Public-Private Partnerships: Factors to Consider When
Deliberating Governmental Use as a Real Property Management Tool
(01-OCT-01, GAO-02-46T).
This report discusses the nature of and the potential benefits to
the federal government of joining into public-private
partnerships on real property. The basic structure of a
public-private partnership would entail the private sector
providing cash and financing ability to renovate or redevelop
real property contributed by the federal government with each
partner sharing in the net cash flow. Two key factors when
considering properties for partnership are location in a strong
office real estate market and the demand for federal and
non-federal office space. Potential benefits to the federal
government of public-private partnerships include the attainment
of efficient and repaired federal space and the conversion of
properties that are currently a net cost into revenue producers.
Public-private partnerships are essentially financial business
deals for the private sector and it would consider the financial
benefits of such an arrangement. This testimony summarized the
July report, GAO-01-906.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-02-46T
ACCNO: A02089
TITLE: Public-Private Partnerships: Factors to Consider When
Deliberating Governmental Use as a Real Property Management Tool
DATE: 10/01/2001
SUBJECT: Federal property management
Financial management
Real property
Private sector practices
Joint ventures
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GAO-02-46T
United States General Accounting Office
GAO For Release on Delivery Expected at 2: 00 p. m. EDT Monday October 1,
2001
PUBLIC- PRIVATE PARTNERSHIPS
Factors to Consider When Deliberating Governmental Use as a Real Property
Management Tool Statement of Bernard L. Ungar Director, Physical
Infrastructure Issues
GAO- 02- 46T
Testimony Before the Subcommittee on Technology and Procurement Policy,
Committee on Government Reform, House of Representatives
Page 1
Mr. Chairman and Members of the Subcommittee: We are pleased to be here
today to discuss our report entitled PublicPrivate Partnerships: Pilot
Program Needed to Demonstrate the Actual Benefits to Using Partnerships
(GAO- 01- 906, July 25, 2001), which identifies the potential benefits to
the federal government of entering into public- private partnerships on real
property. We have reported that the General Services Administration (GSA)
has a multibillion dollar backlog of deferred maintenance in federal
buildings, and that public- private partnership authority could be an
important management tool to address problems in deteriorating federal
buildings. However, further study of how the partnerships would actually
work and of their benefits compared with other options, such as
appropriations, is needed. Numerous buildings in GSA?s inventory either have
or are at risk of having a negative cash flow because of their deteriorating
condition. In our report, we recommended that the Administrator of GSA use
all available strategies to address the problems of such buildings in GSA?s
inventory. We also recommended that the Administrator of GSA seek statutory
authority to establish a pilot program that would demonstrate the actual
benefits that may be achieved from public- private partnerships that achieve
the best economic value for the government. GSA?s Commissioner for the
Public Buildings Service agreed with the findings and recommendations in our
report.
In my testimony, I will discuss four issues from our report that you asked
us to focus on for this hearing:
The structure of public- private partnerships; factors that indicate a
property may be a potential candidate for a publicprivate partnership;
benefits of public- private partnerships to the federal government; and
factors a private- sector entity considers when determining the viability of
a public- private partnership and its benefits to the private- sector
entity. In addition, as you requested, I will briefly discuss the
authorities available to the Department of Veterans Affairs (VA) and the
Department of Defense (DOD) that allow them to enter into ventures with the
private sector.
In summary, the basic structure of a public- private partnership would
entail the private sector providing cash and financing ability to renovate
or redevelop real property contributed by the federal government and each
partner sharing in the net cash flow resulting from the property. Location
in a strong office real estate market and the demand for federal and
nonfederal office space are two key factors when considering properties for
Page 2
partnership opportunities. Potential benefits to the federal government of
public- private partnerships include the attainment of efficient and
repaired federal space and the conversion of properties that are currently a
net cost into revenue producers. Public- private partnerships are
essentially financial business deals for the private sector and it would
consider the financial benefits of such an arrangement. Unlike GSA, VA, and
DOD currently have the authority to enter into joint ventures with the
private sector.
To identify the potential benefits to the federal government of entering
into public- private partnerships on real property, we contracted with Ernst
& Young LLP, who, together with a subcontractor, Signet Partners, developed
and analyzed hypothetical partnership scenarios for seven selected GSA
buildings. We also contracted with AEW Capital Management, L. P. (AEW) to
update a study it had previously done for GSA on the public- private
partnership financial viability for three properties in Washington, D. C.
For a complete listing of the 10 properties included in our study, see
attachment I. Additional information about our methodology, including how
the hypothetical partnership scenarios were structured and how the
properties were selected, is included in attachment II. We obtained
information on the authorities available to VA and DOD by talking with
officials from these agencies and by reviewing applicable legislation.
