Military Housing Privatization
DOD Faces New Challenges Due to Significant Growth at Some Installations and Recent Turmoil in the Financial Markets Gao ID: GAO-09-352 May 15, 2009In response to challenges the Department of Defense (DOD) was facing to repair, renovate, and construct military family housing, Congress enacted the Military Housing Privatization Initiative in 1996. The initiative enables DOD to leverage private sector resources to construct or renovate family housing. As of March 2009, DOD had awarded 94 projects and attracted over $22 billion in private financing. DOD plans to privatize 98 percent of its domestic family housing through 2012. Since GAO's last housing privatization report in 2006, major force structure initiatives have placed new demands on DOD for housing. GAO was asked to assess (1) the progress of DOD's housing privatization program, (2) the occupancy rates of the housing projects, (3) the impact of various force structure initiatives and DOD's efforts to mitigate any challenges, and (4) the effect of financial market turmoil on some projects. To perform this work, GAO visited 13 installations with privatization projects; analyzed project performance data; and interviewed DOD officials, real estate consultants, and private developers.
DOD has made significant progress since 1996 to remove inadequate family housing from DOD's inventory by transferring these homes to developers, but it will be several more years before all of these inadequate houses are either replaced or renovated. Developers had replaced or renovated about 67 percent of the inadequate privatized housing as of February 2009. While about 70 percent of military housing privatization projects are exceeding DOD's expected occupancy rate of 90 percent, each service has some projects below this rate. Some privatization projects with occupancy rates below 90 percent are challenged to generate enough revenue to fund construction, make debt payments, and set aside funds for recapitalization, which could negatively affect the condition and attractiveness of privatized homes and make it harder to compete with other homes in the community. Base realignment and closure actions, overseas rebasing, Army modularity, and grow-the-force initiatives are challenging DOD's ability to provide family housing at some installations, and the services are taking steps to mitigate the challenge. Among other measures, Army developed an approach where an already awarded project is retrofitted with a new or another already awarded project. Once retrofitted, Army's total investment in the developer carrying out the projects must stay below a certain percentage of the capital costs of both projects combined, not a percentage of each project separately. This practice often results in DOD investing additional funds towards retrofitted projects. The House Appropriations Committee directed DOD to report on the status of each privatization project underway on a semiannual basis. However, DOD's most recent semiannual report did not include information on the retrofitting model it is using for certain projects. Including information on the changed status of privatized projects in DOD's report would assist congressional oversight of the program. Several factors related to turmoil in the financial markets have reduced available funds for project construction, resulting in more renovations relative to new construction and reduced amenities at some newly awarded projects. First, higher interest rates in bond financing have increased the cost of some projects. Second, due to the diminished value of bond insurance, developers are having to set aside project funds to increase assurances the debt is repaid but that reduces available funds for construction. Third, financial turmoil has resulted in lower rates of return on invested funds. Consequently, as more homes are renovated given effects of today's financial markets, more recapitalization funds could be required. In H.R. Conf. Rep. No. 110-424, the conference committee expressed interest in monitoring developers' contributions to recapitalization accounts in DOD's semiannual report. However, information these effects have had on housing privatization projects was not included in DOD's most recent report. By including this information in its semiannual report, DOD could provide defense committees with a more current view of the financial market effects on these privatized projects.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-09-352, Military Housing Privatization: DOD Faces New Challenges Due to Significant Growth at Some Installations and Recent Turmoil in the Financial Markets
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Report to the Subcommittee on Readiness, Committee on Armed Services,
House of Representatives:
United States Government Accountability Office:
GAO:
May 2009:
Military Housing Privatization:
DOD Faces New Challenges Due to Significant Growth at Some
Installations and Recent Turmoil in the Financial Markets:
GAO-09-352:
GAO Highlights:
Highlights of GAO-09-352, a report to the Subcommittee on Readiness,
Committee on Armed Services, House of Representatives.
Why GAO Did This Study:
In response to challenges the Department of Defense (DOD) was facing to
repair, renovate, and construct military family housing, Congress
enacted the Military Housing Privatization Initiative in 1996. The
initiative enables DOD to leverage private sector resources to
construct or renovate family housing. As of March 2009, DOD had awarded
94 projects and attracted over $22 billion in private financing. DOD
plans to privatize 98 percent of its domestic family housing through
2012. Since GAO‘s last housing privatization report in 2006, major
force structure initiatives have placed new demands on DOD for housing.
