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PLEASE NOTE: The following transcript is a portion of the official hearing record of the Committee on Transportation and Infrastructure. Additional material pertinent to this transcript may be found on the web site of the Committee at [http://www.house.gov/transportation]. Complete hearing records are available for review at the Committee offices and also may be purchased at the U.S. Government Printing Office.
INNOVATIVE FINANCING FOR ACQUIRING REAL ESTATE AND SCORING ISSUES
THURSDAY, MAY 15, 1997
U.S. House of Representatives,
Subcommittee on Public Buildings and Economic Development,
Committee on Transportation and Infrastructure,
Washington, DC.
The subcommittee met, pursuant to call, at 10:00 a.m., in Room 2253, Rayburn House Office Building, Hon. Jay Kim (chairman of the subcommittee) presiding.
Mr. KIM. Good morning, ladies and gentlemen. The subcommittee will come to order. I welcome the members this morning to this meeting of the Subcommittee on Public Buildings and Economic Development. If anybody is in the wrong room, this is a good time to leave.
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This is the third hearing we have held concerning this GSA rent shortfall, seeking alternative financing options to support continuing capital investment program. The testimony at the first two hearings focused on the costs, how they happen, why they happen. Today we are going to talk about how to solve this problem by using some alternative financing methods. Therefore, this meeting will have focus in different—different focus.
The topic is of great interest to our Ranking Member of this subcommittee, Mr. Traficant, who is not here yet. His bill, House Resolution 623, addresses the subject of today's hearing.
However, I would like to make just a couple of comments just prior to this hearing. Today, the subcommittee was fully prepared and indeed expected to receive testimony from one of the key agencies responsible for determining the existence and size of the Federal Government's capital investment program, the OMB. However, initially—after initially accepting our invitation, OMB informed us yesterday that they cannot be attending today.
This is second time that OMB has backed away from testifying before this committee. I am very disappointed. And I understand in a letter dated May 9, 1997, that the Director of OMB, Mr. Raines, assured us that Mr. Jacob Lou would be attending. I regret that OMB has chosen not to engage in this endeavor. I am very—I wouldn't be tolerant of this kind of relationship; and if OMB does not view the investment of taxpayers' dollars in the Federal Government real estate holdings—they don't think it is an important topic, I have a serious problem with them.
As the Chairman of the subcommittee, I do not appreciate OMB's treatment of this subcommittee's invitation. Their behavior is totally unacceptable, and it is not going to be tolerated. I also express my regret to the gentleman from Ohio, Mr. Traficant, who made it clear at our last hearing that OMB has a significant role on this discussion.
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Nonetheless, the subcommittee is pleased to receive testimony from our other witnesses. I would like to welcome them. We have outstanding witnesses today.
At this time, does any member wish to make a statement? All right, hearing none, we will just proceed.
This is going to be a general vote. We are wasting taxpayers' money. That is what I thought, general vote.
Our first speaker will be Mr. Peck. I would like to welcome again Commissioner Peck. We appreciate your attendance this morning. I hope you can bring us some enlightened good news about the alternative financing.
TESTIMONY OF ROBERT A. PECK, COMMISSIONER, PUBLIC BUILDINGS SERVICE, U.S. GENERAL SERVICES ADMINISTRATION
Mr. PECK. Thank you, Mr. Chairman, and Mr. Lampson. I have a brief statement, very brief, which I would like to submit for the record, and I would like to summarize a bit; and then I am prepared to answer your questions.
Let me say to you at the outset, I am going to talk about some of the management actions we have taken to deal with the accuracy and reliability of our data and our rent collection system. That is my formal statement. And I am prepared to respond to questions about alternative financing. And we have done quite a bit of homework on that as well.
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As I have testified previously, one of the things that we have had under way for more than a year is the acquisition of a new computer system to track our real estate inventory. It is a system that we are acquiring from AT&T. They have used it to monitor their real estate inventory for some time. It is called the STAR system.
Because one of the problems that we have encountered in dealing with our revenue gap this year, and in previous years for that matter, is figuring out reliably what we have in our inventory which is spread across 1,800 government-owned buildings and 6,200 leased locations across the country. We do not have a system that has given us reliable information about vacancy, occupancy, rental rates, and the like. To ensure that our transition to this new system is efficient, we have taken the following actions since I last appeared before you:
We have asked the GSA Inspector General to audit our inventory data, because there is no sense moving to a new computer system if the data that goes into it is garbage. So we will take a statistically significant sample of the GSA inventory. We will physically measure those—the buildings, the actual square footage. We will check it against data in our existing information system, including how much square footage we count in our lease payments from Federal agencies and the square footage they are using to build those tenant agencies. We will also audit such things as rental rates, space classification and specific agency assignments.
If the initial results of that review indicate the need, we will expand that inventory verification to additional buildings, using outside contractors probably until we are satisfied that the database is accurate.
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And it is important, we believe that we will be able by this fall when the system starts to—the STAR system starts to come on-line to have an accurate database that, one, that we can rely on and that our people in the field will be able to rely on and therefore use and update. One of the problems with our current system is that the system is so cumbersome that our property managers in the field, I am quite certain, do not use it very much. So the data has become stale and is often not accurate.
Further, and I alluded to this in the last hearing, we have over the past several months, beginning back in about February, put into place a number of interdisciplinary agency-wide teams within the Public Buildings Service charged with examining such things as the rent forecasting system, the effective downsizing of our inventory and rent stream and strategic financing, the subject of this hearing this morning. I am looking for recommendations from those teams within the next couple of weeks, in fact.
We have also instituted a weekly financial management meeting with the senior managers of the Public Buildings Service, as well as GSA's chief financial officer and budget director. We have a new chief financial officer in the Public Buildings Service, who has an MBA and a CPA. We are conducting intensive quarterly reviews of monthly income and expense data, tracking our billing and collection systems and monitoring data on a monthly basis to see where we were.
Thus far, in the current fiscal year, we are experiencing normal month-to-month fluctuations in our revenue. We are within what we consider the normal range of fluctuations in a year, which is within about 2 percent of our projections. That is our historical basis in a year for being off from budget projections, which were made 18 months in advance, and so we are fairly confident that we are on track with the budgets that we have presented to you before.
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Finally, if there is a way to make lemonade out of this lemon of a budget gap that we have, it is this: that this shortfall from our projections has caused us all to focus much more intensely on the health of the Federal Buildings Fund—the way it is managed, what it can produce and what it can't produce, and the need possibly for alternative means of providing funding for—particularly for our capital projects, by which I mean new construction and major rehabilitation of our buildings.
Mr. Chairman, I am prepared to respond to your questions.
Mr. KIM. Mr. Peck, thank you. We should take about 15 to 20 minutes' recess.
[Recess.]
Mr. KIM. I would like to reconvene our meeting.
Mr. Peck, you finished your testimony, right?
Mr. PECK. Yes, sir.
Mr. KIM. A couple of questions for you. I want to make sure that we understand clearly what the problems are.
It seems to me that—if I am wrong, you can point out to me—we have this huge revenue deficit, revenue loss, 700 million, roughly. For that revenue loss, you propose to stop all the projects, 1998, which we can not accept. Those projects are vitally important. Some projects require some modifications which involve public safety. We just cannot compromise these projects being stopped.
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So I ask you, what is—is there any way we can just go on and continue these projects at the same time, and then overcome this huge loss spread out for I don't know how many years and ask you to come back with some kind of innovative financing idea, how to finance these projects that were committed, budgeted, authorized last year, plus new ones?
And then I reviewed your information and found out that you have got another problem. The scoring system is pathetic. I have never seen such a scoring system in my life. Private industry, they don't do that. Obviously, even though you know there are certain options, such as buying or lease/option to buy, but your objective—that is the best way to go to save the taxpayers money, but you don't exercise that option because of scoring system. That is, you know, unbelievable, project after project doing exactly the contrary. That is a second shock to me, why we do such stupid things; I never understand that.
So we have got two problems. One is huge revenue loss, the other one is the scoring system.
Now, instead of criticizing, I would like to find a way to fix this. We are going to have a separate hearing with OMB to find out why they have such a strange scoring system, actually hindering operation. Not only is it totally wasting public monies, it is pathetic.
Now, going back to this innovative financing, I don't know; I haven't heard anything from you yet, sir, what kind of idea you have to finance these projects. You have got several options: the lease to purchase, buying it, building it. There are six ideas.
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And can't you borrow the money from a conventional bank using this building as collateral? Can't you borrow from—you have to wait until this—this, what do you call, this devolving fund?
Mr. PECK. Federal Buildings Fund.
Mr. KIM. Yes, FBF.
