Military Housing: Management Improvements Needed As the Pace of Privatization Quickens (06/21/2002, GAO-02-624}

-------------------------Indexing Terms-------------------------
REPORTNUM:   GAO-02-624
    TITLE:   Military Housing: Management Improvements Needed As the Pace of Privatization Quickens
     DATE:   06/21/2002



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of Privatization Quickens' which was released on June 21, 2002. 

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United States General Accounting Office: 
GAO: 

GAO Report to the Subcommittee on Military Construction, Committee on 
Appropriations, House of Representatives: 

June 2002: 

Military Housing: 

Management Improvements Needed As the Pace of Privatization Quickens: 

GAO-02-624: 

GAO Highlights: 

Highlights of GAO-02-624, a report to the Subcommittee on Military 
Construction, House Committee on Appropriations: 

Why GAO Did This Study: 

Renovating or replacing 168,000 inadequate military family housing 
units using traditional military construction methods would take over 
20 years and cost about $16 billion. In 1996, to improve housing 
faster and more economically, Congress authorized the Military Housing 
Privatization Initiative to allow private-sector financing, ownership, 
operation, and maintenance of military housing. 

At the request of the Subcommittee on Military Construction, House 
Committee on Appropriations, GAO examined the reliability of military 
housing needs assessments, as well as achievement of privatization
financial goals and government protections in contract provisions. 

What GAO Found: 

Privatization projects are not supported by reliable needs assessments,
and the overall requirement for military housing is not well-defined. 
With uncertain requirements, the military may be entering into long-term
privatization contracts to construct, replace, or renovate housing that
may not be needed. 

DOD exceeded its overall goal for leveraging government funds with
private-sector financing. By investing about $185 million in the first 
10 awarded projects, DOD should obtain housing improvements that would
have required about $1.19 billion in military construction funds without
private-sector contributions. However, it is not clear whether DOD will
achieve its goal that each projectï¿½s life-cycle costs be the same or 
less than that of an equivalent military construction project. Use of 
DOD guidance for performing the analyses shows that each of the first 10
projects will cost less. However, these results might not be reliable,
because weaknesses in the methodology outlined in the guidance can
make the privatization option appear more favorable than is justified. 

Moreover, steps need to be taken to further protect the governmentï¿½s
interests. In seven projects, developers will receive about $369 million
more in profits and fees than anticipated because the contracts did not
fully anticipate increases in servicemember housing allowances, which
are used to pay rent in privatized housing. Furthermore, the department
appears to have limited oversight of future project spending decisions.
This could lead to unnecessary or inappropriate project spending. GAO
also found no department guidance for contract assumptions and fees for
services paid to developers. As a result, it is unclear whether contract
assumptions and fees are reasonable and result in the lowest costs. 

[Figure: Refer to PDF for image: Photograph] 

Newly constructed military family housing at Fort Carson, Colorado. A 
private developer was contracted to renovate 1,823 existing units, 
construct 840 new housing units on base, and own, operate, and 
maintain all 2,663 units for 50 years. 

[End of figure] 

What GAO Recommends: 

GAO recommends that DOD use a broader range of factors in defining its 
military housing requirements, modify its guidance for performing life-
cycle cost analyses, and implement several changes to enhance government
protections in the privatization program. 

In commenting on a draft of this report, DOD generally agreed with the 
recommendations and outlined ongoing or planned management actions to 
address the concerns noted in the report. 

This is a test for developing Highlights for a GAO report. The full 
report, including GAO's objectives, scope, methodology, and analysis 
is available at [hyperlink, http://www.gao.gov]. For additional 
information about the report, call Carol Schuster at (202) 512-4013. 
To provide comments on this test Highlights, call Keith Fultz at (202) 
512-3200 or send an email to [email protected]. 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

Military Family Housing Requirements Assessments Are Unreliable Key 
Financial Goals Generally Achieved: 

Privatization Program Includes Government Safeguards, but Improvements 
Are Possible: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Differences Over Budgetary Scoring for DOD's Military 
Housing Privatization Program: 

Appendix II: Scope and Methodology: 

Appendix III: Description of First Ten Privatization Projects: 

Appendix IV: DOD's Military Housing Privatization Program 
Implementation Status and Plans: 

Appendix V: Services' Life-Cycle Cost Estimates: 

Appendix VI: Comments from the Department of Defense: 

Appendix VII: GAO Contacts and Staff Acknowledgments: 

Tables: 

Table 1: Leveraging Ratios for the First 10 Projects: 

Table 2: GAO Alternative Life-Cycle Costs Estimates for the First 
10 Projects: 

Table 3: DOD Property Conveyances Not Included in Budget Scored 
Amounts: 

Table 4: DOD and Private Sector Contributions to Project Development 
Costs: 

Table 5: Government Financial Exposure in the First 10 Projects: 

Table 6: Projected Extra Rental Revenues, Profits, and Fees Resulting 
from the Housing Allowance Initiative: 

Table 7: Services' Estimates of Life-Cycle Costs: 

Figures: 

Figure 1: Projected Cumulative Amounts Available for Reinvestment in 
the Projects: 

Figure 2: Cumulative Number of Housing Units Under Contract: 

Abbreviations: 

DOD: Department of Defense: 

GAO: General Accounting Office: 

[End of section] 

United States General Accounting Office: 
Washington, DC 20548: 

June 21, 2002: 

The Honorable David L. Hobson: 
Chairman: 
The Honorable John W. Olver: 
Ranking Minority Member: 
Subcommittee on Military Construction: 
Committee on Appropriations: 
House of Representatives: 

The Department of Defense (DOD) estimates that about 168,000 military 
family housing units are inadequate, lacking modern amenities, and in 
need of major renovation or replacement. According to DOD, completing 
this work using traditional military construction methods would take 
more than 20 years and cost about $16 billion. To improve housing 
faster and more economically than could be achieved if only 
traditional military construction funds were used, the Congress, at 
DOD's request, enacted legislation in 1996 to authorize the Military 
Housing Privatization Initiative.[Footnote 1] This program allows 
private-sector financing, ownership, operation, and maintenance of 
military housing.[Footnote 2] Under the program, the department can 
provide direct loans, loan guarantees, and other incentives to 
encourage private developers to construct and operate housing either 
on or off military installations. Servicemembers, in turn, may use 
their housing allowance to pay rent and utilities to live in the 
privatized housing. Department financial goals for the program state 
that (1) government funds should be leveraged with private sector 
investment to obtain at least three dollars in military housing 
improvements for each dollar that the government invests, and (2) the 
government's estimated total costs for a privatization project should 
be equal to or less than the total costs for the same project financed 
by military construction funding. The services perform a project life-
cycle cost analysis to estimate and compare these costs prior to 
solicitation as part of a project's approval process. 

In response to your request, this report addresses the following 
questions: 

(1) Are privatization projects based on reliable assessments of 
housing requirements? (2) Is DOD achieving its financial goals for the 
privatization program? (3) Do DOD's privatization contracts protect 
the government's interests? In addition, as requested, we address the 
differences between the Office of Management and Budget and the 
Congressional Budget Office over budgetary scoring for the 
privatization program (see appendix I). 

Our analysis included site visits, reviews of DOD data, and 
consultations with military and civilian officials. A more detailed 
description of our scope and methodology is included in appendix II. 

Results in Brief: 

Although DOD has awarded contracts to construct or improve about 
16,000 units and has plans to privatize an additional 96,000 units by 
the end of fiscal year 2006, privatization projects are not supported 
by reliable or consistent needs assessments, and the overall 
requirement for military family housing is not well-defined. Accurate 
requirements determinations can help DOD to construct and maintain 
government housing, whether privatized or not, only at installations 
where the local communities cannot meet the military's family housing 
needs. Yet, DOD has failed to fix this longstanding problem. Our 
current and past work, as well as the work of others, including the 
DOD inspector general, has shown that the services use inconsistent 
methodologies to determine the availability of private-sector housing 
for military families in communities surrounding military 
installations, and these methodologies often underestimate the ability 
of the private sector to meet housing needs. As a result, the 
requirement for government housing is often overstated. Further, 
although an initiative to increase housing allowances should make 
community housing more affordable and reduce the need for government 
housing, DOD has not analyzed on an installation basis the potential 
impact of this initiative on military housing requirements. Finally, 
contrary to DOD's stated policy of relying on community housing, a 
disparity exists between on-base and off-base housing standards that 
creates an incentive for servicemembers in lower enlisted pay grades 
and with larger families to seek government housing rather than 
community housing. DOD has not assessed the effect of these different 
standards on housing requirements or the merits of a program that 
would adjust housing allowances according to family size. With its 
housing requirements uncertain, the department may be entering into 
long-term privatization contracts to construct additional housing or 
replace or renovate existing inadequate military housing that may not 
be needed. 

The department has generally achieved two key financial goals for the 
privatization program-ï¿½leveraging of government funds and lower 
project life-cycle costs. First, DOD exceeded its overall goal for 
leveraging government funds with private-sector financing in the first 
10 privatization projects awarded under the military housing 
privatization initiative.[Footnote 3] In the aggregate, by investing 
about $185 million in the 10 projects, DOD should obtain housing 
improvements that would have required about $1.19 billion in military 
construction funds had only government funds been used. This is a 
leveraging ratio of 6.4 to 1. On an individual project basis, only 1 
of the first 10 projects did not achieve DOD's leveraging goal of at 
least 3 to 1. Second, it is not clear whether DOD will achieve its 
goal that each project's life-cycle costs be the same or less than 
that of an equivalent military construction project. Use of DOD 
guidance for performing life-cycle cost analyses shows that each of 
the first 10 privatization projects will cost less than the equivalent 
military construction projects.[Footnote 4] However, this guidance can 
make the privatization option appear more favorable than justified 
because it does not expressly state that government contract oversight 
costs should be included and uses methods that can result in 
overstated operation and maintenance costs for the military 
construction option. On the other hand, DOD officials pointed out that 
the guidance also excludes other costs that can make the military 
construction option appear more favorable than justified. Changes in 
the guidance could improve the accuracy and reliability of life-cycle 
cost analyses and provide for more informed decisions on future 
privatization proposals. 

While DOD has included provisions designed to protect the government's 
interests against adverse events, we found some areas where DOD could 
further enhance protections to the government. First, some contracts 
did not fully anticipate the increased rent that will be paid to project
developers as a result of a DOD initiative to increase housing 
allowances for servicemembers. As a result, project revenue may 
increase by about $1.3 billion over the life (up to 50 years) of seven 
projects, and developers may receive $369 million more in profits and 
fees than DOD anticipated. On a cumulative basis, most of the 
additional rental revenue is not expected to go to the developers. 
Second, although military installation officials will participate with 
developers in making project improvement decisions valued at about 
$3.9 billion over contract terms of nine projects, DOD and service 
headquarters oversight of these decisions appears limited. A lack of 
oversight could lead to unnecessary or inappropriate spending on 
project improvements. Third, we found wide variation in the 
privatization contracts regarding assumptions and fees for services 
paid to developers. As a result, it is unclear whether DOD is 
minimizing its costs. Finally, although DOD has developed a semi-
annual report to help it monitor and evaluate financial and management 
data and assess the performance of individual projects, the reports 
have not been completed in a timely manner, do not include all 
relevant information, and are not subject to independent verification. 

We are recommending that DOD revise its housing requirements 
determination process by taking into account greater use of community 
housing to fulfill housing needs and the potential impact of the 
housing allowance initiative on military housing requirements. We are 
also recommending that DOD improve privatization implementation by 
modifying its guidance for performing life-cycle cost analyses and 
making several changes to enhance government protections in the 
program. In comments on a draft of this report, the department 
generally agreed with the report's findings and recommendations and 
outlined management actions to address the concerns noted in the 
report. The department also provided technical clarifications, which 
we incorporated as appropriate. 

Background: 

DOD plans to spend over $11 billion in fiscal year 2002 to provide 
housing for families of active-duty military personnel. DOD's policy 
is to rely on the housing in local communities near military 
installations as the primary source of family housing. About two-
thirds of all military families in the United States live in community 
housing and receive a cash housing allowance to help defray the cost 
of renting or purchasing a home. Until 2001, the housing allowance 
covered an average of 81 percent of the typical housing costs, and 
servicemembers paid the rest out of pocket. The remaining military 
families live in government-owned or privatized housing. These 
families pay no out-of-pocket costs for housing or utilities. Families 
in government housing receive no housing allowance, while families in 
privatized housing use their housing allowance to pay rent and normal 
utility costs. DOD plans to eliminate this inequity in out-of-pocket 
costs between servicemembers who live in local community housing and 
those who live in government-owned or privatized housing. An 
initiative started in 2001 is intended to increase housing allowances 
and reduce average out-of-pocket costs to zero by 2005.[Footnote 5] As 
a result, more existing local community housing will be affordable to 
military families, families already living in local community housing 
should be better able to cover their housing costs, and developers of 
privatized housing will receive higher rents. 

