Supplementary Statement of Financial Position Supplementary Profit and Loss Data Supplementary Cash Flow Data Supplementary Data Required by HUD Schedule of Expenditures of Federal Awards 23 Independent Auditor s Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards Independent Auditor s Report on Compliance for Each Major Program and on Internal Control Over Compliance Required by the Uniform Guidance Schedule of Findings and Questioned Costs Page i

4 L & C Leaf & Cole, LLP Certified Public Accountants A Partnership of Professional Corporations Independent Auditor s Report To the Board of Directors Grace Tower Report on the Financial Statements We have audited the accompanying financial statements of Grace Tower, which comprise the statement of financial position as of December 31, 2016, and the related statements of activities and cash flows for the year then ended, and the related notes to the financial statements. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion Camino Del Rio South, Suite 200, San Diego, California , fax, leafcole@leaf-cole.com

5 To the Board of Directors Page 2 Grace Tower Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Grace Tower as of December 31, 2016, and the changes in its net assets and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Other Matters Other Information Our audit was conducted for the purpose of forming an opinion on the financial statements as a whole. The accompanying supplementary information on pages 14 to 22 is presented for purposes of additional analysis as required by the Uniform Financial Reporting Standards issued by the U.S. Department of Housing and Urban Development, Office of the Inspector General, and is not a required part of the financial statements. The accompanying schedule of expenditures of federal awards, as required by Title 2 U.S. Code of Federal Regulations (CFR) Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, is presented for purposes of additional analysis and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated, in all material respects, in relation to the financial statements as a whole. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated May 10, 2017, on our consideration of Grace Tower s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering Grace Tower s internal control over financial reporting and compliance. San Diego, California May 10,

6 STATEMENT OF FINANCIAL POSITION DECEMBER 31, 2016 ASSETS Investment in Real Estate: (Notes 2 and 5) Land $ 197,793 Buildings 3,211,033 Furnishings and equipment 196,521 Construction-in-progress 12,824,258 Less: Accumulated depreciation (2,330,131) Net Investment in Real Estate 14,099,474 Other Assets: (Note 2 and 3) Cash and cash equivalents 25,171 Prepaid expenses 57,991 Restricted deposits: Escrow deposits 12,803 Replacement reserve 576,033 Change order reserve 559,892 Relocation reserve 600,000 Initial operating deficit reserve 297,105 Working capital reserve 198,070 Tenant security deposits 77,166 Total Other Assets 2,404,231 TOTAL ASSETS $ 16,503,705 LIABILITIES AND NET ASSETS Liabilities: (Notes 2, 4, 5 and 6) Mortgage payable, net $ 7,917,172 Accrued interest payable 53,078 Accounts payable and accrued expenses 56,704 Accounts payable - Construction 2,781,571 Related party payable 2,131,318 Tenant security deposits 77,166 Total Liabilities 13,017,009 Unrestricted Net Assets (Note 2) 3,486,696 TOTAL LIABILITIES AND NET ASSETS $ 16,503,705 The accompanying notes are an integral part of the financial statements. 3

7 STATEMENT OF ACTIVITIES FOR THE YEAR ENDED DECEMBER 31, 2016 Income: Gross potential rents $ 2,113,163 Less: Vacancy loss (6,545) Total Rental Income 2,106,618 Interest income 3 Other income: Laundry and vending income 3,468 Miscellaneous tenant charges 30 Total income 2,110,119 Expenses: Program Expenses: Operating and maintenance 307,736 Utilities 178,580 Taxes and insurance 154,535 Depreciation 81,751 Financial 58,223 Total Program Expenses 780,825 Supporting Services: Administrative expenses 417,179 Total Program and Supporting Services Expenses 1,198,004 Change in Unrestricted Net Assets 912,115 Unrestricted Net Assets at December 31, ,574,581 UNRESTRICTED NET ASSETS AT DECEMBER 31, 2016 $ 3,486,696 The accompanying notes are an integral part of the financial statements. 4

