[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
CREDIT CRUNCH: EFFECTS ON
FEDERAL LEASING AND CONSTRUCTION
=======================================================================
(110-158)
HEARING
BEFORE THE
SUBCOMMITTEE ON
ECONOMIC DEVELOPMENT, PUBLIC BUILDINGS, AND EMERGENCY MANAGEMENT
OF THE
COMMITTEE ON
TRANSPORTATION AND INFRASTRUCTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
JULY 30, 2008
__________
Printed for the use of the
Committee on Transportation and Infrastructure
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43-848 WASHINGTON : 2009
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COMMITTEE ON TRANSPORTATION AND INFRASTRUCTURE
JAMES L. OBERSTAR, Minnesota, Chairman
NICK J. RAHALL, II, West Virginia, JOHN L. MICA, Florida
Vice Chair DON YOUNG, Alaska
PETER A. DeFAZIO, Oregon THOMAS E. PETRI, Wisconsin
JERRY F. COSTELLO, Illinois HOWARD COBLE, North Carolina
ELEANOR HOLMES NORTON, District of JOHN J. DUNCAN, Jr., Tennessee
Columbia WAYNE T. GILCHREST, Maryland
JERROLD NADLER, New York VERNON J. EHLERS, Michigan
CORRINE BROWN, Florida STEVEN C. LaTOURETTE, Ohio
BOB FILNER, California FRANK A. LoBIONDO, New Jersey
EDDIE BERNICE JOHNSON, Texas JERRY MORAN, Kansas
GENE TAYLOR, Mississippi GARY G. MILLER, California
ELIJAH E. CUMMINGS, Maryland ROBIN HAYES, North Carolina
ELLEN O. TAUSCHER, California HENRY E. BROWN, Jr., South
LEONARD L. BOSWELL, Iowa Carolina
TIM HOLDEN, Pennsylvania TIMOTHY V. JOHNSON, Illinois
BRIAN BAIRD, Washington TODD RUSSELL PLATTS, Pennsylvania
RICK LARSEN, Washington SAM GRAVES, Missouri
MICHAEL E. CAPUANO, Massachusetts BILL SHUSTER, Pennsylvania
TIMOTHY H. BISHOP, New York JOHN BOOZMAN, Arkansas
MICHAEL H. MICHAUD, Maine SHELLEY MOORE CAPITO, West
BRIAN HIGGINS, New York Virginia
RUSS CARNAHAN, Missouri JIM GERLACH, Pennsylvania
JOHN T. SALAZAR, Colorado MARIO DIAZ-BALART, Florida
GRACE F. NAPOLITANO, California CHARLES W. DENT, Pennsylvania
DANIEL LIPINSKI, Illinois TED POE, Texas
NICK LAMPSON, Texas DAVID G. REICHERT, Washington
ZACHARY T. SPACE, Ohio CONNIE MACK, Florida
MAZIE K. HIRONO, Hawaii JOHN R. `RANDY' KUHL, Jr., New
BRUCE L. BRALEY, Iowa York
JASON ALTMIRE, Pennsylvania LYNN A WESTMORELAND, Georgia
TIMOTHY J. WALZ, Minnesota CHARLES W. BOUSTANY, Jr.,
HEATH SHULER, North Carolina Louisiana
MICHAEL A. ARCURI, New York JEAN SCHMIDT, Ohio
HARRY E. MITCHELL, Arizona CANDICE S. MILLER, Michigan
CHRISTOPHER P. CARNEY, Pennsylvania THELMA D. DRAKE, Virginia
JOHN J. HALL, New York MARY FALLIN, Oklahoma
STEVE KAGEN, Wisconsin VERN BUCHANAN, Florida
STEVE COHEN, Tennessee ROBERT E. LATTA, Ohio
JERRY McNERNEY, California
LAURA A. RICHARDSON, California
ALBIO SIRES, New Jersey
DONNA F. EDWARDS, Maryland
(ii)
Subcommittee on Economic Development, Public Buildings, and Emergency
Management
ELEANOR HOLMES NORTON, District of Columbia, Chair
MICHAEL H. MICHAUD, Maine SAM GRAVES, Missouri
JASON ALTMIRE, Pennsylvania BILL SHUSTER, Pennsylvania
MICHAEL A. ARCURI, New York SHELLEY MOORE CAPITO, West
CHRISTOPHER P. CARNEY, Virginia
Pennsylvania, Vice Chair CHARLES W. DENT, Pennsylvania
TIMOTHY J. WALZ, Minnesota JOHN R. `RANDY' KUHL, Jr., New
STEVE COHEN, Tennessee York
JAMES L. OBERSTAR, Minnesota JOHN L. MICA, Florida
(Ex Officio) (Ex Officio)
(iii)
CONTENTS
Page
Summary of Subject Matter........................................ vi
TESTIMONY
Chessen, James, Chief Economist, American Bankers Association.... 3
DiPrinzio, Raymond, Managing Director, Head of Project Finance,
CIFG Assurance North America, Inc.............................. 3
Grigg, Steven A., President and Chief Executive Officer, Republic
Properties Corporation, Representative DCBIA................... 24
Purtell, Richard D., Chair and Chief Elected Officer, Building
Owners and Managers Association International.................. 24
Rudy, Kenneth, International Director of Corporate Capital
Markets, Jones Lang LaSalle.................................... 3
Winstead, David, Commissioner, Public Buildings Service, U.S.
General Service Administration................................. 24
PREPARED STATEMENTS SUBMITTED BY MEMBERS OF CONGRESS
Cohen, Hon. Steve, of Tennessee.................................. 49
Graves, Hon. Sam, of Missouri.................................... 50
Norton, Hon. Eleanor Holmes, of the District of Columbia......... 54
Oberstar, Hon. James L., of Minnesota............................ 57
PREPARED STATEMENTS SUBMITTED BY WITNESSES
Chessen, James................................................... 59
DiPrinzio, Raymond A............................................. 68
Grigg, Steven A.................................................. 71
Purtell, Richard D............................................... 73
Rudy, Kenneth.................................................... 79
Winstead, David L................................................ 96
SUBMISSIONS FOR THE RECORD
Winstead, David, Commissioner, Public Buildings Service, U.S.
General Service Administration, responses to questions from the
Subcommittee................................................... 101
[GRAPHIC] [TIFF OMITTED] 43848.001
[GRAPHIC] [TIFF OMITTED] 43848.002
HEARING ON CREDIT CRUNCH: EFFECTS ON FEDERAL LEASING AND CONSTRUCTION
----------
Wednesday, July 30, 2008
House of Representatives
Committee on Transportation and Infrastructure,
Subcommittee on Economic Development, Public Buildings, and
Emergency Management,
Washington, DC.
The Subcommittee met, pursuant to call, at 1:10 p.m., in
Room 2167, Rayburn House Office Building, the Honorable Eleanor
Holmes Norton [Chair of the Subcommittee] presiding.
Ms. Norton. Good morning. I welcome the witnesses to
today's Subcommittee hearing concerning the tightening credit
market, which originated in the subprime mortgage crisis, and
on other factors affecting Federal leasing and construction in
the commercial marketplace.
GSA is perhaps the largest customer for office space in the
real estate market in the United States. GSA leases slightly
more space than it owns, approximately 176 million square feet
of leased space, housing over 700,000 employees compared with
175.5 million square feet of owned space, providing office
space for 640,000 Federal workers. The Federal inventory ranges
from 2500 square foot border crossing stations to a million
square foot courthouse complexes in major metropolitan areas.
GSA's stake in maintaining its strong position in the
marketplace is high, particularly in the leasing market, in
light of the continuing shift to Federal agency leased space.
At this hearing, we seek to learn how developers, building
owners, lenders, and construction companies, who are accustomed
to unimpeded access to credit, position themselves in today's
puzzling market. We have concerns, even though the strictly
competitive system for Federal contract awards guarantees that
only the most creditworthy need apply or need compete. When I
began talking with experienced developers and building owners
as the subprime mortgage crisis worsened, their strong credit
standing with lenders and the lengthy time frames and lead time
for construction and leasing left them pretty much unworried.
However, since then, seven banks have closed, particularly
IndyMac, which had significant home ownership loans. It seems
doubtful that a departure as unprecedented as a mountain of
bad, securitized subprime mortgages sold in an unregulated
global market, can be contained. Today, a year after the
housing crisis became full blown, even the largest banks, whose
customers also significantly include commercial real estate,
are showing record profit losses.
Although many of the players in today's commercial
marketplace remain untouched for now, experts say that today's
crisis is unmatched since the Great Depression. The Nation's
largest bank, the Bank of America, has experienced a large
increase in bad small business-related loans and recently took
a 41 percent reduction in profit. Some analysts have raised the
possibility that commercial loans could be a ``ticking bomb.''
Some also predict that this quarter may mark a turning point,
with lending flat, down from record highs.
However, the best evidence that something that cannot be
ignored is afoot are recent actions by the Federal Reserve and
Congress, who have moved to quell the perfect storm of a
housing downturn on which economic growth, although housing has
been the basic source of our economic growth, double-digit
increases in many basic food products, and indeterminate gas
increases. Driven by the economy itself, rather than by any
piece of it, President Bush has thought better of his threat to
veto the most far-reaching housing bill in decades.
This Subcommittee has an obligation to look now at whether
there is or could be a metastasis of the housing crisis and
other economic problems that could surface in the commercial
sector and what, if anything, could be done about it when it
comes to Federal leasing and construction.
A credit crunch typically refers to factors that lead
lenders to reduce the available credit by declining to make
loans or doing so only at increased costs or with special
terms, even for those who are creditworthy. The uncertainty
about the losses from the subprime mortgage crisis still
playing out with mortgage lenders has caused the credit markets
to shrink considerably.
Although Federal leases and construction contracts might be
said to be worth their weight in gold, private sector
competitors don't have that assurance when they compete for a
lease or construction contract. If credit becomes too difficult
or costly, commercial office space available to the Federal
Government could diminish or allow too few to take the risk of
competing, raising costs to taxpayers.
GSA's reliance on the commercial office space market to
house Federal agencies ties the agency directly to commercial
market conditions. The agency must begin to use its prime
position in the commercial marketplace by leveraging its buying
power and capturing its great potential for reduced costs to
taxpayers. For example, in the last three years, fiscal year
2005 to 2008, the FBI presented this Subcommittee with 23
leases, the largest group of long-term leases.
As a result, the Subcommittee has indicated that it wants
GSA to look very closely at a comprehensive lease package for
agencies like the FBI, which have long-term viability in
metropolitan areas. Almost all the FBI leases will be built-to-
suit the agency, but already GSA has seen a reduction in
competitors for these FBI leases. We must discover why this is
so and whether it constitutes the beginning of a trend.
In today's atmosphere of soaring budget deficits and rising
costs for all concerned, GSA also must work collaboratively
with the private sector to reduce the cost of acquiring
commercial office space. By working with our private sector
partners to achieve the vision and the know-how necessary to
cut costs across the board, together we have the potential to
help stimulate the local and national economy while addressing
the needs of the Federal Government. Today, we are very pleased
to hear from the GSA, from financial and economic experts on
the commercial markets and office development who are before us
and have prepared testimony.
The Ranking Member had very much wanted to be here and had
asked that we change the day of the hearing so he could, but
something has come up as we near the end of the session, so I
am inserting his remarks in the record by unanimous consent.
We want to begin by figuring out where we are. We are not
going to get to the remedy unless we have a fix on what is
happening in a very puzzling economy. It has fascinated me from
the beginning, just as a general matter, and even more so as it
has progressed with all of the unknowns that we are having to
deal with for the first time.
Therefore, I am pleased to welcome panel one, James
Chessen, the Chief Economist of the American Bankers
Association; Raymond DiPrinzio, Managing Director and Head of
Project Finance at CIFG Assurance North America, Inc.; and
Kenneth Rudy, International Director of Corporate and Capital
Markets, Jones Lang LaSalle.
Actually, you may testify in whatever order you feel like.
I have no preference, since you are not Government officials
and there is no protocol.
Mr. Chessen, of the American Bankers Association.
TESTIMONY OF JAMES CHESSEN, CHIEF ECONOMIST, AMERICAN BANKERS
ASSOCIATION; RAYMOND DIPRINZIO, MANAGING DIRECTOR, HEAD OF
PROJECT FINANCE, CIFG ASSURANCE NORTH AMERICA, INC.; AND
KENNETH RUDY, INTERNATIONAL DIRECTOR OF CORPORATE CAPITAL
MARKETS, JONES LANG LASALLE
Mr. Chessen. I would be happy to begin, Madam Chairwoman.
Madam Chairwoman and Members of this Subcommittee, my name
is James Chessen. I am the Chief Economist of the American
Bankers Association, and I very much appreciate the opportunity
to testify on the current state of funding for commercial real
estate, including properties leased by the Federal Government.
Our Nation is certainly facing difficult economic conditions,
one that affects all businesses, including banks. We have gone
through these periods before and have emerged much stronger as
a result.
I want to emphasize one basic point: the core business of
banking is lending. That is what banks do. Banks will continue
to be a source of financial strength in their communities in
both good times and bad. Even in a weak economy, there are
strong borrowers, including developers and owners of government
leased property, that merit bank funding.
I am also very positive about the banking industry. Before
turning to my main points, many of you may be wondering about
the health of the banking industry in light of the several
recent failures that you mentioned, Madam Chairwoman. Let me
assure you that the industry remains fundamentally sound. Banks
entered this period with a very strong capital base and banks
have continued to build capital over the last several quarters.
In fact, 99 percent of the banks are classified as ``well
capitalized,'' which is the highest designation that can be
given by bank regulators. Simply put, the industry has the
capital and reserves to continue to make loans that are so
vital to our communities.
Let me now turn to commercial real estate lending. Like all
specialized forms of lending, loans for construction,
development, long-term funding of government leased properties
have unique risks. These risks exist regardless of the economic
cycle. The weak economy, however, does add an extra element of
risk that affects the availability and price of credit. Against
this backdrop, it is only reasonable and prudent that banks
exercise caution in making new loans. Bankers are asking more
questions of their borrowers and our regulators are asking more
questions of the banks that they examine. This does mean that
some higher risk projects that might have been funded when the
economy was stronger may not be funded today.
A very important factor affecting the volume of lending is
the ability to sell loans on the secondary market, something
that you mentioned, Madam Chairwoman. Even though problems in
commercial real estate loans are low by historical standards,
investors reacted to the problems in housing and have shunned
new commercial mortgage-backed securities. As you mentioned,
this has the consequence of reducing funding and raising the
cost of new commercial real estate loans.
Certainly, just as too much risk is undesirable, a
regulatory policy that discourages banks from making good loans
to creditworthy borrowers also has serious consequences. We are
very concerned that a regulatory over-reaction could quickly
convert a credit caution to a credit crunch. We witnessed just
such a regulatory-induced credit crunch following the 1991
recession, and we are hopeful that regulatory reason will win
the day this time.
However, we hear reports from our bankers that examiners
are demanding costly new appraisals on properties and forcing
banks to write down collateral values even though the bank is
not relying on collateral for the repayment of the loan. These
unnecessary appraisals and write-downs will discourage banks
from lending on similar projects.
Fortunately, the bank agency heads seem to be sensitive to
this potential problem and have pledged to avoid a repeat of
the 1990s. The great challenge, however, may be to ensure that
that message from those agency heads reaches the regulatory
personnel examining banks in the field.
