Enabling Infrastructure Investment - NCPPP

Enabling Infrastructure Investment Leveling the Playing Field for Federal Real Property ULI Public Development and Infrastructure Council November 2016

Enabling Infrastructure Investment Leveling the Playing Field for Federal Real Property ULI Public Development and Infrastructure Council November 2016

About the Urban Land Institute

Project Staff

The Urban Land Institute is a nonprofit research and education organization whose mission is to provide leadership in the responsible use of land and in creating and sustaining thriving communities worldwide.

Todd Herberghs Executive Director National Council for Public-Private Partnerships

Established in 1936, the Institute today has more than 39,000 members and associates from 82 countries, representing the entire spectrum of the land use and development disciplines. ULI relies heavily on the experience of its members. It is through member involvement and information resources that ULI has been able to set standards of excellence in development practice. The Institute is recognized internationally as one of America’s most respected and widely quoted sources of objective information on urban planning, growth, and development.

Paul Kalomiris Deputy Director National Council for Public-Private Partnerships

About the National Council for Public-Private Partnerships The National Council for Public-Private Partnerships is a nonprofit, nonpartisan organization founded in 1985. NCPPP’s mission is to advocate and facilitate the formation of public/ private partnerships at the federal, state, and local levels and to raise the awareness of the means by which the cooperation can cost-effectively provide the public with quality goods, services, and facilities. The Council is a forum for the brightest ideas and innovators in the partnership arena. Its growing list of public and private sector members, with experience in a wide variety of public/ private partnership arrangements, and its diverse training and public education programs represent vital resources for partnering nationwide. The Council’s members bring an unmatched dedication to providing the most productive and cost-effective public services.

Marta Goldsmith Senior Adviser National Council for Public-Private Partnerships

Stockton Williams Executive Director, ULI Terwilliger Center for Housing Urban Land Institute James A. Mulligan Senior Editor Urban Land Institute Joanne Platt, Publications Professionals LLC Manuscript Editor Betsy Van Buskirk Creative Director Urban Land Institute Craig Chapman Senior Director, Publishing Operations Urban Land Institute

© 2016 by the National Council for Public-Private Partnerships 2020 K Street, NW Suite 650 Washington, DC 20006 © 2016 by the Urban Land Institute 2001 L Street, NW Suite 200 Washington, DC 20036 Printed in the United States of America. All rights reserved. No part of this book may be reproduced in any form or by any means, electronic or mechanical, including photocopying and recording, or by any information storage and retrieval system, without written permission of the publisher. Recommended bibliographic listing: National Council for Public-Private Partnerships/Urban Land Institute. Enabling Infrastructure Investment: Leveling the Playing Field for Federal Real Property. Washington, DC: Urban Land Institute, 2016.

Cover photos: Top: Federal Trade Commission Building, Washington, D.C. Carol Highsmith/Wikimedia. Bottom: Washington, D.C. Pixabay.

3 | Enabling Infrastructure Investment

Contents 5 Foreword 6 Executive Summary 7 Introduction 10 Current Approach—and an Alternative 15 Recommendations 18 Conclusion 19 Appendix: About the Project 21 Notes

The Pension Building, home of the National Building Museum, in Washington, D.C. Gryffindor/Wikimedia Commons


Foreword Donald Trump has signaled that infrastructure will be a top priority in his administration. His policy documents indicate a focus on pursuing “an ‘America’s Infrastructure First’ policy that supports investments in transportation, clean water, a modern and reliable electricity grid, telecommunications, security infrastructure, and other pressing domestic infrastructure needs” and state an intent to “leverage new revenues and work with financing authorities, public/private partnerships, and other prudent funding opportunities.”1 Much has been written about the state of public infrastructure in the United States. Most objective analyses conclude that this issue is serious; many facilities are in need of replacement or repair and many more are poorly maintained. This situation is true for both the civil works infrastructure—roads, bridges, tunnels, airports, railroads, ports, and waterways—and federal real estate that the government owns and occupies, including buildings, bases, and hospitals. Although civil works infrastructure has begun to see benefits from innovative financing and public/private programs authorized by Congress, the fiscal and political environment has made it difficult for the federal government to participate in partnership funding opportunities for federal real estate under the present budgetary rules for scoring projects. The National Council for Public-Private Partnerships (NCPPP) and the Public Development and Infrastructure Council of the Urban Land Institute (ULI) undertook this project to explore the opportunities and options for responsible reform of the federal project scoring rules as they relate specifically to one asset class—federal real estate—as a way to propose solutions that may be applicable to other asset classes. A small Advisory Group of leading experts on federal budgeting and public/private partnerships was convened to guide the project. Its findings and recommendations, as well as a description of the project, are included in this report. ULI and NCPPP wish to acknowledge the work of the members of the project Advisory Group in developing these recommendations, in participating in the various events, and in writing this report. We especially wish to thank Dan Tangherlini, chair of the Advisory Group, for his leadership, insights, perseverance, and work as principal author of this report. We would also like to thank those who participated in both the Advisory Group discussion sessions and the special Experts Roundtable held in conjunction with the 2016 ULI Spring Meeting. In addition to the members of the Advisory Group, we want to thank Marta Goldsmith for her work in organizing this effort, Sandy Apgar for his input and research, David Haun for his willingness to participate in various events and to serve as a capable foil, and Susan Irving of the U.S. Government Accountability Office for her steadfast efforts to explain the current approach. Finally, ULI and NCPPP express their appreciation to Alvarez & Marsal Public Sector Real Estate Services, the Association for the Improvement of American Infrastructure, Booz Allen Hamilton, and Hunt Companies Inc. for their generous support of this project. It is our hope that the new administration will consider these ideas as it explores strategies to address our serious infrastructure deficit and to support growth in the American economy.