8 STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2016 Cash Flows From Operating Activities: Change in unrestricted net assets $ 912,115 Adjustments to reconcile change in unrestricted net assets to net cash provided by operating activities: Depreciation 81,751 Amortization of debt issuance costs 822 (Increase) Decrease in: Accounts receivable 499,342 Prepaid expenses 4,690 Tenant security deposits 1,232 Increase (Decrease) in: Accrued interest payable 328 Accounts payable and accrued expenses (18,378) Tenant security deposits (1,232) Net Cash Provided by Operating Activities 1,480,670 Cash Flows From Investing Activities: Net purchase of investment in real estate (8,816,488) Net deposits to escrow deposits (12,803) Net withdrawals from replacement reserve 18,172 Net deposits to change order reserve (559,892) Net deposits to change order reserve (600,000) Net withdrawals from off-site escrow reserve 10,203 Net withdrawals from debt service reserve 86,069 Net Cash Used in Investing Activities (9,874,739) Cash Flows From Financing Activities: Proceeds from mortgage payable 6,279,145 Payments on mortgage payable (8,805) Related party advance 2,131,318 Net Cash Provided by Financing Activities 8,401,658 Net Increase in Cash and Cash Equivalents 7,589 Cash and Cash Equivalents at Beginning of Year 17,582 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 25,171 Supplemental Cash Flow Information: Cash paid for interest, net of capitalized interest (Note 5) $ 3,469 The accompanying notes are an integral part of the financial statements. 5

9 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2016 Note 1 - Organization: Grace Tower (the Project ) was developed by Grace Tower Inc. (the Corporation ), which was organized as a Nonprofit Public Benefit Corporation, and began operations in 1967 as an apartment complex of 168 units in San Diego, California. The Project is regulated by HUD as to rent charges and operating methods. These financial statements only include the activities of Grace Tower. The activities of the Grace Lutheran Developments Trust account which are part of Grace Tower, Inc. have not been included in these financial statements. Note 2 - Summary of Significant Accounting Policies: Accounting Method The Project s books are maintained on the accrual basis of accounting, which is in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and, accordingly, reflect all significant receivables, payables, and other liabilities. Financial Statement Presentation The financial statements present information regarding the financial position and activities according to three classes of net assets: unrestricted net assets, temporarily restricted net assets and permanently restricted net assets. Change in Accounting Principle During 2016, the Project adopted the provisions of Accounting Standards Update , Simplifying the Presentation of Debt Issuance Costs (ASU ). Under this new accounting policy, the Project has retrospectively presented all debt issuance costs as a direct deduction from the carrying amount of the related obligation in the statement of financial position. Amortization of the debt issuance costs is calculated using the interest method and is included as a component of interest expense. The effects of the retrospective application of the accounting change on the year ended December 31, 2015 is to decrease total assets and long term liabilities by $394,546 in the statement of financial position. Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 6

10 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2016 Note 2 - Summary of Significant Accounting Policies: (Continued) Fair Value Measurements Fair value accounting standards define fair value, establish a framework for measuring fair value, outline a fair value hierarchy based on inputs used to measure fair value and enhance disclosure requirements for fair value measurements. The fair value hierarchy distinguishes between market participation assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Level 1 or 2 of the hierarchy) and the reporting entity s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). The Project had no financial instruments at December 31, Capitalization and Depreciation The Project capitalizes all expenditures in excess of $10,000 for investment in real estate at cost, while donations of property and equipment are recorded at their estimated fair values. Such donations are reported as unrestricted support unless the donor has restricted the donated asset to a specific purpose. Assets donated with explicit restrictions regarding their use and contributions of cash that must be used to acquire property and equipment are reported as restricted support. Absent donor stipulations regarding how those donated assets must be maintained, the Project reports expirations of donor restrictions when the donated or acquired assets are placed in service as instructed by the donor. The Project reclassifies temporarily restricted net assets to unrestricted net assets at that time. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives. The estimated service life of the assets for depreciation purposes may be different than their actual economic useful lives. Method Estimated Life Buildings Straight-line years Furnishings and equipment Straight-line 7-35 years Depreciation totaled $81,751 for the year ended December 31, Maintenance, repairs and minor renewals are charged to operations as incurred. Upon sale or disposition of property and equipment, the asset account is relieved of the cost and the accumulated depreciation account is charged with depreciation taken prior to the sale and any resultant gain or loss is credited or charged to earnings. 7

