Budget Scoring: Budget Scoring Affects Some Lease Terms, but Full Extent Is Uncertain
Released: 2001-08-31T00:00:00

Letter

Background

Budget-scorekeeping rules were developed by the executive and legislative branches in connection with the Budget Enforcement Act of 1990. These rules are to be used by the scorekeepers to assure compliance with budget laws. Their purpose is to ensure that the scorekeepers measure the effects of legislation consistent with scorekeeping conventions and specific legal requirements. The rules are reviewed annually and revised as necessary to achieve that purpose. Leases may be of two general types—operating and capital. The Office of Management and Budget (OMB) identifies six criteria that a lease must meet in order to be considered an operating lease rather than a capital lease.

Ownership of the asset remains with the lessor during the term of the lease and is not transferred to the government at or shortly after the end of the lease term.

The lease does not contain a bargain-price purchase option. The lease term does not exceed 75 percent of the estimated economic life of the asset.

The asset is a general purpose asset rather than being for a special purpose of the government and is not built to unique specifications of the government lessee.

There is a private sector market for the asset. The present value of the minimum lease payments over the life of the lease does not exceed 90 percent of the FMV of the asset at the beginning of the lease term.

If a lease does not meet all six criteria above, it must be treated as a capital lease for budget-scoring purposes. For a capital lease, the net present value of the total cost of the lease is scored as budget authority in the year budget authority is first made available for the lease. For GSA operating leases, only the budget authority needed to cover the annual payment is required to be scored. As we previously reported, in general, capital facilities should be funded up front at the time the federal government enters into the commitment.

In June 1991, GSA wrote to OMB generally describing the policies and procedures it would follow to ensure the proper implementation of the new budget scoring rules. These rules were incorporated in OMB Circular A-11. Appendix B of the circular contains the scoring rules for lease- purchases and leases of capital assets. In March 1992, GSA wrote to OMB saying that after reviewing its nonprospectus inventory, as well as OMB policies and procedures, GSA concluded that nonprospectus leases should be considered operating leases for scoring purposes without the necessity of a case-by-case determination. In this letter, GSA stated that there was no practical way to implement a policy of determining whether each nonprospectus lease met the criteria for being considered an operating lease without severely damaging its ability to meet client-agency needs. GSA considered this view consistent with OMB’s intent, as well as an operational necessity. In April 1992, GSA issued guidance on lease scoring in which it stated that all nonprospectus leases are to be considered operating leases unless the lease is a lease-purchase, the lease contains a nominal or bargain purchase price, or the lease is on government-owned land. All nonprospectus leases that met one of these exceptions were to be scored as capital leases by the regions. All prospectus-level leases were to be scored at GSA’s central office.

In October 1998, GSA announced it was no longer following the policy of considering most nonprospectus leases as operating leases. Since then, according to GSA officials, GSA has required regional offices to apply the appropriate criteria to all prospectus and nonprospectus leases and that copies of the resulting scoring be retained in the regionally maintained lease file. GSA headquarters is to review the scoring of all prospectus-level leases.

Two of the six scoring criteria used to determine an operating lease concern the term of a lease: that the lease term not exceed 75 percent of the estimated economic life of the asset and that the present value of the minimum lease payments over the life of the lease not exceed 90 percent of the FMV of the asset at the beginning of the lease term. According to GSA officials, GSA’s leases generally meet the first of these two criteria. If GSA rents new space, it meets this criterion because it only has 20-year leasing authority and tax law specifies that a new building’s economic life is longer than 30 years (30 yrs. times 75% = 22.50 yrs.). If GSA rents older space, it generally requires it to be upgraded, which extends the building’s estimated economic life, thereby meeting this criterion. Thus, the remaining criterion that could affect the lease term is that the present value of the minimum lease payments over the life of the lease not exceed 90 percent of the FMV of the asset at the beginning of the lease term. For example, if a lease has a 20-year term whose present value of the minimum lease payments exceeds 90 percent of FMV then by reducing the 20-year term, the present value of the minimum lease payments is reduced while the FMV of the asset remains the same. This lowering of the percentage relationship between present value of the minimum lease payments and 90 percent of FMV allows a lease to meet this scoring criterion. However, if a lease does not meet any one of the other four scoring criteria, the lease would be a capital lease no matter what the term.