That is kind of ridiculous to me that you wait until enough money is deposited and then spend all of it at once. Is there any way you can have some other way to spread out this program, and also get private funding or government funding to proceed with the projects and then make installments, just like everybody else is doing? Tell me why you cannot do that.
Can you tell us any idea you have at all, how to finance all the projects in 1998, instead of freeze up and stopping this?
Mr. PECK. Well, Mr. Chairman, let me respond this way. If you will allow me a few minutes, I will—I will.
Within the—there are a number of ideas which I can put on the table and which some of your private sector witnesses and Mr. Franklin from the Architect's Office, the Architect of the Capitol's office can also present. I am of course constrained by the fact that I represent the administration and cannot make a recommendation to you at this moment on behalf of the administration.
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So let me say, if I may, two things. One is, I do know that the Office of Management and Budget was prepared to testify today. I spoke to Mr. Lou, the deputy director last Friday, who was preparing to come, and I do know they prepared draft testimony. And I think the ongoing budget negotiations following the budget agreement have kept them away.
I am happy to hear you will have him up here, because he can speak better than I can as why the scoring rules are instituted. And they have to do with—again, I can say no more other than they have to do with the impact basically of the $1.7 trillion Federal budget on the economy. So there is some logic to it.
At the same time, I have to note that most government jurisdictions in our country, other than the Federal Government, do separate capital expenditures and the capital budget from the operating budget. And, indeed, President Clinton has established a Capital Budget Commission to take a look at the possibility of a capital budget for the United States. And that would have a tremendous impact on our program. A lot of what we do would be in the capital budget.
So let me say—make a couple of notes about the Buildings Fund and why we are in the situation we are in, and why it is true, as you point out, that it is—let me just say this. If we were a private sector company with an income stream which appears to be down because we have downsized, but which nonetheless is $4.7 billion a year, and an asset-based, depending on how you assess our buildings, I believe of something on the order of 20 to $25 billion in installed assets, if you had what we are experiencing, which is a 7 percent revenue gap in each of 2 years, you would probably go to the private sector and say, I will either—I can place my $24 billion worth of assets up as collateral or I can guarantee you a $4.7 billion income stream out of which I can repay a loan. You wouldn't have a very difficult time getting very favorable rates in the market. And, of course, in fact, the reason the Federal Government gets such favorable rates in the capital markets is that it can guarantee repayment. And we could, too.
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Let me note how our Buildings Fund works; I want to run a little bit how we got to where we are, because it lays the groundwork for what I think we need.
The Federal Buildings Fund was a good idea and is a good idea. It has Federal agencies pay rent to the GSA for their space. It makes Federal agencies take account of the cost of that space. It uses market economics to make Federal agencies be as efficient as they can be in real estate to economize on their space. It encourages the GSA to be market-like in thinking about expenses and revenues. We can compare expenses and revenues in a building; that makes us more efficient if we manage that properly.
A couple of things that I think Congress thought would happen with the Buildings Fund have not played out and have led to our not having the funds that we need for capital projects; and in this discussion, I will define ''capital projects'' as new construction, acquisitions—purchases of buildings, that is—and major rehabilitation and replacements in Federal buildings as opposed to minor repairs, which are sometimes in our accounting called a ''capital expense'' as well. So I am holding to construction and rehabilitation.
Congress, when it passed the legislation in 1972 establishing the Buildings Fund was looking at a program in which about 75 percent of our inventory was owned by the government, and buildings which were even then somewhat old. And I will show you a chart in a moment which shows how old our inventory actually is. What has happened since is that a larger chunk of our inventory has gone to leased buildings.
In our own buildings, we obviously at some point, like any building owner, built up a surplus. As buildings depreciate, you own the asset, you operate it, but you actually have money available to put aside, in essence for a rainy day, for major repairs and rehabilitations. When we lease space from the private sector, we basically charge Federal agencies about the same rate that we pay to the lessor. So we don't make—we don't have an income surplus there that we can apply to renovations. That has eaten away what I think people thought would be a reserve building up in the Buildings Fund.
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Second, clearly Congress—and this is another reason I support the Buildings Fund—we are in much better shape having a reliable and predictable source of funds from Federal agencies, as is true in like the Highway Trust Fund and airports, than if we were dependent every year on appropriations from Congress, and because of budgetary situations that can be all over the place.
Here is another reason the Buildings Fund has not built up the kind of money it needs to finance new construction and renovation. When unforeseen major expenditures come up, such as in the last couple of years the additional $240 million on security we have spent since the Oklahoma City bombing, we have taken that out of the Buildings Fund, out of our—we have managed to operate our buildings, but that is money that otherwise would have been available to pay for new projects or rehabilitations.
When the Federal Government enacted seismic standards which are certainly laudable, but which, in some cases, are higher than the prevailing seismic building standards in other areas, we paid for that. We paid for asbestos abatement out of the buildings fund.
Some of our clients have expanded significantly, like, like the courts. And we have had to spend money providing space for them. There are also competing public policies. There are rent caps imposed on our fund that would not happen if you were in the private sector. We lose something like, someone correct me if I am wrong, from about $65,000 a year from rents we would otherwise collect from social security and other trust fund agencies because by law we only charge them our actual costs rather than market equivalent rents.
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Now, as a matter of public policy, to be fair to those who impose that, that is $65 million that those agencies have available to spend on other things, and valuable and—in the pursuit of laudable public policies. Finally, when we sell our assets, in the private sector, if we were to sell a building we no longer needed, we would take that money and have it available to spend on new acquisitions or rehabilitation. In our case, in most instances, the money is paid into the Land and Water Conservation Fund to be used for, again, for laudable environmental goals, but doesn't go to the Buildings Fund.
The scoring rules, obviously, are peculiar when they come to us and we have thought about this a lot. What is it about the scoring rules that make things sort of difficult for us? It is this; that the scoring rules say that if you pay for a building, you have to pay for it all up front. Even if you are leasing it from the private sector for 20 years and have a one-dollar option at the end to own the building.
The scoring rules tell us that in that case, it becomes very much like a purchase and we have to score all of those payments up front. That makes it very difficult for us to take advantage of, one alternative financing procedure the private sector would use.
The scoring rules make it difficult for us to time our major renovation and construction expenditures, because is the crux of a serious problem we have: We are all looking now, because of this revenue gap, at the fact that we will not have major funding for new projects next year. But I have to tell you, I am equally concerned about the fact that, over the past 20 years, we have not had sufficient money to rehabilitate our buildings at the rate we should.
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And if I can show you why that is significant. This is a—this is a chart—when people go out and invest in real estate, I can tell you that they like to look at buildings that are less than 20 years old. At the 20-year date in a building you know that you have major work to do. Almost every building 20 years later becomes obsolete.
I will note that most major construction that has taken place in the Federal Buildings Fund over the past 20 years or a good chunk of it has taken place because of a number of specific programs which the Congress funded. In the mid-70s, the Congress funded a purchase contract program in which basically we did go out and pay for buildings over time and own them at the end of that time.
Those buildings are now 20 years old. We built 68 buildings under that program. They all now need major rehabilitation. Similarly in the late '80s, Congress gave us authority for 11 or 13 lease purchase projects, same sort of thing, many of those which are just now being built. But I can tell you 15, 20 years from now they are going to need rehabilitation.
Our inventory is an incredibly old inventory. We have a lot of historic buildings. They are wonderful. The average age of the buildings are over 50 years. You can see in gross feet the total inventory of about 200 million square feet. You can see here less than 20 years old, 37 million square feet. So we have a huge need for rehabilitation funds. Those need to come out of the Buildings Fund.
New construction needs to come out of the Buildings Fund at this point. And here is the bottom line, over the 20 years, if you look at—let me show you another chart. If you look at the funds which we have had available from the Buildings Fund, I can tell you that, and I would like to see the requirements for repair and alteration to—if you just look, we have enough money building up in the fund every year even with the rent caps and all that other stuff to do one of two things but not both.
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We wind up with enough money to build new facilities or acquire them at the rate of say $400 million a year in most recent terms, or to renovate our buildings, for which we believe we need something like 6 to $700 million. Here is the actual money we have been getting for rehabilitation, somewhere down more like 300, $350 million, so we are funding about half the renovation needs that we have.
Now, some of the money that should go to rehabilitation, is going to new construction. We cut into our rehabilitation needs to build new buildings. But also in the last 4 years, Mr. Chairman, most of our construction funds have come from congressional appropriations. So I have to say, what I think the OMB would say is that the solution to needing more, to building more buildings is to get an appropriation. And it is true, in fact, that when you look at the Federal cost of borrowing versus any of the alternative financing schemes that I will describe to you, the Federal Government borrowing the money, putting it up front and building the building strictly in financial terms is probably the cheapest way to go.