GAO was asked to assess (1) the progress of DOD‘s housing privatization
program, (2) the occupancy rates of the housing projects, (3) the
impact of various force structure initiatives and DOD‘s efforts to
mitigate any challenges, and (4) the effect of financial market turmoil
on some projects. To perform this work, GAO visited 13 installations
with privatization projects; analyzed project performance data; and
interviewed DOD officials, real estate consultants, and private
developers.
What GAO Found:
DOD has made significant progress since 1996 to remove inadequate
family housing from DOD‘s inventory by transferring these homes to
developers, but it will be several more years before all of these
inadequate houses are either replaced or renovated. Developers had
replaced or renovated about 67 percent of the inadequate privatized
housing as of February 2009.
While about 70 percent of military housing privatization projects are
exceeding DOD‘s expected occupancy rate of 90 percent, each service has
some projects below this rate. Some privatization projects with
occupancy rates below 90 percent are challenged to generate enough
revenue to fund construction, make debt payments, and set aside funds
for recapitalization, which could negatively affect the condition and
attractiveness of privatized homes and make it harder to compete with
other homes in the community.
Base realignment and closure actions, overseas rebasing, Army
modularity, and grow-the-force initiatives are challenging DOD‘s
ability to provide family housing at some installations, and the
services are taking steps to mitigate the challenge. Among other
measures, Army developed an approach where an already awarded project
is retrofitted with a new or another already awarded project. Once
retrofitted, Army‘s total investment in the developer carrying out the
projects must stay below a certain percentage of the capital costs of
both projects combined, not a percentage of each project separately.
This practice often results in DOD investing additional funds towards
retrofitted projects. The House Appropriations Committee directed DOD
to report on the status of each privatization project underway on a
semiannual basis. However, DOD‘s most recent semiannual report did not
include information on the retrofitting model it is using for certain
projects. Including information on the changed status of privatized
projects in DOD‘s report would assist congressional oversight of the
program.
Several factors related to turmoil in the financial markets have
reduced available funds for project construction, resulting in more
renovations relative to new construction and reduced amenities at some
newly awarded projects. First, higher interest rates in bond financing
have increased the cost of some projects. Second, due to the diminished
value of bond insurance, developers are having to set aside project
funds to increase assurances the debt is repaid but that reduces
available funds for construction. Third, financial turmoil has resulted
in lower rates of return on invested funds. Consequently, as more homes
are renovated given effects of today‘s financial markets, more
recapitalization funds could be required. In H.R. Conf. Rep. No. 110-
424, the conference committee expressed interest in monitoring
developers‘ contributions to recapitalization accounts in DOD‘s
semiannual report. However, information these effects have had on
housing privatization projects was not included in DOD‘s most recent
report. By including this information in its semiannual report, DOD
could provide defense committees with a more current view of the
financial market effects on these privatized projects.
What GAO Recommends:
GAO recommends that DOD provide more current information on investment
caps and the impact of the current financial market on projects in its
semiannual report to Congress. In response to a draft of this report,
DOD concurred with our recommendations.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/products/GAO-09-352]. For more
information, contact Brian Lepore at (202) 512-4523 or Leporeb@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
DOD Has Made Progress in Transferring Inadequate Family Housing to
Developers Although Actual Replacement Will Take Several Years:
Although a Majority of Privatization Projects Exceed DOD's Generally
Expected Occupancy Rate, Certain Projects Are Not Meeting This Rate:
Several Defense Initiatives Are Adding to the Challenge in Providing
Affordable and Adequate Housing and the Services Are Taking Steps to
Mitigate That Challenge:
Current Turmoil in Financial Markets Has Reduced Available Construction
Funding for Some Privatization Projects:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Comments from the Department of Defense:
Appendix III: GAO Contact and Staff Acknowledgments:
Related GAO Products:
Tables:
Table 1: Actual and Projected Number of Military Family Houses
Privatized:
Table 2: Military Family Housing Privatization Projects with Occupancy
Rates below 90 Percent as of September 2008:
Table 3: Army's Planned Grow-the-Force Investments for Military Family
Housing Privatization Projects at Certain Growth Installations (Fiscal
Years 2008 and 2009):
Table 4: Installations Visited during Our Review:
Figures:
Figure 1: Typical Entities Involved in Bond Financing of Military
Family Housing Privatization Projects:
Figure 2: Older and Newly Constructed Housing at Fort Meade, Maryland:
Figure 3: Older and Newly Constructed Housing at Holloman Air Force
Base, New Mexico:
Figure 4: Older and Newly Constructed Housing at Navy's San Diego
Complex, California:
Figure 5: Percentage of Construction and Renovation Completed by
Military Family Housing Privatization Developers (as of February 28,
2009):
Figure 6: Relationship between Occupancy and Finances of a Typical
Military Family Housing Privatization Project:
Abbreviations:
DOD: Department of Defense:
OSD: Office of the Secretary of Defense:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
May 15, 2009:
The Honorable Solomon Ortiz:
Chairman:
The Honorable J. Randy Forbes:
Ranking Member:
Subcommittee on Readiness:
Committee on Armed Services:
House of Representatives:
In the mid-1990s, the Department of Defense (DOD) became concerned that
inadequate and poor quality housing was hurting quality of life and
readiness by contributing to servicemembers' decisions to leave the
military. At that time DOD designated about 180,000 houses, or nearly
two-thirds of its domestic family housing inventory, as inadequate,
needing repair or complete replacement. DOD believed that it would need
about $20 billion in appropriated funds and would take up to 40 years
to eliminate poor quality military housing through new construction or
renovation using its traditional military construction approach. The
cost and time needed to eliminate poor quality housing prompted DOD to
seek a new way to remedy the problem of its inadequate housing more
quickly.