11 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2016 Note 2 - Summary of Significant Accounting Policies: (Continued) Impairment of Real Estate The Project reviews its investment in real estate for impairment whenever events and changes in circumstances indicate that the carrying value of such property may not be recoverable. Recoverability is measured by a comparison of the carrying amount of the real estate to the future net undiscounted net cash flows expected to be generated by the rental property and any estimated proceeds from the eventual disposition of the real estate. If the real estate is considered to be impaired, the impairment to be recognized is measured at the amount by which the carrying amount of real estate exceeds the fair value of such property. There was no impairment loss recognized in Debt Issuance Costs Debt issuance costs are incurred in order to obtain permanent financing for the Project. Debt issuance costs are amortized on a straight-line basis over the term of the related loan, which approximates the interest method. Unamortized deferred financing costs are presented as a direct reduction from the carrying value of the related obligation to which such costs relate. Amortization of debt issuance costs is reported as a component of interest expense and totaled $822 for the year ended December 31, Allowance for Doubtful Accounts Bad debts are recognized on the allowance method based on management s evaluation of outstanding accounts receivable. Management believes that all accounts receivable were fully collectible; therefore, no allowance for doubtful accounts receivable was recorded at December 31, Deferred Revenue and Prepaid Rents Laundry payments received in advance are classified as liabilities until earned. Advanced laundry payments are earned and recognized as revenue over the term of the laundry contract. Rental payments received in advance are deferred and classified as liabilities until earned. Distributions The Project s Regulatory Agreement with HUD stipulates, among other things, that the Project will not make distributions of assets or income to any of its officers or directors. No distributions were made for the year ended December 31, Revenue Recognition Rental revenue attributable to residential leases is recorded when due from residents, generally upon the first day of each month. Leases are for periods of up to one year, with rental payments due monthly. Other revenue includes fees for late payments, cleaning, damages, laundry facilities and other charges and is recorded when earned. Rental income is shown at its maximum gross potential. Vacancy loss is shown as a reduction in rental income. Rental units occupied by employees are included in rental income and as an expense of operations. 8

12 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2016 Note 2 - Summary of Significant Accounting Policies: (Continued) Housing Assistance Payments Contracts The Project entered into a housing assistance payment contract with the Department of Housing and Urban Development ( HUD ). Contract #CA33M expires July 31, The amount earned on the contract totaled $70,152 for the year ended December 31, 2016, and is included in rental income. The Project entered into a senior preservation rental assistance contract (SPRAC) with the Department of Housing and Urban Development. Contract #CA16SP00002 expires July 31, The amount earned on the contract totaled $1,217,422 for the year ended December 31, 2016, and is included in rental income. Allocated Expenses Expenses by function have been allocated among program and supporting services classifications on the basis of internal records and estimates made by the Project s management. Income Taxes The Corporation is a nonprofit organization and is exempt from income taxes under Section 501(c)(3) of the Internal Revenue Code and Section 23701(d) of the California Revenue and Taxation Code. The Corporation believes that it has appropriate support for any tax positions taken, and as such, does not have any uncertain tax positions that are material to the financial statements. The Corporation is not a private foundation. The Corporation s Return of Organization Exempt from Income Tax for the years ended December 31, 2016, 2015, 2014 and 2013 are subject to examination by the Internal Revenue Service and State taxing authorities, generally three to four years after the returns were filed. Concentrations The Project s operations are concentrated in the multifamily real estate market. In addition, the Project operates in a heavily regulated environment. The operations of the Project are subject to the administrative directives, rules and regulations of federal, state and local regulatory agencies. Such administrative directives, rules and regulations are subject to change by an act of congress or an administrative change. Such changes may occur with little notice or inadequate funding to pay for the related cost, including the additional administrative burden, to comply with a change. 9

13 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2016 Note 2 - Summary of Significant Accounting Policies: (Continued) Cash and Cash Equivalents For purposes of the statement of cash flows, the Project considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. U.S. Treasury bills and certificates of deposit may be redeemed without significant penalty and are considered cash and cash equivalents, regardless of maturity. Cash is defined as cash in demand deposit accounts as well as cash on hand. Not included as cash are funds restricted as to their use, regardless of liquidity, such as escrow deposits, replacement reserve, change order reserve, relocation reserve, initial operating deficit reserve, working capital reserve, off-site escrow reserve, debt service reserve and tenant security deposits. The Project occasionally maintains cash on deposit at a bank in excess of the Federal Deposit Insurance Corporation limit. The Project has not experienced any losses in such accounts. Subsequent Events In preparing these financial statements, the Project has evaluated events and transactions for potential recognition or disclosure through May 10, 2017 the date the financial statements were available to be issued. Note 3 - Restricted Deposits: Escrow Deposits In accordance with the loan agreement, restricted funds are held by Berkadia Commercial Mortgage, LLC to be used for mortgage escrow deposits. Balance, December 31, 2015 $ - Add: Monthly deposits 12,803 Balance, December 31, 2016 $ 12,803 Replacement Reserve In accordance with the provisions of the Regulatory Agreement, funds are held by Berkadia Commercial Mortgage, LLC to be used for replacement of property with the approval of HUD. Balance, December 31, 2015 $ 594,205 Add: Monthly deposits 5,600 Less: Approved withdrawals (23,772) Balance, December 31, 2016 $ 576,033 10