Of course, the Catch 22 here is that it is difficult to get an appropriation up front. So it is fine to say that that is the cheapest way to go, the only problem is given the constraint under Federal budget, we can't get that money. So I just want to lay that on the table. That is one of the problems that scoring gives us.
Scoring on a project like this, because from year to year we are trying to find the money in the budget to rehabilitate buildings and build new ones, it means that while if I were in the private sector I would know in 1997 with buildings 20 years old with a purchase contract program I would need a chunk of money to rehabilitate. I would go to the market and borrow the money. I can't do that. I have to come to the Congress.
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I don't know whether I can get the money. And I can't tell you how many agencies are asking us why their buildings are old with major requirements for new air conditioning systems or heating systems or elevator systems, and I have to continually say we can try to get the money, but the cost of rehabilitating your particular building is $100 million. It is hard to get that kind of line item appropriation. So what can we do?
We have the—let me just say this? There are lots of ways to cut this. And some of them Congress has approved in the past. One is to provide—we could take—I am focusing on rehabilitation because it is one of those things, sort of like operational funds in the military that often get lost in the shuffle as people focus on new things. But like I said, if we could spend Federal Buildings Fund revenues on rehabilitation, and get an appropriation for new construction, we would be fine. If we could, again, get an appropriation for rehabilitation and use Federal Buildings Fund for new construction, we would also be fine. We don't have enough money for both. We could, and getting an appropriation, as you know, is very difficult.
The Congress, in the past, and as I mentioned in—two cases in the last 20 years has come up with a program in which the Federal Government, in essence, borrows money from the private sector or from the Federal financing bank to build new Federal buildings. And that is an option which we have before us today to.
I only note one concern I have that goes back to rehabilitation. I am a little worried that, sometimes, if I do a project in which the private sector builds it, we lease it for 20 years, and then we own it, unfortunately, at the 20-year point is just when it needs major expenditures. And once again, we run into the fact that we can't get money for rehabilitation. So I may be stuck with not such a great asset.
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Here are a couple of other alternatives I would like to mention. We would get more money if we changed the way we had to deposit funds from building assets that we get rid of. We do have some buildings that are obsolete that we can sell, but like I said, proceeds from those at the moment going to the Land and Water Conservation Fund do not come back to us.
There are any number of ways in which we could partner with the private sector in building new facilities or rehabilitating them. Where we have vacant Federal land, we could have the private sector—obviously, one option is have the private sector build the building, we lease it from them, and then at the end of the time we own it. Or we can ground rent the land to them.
However, OMB, again, scores those as full Federal construction because it is on Federal land. And knowing that we will own the building, all of the installment payments get scored up front.
Another possibility which, Mr. Chairman, you and I have discussed once, is what private sector people do, which is a sale lease back. Now, sale lease back, it is quite—most appropriations that do sale lease back, which is to say you sell off your asset and then lease it back from the person who bought it, because they still wanted to use it, a lot of corporations do that because they decide they want to get out of the real estate business. I don't want to get out of the real estate business. I don't think the government wants to get out of the real estate business. But it is a way to get an influx of funds. What you do, of course, is give up the valuable asset over time.
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Finally, let me just—let me make—I will have three other points. One, if you borrow money, there are two ways you can do it. One is you can borrow using the Federal Government's borrowing facilities, which is, of course, at a cheaper rate of funds. Or, second, you can just lease a building and have the private sector borrow the funds.
In essence, when you see a lot of proposals from us, including some that are coming up on the headquarters of Federal buildings and suggests that, that suggest that we lease that space, because of scoring rules, usually, we should note that what we are really doing is just asking the private sector to borrow the funds and build a building for us. The private sector borrows funds at a higher rate than we do. Nonetheless, as often as, you know, avert to that choice, because we don't have any other choice for getting a facility built.
I also note that this, although this is not a new way to get new facilities built, and I think—and one of the other witnesses will talk about this in greater deal, we can also cut our costs in part by changing the way we do leases so that private sector people who lease to us would be able to use commercial mortgage-backed securities to bring down their costs of borrowing. Because we are—some of the people we lease from have a number of buildings with Federal leases in them.
If our leases, lease clauses are changed and we have looked at this, they could bundle those leases together, go to the capital markets and borrow money at a cheaper rate. If we are smart and we are smart, we will make sure that they rebate to us some of the savings from that borrowing.
In essence, then, what I am telling you is that there are a number of ways that we can change the way we account for our construction. I would note that it—the simplest and most direct way to get projects funded in fiscal year 1998 is Congress to decide simply to appropriate more money to get the buildings built. But as I note, there are other alternatives involving, mostly involving various forms of boring which could get us to the same place. And, again, I really do want to emphasize one of the things we are—what I will continually present to you is to focus on the need for capital expenditures, both in rehabilitating buildings and investing in new ones. And the reason I mention rehabilitation also is that as we downsize, as the government is downsized, one of the reasons, as we described to you, is that $232 million of the 700 million that we have not collected over the last 2 years is because Federal agencies have given space back to us, for which we still have to pay, but when which—but we don't have the resources to modernize that space, move agencies around so we can take best advantage of it and lower our vacancy rate. So there, in essence, is our—is what I can tell you about—about various things that we have looked at.
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Let me note one other thing, Mr. Kim, in response to a question you had before. And I want to be careful about how I say this, because it will ruffle some feathers. You asked if we could raise rents to solve some of this income gap. And I responded to you and still hold to this answer that we cannot arbitrarily raise rents. We are supposed to charge commercially equivalent rents. Where we find we are below the market, we can, in fact, raise rents.
Here is another way that we can change the way we calculate our rents and we have taken a look at some of these numbers. When we build special purpose facilities like border stations, courthouses and laboratories, we charge rents. We attempt to make commercially equivalent rents at the moment by trying to make a comparison between that and private sector buildings. Well, the private sector doesn't build courthouses, border stations; they build some laboratories, but our facilities are unique.
In the private sector, if you were to go to a developer and I need a unique laboratory, which nobody else is probably going to be able to use if we were to ever move out, the private sector would say, I will tell you what, I will build it for you. I will figure out what it costs me to borrow the money to build it, what return on investment that I want from this money, and I will charge you a rent that reflects my cost of building this thing and borrowing money.
What they will say, in essence, is if you are going to rent this from me for 20 years, I will compare the rent you are going to give to me by what I would get if I simply invested the construction cost in government funds or stocks or something and I want the same rate of return. We have taken a look at what the rental rate on some—on a typical courthouse would be if we did that rate of return. And we got some interesting—we got some interesting answers. But I want to assure you, these would not in any significant way solve the $350 million a year revenue decline we have experienced.
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In low-rise and mid-rise—in the smaller courthouses, I have looked at larger ones actually on a rate of return analysis. The rents we are charging are about right. On smaller courthouses the rents would probably increase by a couple dollars per square foot.
Mr. KIM. Mr. Peck, we still have a lot of witnesses. Would you wrap this up please?
Mr. PECK. Yes, sir. If we were to charge rents on courthouses on a return of rate analysis we might get a couple of million dollars extra into the Buildings Fund for those rental rates. I should also hasten to point out that if we did the same rate of return analysis on some of our older courthouses we would probably have to decrease the rents we charge the court so it might well be a wash. At any rate, those are a number of alternatives.
Mr. KIM. Thank you. I am afraid to ask any more questions.
Mr. PECK. That was in lieu of the prepared statement I gave.
Mr. KIM. I would like to reserve my comments and questions later after hearing all these other witnesses.
Do you have any comments or questions to make, Mr. Traficant.
Mr. TRAFICANT. Yes. Mr. Chairman. But before I do, we are graced with a new member of our subcommittee, a young Democrat from Texas, the Ninth District, Nick Lampson, from the Beaumont area. And I am not sure if that is where old Herman Driver was from, the great receiver all-star setting receiver.
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Mr. LAMPSON. Who?
Mr. TRAFICANT. Herman Driver from Texas Southern. Maybe it was Brownsville. But I want to introduce Mr. Lampson here. He is from the former district of Jack Brooks, and, man, that really set a precedent down here. So, Nick, you have big shoes to fill.
Mr. LAMPSON. I don't smoke cigars, but thank you, Mr. Traficant. It is a pleasure to be here.
Mr. TRAFICANT. I have a couple comments I have to make. I notice OMB is not here. They probably have somebody sitting here. I am a little disappointed. Because the heart of the problem at GSA and financing Federal real estate transactions does not lie with Robert Peck, nor GSA. It lies with OMB. And unless Congress has become background music in a doctor's office I think something has to be done, because Mr. Peck, you are giving us all kinds of excuses how you are trying to machinate some reasonableness into this financing scheme with scoring rules that defy the logic of the Three Stooges. I am going to ask the Chairman to leave the record of the hearing open until OMB honors us with their presence.