In 1996, Congress enacted the Military Housing Privatization
Initiative,[Footnote 1] which provided DOD with a variety of
authorities that may be used to obtain private sector financing and
management to repair, renovate, construct, and operate military family
housing. For example, the legislation authorizes the secretary of a
military department to make direct loans to and invest limited amounts
of appropriated funds in developers[Footnote 2] carrying out projects
for the construction or renovation of housing units that are suitable
for use as family housing to servicemembers and their families.
In a typical privatized military housing project, a military department
leases land to a developer for a term of 50 years. The military
department generally conveys existing homes that are located on the
leased land to the developer for the duration of the lease. The
developer is responsible for constructing new homes or renovating the
existing homes and then leasing them, giving preference to military
servicemembers and their families. Further, in a typical privatized
military housing project, a limited liability company or partnership is
formed for the purpose of carrying out a specific housing project or
projects, and for the purposes of this report, constitutes the
developer carrying out the project. If the secretary of a military
department has made an investment in the limited liability company or
partnership, the department may possess some decision-making authority
for certain major decisions with regard to the project. While the major
decisions may differ from project to project, they often include, for
example, decisions to make changes in (1) the number of houses in the
project, (2) the number of new homes versus renovated homes in the
project, and (3) the project's financing, such as increases or
decreases in the project's debt. Among DOD's housing privatization
goals is the intent to minimize its role in operating military family
housing. As a consequence, DOD will convey to developers houses that
need to be replaced through new construction or renovation as well as
houses that require little or no renovation.
DOD can also invest a limited amount of appropriated funds or other
assets into a developer who proposes to carry out a project or
projects. In turn, the developer uses these funds to help obtain
private financing for construction or renovation. Developers obtain
their funds through bank loans or military housing bonds obtained
through private sector financial markets. Developers also typically
obtain funds from the military services through either investments of
cash or assets, such as land and homes, or from loans provided by the
military services. When these homes obtained from DOD are ready for
occupancy, the developer makes them available, giving preference to
military servicemembers and their families. Servicemembers who choose
to live in the developer's housing then use their basic allowance for
housing to pay rent. Servicemembers are not obligated to live in
privatized houses at the installation and may opt instead to lease
housing or buy a home off the installation and use their housing
allowance for that purpose. If servicemembers choose to live in the
housing provided by the developer, the servicemembers then pay rent to
the developer, often through the establishment of an allotment. DOD's
housing privatization program has, in effect, made privatized houses at
an installation part of the local competitive housing markets. Thus
once established, privatized housing at the installation operates
similarly to any other private rental property business, i.e., through
competition with other housing options in a given market.
As of March 2009, DOD had awarded 94 projects and turned over housing
to real estate developers, who in turn have generated over $22 billion
in private sector financing to construct new housing or renovate
existing housing on military installations. DOD plans to have
privatized about 98 percent of its domestic housing (or nearly 219,000
houses) through 2012. The Office of the Secretary of Defense (OSD)
reports its progress under the housing privatization initiative to
congressional defense committees in its semiannual Military Housing
Privatization Initiative Program Evaluation Plan Executive Report. This
report provides information on deal structures, government costs, use
of government authorities, program performance, and tenant
satisfaction, among other information.