To achieve our mutual goal of a safe and strong financial
system, it is extremely important to remember the vital role
played by good lending in restoring economic health, and not to
allow a credit crunch to stifle the economic recovery.
Thank you again, Madam Chairwoman, for the opportunity to
present the views of the American Bankers Association at this
hearing today. I would be happy to answer any questions that
you have.
Ms. Norton. Thank you very much, Mr. Chessen.
Who would like to go next? Mr. DiPrinzio?
Mr. DiPrinzio. Sure. Thank you.
Good morning, Madam Chairperson, Members of the Committee.
My name is Raymond DiPrinzio. Thank you for the opportunity to
address the Committee on the impact of the current credit
crisis on the development and financing of Federal real estate.
I am currently head of Project Finance for CIFG, a financial
guaranty firm headquartered in New York.
Financial guaranty providers are essential proxies for
retail and institutional investors in the capital markets, or
lenders in the case of the bank loan market, since under the
terms of their guaranty or credit protection contracts they are
obligated to make principal and interest payments to investors
and lenders in the event the borrower fails to do so. In this
capacity, I am responsible for underwriting all forms of
project financings for infrastructure, including
transportation, energy, environmental and public use real
estate facilities, such as office buildings, military and
student housing, stadiums, and arenas.
Federal project financing is a subset of the larger
infrastructure market, a sector that has enjoyed unprecedented
levels of interest from institutional investors across the
globe due to the deep levels of demand for financing
infrastructure in the United States which is in need of
replacement or for new facilities which must be built to
accommodate growth. In my 24 years working as a finance
professional, I have had the opportunity to work on Federal
projects as a financial advisor and investment banker to
Federal agencies, as well as a provider of credit protection to
investors in the capital markets.
I have worked on financings for Energy, Justice, Veterans
Administration agencies in both GSA form, as well as what I
would refer to as direct agency leases. Given my background, I
am speaking today with the perspective of a practitioner in the
capital and bank markets, and more specifically one who has the
perspective of both the borrower as well as the lender.
The current difficulties in the financial market are
unprecedented in both the breadth and depth of its reach, and
it should come as no surprise that the market for Federal lease
transactions has not escaped unharmed. I should mention I am
looking really from the perspective here of the lease
construction market, the types of financings that GSA and
agencies enter into that require a build-to-suit and, more
specifically, the raising of capital in either the bank market
or the capital markets.
While real estate projects involving Federal tenants under
long-term leasing arrangements are viewed more favorably
relative to their commercial counterparts, the overall
reduction in liquidity, repricing of risk, and either the
unavailability of credit protection from monoline bond insurers
or the market's diminished view of the value they bring, has
led to delays in completed financings, tighter credit terms
and, most importantly, dramatically increased credit spreads,
i.e., higher borrowing costs. Indeed, higher borrowing costs
are making many transactions impossible to complete as it
translates to rental rates outside of approved levels.
More specifically, financings that were able to get credit
protection and complete a transaction saw spreads widen to 70
to 100 basis points over previous levels compared to the pre-
credit crisis. Without credit protection, spreads have widened
200 to 300 basis points, levels never seen in markets for
credit for Federal leasing.
What can be done? In my prepared testimony, I have laid out
a number of recommendations, but I think I would like to just
touch on them briefly.
What is striking to me, as an investment banker and a
lender, is how unknown this market truly is to the wider
capital markets. I have been struck by its obscurity, the lack
of understanding of these transactions given the depth and the
role the Federal Government plays in the real estate market,
and the needs of the GSA. In many ways, Federal financing has
significant untapped potential which, if properly harnessed,
can result in broader market acceptance, higher levels of
investor interest, lower borrowing costs, and ultimately lower
rental costs.
In this regard, I offer the following areas for
consideration, and they are basically, I would say, four areas:
market education, a more programmatic approach, addressing OMB
rules that impact the structure of these transactions, and the
consideration to enhance use leasing potentially for GSA
agencies.
On the market education front, my point basically is I
think GSA and the other agencies could take a more
comprehensive approach to educating both the bankers and
advisors, as well as the rating agencies on the operation of
the Federal Government in Federal financing.
With respect to a programmatic approach, what is striking
to me is how decentralized the approach to financing the
Federal Government is in these markets, and an effort to bring
together a more comprehensive programmatic approach to the
market would go a long way, I think, to addressing these
issues.
OMB, quite rightly, guards the Federal budget process and
balance sheet, but consideration should be given to revising
the rules with an eye to an appropriate level of risk
allocation between Federal agencies and private sector
developers and financial participants, as well as the ultimate
impact on financing structure and costs.
In summary, while the current crisis in the credit markets
is taking its toll on all players, including Federal agencies,
the dislocation in market coupled with unprecedented levels of
demand for properly structured infrastructure investments also
provides an opportunity for the Federal Government going
forward in its approach to financing real estate and other
essential infrastructure. Steps should be taken to broaden the
level of understanding of the Federal role as a user of
facilities critical to the operation of government, streamline
its approach to the market, and address the rules and
regulations which govern its role while maintaining a careful
eye on the impact on risk and return.
Thank you, and I am happy to answer any questions.
Ms. Norton. Thank you, Mr. DiPrinzio.
Mr. Rudy?
Mr. Rudy. Good morning, Madam Chairwoman. Thanks for having
me. I am Kenneth Rudy, and I am President of Jones Lang
LaSalle's Capital Markets organization in the Americas. I have
been a practitioner for about 25 years. Our group tends to
serve private sector investors, owners, and occupants on
capital strategies dealing with the capital markets in the
United States.
I hope you had a chance to read my prepared testimony, so
at this time I will just take the opportunity to summarize and
reflect on some of the things that have already been said.
With your opening remarks, Madam Chairwoman, you talked
about the subprime mess and how it has spread to larger
markets, so I think it is good to level-set and understand
where we are so we can predict where we might be going. With
that, there is the recognition that real estate has always
operated in cycles; it is a very cyclical asset class subject
to lots of volatility, lots of swings because it is a
complicated asset class subject to debt, supply, demand,
confidence, and other economic fundamentals. As a result, it
will swing. In my career, I am in my fifth real estate cycle of
significance, and this one is a very significant one.
So when you try to predict where we are going to go, why we
are where we are today, and principally it is overflow from the
massive amounts of capital that was chasing real estate
investments both on the commercial and residential side. We all
know what has happened with the abundance of mortgage debt and
the origination of debt for less worthy creditors and
borrowers.
In the residential markets, that has led to an oversupply
of product, as well as defaults for people who can no longer
afford to pay their mortgages. What has happened now is those
very same lenders, who are having trouble with their balance
sheets because of the mortgage mess from the residential side,
are also restricted from providing loans on the commercial
side.
You mentioned also earlier you don't think that the
commercial mortgage mess has spread, or there is such a mess
yet, and that is true; the default rates on commercial
mortgages are very low today. That is because on the commercial
the fundamentals, meaning the supply and demand that creates
value in commercial real estate, has largely been in balance
since the last cycle.
However, as a lot of these commercial loans are coming due,
especially the acquisition loans that were made during this
last cycle peak, it may be difficult for a lot of owners to
refinance these loans. That, coupled with the overall scarcity
of acquisition debt in the commercial markets, makes the
investment cycle or the market pricing of assets very
difficult, and therein lies the conundrum.
A market is determined by buying and selling activity, or
by two parties coming together. When transaction activity has
hit the levels that it has hit today, which is nearly down 70
to 80 percent from years prior, it is difficult to come up with
a market clearing price for asset values, commercial asset
values. There is a big gap between the bid and ask, as they
say. And when that occurs, the lending markets who help finance
these acquisitions, they themselves have difficulty determining
the value of the underlying asset as they are considering
granting loans to commercial developers or investors buying
real estate.
So the whole pricing process is in disarray. And whenever
there is disarray, uncertainty goes up and risk goes up, and
risk is reflected in higher pricing of capital, both on the
debt and on the equity side. For occupiers of leased or
investment real estate, that translates into higher occupancy
costs or greater challenges in doing deals.
So this is where we are today. People often ask where are
we going in the future, and the only thing I can assure you is
that--again, this is a cliche being in the real estate
business--the only constant in real estate is change. You can
be certain that it will improve, we will find a new bottom, but
most economists will tell you you don't know when you are there
until you are looking in our rearview mirror, until you have
already passed that bottom.
Right now there is a great deal of uncertainty. Just this
week you read that Merrill Lynch finally sold what was a
portfolio of $30 billion of CDOs to a private investor that
they had previously marked down to $11 billion, and they sold
it for $5.8 billion. That gives you an indication of the great
deal of uncertainty that there is in pricing securities and
assets associated with real estate.
Also in my written testimony I showed you the drop-off in
the CMBS market, which is the amount of securitization of
commercial loans that are available in the market. It is
running at nearly 10 percent of where it was at the last market
peak. So the scarcity of capital is creating difficulty for
borrowers and investors and speculators in real estate. Again,
we won't know where the bottom is until we are passed it and
there has been a market clearing price for real estate assets.
What does that mean to the Federal Government? Well, for
the Federal Government it represents the best credit out there,
and there is still money available, as you heard in the prior
testimony. Real estate is still a valued investment asset
across the world. It is in a balanced portfolio for most
investors and it will continue to remain so, and there are
lenders that are available.
The difference between today and yesterday is now the
lenders are primarily balance sheet lenders who do sound
underwriting, sound credit analysis, as opposed to what you
have heard in the residential market, the covenant-light, no
dock loans. That occurred in the commercial market too, where
there was a covenant-light commercial mortgages. That doesn't
exist any more.
What it means when you have covenants in underwriting is
the lenders and equity sponsors need to be able to pay back the
loans more quickly, have lower amount of loan relative to the
overall value of the asset--and that value is still
undetermined in this marketplace today--and other sort of more
restrictive terms. The Government can play well in that market
because it can promise the equity sponsor and the lenders
better ability to have that loan repaid, provided that the
documents that are securing that income flow to that property
are what we would call market conforming, or at least have
market conforming sort of provisions to allow the equity
sponsor and the lender to underwrite that risk, to know what
they are getting when they make a loan on a commercial
property.
So I have provided in my written testimony a list of
potential clauses and other features of GSA leases which, when
made market conforming, have the effect of reducing borrowing
costs and, therefore, equity yields and, therefore, occupancy
costs for the Federal Government when they do leases. But the
money is there for good projects, good sponsors, and good
tenants.
Thank you.
Ms. Norton. Thank you very much, Mr. Rudy.
Now, let me see if we can get some of the basics. This is
very, very compelling testimony.
Let me ask you, Mr. Chessen. You warned about the so-
called 1991 overreaction and the reaction today. Do you
consider what the Fed is doing, what the Congress is doing, do
you reconsider that within the realm of reaction or
overreaction?
Mr. Chessen. I think, Madam Chairwoman, that was a very
good reaction to try to stop what could eventually become a
bigger credit problem. So I congratulate you and the Members of
Congress for moving forward on that plan.
My concern is what happened in the 1990s was that the
regulators were looking over banks' shoulders for every type of
loan they made, and the message back then from Congress, as
well as the regulators, was make no mistake in lending; and
that has a chilling effect on the willingness of banks to get
out and make any type of loans.
Just to give you a recent example of that, Madam
Chairwoman, we had a big meeting with 300 bankers and a banker
from New York came up to me and he said they had examiners in
his bank, and he has a lot of capital, never got into the
problems with the housing, and he is anxious to lend, and he
was describing to the examiner a loan that he wanted to make on
a commercial property, and the examiner said why on earth would
you want to make this type of loan in this environment, and he
was stunned by that.
He is a bank that is out there, willing to lend, he has the
capital, doesn't have the problems that are out there, and his
regulators are saying, whoa, wait, I am not sure that is going
to be a good loan a year from now. That is what we worry about.
Ms. Norton. His Federal regulators were saying that?
Mr. Chessen. Yes, ma'am.
Ms. Norton. And you do not believe this was a risky loan?
Mr. Chessen. I don't know the details of the loan. He
believed that this was a loan that met his underwriting
standards and he was comfortable in making.
Ms. Norton. And if he was comfortable, one would wonder why
the regulator was not. I don't know the particulars there, but
I must say to second-guess somebody, unless there is some issue
for the Federal Government, is an interesting notion for a
regulator.
Mr. DiPrinzio, you mention on page two of your testimony
properly harnessing--these are your words--properly harnessing
Federal financing. I wish you would elaborate that and describe
some of the benefits that you think this harnessing would bring
to the Federal Government.
Mr. DiPrinzio. What I am getting at, really, is that the
role of the Federal Government in the capital markets as a user
of financing, if you will, a borrower, is not very well
understood. There is a very small subset of practitioners out
there who really understands how Federal leasing contracts work
either at the GSA level and certainly at the agency level.
It is striking to me how decentralized the financing of
real estate for Federal properties is, and I have been doing it
now for a number of years, so I have kind of seen it from time
to time. If you look at other examples of the Federal
Government approaching the market comprehensively, military
housing, the privatization of family military housing is a
great example of where a comprehensive approach was taken,
legislation was put into place in 1996 and private capital has
come in in droves. I think the numbers are roughly $20 billion
has been raised over time.
Ms. Norton. What are they doing with military housing
compared with what they were doing before?
Mr. DiPrinzio. Essentially, the Federal Government got out
of the role of providing housing for military families.
Ms. Norton. So what, did it contract to get it before and
now what does it do?
Mr. DiPrinzio. And now basically money is raised in the
capital markets; bonds are sold, either with bond insurance or
without bond insurance, or privately placed to investors and
the Federal Government is essentially allowing the BAH, the
basic allowance for housing, to be used as a source of
repayment for those bonds.
The point being, not to get into the specifics of that
program, but that it was a comprehensive approach. While there
are differences among the services, Army versus Navy versus Air
Force--they do things slightly differently, they have
maintained the flavor of the different services in their
approach to the market--there are broad rules and understanding
as to what the intent of the Defense Department is in bringing
in private capital, and it has worked really well. The rating
agencies understand it and the market has accepted these
transactions.
Ms. Norton. I am trying to analogize to the GSA, where I
take it the lease payment would be the analogy.
Mr. DiPrinzio. That is correct.
Ms. Norton. How is the VA in the picture, then?
Mr. DiPrinzio. How is VA in the picture?
Ms. Norton. How is VA in the picture?
Mr. DiPrinzio. Right. Among the agencies, VA probably has
the most sophisticated program and approach, and is probably
one of the more well known agencies to the market. Again, it
does things differently; it has its own approach to how it
wants financings done. But as a practitioner, as a lender or
finance professional, I recognize how the VA has been----
Ms. Norton. I am sorry, I said VA. I meant DOD. DOD. I am
trying to see if essentially the housing is given over to the
private sector to build.
Mr. DiPrinzio. That is right.
Ms. Norton. What role does DOD play in the process?
Mr. DiPrinzio. Well, essentially, the Government is deeding
the property over, it is conveying the property to a private
entity under a 50 year development contract. At the end of 50
years, the property comes back to the agency. So unlike a
project where you have nothing from scratch, you are basically
going into the market with an existing group of housing that
service members are living in, and the Defense Department or
the services themselves convey that property and then basically
enter into a development agreement with a private developer who
is raising financing in the capital markets to either renovate
or construct new housing for military family members and
operate that housing over the course of a 50-year period.