Sandra Sullivan, President National Council for Public-Private Partnerships

Wes Guckert, Chair Public Development and Infrastructure Council Urban Land Institute


Executive Summary Much of the debate on creating a meaningful framework for the federal government to employ public/private partnerships and other alternative financing mechanisms for federal real estate has revolved around how budget scoring has negatively affected the government’s ability to use alternative project delivery methods, such as public/private partnerships. But scoring is NOT a bad thing. In fact, scoring is intended to shed light on the financial implications of government actions, to monetize decisions, and to create a framework for transparency and tradeoff. However, as project Advisory Group member Dorothy Robyn wrote in an April 2014 piece for the Brookings Institution, “The budgetary rules that govern investment in these assets are a blunt instrument that does serious collateral damage. Reforming these rules would allow the government to shrink its real estate footprint, modernize its legacy infrastructure for the 21st century, and save billions of dollars.”2 We now have nearly 25 years of experience with the current scoring and evaluation regime and can review the outcomes—both intended and unexpected—of the Budget Enforcement Act of 1990 and its subsequent modifications. In addition, the new administration and Congress will continue to face fiscal constraints, pressure for a balanced budget, and the need to demonstrate success and progress. We believe the installation of a new administration and Congress presents an opportunity to reconsider current practice and to develop and present a thoughtful set of strategies for the new leadership to explore alternatives. Therefore, we are recommending that the incoming administration prioritize reform of the means of financing and budgeting for the federal real

estate investments. These reforms should include creating avenues for private and commercial investment and finance. Our key recommendation is that the administration and Congress revisit the existing regime of scoring operating and capital leases, capital investments, and purchases to eliminate the exceptions that allow the costs of such investments to be spread over multiple fiscal years. In place of the current regime, these types of investments should be evaluated on a life-cycle cost basis and budget authority for the net present value of the investment recorded in the year of the supporting appropriation. The project Advisory Group explored the following four ideas: n In the short term, the Office of Management and Budget (OMB) should test an alternative approach to scoring real property transactions that eliminates exceptions that allow the budgeted cost of investments to be spread over multiple fiscal years. n Federal investments in real estate assets should be evaluated on a life-cycle cost basis, with upfront funding provided for the net present value of long-term costs for all investments. n OMB should develop and evaluate a model that calculates the long-term cost of deferred maintenance of federally owned real estate, effectively scoring the “cost of doing nothing.” n The administration and Congress should reconvene a Commission on Budget Concepts to review the performance of the current model and to develop new paradigms for assessing the cost and value of capital investments.


Introduction The unmet needs for infrastructure investment have been documented as reaching into the trillions of dollars, yet the limitations on the financial capacity of government have never been more acute. One possible solution that has surfaced is the public/private partnership—a means of financing public infrastructure that relies on various forms and degrees of private investment.

The National Museum of the American Indian–New York at the Alexander Hamilton U.S. Custom House in New York City. Ingfbruno/Wikimedia Commons

Other industrialized nations, such as the United Kingdom, Canada, and Australia, as well as state and local governments in the United States, have turned to public/private partnerships (PPPs, or P3s) to help address these needs. Some argue that PPPs expand the government’s capacity for long-term financing of much-needed transportation, water, and real property infrastructure by providing direct access to private capital.

However, for a variety of reasons, the ability of the U.S. government to use PPPs for federal infrastructure projects remains limited. That limitation is due, in large part, to the federal government’s inability to enter into project-specific, long-term financial obligations that are essential to access private capital. Although PPPs have become a subject of policy discussion and debate, they are not widely used as a means of federal support for financing our nation’s federally funded infrastructure. There are, however, a number of instances where the federal government has embraced PPP approaches. For example, the Transportation Infrastructure Finance and Innovation Act has been instrumental in facilitating the use of PPPs for highway projects. The 2014 Water Infrastruc-


