United States General Accounting Office

GAO

For Release on Delivery

Expected at

2:00 p.m. EDT

Monday

October 1, 2001

PUBLIC-PRIVATE

PARTNERSHIPS

Factors to Consider When

Deliberating Governmental

Use as a Real Property

Management Tool

Statement of Bernard L. Ungar

Director, Physical Infrastructure Issues

GAO-02-46T

Testimony

Before the Subcommittee on Technology and Procurement

Policy, Committee on Government Reform, House of

Representatives
Page 1

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here today to discuss our report entitled PublicPrivate Partnerships: Pilot Program Needed to Demonstrate the Actual

Benefits to Using Partnerships (GAO-01-906, July 25, 2001), which

identifies the potential benefits to the federal government of entering into

public-private partnerships on real property. We have reported that the

General Services Administration (GSA) has a multibillion dollar backlog of

deferred maintenance in federal buildings, and that public-private

partnership authority could be an important management tool to address

problems in deteriorating federal buildings. However, further study of how

the partnerships would actually work and of their benefits compared with

other options, such as appropriations, is needed. Numerous buildings in

GSA’s inventory either have or are at risk of having a negative cash flow

because of their deteriorating condition. In our report, we recommended

that the Administrator of GSA use all available strategies to address the

problems of such buildings in GSA’s inventory. We also recommended that

the Administrator of GSA seek statutory authority to establish a pilot

program that would demonstrate the actual benefits that may be achieved

from public-private partnerships that achieve the best economic value for

the government. GSA’s Commissioner for the Public Buildings Service

agreed with the findings and recommendations in our report.

In my testimony, I will discuss four issues from our report that you asked

us to focus on for this hearing:

• The structure of public-private partnerships;

• factors that indicate a property may be a potential candidate for a publicprivate partnership;

• benefits of public-private partnerships to the federal government; and

• factors a private-sector entity considers when determining the viability of

a public-private partnership and its benefits to the private-sector entity.

In addition, as you requested, I will briefly discuss the authorities available

to the Department of Veterans Affairs (VA) and the Department of Defense

(DOD) that allow them to enter into ventures with the private sector.

In summary, the basic structure of a public-private partnership would

entail the private sector providing cash and financing ability to renovate or

redevelop real property contributed by the federal government and each

partner sharing in the net cash flow resulting from the property. Location

in a strong office real estate market and the demand for federal and nonfederal office space are two key factors when considering properties for
Page 2

partnership opportunities. Potential benefits to the federal government of

public-private partnerships include the attainment of efficient and repaired

federal space and the conversion of properties that are currently a net cost

into revenue producers. Public-private partnerships are essentially

financial business deals for the private sector and it would consider the

financial benefits of such an arrangement. Unlike GSA, VA, and DOD

currently have the authority to enter into joint ventures with the private

sector.

To identify the potential benefits to the federal government of entering

into public-private partnerships on real property, we contracted with Ernst

& Young LLP, who, together with a subcontractor, Signet Partners,

developed and analyzed hypothetical partnership scenarios for seven

selected GSA buildings. We also contracted with AEW Capital

Management, L.P. (AEW) to update a study it had previously done for GSA

on the public-private partnership financial viability for three properties in

Washington, D.C. For a complete listing of the 10 properties included in

our study, see attachment I. Additional information about our

methodology, including how the hypothetical partnership scenarios were

structured and how the properties were selected, is included in

attachment II. We obtained information on the authorities available to VA

and DOD by talking with officials from these agencies and by reviewing

applicable legislation.

We have suggested that the Congress consider providing the Administrator

of GSA with the authority to experiment with funding alternatives,

including public-private partnerships, when they reflect the best economic

value available for the federal government. Congress has enacted

legislation that provides certain other agencies with a statutory basis to

enter into joint ventures with the private-sector. This additional property

management tool has been provided to VA and DOD. Furthermore, in an

effort to provide more agencies with a broader range of property

management tools, the Federal Asset Management Improvement Act (H.R.

2710) was recently reintroduced.

The term public-private partnership can be used to describe many

different types of partnership arrangements. When we refer to publicprivate partnerships, we are referring to partnerships in which the federal

government contributes real property and a private entity contributes

financial capital and borrowing ability to redevelop or renovate the real

property. Regarding the structure of the hypothetical partnerships

Background

Structure of PublicPrivate Partnerships
Page 3

developed for our study, the federal government and the private sector

entity negotiate to agree on how the specifics of the partnership will work,

including how the cash flow will be shared to form the partnership. The

private partners will generally require a preferred return to compensate it

for the risks it is taking in the partnership. This preferred return is

generally a percentage of the cash flow; for our study, the contractors used

11 percent for the Washington, D.C. properties and 9 percent for the other

properties. The net cash flow is then divided between the private partner

and the federal government at an agreed-upon percentage. Attachment III

shows graphically how the hypothetical partnerships in our study were

structured.