According to DOD, the quality of government-owned housing has declined 
for more than 30 years, primarily because maintaining the housing was 
not a priority. Concerned that poor-quality housing could cause 
servicemembers to leave the military, DOD proposed a privatization 
initiative aimed at solving its housing problem faster and more 
economically by taking advantage of the private sector's investment 
capital and housing construction expertise. The resulting Military 
Housing Privatization Initiative, enacted in 1996, authorized DOD to 
enter into a variety of arrangements with private-sector entities to 
build and renovate military housing both on and off military bases. 
With private-sector investment, DOD planned to obtain at least three 
dollars in military housing improvements for each dollar that the 
government invested, thereby reducing the amount of government funds 
initially required to revitalize housing and accelerating the 
elimination of inadequate housing. DOD's Competitive Sourcing and 
Privatization Office, which reports to the Deputy Under Secretary of 
Defense (Installations and Environment), provides oversight of this 
program, but the primary responsibility for implementing it rests with 
the individual services. 

Although implementation of the privatization program started slowly, DOD
has picked up the pace and plans to use the program as the primary means
to meet a revised goal of eliminating inadequate military family 
housing by 2007, instead of the original goal of 2010. Also, to bring 
additional attention and priority to achieving this goal, the Bush 
administration has increased emphasis on the program by making 
privatization of military housing 1 of 14 key initiatives for 
improving government management and performance. Appendix IV includes 
details about DOD's privatization implementation status and plans. 

Since 1998, we have issued three reports on DOD's military housing 
program-ï¿½two about the military housing privatization initiative and 
one about DOD's process for determining military housing requirements. 
In July 1998, we reported several concerns. These included (1) whether 
privatization would result in significant cost savings and whether the 
long contract terms of many projects might result in building housing 
that will not be needed in the future, (2) whether controls were 
adequate to protect the government's interests in the event developers 
might not operate and maintain the housing as expected, and (3) 
whether DOD would face certain problems if privatized housing units 
were not fully used by military members and were subsequently rented 
to civilians, as the contracts permit.[Footnote 6] In March 2000, we 
reported that initial implementation progress was slow, the services' 
life-cycle cost analyses provided inaccurate cost comparisons because 
DOD had not issued standardized guidance for preparing the analyses, 
and DOD lacked a plan for evaluating the effectiveness of the program. 
[Footnote 7] Subsequently, DOD implemented several key 
recommendations, such as issuing life-cycle cost analysis guidance and 
developing a privatization program evaluation plan. In an August 2001 
report, we noted that despite earlier recommendations, DOD had not 
implemented a standard process for determining military housing 
requirements.[Footnote 8] In that report, we pointed out that the 
initiative to increase housing allowances heightened the urgency for a 
consistent process, because the initiative could lessen the demand for 
military housing by making housing in local communities more 
affordable. This effect is possible because personnel surveys have 
consistently shown that military personnel would prefer to live in 
surrounding communities rather than in military housing if they did 
not incur additional out-of-pocket costs. 

Military Family Housing Requirements Assessments Are Unreliable: 

Fundamental to the success of DOD's housing program is a process that 
consistently and accurately determines the services' housing needs and 
the ability of the local community to meet those needs at each 
installation. Accurate requirements determinations can help DOD to 
construct and maintain government housing, whether privatized or not, 
only at installations where the local communities cannot meet the 
military's family housing needs, as specified by DOD policy. Yet, DOD 
has failed to fix this longstanding problem. Our current and past 
work, as well as the work of others, including the DOD inspector 
general, has shown that the services use inconsistent methodologies to 
determine the availability of community housing and often overstate 
the amount of housing DOD should provide. Complicating the task of 
determining housing requirements is the uncertainty about future 
demand for government-provided housing caused by the initiative to 
increase housing allowances. Moreover, DOD housing standards for 
servicemembers differï¿½depending on whether they live in government-
owned or privatized housing or in community housingï¿½and may be 
boosting the demand and requirements for government-owned or 
privatized housing, which is inconsistent with DOD's stated policy of 
relying to the maximum extent on community housing. 

Services Use Inconsistent Methods to Determine Housing Requirements: 

The DOD Housing Management Manual 4165.63M states that a housing 
market analysis should be performed at installations where acquisition 
of housing is programmed. This market analysis should help to 
determine military housing needs and the ability of the local 
communities to meet those needs. Each analysis normally includes a 
detailed estimate of the installation's housing requirements, taking 
into account servicemembers' pay grades and bedroom needs relative to 
family size. The services compare these military family housing 
requirements with the inventory of government-owned housing units and 
with the estimated number of available community housing units that 
meet the military's criteria for suitability and affordability. 
[Footnote 9] The process is intended to predict whether an 
installation will have a housing surplus or deficit in the near future.
Predicted deficits can form the basis for justifying a privatization 
project to construct newï¿½-or replace or renovate existing-ï¿½military 
housing. 

Predicted surpluses can indicate a need to close government-owned 
units when they are no longer useful. 

As we have reported since 1996, the services use inconsistent 
methodologies to determine the availability of private-sector housing 
for military families in communities surrounding military 
installations, and these methodologies often underestimate the ability 
of the private sector to meet housing needs. As a result, the 
requirement for government housing is often overstated. For example, 
the housing market analyses for some installations first matched 
military family housing requirements with existing government housing 
units before considering community-housing units. In other cases, the 
analyses required a minimum number of government housing units 
regardless of the community's ability to meet needs. These procedures 
are inconsistent with DOD's policy of relying first on community 
housing and can lead to unjustified support for retaining government-
owned housing units. Another problem is that some of the services' 
analyses assumed that only small portions-in some cases less than 12 
percent-ï¿½of a community's vacant rental units were available for 
military families to occupy. As a result, the analyses underestimated 
community housing availability because they excluded from 
consideration hundreds of suitable vacant units. 

Without a reliable, consistent process for determining military family 
housing requirements, DOD cannot know with assurance how many housing 
units it needs, where it needs them, whether its housing investment 
decisions are justified, and whether its overall housing costs are 
minimized. Constructing and maintaining military family housing, 
whether financed through military construction funding or 
privatization, costs more than paying housing allowances and relying 
on local community housing. Past studies have reported that DOD 
annually saves from $3,200 to more than $5,000 per family by providing 
a housing allowance instead of using military construction funds to 
build and maintain a government-owned house.[Footnote 10] Even when 
compared to privatization financing, providing housing allowances and 
relying on community housing is less expensive. We compared the life-
cycle costs of the first 10 privatization projects using DOD's life-
cycle guidance with housing allowance costs, assuming all 
servicemembers included in the projects could have lived in the local 
communities. The analysis showed that reliance on community housing 
would cost about $315 million, or 6 percent, less than privatization. 
This is not to say that the local communities could have met the 
housing needs included in these 10 privatization projects, nor that 
suitable community housing within reasonable commuting distances is 
available at all locations. But costs can only be minimized through 
accurate analyses of housing requirements and aggressive application 
of DOD's policy of relying on community housing. 

DOD agrees that it needs a framework for a single, consistent process 
for determining housing requirements that relies first on civilian 
community housing. DOD housing officials stated that they have been 
developing a new process that should be finalized this year. However, 
even after the new process is in place, the officials stated that it 
will take years to update housing requirements DOD-wide, because new 
housing market analyses must be performed base by base. In the 
meantime, DOD risks investing in privatization projects to build or 
improve housing that may not be needed. Also, notwithstanding DOD's 
plans for finalizing a new process by the end of 2002, DOD has 
reported such plans for several years and each time failed to reach a 
consensus with the services on a new requirements determination 
process. 

Impact of Housing Allowances Initiative on Requirements Not Fully 
Assessed: 

The initiative to increase servicemember housing allowances and reduce 
their average out-of-pocket costs to zero by 2005 will have a 
significant impact on the military housing program. First, increased 
allowances should result in an increased number of community housing 
units that are affordable to servicemembers. This should decrease the 
requirement for government-owned or privatized houses by making 
housing in local communities more affordable. Second, over time, 
increased allowances could result in private housing developers 
building new housing near military installations as developers see 
opportunities to profit from renting to servicemembers at market 
rates. This would increase the supply of community housing available 
to military families and could decrease the requirement for government-
owned or privatized housing. Third, increased allowances should allow 
DOD to better satisfy the preferences of most servicemembers to live 
off base and result in reduced demand for government housing. We 
previously reported that, based on the results of DOD's 1999 Survey of 
Active Duty Personnel, military members prefer civilian housing if 
costs are equal. Of those currently receiving a housing allowance or 
living in military housing, about 72 percent said they would prefer 
community housing if costs were equal, while 28 percent said they
would prefer military housing.[Footnote 11] In 1999, RAND reported 
that only about 20 percent of military members prefer military 
housing, and that the predominant reason servicemembers live in 
military housing is that they do not need to pay any money out of 
pocket, as they would if they lived in the local community.[Footnote 
12] Although some families may still elect to live in military 
housing, by 2005 the allowance initiative should eliminate the 
economic incentive to do so by eliminating the need for those living 
in the local community to pay money out of pocket for their housing. 

Despite these significant impacts of the allowance initiative, DOD has 
not conducted detailed studies and analyses on an installation basis 
to determine how the initiative will affect the requirement for 
government-owned or privatized housing. Thus, DOD plans call for 
replacing or renovating most of its existing housing inventory by 
2007, even though some of this housing may not be needed after 
community housing becomes more affordable for military families. 
Further, if increased allowances result in servicemembers' reduced use 
of privatized housing located on base, surplus housing could be rented 
to civilians, thereby raising concerns about civilians living on 
military installations. 

Differences in Housing Standards Inflate Demand for Military Family 
Housing: 

The difference in DOD's housing standards for servicemembers living in 
government-owned or privatized housing and for those living in 
community housing inflates the demand for military family housing. DOD 
considers family size when determining military housing requirements 
and assigning servicemembers to government housing, but ignores family 
size when determining housing allowances for servicemembers living in 
local communities. As a result, many servicemembers are entitled to a 
larger residence in government or privatized housing than they are 
able to afford in the local community. 

DOD's current standards for community housing were determined in 1998, 
when it developed a new method for establishing housing allowances. 
Under this method, servicemembers' housing allowances are based on the 
costs of housing typically occupied by civilians with comparable 
incomes. To determine allowances, DOD identified six housing 
standards, ranging from a one-bedroom apartment to a four-bedroom 
single-family detached house. DOD then associated, or anchored, those 
standards to each military rank, or pay grade, matching them to the 
type of housing normally occupied by civilians with comparable 
incomes. The housing allowances do not vary by family size. For 
example, the housing allowance for a married servicemember in a lower 
enlisted pay grade is roughly equivalent to the cost of renting a two-
bedroom apartment or a two-bedroom townhouse in the local community. 
The allowance is the same regardless of the number of people in the 
servicemember's family. 

In contrast, DOD standards for servicemembers living in government or 
privatized housing consider family size and often provide for larger 
housing units. First, the services do not have typical apartment units 
on-base. Government housing units normally consist of townhouses, 
duplexes, and single-family units. Second, the services generally 
assign servicemembers with more dependents to housing units with more 
bedrooms. For example, a married junior enlisted member in pay grade
E-4 with two children typically would be assigned to a three-bedroom 
townhouse or single-family detached house. However, if this same 
servicemember lived in community housing, the housing allowance would 
only cover the cost of a typical two-bedroom apartment or townhouse. 

The disparity in housing standards creates an incentive for
servicemembers in lower pay grades and with larger families to seek 
government housing. This is because the servicemember can secure a 
larger home for his or her family in government or privatized housing 
without having to pay any out-of-pocket costs, as the servicemember 
would be required to do to secure comparable housing in the community.
This situation creates demand for government housing that might not 
exist were it not for this incentive. The standards disparity can also 
result in increased government housing requirements because the 
services' housing market analyses consider family size, and, as a 
result, fewer housing units in the local community are considered 
affordable. Eliminating the standards disparity could result in 
reduced demand for government housing and increased reliance on local 
community housing. For example, if housing allowances for junior 
personnel increased with family size, more community housing with 
three or more bedrooms would become affordable. Thus far, DOD has not 
studied the benefits and costs of options to address the standards 
disparity. 