Ms. Norton. I am searching for whether or not we have done
anything like this. We have often spoken of the DOD and the VA
and what looks like a one-time transaction, because I haven't
been able to spread it. We were able to do that at the
Southeast Federal Center when I was tired of not being able to
get a Federal agency to move down there and put in a bill,
which essentially has allowed that to happen, and look what is
happening; they are building on the property.
This was one of the most valuable properties in the
Country. When I tried to say there must be similar property
across the Country, why don't we do it elsewhere, we were met
with the notion, well, it scores. How can it score if it didn't
score here? I still haven't been able to find that out.
But this notion of scoring may be familiar to all of you. I
don't know if it was you, Mr. DiPrinzio, but one of you
mentioned in your testimony scoring. I wish I could say that
something would happen to change it. The worst times get, the
more I think we won't. The waste of it sends us up the wall, I
can tell you. The willingness to spend money, billions of
dollars because something scores, and especially because real
estate is treated as if it were like any other commodity.
I wonder if you have any notions about how to encourage the
Federal Government to understand how distinctly different real
estate is from other goods and services that are scored,
because if we go with scoring generally, we obviously get
pushed back, and we find that scorers have almost no
understanding of real estate, and this is very threatening to
us. We just got a bill, I had to do a bill--shouldn't have had
to do a bill, but because I had to do a bill because OMB
wouldn't move on the Old Post Office, this priceless heirloom
at 12th and Pennsylvania Avenue.
Obviously, no cost to the Government and we have a perfect
example to prove it, and that is the old Tariff Building, which
is now the Hotel Monaco, and the scorers scored it. Susan
Britta here was tasked with somehow beating them back and she
beat them back, frankly, because she knew a whole lot more
about real estate than they did, number one, and, two, the
Tariff Building was an example of how it works.
But anything the three of you have to say on scoring, we
would particularly pleased to hear. For example, does the DOD
approach meet any scoring problems? How are they able to do
that? I can't imagine doing that on this side.
Mr. Rudy. I am moderately----
Ms. Norton. Maybe it is the 50-year, because it comes back
to the Government and, of course, we could do that as well. The
Government still owns the property. You put it in the hands of
the developer long enough so that he can in fact benefit, even
though he doesn't own it. I can see that.
Could we do something like that approach, Government
property in that way? For example, at Saint Elizabeths we are
about to build the Department of Homeland Security. This
Department, GSA has never built anything like this. It is not
like building a building; it is building a half dozen buildings
and putting them in one place. It is a compound. If you were
tasked with that, what approach would you use? How would you do
it? And keeping in mind some of the issues we have in the
Federal Government.
I am taking some of my cues from this 50-year military
housing approach. How would you do it other than the way we do
it now, which is building by building, essentially direct
appropriation? The ownership of the property is the--the ground
is ours, but the building belongs to the person who puts it up
there. How would you do it if somebody said, okay, for the
first time--because this really is--if we have any chance, we
have it now, because we have never done anything like this.
Even the Pentagon wasn't like this. That is the biggest one,
maybe.
This, by the way, will probably be the second biggest, but
it won't be one building. So you could argue that precisely
because you know exactly what you are going to do. There had to
be a plan for what agencies, how many, exactly where they are
located on federally owned property. Brand new situation for
the Government. What would you do?
Mr. Rudy. Madam Chairwoman, I want not remind you that my
perspective and my history is servicing the private sector,
which is I think why you asked me to testify, to bring private
sector ideas to questions like you just asked. So I run the
risk, when giving you some analogies, that I may not have a
perfect analogy, whether it is to the DOD program or how you
may want to build out Saint Elizabeths, but a real quick
comment on the DOD program.
My company is heavily involved in helping the Department of
Defense with Army and Air Force housing. There were some
different objectives there. Clearly, it was to keep the
Department of Defense from using its war fighting dollars on
housing and to bring in private sector capital----
Ms. Norton. There is no different objective. This is awful.
This uses what is unheard of in real estate. We are now waiting
to get out $300 million for the Coast Guard building, over $300
million for one building. Direct appropriation means here is
the money.
Mr. Rudy. You are right. Money is----
Ms. Norton. So I understand that you can understand that is
for war fighting, but most of it doesn't go into war fighting.
So they are using taxpayer dollars, and instead of handing the
money over in one lump sum to build this housing, ----
Mr. Rudy. Well, they actually did it a positive way. They
didn't hand any money over, they attracted capital, and they
attracted it because they needed the capital and the management
and development expertise to upgrade the housing and to
modernize it and maintain it in a very nice fashion for the
soldiers. So it has been a successful program.
You asked about Saint Elizabeths, what would you do with
Saint Elizabeths. I am setting aside whatever scoring rules or
other rules of engagement there are and just saying, if it was
a clean sheet of paper, what would you do. One of the things
the private sector certainly would be interested in is some
sort of a public-private arrangement where the Government owns
the land--it is very valuable land, it is a terrific location--
the Government has the occupancy demand with the agencies that
want to be there, and these are permanent agencies, if there is
such a thing as permanent. They could provide a very long-term
commitment to be housed in buildings to be built.
So what does the private sector wants? The private sector
wants what they wanted with the DOD, they want a reasonable
rate of return to provide their own capital, both debt and
equity, to build buildings to house the Federal Government,
with the recognition that maybe at some point in the future
there could be some risk out there of the Government no longer
needing those buildings and them still having some financial
responsibility for what is remaining on those buildings. So
building a market conforming asset, one that physically could
have adaptive reuse; designing the campus in a way where it is
flexible, yet still meets the needs of the Government.
So instituting some of the private sector disciplines in
terms of asset value creation and financing, and on the
financing side they would need to be able to secure whatever
debt financing and equity yields by the lease structure that is
in place; and that goes back to some of the market conforming
comments I made in my written testimony. And the Federal
Government is already experienced with those sort of lease
forms.
There is a form I am not that familiar with, called 3517X,
which is essentially a financially optimized lease structure
that the Government has used that enables the private sector to
understand and underwrite the cash flow streams and separate
cash flows between retiring debt or paying operating expenses
and utilities and other sort of features that reduces the risk
of those investors and allows them then to commit capital to
get these sort of assets built. So there are tools out there
that are available.
I could elaborate more if you have questions.
Ms. Norton. That distinction you were just making, does GSA
do that, does the Government do that?
Mr. Rudy. This lease form is a Federal Government lease
form, yes.
Ms. Norton. Do you have any ideas as well, Mr. DiPrinzio,
on the Saint Elizabeths opportunity for the Federal Government?
Mr. DiPrinzio. Yes, thank you, Madam Chairperson. I think
what I would add to Mr. Rudy's testimony is that with a
situation like Saint Elizabeths, the problem you are going to
run into is if you have multiple buildings in a campus-like
environment, in some ways that is an ideal situation for
attracting private capital. The problem that you are going to
have is to the extent that you allow the Government to walk
away from one building, but not another, addressing that risk
is always going to be a problem.
Where the private sector gets most comfortable is when we
see the Federal Government coming in and taking a large amount
of space. If you go back and you look at the lease renewal
statistics for GSA, the biggest campus-like transactions are
the ones that have the least amount of risk for the private
sector. Again, the problem here would be to the extent you have
multiple buildings and one can be cherry-picked, if you will,
over the course of a 10, 20, 30-year period, that is going to
cause a concern.
So an all or nothing approach I think is something that you
consider. If there is some way that the renewal of the leases
are not building-specific, but across the entire campus, that
may not be possible, but that is going to be probably the
biggest issue that you grapple with.
Ms. Norton. I am sorry, the biggest issue will be what
again?
Mr. DiPrinzio. To the extent that a Federal agency within
that complex can decide to not renew the lease on a particular
building, versus the entire whole, if you can cherry-pick one
building off of another, that is going to diminish the ability
of the capital markets or the bank markets to finance the
entire project.
Ms. Norton. I must say, when you consider--I am interested
that you say that. I could understand if this were a finite--
this is Federal property.
Mr. DiPrinzio. Right. I understand.
Ms. Norton. So the last group that can afford to just take
the risk of the building that nobody will be in the building
would be, of course, the Federal Government. Now, we are also
putting out there maybe six agencies out of how many? There may
be twice as many agencies there. We can't find any one place to
house them all and to get them all. They are headquarters
agencies, so they have to be there. So I am interested in your
notion that an agency might walk away.
Mr. DiPrinzio. Individually. I think----
Ms. Norton. Of course, they can't just walk away, they
would have to come through--it would have to be an awfully good
reason, maybe growing. Let me give you your hypothetical. Maybe
it just grows--normally, as you may know in this region--so it
gets an asset somewhere else for where it grows. The FBI has
grown, so it is also going up to NoMa. So one wonders.
Maybe I should go to Mr. Chessen. Is that a risk from the
point of view of a bank who is lending the money? What is the
risk you see at Saint Elizabeths at the Homeland Security?
Mr. Chessen. Well, I don't claim to know a lot about Saint
Elizabeths. I can tell you, though, that protection of
collateral for a bank is extremely important. So, as was
described here, any danger that might undermine that--
separating out that collateral, having that become vacant, not
being able to lease that again--does pose a risk to that
lender. So I think anything that reduces the risk to that
lender is going to lower the price of that loan.
Ms. Norton. Do you think that the Government, if that is a
risk with a cost, should seek to reduce that risk by--I hate to
use the word guarantee_by some assurance that would be given to
the owner?
Mr. DiPrinzio. I think to the extent that your objective is
the lowest cost of financing and the lowest rental rates, some
mechanism that groups together the multiple properties at Saint
Elizabeths and the multiple rental streams from the different
agencies that will be occupying those properties would go a
long way to allowing you to approach the market with a
comprehensive larger revenue stream to raise the most amount of
dollars at the lowest rate.
That is really the issue. It is very hard to--it is not
easy to do. We saw one situation, I believe, with the Energy
Department----
Ms. Norton. The rental streams do not come individually
from the agency, they come to one agency. That is one thing the
Government has done right; it has a real estate arm.
Mr. DiPrinzio. So you wouldn't have a GSA lease for all of
it on a comprehensive basis.
Ms. Norton. Well, no, whether it will be for all of them is
the--the point is that it is all GSA construction, it all comes
out of GSA. There may be individual agencies. What intrigues me
about you was the notion of rental stream. It is one agency.
How come all the rental streams--the existing rental streams,
albeit paid over to GSA----
Mr. DiPrinzio. Will there be a single GSA lease for the
entire campus or will it be multiple GSA leases?
Ms. Norton. The way it is now--and this is what, of course,
I rebel against--it is done as if GSA was building, let's say,
six different buildings in six different places, without
leveraging the benefit of having a compound where you could say
look at all of these.
Now, you might want to compete them differently, especially
since it is not being built at the same time, but the notion of
not regarding this, when, in order for the authorization to
occur, you have to have indicated what it is you intend to do
over the time; and then to kind of forget that and to go back
to what you always do, building by building, is what I am
trying to find a way out of.
Of course, we are dealing with not only the way it has
always been, but within an entire Federal Government who has no
knowledge and not much interest in real estate unlike the DOD,
which is spread all over the world and has far more of its
dollars going to real estate.
I don't even know how the VA got--I am not sure whether the
VA has more of its dollars going, but you mentioned the VA -- I
think it was Mr. DiPrinzio--which has its own authority and
apparently deals with building various kinds differently from
GSA. Would you speak about their enhanced authority?
Mr. DiPrinzio. Well, the VA, quite rightly, Madam
Chairperson, does have its own leasing authority, and it also
has enhanced use leasing authority, which it has been utilizing
in recent years to reduce its cost, ultimately of----
Ms. Norton. So speak about what do you mean by enhanced
leasing authority?
Mr. DiPrinzio. Enhanced use leasing authority allows the VA
to basically take excess space--that may not be the proper
term, but basically space that is not currently at the highest
level of priority--and allow a private developer to develop
that excess space in return for providing the VA with a lower
cost of overall occupancy at say, for instance, a separate
facility. There is a lot of interest in that.
Obviously, it depends upon the particular property at hand.
In Cleveland, the VA is vacating one facility and basically
allowing the developer to take control of the land at that
particular facility that it is vacating in return for a lower
rental rate on a new facility that it is building at Louis
Stokes. So, in that instance, the EUL, the enhanced use lease,
basically allows the VA to lower the cost of financing to a new
build-to-suit building that is being put in place at Louis
Stokes. Very powerful.
The Defense Department is attempting to do similar things
using its own EUL authority.
It is striking to me, if I am not mistaken, GSA does not
have its own EUL authority, and I would think, just based on my
understanding, that there would be a lot of opportunities to
better utilize and bring in private capital for space that is
either deemed excess or not at the highest priority.
Ms. Norton. We attempted to give GSA what we call Section
412 authority, which bit off a piece of that, and they not only
sat on it, but OMB has kept them from using it, and I am going
to try to--with the change in administration-- loosen this up,
make somebody understand how much money we are losing in the
OMB; and OMB tends to have a say. If you have to go to OMB for
everything, then, of course, you are really dealing with people
who are outside of the whole real estate conundrum, dealing in
another world, and yet they make rules that have to do with
real estate.
I am trying to find out how does the GSA lease? Because we
build a lot of stuff. We are not going to build a lot more
stuff, and that is why the Homeland Security is so important to
me. But the Federal Government continues to grow, even in this
climate. We always think, because there is so much competition
in this region for a GSA lease, that that is the gold standard.
How is the GSA lease viewed in terms of risk?
Mr. Rudy. Let me try that one. If you don't mind, can I
just circle back and put an exclamation point on the Saint
Elizabeths scenario?
You have been asking how to compare it to the DOD. I think
there are actually a lot of great analogies. What I think the
Federal Government is trying to accomplish with Saint
Elizabeths is to get a commitment from private sector capital
and development capabilities that extends beyond one asset but
goes over a period of time. Because in a cavernous environment,
you are going to be building for quite a long time. And the DOD
has been successful in arranging those sort of structures in
exchange for all the right documents, the right risk
assessment, risk assignment between the parties, deeding land
or buildings or improvements to the private sector, then
allowing the private sector to compliment with their own
capital and get a good rate of return.
For Saint Elizabeths, again, a similar structure could be
thought about, where you already own the land, so the cost
basis of that land does not have to be embedded in the overall
project cost once a building goes up. So now a developer has
the ability, using whatever the private sector cost of capital
is, with a good lease structure--you have asked about leases.
You said the gold standard.
Maybe there is a gold standard of a lease structure out
there that an investor could get their arms around and
underwrite along with their lending partners, and provide not
only capital for one building, but a forward commitment for
multiple buildings over a period of time. And if that lease has
the right assignment and allocation of risk between the Federal
Government and the developer in terms of design, delivery,
long-term maintenance and occupancy costs that the private
sector is accustomed to, you will get very low cost capital
commitments and a lot of interest in delivering that sort of
real estate to the Federal Government to be occupied. And these
20-year leases are sufficient to get ample amortization of
debt, so when the debt is nearly fully paid off or reduced to a
significant amount, it really almost doesn't matter whether the
Government decides to renew or not.
I would suggest that that campus environment, there is a
story to be told about it that private investors understand
when they do real estate deals, and that is there is a
reasonable probability that the Government is not going to
leave; and they are not afraid of that residual risk tail. And
that residual risk tail is an important component of your
overall occupancy cost.