In structuring partnerships for individual properties, it must be

remembered that each property is unique and will thus have unique issues

that will need to be negotiated and addressed as the partnership is formed.

Great care will need to be taken in structuring partnerships to protect the

interests of both the federal government and the private sector. In

conducting this study, the contractors assumed that certain conditions

would govern a public-private partnership.1

 For example, the property

must be available for use, in whole or in part, by federal executive

agencies, and agreements must not guarantee occupancy by the United

States. In addition, the government would not be liable for any actions,

debts, or liabilities of any person under an agreement, and the leasehold

interests of the United States would be senior to any lender of the

nongovernmental partner.

There are various factors that indicate whether a property is a potential

candidate for a public-private partnership. There must be not only a

federal need for space, but also a private-sector demand for space, since

the government is not guaranteeing that it will occupy the property. The

stronger the market for rental space, both federal and nonfederal, the

more likely that the space will be rented and thus producing income. The

property must have the ability to provide a sufficient financial return to

attract and utilize private-sector resources and expertise. A property in a

strong rental market and at a good location is more likely to attract

private-sector interest than a property without these characteristics.

Another factor is the existence of an unutilized or underutilized asset on

 1

 These conditions are based on legislation that was introduced during the 106th Congress,

H.R. 3285.

Factors That

Indicated Potential

Properties for PublicPrivate Partnerships
Page 4

the property, which could be used to increase the value of the property.

Several of the properties we studied had vacant land. The existence of

excess land on the property that could be used to increase the amount of

office space by expanding or building a new building, could increase the

opportunity for an income-generating partnership. The property in Seattle,

WA, has a deepwater port that the government is not using to its potential

but that could be very valuable to another user.

Any partnership would have to conform with budgetary score-keeping

rules. Federal budget scoring is the process of estimating the budgetary

effects of pending and enacted legislation and comparing them to limits

set in the budget resolution or legislation. Scorekeeping tracks data such

as budget authority, receipts, outlays, and the surplus or deficit. Office of

Management and Budget (OMB) staff indicated that where there is a longterm need for the property by the federal government, it is doubtful that a

public-private partnership would be more economical than directly

appropriating funds for renovation. In addition, depending on how OMB

scores these transactions, some of the scenarios could trigger capital

lease-scoring requirements due to the implicit long-term federal need for

the space.

Our study designed a conceptual framework for public-private

partnerships in order to identify potential benefits of these partnerships.

Our contractors developed and analyzed hypothetical public-private

partnerships for 10 specific GSA properties. Multiple potential benefits to

the federal government were identified. These potential benefits include

the

• utilization of the untapped value of real property,

• conversion of buildings that are currently a net cost to GSA into net

revenue producers,

• attainment of efficient and repaired federal space,

• reduction of costs incurred in functionally inefficient buildings,

• protection of public interests in historic properties, and

• creation of financial returns for the government.

Our study did not identify or address all the issues of partnerships that will

need to be considered by the decisionmakers and policymakers as

partnerships are developed. Before any partnerships are developed, indepth feasibility studies would have to be done to evaluate partnership

opportunities and other options, such as appropriations, to determine

which could provide the best economic value for the government. When

Multiple Potential

Benefits to the

Federal Government

Identified
Page 5

deciding whether to enter into a partnership, the government will need to

weigh the expected financial return and other potential benefits against

the expected costs, including potential tax consequences, associated with

the partnership. Any cost associated with vacating buildings during

renovation work would also have to be considered in any alternative

evaluated. In addition, any actual partnerships involving the properties in

our study may be very different from the scenarios developed by our

contractors.

For a public-private partnership to be a viable option, there must be

interest from the private sector in partnering with the government on a

selected property. A private-sector partner would generally enter a

partnership as a financial business decision. While the private-sector entity

would consider numerous factors to determine the viability of a publicprivate partnership, the financial return from the partnership is the critical

factor in the decision on whether to partner with the federal government.

According to our contractors, about a 15-percent internal rate of return

(IRR)2

 would likely elicit strong interest from the private sector in a

partnership. However, this is only one factor, and the circumstances and

conditions of each partnership are unique and would have to be evaluated

on a case-by-case basis by both the private sector and the federal

government. For example, a somewhat lower IRR could be attractive if

other conditions, such as the risk level, are favorable. In addition, when

our contractors discussed possible partnership scenarios with local

developers, the developers said that, to participate, they would want at

least a 50-year master ground lease.