Key Financial Goals Generally Achieved: 

DOD has generally achieved two key financial goalsï¿½leveraging of 
government funds and lower life-cycle costsï¿½for the privatization 
program. DOD exceeded its overall goal for leveraging government funds 
with private-sector financing in the first 10 privatization projects, 
based on Office of Management and Budget's guidance. However, it is 
not clear whether DOD will achieve its goal that each project's life-
cycle costs be the same or less than the military construction 
alternative. Although use of DOD's guidance for performing life-cycle 
cost analyses shows that each of the first 10 privatization projects 
most likely will cost less than an equivalent military construction 
project, use of the guidance causes some uncertainty in the accuracy 
of these estimates. Furthermore, project leveraging ratio calculations 
and estimated life-cycle costs do not include the value of some 
government contributions to privatization projects because certain 
contributions are not required to be included in these analyses. Thus, 
the value of many DOD contributions to privatization projects was not 
apparent during our review of these program assessment tools. 

Most Projects Exceed Goal for Leveraging Government Funds, Based on 
the Office of Management and Budget's Guidance: 

According to DOD, a key advantage of privatization is the ability to 
leverage available government funds with private-sector financing to 
improve military housing faster than would otherwise be possible. DOD 
incurs certain costs to secure each privatization project, such as 
making cash contributions, loans, or loan guarantees. DOD's goal is 
for each project to result in at least three times as much housing 
improvement as government funds alone would have produced. In 
leveraging government funds by a minimum ratio of 3 to 1, DOD 
officials state that the military can revitalize three times as many 
housing units as it could with a military construction project for the 
same initial amount of money, thus solving the housing problem three 
times faster. 

The leveraging ratio is calculated by dividing the estimated cost of 
an equivalent military construction project by the privatization 
project's budgetary scored amountï¿½defined as the amount of 
appropriated funds the Office of Management and Budget determines 
should be recorded as an obligation at contract award. As shown in 
table 1, all but 1 (Everett) of the first 10 privatization projects 
exceeded DOD's 3-to-1 leveraging goal, based on Office of Management 
and Budget's guidance. In aggregate, by investing about $185 million 
in the 10 projects, DOD should obtain housing improvements that would 
have required about $1.19 billion in military construction funds had 
only government funds been used. This is a leveraging ratio of 6.4 to 
1. As discussed in appendix I, the Congressional Budget Office 
estimated higher budgetary scoring amounts than the Office of 
Management and Budget, which would have affected whether the projects 
would have achieved the leveraging goal. 

Table 1: Leveraging Ratios for the First 10 Projects: 

Project: Fort Carson; 
Military construction alternative cost: $196.9 million; 
Budgetary scored amount: $10.2 million; 
Leveraging ratio: 19.3. 

Project: Fort Hood; 
Military construction alternative cost: $273.5 million; 
Budgetary scored amount: $52.0 million; 
Leveraging ratio: 5.3. 

Project: Lackland; 
Military construction alternative cost: $50.0 million; 
Budgetary scored amount: $6.2 million; 
Leveraging ratio: 8.1. 

Project: Robins; 
Military construction alternative cost: $50.1 million; 
Budgetary scored amount: $12.6 million; 
Leveraging ratio: 4.0. 

Project: Dyess; 
Military construction alternative cost: $50.3 million; 
Budgetary scored amount: $16.3 million; 
Leveraging ratio: 3.1. 

Project: Elmendorf; 
Military construction alternative cost: $135.3 million; 
Budgetary scored amount: $23.4 million; 
Leveraging ratio: 5.8. 

Project: Kingsville; 
Military construction alternative cost: $20.4 million; 
Budgetary scored amount: $6.2 million; 
Leveraging ratio: 3.3. 

Project: Everett; 
Military construction alternative cost: $47.8 million; 
Budgetary scored amount: $17.5 million; 
Leveraging ratio: 2.7. 

Project: Camp Pendleton; 
Military construction alternative cost: $87.3 million; 
Budgetary scored amount: $19.4 million; 
Leveraging ratio: 4.5. 

Project: San Diego; 
Military construction alternative cost: $274.5 million; 
Budgetary scored amount: $20.9 million; 
Leveraging ratio: 13.1. 

Project: Total; 
Military construction alternative cost: $1.186 billion; 
Budgetary scored amount: $184.7 million; 
Leveraging ratio: 6.4. 

Source: GAO analysis of DOD cost data. 

[End of table] 

The overall average leveraging ratio of 6.4 achieved in the first 10 
projects would have been closer to 3.9 had the budgetary scored 
amounts included the government's costs to pay utilities for military 
families occupying privatized housing at DOD's first two projects, at 
Fort Carson and at Lackland Air Force Base. Normally, the Office of 
Management and Budget would have included the government's estimated 
utility costs over the life of the 50-year contracts as part of each 
project's budgetary scored amount. However, the Office allowed an 
exception for these projects because the budget scoring rules for the 
privatization program were not finalized at the time the projects were 
awarded. Had utility costs been included in the budgetary scored 
amounts, neither project would have met the 3-to-1 leveraging goal. 
Specifically, Fort Carson's leveraging ratio would have been 1.7 
instead of 19.3 and Lackland's ratio would have been 2.5 instead of 
8.1.[Footnote 13] With these ratios, however, DOD might not have 
approved the projects. 

Results from Life-Cycle Costs Analyses Are Uncertain: 

According to DOD, although the amount of government funds needed to 
initiate housing projects under the privatization option can be 
substantially less than needed under the military construction option, 
the government's long-term total costs for the projects will not 
necessarily be less under privatization because annual costs differ 
under each option. The services prepare life-cycle cost analyses to 
estimate and compare the government's long-term costs for proposed 
projects financed through privatization and through military 
construction. They then use the results to help decide whether 
proposed privatization projects should be approved. Because life-cycle 
cost analyses use numerous assumptions and estimates, actual costs 
from implemented privatization projects will vary from the results of 
the analyses. Nevertheless, the analyses are an important tool to 
evaluate the merits of proposed projects. 

We used two methods to estimate and compare the life-cycle costs for 
the first 10 privatization projects with the military construction 
alternative. First, we computed the life-cycle costs for each project 
using DOD's February 2002 guidance. Then, we recomputed these costs, 
deviating from DOD's guidance to include contract oversight costs in 
the privatization estimates and apply an alternative method for 
determining operations and maintenance costs in the military 
construction estimates. We deviated from the guidance on these two 
points to compensate for two areas where use of the guidance can make 
the privatization option appear more favorable than justified. 

Life-Cycle Cost Analysis Based on DOD Guidance: 

The February 2002 DOD guidance lists the assumptions and types of 
costs that the services are to use in performing the analyses. For 
example, among the costs to be included in the analysis of the 
privatization option are cost estimates for project planning, housing 
allowances, and the budgetary scored amount. These costs are to be 
offset by any expected project monetary returns to the government. 
Among the costs to be included in the analysis of the military 
construction option are cost estimates for initial construction, out-
year revitalization, and annual operation and maintenance costs. 

Using this guidance, and considering current DOD cost information such 
as the increased housing allowances resulting from the allowance 
initiative, we estimated that each of the 10 projects will most likely 
cost less than the military construction alternative. The cost 
differences averaged about 17 percent and ranged from 2 percent in the 
San Diego project to 42 percent in the Kingsville project. 

The services had previously estimated that each privatization project 
would cost from 6 to 27 percent less than the military construction 
alternative (see appendix V for details). However, our estimates 
differed from the services' estimates for several reasons. First, our 
analyses use current cost estimates, whereas the services used cost 
estimates available when they prepared their analyses months or years 
prior to project approval. Second, our analyses considered the 
increased costs of privatization resulting from the housing allowance 
initiative, which increases allowances by about 19 percent between 
2000 and 2005. Because allowances are used by servicemembers to pay 
rent for privatized housing, the initiative will significantly 
increase privatization costs over the long terms of the projects. Only 
three of the services' analyses had considered the impact of the 
allowance initiative. Third, the services' analyses did not use DOD's 
guidance, because it was not issued until February 2002. As a result, 
the services' analyses were inconsistently prepared, and many did not 
include all relevant costs. 

Life-Cycle Cost Analysis Based on Modified Assumptions: 

We recomputed the life-cycle costs of the 10 privatized projects after 
making two adjustments to DOD's guidance. First, we included costs 
that will be incurred to oversee the project contracts in the 
privatization estimates. Second, we used an alternative method to 
determine operation and maintenance costs in the military construction 
estimates. The alternative method used conventional apartment dataï¿½-
instead of federally assisted apartment data as called for in the 
guidance-ï¿½and excluded the cost of real estate taxes from the data. 
Based on these two adjustments, we estimated that privatization will 
likely cost less than military construction in seven of the projects 
and cost more in the other three projects (Lackland, Elmendorf, and 
San Diego), as shown in table 2. 

Table 2: GAO Alternative Life-Cycle Costs Estimates for the First 10 
Projects: 

Project: Fort Carson; 
Privatization option: $895 million; 
Military construction option: $929 million; 
Difference: -$34 million; 
Percentage difference: -4%. 

Project: Fort Hood; 
Privatization option: $1.638 billion; 
Military construction option: $1.970 billion; 
Difference: -$332 million; 
Percentage difference: -17%. 

Project: Lackland; 
Privatization option: $130 million; 
Military construction option: $127 million; 
Difference: $3 million; 
Percentage difference: 2%. 

Project: Robins; 
Privatization option: $151 million; 
Military construction option: $189 million; 
Difference: -$38 million; 
Percentage difference: -20%. 

Project: Dyess; 
Privatization option: $87 million; 
Military construction option: $105 million; 
Difference: -$18 million; 
Percentage difference: -17%. 

Project: Elmendorf; 
Privatization option: $376 million; 
Military construction option: $354 million; 
Difference: $22 million; 
Percentage difference: 6%. 

Project: Kingsville; 
Privatization option: $30 million; 
Military construction option: $40 million; 
Difference: -$10 million; 
Percentage difference: -25%. 

Project: Everett; 
Privatization option: $86 million; 
Military construction option: $91 million; 
Difference: -$5 million; 
Percentage difference: -5%. 

Project: Camp Pendleton; 
Privatization option: $207 million; 
Military construction option: $227 million; 
Difference: -$20 million; 
Percentage difference: -9%. 

Project: San Diego; 
Privatization option: $1.289 billion; 
Military construction option: $1.094 billion; 
Difference: $195 million; 
Percentage difference: 18%. 

Project: Total; 
Privatization option: $4.889 billion; 
Military construction option: $5.126 billion; 
Difference: -$237 million; 
Percentage difference: -5%. 

Note: Life-cycle cost analyses estimate all costsï¿½including future 
costsï¿½in current dollars to consider the time value of money. 

Source: GAO analysis of DOD cost data. 

[End of table] 

We believe that this recomputation is a more accurate reflection of 
relative costs. First, costs will be incurred to monitor contract 
implementation and developer performance adequately, and the services 
are already paying consultants to help with this oversight Yet, DOD's 
guidance does not specifically require that such costs be included as 
a cost of the privatization option. Second, for simplicity and 
consistency in estimating operations and maintenance costs for the 
military construction option, the guidance directs the services to use 
operations and maintenance data for federally assisted apartments 
published annually by the Institute for Real Estate Management. The 
institute also publishes this data for conventional apartments. We did 
not determine whether use of institute data is the best method for 
estimating military construction operations and maintenance costs, and 
DOD provided little support to show that use of this data was the best 
choice. We also did not evaluate the relative merits of using these 
two respective data sets. However, incomes of most military families 
may be more like those of civilian families renting conventional 
apartments than those of families in federally assisted apartments; 
consequently, we used the conventional apartment data. Further, the 
institute's data includes expenses for real estate taxes normally paid 
by private-sector developers but which would not be paid under the 
military construction alternative. Using this data without making an 
adjustment for real estate taxes increases the cost of the military 
construction alternative inappropriately and makes the privatization 
option appear more favorable than it should. On the other hand, DOD 
officials pointed out that the guidance also excludes other costs, 
such as capital repair and replacement costs, from the military 
construction option. Excluding these costs from an analysis makes the 
military construction option appear more favorable than justified. 