You said in your earlier testimony educate the consumer,
educate the development investment community around what it
means to do business with the Government. So educate them on
risk of departure or renewal, educate them on the use of the
facilities, perhaps deed the land over under a ground lease so
it is not embedded in the building cost, write a commercially
conforming lease, and you will attract abundant capital with
good development expertise to get commercially viable buildings
built for your agencies. I mean, that is a clean sheet of paper
solution utilizing tools that I think are available to the
Federal Government now.
Mr. DiPrinzio. If I may, I would like to pick up on Mr.
Rudy's point about residual or renewal risk at the end of a GSA
lease term.
We use the term ``essentiality'' quite a bit in the larger
public finance markets and specifically with respect to Federal
facilities that are being financed. To the extent that one
educates the investor--and obviously the investment bankers and
the advisors that are working on these transactions--of the
essential nature of a particular facility, the essentiality of
that facility to the Federal Government, that will go a long
way to reducing that residual risk and that renewal risk.
It is significant. It is probably the biggest issue that
anyone faces in looking at a GSA financing from a credit risk
perspective, setting aside the terms and conditions of the
lease and how those may impact one way or the other. The
renewal risk at the end of 20 years or 15 years, depending upon
how it is structured, is critical.
One of the things that the market does understand is the
notion of essentiality as it applies to State and local
government, we see it all the time. Appropriation risk, the
risk of annual renewal is something that the public finance
markets have been used to taking for State and local government
financings.
We are essentially applying that to Federal financings, and
being able to communicate the essentiality of a given facility
to an agency, to a larger campus environment is critical to
reducing that residual risk; and taking it outside of the way
the commercial market looks at residual risk and putting it
more in the context of an infrastructure financing for a
Federal agency that, quite frankly, in many instances has no
intention of not renewing.
So you want to get that down. You want to do a good job of
educating the investor ultimately, and the rating agencies or
the bond insurers, whoever it might be that is involved in the
financing, on the essentiality of that facility.
When we look at military housing--just, again, to touch on
another analogy--if a military base were to close, the
investors are taking the risk of base closure. What the DOD
does is essentially--pardon the term--it educates the investors
on the essentiality of that base, on the importance of that
base overall.
Ms. Norton. Well, that is interesting. Let's take that one,
because I have gone through a couple of BRAC proceedings here
and bases have closed. I think the chances of a base closing
are perhaps greater than the chances of having an agency move
out of Saint Elizabeths.
Mr. DiPrinzio. I completely agree. And the market has done
$20 billion worth of military housing financing that has base
closure risk all over it. So the notion of Federal----
Ms. Norton. So what happens when a base closes? So a base
closes, nobody knows what BRAC is going to do the next time, so
what happens to the housing then?
Mr. DiPrinzio. Essentially, the housing converts to
commercial housing.
Would you like to pick up on that?
Mr. Rudy. I would suggest that the bases that the Air
Force, Army, and Navy have pursued in terms of the housing
privatization, they probably started at the top of the list of
core bases, ones that had the least amount of risk for a
closure. They haven't rolled the program out----
Ms. Norton. Least amount of risk because?
Mr. DiPrinzio. They have the least amount of closure risk.
Mr. Rudy. Closure risk for whatever reasons. I can't speak
to the military strategy there. It may have been a very
essential base.
Mr. DiPrinzio. But the important point is there is an
education effort that is put in place to let the capital
markets and the investors understand that. Federal renewal risk
on a lease is a similar issue, and to the extent that one
focuses on that and you reduce that concern, especially in a
campus-wide environment, that is in some ways at the top of the
list of the kinds of financings that the Federal Government can
very easily tap private capital for.
Ms. Norton. What we struggle for and forget, frankly, is
the ownership option, and staff always presses this, but the
push-back is awful, and last time we did do it--before I came
to Congress--it wasn't an ownership option. In fact, I am not
sure when the Government has allowed that and, therefore, I
always look for analogies.
What strikes me, particularly since it took a statute that
I was able to get through when I was in the minority without
any trouble here, for the Southeast Federal Center, what
strikes me is to take a closer look at the enhanced use
authority, at least of the VA. Now, are they outside of the
scoring system?
Mr. DiPrinzio. It is always risky to venture----
Ms. Norton. Mr. Winstead is shaking his head, so scoring--
do you think that the kind of enhanced authority you have
described--I guess it was Mr. DiPrinzio--if that was used
again, let's take Saint Elizabeths, Homeland Security, how
would that work and would that reduce the risk? How would that
improve or not things for building out there?
Mr. Rudy. I am not an enhanced use leasing expert, but it
seems to me--again, I go back to this financially optimized
lease form that the Federal Government already uses. They use
it for the PTO. So you have a campus environment, private
sector capital, and leases that are in place that allow those
sort of improvements to be built and leased to the Federal
Government.
Ms. Norton. What are you calling it? I am sorry.
Mr. Rudy. What is called a financially optimized lease.
Ms. Norton. What?
Mr. Rudy. Financially optimized lease.
Ms. Norton. Financially optimized. All right.
Mr. Rudy. And the components of that, as I understand it,
are components that make it more financiable, almost like a
private sector bondable lease. It has a lot of definitions
around where the lease cash flows go in terms of reducing debt
service, in terms of paying for operating expenses. It has
better assignment of risk relative to default provisions and
capital improvements, and other sort of features that allow the
private sector holder of that lease to get it financed.
Ms. Norton. Goodness. If the PTO used it----
Yes, Mr. DiPrinzio.
Mr. DiPrinzio. Just along those lines, I think one of the
biggest concerns that the capital markets would have is the
ability to set off lease payments because of some degradation
in service provided within the building. So to the extent that
you segregate a debt service component, if you will, of the
rental rate versus the O&M component, and the two can never
really go against each other--I have seen that done, if I am
not mistaken, PTO I think did have that.
Mr. Rudy. That is a feature of this lease, it is a
bifurcated lease stream.
Mr. DiPrinzio. That is critical.
The EUL authority, you had asked about that as it applies
to Saint Elizabeths. Not knowing, frankly, enough about the
current approach that the Government is taking at Saint
Elizabeths, I don't want to----
Ms. Norton. They are taking no approach. Please, the
approach is the same approach that we used for building, I
don't know, the ATF, all right. There is nothing different. So
whatever you know about how the Government in fact goes about
bidding for a new building and then moving a Federal agency in
it, that is exactly what the Federal Government is trying to do
here and what I am trying to get out and regard the building of
a compound as an opportunity, at least for the compound, to get
out of.
Mr. DiPrinzio. Let me just put one possibility out there
that might be helpful in the context of a campus like Saint
Elizabeths. At Fort Detrick, where the national interagency bio
defense campus is being developed, enhanced use leasing
authority allowed the Defense Department to take a parcel of
land, give that parcel of land under an enhanced use lease to a
private developer--in this case Keenan, in conjunction with
Chevron--and have Keenan and Chevron build a central utility
plant to provide steam, chilled water, conditioned power,
backup power to the agencies that are taking those services
from that plant.
It would seem as though you could do something very similar
with EUL authority at Saint Elizabeths, where, if you are
building multiple buildings, the need for steam, chilled water,
backup power would apply in a campus-like environment like
that, and you would get a lower cost for that by using an EUL
in order to provide the site for that central utility plant at
a facility such as Saint Elizabeths.
Again, I am just positing one example.
Ms. Norton. No, keep positing, because, first of all, what
you are dealing with are versions of things we are already
using, and that is the only way I am going to be able to
convince people; otherwise, they have to educate themselves in
a whole area that they are not much interested in, which is
real estate.
Mr. DiPrinzio. My years of advising the Government has
trained me to reach for analogies. If it is done over here, it
is always helpful to be able to pick up on that and see to what
extent we can replicate something maybe that was done in one
area or one agency for another.
Ms. Norton. In today's market, if somebody has a GSA-- I
was interested that you said the market doesn't have-- that GSA
is not as if--and that is interesting. Here, you would think
GSA is a big player in the market nationally, but they are not
much knowledge in the knowledge about how the Federal
Government operates.
Why is that? I mean, maybe they are not as big a player as
I have posited. Here, we live, of course, in a region where
there is a lot of Government work. How is the GSA lease
regarded? Do GSA leases make up a significant part of the
market or a part of the market that the market is interested in
because it is the Federal Government? How does the GSA lease
stand in the market when somebody goes with such a lease?
Mr. Rudy. Let me give you a few of my personal observations
over my career. I was talking about this at breakfast this
morning.
Outside of the National Capital region, while the Federal
Government is clearly an important occupier of space, it pales
in comparison to many other occupants all over the Country, so
the private sector----
Ms. Norton. But you see that the work is done here.
Mr. Rudy. Understood. But you are asking a question about
the understanding, I think, of the private sector's perception
or knowledge of the GSA lease instrument. And when developers
in other parts of the Country or landlords are interested in
doing a lease with the Federal Government, this is not
something they do on a regular basis. Most of the development
community here in Washington, just to exist here, has done lots
of business with the Federal Government and are probably more
expert at it.
But out in everywhere else it is back to the education
discussion earlier, educating the private sector on really what
does it mean to do business with the Federal Government, how do
you go through a procurement, what are the risks of renewal,
what are the rules governing how do you comply with the RFP or
the SFO, and all those things. That level of uncertainty or
just unknowingness on behalf of private developers leads them
to price and risk.
Ms. Norton. This is important to hear from you because the
Subcommittee had to beat the agency about the head and
shoulders in order to get some centralized leasing component
here. I mean, it bothered us to no end that leasing was going
on in the field with out the centralized component here,
essentially in charge, if I may say so, in charge; and now,
apparently, that has been rectified. We will be following that.
But you can see just how far behind GSA is in measuring up
to what, let's say, if this were headquarters of a major
corporation that had to build things around the Country,
imagine letting those folks go out there and do their leases,
and they are knowledgeable, without bringing to bear the market
position of the Federal Government. That is what we are
contending with and what we are trying to move from.
But we are contending with it because the GSA has had a lot
of incentive to do things differently. That is why you hear me
keep talking about GSA. Perhaps people will see the huge waste,
if they see that you have many leases to deal with.
Now, in terms of credit rating and Wall Street recognition
of the Federal lease, how does the Federal lease stand? Here
you have something close to the full faith and credit of the
Federal Government; you know that that is going to be paid. Is
that how it is regarded by the market? What kind of credit
rating does the Federal Government have?
Mr. Rudy. It is about as good as it gets. Again, my comment
just a moment ago and now was not so much as to the process of
leasing and how it is done centrally versus distributed, it was
more a matter of the private sector's understanding of the
process of doing a lease, their side of it, their perception;
how complicated is it to do a lease and how complicated and
nonconforming is the lease itself, which I think is the
question you are now asking.
The credit is great, but then you start detracting away
from the benefits of that credit when the investor starts
looking at clauses in the lease that gives them concern.
Ms. Norton. Such as?
Mr. Rudy. Such as caps on operating expense pass- throughs,
the inability----
Ms. Norton. Say that again?
Mr. Rudy. Limits on the ability to pass through actual
operating expenses--maintenance and utilities--associated with
that lease to the Government because of the structure of the
limitations of those pass-throughs in the lease is one example.
Ms. Norton. How would you control that if you just had an
ordinary pass-through? It is the Government, now.
Mr. Rudy. Well, the private sector has the same concerns,
by the way, so I don't want to make you----
Ms. Norton. What did you say?
Mr. Rudy. The private sector has the same concerns. A
strong credit corporate tenant is also concerned, oftentimes,
about whether a landlord runs building amuck, does it run it
efficiently, and they try to negotiate limitations on those
pass-throughs. So the private sector is used to those sort of
negotiations and limits----
Ms. Norton. So those should be negotiated, you are saying.
Mr. Rudy. They can be negotiated.
Ms. Norton. And this, I take it, would give an incentive to
the owner to come up with perhaps ways to control it that would
be attractive to the GSA.
Mr. Rudy. Correct, energy saving, other sort of cost
savings. So that is one feature of the lease. There are default
features. Somebody on the panel mentioned earlier about the
risk associated with potential interruption of services or some
other sort of failure of a generator or an elevator or piece of
plumbing.
Ms. Norton. Yes, that is troublesome. Spell out what would
happen, what that lease means, that default clause means.
Mr. Rudy. Well, if a tenant claims default, ultimately
constructive default, it can terminate the lease as a result.
That is pretty Draconian.
Ms. Norton. Now, of course, we know that never happens.
Mr. Rudy. Well, if it never happens----
Ms. Norton. But how should the Government--it doesn't.
These things happen. They are not going to move somebody out of
the building, probably. I can think of no circumstance. I won't
say it won't happen, but I would be interested--just a moment.
Apparently, in the old DOT building there was mold and--they
moved them out of two or three floors.
I was trying to come up with whether it had ever happened.
The only reason I raise it has never happened is that if, in
the experience of the Federal Government it almost never
happens, then to continue to put it in like it does, without
making any modification, at higher cost to the taxpayer sweats
me. So the question becomes what should the Government use
instead of something like a blanket default, which, of course,
they have never had to use.
Mr. Rudy. Well, the Government definitely needs its
protection, so I am not suggesting they don't need any of the
protection----
Ms. Norton. Yes. So what kind of protection?
Mr. Rudy. I am only suggesting that in the private sector,
the triggers and clauses and remedies available to the private
sector may be up here in terms of the negotiated thresholds;
whereas, for the Federal Government it is much lower, much
quicker, much more ability for the Federal Government to claim
a default, to provide self-help and their own remedies. Which
means they can offset rent, stop the rental payments, they can
fix the buildings themselves, repair things, going around what
might be the third-party management that is responsible for
doing that, as opposed to going through what I would say is,
again, a commercially viable private sector negotiated path for
doing those things. So it is those additional trip wires that
create additional risk to the investor that they have to
somehow underwrite, they have to embed in their expected rate
of return.
Mr. DiPrinzio. Again, I would add to that. You picked up on
rating and credit rating for a GSA lease financing, setting
aside what agencies can do themselves. That is where renewal
risk and essentiality comes into play from my perspective, what
I underwriting, a setting aside the term of the lease. When GSA
is in the firm term period, no one questions the
creditworthiness of the tenant at that point. What we have at
the front end is construction risk and what we have at the back
end typically is renewal risk, and those two components will
degrade from AAA, which is essentially the Federal Government's
rating, down to some lower----
Ms. Norton. Well, now, renewal risk would be there for
everybody. Nobody can expect that they have the benefit of a
lease. I don't know why it would be any greater for the Federal
Government than anybody else. Nor do I know why the front end
would be any greater.
Mr. DiPrinzio. Right. I think that is correct. The
construction risk on the front end is no different. But,
frankly, I think, with respect to the renewal risk, given what
we were talking about earlier, about essentiality and the
importance of a facility to a Federal agency, reducing that
risk of non-renewal through an education process, an ability to
allow the investor--and this is what I do when I underwrite
these transactions, I go in there and I understand what is the
likelihood of non-renewal. How important is that facility to
the Federal agency.
I think, frankly, the Federal Government has a much better
story to tell in the vast majority of cases with respect to
renewal, which would ultimately raise the rating and bring down
the financing cost and ultimately the rental cost.
Ms. Norton. Indeed, I bet the Federal Government has a
better record at renewal than private agencies, particularly in
this region, where there is no place to run, no place to go.
Is this what you mean, Mr. Chessen, when you speak in your
testimony about Government leases that add risk to doing
business? You call them covenants.