And furthermore, I recommend that a subpoena be issued forthwith for OMB to comply with the subcommittee that has oversight. I am going to make a formal request of that a little later here. But I want to just state this for Mr. Peck and for those who cover this, the following preliminary information regarding the present value cost advantage of using lease purchase over leases. I will reflect for just the following projects.
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For the Department of Agriculture space in Kansas City, $26.3 million. For the Agricultural and Army Audit Agency space in Northern Virginia, $13 million. For the Federal Emergency Regulatory Commission in D.C., about $9 million. For Internal Revenue Service space in Fresno, California, almost $8 million.
This adds up to almost a 60 million cost advantage, which could have accrued and enured to the benefit of the United States taxpayers were it not for scoring rules that are stupid, nonprogressive, are not cost-effective, and destroy our competitiveness.
Without getting back, Mr. Chairman, you were not here at that time. In that subpoena, there should be a specific questions raised again: Did OMB sign off on a 30-year lease at $25 million a year in Atlanta, Georgia, with no equity position? That is three-quarters of a billion dollars. And the taxpayers, at the end of 30 years in that high price market, would not have any ownership and have to release. And they are not here.
And Mr. Peck doesn't deserve to be pecked at here. I think—he has done a fine job. And I think that some of the animosity is coming out because of this disgust is being unduly channeled at GSA who is trying within the tremendously foolish environment trying to craft some business deals for us.
So Mr. Chairman, I ask unanimous consent that unless there is an agreement forthwith from OMB to attend a future hearing in a reasonable period of time, that a subpoena be issued from this committee—subcommittee and committee, which would compel OMB to come in and discuss the issue of scoring which has cost taxpayers hundreds and hundreds of millions of dollars.
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Mr. KIM. Any objections?
Mr. LAMPSON. None.
Mr. KIM. Without objection, so be it. Is that illegal?
I would like to move on to the next speaker, Mr. Franklin, Executive Officer, Architect of the Capitol.
Mr. COOKSEY. [presiding.] Mr. Franklin, you can proceed. I apologize for being late. This is my fourth hearing in the last couple of hours, so, they do make freshman work. But anyway, if you would respect the 5-minute rule on this time limitation.
TESTIMONY OF HERBERT M. FRANKLIN, EXECUTIVE OFFICER, ARCHITECT OF THE CAPITOL
Mr. FRANKLIN. Thank you, Mr. Chairman. I would like to submit my statement for the record, and I will just simply abbreviate it and perhaps embroider it a bit. I am not an expert on the OMB scoring conventions, but I do know a lot about the Federal Judiciary Building, which sits on this campus less than 10 minutes away. And I strongly urge the committee and the staff to see the building. If they wish to, we would be glad to give you a tour of the building.
I think it is a model for innovative financing. And, fortunately, we were able to close the financing before OMB knew what we were doing. And we could not do it again, because of these scoring conventions, which the Chairman properly described as ''pathetic.'' Another word might be ''crazy.''
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I can speak more candidly than Mr. Peck, because I am not constrained. I am not here as a spokesman for the administration. I am here as an agent of the Congress. And I happen to think, if that scoring convention needs to be changed, it probably will have to be changed by legislation. I hope this exercise by this committee, which I think is a terribly important exercise will be successful. But 7 years ago, Senator Moynihan brought the Deputy Director of OMB before him on the very same subject and got a promise from him that they would be changing their scoring rules so as not to inhibit the financing of Federal capital acquisitions. And, in fact, Mr. Diefenderfer told Senator Moynihan he would be glad to tell him on a weekly basis of their progress in changing the rules.
And Senator Moynihan graciously said, well, you can just inform us on a quarterly basis. I have to observe that 29 quarters have gone by and there has been no change in the scoring rules. The Federal Judiciary Building was financed in an innovative way, as has been set out in my statement, and I don't propose to repeat the technical aspects of that at this point. But let me say that I think it is a model that can be followed by the Federal Government, because it is really the best example I know of of a public-private partnership that was created to get that building built. We often hear a lot of rhetoric about public-private partnerships, but this is one that is there in reality and has a lot of aspects of success to it.
It consolidated several agencies of the judiciary, which were previously separated amongst a lot of buildings paying GSA rents that were continually escalating. And it brought them into one building where a base rent is going to be paid by them for 30 years that will never change because of the nature of the financing. Therefore, it is going to be saving the taxpayers a tremendous amount of money. And after the end of 30 years, that building will revert wholly to the United States Government, which is now leasing it, without the payment even of one dollar. We will never have to be charging rent to the judiciary after that point.
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The United States will then have the building free and clear at enormous savings to the taxpayer. We have set up an operating reserve under this financing—this was brought to my mind when Mr. Peck described the problems he has in rehabilitating older buildings—which we think is sufficient so that we will never have to come to the Congress for appropriations to rehabilitate that building after it ages. The building has been, incidentally, in operation for 5 years and it looks as fresh and clean as the day it opened. And, again, I invite you to tour it.
The private sector actually developed the building under a development management agreement with the Architect of the Capitol, and they brought it into completion under budget and on time at significant savings to the taxpayer. Now, let me mention one thing about the way in which this financing was structured. The future rental income stream of the building was monetized, to use the Wall Street expression, and then securitized with certificates of participation sold to investors.
We got enough money from that sale to build the building. We took the money when we got it and put it in an interest-bearing account at the time the building was being developed. In fact, unlike the conventional private sector development, if there had been a delay in construction, we would have been earning interest on the money instead of having to pay interest on the money. But nevertheless, the building was fully developed on time. And the investors are being paid now as the rent comes in appropriated to the judiciary.
So $8,615,000 in appropriated rent comes in on the first of February and the first of August to the AOC. We give that money to the trustee, and he pays off these obligations that mature serially.
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Now, in the unlikely event that the Federal Government didn't appropriate the money for the rent which is used to pay off the investors, the investors do not have the right, legally, to accelerate the full indebtedness. They can only go to the Court of Claims and sue on their particular certificate. So OMB, when they looked at this, said, well, no, this is a capital lease and there is this long-term legal commitment of the Federal Government. Well, in fact, there is no long-term legal commitment of the Federal Government.
The Federal Government is paying rent as it would in any other building for a Federal agency. We take that rent. We pay off each certificate as it matures. And at the end of the 30 years, all those certificates will be paid off. The building will be free and clear. There will be no more rent to pay. And we will have our own building rent free. And it was not a full faith and credit obligation to begin with. It was something like a full faith and credit obligation, but we have to pay a little premium because it was not a full faith and credit obligation.
Now, what did OMB do about all this when they finally discovered what we were doing? They said this is like a direct Federal purchase and, therefore, we have to score this at $142 million up front. Not only did they do that, but I suspect—I haven't had the chance to check—but I suspect they are still scoring the $70.5 million rent being paid every year. So under the scoring convention, this building is being paid for at least twice, instead of actually scoring it as they should have, $17.2 million a year for rent, because that is all that is being appropriated for this building.
So I think from an economic and legal standpoint, this is very much like a straight lease with the government ending up with the assets. The scoring convention that we are now being told is in existence is crazy. And, of course, under it we couldn't do this financing again. So what seems to be happening is that OMB is saying, well, you know the cheapest way to finance Federal buildings is through direct purchase. And then they come up with a scoring system that says for direct purchase, we are not going to allocate budget authority or outlays over the life of the asset. We are going to allocate it up front as though it were a paper clip or fuel oil. They do not have a capital budget approach to these assets.
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Let me conclude my brief oral statement by saying that there is another approach, also, although I think ours is a model. It seems to me the government should regard its accumulated real property asset base like any private asset manager would. A lot of those assets are underperforming or nonperforming, possibly because of what is on them, possibly because of where they are located.
It may be possible, taking a holistic view of the government's real property assets, to say to the private sector, you know, we need an office building over here. But maybe if you look at our accumulated asset base and our list of nonperforming and underperforming assets, you can realize and unlock value in them if we cut a deal with you. Maybe the land is valuable. We will give you that land over there if you in turn build us this building over here.
The Postal Service has done this, I am told, with great success and has actually used a lot of their accumulated real property in a way that has brought the private sector in so it can unlock the value for the private sector and, in return, produce value for the Postal Service. We don't look upon the District of Columbia these days as necessarily an innovative financing vehicle. I am sure Congreessman Davis knows much more about this than I do, but take the Stevens School downtown in the District.