Budget Scoring Impacts Some Leases, But Full Extent Is Unknown

Six of GSA’s 11 regions identified 12 projects or leases for which the scoring process had affected the term of the lease. In one other region, according to a GSA official, GSA thought that the term of about eight other leases had been affected in the last 2 years but they could neither identify those leases nor the impact of budget scoring on the lease term. GSA officials from the other four regions said they could not identify any projects affected by budget scoring. Only 2 of the identified 12 projects—a lease for the Immigration and Naturalization Service and a lease for the Secret Service—were among the 39 prospectus-level projects reviewed, and none came from the 102 lease files we reviewed. According to GSA officials, other factors, such as the agency or the market, determined the term of these other leases. Table 1 lists the leases or lease projects that we or GSA identified as being affected by scoring.

According to GSA officials, during the planning for the Department of Transportation lease, it was realized that due to the rental rates in the District of Columbia, a 20-year lease would probably not satisfy the 90 percent scoring criterion. In order to address this issue, GSA reduced the lease term to 15 years, estimating that the present value of the minimum lease payments for a 15-year lease would not exceed 90 percent of the FMV. For the SSA lease, according to officials, it was originally submitted as new construction but not approved. GSA then decided to do it as a 20- year build-to-suit lease, but when reviewed it was determined that it would be a capital lease because it did not satisfy the 90-percent scoring criterion. At OMB’s direction, the lease was awarded as a 10-year lease because OMB thought that SSA space needs might be reduced in the future because of automation.

Factors Limiting the Identification of Lease Term Influenced By Scoring

Four factors limited the identification of leases affected by budget scoring, according to GSA officials. First, GSA did not begin determining whether each nonprospectus lease met the scoring criteria for being considered an operating lease until about October 1998. GSA issued guidance in 1992 that stated there was no practical way to implement a policy of determining whether each nonprospectus lease met the criteria for being considered an operating lease without severely damaging its ability to meet client-agency needs. Nonprospectus leases were to be considered operating leases unless the lease was a lease-purchase, the lease contained a nominal or bargain purchase price, or the lease was on government-owned land. Thus, it is unknown if nonprospectus leases would have been affected by scoring between 1992 and 1998. Second, prospectus-level leases were scored in headquarters until September 1998, and scoring records were not kept in the lease files that are maintained by GSA’s regional offices. Third, GSA headquarters does not maintain documentation on whether the scoring process affected the lease term. According to a headquarters official, although GSA kept copies of scoring for prospectus leases, the records do not show whether the term was directly affected by scoring. Fourth, according to GSA officials, budget-scoring rules affect an unknown number of leases because if staff believe a project will be affected by budget-scoring rules, they reduce the term to avoid the potential scoring conflict. However, they do not formally score the lease and do not use the scoring rules as a tool to identify the best term. As of October 1998, GSA’s regional offices were to score and document the scoring of both prospectus and nonprospectus leases, according to officials. However, the officials said that the files will contain only the final scoring sheets and not preliminary runs that might identify situations where a lease term was adjusted in order for the lease to score as an operating lease.

Overall Monetary Impact of 10-Year Leases Versus 20-Year Leases Is Not Known

We could not determine the actual monetary impact of reducing the lease term. However, we found two leases in which GSA requested 10-year and 20-year and 15-year and 20-year lease costs. GSA provided a consultant’s report showing the difference between 10- and 20-year lease costs for another project and the SEC lease had 15- and 20-year lease costs. GSA did not identify these two lease terms as being affected by budget scoring. However, the SEC lease term was affected by scoring. According to GSA officials, GSA does not generally seek comparisons of short- and long-term lease costs in the solicitation process. Also, GSA officials stated that the use of a 20-year lease is only appropriate in certain situations, such as if the agency has a long-term need and the federal presence is large enough in the market to backfill the space with other federal employees if the needs of the requesting agency change over time. Also, they pointed out that in most cases it would be less costly to construct a federal facility to meet a long-term need than it is to lease. We previously reported that construction was usually the least costly approach for meeting long-term space needs. Further, GSA pointed out that other factors, such as market, location, and the agency’s desires, affect the selection of the lease term.

While reviewing files, we identified two leases for which GSA had solicited offers for both 10- and 20-year and 15- and 20-year leases. The first lease was for a 20-year lease structured as either a 10-year lease with a 10-year option or a 20-year lease. The 20-year lease term was 3.24 percent less expensive per NUSF than the 10-year lease that was awarded. This lease was awarded as a 10-year lease with a 10-year option because the agency’s long-range plans were unknown. Eight final offers showed that the 20-year lease ranged from 0 to 12.9 percent less expensive per NUSF than the 10- year lease. However, for two other final offers the 20-year lease ranged from .06 percent to 1.19 percent more expensive per NUSF than the 10- year lease. The second lease was for a 20-year lease structured as a 20-year lease with cancellation rights at 15 years or a 20-year lease. The 20-year lease term was 5.56 percent less expensive per NUSF than the 20-year lease with cancellation rights at 15 years for the offer selected for award. The contract was awarded as a 20-year lease with cancellation rights at 15- years. It is not clear from the file why this option was chosen. Four final offers showed that the 20-year lease ranged from 5.56 percent to 7.75 percent less expensive per NUSF than the 20-year lease with cancellation rights at 15 years. However, for two other final offers the 20-year lease was 5.99 percent and 7.97 percent more expensive per NUSF than the 20-year lease with cancellation rights after 15 years. Furthermore, a consultant’s report on locating an FBI building in Texas showed that a 20-year lease was 32 percent less expensive per square foot than a 10-year lease. The consultant pointed out that the cost difference might be due to the specialized nature of the FBI building.