A public-private partnership would generally be a financial undertaking for

the private-sector entity, and the main benefit to it would be financial.

With regard to some properties, the private sector may believe it is a

benefit to be associated with a particular project if a developer believes

that a project is prestigious and might open future opportunities.

According to our contractors, the analysis of the hypothetical partnerships

for many of the properties in our study showed a sufficient potential

financial return to attract private-sector interest in a partnership

arrangement. Our contractors determined that 8 of the 10 GSA properties

 2

 The IRR measures the return, expressed as an interest rate, that an investor would earn

on an investment.

Considerations of and

Benefits to the

Private-Sector Entity
Page 6

in our study were strong to moderate candidates for public-private

partnerships. This determination was based on the (1) estimated IRR for

the private- sector partner in year 10 of the project, which ranged from

13.7 to 17.7 percent; (2) level of federal demand for the space; and (3) level

of nonfederal demand for space. The level of demand for space, both

federal and nonfederal, affects the level of risk that the space will be

vacant and thus non-income-producing. The stronger the local market is

for rental space, the more likely the space will be rented and thus produce

income for the partnership. The properties that were strong candidates for

partnerships were located in areas with a strong federal and nonfederal

demand for space, and many had untapped value that the partnership

could utilize, such as excess land on which a new or expanded building

could be built.

Leasing authority is available to VA and DOD.3

 Under VA’s enhanced use

leasing (EUL) authority, an EUL must enhance the use of the property and

provide some space for an activity that contributes to VA’s mission or

otherwise improves services to veterans. VA receives fair consideration,

monetary or in-kind, as determined by the Secretary and the lease term is

not to exceed 75 years. For DOD, terms must promote national defense or

be in the public interest, and the lease term may not exceed 5 years

without the Service Secretary’s approval. The lease proceeds may be used

to fund facility maintenance and repair or environmental restoration at the

military installation where the property is located and elsewhere.

According to VA and DOD, their ventures yield both financial and

nonfinancial benefits. Financial benefits include receiving below market

rental rates and the receipt of cash revenue in some cases. Nonfinancial

benefits include maximizing the use of capital assets as well as in-kind

benefits such as the use of a child care center at reduced rates. In 1999, we

reported on two projects under the VA’s EUL authority.4

 In Texas, a

private developer constructed a VA regional office building on VA’s

medical campus. VA then leased land to the developer on the medical

campus and the developer constructed buildings on the land and rented

space in them to commercial businesses. In Indiana, the state leased

underutilized land and facilities from VA to use as a psychiatric care

 3

 (38 U.S.C. § 8161-8169) and (10 U.S.C. § 2667)

4 Public-Private Partnerships: Key Elements of Federal Building and Facility

Partnerships (GAO/GGD-99-23, Feb. 3, 1999).

Authorities Available

to VA and DOD
Page 7

facility. The leasing revenue that VA receives from both sites is to be used

to fund veterans programs.

Aside from the work we did in connection with our 1999 report, it is

important to note that we did not explore these authorities in depth, nor

did we examine the budget scoring implications for projects undertaken

based on these authorities. Currently, we are examining DOD’s

implementation of its authority to lease non-excess property and how the

military services are using this and other special legislative authorities to

reduce base operating support costs. We expect this work to be completed

early next year.

This concludes my prepared statement. I would be happy to respond to

any questions you may have.

For information about this testimony, please contact Bernard Ungar,

Director, Physical Infrastructure Issues, on (202) 512-8387. Individuals

making key contributions to this testimony included Ron King, Maria

Edelstein, and Lisa Wright-Solomon.

Contacts and

Acknowledgments
Page 8

Property Tenants

Building size

(square feet)

Current

occupancy rate

(percentage)

Funds from

operations,

fiscal year

2000

Private

partner

IRRa Notes

Seattle, WA Army Corps of

Engineers,

FBI motor pool,

out-lease warehouse

space

607,543

rentable

(mixed use)

200,000 office

Office: 8%

Warehouse: 80%

Motor pool: 100%

$3,293,485 17.7% Army Corps of Engineers

believes that it must

relocate to a facility that

meets seismic standards

Washington,

D.C.

Federal Office

Building 9

Office of Personnel

Management (OPM)

768,530 gross

673,924

rentable

98% $9,922,041 17.3% Delegated building

Portland, OR Immigration and

Naturalization Service

(INS)

137,281 gross

122,505

rentable

50% $(207,980) 15.7% May be hard to retain INS

at end of lease in fiscal

year 2002 if building

needs are not addressed

Washington,

D.C.