The U.S. Infrastructure Deficit According to a 2015 report by the Office of Economic Policy in the U.S. Treasury Department,a underinvestment in public infrastructure imposes massive costs on our economy. Motorists in the United States spend 5.5 billion hours annually in traffic, resulting in costs of $120 billion in fuel and lost time. U.S. businesses pay $27 billion in additional freight costs because of the poor condition of roads and other transportation infrastructure. Continuing deterioration of water systems throughout the United States results in about 240,000 water main breaks annually, causing significant property damage and costly repairs. Yet outlays for transportation and water infrastructure made by all levels of government, as a share of gross domestic product, have declined in recent decades. A 2014 report by the Government Accountability Officeb indicates that the Federal Real Property Profile estimates for deferred maintenance and repair in fiscal year 2012 were $4.7 billion for the General Services Administration, $5.1 billion for the Department of Energy, $14.4 billion for the Department of the Interior, and $12.5 billion for the Department of Veterans Affairs. a. Elaine Buckberg, Owen Kearney, and Neal Stollerman, “Expanding the Market for Infrastructure Public-Private Partnerships: Alternative Risk and Profit Sharing Approaches to Align Sponsor and Investor Interests,” Office of Economic Policy, U.S. Department of the Treasury, Washington, DC, April 2015. b.“Federal Real Property: Improved Transparency Could Help Efforts to Manage Agencies’ Maintenance and Repair Backlogs,” GAO-14-188, U.S. Government Accountability Office, Washington, DC, January 23, 2014.

ture Finance and Innovation Act will potentially allow the availability of similar project delivery models in the water and wastewater sectors. Nevertheless, the ability of the U.S. government to use PPPs to finance projects in other asset classes—particularly those intended for use by or for the direct benefit of agencies, such as federal real p roperty—remains limited, due in large part to current budgetary rules for project scoring. In general, federal budget scoring concepts are based on the premise that fiscal actions should be fully accounted for at the time an action is taken. This principle provides accountability, transparency for taxpayers, and flexibility for future decision makers as they are not locked into long-term agreements of their predecessors. These precepts combine to meet the goal to control and measure federal spending. However, as currently implemented, the practice of scoring capital expenditures (or capital leases) fully in the first year of obligation has the potentially unintended effect of favoring operating costs, entitlements, or tax expenditures over capital or other asset-based

funding priorities. More starkly put, because of differences in budgetary accounting treatment, federal spending is tilted toward transfers over investments. Furthermore, the economic principle of “user pays”—that is, the beneficiary of a public expenditure should help defray costs—is not brought to bear under this approach. The current guidelines used to score privately financed infrastructure came about in the early 1990s in reaction to perceived abuses in the area of real estate lease purchases. At the time those rules went into effect, the federal government elected to use the principles embodied in Financial Accounting Standards Board (FASB) Statement 13, which is a set of accounting rules designed to govern how private sector companies either expense or capitalize leases. Now that more than 25 years have passed, it is necessary to revisit the continued application of these principles. This reassessment is particularly important because the accounting rules that served as the basis for the current scoring methodology have themselves evolved and have been amended,


now distinguishing capital leases from other forms of PPP and privately financed infrastructure, such as concessions (as contemplated under Government Accounting Standards Board Statement 60). Moreover, these current budget scoring policies do not reflect global norms. As set forth in OMB Circular A-11, Appendix B, our federal government has opted—by policy—to use the “control methodology” for determining the budgetary treatment for PPP projects. This approach focuses principally on the level of government control of services to determine whether the asset should be classified as “on balance sheet” and scored as a capital purchase (essentially, as debt), with all obligations associated with the PPP (including future payments) being scored upfront. The risk/reward methodology, however, is a more widely applied approach, as codified, for example, in European System of Accounts ESA10 and ESA95. The fundamental principle in the risk/ reward methodology is that economic ownership of an asset lies with the party that possesses the asset and carries the risks, benefits, and burden in connection with the asset. Where most of the project risk has been transferred to the nongovernment partner, then the assets should be

classified as “off-balance sheet,” and any budget payments would be scored like an operating lease, over the life of the project. If project risk is not transferred, the asset would be classified as “on balance sheet” and scored upfront. This approach, which is well regulated and understood on a global level, achieves the same objectives as current OMB budget scoring guidelines, while more accurately reflecting the underlying risk allocation contemplated in PPP arrangements. Although some members of the project A dvisory Group came to the discussion thinking that budgetary scoring rules are a major problem and need immediate reform, the group’s position evolved, and they ultimately concluded that the current scoring regime could work well, if it were applied rigorously and universally. In fact, the members of the Advisory Group recognized that it may be many of the exceptions to current scoring procedures that are the real problem. Rather than recommend that the number and types of exceptions be expanded, their final unanimous recommendation is that the federal government eliminate the exceptions and create a level playing field for evaluating the relative costs and merits of different projects and financing structures.


Current Approach—and an Alternative To know where to go, it is useful to know where we have been. Under the current rules of appropriation scoring used to determine how to budget for an investment, a lease is scored as either an operating lease or a capital lease, using criteria set forth in OMB Circular A-11, Appendix B. Those rules require any lease for which the net present value of its lease payments exceeds 90 percent of the value of the building to be considered a capital lease and the full amount of the lease payments to be funded in the first year of an appropriation. Clearly then, an agency seeking to lease a facility will work to structure the term and rent so that it does not need to seek a major, upfront appropriation—an extremely difficult request in an age of continuing resolutions, sequestration, and severe budget constraints. The result is a virtual spin cycle of leasing, with the government leasing a building, re-signing the lease, and leasing it again, paying for a building repeatedly over time. A recent Government Accountability Office study found that “in general, buying a building often costs less than entering into a long-term lease.” However, the report continued, the General Services Administration (GSA) “typically lacks the budget authority . . . needed to purchase buildings outright and, according to GSA officials, must resort to leasing to fulfill the federal government’s space requirements.”3 Federal budget scoring concepts are based on the premise that fiscal actions should be fully accounted for at the time the action is taken. This principle provides for (a) accountability for actions, (b) transparency for taxpayers, and (c) flexibility for future decision makers, as they are not locked into long-term agreements made by their predecessors. Those precepts combine to meet the goal to control and measure federal spending.