The bottom line is that the many assumptions and uncertainties in the 
estimates used to determine life-cycle costs make it difficult to 
achieve reliable estimates of costs over the terms of the contracts. 
Thus, complete and precise guidance for performing these analyses 
would increase the likelihood that the analyses contribute to informed 
decisions about future privatization proposals. In cases where 
military construction appears to be the less costly alternative, 
privatization may still be DOD's preferred option because, according 
to defense officials, annual military construction funding would need 
to increase substantially over current levels-ï¿½and beyond what 
Congress might consider acceptableï¿½-to finance an equivalent number of 
housing units. 

Some DOD Contributions to Projects Are Not Included in Financial 
Analyses: 

Although DOD often conveys existing government-owned housing to 
privatization developers and leases or conveys government land to the 
developers at no cost, the value of these contributions is not 
included in most financial analyses for the privatization projects. 
DOD is permitted to convey or lease existing property and facilities 
to developers as part of the agreements to obtain improved housing. 
Because such conveyances or leases do not require government 
expenditures and do not affect the federal budget, there is no 
requirement that the value of property conveyed or leased be included 
in project budgetary scored amounts, leveraging ratio calculations, or 
life-cycle cost analyses. 

DOD made conveyances of housing and land that were not included in the 
scored amounts of 7 of the first 10 projects, as shown in table 3. For 
5 of the projects, DOD also leased land to developers at no cost over 
the contract terms but did not estimate the value of the leases. 

Table 3: DOD Property Conveyances Not Included in Budget Scored 
Amounts: 

Project: Fort Carson; 
Number of housing units conveyed: 1,823; 
Acres of land conveyed: 0; 
DOD estimate of conveyance value: $69.7 million. 

Project: Fort Hood; 
Number of housing units conveyed: 5,622; 
Acres of land conveyed: 0; 
DOD estimate of conveyance value: $53.3 million. 

Project: Robins; 
Number of housing units conveyed: 670; 
Acres of land conveyed: 270; 
DOD estimate of conveyance value: $6.5 million. 

Project: Elmendorf; 
Number of housing units conveyed: 584; 
Acres of land conveyed: 0; 
DOD estimate of conveyance value: $38.0 million. 

Project: Kingsville; 
Number of housing units conveyed: 244; 
Acres of land conveyed: 30; 
DOD estimate of conveyance value: $0.3 million. 

Project: Camp Pendleton; 
Number of housing units conveyed: 512; 
Acres of land conveyed: 0; 
DOD estimate of conveyance value: $7.6 million. 

Project: San Diego; 
Number of housing units conveyed: 2,660; 
Acres of land conveyed: 0; 
DOD estimate of conveyance value: $97.1 million. 

Project: Total; 
Number of housing units conveyed: 12,115; 
Acres of land conveyed: 300; 
DOD estimate of conveyance value: $272.5 million. 

Source: GAO analysis of DOD data. 

[End of figure] 

DOD officials stated that its contribution to a privatization project, 
whether included in the project's scored amount or not, is a key 
ingredient that makes the project financially feasible for private-
sector developers. Also, most of the housing units conveyed were the 
inadequate units that the developers will replace or renovate. Our 
point is only to note that the value of many DOD contributions to 
privatization projects is not apparent from a review of the normal 
financial tools used to assess the program. Also, DOD's valuation of 
some contributions is subject to question. For example, the Navy 
estimated that the value of its conveyance of 244 housing units and 30 
acres of land was $300,000 in the Kingsville project. Navy officials 
stated that the estimate only included the value of the land, because 
the conveyed housing was old, dilapidated, and not up to current 
codes. Yet, the developer has recently begun placing newspaper 
advertisements offering the housing for rent starting at $600 monthly 
for each unit. 

Privatization Program Includes Government Safeguards, but Improvements 
Are Possible: 

DOD has required the private sector to bear most of the financial 
risks in the first 10 privatization projects and has designed 
privatization contracts to help protect the government's interests. 
During our visits to Fort Carson, Lackland Air Force Base, and 
Kingsville Naval Air Station, we discussed project implementation 
results with local officials. In each case, the officials stated that 
implementation was proceeding on or ahead of schedule, the quality of 
the housing improvements exceeded expectations, and the developers 
added some upgrades to units at no cost to the government. The 
officials stated that military families occupying privatized units 
were very satisfied with the developers' operation and maintenance of 
the housing, and this was supported by our observations. The officials 
added that they knew of no examples of poor developer performance, 
although contract provisions were available to deal with poor 
performance, if needed. Still, we found DOD could further enhance 
protections to the government with contract provisions for 
unanticipated events, required oversight of future project 
reinvestment decisions, guidance for contractual assumptions and fees 
paid to developers, and improvements to the privatization program 
evaluation report. 

Private Sector Bears Most Financial Risks: 

Private sector equity and loans provided $1.03 billion, or 82 percent, 
of the $1.26 billion in initial development costs for the first 10 
privatization projects, as shown in table 4. DOD's cash and loans 
provided the remaining $231 million, or 18 percent. DOD's 
contributions in cash and loans to the individual projects ranged from 
zero percent at Fort Carson to 79 percent at Dyess Air Force Base, 
where DOD provided the first mortgage loan. 

Table 4: DOD and Private Sector Contributions to Project Development 
Costs: 

Project: Fort Carson; 
Private equity and loans: Amount: $228.6 million; 
Private equity and loans: Percentage of total: 100%; 
DOD cash and loans: Amount: 0; 
DOD cash and loans: Percentage of total: 0; 
Total project development cost: $228.6 million. 

Project: Fort Hood; 
Private equity and loans: Amount: $223.3 million; 
Private equity and loans: Percentage of total: 81%; 
DOD cash and loans: Amount: $52.0 million; 
DOD cash and loans: Percentage of total: 19%; 
Total project development cost: $275.3 million. 

Project: Lackland; 
Private equity and loans: Amount: $31.3 million; 
Private equity and loans: Percentage of total: 75%; 
DOD cash and loans: Amount: $10.6 million; 
DOD cash and loans: Percentage of total: 25%; 
Total project development cost: $41.9 million. 

Project: Robins; 
Private equity and loans: Amount: $34.2 million; 
Private equity and loans: Percentage of total: 61%; 
DOD cash and loans: Amount: $22.3 million; 
DOD cash and loans: Percentage of total: 39%; 
Total project development cost: $56.5 million. 

Project: Dyess; 
Private equity and loans: Amount: $7.5 million; 
Private equity and loans: Percentage of total: 21%; 
DOD cash and loans: Amount: $28.9 million; 
DOD cash and loans: Percentage of total: 79%; 
Total project development cost: $36.4 million. 

Project: Elmendorf; 
Private equity and loans: Amount: $61.9 million; 
Private equity and loans: Percentage of total: 56%; 
DOD cash and loans: Amount: $48.0 million; 
DOD cash and loans: Percentage of total: 44%; 
Total project development cost: $109.9 million. 

Project: Kingsville; 
Private equity and loans: Amount: $7.8 million; 
Private equity and loans: Percentage of total: 54%; 
DOD cash and loans: Amount: $6.7 million; 
DOD cash and loans: Percentage of total: 46%; 
Total project development cost: $14.5 million. 

Project: Everett; 
Private equity and loans: Amount: $30.1 million; 
Private equity and loans: Percentage of total: 71%; 
DOD cash and loans: Amount: $12.2 million; 
DOD cash and loans: Percentage of total: 29%; 
Total project development cost: $42.3 million. 

Project: Camp Pendleton; 
Private equity and loans: Amount: $53.9 million; 
Private equity and loans: Percentage of total: 65%; 
DOD cash and loans: Amount: $29.4 million; 
DOD cash and loans: Percentage of total: 35%; 
Total project development cost: $83.3 million. 

Project: San Diego; 
Private equity and loans: Amount: $346.6 million; 
Private equity and loans: Percentage of total: 94%; 
DOD cash and loans: Amount: $20.9 million; 
DOD cash and loans: Percentage of total: 6%; 
Total project development cost: $367.5 million. 

Project: Total; 
Private equity and loans: Amount: $1,025.2 million; 
Private equity and loans: Percentage of total: 82%; 
DOD cash and loans: Amount: $231.0 million; 
DOD cash and loans: Percentage of total: 18%; 
Total project development cost: $1.256 billion. 

Source: GAO analysis of DOD data. 

[End of table] 

The government's total financial exposure in the first 10 projects is 
greater than its $231 million contribution in cash and loans. This is 
because in 4 of the projects--Fort Carson and Lackland, Robins, and 
Elmendorf Air Force Bases--DOD provided loan guarantees to private 
lenders in the event of project financial failure caused by base 
closure, downsizing, or significant deployment.[Footnote 14] According 
to DOD officials, loan guarantees are provided in some cases to 
improve the availability of private-sector financing or obtain a lower 
interest rate. Thus, with the guarantees, the government's total 
financial exposure would be significantly higher in a worst-case 
scenario where (1) these four bases closed and the developers 
defaulted on their loans and (2) the remaining six projects failed 
financially, leaving the government unable to recover its cash 
contributions and not receive repayment for its loans. In such a case, 
the government's maximum financial exposure would be about $481 
million for all 10 projects, or about 38 percent of the total 
development costs for the projects (see table 5). 

Table 5: Government Financial Exposure in the First 10 Projects 

Project: Fort Carson 
Total project development: $228.6 million; 
Government financial exposure: 
Cash and loans: 0; 
Loan guarantee: $147.0 million; 
Total: $147.0 million. 

Project: Fort Hood 
Total project development: $275.3 million; 
Government financial exposure: 
Cash and loans: $52.0 million; 
Loan guarantee: 0; 
Total: $52.0 million. 

Project: Lackland 
Total project development: $41.9 million; 
Government financial exposure: 
Cash and loans: $10.6 million; 
Loan guarantee: $29.4 million; 
Total: $40.0 million. 

Project: Robins 
Total project development: $56.5 million; 
Government financial exposure: 
Cash and loans: $22.3 million; 
Loan guarantee: $25.6 million; 
Total: $47.9 million. 

Project: Dyess 
Total project development: $36.4 million; 
Government financial exposure: 
Cash and loans: $28.9 million; 
Loan guarantee: 0; 
Total: $28.9 million. 

Project: Elmendorf 
Total project development: $109.9 million; 
Government financial exposure: 
Cash and loans: $48.0 million; 
Loan guarantee: $48.0 million; 
Total: $96.0 million. 

Project: Kingsville 
Total project development: $14.5 million; 
Government financial exposure: 
Cash and loans: $6.7 million; 
Loan guarantee: 0; 
Total: $6.7 million. 

Project: Everett 
Total project development: $42.3 million; 
Government financial exposure: 
Cash and loans: $12.2 million; 
Loan guarantee: 0; 
Total: $12.2 million. 

Project: Camp Pendleton 
Total project development: $83.3 million; 
Government financial exposure: 
Cash and loans: $29.4 million; 
Loan guarantee: 0; 
Total: $29.4 million. 

Project: San Diego 
Total project development: $367.5 million; 
Government financial exposure: 
Cash and loans: $20.9 million; 
Loan guarantee: 0; 
Total: $20.9 million. 

Project: Total 
Total project development: $1,256 billion; 
Government financial exposure: 
Cash and loans: $231.0 million; 
Loan guarantee: $250.0 million; 
Total: $481.0 million. 

Source: GAO analysis of DOD data. 

[End of table] 

Some Contracts Did Not Adequately Provide for Unanticipated Increases 
in Project Revenue: 

Because privatization contracts cover long periods of time--often 50 
years--contract provisions cannot be written for every event that 
could affect the operations or financial performance of the projects. 
Yet contracts without provisions for unanticipated events that 
significantly change planned project revenues and expenses can result 
in unanticipated profits or losses to the developers. Although the 
privatization program is relatively new, DOD has already experienced 
the impact of one such event--implementation of the housing allowance 
initiative. 

DOD's initial contracts did not include adequate provisions to 
minimize potential unanticipated profits accruing to developers from 
unanticipated revenue increases. As a result, for some projects, the 
increased rental revenue from the allowance initiative will flow in 
part or in total to the developers in the form of extra profits and 
fees. For example, in 1998, when the Lackland Air Force Base project 
was awarded, few would have anticipated an initiative to increase 
housing allowances by 19 percent to eliminate out-of-pocket costs. The 
Lackland project did not include a provision to capture unexpected 
revenue increases or to compensate the developer for any revenue 
decreases. As a result, all extra rental revenue resulting from the 
allowance initiative will flow to the developer. We estimated that the 
allowance initiative will increase Lackland's rental revenues by 
approximately $64 million over the contract term, all of which will go 
to developer profits or fees. 