We last reported on the military housing privatization program in 2006.
In that report, we recommended several areas where DOD could better
manage the privatization program. We also raised concerns that lower-
than-expected occupancy could cause financial stress and reduce funds
available for future reinvestment.[Footnote 3] DOD fully agreed with
three of our recommendations and partially agreed with two and stated
that shortcomings identified in our report would be addressed. Since
that time, DOD has awarded 42 additional projects to help achieve its
goals of eliminating its inventory of inadequate family housing and has
turned over operation of the housing to the developer.
In addition, DOD has begun several extensive force structure and
infrastructure initiatives--such as the permanent relocation of about
70,000 military personnel back to the United States from overseas
bases; the implementation of about 800 Base Realignment and Closure
actions by 2011; the continued transformation of the Army's force
structure from an organization based on divisions to more rapidly
deployable, brigade-based units; the planned increase in the end
strength of the Army and the Marine Corps by a combined 101,000
military members; and the planned drawdown of troops from Iraq--all of
which will place new demands on DOD to provide affordable and adequate
housing for servicemembers and their families at several installations
expecting significant growth in military personnel numbers.
You asked us to review DOD's military housing privatization program and
to determine the impact of the military's force structure changes and
the recent turmoil in financial markets on DOD's housing privatization
program. This report: (1) assesses the progress of DOD's military
housing privatization program in eliminating inadequate family housing;
(2) evaluates recent occupancy rates of military privatized housing;
(3) identifies the impact of DOD's major force structure and
infrastructure initiatives on the military housing privatization
program and actions the services have taken to mitigate any challenges;
and (4) assesses the effect of turmoil in financial markets on recently
awarded military housing privatization projects.
To address these objectives, we reviewed relevant documentation
including DOD and service guidance on the implementation of the
military housing privatization initiative, project progress and
performance reports developed by the services, and prior GAO reports.
To assess progress of the program and occupancy rates, we obtained
performance data on each of DOD's privatization projects awarded as of
the time of our work. We visited 13 military installations with
established privatized housing projects. We selected these
installations because they had established privatization projects,
represented each of the military services, or fit certain criteria such
as expecting increases in housing needs due to DOD's force structure
initiatives. At these installations, we interviewed base commanders,
project managers, and developers' representatives to discuss any
challenges experienced in managing their privatization projects, any
mitigation efforts planned or underway, and the impact of the economic
environment in 2008 and early 2009 on their projects. Our analysis of
the 13 installation visits cannot be generalized to other military
housing privatization projects. We also interviewed officials from the
Office of the Secretary of Defense and the services' offices
responsible for the military housing privatization program.
Furthermore, we interviewed the Army and Air Force's real estate
consultants on the impact of turmoil in the financial markets on
recently awarded housing privatization projects and the overall
program. Although we did not independently validate DOD's construction,
renovation, or occupancy data, we compared these data to data presented
in the semiannual report to the congressional defense committees. We
also discussed with these officials steps they have taken to ensure
reasonable adequacy of the data. As such, we determined the data to be
sufficiently reliable for the purposes of this report.
We conducted this performance audit from April 2008 to April 2009 in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives. Further details on our scope
and methodology can be found in appendix I.
Results in Brief:
DOD has made significant progress since 1996 in removing inadequate
military family housing from its inventory through its privatization
program, although it will be several more years before developers are
able to replace or renovate all of the inadequate houses. Through
fiscal year 2009, DOD plans to have privatized over 197,000 houses.
According to DOD, it will have transferred all inadequate family
housing from its inventory and placed it in the developers' inventory
by the end of fiscal year 2009. While the transfer will have removed
these homes from DOD's inventory, actual replacement of inadequate
homes through new construction or renovation will take several more
years. As of February 2009, developers had completed the construction
or renovation of about 67 percent of the inadequate transferred homes.