Mr. Chessen. Right. That is exactly right, it is all the
terms that surround the loan or the lease that a bank has to
look at to evaluate how to price that loan and what risk they
assume, and I think it was described very well here. You do
have the construction at the beginning, which is like any other
construction project; you have to weigh that and who is doing
it and how you are financing that, what is the risk of that
builder defaulting.
And on the back side I would absolutely agree with you, I
think the Government is probably better at that renewal rate
than most companies. But there may be cases where the
Government wants to abandon a property or they are leasing
property that is only a small percentage of that overall
building, and could put that owner in a situation where they
may want to do something different, such as get another tenant
and lease in the property, as opposed to the Government.
So there are factors you have to weigh in terms of what is
the risk_we think of the property, of course, as being owned
and fully occupied by the Government, but I am sure there are
areas where the government only leases a certain portion of
that building, and that would be considered by the lender in
terms of the risk of that whole property of non-renewal.
Mr. Rudy. Mr. Chessen brings up a very interesting point on
the renewal thing. I also agree with you that the renewal risk
is inherent in any lease for any occupant, whether it is
Government or private sector. But it is actually the end of the
term issues that are also non-market conforming in a Federal
lease that present some risk, such as the private sector
developer has much less teeth or ability to move the Federal
Government tenant out of the space at the end of the expiration
if the Federal Government tenant wants to hold over, even
beyond expiration. And that is a problem because they may have
re-leasing plans or plan to bring in a new tenant to replace
the income they may in fact be losing. So it is the end of the
term issues that is one example.
Another one is the Federal Government has the ability to
make physical alterations to their improvements, their space,
through the lease term without necessarily having the
obligation to restore those improvements to an originally
approved condition.
That is not correct?
Mr. DiPrinzio. No, no, that wreaks havoc on the financing.
Mr. Rudy. Yes. So, again, those residual risks we are
talking about go up, not because of renewal risk, necessarily,
but because of some of the end of the term issues, such as the
two I mentioned.
Ms. Norton. Talking about irrational issues in the
Government, the condemnation and the holdovers, we tried to get
behind that to find out what it is doing. Here, you raise the
cost of credit because you don't have enough experienced staff,
apparently, to renegotiate, as we heard testimony, the renewal
of the lease, so you put the homeowner--sorry, the building
owner in an impossible position. You use this authority that
nobody else would have, only the Federal Government, and it is
a total outrage.
As you can see, part of the problem is that nobody has
looked with fresh eyes at any of this process for a very long
time, and as we try to do so and are harnessed somewhat by OMB,
we nevertheless see, particularly from your testimony, ways to
begin to find our way out of this thicket.
I want to thank each of you for, really, very, very helpful
testimony to us as we try to look next term toward what can
only be called a redesign of the entire system. We want to do
leasing and construction very differently. We think we will
have a good case to make about taxpayer savings, and we want to
use some of the testimony you have given us to try and get an
entirely different approach based on the model, perhaps, of
showing what can be done with the group of buildings that will
go up for the Homeland Security Department.
So I thank you once again for excellent testimony; it has
been very useful to us.
The next witnesses Steven Grigg, Executive Committee past
President, as well as District of Columbia Building and
Industry Association; Richard Purtell, Chair and CEO, Building
Owners and Management Association, or BOMA; and, of course, our
Commissioner of the Public Building Service, David Winstead.
We will, of course, begin with Mr. Winstead.
TESTIMONY OF DAVID WINSTEAD, COMMISSIONER, PUBLIC BUILDINGS
SERVICE, U.S. GENERAL SERVICE ADMINISTRATION; RICHARD D.
PURTELL, CHAIR AND CHIEF ELECTED OFFICER, BUILDING OWNERS AND
MANAGERS ASSOCIATION INTERNATIONAL; AND STEVEN A. GRIGG,
PRESIDENT AND CHIEF EXECUTIVE OFFICER, REPUBLIC PROPERTIES
CORPORATION, REPRESENTATIVE DCBIA
Mr. Winstead. Madam Chair, again, I am David Winstead,
Commissioner of the Public Buildings Service, and I thank you
for inviting us here again today to discuss the impact of the
tightening credit market on GSA's capital program. I want to
recognize that we have had a number of hearings over the last
three months. We appreciate the attention the Committee is
giving our leasing program and our construction program, as
well as trying to determine what the impact of the current
financial situation is on our business.
I did want to mention several areas I wanted to touch on.
Clearly, the former panel--we very much appreciate their
input--focused obviously on leasing and scoring issues, and the
authorities that we have, or lack thereof, to do lease
financing approaches. I did want to focus, first off, on new
construction and modernization, because through the funding of
direct appropriations from the Federal Buildings Fund, our new
construction modernization R&A program is really not directly
affected by the decreases in the availability of credit
generally.
As noted by the former panel, we have seen 70 percent of
the financing in real estate disappear over the last year. We
see $235 billion that has been lost in financing for real
estate and the economy generally. I think that Mr. Rudy's
comments certainly demonstrated that. So we are continuing to
see issues on the construction side in terms of escalation of
cost and subcontractors in terms of what they typically
require. But, as you know, we do not obtain third-party
financing, and most of our construction is financed through the
Federal Buildings Fund, direct appropriations.
Secondly, on the leasing side, which the prior panel and
your questions largely dealt with, I do want to say that we are
noticing some impact of the credit crunch on our leasing
program. As you know, our leasing program consists of 176
million square feet of space, of which a third is in the
National Capital Region, your district, or the Metropolitan
Washington area. We have asked, as a result of this hearing,
each of our regional offices whether GSA offerors were
experiencing difficulty obtaining financing for GSA leases.
We had a prospectus hearing earlier last month on this, and
we have determined that most costly leasing terms, of course,
generally result in higher rates for the Government. But what
we are finding is that we are not experiencing a lot of lack of
competition on our major prospectus leases. Therefore, in a
general way, when credit becomes more expensive, it obviously
could be reflected in increasing rent downturn and, also, on
the financing side, 75 percent of capital financing and real
estate has disappeared over the last year. The terms are
getting more constricted and, obviously, certain developers
aren't going to find the financing to proceed and deliver new
office space on time.
In a few instances, we have seen successful GSA offerors
who, because of the issues in the credit markets that the
former panel addressed, have not been able to proceed with
lease construct projects. At our last hearing we dealt a lot
with the FBI lease program, the SSA lease program. Offerors
have attributed some of these issues to tighter credit markets.
For example, in 2005, GSA initiated a lease construction
project for the FBI for up to 266,000 square feet and 271
parking spaces in Detroit, Michigan.
In May of 2006, we finalized negotiations for a no-cost
assignment of 10 acres on a two-phased, best value procurement
for that space. We awarded the lease, actually, of that
development in February of 2007. The developer indicated that,
as a result of the tight credit market and post-award addition
of modifications to the projects, they couldn't secure the
financing as they had anticipated, and we actually rescinded
that contract in February of this year and are out now for
rebidding it.
So while I testify here today, it is not as if we are not
immune from impact; there are two or three cases which I would
be happy to supply this Committee full information on where it
has created problems.
Secondly, the former panel talked a lot about--a different
term was used, but persuading and our utilization of credit
tenant leases, or what we call CTL leases, and we have
proceeded on that. The PTO project, the DOT project in the
District that you know well, were under credit tenant leases,
and it does allow the developer to gain better leasing terms
for more effective financing availability. The CTL has been
used with varying degrees of success in several GSA regions. We
did have a GAO report that alluded to the fact that we can get,
and are getting, better leasing terms under some of these CTL
leases.
I will tell you that GSA has, in response to those two
leases here in the region that you are probably most familiar
with, modified general clauses in the CTL to enable better
lease financing for major transactions. Under the CTL,
successful offerors may be able to obtain better and higher
loan amounts at lower interest rates under the CTL.
Once the lease space is delivered according to the lease
requirement, the Government, GSA, has been able to compromise
on some termination and setoff rights against the debt service
portion of the rental payment in order to allow an
uninterrupted rent flow to the lessor's debt. So the Government
retains its rights to enforce the lease service obligation in
any regard.
In order to ensure that we are obtaining the value of the
lease modification, we have encouraged our regions to request
pricing on both standard lease requirements and CTL so that we
can be seeing savings, and, obviously, the current credit
market requires this. At the same time, Madam Chair, I will
tell you 80 percent of our lease actions nationwide are under
20,000 square feet, and what we are talking about is the real
value or the large prospectus leases that we are looking at CTL
approaches for. Chip Morris, who heads up our leasing programs,
is behind me and could certainly provide additional information
to the Committee on those specific cases.
A third area that we are seeing some impact, which I know
has been the subject of hearings here before, and that is on
our green building program. We are relying on energy savings
performance contracts to accomplish renovations of building
systems in our some 1500 owned inventory, of which 600 are 30
and 40 years old. Through these ESPCs, we conduct a
comprehensive energy audit, identify improvements that will
save energy to the facility, and arrange financing to pay for
them.
The energy service company guarantees that the improvements
will generate savings sufficient to pay for the project and we
estimate that our potential use of these ESPC and utility
energy service contracts in the current fiscal year, fiscal
year 2009, will be approximately $24 million. We are seeing
that ESPC financing is not traditional financing, it is based
by guaranteed energy savings resulting from improvement, and,
therefore, the financing markets are impacting the ESPC
contracts where we see rates now 6 to about 10 percent.
A fourth area that we do see some potential impact, but,
fortunately, we haven't seen any here in the National Capital
Region, is on retail leasing. Obviously, the economy is having
real recession issues, purchasing and information is a bit more
than it was a year ago, and we do, as you know, have mixed use
and retail tenancy. The Ronald Reagan Building, the
International Trade Center, the ATF Headquarters building has
8,000 square feet of retail and restaurant space and the ATF.
Banks are tightening standards for loans to small business, and
a lot of the retail food service vendors that we have.
But so far, fortunately, these more restrictive credit
conditions that the former panel presented to the Committee are
really not having an adverse impact on our retail tenants in
the Reagan or the ATF situation. In fact, the Ronald Reagan
Building is fully leased at 100 percent of retail space; the
ATF Building, as you know well in the NoMa District, has four
retail tenants that are in the process of moving in. We have
had some unfortunate delays as a result of getting gas service
to the facility, but we do anticipate that by the end of August
[subsequently edited to ``January'' - ed.] those retail tenants
will be in place and providing food service and other amenities
to the ATF employees.
So in conclusion, Madam Chair, the tightening of the credit
market does potentially affect GSA in three areas: obviously
leasing, energy service performance contracts, and retail
leasing, as well. So far, none of these areas we have seen any
significant impact negatively on GSA and its leasing actions.
Credit is available to our lessors at favorable rates with the
Government tenancy, the AAA rating that the panel member
earlier alluded to.
The Federal Government generally may experience an
increased reliance on larger ESPC contracts that might have
higher rates, but although some small businesses may in fact,
in our retail functions in some of our mixed space in our
buildings, may find tighter credit, we do not see that in the
current situation with those buildings I mentioned in
Washington.
Madam Chair, the last thing I would mention before turning
it on to the other panelists is that, as Mr. Rudy mentioned, in
the Jones Lang LaSalle testimony earlier, being a major player
in the market, we do see the credit tenant leases getting very
competitive offers to date. We are seeing, fortunately, in the
slow down that there is less demand, for example, in Lower
Manhattan because of the Bear Stearns collapse. There is a lot
of space on the market in Lower Manhattan now and a lot better
rates, and we are seeing 600,000 square feet available in Lower
Manhattan for Federal tenants. We are actually getting better
deals as a result of some of the market turning down.
But I would conclude, lastly, that we appreciate the
Committee's inquiry into these leasing issues, the former
discussion on scoring I dealt with on June the 10th in great
detail and St. Elizabeths as an example. Thank you again for
this opportunity.
Ms. Norton. Thank you very much.
Mr. Purtell?
Mr. Purtell. Thank you. Good morning, Chairman Norton and
Members of the Subcommittee. Thank you for holding this
important hearing on the impact the current credit crunch is
having on the leasing and construction of Federal office
buildings. I am Dick Purtell, Portfolio Manager for Grubb and
Ellis Management Services, and I am here today in my role as
Chair and Chief Elected Officer of the Building Owners and
Managers Association International.
With the rise in delinquencies and defaults on subprime
mortgages over the past couple of years, it is only inevitable
that this financial crisis would ultimately have some impact on
commercial real estate. My testimony today will touch on how
the current economic circumstance is affecting the renovation
of buildings, build-to-suit leases, attracting and retaining
tenants, as well as rents and occupancy rates.
In general, much of the economic dynamics of the commercial
real estate sector can vary due to local market forces.
However, one thing our member all across the Country
acknowledge: it is becoming increasingly difficult to acquire
capital for new projects and renovations for public buildings,
as well as those intended for private sector use. Lenders are
making it more and more expensive for even the most
economically sound companies to borrow money.
And for those whose balance sheets aren't as healthy, it is
nearly impossible. Consequently, this has negatively affected
building owners wishing to refinance, sell existing buildings,
or plan for future renovations in which the financing for the
project has not yet been secured. It could also become a favor
in a building owner's ability to attract and retain tenants by
limiting tenant improvement packages offered in the future.
An example of where access to capital has made it difficult
to liquidate properties is in San Diego, where one BOMA member,
who has the responsibility for a municipal government's
portfolio, has had a number of buildings on the market for over
a year at what are considered bargain basement prices. But due
to the increased borrowing restraints and cost of funds, he has
had trouble finding buyers without having to reduce the price
even further. In Philadelphia, we have received reports that
building owners are currently moving forward with renovations
and improvements that were more than likely already in the
pipeline; however, plans for renovations in 2009 do not appear
to be in the budgets of most.
The increased difficulty to obtain capital for the purposes
of developing commercial buildings has also negatively impacted
build-to-suit leases. We are hearing that very few build-to-
suit leases are being executed at this time. Stricter
underwriting requirements, skyrocketing construction costs,
combined with the increasing vacancy rate, decreasing effective
rent and economic slowdown, has eliminated any new
construction. Currently, those build-to-suit leases that are in
the works were either begun some time ago or are being financed
largely through private equity.
From the Federal Government's perspective, in areas where
there are owners or developers with larger existing buildings
or buildings under construction that are looking at the
Government as prospective tenants, current conditions may
actually help the Government, as their demand never goes down.
However, it is adversely affecting large build-to-suits,
even those for the Federal Government, due to the uncertainty
of financing, capitalization rates, and buyers. Since, in these
times, the Government is an even more important player in the
building and construction industry than it is normally due to
its demand for space continuing at a more constant rate than
private industry, it becomes even more critical for the
Government to eliminate barriers and constraints to the
Government leasing space, especially in build-to-suits that
were discussed in previous BOMA testimony before this
Committee.
The ability of building owners to attract and retain
tenants, as well as stabilize rents and occupancy rates, are
issues that appear to be more sensitive to the local area's
supply and demand. Some reports from members have indicated
that rents continue to be on the rise, but not quite as rapidly
as in recent years, as is the case in the District.
In other markets, the economic slowdown has hurt overall
occupancy levels as tenants are struggling to survive. Owners
are still trying to maintain the same rental rates, but are now
offering significant tenant and broker incentives. In these
parts of the Country, it is definitely a tenant's market. In
buildings with weak occupancy, owners are having even more
trouble making mortgage payments.
In some markets, owners are taking a wait and see approach
to see if the slowing economy leads to tenants shedding
unwanted space. Due to the nature of the industry, the possible
negative effects in certain parts of the Country may not be
felt for several years.