The contracts for 7 of the first 10 privatization projects did not 
consider the increased rental revenue that will result from the 
housing allowance initiative. For these projects, table 6 shows the 
extra rental revenue expected from the allowance initiative and the 
amount of this extra revenue projected to go to the developers in 
profits and fees. 

Table 6: Projected Extra Rental Revenues, Profits, and Fees Resulting 
from the Housing Allowance Initiative: 

Project: Fort Carson; 
Extra rental revenue: $317.2 million; 
Developer's portion of extra rental revenue: 
Extra profit: $51.9 million; 
Extra fees: $12.7 million; 
Total extra profit and fees: $64.6 million; 
Percentage of extra rental revenues: 20.4%. 

Project: Fort Hood; 
Extra rental revenue: $516.4 million; 
Developer's portion of extra rental revenue: 
Extra profit: $5.1 million; 
Extra fees: $20.7 million; 
Total extra profit and fees: $25.8 million; 
Percentage of extra rental revenues: 5.0%. 

Project: Lackland; 
Extra rental revenue: $63.9 million; 
Developer's portion of extra rental revenue: 
Extra profit: $62.0 million; 
Extra fees: $1.9 million; 
Total extra profit and fees: $63.9 million; 
Percentage of extra rental revenues: 100.0%. 

Project: Robins; 
Extra rental revenue: $52.0 million; 
Developer's portion of extra rental revenue: 
Extra profit: $40.2 million; 
Extra fees: $1.7 million; 
Total extra profit and fees: $41.9 million; 
Percentage of extra rental revenues: 80.6%. 

Project: Elmendorf; 
Extra rental revenue: $168.9 million; 
Developer's portion of extra rental revenue: 
Extra profit: $73.1 million; 
Extra fees: $10.3 million; 
Total extra profit and fees: $83.4 million; 
Percentage of extra rental revenues: 49.4%. 

Project: Kingsville; 
Extra rental revenue: $7.0 million; 
Developer's portion of extra rental revenue: 
Extra profit: $4.4 million; 
Extra fees: $0.8 million; 
Total extra profit and fees: $5.2 million; 
Percentage of extra rental revenues: 73.4%. 

Project: Camp Pendleton; 
Extra rental revenue: $175.6 million; 
Developer's portion of extra rental revenue: 
Extra profit: $79.2 million; 
Extra fees: $5.3 million; 
Total extra profit and fees: $84.5 million; 
Percentage of extra rental revenues: 48.1%. 

Project: Total; 
Extra rental revenue: $1.301 billion; 
Developer's portion of extra rental revenue: 
Extra profit: $315.9 million; 
Extra fees: $53.4 million; 
Total extra profit and fees: $369.3 million; 
Percentage of extra rental revenues: 28.4%. 

Source: GAO analysis of DOD data. 

[End of table] 

Table 6 also shows that, on a cumulative basis, most of the additional 
rental revenue is not expected to go to the developers. This is 
because, except for Lackland, the projects included contract 
provisions designed to capture at least a portion of any unanticipated 
rental revenues that exceeded project expenses and expected developer 
profits. Controlled by contract provisions, the captured funds will 
accumulate into project reinvestment accounts and can be used to pay 
for future renovations, improvements, and amenities for the projects 
during their contract terms. In accordance with the contract 
provisions of some projects, such as Fort Hood, relatively little of 
any unanticipated revenue increases or expense reductions is expected 
to go the developers. DOD officials stated that DOD expects that all 
future project contracts will include reinvestment account provisions 
to capture a portion of extra revenues or reduced expenses. However, 
DOD has not issued guidance requiring this or providing parameters for 
establishing the amounts needed in the reinvestment accounts to meet 
future project needs. 

Required Oversight of Reinvestment Decisions Appears Limited: 

Projects with reinvestment accounts normally include contract 
provisions stating that the accumulated funds can only be used to 
benefit the project and that service officials and the developer 
decide how to spend the funds. Generally, rental revenue funds flow 
into the reinvestment account in accordance with the contract 
provisions after payment of normal project expenses and developer 
profits. Reinvestment funds are supposed to be used to pay for future 
renovations and major improvements. Large sums are expected to be 
deposited into the reinvestment accounts of some projects, 
particularly with the increases caused by the housing allowance 
initiative. For the first 10 projects, we estimate that about $3.9 
billion will be deposited to the reinvestment accounts over the terms 
of the contracts (see figure 1). 

Figure 1: Projected Cumulative Amounts Available for Reinvestment in 
the Projects: 

Project: Fort Carson; 
Amount Available for Reinvestment: $957 million; 

Project: Fort Hood; 
Amount Available for Reinvestment: $1.268 billion. 

Project: Lackland;
Amount Available for Reinvestment: $9 million; 

Project: Dyess; 
Amount Available for Reinvestment: $12 million; 

Project: Robins; 
Amount Available for Reinvestment: $10 million; 

Project: Elmendorf; 
Amount Available for Reinvestment: $223 million; 

Project: Kingsville; 
Amount Available for Reinvestment: $3 million; 

Project: Everett; 
Amount Available for Reinvestment: $27 million; 

Project: Camp Pendleton; 
Amount Available for Reinvestment: $233 million; 

Project: San Diego; 
Amount Available for Reinvestment: $1.18 billion. 

Note: Amounts shown do not include reserves for routine project 
maintenance. 

Source: GAO analysis of DOD data. 

[End of figure] 

Normally, military installation officials and project developers make 
joint decisions on how to spend money from the reinvestment accounts. 
Fort Carson officials stated that they will work with the developer to 
make these decisions on their project. Navy officials stated that they 
are usually partners with the developer in their projects, and, as 
such, will participate in decisions to spend reinvestment money. 
According to service officials, amounts remaining in the reinvestment 
accounts at the end of the contracts will, as a rule, be returned to 
DOD and be available to help finance other privatization projects. 
However, it is questionable how much money might actually revert to 
DOD, since incentives exist for local service officials and developers 
to spend all funds accumulated in the reinvestment accounts. For 
example, local officials want the privatized housing to offer the 
highest possible quality of life to military families occupying the 
housing. They also know that funds not spent by the end of the 
contract will revert to DOD and be unavailable for use in the project. 
Developers also want to provide the best housing possible so that 
military families will continue to choose to live in the housing. 
Also, the developers can benefit from decisions for additional 
construction or renovations and earn additional fees and profits when 
they perform the work. 

For these reasons, required oversight of major reinvestment spending 
decisions is important to add assurance that the decisions are 
appropriate. For example, inadequate oversight could result in 
decisions to use reinvestment funds to add improvements and amenities 
to privatized housing to the point that the housing exceeds typical 
community housing standards. Contrary to encouraging servicemembers to 
live in local communities, this could result in creating artificial 
demand for the privatized housing because servicemembers could not 
secure the same housing in the local community without paying out-of-
pocket amounts. Further, inadequate oversight could result in using 
reinvestment funds to construct housing units beyond the number 
approved in the original project scope without following the normal 
justification and review process. Yet oversight procedures for major 
reinvestment decisions have not been clearly defined, and there is no 
requirement that service headquarters and the Office of the Secretary 
of Defense review and approve expenditures. 

Widely Varied Contractual Assumptions and Fees Can Affect DOD Costs: 

Contractual assumptions and fees can affect DOD's privatization costs, 
and thus it is important that the services have guidance to help 
establish appropriate assumptions and fees. Although several 
nationally recognized organizations publish private-sector data that 
could be used to help establish suitable benchmarks, DOD has not 
provided such guidance for the services' use. During our review of the 
first 10 privatization projects, we found wide variation in some 
assumptions used to estimate project revenues and expenses, expected 
developer internal rates of return, and the types and ranges of 
project fees charged. 

Developers make certain assumptions-ï¿½such as the expected vacancy rate 
in privatized housing and allowances for unpaid rents-ï¿½to estimate 
project revenues and expenses. The accuracy of these assumptions is 
important because they affect the estimated amount of project revenue 
that will be available for expenses, profits, and reinvestment 
accounts. Yet the vacancy rate assumptions for the first 10 projects 
varied from 2 to 5 percent, and only one project included an 
assumption for unpaid rents--1 percent. 

Another area of concern is related to the expected internal rate of 
return on the developer's equity in the project. A developer's 
expected internal rate of return is known at the time of contract 
award because privatization contracts include forecasts of expected 
project revenue, expenses, and profits. The actual internal rate of 
return will vary depending on the performance of the project and the 
effects of any unanticipated changes in revenue and expenses. DOD 
officials stated that the normal internal rate of return for similar 
housing projects in the private sector ranges from 12 to 14 percent. 
For the first 10 projects, the expected internal rate of return at 
contract award varied from 1.6 to 16.7 percent. However, the increased 
rental revenue resulting from the housing allowance initiative has 
increased the expected internal rate of return for 7 of these 
projects. Considering the impact of the allowance initiative and the 
terms of the individual contracts, and assuming no other changes in 
expected revenue and expenses, we estimate that the developer's 
internal rates of return will actually range from 3.3 to 25.7 percent. 

Finally, most contracts included fees to be paid to the developers 
during operation of the privatized housing over the contract terms. 
For example, all contracts included a property management fee, which 
is designed to pay for the daily management and oversight of the 
housing project. The fee is normally assessed as a percentage of 
rental revenues. In the first 10 projects, this fee varied from 2.5 to 
5.1 percent. Because revenues are significant in some cases, a 
difference of just 1 percent can result in increasing the property 
management fee by over $400,000 each year. In 4 of the 10 projects, 
the services also included a property management incentive fee to be 
paid on the basis of specified criteria. This incentive fee ranged 
from 1.0 to 2.0 percent. In 2 of the 10 projects, the services 
included payment of an asset management fee. This fee covers services 
to monitor and oversee financial aspects of the projects, and, 
according to a national association representing large multi-family 
housing owners, the fee normally ranges from 2 to 3 percent. However, 
for one project, the fee was 4.5 percent of net operating income, and 
for another project the fee was 60 percent of net cash flow up to a 
maximum of $80,000 annually (averaging about 10 percent of net 
operating income over the contract term). 

Program Evaluation Report Has Not Met Its Potential: 

In our March 2000 report on the privatization program, we noted that 
DOD had not developed an evaluation plan to consistently measure the 
progress and effectiveness of the program from project identification 
through the end of each contract.[Footnote 15] We recommended 
development of an evaluation plan that would be used by all services, 
include performance measures to help officials determine whether the 
program is meeting goals, provide a means to evaluate the merits of 
the individual authorities, compare the estimated and actual costs of 
each project, assess key aspects of developer performance, collect 
statistics on the use of the housing, and assess servicemembers' 
satisfaction with the housing. 

DOD agreed with our recommendation, and on January 10, 2001, issued 
final reporting requirements for a new privatization program 
evaluation report. The services are required to summarize and report 
semi-annually on many financial and management aspects of each awarded 
project, and DOD officials have stated that the report will be used to 
oversee the program's implementation and overall financial management. 
Although the report is an extensive and potentially useful tool for 
monitoring and evaluating program implementation, the value of the 
report has been limited because (1) the report has not been completed 
in a timely mannerï¿½-the report for the period ending June 30, 2001, 
was due by September 15, but was not completed until February 2002; 
(2) the report does not include information on funds accumulated in 
project reinvestment accounts; and (3) key elements of the report are 
not subjected to periodic independent verification to check accuracy. 
As a result, the report has not been as useful to decisionmakers as 
originally envisioned in helping to evaluate program effectiveness, 
address questions and concerns, and identify whether program 
modifications are needed. 

Conclusions: 

DOD appears to be positioned to significantly increase its use of 
privatization to eliminate inadequate military family housing over the 
next several years. Yet, because of inconsistent housing needs 
assessments, significant uncertainty exists in both the number and 
location of housing units that will be required in the future. This 
could lead DOD to enter into long-term contracts for privatized 
housing, some of which might not have been needed in areas where local 
communities might have provided housing at lower costs. Also, although 
DOD's stated policy is to rely on community housing to the extent 
possible, officials have acknowledged that the disparity in on-base 
and off-base housing standards creates an incentive for servicemembers 
in lower enlisted pay grades and with larger families to seek 
government housing rather than community housing. Further, increased 
housing allowances will result in increased life-cycle costs for 
privatization projects. As a result, the long-term savings from 
privatization may be less than estimated, although accurate estimates 
of life-cycle costs are hindered by use of DOD's guidance for 
performing the analyses. Improved DOD guidance for performing life-
cycle cost analysesï¿½-that is, including privatization contract 
oversight costs in the analyses and validating the types and sources 
of data used to estimate military construction operations and 
maintenance costsï¿½-would lead to more accurate analyses and better 
informed approval decisions on proposed privatization projects. 