Stevens School is an obsolete public school, but it happens to be sitting on land that is quite valuable. And I understand that under the school closing program, what they are basically proposing to do is say to the private sector, take this land and this asset, build us a new school, and use this land to achieve something that you think is of value from the standpoint of your development program. And that way, the accumulated asset base of the District in terms of that public school is going to be used to unlock the possibility of getting a new school while the private sector gets something that will be of value to them as well.
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So I think that model is another model that should be explored in terms of the Federal Government. But as I say, within 10 minutes of where we sit, there is a model you can look at for innovative financing. And it is not possible to do it again unless we change the scoring rules. And that is all I have to say at this point. I am glad to answer your questions.
Mr. COOKSEY. General question. Do you think the taxpayers, and that is who we all really are supposed to be working for, and I just left that private sector a few months ago, would be better served by the models that you have alluded to this morning, these two, one for certain and another one possibly, or do you think we—the taxpayers would be better served by some models that are set up by politicians, bureaucrats? Easy question.
Mr. FRANKLIN. Let me pay tribute to the Congress because the Federal Judiciary Building was developed under legislation passed by the Congress and under the oversight of a special commission of the Congress. However, my written statement points out there was a great deal of study and analysis that went into that. And so the Congress was guided by a lot of experts who developed that financing model. And I think that, yes, the taxpayers would benefit tremendously if that model were adopted, because while the government can borrow more cheaply than the private sector, the private sector, in my judgment, can develop more cheaply than the government. And if the private sector can develop in a faster time and with less bureaucratic delay, which is the indication in our situation, you can analyze those savings.
We had a lot of construction savings in that job which were put in interest right away. In fact, we are still making some investments in that building which are project-related. For example, the security enhancements that are required because of the upgrading that is going on throughout the government are being paid for by construction savings, which were put at interest and are now being tapped to pay for those enhancements. And 20 years from now, 25 years from now when the building needs rehabilitation, maybe a new roof, new mechanical systems or what have you, that money has been set aside in interest under the financing. And we will not have to come to the Congress for an appropriation from the taxpayers. And, again, as I said, after 30 years, the taxpayers will have this building free and clear. So, yes, the answer is, yes.
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Mr. COOKSEY. That sounds good. I would like to acknowledge that Congressman Davis is here. I think he might be able to shed some light on this. And Congressman Blumenauer is here. But I would like to hear from my colleague, Mr. Traficant. He, I am sure, can shed some light. He always has some words of wisdom.
Mr. TRAFICANT. Thank you, Mr. Chairman. Mr. Franklin, if the AOC had to complete this process under today's scoring rules, do you have any kind of an analysis of what the estimate of this thing would be, the cost of it?
Mr. FRANKLIN. There would be a political impediment, first, Congressman Traficant, because the OMB scoring rules would hit us or hit—hit the legislative branch budget, if you will, with like $142 million in the first year before the building ever got started. So that, we would have this political impediment that, would make it, politically infeasible, it seems to me, under present budget circumstances. We believe that to be totally misguided in terms of what is the actual economic reality of this project.
Mr. TRAFICANT. It appears that savings we are realizing in three ways with a single permanent interest rate applying.
Mr. FRANKLIN. Yes.
Mr. TRAFICANT. First AOC was not required to get a separate construction loan and then a permanent financing
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loan.
Mr. FRANKLIN. Correct.
Mr. TRAFICANT. Second, the initial financing was invested in a guaranteed investment contract-earning interest.
Mr. FRANKLIN. Correct.
Mr. TRAFICANT. And, finally, because the 30 rate was constant, the base rent charged to the judiciary tenants would be thus also constant over 30 years.
Mr. FRANKLIN. That is correct.
Mr. TRAFICANT. So was the fixed rate part of the winning proposal, or did AOC negotiate with the developer for that arrangement?
Mr. FRANKLIN. I was not present in that stage of the financing, but my recollection is that all of the competitors—what was interesting about this particular development, Mr. Traficant, is that it was a result of a developer/architect competition. And we brought the developers into that competition, because although esthetics were going to be a very important part of the winning selection, we wanted to make sure we had a financing scheme that made sense and was beneficial to the taxpayer.
So my recollection was that the developer—who was Boston properties came in with this financing structure which had been worked out with some underwriters on Wall Street. Of course, among the criteria was that there ought to be savings to the taxpayer. But I don't believe in the competition we actually were specific in saying that the base rent had to be stable. Obviously, once we saw that suggestion, it seemed to make a lot of sense.
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Mr. TRAFICANT. Well, I want to compliment you on some of the work that you have done to manipulate the variables at your disposal to get a decent deal under a pretty difficult environment.
I have a number of other questions, Mr. Chairman, and I want to ask unanimous consent that they be submitted to Mr. Franklin in writing and he can respond to them in a reasonable time.
Mr. COOKSEY. That would be fine.
Mr. FRANKLIN. I would be happy to do so, Mr. Traficant.
Mr. COOKSEY. Excuse me, Congressman Blumenauer is here from another meeting. He has got a short time frame window that he can work in and he has a statement he would like to make to this committee.
TESTIMONY OF HON. EARL BLUMENAUER, A REPRESENTATIVE IN CONGRESS FROM OREGON
Mr. BLUMENAUER. Thank you very much, Mr. Chairman, for your courtesy. I did make a brief presentation at last week's markup, being impressed with the GSA's efforts to help the Federal Government become a better neighbor in our communities through the ''Good Neighbor'' policy. I have had some concerns, however, about our ability to work with the business improvement districts around the country.
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I would like to move the ''Good Neighbor'' policy beyond a ''feel-good'' concept. Working with your subcommittee, with the staff, with our committee, I beleive we have an opportunity to empower the GSA to behave like any private property manager and help revitalize our communities all across the country without new Federal programs and without increased expenditures.
As members of the subcommittee know, this program gives GSA the ability to enter into contracts with business improvement districts (BIDs). BIDs are cost-effective public-private partnerships that have sprung up in a thousand communities in approximately 40 States across the country. They provide a variety of enhanced services for security, maintenance, landscaping, street cleaning, advocacy, things that help make these urban centers vital and attractive places to live and work.
BIDs not only improve our downtown, but they do also a lot for the Federal Facilities located in these areas, because BID-Services provide a safe, secure, attractive, place for our employees to work. Oftentimes these are people who do not work regular business hours, so BID-Services can make a big difference for people coming back downtown or folks that have odd shifts. Most important, and something that gets lost in the shuffle, I am afraid, is the impact these programs have on our customers.
Federal agencies are there, by and large, is to be able to serve the general community. And if the facilities are in an environment that is safe, clean, attractive, and well-managed, it is a better place for our Federal taxpayers, our customers to do business.
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Now, there is an incredible opportunity for the Federal Government, by entering into partnerships with these public, private consortia, to take a leadership role in helping promote them, and to do our job as any responsible property manager should do. But I have, frankly, been concerned that, as I have met with people from coast to coast, from border to border, who are working with these programs, it is not clear exactly what the guidelines are for the Federal Government. It is too hard to enter into these agreements and to get consistent outcomes.
Now, what I would hope to do with the help of this subcommittee, with your staff, with interested parties, would be for us to be able to send two very clear signals. First, that it is entirely appropriate—and, in fact, the Federal Government encourages our local property managers through GSA—to enter into these relationships like other responsible business owners are doing in towns large and small all across the country.
The presumption ought to be that the Federal Government is going to be a full partner. This would help settle the question for some administrators who may, because of conflicting rules, regulations and past statutory interpretations, wbe confused about appropriate contracts because they want to be careful stewards of the public property. And second, and I think this is an area that is very important for us is to deal with the definition of what that Federal benefit is for entering into these relationships.
I think we can help define guidelines for these business improvement districts that have general membership, that have a reasonable fee schedule, and that provide enhanced safety and security and cleanliness services. We ought to be able to help with a statutory definition, to clarify that there is, in fact, a Federal benefit that accrues to our employees, to the value of the property that we own and manage, and most importantly, to the people who rely on the Federal Government for these services.
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I appreciate your courtesy in raising the issue with you, of being able to make my concerns a part of your record, and look forward to an opportunity to share with you what I have learned from other private sector partners to see if we can't clarify the Federal role in these programs and the guidelines that will help provide uniform application across the country.
Mr. COOKSEY. Yes, Congressman Traficant.
Mr. TRAFICANT. I want to compliment the Congressman, one of our newest Congressman, who has taken some issues of this subcommittee to heart and I am glad to see that. I would like to ask unanimous consent that the dialogue and discussions taking place between Mr. Blumenauer and the GSA, that those recommendations be forwarded to this subcommittee for review and placed on our record of this meeting.
Mr. COOKSEY. I think it is a good idea, and I am sure we can do that. And it will occur. Let me clarify two signals you want to send. Number one is that you want to send a signal to these potential private investors that the Federal Government will enter into these relationships as a full partner.