If there is an upside to this, it is the amount of supply
coming online over the next several years will be significantly
less, which will have a positive impact on the market overall
from a landlord's perspective.
We thank the Subcommittee for holding this important
hearing and hope this testimony has provided some insight on
the effect of the credit crunch has had on the commercial real
estate industry. I would welcome any questions you may have.
Ms. Norton. Thank you, Mr. Purtell.
Mr. Grigg?
Mr. Grigg. Good morning, Chairman Norton. It is good to see
you again, Ms. Britta and the rest of the staff. I am Steve
Grigg, President of Republic Properties Corporation. I am here
testifying on behalf of the D.C. Building Industry Association,
where, as you know, I am past President, one of them, and
member of the Executive Committee.
As it has been clear to the Committee and to everyone else,
the credit crunch is having a direct and broad impact on
development, leasing, and management of commercial office space
nationwide. The District of Columbia and the Nation's Capital
Region are neither distinct nor immune from those problems. The
collapse of conventional debt financing for development
projects and the permanent financing market are working in
tandem to make new development and major renovations of
existing buildings much more difficult and expensive.
With the collapse of securitized debt markets and with the
values of existing loan portfolios in doubt, lenders have
become reluctant to assume any risk, underwriting standards
have been tightened, and loan-to-value ratios have shrunk. The
result is higher borrowing costs and higher levels of required
equity participation, if capital funding is available at all.
Meanwhile, equity investors are repricing their conceivable
participation to reflect higher perceived risk.
The Federal Government is a major user of office space and
is not immune from the impact of this credit crunch. It is
probable that the Government has not seen the impact of the
credit situation thus far. As existing space is being absorbed
up, however, that will become an inevitable change. Larger
procurements with prospectus level rents that were established
some time ago are going to be seeing less competition now and
going forward.
The Government is a special class of user of commercial
office space; hence, the Government leases are essentially flat
for various terms. Space leased by the Government used to be
advantaged by steady, prompt payment of rent. The margins
associated with rental income have declined as a result of
problems in timing and the amount of reimbursement in increases
and real estate pass-throughs and operating expenses, which are
indexed to CPI increases. Both the business reality and
underwriting standards have increasingly noted those changes in
dealing with the Federal Government in leases and occupancies.
Either the system has to change or face rents will dramatically
increase to reflect these conditions.
The Government's prospectus level rents and expectations of
various tenant agencies will have to be adjusted upward in the
future. While we believe that the availability of financing
will eventually be eased, the effective increased costs will
become more predominant over the coming years.
Thank you for your attention. I am available to answer any
questions.
Ms. Norton. Thank you, Mr. Grigg.
We put the three of you together. Normally, the Government
witness is separate. We mean no breach of protocol, but the
fact is that Mr. Winstead's job is to work with people around
his table, for the benefit of the taxpayer, to be sure. Thus,
the exchange among you would be very valuable to us. For
example, Mr. Winstead spoke of getting better deals. He spoke
of the Government's AAA rating. And Mr. Winstead knows that my
concern is whether or not we are taking full advantage of that
rating.
But you have testified we are getting better deals. You
pointed to the vacancy rate in New York. I would like to hear
you elaborate on that and give me an example of what a better
deal is and let me ask you about the vacancy rate in the
National Capital Region. That is a two-part question. You hear
Mr. Purtell say it is a tenant's market. You hear it from the--
excuse me, Mr. Purtell--horse's mouth.
Mr. Winstead. Madam Chair, I think, obviously, the market,
as alluded to, in terms of the crunch and Mr. Grigg talked
about the impact of the financing tightening lending on the
delivery of new space, and that will impact. I think it is
going to be a couple years before we really see that.
Ms. Norton. So it is very important to note for the record,
because I think Mr. Winstead's testimony was like the early
reports we had from developers who were already in the market,
from business owners. They didn't see much different. The
Committee sits here trying to think ahead, trying to think as I
am, for example, about Saint Elizabeths. Hey, there are some
people in some buildings now, there are some leases that
neither party, frankly, can do much about, but the Federal
Government is, for example--leave aside leasing new space all
the time--about to build the largest compound, at least for
GSA, in its history. So even when it comes to leasing, while I
accept Mr. Winstead's testimony, I am sobered by the testimony
of his brethren beside him.
Who am I quoting from here? Become increasingly difficult
to acquire capital for new projects and renovations for public
buildings, as well as those intended. This may be you, Mr.
Winstead.
Mr. Winstead. Madam Chair, your comment----
Ms. Norton. Wait a minute. Both Mr. Grigg and Mr. Purtell
have spoken really to the major concern we have. Mr. Winstead,
our own work verifies what you say about present conditions.
You have been dealing with the top of the mark; you always
will. But the testimony here from those who have those leases,
have those contracts is that those same very creditworthy
owners are finding it difficult today--if they were today, not
the process that we deal with--what does it take, 10 years, 8
years, 5 years, whatever it is, to get going -- but today--that
there would be increased costs to borrowing.
There would be, in other words, a totally different
situation from what it is right now. And what I am trying to
learn is, for example, from your own testimony, that you are
already beginning to take advantage of the tenant's market,
what is the difference between what you have been doing before
and what you are doing--let's take your own example--in New
York now.
Mr. Winstead. Madam Chair, you have raised several
questions and I will try to answer them. First one was about
our vacancy. You know, this Committee well knows, improving our
leases prospectuses, that we are managing our leased portfolio
of 176 million square feet, a third of which is in the National
Capital Region, very tightly because we control those terms and
it is about a 1.5 percent vacancy on our leased inventory
currently nationwide. So that is a very tight margin.
Secondly, your question about St. Elizabeths and the market
and how it might change. There is no question that if in fact
there is attrition in----
Ms. Norton. I am sorry, I was trying to understand. What
vacancy are you talking about?
Mr. Winstead. I am talking about on our leased inventory.
If you look at----
Ms. Norton. Your own leases?
Mr. Winstead. All leases, 176 million square feet
nationwide, in terms of any vacancies. We keep that very tight
because we are obviously leasing the space about 1 percent.
Nationwide, in terms of Federal ownership, it is higher,
unfortunately, because we have had some attrition,
consolidation of IRS, FBI moving out of some, as you well know,
center city buildings in Federal field offices, new offices.
Your second question dealt with St. Elizabeths and its
impact on the market, and there is no question that as
financing of new projects and the----
Ms. Norton. Wait a minute. I also asked you what were you
doing--I am sorry, you said you were able to get better deals.
I am not sure I heard the answer to that question. Because I
wanted to know what is a better deal.
Mr. Winstead. Well, I don't think there is any--okay, in
terms of better deal, you know, whether--you want specific
rental rates in D.C. or----
Ms. Norton. You acknowledged----
Mr. Winstead. There is no question the next couple of
years, and currently, with the impact of the credit crunch, we
are going to see vacancies creeping upwards; we are going to
see effective rents going downwards; we are going to see
specific markets in urban areas like New York and Lower
Manhattan, where we have had huge vacancies created because of
Bear Stearns' failing and consolidation, we are going to see
better deals.
Ms. Norton. So what would the GSA do? Not what is it doing,
but what is it that the GSA would do differently, operating in
that market today, with vacancy rates up? How would you operate
any differently from how you have been operating before? What
kinds of different deals might you be able to forge?
Mr. Winstead. Well, I think, again, it is largely,
unfortunately, the lack of authority for enhanced use leasing
and some of these other authorities DOD has and VA----
Ms. Norton. So you think enhanced use leasing would help?
Mr. Winstead. Enhanced use leasing has been shown, Madam
Chair--I supplied this Committee six months ago our 10 most
costly leases in which we showed the relative cost of lease
construct versus direct Federal construction versus enhanced
use leasing, and enhanced use leasing is almost as cost-
effective as Federal construction in building out those housing
demands. So you have good evidence of our analysis of the cost
of options.
Ms. Norton. So you would need----
Mr. Winstead. Authority.
Ms. Norton. You would need authority, statutory authority.
Mr. Winstead. We also would need OMB's approval in terms of
prospectus, and from both the June 6th hearing, the July 11th
hearing and this hearing, it is clear to me that this Committee
would love to see more use of that kind of authority that DOD
and VA----
Ms. Norton. As of now--and you heard me say I am going to
try to get more authority and you heard me say I am trying to
find out as much about the authority that other agencies have
that will help me convince the Congress that we should have the
same authority, but being in the position you are now, seeing
with some leases and some agencies are up, and an agency--I am
trying to give you a direct hypothetical-- an agency looking
for space--and you have heard Mr. Purtell call it a tenant's
market--how, given the limitations on you now, would you go
about seeking space in a tenant's market?
Mr. Winstead. Madam Chair, I think we are leveraged very
well with our partners in the private sector to take advantage
of the best deals, and if they are going down in the near term
because of this unfortunate credit crunch, then I think that
through the national brokerage contract that you have asked a
lot of questions about, we have supplied a lot of information,
we are leveraging the strength of the Federal purchasing power
and getting below market lease rates around the Country.
Ms. Norton. Would you give us examples of getting below
market lease rates?
Mr. Winstead. Well, I would certainly suggest that recent
acquisitions in NoMa--and I know some are being contested--have
had very competitive rates because availability and new space
coming online in NoMa.
Ms. Norton. So you believe those were below market rates?
Mr. Winstead. I think they were very effective rates. I
mean, they responded----
Ms. Norton. You may be right on NoMa. NoMa, of course,
looked at the market and said what do our rates have to be to
get people to move here, and you may be right there. If it were
a part of the city, for example, midtown, would you be able to
negotiate similar rates?
Mr. Winstead. Well, Madam Chair, I am not a financial
expert, I am a lawyer by background, but I will tell you that
if some of the financing arrangements on these major landmark
buildings, private sector buildings in downtown have to be
refinanced with the impact of the credit crunch, and new
financing terms that might be imposed on these building owners,
we might see rental rates, because of that, them being forced,
you know, for them to go up.
So we might see that under current credit and financing
rates for these buildings they structure the deal with us based
on a rent that we committed in contract to pay. If they are
having to refinance these buildings at a time in which cap
rates are going up and at a time in which leasing terms are
more restrictive, they might find themselves less competitive
for our leases.
Ms. Norton. Let me take an analogy from the real crisis in
the housing market. The marketplace knows how to respond when
it is down, and if you take the worst place in the marketplace,
they are all but giving away the house. But they don't want to
do that, so you have heard fantastic things-- obviously, real
estate isn't in the same position, but it makes my point--if
you buy this house, we will give you gas for a year, for
example, because they see that one of the major problems with
where homes are located today is something we really can't do
anything about, and that is gas prices are going up with
nothing except pricing, frankly, to bring it down.
Okay, we speak of concession packages. I think you spoke
about them in your last testimony. Give me an example of a
concession package that might be asked for by the Federal
Government if it wanted to acquire space in Downtown
Washington.
Mr. Winstead. Well, obviously, we would be looking for the
factors under our credit lease structure deal with right of
assignment, looking at tenant fit-out, looking at casualty and
termination rights, looking at rental offsets for maintenance
and services.
I mentioned earlier in my testimony----
Ms. Norton. So some changes in these clauses.
Mr. Winstead. That is correct. I mentioned earlier that
under the credit tenant lease that we are applying to large
prospectus leases, which you know a lot about and we have seen
a lot come before this Committee--the bigger deals, not the 80
percent under 20,000 square feet, the large prospectus leases--
we are, under this CTL, acknowledging that we do need to attend
and are relaxing and modifying the casualty and termination
rights under that kind of CTL lease approach, also the rental
offset rights for maintenance and service. So we are
acknowledging and are negotiating and applying----
Ms. Norton. And those you are using with CTL.
Mr. Winstead. That is correct.
Ms. Norton. Is it the GSA now committed to using CTL
wherever it can?
Mr. Winstead. Madam Chair, on the large prospectus leases
we are. The last two were obviously DOT and PTO and others, but
we are looking at this and talking with the industry. Actually,
yesterday--this came up in a lease construct workshop that I
mentioned that we had in early June. Yesterday, our team was
sitting down with financial experts as a result of the current
market conditions and looking at the credit tenant lease and
looking at how we can modify those clauses without damage to
the Federal Government and our obligation, but to get better
deals, to allow some flexibility in those two areas where a
potential offeror or lessor could in fact get better financing
terms and thus get better rates for us, as well as reflect the
issues that Mr. Grigg mentioned that are in the market.
Ms. Norton. This Subcommittee does not intend to press the
GSA to put the Government at any substantial risk. We are very
open to hearing why the GSA doesn't leverage some of these--it
has got them now. We know industry hates it. Why it doesn't
leverage that to at least get a better price by making
modifications where there may be no history of needing, for
example, clauses as strict as some of those. So risk might be
said to be rather insubstantial. We don't want to ever put the
Government in the position where anybody takes its thinking of
risk, but the way in which--well, let me ask Mr. Grigg and Mr.
Purtell.
Surely there are private sector businesses whose business
is of a kind that they need certain kinds of protections when
they move into a building, and they have the same financial
pressures that we are speaking about in this hearing. What I am
really interested in is how somebody who has--and I recognize
the Government would be at the highest level--has to, let's
say, lease a building that may be outside of the norms of what
you might expect in particular clauses to accommodate this
particular business and its lease. I mean, you might truly have
such in this region, but I am talking about private businesses
now.
I am trying to get some idea of how the business, let's
say, would negotiate in order to offset its cost without
substantial increase in risk where it knows it is almost using
boilerplate language--because that is what the Government is
doing--for many of these clauses, how some kind of
accommodation would be reached between the business, which
knows it needs something somewhat different from the average
tenant, and the owner.
What kinds of things would they feel they could negotiate
and how would that be structured? What kinds of exchanges of
win-wins, whatever you like to call it, do you think might be
structured in that kind of situation, where you really do need
something extra but you really don't need the kind of standard
clauses that they could get out of a book and, for that matter,
GSA gets out of its play book?
Mr. Grigg?
Mr. Grigg. Well, I think that the simple answer to that
question is if you can make Government leases more consistent
with the private sector, then you would gain some advantages.
There are examples that deal with the reimbursement for tax
increases, which are essentially, by lease, are phased many,
many months beyond what a private tenant would have.
Ms. Norton. Federal tax increases?
Mr. Grigg. No, real estate tax increases. I didn't mean
income tax. Essentially what that does is it requires the
landlord to carry those payments as a balance over an extended
period of time. The increases for Consumer Price Index have
recently not been competitive. The increases in power and in
wages haven't matched the published price indexes for years.
There is some question as to what the Consumer Price Index
means in general and who manipulates it, and that is beyond
maybe the discussions today, but, from a cost standpoint, that
represents essentially a phantom loss that one has to absorb in
a way that you wouldn't in most private leases.
Ms. Norton. And you think that negotiating with these items
you have mentioned would reduce cost to the Government
ultimately? See, the question is the Government is going to
look and say, well, this is going to increase. It is going to
do a straight line look at it.
Mr. Grigg. Well, you have to look at it not in an
individual moment of the next 12 months or two years, but you
have to look over a long-term basis.
Ms. Norton. Well, over, for example, the lease. You think
over the lease itself, over the time of the lease itself. What
are they, 10 year leases, usually? Ten or 15 year leases
themselves. You think a case can be made for that?
Mr. Grigg. I would think the average Government lease is
actually somewhere about five to seven years, but they could--
--
Ms. Norton. Mr. Winstead, are they really only five to
seven?