14 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2016 Note 3 - Restricted Deposits: (Continued) Change Order Reserve The Project has funded a change order reserve held by Berkadia Commercial Mortgage, LLC as required by HUD. The change order reserve was established to cover change orders. Balance, December 31, 2015 $ - Add: Deposits 2,096,437 Less: Withdrawals (1,536,545) Balance, December 31, 2016 $ 559,892 Relocation Reserve The Project has funded a relocation reserve held by Berkadia Commercial Mortgage, LLC as required by HUD. Balance, December 31, 2015 $ - Add: Deposits 600,000 Balance, December 31, 2016 $ 600,000 Initial Operating Deficit Reserve The Project has funded an initial operating deficit reserve held by Berkadia Commercial Mortgage, LLC as required by HUD. Balance, December 31, 2015 $ 297,105 Balance, December 31, 2016 $ 297,105 Working Capital Reserve The Project has funded a working capital reserve held by Berkadia Commercial Mortgage, LLC as required by HUD. The working capital reserve was established to meet the cost of equipping and renting the Project subsequent to completion of the entire Project or units thereof, and to be applied to taxes, mortgage insurance premiums, property insurance premiums and assessments required by the terms of the mortgage accruing subsequent to initial endorsement of the mortgage for insurance, and not included in the proceeds of the mortgage. Balance, December 31, 2015 $ 198,070 Balance, December 31, 2016 $ 198,070 11

15 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2016 Note 3 - Restricted Deposits: (Continued) Off-Site Escrow Reserve The Project has funded an off-site escrow reserve held by Berkadia Commercial Mortgage, LLC as required by HUD. The off-site escrow reserve was established to cover off-site utilities. Balance, December 31, 2015 $ 10,203 Less: Withdrawals (10,203) Balance, December 31, 2016 $ - Debt Service Reserve The Project has funded a debt service reserve in an amount equal to the annual mortgage payment. The reserve was held in a liquid certificate of deposit which was considered cash and cash equivalents. Balance, December 31, 2015 $ 86,069 Add: Interest income 3 Less: Withdrawals (86,072) Balance, December 31, 2016 $ - Tenant Security Deposits The Project is required to hold security deposits in a separate bank account in the name of the Project. The amount held by the Project totaled $77,166 at December 31, Note 4 - Related Party Payable: The Project was advanced funds from Trinity Manor, a related party, for the rehabilitation of the property. The unsecured advance is non-interest bearing, payable on demand and totaled $2,131,318 at December 31, The Corporation and Trinity Manor share the same Board of Directors. Note 5 - Mortgage Payable: The 3.85% mortgage payable is held by Berkadia Commercial Mortgage, LLC, and insured under Section 221(d)(4) of the National Housing Act. Interest only payments are due through November, Principal and interest will be payable in monthly installments of $35,963 beginning December 1, 2016, with any remaining unpaid principal due in full on November 1, Accrued interest payable totaled $53,078 at December 31, Substantially all investment in real estate is pledged as collateral to the mortgage payable. 12

16 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2016 Note 5 - Mortgage Payable: (Continued) The future principal payments on the mortgage payable are as follows: Years Ended December $ 113, , , , ,897 Thereafter 7,700,185 Total 8,310,896 Less: Unamortized debt issuance costs (393,724) Total, Net $ 7,917,172 Debt issuance costs total $394,546, less accumulated amortization of $822 at December 31, Interest totaling $211,864 for the year ended December 31, 2016 was capitalized and included in construction in progress. Note 6 - Management Fee: Management fees were earned by Falkenberg/Gilliam & Associates as follows for the year ended December 31, 2016: Accrued Management Fee, December 31, 2015 $ 5,833 Management fee earned 172,441 Management fee paid (166,809) Accrued Management Fee, December 31, 2016 $ 11,465 (Included in accounts payable and accrued expenses) 13

17 SUPPLEMENTARY STATEMENT OF FINANCIAL POSITION DECEMBER 31, 2016 ASSETS Current Assets: 1120 Cash - Operations $ 25, Prepaid expenses 57, T Total Current Assets 83,162 Deposits Held in Trust: 1191 Tenant security deposits held in trust 77,166 Restricted Deposits: 1320 Escrow deposits 12, Replacement reserve 576, Other reserves 1,655, T Total Restricted Deposits 2,243,903 Fixed Assets: 1410 Land 197, Buildings 3,211, Office furniture and equipment 168, Maintenance equipment 27, Miscellaneous fixed assets 12,824, T Total Fixed Assets 16,429, Less: Accumulated depreciation (2,330,131) 1400N Net Fixed Assets 14,099, T Total Assets $ 16,503,705 14