Mr. BLUMENAUER. Excuse me, Mr. Chairman. I may not have been clear about what we are finding in the majority of these communities, these thousand communities around the country, including many major communities represented by members of our committee. They are, in fact, approaching the Federal Government to be a partner. I received information from GSA that they are currently in negotiations with 21 different business districts from Washington, D.C. to Baltimore, Los Angeles, New Orleans, I am sure.
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Mr. COOKSEY. Oregon.
Mr. BLUMENAUER. We have this going on now. What is not clear is that the Federal Government actually is encouraged to step up and be a partner the same way any other property manager would representing major properties in these communities. Virtually all of these BIDs are in areas in which local government are involved. I know I helped set one up in our community as Public Works Commissioner for the City of Portland 10 years ago. The Portland BID, like BIDs across the country, is in response to voluntary action from local government where businesses step forward, downtown property owners in cities, large and small, to set them up. We want to make sure that the Federal Government is included in that, and that the people who manage our property feel comfortable entering into the arrangement.
Mr. COOKSEY. Good. Could I ask, then, that you submit, to clarify exactly what these two signals are——
Mr. BLUMENAUER. Yes, sir.
Mr. COOKSEY. Deal with the definition, clarify what the full partner is. Thank you very much.
[The information follows:]
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Mr. BLUMENAUER. Thank you for your courtesy.
Mr. COOKSEY. Mr. Davis.
Mr. DAVIS. I will be brief, but thank you. I just read your statement as I came through here, and I think it is really timely with the Budget Enforcement Act of 1990 coming up—expiring next year. And the whole budget controversy is going through right now. This is a great time, I think, to address some of these issues.
As you know, in my prior life, I was the head of the government out in Fairfax County, 900,000 people out across the river where we built our Government Center and everything with public-private partnerships. It was the only efficient way to do it. And if you do it at the Federal level, you get no credit for it at all, because they don't take into account risk and other areas.
I am particularly intrigued by the speed, you note the speed that the private sector can sometimes do these things because they are not subject to the rules and the regulations that government agencies are. And time is money. And you articulate these very well.
I would just note that the scoring burdens that we have right now under the Budget Enforcement Act are not just hampering us in this area. When we wrote the Control Board legislation for the District, we ended up with some borrowing language that didn't do what we wanted it to do. Because of scoring issues, it had to be constructed and it ends up costing more money. And in the administration's proposal this year to save the city with underfunded pension liability, they, because of scoring issues, they are doing it in a way that costs us a billion dollars more over 10 years than if you could have a more realistic way of looking at that.
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So you are not alone in terms of seeing how some of the best intentions sometimes leads to some unintended consequence and end up not saving money and costing. I want to compliment you on bringing this analysis that you brought here. It seems to me that capital investment is so different than rent. How you score those savings ought to be a part of the equation and you have articulated a number of other areas as well. So thank you. Hopefully, this is an opportune time to not just address this committee, but this committee can pick up the mantle here and go forward as part of the Budget Act this year and readdress. Hopefully, we can save billions over the coming year.
Mr. FRANKLIN. Thank you. Mr. Chairman, if I might add before we conclude, I have been approached by representatives of the business improvement district in the District of Columbia to—just to begin conversations with the Architect of the Capitol in terms of the possibility of the BID of, of what would come to the borders of the Capitol precinct, both on the Pennsylvania Avenue side and the Capitol Hill side on Pennsylvania Avenue, and if the Congress does enact legislation such as the Congressman has suggested, I would hope you would include the Architect of the Capitol as an agency with authority.
Sometimes we are not included when that kind of legislation is enacted, because I think we would like to be as proactive and positive in relating to these local communities as we can be.
Mr. COOKSEY. I am sure that can be done and should be done. Mr. Lampson, Mr. Lampson is a freshman that is even fresher than I am.
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Mr. LAMPSON. Thank you, Mr. Chairman. I don't have any questions right now. I am learning a lot. It is interesting. I will have plenty to say in time. Thank you for letting me be here. I will get my questions down later. Thanks.
Mr. COOKSEY. Thank you, Mr. Franklin.
We will have the next panel if we could. It is the panel of industry experts. I would comment that we would, there are a lot of other activities going on in the buildings and committee hearings today and in the House. And so if we can move through this and be finished up in 32 minutes, we will be on schedule.
Mr. BULLS. Mr. Chairman, I appreciate that.
Mr. COOKSEY. Could we go ahead and have the rest of the panel come up and be seated now? Mr. Chagares and Mr. Zarrilli.
Mr. Bulls.
TESTIMONY OF HERMAN E. BULLS, PRINCIPAL, LA SALLE PARTNERS; ROBERT L. CHAGARES, MANAGING DIRECTOR, TRAMMEL CROW COMPANY; AND THOMAS P. ZARRILLI, SENIOR VICE PRESIDENT, DILLON, READ AND CO. INC
Mr. BULLS. Thank you very much, Mr. Chairman. What I will do is briefly summarize my written statement, and I would like to formally submit it to the subcommittee.
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My name is Herman Bulls. I am a principal with La Salle Partners. And I lead the firm's Washington D.C. office.
La Salle is active in the acquisition, disposition of land assets, real estate investment banking, tenant representation, management and leasing, development and investment management. We are the country's largest office property manager and the third largest real estate investment advisor.
Specific public, private partner projects we have been involved in in the area would include the redevelopment of Union Station, which we currently manage and lease. We are currently working on New York's Grand Central Terminal to renovate and remerchandise that property. We are also an advisor to the Resolution Trust Corporation during the savings and loan clean up operation.
I am a principal in charge of La Salle's nationwide public institutions practice. We provide integrated real estate services to Federal, State and local governments and colleges and universities.
For the GSA, we have worked on several projects to include review of their asset management policies here in the National Capital Region. I reviewed the Old Post Office Pavilion project on Pennsylvania Avenue, and provided outsource service for lease acquisition services in Region 3 in Philadelphia.
Prior to joining La Salle, I also had a public sector life, spending 11 years as an officer in the United States Army, where I also worked on real estate related issues.
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The basic function of any corporate real estate program is to effectively support the organization's strategic and operating missions. The real estate program must be structured to accomplish the following goals: Procure appropriate space at the appropriate time, provide the space at the most efficient, but not always the lowest cost, and maintain appropriate flexibility, since organizational strategy and the mission will likely change over time.
While the U.S. Government and corporate America are different in many ways, I believe in terms of real estate the two are very similar. The real estate industry is dealing with many issues affecting many other industries in America today, including declining margins and customers' demands for more service and lower costs.
I note five major trends in real estate today which may be relevant to the GSA. This includes, as the previous witness noted, proactive asset management of owned and leased portfolios. My written statement goes into more detail on that. The five trends are: The consolidation of service providers and the impact it is having on the firms that are available to provide assistance, the outsourcing of services, which I will talk a little more about, securitization, and development trends.
As far as outsourcing is concerned, it is a fact in private industry that organizations are concentrating on their core competencies. Typical functions outsourced today include information technology, logistics, mailroom operations, security, and real estate. For many firms, real estate outsourcing includes everything from lease acquisition and lease administration to development and disposition of facilities.
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When La Salle Partners becomes the outsourced real estate partner for a major corporation, we call the partnership a strategic alliance. The intent is to align interests and create a long-term service provider team and process, to provide an expanded range of consistent state-of-the-art services over the entire portfolio.
La Salle's Partners and strategic alliance clients include Ameritech, 48 million square feet, Bank of America, Commonwealth Edison and quickly expanding Sun Microsystems.
One point I think from the Sun assignment that is very relevant to the committee and the GSA and what I think the Commissioner is trying to accomplish is related to time. We have learned from that assignment not to think in months and weeks and days, but to think in nanoseconds. Because, as Mr. Davis said, time is money, and decisions need to be made quickly, particularly in this economy we are operating in.
Many State, local, and Federal Government agencies, including the GSA, are participating in outsourcing relationships. Other public institutions that we are involved with, include the City of Chicago, the Chicago Transit Authority, the DeKalb County Development Authority in Georgia, as well as the State of California. We also participated in a pro bono facilities assessment for the District Government here in Washington.
Securitization is the next issue I would like to cover. One of the most important real estate trends in the 1990s has been the rapid growth of public security real estate. The real estate recession and capital shortage in the late 1980s and early '90s paved the way for the fast growth of the public real estate market. The public equity real estate market has grown rapidly since then with the total real estate equity market capitalization increasing from under $10 billion to $100 billion today.
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The public debt market has also grown quickly over the last 5 years. The issuance of commercial mortgage backed securities was a record setting $23 billion in 1996. The total outstanding CMBs is to date over $80 billion.