The Current Model and Unintended Consequences As an example, the current regime of scoring capital expenditures (or capital leases) fully, in the first year of obligation—as required by OMB budget scoring Circular A11, Appendix B—has the poten-

tially unintended effect of favoring operating costs, entitlements, or tax expenditures over capital or other asset-based funding priorities. More starkly put, these rules tilt spending toward transfers over investments, bypassing a first principle of infrastructure financing—user pays. This approach is exacerbated by exceptions to the rules that allow certain leases and investments to be scored on an operating basis as annual recurring funding rather than with a single upfront appropriation. Perversely, this exception—primarily built into GSA’s Federal Buildings Fund—makes a multiyear lease a more attractive strategy than a capital investment, because the lease is scored only at the time of obligation on the basis of the annual expenditure versus the full cost of the capital investment. In other words, a building that would cost $100 million to build would be scored at that level in the first year of obligation, whereas the lease of an equivalent building over ten years—even if it were more costly on a net present value basis—would require funding for only the first year’s rent. An excellent example of this unintended consequence is the former David Nassif Building in Washington, D.C. The Nassif Building was built in 1969 with the express purpose of housing the then new U.S. Department of Transportation (DOT). It would be the first agency headquarters not owned by the government and the largest privately owned building in Washington. The land for the building was purchased from a quasi-federal agency, the Redevelopment Land Authority, for $5.9 million, and construction was financed for $38 million (with an actual cost estimate of $27.5 million). The initial 20-year lease cost a total of $98 million. DOT extended its lease several times until 2000, when it announced it would leave the building, which it did in 2007. After a two-year renovation costing $250 million and two years of lease-up, the building was renamed and sold fully leased for $734 million. It is appraised as the most valuable privately owned building in Washington. It is occupied exclusively by federal agencies with ten-year term leases at $50 per square foot.


Constitution Center, the former David Nassif Building, in Washington, D.C. ©Tim1965—Own work, CC BY-SA 3.0/Wikimedia Commons

To avoid this outcome, the Advisory Group discussed a variety of alternative scoring regimes and exceptions, some of which are described below. However, they concluded that the best approach would likely be to place the various options—such as construction of the building by the federal government, leasing from the private sector, or some hybrid—on an equal analytical and scoring footing so that the net present value of each option could be calculated and a decision made, based on the best long-term value to the federal government at the lowest overall— not annual—cost.

Private versus Public Cost of Capital and Risk Those who defend the current regime for budgeting federal capital expenditure over an alternative with more privately financed capital investments that are leased back to the government cite several primary reasons for their position. In particular, and mentioned earlier, are the issues of transparency and flexibility. Fully funding a capital investment in the first year makes the cost of an investment clear. Further, this approach forces those making the investment decision to identify and set aside the resources to fund it, ensuring future flexibility for subsequent decision makers who will not inherit multiple streams of contractually obligated expenses. Although this structure breaks the “user pays” bond—in that prior generations will pay for the consumption of future

ones—it seems like the lesser of two evils when decision makers are trying to manage or control near-term expenditures. The more frequently cited reason for this approach to budgeting, though, is the issue of the relative cost of public versus private capital. More succinctly put, the U.S. government—as the largest and safest credit risk in the world—is able to borrow at the lowest interest rates available. As this argument goes, why would one commit to paying a higher cost of capital by allowing private financing of a public investment when the government could pay for that investment with much less expensive capital it borrows itself? One problem with this logic is that through spending caps, sequestration, and continuing resolutions, the federal government has created two classes of public capital. One is the least expensive capital available in the market, which is what the federal government uses to cover its current accounts balance—or put more starkly, fund its recurring deficit spending. The other class of capital has an undeterminable effective rate, in that it is not extractable from the budgeting process. That is to say, the unwillingness to fund reinvestment in federal real estate leaves agencies with two choices: (a) to allow the asset to continue to deteriorate, without adequate maintenance or reinvestment (a course that leads to an eventual cost that is five to seven times more than if the asset were maintained); or