Mr. Winstead. Madam Chair, most of these smaller leases
that I mentioned, 80 percent of the portfolio are shorter term
leases, they are smaller, more flexible uses, under 20,000
square feet. So I think Mr. Grigg is correct.
Mr. Purtell. I can speak, maybe, to that. I am from
Cincinnati, Ohio and I have recent experience in this area with
the Department of Energy on a lease of about initially 40,000
feet, and it was a five-year lease--actually, a ten- year lease
with a five-year cancellation, which causes some issues.
Mr. Norton. Is that good or bad for the private sector?
Mr. Purtell. Probably a negative, if we have to be prepared
for that lease to be cancelled after five years. But I would
echo some of the things that have been said regarding
flexibility and previous testimony----
Ms. Norton. Excuse me.
Mr. Winstead, why are the leases five to seven years, so I
can understand?
Mr. Winstead. Well, again, they are based on our leased
tiering approach and agencies' needs, and basically the term of
the housing giving their tenancy and also getting the best deal
on the market for the Government. I mean, this may not be the
best deal for the offeror, but for the Government. That is what
we negotiate for.
Ms. Norton. So a long-term lease would not be the best?
Mr. Winstead. Well, the DOT lease, which is, as I said, a
CTL lease, a credit tenant lease, we did get a longer 20- year
term, and you are well aware of the size, 1.2 million square
feet.
Ms. Norton. But you think that is appropriate only for
larger leases?
Mr. Winstead. Well, what in fact we do see is that the
larger leases, the longer leases than the shorter leases, more
flexibility under lease tiering approach that we are doing. We
are looking to agency changes. We are having consolidation of
the IRS. The Social Security Administration has wanted smaller,
more rural offices because the demographics of retirees are
changing, so they are going to where the retirees are. It is a
constant flow.
And what I did mention in the June hearing is like we have
on the portfolio side, with portfolio restructuring and using
section 412 authority to access under--we are now applying the
same sort of lease tiering approach so that we can predict when
these leases are expiring, when we need to have notice, clear
the housing plan with the agency and get back in the market to
test the best deal, and that is really why those lease terms
are structured to be short or long.
Ms. Norton. I am sorry, I didn't want to interrupt you, Mr.
Purtell, I was trying to understand.
Mr. Purtell. That is all right. One thing we did in this
lease, which is a fairly recent lease, we did take out the
property tax issue, and that is a separate issue with this
lease now, in that we have direct pass-through on property
taxes. We still do not have----
Ms. Norton. Was this a lease with the Government?
Mr. Purtell. Yes, it was, it is a GSA lease, and worked
with the Chicago office on this document.
Ms. Norton. So you sat and simply negotiated that.
Mr. Purtell. Yes. Yes. That was part of the negotiation, to
have the direct pass-through on property taxes, because it is
an uncontrollable expense which typically, with all the other
leases, is the way it works.
But we still have issues, and I think to be more
competitive, from your perspective, if there is more
flexibility there--because when bidders are bidding on leases,
they are protecting themselves by covering these items that
they have to allow for certain increases. For example, one of
the biggest ones right now is utilities. To have to cover
utilities and have that built in to the lease for a 10- year
period is a real challenge for a landlord.
Ms. Norton. Yes, Mr. Grigg.
Mr. Grigg. I think in answer to an earlier question that
you asked Mr. Winstead, how would you change the pattern, I
think that from a portfolio standpoint, in an environment where
there is a great vacancy that is available in a marketplace,
the answer is that GSA should be leasing more rather than less,
instead of self-building. And when there isn't much vacancy in
the marketplace and it is essentially having to compete
increasingly with that, it should use its buying power by
building more buildings which----
Ms. Norton. What do you mean, self-building? They don't
build much, Mr. Grigg. They build to suit.
Mr. Grigg. Right.
Ms. Norton. So they are leasing most of the time. Now, they
build to suit on these cross border stations. That is the FBI,
of course. Their FBI stations are going to be built from the
ground up, of course.
Mr. Grigg. Well, you were describing the Homeland Security
headquarters or cluster at Saint Elizabeths.
Ms. Norton. But how could that--I mean, they own the land
there, and that is the only reason it is being built on the
West Campus of Saint Elizabeths, is that finally we own the
land, we can build on our own land. And guess what? We act as
if we didn't, because we are building in the same way we would
in Downtown Washington. So I am not sure that Homeland Security
provides us with an opportunity, since we don't have to
purchase the land, at least, in order to build there.
Mr. Grigg. Well----
Ms. Norton. So if that is what you think should happen, I
think it is happening and, thus, I am far more interested in
the leasing market than I am in the construction market,
because I don't see the Government coming up--particularly with
the way in which we pay for construction--for a courthouse. If
we are going to build a million square foot courthouse complex,
which is usually a courthouse and an office building with it,
we have to get the appropriation up front, and there is no
capital budget here. If that sounds stupid, it is.
But that means that forces the Government into the leasing
market and, therefore, I am looking for savings, for
partnerships with the leasing market to save each money that is
being spent because GSA makes it and, therefore, the taxpayers
get left holding the bag. This is the big leasing territory for
the Federal Government.
Mr. Grigg. Well, certainly, the National Capital Region is
that and Washington, D.C. But I think then I go back to my
previous response, and that is to the extent the Government can
make its performance more like the private sector, it will
probably be able to negotiate the best economic terms on a
long-term basis.
That is not to say in specific instances that it can't
drive a harder bargain in the short-run, but the long-term
benefits to the Government would be better served by modifying
its standard practices to be more consistent, and those involve
payment approvals, timing of reimbursements, term provisions,
might include escalation of costs over a period of time instead
of demanding flat leases, and the like.
Ms. Norton. Oh, well, this is an important point. We can't
depend on, assuming we could get a better deal in this market,
who would want this market.
So we have to assume that this is, I think, something more
than cyclical, but we have to assume that it has real cyclical
aspects to it and, if it does, that it is going to get better
and it always does get better. If so, then we are left with the
same procedures that we had before, and then we are robbed of
whatever leverage we thought we had during a time of downturn.
Mr. Purtell. I would comment that the full, as I said in my
testimony, the full impact may not be felt for a couple years,
and I think the timing of this hearing and what you are doing
has well positioned GSA to prepare for the opportunities I
think that are out there for any expiring leases or any new
lease opportunities.
Ms. Norton. Mr. Winstead, let me ask you, how are you
preparing for that? We have many leases expiring. Indeed, you
have leases that you are sitting on or using the condemnation
notion or holdover notion.
Mr. Winstead. Madam Chair, I think continue both with our
existing landlords and successive offerors to look ahead to
both space requirements and when those lease expirations are
occurring.
I did state on the June 6th hearing that I was very
concerned. I do not see a national trend in some of the
holdover issues we discussed.
I know Mr. Grigg commented about rent payment, and we are
committed to paying rent on time, and we are committed to
paying our construction bills on time. I did mention at great
length, I think in June, what we are doing to trying to ensure
that.
Ms. Norton. Are you saying, Mr. Purtell, holdovers, Federal
holdovers are condemnation use by GSA?
Mr. Purtell. I, personally, haven't witnessed that.
Ms. Norton. Mr. Grigg, do you know of any?
Mr. Grigg. Yes.
Ms. Norton. In this region, for example?
Mr. Grigg. Yes.
Ms. Norton. What does a building owner do when these
procedures are used?
Mr. Grigg. Vote every couple years.
Ms. Norton. Does what?
Mr. Grigg. Votes every couple years. There isn't a lot that
the building owner and the government----
Ms. Norton. You can't vote the GSA in or out if you notice
that, and my great frustration is that I see no difference
between Republican and Democratic administrations. You need a
sea change in this agency.
Mr. Grigg. Although I have been guilty on commenting on GSA
at various times, I don't think this is really a product of
GSA's actions or inactions of and by themselves. They are
providing services to tenant agencies. They have budget issues
associated with the annual budgets. It is a big complex system
that we all operate in.
But holdovers are major features, and the consequences of
those holdovers or passive condemnations, whatever you want to
call them, and the imposing of terms on landlords, it is a
tension that impacts landlords and others in the business
market that could be avoided.
Ms. Norton. Let me ask you this, what effect does that have
on costs and on competition? If you know that holdovers occur,
does that get built into the cost of doing business with the
government?
Mr. Grigg. It has an impact on the whole business plan
depending on the individual buildings.
Ms. Norton. Yes, that is what I mean.
Mr. Grigg. It has impacts on the marketplace. You know you
have the benefit of government occupancy as any other benefit
of having occupants.
It is the only situation where a tenant gets an opportunity
to stay where they are and pay an indeterminate amount of rent
for an indeterminate amount of time with really no mechanism
that is particularly palatable except going to the court of
claims or whatever to kind of seek relief, and one doesn't get
reimbursed for that or relief as opposed to private lease.
If a tenant holds over, the tenant is going to pay the
cost, all the cost of that action including the cost of being
made whole through the courts.
I am not suggesting here we try and restructure the whole
relationship between the government as a tenant and the
landlords in general, but as one would move that bar closer to
a businesslike setting, the government will get long-term
benefits.
It is necessary that the government be able to operate, and
it has superior powers because of the nature of it being a
government. But to the extent you can remove those and balance
things out, the system will work better, more equitably, and
eventually the government will get the benefit of the bargain.
Ms. Norton. Let me ask all three of you this question. I am
still enamored from my days as a full-time professional lawyer
to hypotheticals to make me understand things. That is how
people understand law school. You give them a real life
example. So you have seen what my ever present real life
example is. It is Saint Elizabeths.
Mr. Winstead's testimony says, and I think he is right,
that in general the GSA has not felt the impacts now, as of
when we speak, and he submits some evidence to that effect.
Then he says, however, one thing--is this him? No, sorry.
This was Mr. Purtell's testimony.
I am reading from page two, although I must say Mr.
Winstead agrees with you about the general effect now. But you
said that it was becoming increasingly difficult to acquire
capital for new projects and renovations for public buildings.
That is your testimony.
Now let's assume, obviously, the Federal Government is
committed to a new headquarters for the Homeland Security
Department. Obviously, none of that is happening now. They have
to clean up, and you know how long these things take.
I am not now assuming CTL or advanced. I am just assuming
that it will be built in the ordinary way. How else can I
proceed because we have an appropriation coming down, we hope?
It has been in the President's budget for the last three years
to build the thing.
So if you were to look up the time scale, time frame, you
wouldn't see anything happening there in terms of
groundbreaking competition for how long, Mr. Winstead?
Mr. Winstead. Madam Chair, as you know, the House and
Senate just approved 300 and 180 million. So we now have
funding in 2009 and looking at 2010 as well. We are looking at
2016 for a build-out of that.
Ms. Norton. You are looking at what? Talk directly into the
mic.
Mr. Winstead. I am sorry. We are looking at 2016 for build-
out of that four million square feet of space.
I know the St. Elizabeths situation, based on both panels,
does provide the earlier finance panel looking at options and
better approaches, Mr. Grigg's approach and a more private
sector lease approach that is more conforming to the private
sector. We looked at all those alternatives, as you know, the
GAO study as well as our response to this Committee.
If you looked at the 30-year cost for the reason you
mention, Madam Chair, the acreage we have up there at no cost
to the taxpayer, it is a $2 billion project for us, $1 billion
for DHS. Over 30 years, the net present value savings to the
Federal taxpayers is three-quarters of a billion dollars.
Now, the prospectus, we sent----
Ms. Norton. Now you are counting the savings from what?
Mr. Winstead. I am sorry?
Ms. Norton. Savings based on?
Mr. Winstead. If you look at that lease approach for St.
Elizabeths, we looked at the enhanced use lease approach. We
looked at the Federal program.
Ms. Norton. Is it enhanced use? Where is the 30-year?
Mr. Winstead. No, no, no. The 30-year, three-quarters of a
billion dollars savings is if we took that four million square
feet, wherever we could find it, and I assure you it would be
pretty far out, and we were to lease that under a standard.
Ms. Norton. Yes. In other words, you are saying instead of
leasing where we are leasing now.
Mr. Winstead. That is correct.
Ms. Norton. Okay.
Mr. Winstead. That is correct. So our savings, looking at
that project, looking at the free ground.
Ms. Norton. Well, that is the savings that has nothing to
do with building the project except we won't be paying other
than we don't own. I am talking about on building the project,
Mr. Winstead.
Mr. Winstead. In terms of the lease construct projects
themselves?
Ms. Norton. Whatever. First of all, I want to break my
question down.
Mr. Winstead. Okay.
Ms. Norton. When would you expect, let's say, because this
would assume the competition had occurred, ground to be broken?
I know this is a guesstimate. Assuming all went well, we
got the appropriation out this time, you have already begun to
clean up, what is the earliest you would expect ground to be
broken on the headquarters for the first building?
Mr. Winstead. Well, right now, as you know, we got the
funding for the Coast Guard headquarters where a master plan is
in process right now with ultimate action, we hope, by the
beginning of the year, and I do think next year would be when
we start seeing.
We had done restoration, but we would start seeing design
and moving to construction of that first facility. I think end
of fiscal year.
Ms. Norton. So by next year?
Mr. Winstead. By the end of fiscal year 2010, I would
assume, yes.
Ms. Norton. By the end of next year?
Mr. Winstead. During fiscal year 2010.
Ms. Norton. Sorry?
Mr. Winstead. During fiscal year 2010.
Ms. Norton. During fiscal year 2010.
Now looking toward fiscal year 2010 and assuming we are
talking about the usual GSA processes--they have done the
competition, they are breaking ground--what would you imagine
will be the state of affairs for whoever gets that or wins that
competition as it goes into the credit market at that time to
build that first building?
Mr. Winstead. Madam Chair, I do think--and I would look to
our BOMA colleagues and others--the commercial, the
construction market is in fact not financed. It is largely bank
financed in terms of construction loans. We are not seeing a
major impact on shortage of financing our construction
projects.
Ms. Norton. Right now?
Mr. Winstead. Right now.
Ms. Norton. We had testimony, earlier testimony about
something that has been apparent for some time, and that is
construction costs have escalated. Put that on the table first.
Even if the economy were to come back, construction costs have
tended to go up.
I am just trying to get a sense of whether you think we
will be back to normal when ground is broken.
Mr. Winstead. Well, I think that is more of an economic
question for an AGC or BOMA.
But I would suspect that when we are ready, after this
master plan, as you well know, gets approved and going out for
the Coast Guard construction design effort, that there will be
plenty of interest. There is no lack of interest.
Ms. Norton. It is Mr. Purtell who says it is becoming
increasingly difficult to acquire capital for new projects and
renovations for public buildings.
I am trying to understand whether you think that is purely
cyclical based on what we are going through now. Obviously, it
has huge cyclical aspects to it such that when you break ground
and when you go for what you see right up the road, you think
that cost of capital for new projects for public buildings will
be such that the government will not be surprised.
Mr. Purtell?
Mr. Purtell. Clearly, it has been cyclical. To answer how
long it will last, I think is a good guess.
But you touched on, a minute ago, something that we really
didn't talk about that I think is important to this whole
process, the construction costs. In the market I am in and the
market that I understand, construction costs for tenant
improvements alone have increased probably as much as 20 to 30
percent on steel products in the last year.
Ms. Norton. I don't expect that to go down.
Mr. Purtell. That is not going to go down. So that is my
point.