Occupancy rates for most military family housing privatization projects
are exceeding DOD's generally expected rate of 90 percent, although
each service had some projects below the expected rate.[Footnote 4]
Occupancy is an important factor in generating sufficient revenue from
the military housing privatization projects to ensure that the
developer can make debt service payments, effectively operate and
maintain the homes, and provide management fees. The military services
and OSD generally consider an occupancy rate below 90 percent to be an
indicator that triggers closer monitoring of a project's financial
health. When triggered, DOD monitors other factors such as operating
income, home construction progress, and the financial ability of the
developer to make debt payments and pay operation and maintenance
expenses. Our analysis of DOD's occupancy data as of September 2008
shows that about 70 percent of DOD's privatization projects were able
to maintain occupancy rates of 90 percent or more, with the Air Force
having the highest percentage of projects below the 90 percent expected
rate (12 out of 29 projects, or 41 percent). Some privatization
projects with occupancy rates below 90 percent are less likely to be
able to generate enough revenue to fund home construction, make debt
payments on borrowed funds, set aside funds for maintenance and other
renovation of the homes, and provide reasonable management fees for the
developer. For example, lower-than-expected occupancy rates at the
Wright-Patterson Air Force Base project in Ohio have not generated
sufficient revenue to permit the developer to pay all needed expenses.
According to the Air Force, if occupancy rates do not increase, the
developer is unlikely to generate sufficient funds to invest in and
maintain the quality of the privatized housing over the life of the
project. In that event, the homes' condition is likely to worsen over
the long term, potentially increasing the difficulty of attracting
servicemembers and their families as tenants if off-installation
housing options are seen as more attractive or affordable.
Several force structure and infrastructure initiatives are compounding
DOD's and the developers' challenges in ensuring that affordable and
adequate military family housing will exist when needed. However, the
services are acting to mitigate the challenges. DOD is implementing
base realignment and closure recommendations, returning some military
forces based overseas to defense installations in the United States,
converting Army units to modular brigade combat teams under the Army
modularity initiative, and increasing the size of the Army and Marine
Corps force structure. Army officials told us that the planned growth
at some installations was exceeding the pace at which military family
housing is being made available through new construction or renovation,
potentially meaning that adequate family housing on the installations
would not be available when needed. To increase the pace of new
construction or renovation, the Army has programmed nearly $600 million
in fiscal years 2008 and 2009 to be made available to developers who
are working on five already awarded privatization projects. The Army
believes that its increased investment in the five projects will make
it easier for the developer to obtain additional financing to build or
renovate enough houses to meet the expected increase in housing demand.
Further, the Army has in some cases "retrofitted" projects after
financial closing and actual housing turnover to the developer. The
military housing privatization initiative limits a service's investment
in a developer to not more than 33 percent cash, or 45 percent if land
or facilities are all or part of the investment, of the capital cost of
the project, or projects that the developer proposes to carry out. When
an already awarded project being carried out by one developer is
retrofitted with either a new project or another already awarded
project, the Army's total investment in the developer carrying out the
now-combined retrofitted projects must stay below a certain percentage
of the capital cost of both projects combined, not a percentage of each
project separately. However, had those projects not been retrofitted,
in some cases, the amount of funds allocated towards one pre-
retrofitted project might have exceeded the statutory cap. For example,
the Army is considering retrofitting a project located at Fort Bliss,
Texas, that is near the limit with a project at West Point, New York,
which is well below the limit. By retrofitting these two projects, the
Army's total cumulative percentage investment in the developer carrying
out the retrofitted projects would remain below the statutory cap.
However, DOD would be investing additional funds into its retrofitted
projects. For example, Army officials told us that the total investment
towards the Fort Bliss phase may increase by about $77 million, which,
if the projects were not retrofitted, would exceed the allowable
statutory investment cap for the Fort Bliss phase alone. Army's
retrofitting practice, as described by Army and OSD officials, appears
to be consistent with Section 2875 of Title 10, U.S. Code. To assist in
congressional oversight of the housing privatization program, the House
Report accompanying the Military Quality of Life and Veterans Affairs,
and Related Agencies Appropriations Bill of 2006 directed DOD to report
on the status of each privatization project underway, on a no less than
semiannual basis. Although Army officials have stated that this is a
model that they have used and intend to use for future projects, DOD's
most recent semiannual report to congressional defense committees did
not include information on the retrofitting model it is using for
certain projects. Including information about the changed status of
projects that have been retrofitted, as the congressional defense
committees have requested, would assist congressional oversight of the
program. Thus, we are recommending that DOD include, for each
retrofitted project, an explanation of this practice and information on
DOD's total investment in the retrofitted project in its semiannual
status report to the defense committees.