(b) to rent the asset from the private sector, with no ownership or equity participation by the federal government. This latter scenario means the federal government will pay a market rate for the asset that includes the private cost of capital plus a premium associated with the risk of the government abandoning its tenancy, local taxes, and profit. In other words, to avoid paying the private cost of capital in a transaction, the federal government pays the private cost of capital plus a premium that includes the increased cost of dilapidation. Another issue cited by those who support the current approach is private sector risk. The theory is that for the private sector to be eligible for the private cost of capital there has to be some inherent risk above that of inflation, which is essentially the public cost of capital. In theory, the government’s inability to guarantee a tenancy that will recover more than 90 percent of the value of a leased building justifies a risk premium for paying the implied interest rate of an operating lease. However, this rationale ignores the fact that market-rate rents are adjusted to account for the likelihood of renewal, as well as the cost of capital renewal of a tenant, after the cost of capital is accounted for. In essence, this approach actually permits a risk premium to be charged twice in an operating lease—once for interest rates and once for the risk of renewal—when compared with the public cost of capital. Although the Advisory Group first considered the inherent inconsistencies in these two principles underlying the current scoring regime as a reason to explore additional exceptions to the existing scoring structure, their position evolved. Instead, they recognized that these assumptions could be tested—rather than assumed—if a project evaluation and scoring regime was developed that allowed alternative approaches to be compared on a consistent, life-cycle, net present value basis.

more risk when private financing is used to pay for public infrastructure. The two examples are the Military Housing Privatization Initiative (MHPI) and the Energy Savings Performance Contract (ESPC) mechanism.

Military Housing Privatization Initiative The MHPI illustrates the potential for private financing to benefit investment in public infrastructure. Originally a five-year pilot project run out of the Office of the Secretary of Defense, Congress authorized the MHPI in the mid-1990s to address an acute lack of adequate housing for military families. According to a report issued by the Department of Housing and Urban Development, the Department of Defense (DOD) had privatized 98 percent of its domestic housing units by 2012—or 219,000 houses—using the MHPI. In addition, by 2011, the program had cleared a $7 billion backlog, built 137,500 new and renovated units, and generated a minimum six-to-one private/public investment ratio.4 The MHPI was approved under the otherwise unaccommodating A-11 rules because of the risk assumed by the private sector. The primary risk assumed by the private parties is that DOD families with housing subsidies can choose to live anywhere and are not necessarily required to live in the MHPI homes. This factor created an incentive for the MHPI properties to be competitively priced and well managed. Under the program, DOD transfers land under a 50-year ground lease and then effectively leases it back with improvements through the military housing subsidy program. Although there have been some issues with the initial speed of project ramp-up, concerns of more

Two Recent Exceptions: MHPI and ESPCs The absence of a means to evaluate financing alternatives on an equal scoring footing led to two of the more substantial exceptions to the current scoring regime. These exceptions are based on the premise that the private sector would accept 12 | Enabling Infrastructure Investment

Military family housing on Whidbey Island in Washington state. Courtesy of Hunt Companies

traditional commanders regarding the potential for diminished unit cohesion, and concerns raised by the U.S. Government Accountability Office, most of those involved consider the program a success because of meaningful quality-of-life improvements for military families. Despite challenges posed by base closures and troop drawdowns, the program continues to work well even while the Congressional Budget Office (CBO) has publicly criticized OMB’s decision to allow the program under current scoring rules. Over time, OMB has incrementally changed its guidance to more c losely align with the CBO’s views.

Energy Savings Performance Contracts Another example of the use of private capital for federal government infrastructure is the Energy Savings Performance Contract. The projects are multiyear, privately financed contracts to upgrade or improve the energy efficiency of government facilities. The contractor is paid an amount designed to cover its investment through proceeds that come from reduced expenditures on energy. The contracts are scored and paid on a recurring annual basis, and not upfront, as in a lease purchase or capital lease. This is the case even though the government retains the improvements at the end of the contract term. An exception within Circular A-11, Appendix B, permits the ESPC to be scored on an annual basis if it is used to fund an “energy conservation measure.” A project is defined as an energy conservation measure if it meets the following criteria: n It is applied to a federal building. n It improves energy efficiency. n It is “life-cycle cost-effective,” meaning that the project reduces the total costs of owning, operating, and maintaining a building over its useful life. n It involves energy conservation and may include cogeneration facilities, renewable energy sources, improvements in operations and maintenance efficiencies, or retrofit activities. This exception is codified within Circular A-11, Appendix B, and is the result of a 1998 OMB memorandum (M-98-13, Federal Use of Energy Savings Performance Contracting), although the CBO has never accepted this practice and continues to score ESPCs as federal spending.

An Example of a Possible Alternative A possible alternative to the Nassif Building outcome exists in the example of the General Post Office building, just across the National Mall in Washington, D.C. In this instance, GSA—the largest of the federal government’s commercial real estate management agencies—outleased a former office building for which it could not muster appropriations support to renovate and modernize. Originally built to house the Post Office Department in 1832, the General Post Office is one of the oldest official buildings in Washington, D.C. It was designed by the same architect as that of the Capitol and Washington Monument. In disrepair and largely abandoned by the federal government in 1988, GSA chose to offer it for lease to a private partner. In 2000, the Kimpton Hotel & Restaurant Group signed a long-term lease for the property with the aim of converting it into an upscale hotel. The Hotel Monaco opened in 2002 and heralded the revival of the newly named Penn Quarter neighborhood. The Hotel Monaco/General Post Office exemplifies the potential for PPPs to preserve historic federal buildings and provide necessary space. An alternative model would have had a private developer, similar to Kimpton, lease the building from the federal government, renovate the building, and lease it back to the federal government at a market rate. In this model, the private partner can leverage tax incentives—such as the historic preservation tax credit—and private sector contracting and building management can speed project delivery and quality. Yet the federal government—and ultimately the taxpayer—retains the underlying ownership and an equity stake in the increased value of the asset. Those who oppose this type of partnership cite the relative cost of capital between the federal government and the private sector, as well as the lack of private party risk as a means of creating incentives for cost-effectiveness and quality. These are very real concerns, but these differences could be offset by a variety of flexibilities available to the private sector. The Advisory Group concluded that too many of the general statements made about one approach or another are based