The SEC lease project had offers ranging from 10 to 20 years. For the successful offer, the 20-year lease costs and the 15-year lease costs were the same per RSF. Three other final offers showed that the 20-year lease costs ranged from 1.3 percent to 4.1 percent less expensive per RSF than the 15-year lease costs. One final offer included 10-year lease costs. This offer showed that 20-year lease costs were 8.8 percent less expensive per RSF than 10-year lease costs per RSF. Further, 15-year lease costs were 7.4 percent less expensive per RSF than 10-year lease costs per RSF. The difference identified between terms and costs in these three examples are not projectable to other leases because other factors such as market condition (whether rental rates are high or low) affect the cost of a lease.

In testimony before the Subcommittee on Public Buildings and Economic Development, House Committee on Transportation and Infrastructure, on May 15,1997, a private industry real estate official testified that a 20-year lease term could have annual rental rates as much as 33 percent less expensive than a 10-year lease and 13 percent less expensive than a 15- year lease. Also, he testified that a 15-year lease term can be as much as 23 percent less expensive than a 10-year lease. He further stated that renewal options in a lease are more advantageous than having to renegotiate a new lease for the same location. While GSA officials agree that a long-term lease generally has a lower cost than a short-term lease, they could not quantify the difference between a 20-year lease or 15-year lease and a 10- year lease. Also, they stated that it is generally less costly to construct a federal facility to meet a long-term need—20 years or more—than it is to lease. Furthermore, they pointed out that other factors such as the desires of the agency and the market must be considered along with cost.

For nine GSA lease acquisitions, we previously reported that construction would have been less costly in eight of the nine cases, with the range of cost differences being from a negative $.2 million to a positive $48.1 million for construction. For 11 cities throughout the country, we reported that to build a hypothetical 100,000 square foot office building versus obtaining a 20-year lease, the estimated range of cost savings for construction versus leasing was from $.3 million in St Louis, MO, to $14 million in Washington, D.C.

Also, we previously reported that the budget scoring rules favor leasing and that one option for scorekeeping that could be considered would be to recognize that many operating leases are used for long-term needs and should be treated on the same basis as purchases. This would entail scoring up front the present value of lease payments covering the same time period used to analyze ownership options. Applying the principle of up-front full recognition of long-term costs to all options for satisfying long-term space needs—purchases, lease-purchase or operating leases—is more likely to result in selection of the most cost-effective alternative than the current scoring rules would.

Factors Other Than Scoring That Influence Lease Term Selection

According GSA officials, while scoring does affect the term of some leases, the term of most leases is determined by various factors other than budget scoring, such as the type of space—existing or build-to-suit—lease term desired by the agency, rental market condition, and location of the structure. The importance of each variable may be different for each lease.

GSA officials said that for existing space, lease terms do not usually exceed 10 years. This has been a standard practice for some time. If the requirement is for build-to-suit space, then the term of the lease may have to be longer than 10 years to accommodate the lessor’s ability to finance the building. It is these build-to-suit leases that are most likely to be affected by scoring because the lessor must have a longer term lease to get financing for a new structure.

The lease term to which the agency is willing to commit is another important factor. GSA officials stated that some agencies told GSA that the agency only has authority to commit to a maximum of a 10-year lease. Other agencies only want leases of 10 years or less because of the changes occurring within the agency, such as downsizing or consolidation. An example, according to GSA officials, is the Internal Revenue Service; because of downsizing it does not want to sign a lease longer than 10 years.

The rental market conditions also affect a lease’s term. GSA does not want to commit to a long-term lease when the market rent is considered high. Conversely, if market rent is low, GSA will consider a longer term lease, according to officials. An example is a lease for the Customs Service in Seattle, WA, for which GSA did not want a long-term lease because the current rental rates were high.