We have suggested that the Congress consider providing the Administrator of
GSA with the authority to experiment with funding alternatives, including
public- private partnerships, when they reflect the best economic value
available for the federal government. Congress has enacted legislation that
provides certain other agencies with a statutory basis to enter into joint
ventures with the private- sector. This additional property management tool
has been provided to VA and DOD. Furthermore, in an effort to provide more
agencies with a broader range of property management tools, the Federal
Asset Management Improvement Act (H. R. 2710) was recently reintroduced.
The term public- private partnership can be used to describe many different
types of partnership arrangements. When we refer to publicprivate
partnerships, we are referring to partnerships in which the federal
government contributes real property and a private entity contributes
financial capital and borrowing ability to redevelop or renovate the real
property. Regarding the structure of the hypothetical partnerships
Background
Structure of PublicPrivate Partnerships
Page 3
developed for our study, the federal government and the private sector
entity negotiate to agree on how the specifics of the partnership will work,
including how the cash flow will be shared to form the partnership. The
private partners will generally require a preferred return to compensate it
for the risks it is taking in the partnership. This preferred return is
generally a percentage of the cash flow; for our study, the contractors used
11 percent for the Washington, D. C. properties and 9 percent for the other
properties. The net cash flow is then divided between the private partner
and the federal government at an agreed- upon percentage. Attachment III
shows graphically how the hypothetical partnerships in our study were
structured.
In structuring partnerships for individual properties, it must be remembered
that each property is unique and will thus have unique issues that will need
to be negotiated and addressed as the partnership is formed. Great care will
need to be taken in structuring partnerships to protect the interests of
both the federal government and the private sector. In conducting this
study, the contractors assumed that certain conditions would govern a
public- private partnership. 1 For example, the property must be available
for use, in whole or in part, by federal executive agencies, and agreements
must not guarantee occupancy by the United States. In addition, the
government would not be liable for any actions, debts, or liabilities of any
person under an agreement, and the leasehold interests of the United States
would be senior to any lender of the nongovernmental partner.
There are various factors that indicate whether a property is a potential
candidate for a public- private partnership. There must be not only a
federal need for space, but also a private- sector demand for space, since
the government is not guaranteeing that it will occupy the property. The
stronger the market for rental space, both federal and nonfederal, the more
likely that the space will be rented and thus producing income. The property
must have the ability to provide a sufficient financial return to attract
and utilize private- sector resources and expertise. A property in a strong
rental market and at a good location is more likely to attract private-
sector interest than a property without these characteristics. Another
factor is the existence of an unutilized or underutilized asset on
1 These conditions are based on legislation that was introduced during the
106th Congress, H. R. 3285. Factors That
Indicated Potential Properties for PublicPrivate Partnerships
Page 4
the property, which could be used to increase the value of the property.
Several of the properties we studied had vacant land. The existence of
excess land on the property that could be used to increase the amount of
office space by expanding or building a new building, could increase the
opportunity for an income- generating partnership. The property in Seattle,
WA, has a deepwater port that the government is not using to its potential
but that could be very valuable to another user.
Any partnership would have to conform with budgetary score- keeping rules.
Federal budget scoring is the process of estimating the budgetary effects of
pending and enacted legislation and comparing them to limits set in the
budget resolution or legislation. Scorekeeping tracks data such as budget
authority, receipts, outlays, and the surplus or deficit. Office of
Management and Budget (OMB) staff indicated that where there is a longterm
need for the property by the federal government, it is doubtful that a
public- private partnership would be more economical than directly
appropriating funds for renovation. In addition, depending on how OMB scores
these transactions, some of the scenarios could trigger capital lease-
scoring requirements due to the implicit long- term federal need for the
space.
Our study designed a conceptual framework for public- private partnerships
in order to identify potential benefits of these partnerships. Our
contractors developed and analyzed hypothetical public- private partnerships
for 10 specific GSA properties. Multiple potential benefits to the federal
government were identified. These potential benefits include the
utilization of the untapped value of real property, conversion of
buildings that are currently a net cost to GSA into net
revenue producers, attainment of efficient and repaired federal space,
reduction of costs incurred in functionally inefficient buildings,
protection of public interests in historic properties, and creation of
financial returns for the government.
Our study did not identify or address all the issues of partnerships that
will need to be considered by the decisionmakers and policymakers as
partnerships are developed. Before any partnerships are developed, indepth
feasibility studies would have to be done to evaluate partnership
opportunities and other options, such as appropriations, to determine which
could provide the best economic value for the government. When Multiple
Potential
Benefits to the Federal Government Identified
Page 5
deciding whether to enter into a partnership, the government will need to
weigh the expected financial return and other potential benefits against the
expected costs, including potential tax consequences, associated with the
partnership. Any cost associated with vacating buildings during renovation
work would also have to be considered in any alternative evaluated. In
addition, any actual partnerships involving the properties in our study may
be very different from the scenarios developed by our contractors.