18 SUPPLEMENTARY STATEMENT OF FINANCIAL POSITION (CONTINUED) DECEMBER 31, 2016 LIABILITIES AND NET ASSETS Current Liabilities: 2110 Accounts payable - Operations $ 32, Accounts payable - Construction/Development 2,781, Accounts payable - Entity 2,131, Accrued wages payable 13, Accrued management fee payable 11, Accrued interest payable - First mortgage 53, Current portion of first mortgage payable 113, T Total Current Liabilities 5,135,757 Other Liabilities: 2191 Tenant security deposits payable 77,166 Long-Term Liabilities: 2320 First mortgage payable 7,804, T Total Long-Term Liabilities 7,804, T Total Liabilities 13,017,009 Net Assets: 3131 Unrestricted net assets 3,486, Total Net Assets 3,486, T Total Liabilities and Net Assets $ 16,503,705 15

19 SUPPLEMENTARY PROFIT AND LOSS DATA FOR THE YEAR ENDED DECEMBER 31, 2016 Revenues: Rental Revenue: 5120 Rent revenue - Gross potential $ 825, Tenant assistance payments 1,287, T Total Rental Revenue 2,113,163 Vacancies: 5220 Vacancies - Apartments (6,545) 5200T Total Vacancies (6,545) 5152N Net Rental Revenue 2,106,618 Financial Revenue: 5490 Revenue from investments - Miscellaneous T Total Financial Revenue 3 Other Revenue: 5910 Laundry and vending revenue 3, Tenant charges T Total Other Revenue 3, T Total Revenues 2,110,119 Expenses: Administrative Expenses: 6203 Conventions and meetings 2, Other renting expenses Office salaries 57, Office expenses 13, Management fee 172, Manager or superintendent salaries 122, Administrative rent free unit 6, Legal expenses - Project Audit expense 10, Bookkeeping fees/accounting services 16, Bad debts 6, Miscellaneous administrative expenses 7, T Total Administrative Expenses 417,179 (Continued) 16

20 SUPPLEMENTARY PROFIT AND LOSS DATA (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 2016 Expenses: (Continued) Utilities Expense: 6450 Electricity $ 120, Water 27, Gas 8, Sewer 22, T Total Utilities Expense 178,580 Operating and Maintenance Expenses: 6510 Payroll 169, Supplies 12, Contracts 69, Garbage and trash removal 12, Security payroll/contract 40, Heating/cooling repairs and maintenance 3, T Total Operating and Maintenance Expenses 307,736 Taxes and Insurance: 6711 Payroll taxes 24, Property and liability insurance 54, Workmen's compensation 11, Health insurance and other employee benefits 62, Miscellaneous taxes, licenses, permits and insurance 1, T Total Taxes and Insurance 154,535 Financial Expenses: 6820 Interest on first mortgage payable 4, Mortgage insurance premium 52, Miscellaneous financial expenses T Total Financial Expenses 58, T Total Cost of Operations Before Depreciation 1,116, T Profit Before Depreciation 993,866 Depreciation: 6600 Depreciation expense 81, Change in Unrestricted Net Assets 912,115 S Unrestricted Net Assets at December 31, ,574, Unrestricted Net Assets at December 31, 2016 $ 3,486,696 17

21 SUPPLEMENTARY PROFIT AND LOSS DATA (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 2016 Supplementary Information Related to the Profit and Loss Data: Account Revenue from investments - Miscellaneous: Interest income - Debt service reserve $ 3 S Total first mortgage (or bond) principal payments required during the audit year (12 monthly payments). This applies to all direct loans, amortizing HUD-helds, and fully insured first mortgages. $ 8,805 S Total of 12 monthly deposits in the audit year into the Replacement Reserve account, as required by the Regulatory Agreement, even if payments may be temporarily suspended or reduced. $ 5,600 S Replacement Reserves, or Residual Receipts and Releases which are included as expense items on the Profit and Loss statement. $ - S Profit Improvement Reserve releases under the Flexible Subsidy Program that are included as expense items on the Profit and Loss Statement. None 18