on assumptions and received wisdom. The best approach would be to evaluate alternatives, solicit market input, and make decisions on estimated net present value that are based on actual project data and experience. The current regime, with its bias in favor of operating leases, precludes this evaluation and analysis. The Advisory Group raised the question of whether this sort of public/private collaboration

could have been used to finance a renovation of the building (or a similar building) for continued federal office use under a lease/leaseback transaction. Current rules effectively prohibit such a transaction, but a look at the case study suggests that those rules should be reconsidered. Applying consistent evaluation and scoring criteria to the various alternatives would allow the fair consideration of a federally funded or PPP-funded rehabilitation of an existing building as a substitute for new construction or a long-term lease.


Hotel Monaco in Washington, D.C. ©APK yada yada/Wikimedia Commons

Recommendations The background, examples of suboptimal outcomes, attempts to work around the existing structure at the margins, and the potential for a better process, all outlined in this report, led the Advisory Group to conclude that a change in administration and Congress presents an opportunity to shift course. A new administration should test alternatives, study reform, and engage in a deeper policy discussion. Therefore, the Advisory Group recommends four actions: n Test an alternative approach to scoring real property transactions by revisiting the existing regime of scoring operating and capital leases, capital investments, and purchases to eliminate exceptions that allow the budgeted costs of some investments to be spread over multiple fiscal years, while scoring others in the first year. n Evaluate investments on a life-cycle cost basis and provide upfront funding for the net present value of long-term costs for all investments. n Develop and evaluate a model that calculates the long-term cost of deferred maintenance of federally owned real estate, effectively scoring the “cost of doing nothing.” n Convene a new Commission on Budget Concepts to review the performance of the current model and develop new paradigms for assessing the cost and value of capital investment.

Alternative Approaches The Advisory Group believes that real property, or commercial real estate (CRE), could serve as the ideal pilot category for exploring new capital budgeting and scoring concepts. CRE is a particularly useful category for study and potential disparate treatment, given the very robust nature of the parallel private sector marketplace for this type of asset. The robust private marketplace and widely available data for assessing cost, price, and value should alleviate the traditional concerns of opening a proverbial Pandora’s box of a dditional “investment” types, such as missile systems. In other words, the idea of a CRE pilot study serving as a budgetary wedge is addressed by the fact

that the CRE market is vibrant, transparent, and well-functioning. As such, considerable information is available for evaluating comparable pricing, performance, and value. In addition, federal CRE already has (a) a well- developed mechanism for evaluating the prices of alternatives, for recovering cost through agency rental payments, and for financing through the robust structure of the Federal Buildings Fund; and (b) a robust review process for both the executive and legislative branches. Evaluating recent Federal Buildings Fund investments—such as the new DOT headquarters, the Old Post Office lease, and the pending FBI relocation—could provide excellent examples of life-cycle cost comparisons under today’s budgetary rules versus a comprehensive reformed budgetary scoring structure. The next administration should work with key congressional committees to rethink capital and operating lease scoring rules to consider total cost, continuing need, and residual values. In particular, attention should be paid to the fact that under current rules, any lease agreement that commits to terms, the net present value of which exceeds 90 percent of the value of the asset, must be scored upfront, ignoring the reality that average federal tenancies exceed 25 years and lease re-sign rates exceed 85 percent. Furthermore, purchase options, lease purchases, lease/leasebacks, and capitalized improvements are largely out of bounds for operating lease scoring treatment. As a result, the first principles of the current budget concepts are violated as accountability, transparency, and flexibility are not preserved. The Advisory Group believes that more creative approaches that leverage private capital, allow for federal long-term ownership, and encourage consolidation should be evaluated equally, with similar scoring treatment across all alternatives. The implications for appropriations caps are not insignificant—at least in the case of the congressional committee that has jurisdiction over the GSA appropriation. This issue is discussed at length below.