For a public- private partnership to be a viable option, there must be
interest from the private sector in partnering with the government on a
selected property. A private- sector partner would generally enter a
partnership as a financial business decision. While the private- sector
entity would consider numerous factors to determine the viability of a
publicprivate partnership, the financial return from the partnership is the
critical factor in the decision on whether to partner with the federal
government. According to our contractors, about a 15- percent internal rate
of return (IRR) 2 would likely elicit strong interest from the private
sector in a partnership. However, this is only one factor, and the
circumstances and conditions of each partnership are unique and would have
to be evaluated on a case- by- case basis by both the private sector and the
federal government. For example, a somewhat lower IRR could be attractive if
other conditions, such as the risk level, are favorable. In addition, when
our contractors discussed possible partnership scenarios with local
developers, the developers said that, to participate, they would want at
least a 50- year master ground lease.
A public- private partnership would generally be a financial undertaking for
the private- sector entity, and the main benefit to it would be financial.
With regard to some properties, the private sector may believe it is a
benefit to be associated with a particular project if a developer believes
that a project is prestigious and might open future opportunities.
According to our contractors, the analysis of the hypothetical partnerships
for many of the properties in our study showed a sufficient potential
financial return to attract private- sector interest in a partnership
arrangement. Our contractors determined that 8 of the 10 GSA properties
2 The IRR measures the return, expressed as an interest rate, that an
investor would earn on an investment. Considerations of and
Benefits to the Private- Sector Entity
Page 6
in our study were strong to moderate candidates for public- private
partnerships. This determination was based on the (1) estimated IRR for the
private- sector partner in year 10 of the project, which ranged from 13.7 to
17.7 percent; (2) level of federal demand for the space; and (3) level of
nonfederal demand for space. The level of demand for space, both federal and
nonfederal, affects the level of risk that the space will be vacant and thus
non- income- producing. The stronger the local market is for rental space,
the more likely the space will be rented and thus produce income for the
partnership. The properties that were strong candidates for partnerships
were located in areas with a strong federal and nonfederal demand for space,
and many had untapped value that the partnership could utilize, such as
excess land on which a new or expanded building could be built.
Leasing authority is available to VA and DOD. 3 Under VA?s enhanced use
leasing (EUL) authority, an EUL must enhance the use of the property and
provide some space for an activity that contributes to VA?s mission or
otherwise improves services to veterans. VA receives fair consideration,
monetary or in- kind, as determined by the Secretary and the lease term is
not to exceed 75 years. For DOD, terms must promote national defense or be
in the public interest, and the lease term may not exceed 5 years without
the Service Secretary?s approval. The lease proceeds may be used to fund
facility maintenance and repair or environmental restoration at the military
installation where the property is located and elsewhere. According to VA
and DOD, their ventures yield both financial and nonfinancial benefits.
Financial benefits include receiving below market rental rates and the
receipt of cash revenue in some cases. Nonfinancial benefits include
maximizing the use of capital assets as well as in- kind benefits such as
the use of a child care center at reduced rates. In 1999, we reported on two
projects under the VA?s EUL authority. 4 In Texas, a private developer
constructed a VA regional office building on VA?s medical campus. VA then
leased land to the developer on the medical campus and the developer
constructed buildings on the land and rented space in them to commercial
businesses. In Indiana, the state leased underutilized land and facilities
from VA to use as a psychiatric care
3 (38 U. S. C. sect. 8161- 8169) and (10 U. S. C. sect. 2667) 4 Public- Private
Partnerships: Key Elements of Federal Building and Facility Partnerships
(GAO/ GGD- 99- 23, Feb. 3, 1999). Authorities Available
to VA and DOD
Page 7
facility. The leasing revenue that VA receives from both sites is to be used
to fund veterans programs.
Aside from the work we did in connection with our 1999 report, it is
important to note that we did not explore these authorities in depth, nor
did we examine the budget scoring implications for projects undertaken based
on these authorities. Currently, we are examining DOD?s implementation of
its authority to lease non- excess property and how the military services
are using this and other special legislative authorities to reduce base
operating support costs. We expect this work to be completed early next
year.
This concludes my prepared statement. I would be happy to respond to any
questions you may have.