22 SUPPLEMENTARY CASH FLOW DATA FOR THE YEAR ENDED DECEMBER 31, 2016 Cash Flows From Operating Activities: S Rental receipts $ 2,593,044 S Interest receipts 3 S Other operating receipts 3,498 S Total Receipts 2,596,545 S Administrative (57,877) S Management fee (166,809) S Utilities (183,645) S Salaries (346,414) S Operating and maintenance (151,169) S Property insurance (55,093) S Miscellaneous taxes and insurance (101,509) S Interest on first mortgage (3,814) S Mortgage insurance premium (48,595) S Miscellaneous financial (950) S Total Disbursements (1,115,875) S Net Cash Provided by Operating Activities 1,480,670 Cash Flows From Investing Activities: S Net deposits to escrow deposits (12,803) S Net withdrawals from replacement reserve 18,172 S Net deposits to other reserves (1,063,620) S Net purchase of fixed assets (8,816,488) S Net Cash Used in Investing Activities (9,874,739) Cash Flows From Financing Activities: S Principal payments on first mortgage payable (8,805) S Proceeds from mortgages payable 6,279,145 S Other financing activities - Related party payable 2,131,318 S Net Cash Provided by Financing Activities 8,401,658 S Net Increase in Cash 7,589 S Cash at Beginning of Year 17,582 S1200T Cash at End of Year $ 25,171 (Continued) 19

23 SUPPLEMENTARY CASH FLOW DATA (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 2016 Reconciliation of Change in Unrestricted Net Assets to Net Cash Provided by Operating Activities: 3250 Change in total net assets from operations $ 912,115 Adjustments to reconcile change in unrestricted net assets to net cash provided by operating activities: 6600 Depreciation 81,751 S Amortization of debt issuance costs 822 (Increase) Decrease in: S Tenant accounts receivable 4,875 S Accounts receivable - other 494,467 S Prepaid expenses 4,690 S Tenant security deposits held in trust 1,232 Increase (Decrease) in: S Accounts payable - Operations (27,361) S Accrued liabilities 8,983 S Accrued interest payable 328 S Tenant security deposits payable (1,232) S Net Cash Provided by Operating Activities $ 1,480,670 20

24 SUPPLEMENTARY DATA REQUIRED BY HUD FOR THE YEAR ENDED DECEMBER 31, 2016 Reserve Accounts Data Schedule of Replacement Reserve: 1320P Balance, December 31, 2015 $ 594, DT Total monthly deposits 5, WT Approved withdrawals (23,772) 1320 Balance, December 31, 2016 $ 576,033 Surplus Cash and Fixed Asset Data Computation of Surplus Cash, Distributions, and Residual Receipts - Annual: Cash: S Cash $ 102,337 S Total Cash 102,337 Current Obligations: S Accrued mortgage interest payable 53,078 S Accounts payable - Operations 32,128 S Accrued expenses 24, Tenant security deposits payable 77,166 S Other current obligations - Principal payment - January ,833 S Other current obligations - Replacement reserve deposit - January ,600 S Other current obligations - Mortgage escrow deposits - January ,803 S Total Current Obligations 214,184 S Surplus Cash (Deficiency) $ (111,847) S Deposit Due Residual Receipts $ - Computation of Surplus Cash, Distributions, and Residual Receipts - Mid-Year: None 21

25 SUPPLEMENTARY DATA REQUIRED BY HUD (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 2016 Fixed Asset Data: Balance December 31, 2015 Additions Deletions Balance December 31, Land $ 197,793 $ - $ - $ 197, Buildings 3,211, ,211, Office furniture and equipment 168, , Maintenance equipment 27, , Miscellaneous fixed assets 1,173,387 11,650,871-12,824, T Total Fixed Assets $ 4,778,734 $ 11,650,871 $ - $ 16,429, Accumulated Depreciation $ 2,248,380 $ 81,751 $ - $ 2,330, N Net Book Value $ 2,530,354 $ 14,099,474 Schedule of Additions to Fixed Assets: 1490AT Description Amount Miscellaneous Fixed Assets: Construction in progress 11,650, AT Total Additions to Fixed Assets $ 11,650,871 Schedule of Deletions to Fixed Assets: None 22