Over the long term, La Salle Partners expects that securitization will finance an increasing share of real estate projects. GSA could tap into this large capital source by structuring leases that could secure as CMBs collateral. Creative approaches are also taking place in development, and it is enabling firms to cut cost and retain more control for build to suit activities. Those issues are covered in more detail in the essence of time, in my written statement.
But I would like now to offer a few comments on the GSA. First of all, in my dealing with the GSA, I have been very impressed with the professionalism and knowledge of the senior real estate staff.
Secondly, I believe there is an underlying culture of trying to improve the current way of doing business. However, as we discussed today, good people operating in a system which places significant value on process with little rewards for entrepreneurial flair can sometimes result in less than optimal outcomes.
Finally, as a landlord to the GSA, it is widely acknowledged that the GSA has the best credit of any tenant in the world. The GSA should use this benefit to secure lower occupancy costs for leases and new development by proactively participating in the process of strategic alliances and securitization.
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While the GSA does many things right, I do think there are some areas that could be improved. I would highly recommend that GSA implement some form of credit lease that can be used to collateralize commercial mortgage-backed security.
Second, I would recommend a review of the GSA contracting process with a view toward placing more emphasis on strategic alliances with proven real estate providers. The current detailed procurement process is inefficient from both the GSA's and the private sector's perspective due to significant time requirements associated with preparing RFPs, developing responses, and responding to protests.
The GSA is pursuing an alliance strategy on a limited basis. With proper oversight by senior GSA officials to ensure proper implementation, this strategy will prove to be successful and should be expanded.
Thank you, Mr. Chairman. I will be happy to answer any questions you might have.
Mr. COOKSEY. Just one question. And in the interest of time, you indicated that you felt that the GSA should obtain some benefit because the GSA is the most reliable tenant in the world, has the best credit. How much benefit?
Mr. BULLS. Well, it would—I have not made a specific analysis. However, in terms of financing, you may be talking anything from 10 to 20 to 30 basis points on the financial cost of a lease aspect. I have not analyzed their entire inventory, wouldn't know what total value to place on potential savings. Not every lease would be applicable to this, but leases in which the GSA controls a significant portion of a building, the financial markets would look at that as a very favorable financial risk.
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Mr. COOKSEY. Uh-huh. Mr. Peck.
Mr. PECK. Could I just note, we just recently in Washington were able to change the terms of a lease within the law. And were able to reduce the private sector owner's cost of borrowing by about the number of percentage points that Mr. Bulls talks about. And over the course of this lease, which is about 20 years, it will save the government approximately $12.8 million.
Mr. COOKSEY. Can I assume it will not cost the investor anything at the same——
Mr. PECK. They are getting the lower cost and passing some of the savings on to us.
Mr. COOKSEY. Well that is good. So I assume the La Salle partners will buy under this. All of your real estate.
I have no other questions.
Mr. Chagares; is that correct?
Mr. CHAGARES. Thank you. And good morning, Mr. Chairman. I am pleased to have the opportunity to testify today before this committee. I am a managing director with the Trammell Crow Company, which is one of the largest full-service real estate companies in the United States and one which is very active here in the national capital region.
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I want to emphasize at the outset that my comments are intended to be constructive and assist the Federal Government in the overall execution of its real estate program. I also want to emphasize that my comments reflect my perspective as a developer of real estate and a consumer of capital in the capital markets.
I submitted my written testimony, which I would like to briefly summarize together with a few points which merit further emphasis. I would also like to invite any questions that you may have during or after my statement.
The basis of my testimony is that the OMB scoring for both operating and capital lease structures severely limits the ability of the government to make good market-driven real estate decisions. This occurs because the OMB scoring bulletin and its application do not, on an analogues FASB, GAAP, or tax accounting basis, mirror the private sector's treatment of capital and operating leases.
For example, and we have heard testimony this morning to this effect, the OMB scoring rules require the government to recognize a capital lease expense in its entirety at acquisition or over the construction period in the case of new development, rather than over its useful life, as required under GAAP and tax accounting standards.
The effective of this OMB scoring provision is to cause the government to avoid any capital lease structure irrespective of the economic benefit of actually holding the capital lease, because of the immediate and negative impact on its budget.
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In real estate terms I think most of us as taxpayers can relate to, this would be akin to either having to buy your house outright or rent until you can, which, of course, in Washington, might be forever.
This is further exacerbated by OMB's narrow application of the rules governing operating leases, which tends to make true operating lease status virtually impossible. Again, these rules effectively prohibit the government's proposal of any operating lease structure which would provide the government with a leasehold participation and a residual upside of a property.
The result of all this is that the government is forced to pursue the continuous, short, and intermediate term renewal of leases at above market rents in marginal buildings or enter into long-term leases in new buildings where the benefit of having paid rent, which fully amortizes the cost of the project, is forfeited. The net effect is to diminish the competitive market environment.
In short, if the OMB scoring rules for government leases and, equally important, their applicantion, could be adjusted to simply reflect the treatment of operating and capital leases under similar FASB, GAAP, and tax accounting standards, the government would have the decision-making flexibility in structuring its real estate acquisitions to maximize value to the taxpayer. This is the same flexibility enjoyed by corporate America in owning real estate in ways which maximize value to its shareholders. Thank you.
Mr. COOKSEY. I have lost Mr. Peck. Okay.
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Mr. PECK. I am hiding.
Mr. COOKSEY. Mr. Peck, you and I have had this discussion before about the paucity of accountants in government. In my MBA program I learned a little bit about FASB and GAAP. Does OMB recognize FAAB and GAAP? I realize you are GSA and you are not OMB and I realize that their absence has already been noted today, but.
Mr. PECK. They do have a lot of accountants at OMB, too. More than we have. I honestly don't know. But what Mr. Chagares says is absolutely right, because I do private sector real estate too. And our rules on scoring leases, and, in fact, in accounting for depreciation on buildings that we own are not at all commensurate with what you do in the private sector under FASB and GAAP accounting principals. So I think in some ways, OMB, you will find in some of the circulars reference to GAAP.
But, again, the scoring is a very, it makes everything a very different business. And in fairness to OMB, again, you are going to have to listen to them about why they think that scoring makes some sense. It is a very macro argument about the whole Federal—whole Federal budget. But I think you will hear this when you talk to anybody in government who does capital programs; we are frustrated.
Mr. COOKSEY. Well, Mr. Chagares, I will make note of the fact, and I am sure it has been noted and recorded, that there is a problem. And I do recognize FASB and GAAP. And I am a physician. I am not an accountant. I just happen to go through a little MBA discipline.
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Okay. Since I am the only one left to ask questions I have no other questions of you.
Mr. Zarrilli, you are from Dillon, Read. La Salle Partnerships, Trammel Crow and Dillon, Read.
Mr. ZARRILLI. Correct. Good morning, Mr. Chairman and members of the subcommittee. Dillon, Read welcomes this opportunity to discuss the occupancy costs of buildings where the U.S. Government is the primary tenant.
In this capacity, we have been providing funds through mortgage loans and lease revenue bonds for GSA lease financings since 1991. And, in fact, I personally have been working in that area since 1989. We provide both financing and equity for projects backed by 10, 15 and 20-year GSA leases.
I have entered my comments into the record, so I will just highlight a few points of interest.
The borrowing cost for a GSA lease project is likely to range from 40 to 125 basis points over Treasury's with most projects being in the range of 60 to 80 basis points. The variations within those ranges deal with the lease term and the type of lease that exists.
The overall quality of GSA leases has improved since 7 or 8 years ago and is very financable today, sometimes with slight modifications, but not significant modifications. These leases are securitized in the public and private market and are highly desirable instruments by institutional investors, which benefit all returns to the GSA in the forms of lower rents that these developers are bidding on these development projects.
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We have found, though, the largest cost to occupancy results from having to enter into short and intermediate term leases and also not being allowed to take various free or cheap options which the developers are often anxious to give to the GSA.
We believe that the government can realize significant savings in future rental rates if the GSA is allowed by OMB to implement complement leases and lease provisions that are widely used in the private sector.
The most important example is the lease term. For a newly constructed project, a 20-year lease can have an annual rental rate as much as 33 percent less expensive than a 10-year lease and 13 percent less expensive than a 15-year lease.
Similarly, the annual rent on a 15-year lease can be as much as 23 percent less expensive than a 10-year lease term. For a long-term location such as a courthouse, a 30-year lease can offer rent savings of 14 percent versus a 20-year lease term. These are significant dollars when you compound it over the, the number of buildings that the GSA leases.