Although privatization contracts have included provisions designed to 
protect the government's interests, contract provisions could be 
strengthened to better protect any extra revenues generated from 
unanticipated financial results. Without such provisions, developers 
stand to gain unanticipated profits from money that might more 
appropriately be channeled into reinvestment accounts for possible 
future project improvements. Furthermore, projects with reinvestment 
accounts have limited required oversight of spending decisions. Thus, 
DOD and the services' headquarters do not know precisely how the funds 
are used or whether spending decisions made at the installation level 
are appropriate. Inappropriate spending decisions could waste money 
and result in privatized housing with amenities far beyond typical 
community housing standards, leaving less money available to DOD to 
help finance other privatization projects. DOD's approval of 
expenditures over an established threshold would provide more control 
over such expenditures. Privatization contracts vary widely owing to a 
lack of guidance to establish appropriate contract revenue, expense, 
and reinvestment assumptions and project fees. Assumptions and fees 
outside of normal ranges may result in hundreds of thousands of 
dollars in extra payments to developers. Providing contract guidance 
for the services' use would establish a common framework for arriving 
at appropriate revenue and expense assumptions and project fees. 
Opportunities also exist to strengthen DOD's privatization program 
evaluation report. Currently, the value of the report as a tool for 
monitoring and evaluating program implementation is diminished because 
it is not being completed on time, it omits critical data, and its 
contents are not independently verified. 

Recommendations for Executive Action: 

We recommend that the Secretary of Defense direct the Deputy Under 
Secretary of Defense (Installations and Environment) to revise the 
department's housing requirements determination process to take into 
account greater use of community housing to fulfill needs and the 
projected impact that the housing allowance initiative might have on 
military installation housing requirements. As part of the effort to 
revise the department's process, the Deputy Under Secretary should 
also determine the effect of the difference in the department's 
housing standards for servicemembers living in government-owned or 
privatized housing and for those living in community housing on the 
requirement for military family housing. This should include 
identifying the benefits and costs derived from a program that would 
provide increased allowances based on the number of family members and 
determining the extent to which such a program could reduce 
requirements for government-owned or privatized housing. In addition, 
we recommend that the Secretary of Defense direct the Deputy Under 
Secretary of Defense (Installations and Environment) to take the 
following steps to improve implementation of the military housing 
privatization program: 

* improve the guidance for performing life-cycle cost analyses by 
requiring the inclusion of privatization contract oversight costs and 
validating the types and sources of data used to estimate military 
construction operations and maintenance costs; 

* require provisions in all future privatization contracts to direct 
the benefits from unanticipated increased revenues or reduced expenses 
to flow, in total or in part, into a project reinvestment account for 
possible future use in the project; 

* require service headquarters and the Office of the Secretary of 
Defense to review and approve privatization project reinvestment 
account expenditures over an established threshold; 

* provide guidelines to help establish appropriate privatization 
contract revenue, expense, and reinvestment assumptions and project 
fees; and; 

* improve the value of DOD's privatization program evaluation report 
by completing the report on time, including information on funds 
accumulated in project reinvestment accounts, and obtaining periodic 
independent verification of key report elements. 

Agency Comments: 

In commenting on a draft of this report, DOD generally agreed with the 
report's findings and recommendations and outlined ongoing or planned
and Our Evaluation management actions to address the concerns noted in 
the report. Although DOD believes that our report undervalues the 
strides the department has made thus far in the program, we believe 
the report accurately describes the progress made to date and the 
success it has achieved in meeting financial goals. In particular, DOD 
believes that the Everett project met the leveraging goal of 3.0 
rather than our calculated ratio of 2.7. The details of our respective 
calculations are contained in a note to DOD's comments (see appendix 
VI). 

DOD noted that it partially concurred with three of our recommendations.
First, in responding to our recommendation to improve the guidance for 
performing life-cycle cost analyses, DOD stated that existing guidance 
requires the services to include all costs for both the privatization 
and military construction alternatives. However, the guidance does not 
specify that privatization oversight costs should be included in the 
analysis. DOD stated that it would modify the guidance and also 
validate the data used to estimate operations and maintenance costs 
under the military construction alternative. We believe that the 
planned actions will meet the intent of our recommendation and improve 
the department's guidance for performing life-cycle cost analyses. 

Second, concerning our recommendation that the military services and the
Office of the Secretary of Defense review and approve privatization 
project reinvestment account expenditures over an established threshold,
DOD stated the services and the Office of the Secretary of Defense 
should have oversight of these expenditures but that only the services 
should review and approve specific project expenditures. We agree that 
the military service level is the appropriate review level for most 
project reinvestment spending decisions. However, in some cases, 
reinvestment decisions could involve substantial amounts, such as a 
decision to use reinvestment funds to construct housing units in 
addition to the number initially approved (follow-on projects). We 
continue to believe that major reinvestment expenditures over an 
appropriately determined threshold should be reviewed and approved by 
the Office of the Secretary of Defense and have retained our original 
recommendation. 

Third, in response to our recommendation that guidelines should be 
provided to help establish appropriate privatization contract 
assumptions and fees, DOD noted that the key to getting the best 
housing at the lowest cost is through competition among developers and 
that reliance on strict government guidelinesï¿½instead of the market's 
determination of risk and returnï¿½is not likely to create financially 
sound projects. We agree that competition is a key to successful 
privatization projects and that each project is unique. However, we 
believe that the services could benefit from guidelines that provide 
ranges for normally expected contract assumptions for revenues, 
expenses, reinvestment amounts, and fees. Such guidance would provide 
a framework to identify project proposals that fall outside of normal 
ranges. This could help focus management attention during the project 
review and approval process to ensure that each proposal is 
appropriate and in the best interest of the government.
Accordingly, we have retained our original recommendation. 

DOD's comments are included in this report in appendix VI. We have 
also incorporated DOD's technical comments as appropriate. 

We are sending copies of this report to the appropriate congressional 
committees; the secretaries of Defense, the Army, the Navy, and the Air
Force; and the Director, Office of Management and Budget. We also will 
make copies available to others upon request. In addition, the report 
will be available at no charge on the GAO Web site at [hyperlink, 
http://www.gao.gov]. 

Please contact me at (202) 512-3958 or Mark Little, Assistant 
Director, at (202) 512-4673 if you have any questions concerning this 
report. MAjor contributors to this report are listed in appendix VII. 

Signed by: 

Carol R. Schuster: 
Director, Defense Capabilities and Management: 

[End of section] 

Appendix I: Differences Over Budgetary Scoring for DOD's Military 
Housing Privatization Program: 

As requested, this appendix addresses differences between the Office of
Management and Budget and the Congressional Budget Office over 
budgetary scoring for DOD's Military Housing Privatization Program. 
This issue is important because the budgetary scored amount directly 
affects the amount of appropriated funds needed to secure a 
privatization contract, and high budgetary scores might make proposed 
privatization projects financially unattractive to DOD. 

Each privatization contract that DOD enters into must be scored for 
budget purposes. Scoring seeks to determine the cost that should be 
recognized and recorded as an obligation of DOD at the time the 
contract is signed. The Office of Management and Budget is responsible 
for determining the amount to be obligated, and its Circular A-11 
provides guidelines on how obligations should be recorded in the 
budget. The guidelines are designed to ensure that the budget records 
the full amount of the government's commitments when it obtains 
capital assets. 

As part of its fiscal year 2001 budget review, the Congressional Budget
Office assessed the budget scoring amounts for the first four 
privatization projects. It reported that the methods used by the 
Office of Management and Budget to determine the projects' budget 
score amounts (estimated obligations) were at odds with government-
wide standards and that the budget scores were too low.[Footnote 16] 
Officials at the Office of Management and Budget disagreed. 

Scoring guidelines state that when an asset is for a "special purpose 
of the government," an obligation should be recorded up front. 
Further, the guidance provides criteria to determine if a project is 
for a government purpose. One criterion states that if the project is 
constructed or located on government land, it is presumed to be for 
the special purpose of the government. Congressional Budget Office 
officials concluded that since all but two of DOD's housing projects 
were located on military bases, they are for the special purpose of 
the government, and the obligations should be recorded up front. 
Although less clear, Congressional Budget Office officials believe 
that up-front obligations were also justified for the two projects 
located off the bases. Another major factor in determining if a 
project is for the special purpose of the government is the question 
of whether DOD guarantees occupancy of privatized housing units. 
Officials of both offices agreed that if DOD guarantees occupancy, 
then the cumulative value of the rents to be paid on the housing over 
the contract term must be included in the scored amount. This would 
significantly increase the amount of appropriated funds needed to 
secure a privatization contract, and, as a result, many proposed 
projects would no longer be financially attractive for DOD. However, 
the offices disagree on whether DOD is, in fact, guaranteeing 
occupancy. 

Office of Management and Budget officials stated they did not include 
the value of the rents in the obligated amounts because DOD told them 
project contracts do not include rental guarantees. Rather, the 
contracts include provisions for civilians to rent privatized housing 
if military families choose not to live there. Still, Congressional 
Budget Office officials contend that for at least some projectsï¿½-
especially those located on military bases-ï¿½DOD provides an implicit 
occupancy guarantee and, therefore, the expected rents should be 
included in the obligated amount. To support its position, the Budget 
Office officials noted that (1) a majority of the on-base privatized 
units are replacing units once occupied by servicemembers and their 
families, which indicates the units have a special governmental 
purpose; (2) DOD will likely restrict privatized on-base housing to 
use by military families because of security concerns; and
(3) DOD refers servicemembers to the privatized housing rental offices 
and therefore is essentially committing itself to provide tenants for 
the projects. 

Although it is true that privatization contracts do not provide 
explicit DOD guarantees of occupancy, some service officials told us 
that their service would take any necessary actions to make their 
projects successful. Also, the contract terms for the Fort Hood 
project stated that in the event of declining occupancy, the Army 
could try to avoid or minimize renting to civilians. The contract 
stated that the "Army shall have the option, in its sole discretion, 
to make mandatory housing assignments... and/or to pay the applicable 
rents due on unoccupied housing units." 

[End of section] 

Appendix II: Scope and Methodology: 

We performed work at the Competitive Sourcing and Privatization Office 
and at other DOD offices responsible for housing management and 
housing allowances. We also performed work at Air Force, Army, and
Navy headquarters offices responsible for implementing the 
privatization program. At each location, we interviewed responsible 
officials and reviewed applicable policies, procedures, and documents. 
In addition, we discussed various aspects of the program with 
officials at the Air Force Center for Environmental Excellence and the 
National Multi Housing Council, a private organization that represents 
the interests of larger apartment firms and conducts apartment-related 
research. To discuss budgetary scoring for the privatization program, 
we met with officials from the Office of Management and Budget and the 
Congressional Budget Office. 

To determine whether privatization projects are based on reliable 
assessments of housing requirements, we reviewed prior reports from
GAO, RAND, and others that discussed problems with DOD's housing 
requirements determination process. We held discussions with, and 
reviewed documents from, DOD housing officials about the status of 
plans to improve the process. We also discussed with them potential 
impacts on housing requirements from the initiative to increase 
housing allowances and analyzed data showing the expected housing 
allowance increases through 2005 in total and in the local communities 
surrounding the first 10 privatization projects. Further, we discussed 
with DOD housing and housing allowance officials the differences in 
housing standards for servicemembers living in government and civilian 
housing. 

To determine whether DOD is achieving its financial goals for the 
privatization program, we reviewed DOD criteria for two key financial 
goals-ï¿½leveraging of government funds and reducing life-cycle costs. 
To measure achievement of the leveraging goal, we computed the 
leveraging ratio by dividing DOD's military construction cost estimate 
for each project by the budgetary scored amount for each project. We 
then compared the results with DOD's ratio goal. To measure 
achievement of the life-cycle cost goals, we reviewed DOD's guidance 
for performing life-cycle cost analyses and used this guidance to 
estimate and compare the life-cycle costs of the first 10 
privatization projects and the comparable military construction 
alternatives. We also computed alternative life-cycle cost estimates 
for the 10 projects after making adjustments to the assumptions in the 
guidance to include privatization program oversight costs and to 
remove real estate taxes from the military construction operations and 
maintenance cost estimates in order to achieve more accurate estimates 
of relative costs. In both analyses, we used current DOD cost 
estimates and projected the increase in privatization costs from the 
housing allowance initiative to eliminate out-of-pocket costs. We 
shared the results of our life-cycle cost analyses with service 
officials and revised the analyses on the basis of their comments. 