26 SCHEDULE OF EXPENDITURES OF FEDERAL AWARDS FOR THE YEAR ENDED DECEMBER 31, 2016 Federal Passed CFDA Through to Federal Federal Grantor/Pass-Through Grantor/Program or Cluster Title Number Subrecipients Expenditures U.S. Department of Housing and Urban Development: Direct Programs: Mortgage Insurance - Rental Housing (Section 221 (d)(4)) $ - $ 2,040,556 Section 8 Housing Assistance Payments Program ,152 Senior Preservation Rental Assistance Contract ,217,422 Total U.S. Department of Housing and Urban Development - 3,328,130 Note 1 - Basis of Presentation: The accompanying schedule of expenditures of federal awards (the Schedule) includes the federal award activity of Grace Tower under programs of the federal government for the year ended December 31, The information in this Schedule is presented in accordance with the requirements of Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance). Because the Schedule presents only a selected portion of the operations of Grace Tower, it is not intended to and does not present the financial position, changes in net assets, or cash flows of Grace Tower. Note 2 - Summary of Significant Accounting Policies: Expenditures reported on the Schedule are reported on the accrual basis of accounting. Such expenditures are recognized following the OMB Circular A-122, Cost Principles for Nonprofit Organizations or the cost principles contained in the Uniform Guidance, wherein certain types of expenditures are not allowable or are limited as to reimbursement pass through entity identifying numbers are presented where available. The Corporation has elected to use the 10-percent de minimis indirect cost rate as allowed under Uniform Guidance. Note 3 - Loan Program: Total Expenditures of Federal Awards $ - $ 3,328,130 The following is the activity of the loan payable for the year ended December 31, 2016: CFDA Number Program Name Loans Awarded Loan Principal Loan Outstading at December 31, 2015 for The Year Ended December 31, 2016 Repaid for The Year Ended December 31, 2016 Loan Outstanding at December 31, Mortgage Insurance - Rental Housing (Section 221 (d)(4)) $ 2,040,556 $ 6,279,145 $ 8,805 $ 8,310,896 23

27 L & C Leaf & Cole, LLP Certified Public Accountants A Partnership of Professional Corporations Independent Auditor s Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards To the Board of Directors Grace Tower We have audited, in accordance with the auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States, the financial statements of Grace Tower, which comprise the statement of financial position as of December 31, 2016, and the related statements of activities and cash flows for the year then ended and the related notes to the financial statements, and have issued our report thereon dated May 10, Internal Control Over Financial Reporting In planning and performing our audit of the financial statements, we considered Grace Tower s internal control over financial reporting (internal control) to determine the audit procedures that are appropriate in the circumstances for the purpose of expressing our opinion on the financial statements, but not for the purpose of expressing an opinion on the effectiveness of Grace Tower s internal control. Accordingly, we do not express an opinion on the effectiveness of Grace Tower s internal control. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity s financial statements will not be prevented, or detected and corrected, on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. Our consideration of internal control was for the limited purpose described in the first paragraph of this section and was not designed to identify all deficiencies in internal control that might be material weaknesses or significant deficiencies. Given these limitations, during our audit we did not identify any deficiencies in internal control that we consider to be material weaknesses. However, material weaknesses may exist that have not been identified Camino Del Rio South, Suite 200, San Diego, California , fax, leafcole@leaf-cole.com

28 To the Board of Directors Page 2 Grace Tower Compliance and Other Matters As part of obtaining reasonable assurance about whether Grace Tower s financial statements are free from material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. Purpose of this Report The purpose of this report is solely to describe the scope of our testing of internal control and compliance and the results of that testing, and not to provide an opinion on the effectiveness of the Organization s internal control or on compliance. This report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the Organization s internal control and compliance. Accordingly, this communication is not suitable for any other purpose. San Diego, California May 10,

29 L & C Leaf & Cole, LLP Certified Public Accountants A Partnership of Professional Corporations To the Board of Directors Grace Tower Independent Auditor s Report on Compliance for Each Major Program and on Internal Control Over Compliance Required by the Uniform Guidance Report on Compliance for Each Major Federal Program Grace Tower s compliance with the types of compliance requirements described in the OMB Compliance Supplement that could have a direct and material effect on each of Grace Tower s major federal programs for the year ended December 31, Grace Tower s major federal programs are identified in the summary of auditor s results section of the accompanying schedule of findings and questioned costs. Management s Responsibility Management is responsible for compliance with federal statutes, regulations, and the terms and conditions of its federal awards applicable to its federal program. Auditor s Responsibility Our responsibility is to express an opinion on compliance for each of Grace Tower s major federal programs based on our audit of the types of compliance requirements referred to above. We conducted our audit of compliance in accordance with auditing standards generally accepted in the United States of America; the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States; and the audit requirements of Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance). Those standards and the Uniform Guidance require that we plan and perform the audit to obtain reasonable assurance about whether noncompliance with the types of compliance requirements referred to above that could have a direct and material effect on a major federal program occurred. An audit includes examining, on a test basis, evidence about Grace Tower s compliance with those requirements and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion on compliance for each major federal program. However, our audit does not provide a legal determination of Grace Tower s compliance Camino Del Rio South, Suite 200, San Diego, California , fax, leafcole@leaf-cole.com