In the corporate credit market, renewal options are usually given for one or more renewal terms at the same initial rent as in day one of the lease. That means in the 21st year, you may have rent that still reflects the economics in effect in year one of the lease and can have some free benefits to the government.
With long-term leases, renewal rents can be achieved at bargain levels that reduce, significantly reduce the occupancy cost in the future. Lease purchase is an attractive variation on bargain renewal rents. Installment purchase is an efficient means of providing for the eventual ownership by the government. The lease of improvements on government buildings, although GSA cannot enter into that format now can easily be accommodated for in the private markets.
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On a separate note going back to scoring, we believe, within the existing scoring rules there is a large difference between the way OMB treats the leases and the way the private sector does. A couple of the key areas of differentiation is that we believe that the OMB method results in an inaccurate comparison of costs.
In a proposed rental transaction, the developer looks at the actual cost of the project, including construction costs and soft costs such as construction interests and developer's risk premium, as to whether the project is able to come in on budget or over budget. And we believe these costs, among others, are excluded in the OMB projected cost which is used in determining if the lease is a capital lease.
The lease payments, the GSA lease is not a bond type lease or even a net lease. The GSA lease places substantial risk upon the lessor over the life of the lease.
These are for increases in operating expenses, insurance cost, capital replacement costs, and other areas. This risk, which should be calculated as reduction in scheduled lease payments over time is not recognized by OMB in their calculations as to the present value of the lease payments.
And the third area is the discount rate. In the private sector, the discount rate used in prevent value analysis is the incremental borrowing rate a tenant would have incurred over a comparable lease term to purchase a similar asset.
Now, the appropriate discount rate is at least equal to the comparable Treasury rate, if not a rate used for certain agency obligations or lease transactions that the GSA used in the lease purchase method.
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These have a slight premium to Treasury's. Any lower rate such as a short-term rate will seriously distort the present value analysis that OMB would use.
Due to the ability to meet FASB 13 tests, the private sector routinely does not capitalize 20-year corporate leases, very different approach than OMB.
In summary, OMB's policy results in shorter term leases and lease renewals in location where the GSA believes it has long-term needs. This increases the annual occupancy costs from 13 to 33 percent. Therefore, we believe that the taxpayers' interest can be best served by accounting for operating in capital leases under the methodology more closely aligned with the private sector.
The capital markets are very flexible to meet with, to meet the needs of the GSA and the costs in terms of basis points over Treasury's is very cheap compared to the size of the projects. Lease backs, installments, lease purchases of renovations are all possible if the GSA has authority to do it.
I personally have been involved in such innovations as the National Archives two projects in College Park and other public-private partnerships. I might point out that every transaction we are involved in from $10 million to 200 million is often structured exactly the same as Mr. Franklin's judiciary center project with the same protections for the—the eventual repair and renewal of the building. That concludes my remarks. I will be happy to answer any questions you might have.
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Mr. COOKSEY. We are running out of our 32 minutes, but the message that I am hearing from the three of you is that GSA needs to use more of the mechanisms of managing real estate, financing real estate, renting real estate that is used in the private sector and to gain added flexibility in that; is my interpretation correct?
[All nodded heads].
Mr. COOKSEY. Do you think it would be fair for this subcommittee to send a letter to OMB and ask them to write us their interpretation of FASB 13 and FASB 98 and give us, write the same kind of paper that we all had to do on our MBA programs.
Mr. ZARRILLI. I think that would be useful.
Mr. COOKSEY. Okay. I will ask the committee staff to do that. I am serious, I really do. I mean that is not intended as a trite joke. I think it needs to be done. Just to ask for the comparison.
My colleague, Mrs. Norton has, like me has been in a lot of other committee hearings this morning. There is, I promise there is a lot of activity going on today. But we are delighted to have her here, Mrs. Norton.
Mr. NORTON. Thank you, Mr. Chairman. I want to apologize, particularly that I was unable to hear this set of witnesses, because I am well aware of what your testimony concerned. Ever since coming to Congress, I have been on this committee and have had—faced the absurdity of scoring rules which, beyond not meeting normal standards, frankly, are unprofessional and costing the government money. It has been very difficult for me to understand where at least the latter point hasn't penetrated in a Congress intent upon reducing the deficit.
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I can understand the change in 1990 that brought these scoring rules. What I can't understand now that we are passed, that is why we, given the experience we have had, continue to use those rules. And I do believe that there are ways or safeguards that could be put in place if that was the concern, while still conforming us to the usual rules of how real estate and capital matters are financed.
I have, Mr. Chairman, if you will, only one question.
It really is a hypothetical. Part hypothetical, part real. Over on M street is probably the most valuable piece of land that the Federal Government owns anywhere, if one bears in mind its potential. It is the Southeast Federal Center.
The prior administration, I think, actually it began with the Reagan administration, fully understood it, developed a proposal that would make the site attractive to Federal agencies, because it is a little off the beaten path, if you can call 5 minutes away from the Capitol off the beaten path.
The subways stop there now. And contracts have been let. Huge parcel, at least as large as, I suppose, what the government did on Pennsylvania Avenue and Constitution Avenue combined. But there it lies, while we, of course, rent space for Federal agencies all over this city and all over this region.
What kinds of ways occur to you might this project be developed if it were not a Federal project, caught, as we are now, simply keeping it alive. If this were a project in the private sector, what kind of financing would you use to put together a project that would develop one billion dollars worth of mall-type activity and space for, let's say, half a dozen office buildings. That is essentially, we are not doing housing there, Mr. Peck. What if I gave you that hypothetical and said come back, what would you put together to develop this huge parcel over on M. Street?
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Mr. BULLS. I will take the first crack, madam. First of all, if you build it, they necessarily will not come. So the first issue you have to have is you have to have a use. And I think from the public policy perspective, with many of the agencies that have a requirement to be within the District boundaries, if—you need a nucleus.
Our firm being involved in Union Station, we were facing somewhat of a big risk. But the basic element was there, what you are describing within a reasonable time frame. There are distances at least, there are enough people in it, activity. So you have to create, in this instance, some type of destination, a reason for people to be there.
And what you have from that is you have positive externality. You have the multiplier effect. Meaning if you are able to get one major user involved, the services that are associated with that from the required—being eating establishments to copying centers, et cetera, et cetera, will follow. But the issue is there has to be a critical mass use to get a development such as this started.
Mr. ZARRILLI. It sounds a little bit like Battery Park City in New York, which had a big parcel of land and was close to where the action was, but wasn't quite on it. And what the various authorities did was one by one lease out parcels to the private sector and slowly build a base of users to where now it is a very, very strong location.
Mr. NORTON. What is in Battery Park now.
Mr. ZARRILLI. World Financial Center. There is millions and millions of square feet of office space, residential, hotels, incidental shopping. But it is one of the most valuable projects in New York. I guess I would say that probably the Federal Government doesn't, I am not sure they have authority to lease out individual parcels. And that may go back, again, to the flexibility that the GSA has.
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Mr. NORTON. I think we already have that authority. Beyond that, it is—part of the government vision for the project is that it is going to be a mall there. We are going to build the infrastructure for the mall, but somebody else is going to lease it from us in order to put the restaurants and shops and movies, whatever they have there.
In a real sense the conception which preceded me is brilliant because it recognizes, and it is akin to what you were saying about having to have an anchor there. Well, here we needed more than a major user. You needed a reason to go to a major park of a city that isn't as developed as most Federal agencies are.
The Federal Government says we know how to do this. We are going to build this, we are going to lease these shops, whatever out. But by leasing them, we are going to fill our troughs of the Federal Treasury with money. So as a model for how the Federal Government can help pay for the project, you have something really going here, except it is going on paper. And it is stuck in scoring. And it is stuck in where it is located. Around this parcel, this huge parcel, valuable parcel of land, this privately owned land, some District-owned land, but many parcels of privately owned land, which is waiting to see if the Federal Government can do anything with it.
We are the leader and ought to be the leader. If we don't move, of course, all this other very valuable land won't move. Talk about being stuck on stupid, when you consider the amount of money that we are putting into renting space in the District and in the region and that we are sitting on one of the most valuable parcels of land on the East Coast, but certainly in this region, and don't know how to get out of it. And scoring is a big part of our problem, Mr. Chairman.
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Mr. COOKSEY. I would agree with Mrs. Norton, and it is obvious that OMB needs to be here. And they will. I would expect them to be here at the next meeting of this subcommittee, and they will have their report on FASB, GAAP, and I will have my old accounting proffer help me correct or score it—we will score them next time.
I want to thank you—I want to thank the panels for coming, those that participated. I have run out of time. We have run out of time. If we could quickly vacate this room there is another meeting here in 60 seconds. Thank you very much.
[Whereupon, at 12:00 noon, the subcommittee was adjourned.]
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