To evaluate whether DOD's privatization contracts protect the 
government's interests, we reviewed contracts and other project 
documentation for the first 10 privatization projects. For each 
project, we summarized DOD project cost data and other financial 
details from each contract, such as the value of (1) government loans, 
loan guarantees, and equity contributions, (2) developer equity, and 
(3) private-sector loans. We then compared the extent of financial 
exposure assumed by the government, the developer, and the private-
sector lenders in each contract, and compared contract assumptions, 
fee structures, and expected internal rates of return. We also 
estimated the impact from the housing allowance initiative on 
developer fees and profits and on amounts available for reinvestment 
in the projects. Also, to discuss implementation details and view 
privatized housing units first hand, we visited three installations 
where privatization projects were underway-ï¿½Fort Carson,
Colorado, and Kingsville Naval Air Station and Lackland Air Force Base,
Texas. At each installation visited, we reviewed housing conditions 
and occupancy statistics, discussed the status of privatization 
implementation, obtained opinions on the project from local service 
officials, obtained information on the satisfaction of military 
tenants living in privatized units, and toured new and renovated 
housing units completed by the developers. 

We conducted our review between May 2001 and April 2002 in accordance 
with generally accepted government auditing standards. 

[End of section] 

Appendix III: Description of First Ten Privatization Projects: 

We reviewed the first 10 projects awarded under the Military Housing 
Privatization Program. Details of these projects follow. 

Project: Fort Carson, Colorado; 
Housing units: 2,663; 
Contract award date: September 1999; 
Description: Government to (1) convey all existing units; (2) lease 
777 acres of land; and (3) provide first mortgage guarantee against 
developer default due to base closure, downsizing, or deployment. 
Developer to (1) renovate 1,823 existing units; (2) construct 840 new 
housing units on base; and (3) own, operate, and maintain 2,663 units 
for 50 years. 

Project: Fort Hood, Texas; 
Housing units: 5,912; 
Contract award date: October 2001; 
Description: Government to (1) convey all existing units; (2) lease 
the underlying land; and (3) provide an equity investment and become a 
limited partner. Developer to (1) renovate 4,624 units; (2) convert 
630 two-bedroom units to 315 four-bedroom units; (3) construct 973 new 
units on base; and (4) own, operate, and maintain 5,912 units for 50 
years. 

Project: Lackland Air Force Base, Texas; 
Housing units: 420; 
Contract award date: August 1998; 
Description: Government to (1) lease 96 acres; (2) provide a second 
mortgage; and (3) provide first mortgage guarantee against developer 
default due to base closure, downsizing, or deployment. Developer to 
(1) demolish 272 existing units; (2) construct 420 new housing units 
on base; and (3) own, operate, and maintain 420 units for 50 years. 

Project: Robins Air Force Base, Georgia; 
Housing units: 670; 
Contract award date: September 2000; 
Description: Government to (1) convey 670 existing units and 270 acres 
of land; (2) provide a second mortgage; and (3) provide first mortgage 
guarantee against developer default due to base closure, downsizing, 
or deployment. Developer to (1) demolish 370 existing units; (2) 
construct 370 new units on conveyed land; (3) renovate 300 units; and 
(4) own, operate, and maintain 670 units for 30 years (may be extended 
for two additional 10-year periods). 

Project: Dyess Air Force Base, Texas; 
Housing units: 402; 
Contract award date: September 2000; 
Description: Government to provide a first mortgage loan. Developer to 
(1) construct 402 new housing units on private land off base; and (2) 
own, operate, and maintain the units for 40 years. 

Project: Elmendorf Air Force Base, Alaska; 
Housing units: 828; 
Contract award date: March 2001; 
Description: Government to (1) convey 584 existing units; (2) lease 
219 acres of land; (3) provide a second mortgage loan; and (4) provide 
first mortgage guarantee against developer default due to base 
closure, downsizing, or deployment. Developer to (1) demolish 176 
units; (2) construct 420 new housing units on base; (3) renovate 200 
units; and (4) own, operate, and maintain 828 units for 50 years. 

Project: Kingsville Naval Air Station, Texas; 
Housing units: 150; 
Contract award date: November 2000; 
Description: Government to (1) convey 244 existing units and 30 acres 
of land; (2) provide an equity investment and become a limited 
partner; and (3) provide a second mortgage loan. Developer to (1) 
construct 150 new housing units on developer-provided land off base; 
and (2) own, operate, and maintain 150 units for 30 years (Navy option 
to terminate contract anytime after 15 years). 

Project: Everett Naval Station, Washington; 
Housing units: 288; 
Contract award date: December 2000; 
Description: Government to (1) provide an equity investment and become 
a limited partner and (2) provide over a 15-year period limited lease 
payments in addition to the servicemembers' rental payments. Developer 
to (1) construct 288 new housing units on private land off base and 
(2) own, operate, and maintain the units for 30 years (Navy option to 
terminate contract anytime after 15 years). 

Project: Camp Pendleton Marine Corps Base, California; 
Housing units: 712; 
Contract award date: November 2000; 
Description: Government to (1) convey 512 existing units; (2) lease 
132 acres of land; and (3) provide a second mortgage loan. Developer 
to (1) demolish and replace 312 units; (2) renovate 200 units; (3) 
construct 200 additional new housing units on base; and (4) own, 
operate, and maintain 712 units for 50 years. 

Project: San Diego Naval Complex, California; 
Housing units: 3,248; 
Contract award date: August 2001; 
Description: Government to (1) convey 2,660 existing units; (2) lease 
the underlying land; and (3) provide an equity investment and become a 
limited partner. Developer to (1) demolish 812 units; (2) construct 
1,400 new housing units on the leased land; and (3) own, operate, and 
maintain 3,248 units for 50 years. 

Source: DOD. 

[End of table] 

[End of section] 

Appendix IV: DOD's Military Housing Privatization Program 
Implementation Status and Plans: 

DOD's pace for implementing and its plans for future privatization DOD 
had awarded 11 privatization Figure 2 shows, on a fiscal year units 
DOD actually privatized fiscal year 2006. Developers renovation work 
on 1,740 units basis, and DOD's the privatization projects are 
aggressive. 

Figure 2: Cumulative Number of Housing Units Under Contract: 

[Refer to PDF for image: vertical bar graph] 

Fiscal year: 1998 Actual; 
Cumulative number of units: 420. 

Fiscal year: 1999 Actual; 
Cumulative number of units: 3,083. 

Fiscal year: 2000 Actual; 
Cumulative number of units: 4,155. 

Fiscal year: 2001 Actual; 
Cumulative number of units: 15,293. 

Fiscal year: 2002 Planned; 
Cumulative number of units: 27,762. 

Fiscal year: 2003 Planned; 
Cumulative number of units: 80,598. 

Fiscal year: 2004-2006 Planned; 
Cumulative number of units: 112,1139. 

Source: DOD. 

[End of figure] 

[End of section] 

Appendix V: Services' Life-Cycle Cost Estimates: 

Table 7 shows the results of the services' life-cycle cost analyses 
for the first 10 projects awarded under the Military Housing 
Privatization Initiative. The services' analyses were completed prior 
to the projects' approval, and many costs-such as those for housing 
allowances-have changed significantly since then. Their analyses show 
the military construction alternative to be more costly in each case. 
For comparison purposes, our estimates of life-cycle costs for these 
projects-made using current information and adjustments to DOD's life-
cycle cost guidance-are included in table 2 in the body of the report. 

Table 7: Services' Estimates of Life-Cycle Costs: 

Project: Fort Carson; 
Privatization option: $640.7 million; 
Military construction option: $693.2 million; 
Difference: $52.5 million; 
Percentage difference: 7.6%. 

Project: Fort Hood; 
Privatization option: $1.515 billion; 
Military construction option: $1.886 billion; 
Difference: $371.4 million; 
Percentage difference: 19.7%. 

Project: Lackland; 
Privatization option: $83.2 million; 
Military construction option: $97.9 million; 
Difference: $14.7 million; 
Percentage difference: 15.0%. 

Project: Robins; 
Privatization option: $114.0 million; 
Military construction option: $157.0 million; 
Difference: $43.0 million; 
Percentage difference: 27.4%. 

Project: Dyess; 
Privatization option: $68.0 million; 
Military construction option: $75.0 million; 
Difference: $7.0 million; 
Percentage difference: 9.3%. 

Project: Elmendorf; 
Privatization option: $269.3 million; 
Military construction option: $308.7 million; 
Difference: $39.4 million; 
Percentage difference: 12.8%. 

Project: Kingsville; 
Privatization option: $31.1 million; 
Military construction option: $42.3 million; 
Difference: $11.2 million; 
Percentage difference: 26.5%. 

Project: Everett; 
Privatization option: $71.6 million; 
Military construction option: $98.2 million; 
Difference: $26.6 million; 
Percentage difference: 27.1%. 

Project: Camp Pendleton; 
Privatization option: $163.4 million; 
Military construction option: $210.1 million; 
Difference: $46.7 million; 
Percentage difference: 22.2%. 

Project: San Diego; 
Privatization option: $1.041 billion; 
Military construction option: $1.104 billion; 
Difference: $62.5 million; 
Percentage difference: 5.7%. 

Project: Total; 
Privatization option: $3.998 billion; 
Military construction option: $4.673 billion; 
Difference: $675.0 million; 
Percentage difference: 14.4%. 

Source: DOD. 

[End of table] 

[End of section] 

Appendix VI: Comments from the Department of Defense: 

Note: GAO comments supplementing those in the report text appear at 
the end of this appendix. 

Office Of The Under Secretary Of Defense: 
Acquisition, Technology And Logistics: 
3000 Defense Pentagon: 
Washington, DC 20301-3000: 

Ms. Carol R. Schuster: 
Director, Defense Capabilities Management: 
U.S. General Accounting Office: 
Washington, D.C. 20548: 

Dear Ms. Schuster: 

This is the Department of Defense (DoD) response to the GAO draft 
report GAO-02-624, "Military Housing: Management Improvements Needed 
As Privatization Pace Quickens," dated May 3, 2002 (GAO Code 350074). 
Thank you for allowing us to comment on your draft report. I consider 
the report a very important contribution to our development and 
implementation of the Military Housing Privatization Initiative 
(MHPI). While I generally concur with your recommendations, I believe 
you have undervalued the strides we have made thus far. 

The GAO was asked to look at three program areas: financial goals, 
government protections, and requirements determination. The Department 
has been overwhelmingly successful in achieving its financial goals of 
leveraging appropriations and obtaining lower life cycle costs for 
privatization than for military construction. Every project examined 
by GAO leveraged appropriations beyond the three-to-one objective (the 
table on page 12 of the draft report erroneously lists the Everett 
leveraging ratio as 2.7, rather than the 3.0), and every project met 
the goal that privatization be cheaper than military construction. The 
life cycle cost adjustments recommended by the report are relatively 
minor and are unlikely to alter the fact that all projects have met 
the goal. [See comment 1] 

I am also encouraged by your findings that the private sector is 
bearing most of the risk in our projects. Developer profit is not 
guaranteed, but is dependent upon high occupancies through attracting 
service member tenants to private housing. The private opportunity for 
profit and the risk of loss are fundamental to the MHPI. This private 
risk/return mechanism also weakens the position of the Congressional 
Budget Office that the projects are governmental and that budget 
scores are too low. Bearing this in mind, the Department is striving 
to structure deals that are as private as possible, but which protect 
the government's interests and ensure good housing well into the 
future. 

The requirements determination policy is now in coordination within 
the Department. Considerable time and effort have gone into developing 
a policy that will provide a reliable assessment of our housing 
requirements. We anticipate that the policy will be signed in July 
2002. 

Again, I appreciate GAO's review of the housing privatization program. 
Thank you for your very valuable assistance. Our responses to your 
specific recommendations are enclosed. 

Signed by: 

Raymond F. DuBois, Jr. 
Deputy Under Secretary of Defense (Installations and Environment): 

Enclosure: As stated. 