30 To the Board of Directors Page 2 Grace Tower Opinion on Each Major Federal Program In our opinion, Grace Tower complied, in all material respects, with the types of compliance requirements referred to above that could have a direct and material effect on each of its major federal programs for the year ended December 31, Report on Internal Control over Compliance Management of Grace Tower is responsible for establishing and maintaining effective internal control over compliance with the types of compliance requirements referred to above. In planning and performing our audit of compliance, we considered Grace Tower s internal control over compliance with the types of requirements that could have a direct and material effect on each major federal program to determine the auditing procedures that are appropriate in the circumstances for the purpose of expressing an opinion on compliance for each major federal program and to test and report on internal control over compliance in accordance with the Uniform Guidance, but not for the purpose of expressing an opinion on the effectiveness of internal control over compliance. Accordingly, we do not express an opinion on the effectiveness of Grace Tower s internal control over compliance. A deficiency in internal control over compliance exists when the design or operation of a control over compliance does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, noncompliance with a type of compliance requirement of a federal program on a timely basis. A material weakness in internal control over compliance is a deficiency, or combination of deficiencies, in internal control over compliance, such that there is a reasonable possibility that material noncompliance with a type of compliance requirement of a federal program will not be prevented, or detected and corrected, on a timely basis. A significant deficiency in internal control over compliance is a deficiency, or a combination of deficiencies, in internal control over compliance with a type of compliance requirement of a federal program that is less severe than a material weakness in internal control over compliance, yet important enough to merit attention by those charged with governance. Our consideration of internal control over compliance was for the limited purpose described in the first paragraph of this section and was not designed to identify all deficiencies in internal control over compliance that might be material weaknesses or significant deficiencies. We did not identify any deficiencies in internal control over compliance that we consider to be material weaknesses. However, material weaknesses may exist that have not been identified. The purpose of this report on internal control over compliance is solely to describe the scope of our testing of internal control over compliance and the results of that testing based on the requirements of the Uniform Guidance. Accordingly, this report is not suitable for any other purpose. San Diego, California May 10,

31 SCHEDULE OF FINDINGS AND QUESTIONED COSTS FOR THE YEAR ENDED DECEMBER 31, 2016 Section I - Summary of Auditor s Results: Financial Statements Type of auditor s report issued om whether the financial statements audited were prepared in accordance with U.S. GAAP Unmodified Internal control over financial reporting: Material weaknesses identified? Yes X No Significant deficiencies identified? Yes X No Noncompliance material to financial statements noted? Yes X No Federal Awards Type of auditor s report issued on compliance for major programs: Unmodified Internal control over major programs: Material weaknesses identified? Yes X No Significant deficiencies identified? Yes X No Any audit findings that are required to be reported in accordance with 2 CFR Section (a)? Yes X No Identification of major programs: CDFA Numbers Name of Federal Program or Cluster Mortgage Insurance - Rental Housing (Section 221(d)(4)) Senior Preservation Rental Assistance Contract Dollar threshold used to distinguish between Type A and Type B programs: $ 750,000 Auditee qualified as low-risk auditee? X Yes No 28

32 SCHEDULE OF FINDINGS AND QUESTIONED COSTS (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 2016 Section II - Financial Statement Findings: None Section III -Federal Award Findings and Questions Costs: None 29

33 DECEMBER 31, 2016 MANAGEMENT AGENT S CERTIFICATION I, Sam Orozco, a representative of Falkenberg/Gilliam & Associates, Inc., hereby certify that I have examined the accompanying financial statements and supplementary information of Grace Tower, a project of Grace Tower, Inc. at December 31, 2016, and to the best of my knowledge and belief, the same are complete and accurate. Signature Date Management Agent: Sam Orozco Falkenberg/Gilliam & Associates, Inc. E.I.N.:

34 DECEMBER 31, 2016 CERTIFICATE OF OFFICERS I hereby certify that we have examined the accompanying financial statements and supplementary information of Grace Tower, a project of Grace Tower, Inc. at December 31, 2016, and to the best of our knowledge and belief, the same are complete and accurate. President Date