Space Consolidation as a Scoring Pilot As part of exploring this idea of uniform treatment, the Advisory Group agreed that the approach should be piloted for projects designed to reduce life-cycle cost through space consolidation. In coordination with the appropriate congressional committees and the CBO, the incoming administration should conduct a pilot project to compare alternative approaches to real property investment. Projects that reduce, consolidate, or eliminate agency space and the overall federal real property obligation over time would be selected. These alternative approaches would be scored on an equal footing using a regime that evaluates relative net present value of costs over the project life cycle. For example, imagine a hypothetical project to consolidate the Department of Labor (DOL) Washington, D.C.–area space requirements into a single location. Completed in 1975, the Frances Perkins Building (DOL headquarters) has more than 1 million square feet of space. Assuming space use and telework rates equivalent to those of the current GSA headquarters, the footprint of the current DOL headquarters would be sufficient to house all DOL activities in the region. The federal government could evaluate the net present value of the cost of the current approach

to housing DOL—the cost of maintaining the current building with its highly inefficient space and antiquated systems, as well as the stream of rent payments to house the additional staff—and then compare it with other approaches. Options could include trading the existing asset for a new consolidated headquarters, renovating the existing asset, or undertaking some combination of the two. The cost of each approach would be estimated and compared. The approach offering the greatest value to the federal taxpayer would be chosen. The full net present value of the selected approach would be appropriated and obligated in the year the approach was approved through the appropriations process. This strategy would require a substantial increase in the year 1 budget authority for GSA. For this approach not to freeze the ability to choose the best long-term adjustment, a pilot budgetary programmatic cap adjustment would need to be made to support the activity in the appropriation process. The cap adjustment could be supported by demonstrating either level long-term funding (through selection of the status quo option) or savings through an alternative. An initial pilot with several types of building projects in a variety of markets could be undertaken. Over the course of the first several years of the pilot, audits should be conducted, performance evaluated, Frances Perkins Building in Washington, D.C. ©Ed Brown (Public domain)/ Wikimedia Commons


and recommendations for continuation, revision, or suspension offered. In the end, the risk to the federal government is low. As for the concern that this strategy would generate copycat proposals in other capital investment classes, it is unlikely. Agencies would be hard-pressed to identify anything with similar characteristics to consolidating real property. The availability of a well-developed, transparent marketplace for real estate asset disposal is, in fact, a key differentiator. GSA’s ability to sell or trade real estate assets allows it to leverage equity developed over time into even lower long-term budgetary resource requirements.

Tie Financial Management to Real Estate Finance Testing a project-specific approach that can accelerate the evaluation and decision making around facility consolidation and modernization could also support more precisely tying financial management to investment decisions. Since the passage of the Chief Financial Officers Act of 1990, federal agencies have been required to prepare audited financial statements. Those statements include information related to capital value and depreciation. However, capital asset values, depreciation, and condition evaluations have little or no bearing on the agencies’ annual investment decisions. Little analysis of this information informs the appropriations process, and there is no scoring penalty for underfunding longterm capital replacement or maintenance, even though this type of underinvestment represents a very high-cost wealth transfer from future buying power to the present. Adopting an alternatives-based scoring regime would include this financial statement information and score the so-called cost of doing nothing. For example, project evaluation should consider offsetting capital investments that meet or exceed depreciation and consider the long-term cost of this capital consumption. The Advisory Group did note, though, that depreciation may not be a sufficient mechanism for scoring actual deferred investment, given that it is a somewhat artificial, tax-driven concept. An alternative would be a condition assessment or deferred maintenance measurement as part of the annual agency audit. This form of alternative scoring would create incentives to close or sell redundant, low-performing, or unused assets.

New Commission on Budget Concepts Finally, the Advisory Group believes that a bigger set of issues are confronting the next administration and new Congress with regard to the relevance of the current regime of budget and appropriations scoring and the concepts that undergird them. A host of changes over the past 25 years—dramatically enhanced financial management capability in the agencies, a massive transformation of the federal budget to one primarily composed of transfers (in the form of direct or tax benefits), a dramatic change in technology, rapid urbanization, global competition, and aging federal real estate assets, to name a few—suggests that the theories underlying our current national resource allocation system may require reconsideration on a grand scale. The demographic, fiscal, and geopolitical shifts since 1967 have been seismic, not the least of which is the nation’s aging physical infrastructure, which in many cases is in desperate need of repair. Much of the federal real estate infrastructure was either new or being planned in 1967. Today, the improvement of our public assets is challenged by a budget process favoring consumption spending at the expense of investment. In their article “Time for a New Budget Concepts Commission,” Barry Anderson and Rudolph Penner argue, “It is time to examine the fundamental budget concepts that underlie the federal budget process. Those concepts have not been comprehensively reviewed since the president’s 1967 Commission on Budget Concepts. The 1967 guidelines leave unanswered a number of thorny questions about the budgetary treatment of modern budget legislation.” In particular, they highlight problems with the way that the current budget concepts handle capital investments, saying, “It is obvious that capital investments by the government have a very different impact on the economy than do current expenditures. Assuming that the investments are well allocated, they add to productivity growth and improvements in living standards in the long run. Current expenditures may have immediate benefits but little effect on the long run. Therefore, many advocate that the budget should treat capital outlays differently from current expenditures.”5


Conclusion The principles and rules by which the federal government budgets, appropriates, and accounts for capital investment—which are rooted in concepts developed in 1967 and regulated by rules promulgated in 1991—may no longer reflect the true costs and realities of our government and its agencies today. An incoming administration and a new Congress have an opportunity to explore a bipartisan, commonsense set of proposals to test new methods, explore a more comprehensive approach, and modernize the underlying concepts. Failure to do so condemns agencies and the people they serve to a higher-than-necessary cost structure, low-quality facilities, and impaired

erformance. Unlocking access to carefully p controlled private investment could also unlock the potential for improved civic engagement and enhanced trust in government. We believe this opportunity is ready right now. Unlike other related proposals prepared over the past several years, though, the Advisory Group does not believe that the answer is to create another loophole or carve-out. Instead, the Advisory Group believes a uniform application of the existing scoring rules would provide a more efficient means to evaluate alternatives and to fund the approach that has the highest value and lowest cost for the taxpayer.