[End of letter] 

GAO Code 350074/GA0-02-624: 

"Military Housing: Management Improvements Needed As Privatization 
Pace Quickens" 

Department Of Defense Comments To The Recommendations: 

Recommendation 1: The GAO recommended that the Secretary of Defense 
direct the Deputy Under Secretary of Defense (Installations and 
Environment) to revise the Department's housing requirements 
determination process to take into account greater use of community 
housing to fulfill needs and the projected impact that the housing 
allowance initiative might have on military housing requirements. 
(Page 28/Draft Report). 

DoD Response: Concur. The Military Services and the Office of the 
Secretary of Defense (OSD) have spent significant time and effort 
developing a proposed housing requirements determination process that 
will rely primarily on the private sector to meet the department's 
housing needs and which will include increases in the housing 
allowance. OSD has issued a draft requirements policy document which 
is currently in coordination throughout the Department. Issues 
resulting from the coordination process will be addressed prior to 
forwarding the draft policy to the Deputy Secretary. We anticipate 
issuing the signed policy in July 2002. 

Recommendation 2: The GAO recommended that the Secretary of Defense 
direct the Deputy Under Secretary of Defense (Installations and 
Environment) to determine the effect of the difference in the 
Department's housing standards for service members living in 
government-owned or privatized housing and for those living in 
community housing on the requirement for military family housing. This 
should include identifying the benefits and costs derived from a 
program that would provide increased allowances based on the number of 
family members and determining the extent such a program could reduce 
requirements for government-owned or privatized housing. (Page 
28/Draft Report). 

DoD Response: Concur. The Department has become aware that an 
inconsistency exists for some military members between the size of 
government housing provided and the units that the housing allowances 
would afford in the private sector. This issue will require careful 
study and consideration as the average out-of-pocket costs for our 
military members reaches zero. If the size differential continues into 
the future, it could influence military families to seek government 
housing over available private sector units. 

Recommendation 3: The GAO recommended that the Secretary of Defense 
direct the Deputy Under Secretary of Defense (Installations and 
Environment) to improve the guidance for performing life-cycle cost 
analyses by requiring the inclusion of privatization contract 
oversight costs and validating the types and sources of data used to 
estimate military construction operations and maintenance costs. (Page 
28/Draft Report). 

DoD Response: Partially concur. The Department will modify its 
guidance for performing life-cycle cost analysis. The revised guidance 
will specifically include contract oversight costs. The existing 
guidance requires preparers to include all costs for both the Milcon 
and privatization alternatives; however, it does not specifically 
identify privatization contract oversight costs. [See comment 2] 

We will also validate the data used to estimate military construction 
and operations and maintenance (O&M) costs. The existing policy uses 
IREM (Institute of Real Estate Management) costs, adjusted to reflect 
differences in costs incurred by the Department and the private 
sector. The policy is intended to provide a simple, accurate, and 
consistent methodology for ascertaining Milcon operations and 
maintenance costs. We concur that IREM includes real estate taxes 
which could overstate Milcon estimates in some cases. However, 
eliminating taxes from the analysis would require life cycle preparers 
to research and add back in the department's cost of providing 
services attributable to local property tax revenues. It is not at all 
certain that the department's costs of providing such services would 
be less than those of the locality in question. And the additional 
research might decrease the consistency of the analysis given 
inaccuracies in accounting for O&M costs. Nonetheless, we will examine 
the three sites identified in the report and validate the accuracy of 
the IREM estimates. We will refine the adjustment factor to the IREM 
cost, based on the results of this examination. 

Recommendation 4: The GAO recommended that the Secretary of Defense 
direct the Deputy Under Secretary of Defense (Installations and 
Environment) to require provisions in all future privatization 
contracts to direct the benefits from unanticipated increased revenues 
or reduced expenses to flow, in total or in part, into a project 
reinvestment account for possible future use in the project. (Page 
28/Draft Report). 

DoD Response: Concur. The department requires all projects subsequent 
to the DOD initiative to increase housing allowances to include 
mechanisms to capture such unanticipated increases in project 
revenues. Increased revenues from reduced expenses on the other hand 
naturally flow into the reinvestment account at the bottom of the 
lockbox "waterfall" of funds. 

Recommendation 5: The GAO recommended that the Secretary of Defense 
direct the Deputy Under Secretary of Defense (Installations and 
Environment) to require Service headquarters and the Office of the 
Secretary of Defense to review and approve privatization project 
reinvestment account expenditures over an established threshold. (Page 
28/Draft Report). 

DoD Response: Partially concur. Service headquarters and the Office of 
the Office of the Secretary of Defense should have oversight over 
reinvestment account expenditures. However, service headquarters are 
the appropriate offices to review and approve specific project 
expenditures from privatization project reinvestment accounts. The 
Office of the Secretary of Defense will continue to approve 
expenditures or transfers of funds outside the project, for example 
approval of follow-on project phases, or returns to and expenditures 
from the family housing improvement fund. [See comment 3] 

Recommendation 6: The GAO recommended that the Secretary of Defense 
direct the Deputy Under Secretary of Defense (Installations and 
Environment) to provide guidelines to help establish appropriate 
privatization contract revenue, expense, and reinvestment assumptions 
and project fees. (Page 28/Draft Report). 

DoD Response: Partially concur. The Department concurs that guidance 
regarding the reasonableness of contract revenue, expenses, 
reinvestment assumptions, and project fees is useful for benchmarking 
individual projects. However, the key to getting the best quality 
housing construction and management for the least cost to the Military 
Service remains maximizing competition among developers. Such 
competition drives down project expenses and fees and drives up 
construction quality and management commitments. Privatization deal 
structures differ significantly from project to project. Reliance on 
strict governmental guidelines--instead of the market's determination 
of risk and return--will be unlikely to create financially sound 
projects. For example, developers differ organizationally one from 
another. A fully integrated firm may identify less fees or expenses 
than a development team, but may demand a greater overall return. It 
is the job of service source selection teams to analyze such critical 
financial factors as part of its source selection evaluation. 
Attempting to shoe-horn cost assumptions from one project into another 
across the program would not result in the best projects for the 
government. [See comment 4] 

Recommendation 7: The GAO recommended that the Secretary of Defense 
direct the Deputy Under Secretary of Defense (Installations and 
Environment) to improve the value of DoD's privatization program 
evaluation report by completing the report on time, including 
information on funds accumulated in project reinvestment accounts, and 
obtaining periodic independent verification of key report elements. 
(Page 28/Draft Report). 

DOD Response: Concur. We consider the PEP to be the key program 
management tool. We concur with the need for timely reports and 
improving reporting of such items as project reinvestment accounts. We 
will also obtain periodic independent verification of key report 
elements. 

The following is our response to the Department of Defense's (DOD) 
letter commenting on our draft report. 

GAO Comments: 

1. Concerning the leveraging ratio for the Everett project, the 
project's budgetary scored cost was $17.5 million and the Navy 
originally estimated $47.8 million, or $166,000 per unit, would be 
required to build the project under the military construction 
alternative. Thus, the project's leveraging ratio is 2.7 to 1. 
However, the Navy later revised its military construction cost 
estimate to $52.3 million, or $182,000 per unit. This estimate results 
in a 3.0 ratio. In comparison, the Navy's military construction unit 
cost estimates for new units in the Camp Pendleton and Kingsville 
projects were $153,000 and $136,000, respectively. Because the $47.8 
million estimate was based on a per unit construction cost that 
appears more in line with other Navy projects and because the Navy 
used the $47.8 million estimate in its life cycle cost analysis for 
the Everett project, we believe that using this estimate to calculate 
the 2.7 leveraging ratio is reasonable and results in the most 
accurate estimate. 

2. See our response in the Agency Comments section of the letter on 
page 29. 

3. See our response in the Agency Comments section of the letter on 
page 29. 

4. See our response in the Agency Comments section of the letter on 
page 29. 

[End of section] 

Appendix VII: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Carol R. Schuster (202) 512-3958. 
Mark Little (202) 512-4673. 

Acknowledgments: 

In addition to the individuals named above, Gary Phillips, James Ellis,
Janet Keller, Sharon Reid, James Vitarello, and R. K Wild made key 
contributions to this report. 

[End of section] 

Footnotes: 

[1] This report does not include two Navy projects (589 total units at 
three locations: Corpus Christi and Kingsville, Texas, and Everett, 
Washington) approved under a prior legislative authority which gave 
only the Navy authority to test the use of limited partnerships in 
order to meet the housing requirements of naval personnel and their 
dependents (see section 2803 of Public Law 103-337). The authority to 
use limited partnerships is now available to all services under the 
1996 law establishing the privatization initiative. The Kingsville and 
Everett privatization projects mentioned throughout the remainder of 
this report refer to separate projects that were subsequently approved 
under the privatization initiative. 

[2] The National Defense Authorization Act for Fiscal Year 1996 (P.L. 
104-106, 110 Stat 186). This legislation also provides authority to 
facilitate private sector financing, ownership, operation and 
maintenance of unaccompanied housing, commonly referred to as 
barracks. However, due to the services' mandatory assignment policies 
for single junior enlisted personnel and the lack of funds to pay 
housing allowances for these servicemembers, DOD has not undertaken 
any privatization projects for unaccompanied housing. Thus, this 
report focuses on DOD's use of privatization to improve family housing. 

[3] Appendix III contains a description of the first 10 privatization 
projects. 

[4] See Memorandum for House Privatization Points of Contact, Subject: 
Final Housing Privatization Life Cycle Cost Policy, Office of the 
Under Secretary of Defense (Feb. 11, 2002). 

[5] For 2002, servicemembers' average out-of-pocket share is 11 
percent of typical housing and utility costs in each geographic area 
of the country. DOD's plans call for additional increases in the 
housing allowance so that the average out-of-pocket share falls to 8 
percent in 2003, 4 percent in 2004, and to zero in 2005. 

[6] For example, if civilians rented privatized housing units on base, 
would security concerns be increased at some installations and would 
the government be required to pay education impact aid to the 
community for each civilian child? See U.S. General Accounting Office,
Military Housing: Privatization Off to a Slow Start and Continued 
Management Attention Needed, [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-98-178] (Washington, D.C.: July 
17, 1998). 

[7] U.S. General Accounting Office, Military Housing: Continued 
Concerns in Implementing the Privatization Initiative, [hyperlink, 
http://www.gao.gov/products/GAO/NSIAD-00-71] (Washington, D.C.: Mar. 
30, 2000). 

[8] U.S. General Accounting Office, Military Housing: DOD Needs to 
Address Long-Standing Requirements Determination Problems, [hyperlink, 
http://www.gao.gov/products/GAO-01-889] (Washington, D.C.: Aug. 3, 
2001). 

[9] To be considered suitable by DOD's criteria, a dwelling must be 
located within a 1-hour commute of the installation, meet minimum net 
square-footage requirements, be well maintained, and pose no health, 
safety, or fire hazard. The criteria for affordability considers a 
dwelling's rental cost in comparison with the servicemember's housing 
allowance. 

[10] See Congressional Budget Office, Military Family Housing in the 
United States, (Washington, D.C.: Sept. 1993); U.S. General Accounting 
Office, Military Family Housing: Opportunities Exist to Reduce Costs 
and Mitigate Inequities, GAO/NSIAD-96-203 (Washington, D.C.: Sept. 13, 
1996); and RAND, An Evaluation of Housing Options for Military 
Families, MR-1020-OSD (1999). 

[11] U.S. General Accounting Office, Military Personnel: Higher 
Allowances Should Increase Use of Civilian Housing, but Not Retention, 
[hyperlink, http://www.gao.gov/products/GAO-01-684] (Washington, D.C.: 
May 31, 2001). 

[12] RAND (MR-1020-OSD, 1999). 

[13] After our analysis was completed, DOD officials told us that the 
developer of the Fort Carson project recently agreed to begin 
reimbursing the government for the cost of utilities for the military 
families occupying the privatized housing. Under this scenario, the 
Office of Management and Budget's original budgetary score for the 
project would have been in line with normal budgetary scoring rules 
for privatization projects. 

[14] With the enactment of the National Defense Authorization Act for 
fiscal year 2002, Congress authorized DOD to conduct another round of 
base realignments and closures beginning in 2005. 

[15] See [hyperlink, http://www.gao.gov/products/GAO/NSIAD-00-71]. 

[16] Congressional Budget Office, Cost Estimate, S. 2549 National 
Defense Authorization Act for Fiscal Year 2001 (Washington, D.C.: May 
23, 2000). 

[End of section] 

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