Location becomes an important factor because GSA is required to take space back from an agency with only 120 days notice. So in areas with a limited federal presence, GSA does not want to commit to leases where the space cannot be easily back filled with other federal agency employees, according to GSA officials. For example, in small towns, GSA would not want to commit to a lease term longer than an agency wanted when it is the only federal agency in the location. GSA would not be able to find another federal tenant for this space.

Conclusions

Although efforts to address budget-scoring rules did result in shorter term leases in some cases, we could not determine the total number of leases where the term was actually affected by budget scoring because of GSA’s documentation process for scoring leases. Further, while a shorter term lease can be more costly than a longer term lease, we could not determine the actual overall monetary impact of shorter lease terms because GSA does not generally seek comparisons of short- and long-term lease costs in the solicitation process. In addition to having some effect on the lease term, our previous work has shown that budget scoring can affect the government’s decision whether to construct or lease a facility. Also, we have previously reported that the budget-scoring rules have the effect of favoring leasing and that one option for scorekeeping that could be considered would be to recognize that many operating leases are used for long-term needs and should be treated on the same basis as purchases or construction.

Because of the overall effect budget scoring appears to be having on the acquisition of real property, we plan to address the effects of budget scoring on real property acquisition as part of a govermentwide review of real property management we recently initiated.

Scope and Methodology

To address identifying leases affected by scoring, we reviewed OMB’s guidance on scoring leases (Circular A-11, Appendix B, and Circular A-94), interviewed GSA officials in headquarters and all 11 regions, and reviewed 102 active lease files with terms from 10 to19 years and 100,000 RSF or more in GSA regions 3, 7, 8, and 11, which were the 4 regions with the most leases meeting our criteria of 10 to 19 years and 100,000 RSF or more. We dropped 8 lease files from our original selection of 110 files because the files could not be located during our visit or had been moved to other locations prior to our visiting the region. We did not verify the accuracy of the data used to select the lease files. To determine monetary impact of scoring on the lease term, we reviewed congressional testimony, previous GAO reports, 102 GSA lease files, and 8 final offers for the SEC lease; and we interviewed officials in GSA headquarters, all 11 GSA regions, and SEC. To identify other factors influencing lease term, we reviewed 102 active GSA lease files and interviewed GSA headquarters and regional officials.

We conducted our review at GSA and SEC between October 2000 and July 2001 in accordance with generally accepted government auditing standards. We obtained comments on a draft of the report from GSA and SEC.

Agency Comments

On August 10 and 14, 2001, we received written comments from the Associate Executive Director, SEC, and the Commissioner of GSA’s Public Buildings Service (PBS), respectively. The SEC official provided clarifying information, which has been included in the report. The PBS Commissioner basically agreed with us that budget scoring is affecting the lease term and provided additional comments, which he believes support this position. The first comment stated that seasoned leasing specialists said that the use of 20-year leases had declined since the Congress passed the Budget Enforcement Act of 1990. While this may be true, GSA did not have documentation on the impact of budget scoring on the lease term, other than for the cases cited. Also, it is possible that other factors, such as market conditions, contributed to the decline in the use of 20-year leases. Second, GSA stated that the National Capital Region sets the term of all the above-prospectus leases it submits as part of its capital plan at 10-years, except in certain cases, to avoid budget-scoring problems. For the fiscal year 2000 and 2001 prospectus-level leases that we reviewed, this is accurate. However, prior to fiscal year 2000, both the Patent and Trademark Office and the Department of Transportation leases were submitted for longer terms, 20 and 15 years, respectively. Third, GSA said while options to renew a lease were advantageous, it did not generally seek them for leases with 10-year terms because options are scored as part of the 90-percent scoring criterion and could result in a capital lease. While GSA is correct that OMB guidance requires options to be considered in scoring leases, there is an exception to this rule. According to OMB’s guidance, agencies do not have to include an option for budget scoring if exercising the option would require additional legislative action. Lastly, GSA raised the issue of short-term leases resulting in increased rental costs in some cases because they lead to shorter amortization periods and higher mortgage payments for lessors who use federal leases as collateral for financing. While the report shows that in certain cases shorter term leases are more expensive than long-term leases, we did not look at whether this increased cost was driven by shorter amortization periods and higher mortgage payments. GSA also made some technical comments, which we have reflected in the report where appropriate. We have included GSA’s written comments in appendix I.

We are sending copies of this report to the Chairmen and Ranking Minority Members of congressional committees with jurisdiction over GSA and SEC. We are also sending copies to the Administrator, GSA, and the Chairman, SEC. Copies will also be made available to others upon request.

Key contributors to this report were Ronald L. King and Thomas G. Keightley. If you have any questions, please contact me or Ron King on (202) 512-2834.

Appendix I: Comments From the General Services Administration