Thomas P. O’Neill Jr. Federal Office Building in Boston, Massachusetts. Courtesy of Turner


Appendix: About the Project The National Council for Public-Private Partnerships (NCPPP) and the Urban Land Institute (ULI) undertook this project to addresses the following questions: 1. Could interest and opportunity exist in the next administration to rethink budget concepts and rules as they relate to infrastructure financing in general and federal real estate in particular? 2. If so, what might these new budget concepts and reforms look like? 3. What would be a viable process for moving these new ideas and reforms forward?

Advisory Group A small Advisory Group was recruited to guide the NCPPP/ULI Federal P3 Project. The Advisory Group convened to discuss ideas and issues related to the topic, developed the agenda for the Experts Roundtable in April, and reviewed drafts of the final report. The views expressed in this document reflect a consensus among the group but do not necessarily reflect specific views of individual members or their employers. The Advisory Group members are the following: Dan Tangherlini (Advisory Group Chair) Former Administrator, U.S. General Services Administration; Founder of City’s Garage LLC; and President of SeamlessDocs Federal Kim Burke Principal, the Craddock Group Sinclair Cooper President, Public Infrastructure, Development, Hunt Companies Doug Criscitello Executive Director, MIT Golub Center for Finance and Policy Marshall Macomber President, ThinkP3; Senior Policy Adviser, Association for the Improvement of American Infrastructure

Anita Molino Managing Partner, Bostonia Partners LLC Dorothy Robyn Former Commissioner, Public Buildings Service, U.S. General Services Administration; Former Deputy Undersecretary, Installations and Environment, U.S. Department of Defense Daniel Werfel Director, Boston Consulting Group Donna McLean Donna McLean Associates LLC

Sessions at the NCPPP Federal P3 Summit Each year, NCPPP hosts a Federal P3 Summit in Washington, D.C., where representatives from federal agencies that use PPPs as a project delivery mechanism meet with representatives from the private sector to take a comprehensive look at the status of federal PPPs. Two sessions devoted to reform of the scoring rules for PPPs were held at the NCPPP Federal P3 Summit in March 2016. In the first session, a panel of experts from the public and private sectors provided an overview of the basics of the scoring rules and the constraints they impose on PPPs at the federal level. The purpose of the session was to broaden understanding within the PPP community of these technical but important obstacles and to build understanding and support in the PPP community for responsible reform of scoring rules as they relate to real property. The second session brought together Dorothy Robyn, former commissioner of the Public Buildings Service, and David Haun, former deputy associate director of the Office of Management and Budget, in a point/counterpoint discussion of the current scoring rules and options for change. While in office, Robyn tried unsuccessfully to use PPPs as a vehicle to shrink the federal real estate footprint and modernize its infrastructure. Haun, now with Grant Thornton LLP, administered the scoring rules, the current structure and


interpretation of which effectively blocked—and continue to hinder—wider use of PPPs for federal real estate projects. In this discussion, Haun and Robyn discussed the potential benefits and risks to the government of the current scoring rules and possible changes that could benefit the taxpayer, while limiting risk.

Experts Roundtable at the ULI Spring Meeting With guidance from the Advisory Group and building on the ideas generated in the point/

counterpoint discussion, NCPPP and ULI hosted an Experts Roundtable in Philadelphia, in conjunction with the ULI Spring Meeting in April 2016. The roundtable brought together a cross section of experts from the public and private sectors to further explore (a) the current status of project scoring as it related to federal real property, (b) prospects and options for reform, (c) key issues and obstacles, and (d) strategies for moving forward. The roundtable was chaired by Advisory Group chair Dan Tangherlini, former administrator of the U.S. General Services Administration.


Notes

1. Trump-Pence campaign website, www.donaldjtrump.com/policies/an-americas-infrastructure-first-plan. 2. Dorothy Robyn, “Reforming Federal Property Procurement: The Case for Sensible Scoring,” Brookings Institution, Washington, DC, April 2014. 3. “Leases with Purchase Options Are Infrequently Used but May Provide Benefits,” GAO-16-536R, U.S. Government Accountability Office, Washington, DC, June 21, 2016. 4. “Community Housing Impacts of the Military Housing Privatization Initiative,” Insights into Housing and Community Development Policy, U.S. Department of Housing and Urban Development, Office of Policy Development and Research, Washington, DC, October 2015. 5. Barry Anderson and Rudy Penner, “Time for a New Budget Concepts Commission,” Brookings Institution, Washington, DC, January 2016, p. 7.


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