GSA HQ

GSA headquarters 710,431 gross

623,233

rentable

100% $4,456,891 15.3%

Columbia, SC Veterans Affairs (VA) 83,640 gross

802,249

rentable

100% $332,684 14.5%

Andover, MA Internal Revenue

Service (IRS)

400,502 gross

393,520

rentable

100% $2,016,191 14.4% Delegated building—IRS

pays its operating costs

Washington,

D.C.

Federal Office

Building 8

Food and Drug

Administration (FDA)

522,491 gross

479,840

rentable

100% $12,362,825 13.7% FDA to vacate building

and return it to GSA in

2002 clear of any

environmental hazards

Charleston,

SC

Unoccupied 99,695 BOMA 0 $(1,003,372) 13.7% Building vacant since

1999 due to damage from

Hurricane Floyd

Jacksonville,

FL

U.S. District Courts

U.S. Postal Service

290,855 gross

278,870

rentable

94% $1,517,038 12.4% Courts will move to new

courthouse in 2002

Minneapolis,

MN

Military Enlistment

Processing Service

(MEPS)

154,049 gross

143,197

rentable

10% $599,365 10.3% MEPS plans to vacate

building June 2001

a

In year 10 of a 50-year partnership.

Source: GSA and Ernst & Young.

Attachment I: GSA Properties Analyzed
Page 9

To identify the potential benefits to the federal government and private

sector of allowing federal agencies to enter into public-private

partnerships, we hired contractors to develop and analyze hypothetical

partnership scenarios for 10 selected GSA buildings. GSA’s National

Capital Region had previously contracted for a study to analyze the

financial viability of public-private partnership ventures for three buildings

in Washington, D.C. Because the majority of the work for these properties

had already been done, we had the contractor update its work on these 3

buildings and selected them as 3 of the 10 GSA properties. To help us

select the other 7 properties for our study, GSA provided a list of 36

properties that it considered good candidates for public-private

partnerships. In preparing this list of properties, GSA officials said that

they considered factors such as the strength of the real estate market in

each area, the extent to which the property was currently utilized or had

land that could be utilized, and the likelihood of receiving appropriations

to rehabilitate the property in the near future. We judgmentally selected

seven properties from this list to include properties (1) from different

geographic areas of the country, (2) of different types and sizes, and (3)

with historic and nonhistoric features.

To analyze the potential viability of public-private partnerships for each of

the 10 selected GSA properties, the contractors

• analyzed the local real estate markets,

• created a hypothetical partnership scenario and redevelopment plan, and

• constructed a cash flow model.

In the contractor’s judgment, the partnership scenarios were structured to

meet current budget-scoring rules and provisions in H.R. 3285, introduced

in the 106th Congress. These provisions included the requirements that the

• property must be available for lease, in whole or in part, by federal

executive agencies;

• agreements do not guarantee occupancy by the federal government;

• the government will not be liable for any actions, debts, or liabilities of any

person under an agreement; and

• leasehold interests of the federal government are senior to those of any

lender of the nongovernmental partner.

However, a determination on how the partnerships would be treated for

budget-scoring purposes would have to be made after more details are

available on the partnerships.

Attachment II: Methodology
Page 10

We accompanied the contractor on visits to the seven GSA properties that

had not been previously studied. We interviewed, or participated in

discussions with, developers and local officials in the areas where the

properties were located as well as officials from GSA. We reviewed the

contractors’ work on the 10 properties for reasonableness but did not

verify the data used by the contractors.

The partnership viability scenarios developed for this assignment are

hypothetical, and were based on information that was made readily

available by representatives of the local real estate markets, city

governments, and GSA. Any actual partnerships involving these properties

may be very different from these scenarios. In-depth feasibility studies

must be done to evaluate partnership opportunities before they are

pursued. There may be other benefits and costs that would need to be

considered, such as the possible federal tax consequences and the costs of

vacating property during renovation in some cases.

This study only looked at the potential benefits to the federal government

and private sector of public-private partnerships as a management tool to

address problems in deteriorating federal buildings. We did not evaluate

the potential benefits of other management tools that may be available for

this purpose. We did, however, discuss the implications of using publicprivate partnerships with OMB representatives.

We did our work between November 2000 and June 2001 in accordance

with generally accepted government auditing standards.
Page 11

Source: Ernst & Young LLP and Signet Partners.

Attachment III: Public-Private Partnership

Structure

(543010)
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