For information about this testimony, please contact Bernard Ungar,
Director, Physical Infrastructure Issues, on (202) 512- 8387. Individuals
making key contributions to this testimony included Ron King, Maria
Edelstein, and Lisa Wright- Solomon. Contacts and
Acknowledgments
Page 8
Property Tenants Building size
(square feet) Current
occupancy rate (percentage)
Funds from operations, fiscal year 2000
Private partner IRR a Notes
Seattle, WA Army Corps of Engineers, FBI motor pool, out- lease warehouse
space
607,543 rentable (mixed use) 200,000 office
Office: 8% Warehouse: 80% Motor pool: 100%
$3,293,485 17.7% Army Corps of Engineers believes that it must relocate to a
facility that meets seismic standards
Washington, D. C. Federal Office Building 9
Office of Personnel Management (OPM) 768,530 gross
673,924 rentable
98% $9,922,041 17.3% Delegated building Portland, OR Immigration and
Naturalization Service (INS)
137,281 gross 122,505 rentable
50% $( 207,980) 15.7% May be hard to retain INS at end of lease in fiscal
year 2002 if building needs are not addressed Washington, D. C. GSA HQ
GSA headquarters 710,431 gross 623,233 rentable
100% $4,456,891 15.3% Columbia, SC Veterans Affairs (VA) 83,640 gross
802,249 rentable
100% $332,684 14.5% Andover, MA Internal Revenue
Service (IRS) 400,502 gross 393,520
rentable 100% $2,016,191 14.4% Delegated building- IRS
pays its operating costs Washington, D. C. Federal Office Building 8
Food and Drug Administration (FDA) 522,491 gross
479,840 rentable
100% $12,362,825 13.7% FDA to vacate building and return it to GSA in 2002
clear of any environmental hazards Charleston, SC Unoccupied 99,695 BOMA 0
$( 1,003, 372) 13.7% Building vacant since
1999 due to damage from Hurricane Floyd Jacksonville, FL U. S. District
Courts
U. S. Postal Service 290,855 gross
278,870 rentable
94% $1,517,038 12.4% Courts will move to new courthouse in 2002
Minneapolis, MN Military Enlistment
Processing Service (MEPS)
154,049 gross 143,197 rentable
10% $599,365 10.3% MEPS plans to vacate building June 2001
a In year 10 of a 50- year partnership. Source: GSA and Ernst & Young.
Attachment I: GSA Properties Analyzed
Page 9
To identify the potential benefits to the federal government and private
sector of allowing federal agencies to enter into public- private
partnerships, we hired contractors to develop and analyze hypothetical
partnership scenarios for 10 selected GSA buildings. GSA?s National Capital
Region had previously contracted for a study to analyze the financial
viability of public- private partnership ventures for three buildings in
Washington, D. C. Because the majority of the work for these properties had
already been done, we had the contractor update its work on these 3
buildings and selected them as 3 of the 10 GSA properties. To help us select
the other 7 properties for our study, GSA provided a list of 36 properties
that it considered good candidates for public- private partnerships. In
preparing this list of properties, GSA officials said that they considered
factors such as the strength of the real estate market in each area, the
extent to which the property was currently utilized or had land that could
be utilized, and the likelihood of receiving appropriations to rehabilitate
the property in the near future. We judgmentally selected seven properties
from this list to include properties (1) from different geographic areas of
the country, (2) of different types and sizes, and (3) with historic and
nonhistoric features.
To analyze the potential viability of public- private partnerships for each
of the 10 selected GSA properties, the contractors
analyzed the local real estate markets, created a hypothetical
partnership scenario and redevelopment plan, and constructed a cash flow
model.
In the contractor?s judgment, the partnership scenarios were structured to
meet current budget- scoring rules and provisions in H. R. 3285, introduced
in the 106th Congress. These provisions included the requirements that the
property must be available for lease, in whole or in part, by federal
executive agencies; agreements do not guarantee occupancy by the federal
government; the government will not be liable for any actions, debts, or
liabilities of any
person under an agreement; and leasehold interests of the federal
government are senior to those of any
lender of the nongovernmental partner. However, a determination on how the
partnerships would be treated for budget- scoring purposes would have to be
made after more details are available on the partnerships. Attachment II:
Methodology
Page 10
We accompanied the contractor on visits to the seven GSA properties that had
not been previously studied. We interviewed, or participated in discussions
with, developers and local officials in the areas where the properties were
located as well as officials from GSA. We reviewed the contractors? work on
the 10 properties for reasonableness but did not verify the data used by the
contractors.
The partnership viability scenarios developed for this assignment are
hypothetical, and were based on information that was made readily available
by representatives of the local real estate markets, city governments, and
GSA. Any actual partnerships involving these properties may be very
different from these scenarios. In- depth feasibility studies must be done
to evaluate partnership opportunities before they are pursued. There may be
other benefits and costs that would need to be considered, such as the
possible federal tax consequences and the costs of vacating property during
renovation in some cases.
This study only looked at the potential benefits to the federal government
and private sector of public- private partnerships as a management tool to
address problems in deteriorating federal buildings. We did not evaluate the
potential benefits of other management tools that may be available for this
purpose. We did, however, discuss the implications of using publicprivate
partnerships with OMB representatives.
We did our work between November 2000 and June 2001 in accordance with
generally accepted government auditing standards.
Page 11
Source: Ernst & Young LLP and Signet Partners.
Attachment III: Public- Private Partnership Structure
(543010)
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