Federal officials want the city to justify $15.9 million in questionable expenditures, including money paid to private companies to buy the Hibiscus Hill apartment complex in Waipahu and the Kaneohe Elderly Apartments, or pay the money back.

David Montoya, U.S. Department of Housing and Urban Development inspector general, said in his Aug. 26 report that the city “did not comply with HUD requirements related to cost eligibility and procurement and its own award requirements.”

The report criticized the city for “a decentralized grant administration process (that) created dysfunction, inefficiency and wasted grant funds.”

The audit recommended that the Community Development Block Grant program be consolidated into one department instead of having two city departments — Community Services, and Budget and Fiscal Services — handle separate aspects of it.

Gary Nakata, director of the city Department of Community Services, told reporters Tuesday that the city’s expansive response to the audit’s findings has justified the expenditures.

“At the end of the day, we feel very confident and strongly that in a time when we need more affordable housing in Hawaii, on Oahu in particular, we did just that according to HUD guidelines and in cooperation with the local HUD office,” Nakata said. “The indisputable fact is that today, because of those transactions, there (are) more affordable housing units available.”

Nakata told reporters that he and Budget Director Nelson Koyanagi have worked well together and that he does not agree with the audit’s conclusion that there is inefficiency caused by dysfunction.

The audit concluded that the Hibiscus Hill and Kaneohe Elderly Apartments acquisitions were unnecessary.

The report suggested that the city used a “subjective” and rushed “alternative selection process” to pick a company to purchase Hibiscus Hill. The city used $8.5 million in grants and $1.5 million in loans to lend the A‘ohe Pukana La Housing LLC $10 million as partial funding for the $21 million purchase of the 80-unit Hibiscus Hill apartments in May 2014, the audit said.

While the property was described as one needing rehabilitation, only $1 million was set aside for the replacement of roofs, interior cabinetry and flooring. Two years after the purchase, only eight of the 80 units were rehabilitated at a cost of $146,616. “The relatively low rehabilitation budget and the lack of rehabilitation implementation did not support the stated purpose of the award,” the report said.

Additionally, the $21 million purchase price was $4.27 million more than the property had been appraised at, the audit said.

The audit also found that the 2015 acquisition of the Kaneohe Elderly Apartments by a private company that was awarded $2.9 million of the city’s CDBG funds was unnecessary and premature. The city had reasoned that existing federal housing assistance payment contracts requiring the rental units to be affordable will expire in 2028, possibly triggering a hike in rental prices to market rates.

But the report said there was no immediate risk to lose affordable units and no need to spend the money at the time.

The city, in its written response, said that both the Hibiscus Hill and Kaneohe Elderly complexes met CDBG’s national objective to provide or improve permanent residential units for low- and moderate-income households. Both were also closely reviewed by HUD’s Honolulu Community Planning and Development program office, the city said.

On the audit’s skepticism that the Kaneohe purchase was urgent, the city said it did not believe that demonstrating “certain or imminent” loss of affordable housing was a requirement.

The audit also questioned other CDBG program procedures.

The city allowed one of its grantees to give a contract to one of its affiliates; restricted competitive procurement; did not follow its award requirements; and did not review program income adequately, the audit said.

An affiliate of Hunt Companies Inc. awarded a $3.4 million construction contract to another Hunt company, $1.45 million of which was from CDBG money, according to the audit.

“The city did not have adequate policies and procedures in place to ensure that a potential conflict of interest did not affect the integrity of the procurement process,” the report said.

The audit further said the city arbitrarily amended two requests for bids to expedite the process in order to meet its deadlines for spending the federal funds.

The audit said that “for several years, the city has struggled to pass the CDBG timeliness test” that requires a percentage of the grant money to be spent by a certain date each year or risk losing future grants. The city has been receiving about $7.5 million annually in recent years.

In response, the city said its “attention to timeliness should not impugn the legitimacy or validity of the city’s selection process, the selected projects, or the city’s motives.”