Ms. Norton. Given demand around the world.
Mr. Purtell. And that is not going to change. So that is,
obviously, a big impact on any project you are undertaking.
Mr. Winstead. Madam Chair, again, I think the market. I
totally agree.
I don't think that the material cost increases we are
experiencing now, fiscal year 2009, are as high as they were
back when we were costing out the L.A. courthouse, for example.
I think they are moderating down, but they are going to be ever
increasing because of development around the world and material
needed for the kind of growth we are seeing in other countries
as well.
But I think our efforts, as you know and I think I
testified to earlier, we are having difficulty--I have provided
evidence of that--in estimating and benchmarking these costs in
these markets in terms of material available, in terms of the
cyclical demand.
We know that in L.A. and San Diego, there are billions of
dollars of public procurement going on in addition to ours. The
L.A. School District and in San Diego, there is major
development. All of that competes for material.
Ms. Norton. As your testimony indicated, the Detroit FBI
building, you said it was derailed due to tight credit?
Mr. Winstead. Well, it was tight credit, and it was cost
and materials. I mean both, both Charlotte and Detroit.
Our lease issues in Detroit were basically that back last
October, October of 2007, nine months ago, the offeror there
actually had difficulty getting financing for the project--
part of the issues I raised earlier in terms of the credit
crunch--but we also saw increased costs in terms of land that
was available in that part of Detroit. I think we were
requiring 10 acres. The combination made that deal
unsupportable, and that is why we are back in the market.
Ms. Norton. You see that is what scares me here.
Well, how many competitors did you see for the FBI border
crossing building that some of them have apparently been
competed already?
Mr. Winstead. Yes, ma'am. We have actually had, if you
look, we have had 34 of these construct projects completed. We
have 38 FBI offices. Eight or I guess seven are going to be
Federally owned, like the new one in Houston, but 31 are going
to be leased.
We are seeing, obviously, some difficulty in the Charlotte
situation and in the Detroit situation because of material cost
increases, because of the financial situation that the former
panel described. The deals, the prospectus approval rental rate
and the financial terms that were constructed as a result of
that authority, the offeror could no longer essentially make
work in the current market.
So what we are trying to do is we are recompeting these
problem projects. Now there are only three some that we have
completed.
We are value-engineering the projects to see whether costs
could be taken off so that the financing pro formas work for
those projects.
We are validating the financial aspects, working with, and
obviously these are being recompeted but making sure they are
viable under the prospectus limits, and we are reviewing all
lease construct projects nationwide now because the impact we
have seen with these three problem projects. So we are trying
to react to it.
It is a subset of our overall. I mean the lease construct
is still not the 170 million square feet. It is a small subset
of that group, but it has all the issues.
Ms. Norton. It is a subset, but I am trying to see what it
tells us about the leasing market where, of course, you all
have heavily leveraged.
What concerns me is that though we are experiencing a
cycle, parts of the cycle are not going to go away. The parts
that I mentioned, for example, are the construction costs which
are going up continually. Even when we have had our much better
circumstances, demand for these same materials has only
increased.
So I am trying to analogize. It is not so much the build to
suit but to the leasing market and to the government being in
that market for an ever increasing need.
The cycle comes back, but certain kinds of costs-- energy,
materials--do not. I am trying to understand what GSA will find
in that market when it has to deal not with cyclical change but
with these rather indeterminate, seeming permanent increases
because we are not to the end of them yet.
Mr. Grigg?
Mr. Grigg. Well, I think the simple answer is that the
private market in the case of these build to suit FBI field
offices might be viewed as a canary, if you like, if the
analogy is in a mine situation.
Ms. Norton. That is what I am afraid of.
Mr. Grigg. The cost of operating the buildings as well as
the cost of delivering those buildings, when weighed against
the long-term projections that were made by the builder-lessor
to the government in an underwriting situation, became too
risky or the margin wasn't left that was originally projected.
So the simple answer is that the cost of building the major
facilities for Homeland Security and so forth will probably
escalate more than people anticipated, unless they were
sufficiently protective.
As well, the cost of operating those facilities and
maintaining them over an extended period of time is going to be
a lot higher than probably people anticipated if they were
using historical measures for how things increase. We don't
expect to see a rebound in the cost of power. We expect it to
be growing not at the CPI but at some multiple of the CPI.
Historically, when we were in a regulated energy
environment, because of regulation and because oil prices
frankly weren't growing faster than CPI, the cost of those
elements were really within, everything was in a balance. We
don't view that in a long-term basis as happening really in the
conceivable future.
Energy prices are going to increase at some multiple of
what we call the CPI, and we are going to have to live with
that reality. Steel prices, unless production changes or
technology changes, which we don't anticipate, we are into that
being in a similar situation.
So costs are going to escalate, and we have been through
this cycle before. In the past, because the underlying material
costs rebounded, you had a different circumstance. I don't
think that is going to happen again.
I think the reality is that we have seen a change in that
and the change, as Mr. Winstead pointed out, is probably
external to us as a Country and as an economy. We just need to
be mindful of that.
Mr. Winstead. Madam Chair, you know, obviously, our own
clauses give us the authority on increasing the CPI, and Steve
has certainly alluded to the fact it isn't going away. I mean I
was horrified, reading some market data of energy costs,
preparing for this hearing and predicting that next winter we
are going to see maybe 30 percent higher electric bills.
So the landlords like Mr. Grigg, we are going to have to be
very attentive to the increases that we provide in our lease
largely through the O&M clause provisions. Undoubtedly, we are
going to be paying higher rates through our lease negotiations.
Ms. Norton. I am going to ask just a couple more questions.
There are some limitations on what we can do with these
external factors, these costs that we have never seen go up and
not go away. Everybody is experiencing those, but they don't
have the same constraints the Federal Government has.
I have to ask you, Mr. Winstead. You seem to understand
that we are in a wholly different environment. What is GSA
doing to accommodate itself for the near certainty of the kinds
of costs we were just talking about, not cyclical costs or the
kinds that most disturb me? Energy costs, cost of material, for
example.
I don't know how the Agency is positioned. Do you have
regular meetings even with the private sector on the
availability of space, on how this market is affecting them?
How are you positioning yourself for costs that you know
the government has not taken into account?
I can tell you without fear of contradiction that we didn't
take it in account when the President put the money in the
budget for the Coast Guard building. I am trying to see how you
are going to build that building now. He has had that in his
budget for almost four years.
Mr. Winstead. Madam Chair, I will tell you that our people
in the OCA, the Office of Chief Architect, are looking very
carefully. We have four national contractors that we updated
and recompeted, that are really advising us on every project at
every stage of development of the project on benchmarking of
the cost of that project. We do our best to determine as we go
through, from the authorization process through final opening
of a facility, to make sure that we are building in the actual
costs.
And, I agree with you. I think there has been a benchmark
shift in the last three or four years. We have seen it in gas.
We have seen it with steel costs. We will continue to see it.
It really is incumbent upon us to make sure we are getting
the most accurate estimating information about material costs,
that we are having benchmark verification during both the
design cycle and the construction cycle on the viability and
the competency of those estimates to be delivered on, and we
have to hold our vendors, our contractors and our lessors
accountable to our best judgment on behalf of the taxpayer of
what those costs will be and what the best deal for the public
will be.
But I will tell you the former panel talked about, which
was interesting to me, about engagement of GSA and partnering.
We will continue to do that. I think we are.
DCBIA, that Mr. Grigg represents, we have ongoing liaison
with them, with BOMA. I sit on the National Advisory Council
with BOMA. We are constantly working with them to try to
anticipate where building operating costs are going and making
sure we are, for own inventory, reacting to that as well as new
construction or lease construct projects.
So it has been a very troubled market. I think we have good
counsel. I think we have good contractors to give us the best
estimates.
But the market is very volatile, and it is a difficult
assignment. You saw it with the L.A. courthouse doubling in
cost. You have seen it with the San Diego courthouse.
Ms. Norton. Mr. Grigg, the canary is out of the coal mine.
He just named two projects, FBI and the L.A. courthouse, way
out of the mine.
I am asking Mr. Winstead questions which are not under his
control, and some that I have asked you are not under your
control, certainly the uncontrollable costs.
But I tell you what, I know what the appropriation is that
is coming out of here, and I know they are going to start
building with that appropriation, and I know that somehow I am
going to have to go back to the government and say we don't
have enough money. That bothers me to no end, and one thing I
know I can't do anything about is the amount of money in the
appropriation.
So then I have to look at GSA and say now maybe the lesson
will be learned from what is happening in the first building.
You have heard me say I am going to try to get some enhanced
authority of some kind. Of course, GSA has some authority at
its disposal, some of which it hasn't even used.
But when you look at where the wiggle room is, what bothers
me is when the economy returns, I just don't understand where
the wiggle room is, if it is more money from here or the more
obvious answers.
I guess I am quoting from Mr. Grigg's testimony. I think
GSA has to take it very seriously. ``Space leased by the
government used to be advantaged by steady, prompt payments for
rent. The margins associated with rental income have declined
as a result of problems in the timing and amount of
reimbursements.''
The operative words are things that GSA might be able to do
something about. We know the things it can do nothing about:
``timing and amount of reimbursements for increases in real
estate pass-throughs and operating expenses.''
Then it says, of course, ``which are indexed to CPI
increases.'' I understand the problems you are under there.
But you know one has to begin very seriously if you are in
GSA's position. You have already seen the colossal. Where are
we on the L.A. courthouse, the debacle of the largest
courthouse in the United States?
You see few competitors or too few competitors, rather,
relative to what we expected in the border stations. You see
the failure of the Detroit FBI building with the city saying it
wants it so bad that it will see what it can do to be helpful.
Once you see that occur and you know what we are up against
here, then it seems to me GSA has to begin to look at its, at
the moment, rather small arsenal of tools to see what can be
done to take the standards clauses, the standard way of
operating and squeezing more out of it.
I suppose what I am looking for in this hearing are
examples like some of the examples we have had from the private
sector of how to do that or else, frankly, I see a crisis
looming up there because we are so heavily in the leasing
market and because much of it depends upon expansion and
expansion opportunities.
Mr. Winstead. Madam Chair, I certainly understand your
concern and I think at the earlier hearing in June we did in
response and I have reviewed them here briefly as to the
actions we are going to take. So we have to be on this. We have
to make sure that we have the right estimating crowd with us.
We have to have the right relationship through our brokers,
national brokerage contract, with the industry and directly
DCBIA and ULI and BOMA and AGC and other groups. It is really
incumbent on us bringing them in and making sure we understand
how they view the market and their ability to compete for our
business in the future.
I think we are doing a good job of that now, but I will get
the Committee, again, accountability of what we are doing in
all these areas and just making sure it is very clear, so you
are all aware of it.
As this panel suggested ideas, we will continue.
Ms. Norton. Well, I think GSA needs a five-year plan
looking ahead at costs, some costs that will remain after the
cycle and indeed will continue to go up which the average
homeowner can see and certainly GSA can see. Look for a five-
year plan.
If I were GSA, I would say: Look, Congress, this is what I
see. You are heading for a crisis because you are in the
leasing market, and this is what the private sector you depend
upon is experiencing. We need some relief.
I mean who is in the best position to do this, of course,
is GSA itself.
I leave you with a name, one of Norton's common, ordinary
examples that don't apply here but ought to indicate how the
private sector begins to deal with problems like this,
particularly in real estate.
You will say what does Starbucks have to do with the rental
of office space? I don't know how much of what Starbucks was in
it owned or how much it rented. I know this, that the first
thing it off-loaded when it recognized that people weren't
going to pay four bucks or whatever it is you pay for Starbucks
was its real estate. That is the first thing it did. It is
getting as much out of the real estate business as it can.
It is reducing what was one of the most profitable
businesses in the world first. Of course, it is doing it in
other ways inside, and it is doing the kinds of things you
would expect an extraordinary business like that to do with
respect to its own product, but the first thing it did was to
close down a whole bunch of real estate was eating up its
profit.
I hope you see what I am doing here. I am certainly not
saying that rental market is like Starbucks. But guess what? It
is.
It was up against the rental market and I doubt that they
owned much, but they may have. They were up against costs that
were out of their control. So they looked for ways to bring
them down.
Now we see in the leasing market they are dealing with a
major lessor, at least in this National Capital Region, who is
constrained by an outside force, otherwise known as Federal
regulation, in its bargaining ability.
My concern is that without some very candid five-year
notion, we may have to get GSA to do this. It is best to do it
from the Agency, of what leasing will look like nationwide,
frankly, using the, I will say, totally unforeseeable.
I do not believe that L.A. was foreseeable. I don't believe
that Detroit was foreseeable. But now that we have seen it, it
seems to me that everything else is foreseeable.
Using those case examples to warn the Federal Government
that this has to be seen as an ability to lease where
necessary. You are in a better position to tell me what it
would mean at other locations.
Mr. Winstead. Madam Chair, I would be happy to, again, set
this out in that five-year framework that this Committee can
work with us on or we will provide that, so we do have a clear
sense of how we are dealing with these market fluctuations and
financing and credit issues and how we are responsive to the
private sector's feedback to us.
For example, we had a lease construct workshop on June the
11th, and we had several feedbacks. They said we could do a
better deal on these FBI field offices if we had a purchase
option. They told us that it is better if GSA brings the site
to the deal. They talked about prior to award, getting together
with GSA and the contractor and the tenant to make sure
requirements were fully understood and the risk allocation
issue.
So we actually are taking, as you suggest, based upon the
lease construct program the best practices and ideas. This June
11th workshop was directed to that.
Ms. Norton. You intend to use some of those?
Mr. Winstead. Yes, and I will make sure that we get back to
the Committee how we anticipate because it is going to be five
years before St. Elizabeths. It is going to be five years
before a lot of these constructs how we are responding to
market conditions and offeror's issues that they face to
continue to get a good deal for the government.
Ms. Norton. That would be very helpful. First, I would like
to know how you are going to respond to the feedback from the
private sector on the FBI type buildings.
Mr. Winstead. Right.
Ms. Norton. You listed four or five them.
Mr. Winstead. Right.
Ms. Norton. Then how are you going to respond, as you say,
more generally to what you see up ahead and what the
constraints are of responding?
We know much of this is not in your hands now, and you see
the Committee probing to find how can we find ways to convince
everybody this is not only safe to do. This is what you have to
do, given the growth in the Federal Government and its need for
indispensable space.
I think your two examples of the FBI buildings, the two FBI
buildings make the point about indispensable space.
Mr. Winstead. Right.
Ms. Norton. Of course, those were being built. Both of them
were being built to suit.
You will not find it difficult to make the appropriate
analogies of what you will find in the lease market where they
are building and where you are leasing and where you are, in
fact, going to be looking for space most of the time.
Mr. Winstead. I would be happy to get that back to you
because I think.
Ms. Norton. Would you get us that? I know we would like to
receive that within 60 days.
Mr. Winstead. All right. I will make sure you do.
Ms. Norton. It would be very instructive to us.
If there is anything else that either of you would like to
leave us with before I dismiss you from the table, I would be
most pleased to hear.
I want to thank all three of you, and I particularly thank
you for listening to one another so that you can get a sense of
the dynamic that we think is most helpful to the Committee.
Your testimony has been extremely helpful to us, and I thank
each and every one of you for the testimony you have given here
today.
Thank you, and the Committee is adjourned.
[Whereupon, 1:00 p.m., the Subcommittee was adjourned.]
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