Several factors stemming from the recent turmoil in the financial
markets have reduced available funds for home construction, resulting
in a larger proportion of renovations relative to new construction and
reduced scope and amenities at some newly awarded military family
housing privatization projects. First, developers have had to pay
higher interest rates recently as a result of a reduced pool of
investors interested in purchasing military housing privatization bonds
and more restrictive underwriting criteria for the remaining investors,
resulting in these developers having less money to spend on new
construction or renovation. For example, the developer of the Army's
Fort Lee privatization project in Virginia told us that when the
project went to financial closing, the amount of principal the
developer was eligible to borrow was reduced by $10 million because of
increased interest costs to sell military housing privatization bonds
to raise funds for home construction. The developer told us this
resulted in building 97 fewer new homes and renovating more homes
instead. Second, we were also told by service officials that credit
rating agencies have downgraded the ratings of firms that insure
military housing bonds, thus diminishing the value of buying the bond
insurance used to minimize the impact of default or nonpayment.
Consequently, OSD and service officials told us that due to the credit
rating downgrades of firms that insure bonds are causing developers to
have to set aside cash in reserves to help provide assurances that the
project's debt will be repaid in the event the developer cannot make
debt payments and alternatives to cash funding are no longer available
to satisfy debt service reserve requirements. This in turn is reducing
the amount of funds available for construction, according to defense
officials. Collectively, both higher interest rates and the lack of
alternatives to cash funded debt service reserves have resulted in less
construction funds than planned for the Army's Fort Jackson, South
Carolina project. In this case, the Army agreed to allow the developer
to reduce the number of planned renovations resulting in these homes
receiving no work. Third, current turmoil in the financial markets has
resulted in lower returns on investment from the developers' holding of
project funds in various interest-earning investments until needed for
construction. Since interest earnings is one of the sources of revenue
that provide income to the project to pay for operations, construction,
and future recapitalization, lower-than-anticipated interest earnings
can affect the financial health of a project. Also, lower returns on
investment have led to less money being available for new construction
or renovation, which in turn could lead to reductions in the scope of
some projects. For example, the Air Force is projecting a revenue
shortfall for its Tri-Group family housing privatization project
comprised of Los Angeles Air Force Base, California; Peterson Air Force
Base, Colorado; and Schriever Air Force Base, Colorado, due to the
difference in return rates on invested funds. As a result, the Air
Force is negotiating with the developer a number of changes such as
eliminating two community centers and some new housing to offset the
lower than anticipated investment earnings. At the same time, changes
in project scope can affect the financial health of projects through
lower occupancy, which would consequently reduce rental income for the
developer if more renovated homes or fewer project amenities make the
houses less marketable when compared with competing housing options off
the installation and generate fewer funds in reserve accounts for
recapitalization purposes. As such, the conference committee has
expressed interest in monitoring the Military Housing Privatization
Initiative program and receiving information about the contributions of
developers to the recapitalization accounts of each ongoing family
housing privatization project in DOD's semiannual progress report on
the program. As more homes are renovated rather than constructed, as a
result of the turmoil in today's financial markets, privatization
projects with a large number of renovations could require more
recapitalization funds in the long term and possibly sooner than
expected. However, this information on newly awarded privatization
projects was not included in DOD's most recent semiannual status report
to Congress in January 2009. Including this information in DOD's
semiannual report would provide Congress with a more current view of
the program and enhance congressional defense committees' ability to
monitor the services' efforts to provide military servicemembers with
quality housing over the life of each project. Thus, we are
recommending that DOD include information in its semiannual status
report to congressional defense committees on the effects current
conditions in the financial markets are having on housing privatization
projects.
In written comments on the draft of this report, DOD agreed with both
of our recommendations. DOD's comments are reprinted in appendix II of
this report. DOD also provided technical comments on a draft of this
report, which we incorporated where appropriate.
Background:
Congress established the Military Housing Privatization Initiative in
1996 to ensure adequate military family housing was available when
needed by renovating existing inadequate housing and constructing new
homes on and around military bases more rapidly than was possible using
traditional funding and military construction methods. Under the
initiative, Congress provided DOD with a variety of authorities that
may be used to obtain private sector financing and expertise to repair,
renovate, and construct military family housing, including :
* Real estate tools: The secretary of a military department may convey
or lease existing DOD property or facilities to developers for the
purpose of using that property to provide housing suitable for military
servicemembers.
* Investment tools: The secretary of a military department may invest
limited amounts of appropriated funds in a developer carrying out a
project or projects for the acquisition or construction of housing
units suitable for use as military family housing.
* Financial tools: The secretary of a military department may make
direct loans to a developer or may guarantee a loan made to a developer
if the proceeds of the loans are used to acquire or construct houses
suitable for use as military family housing.
DOD may exercise one or any combination of military housing
privatization initiative authorities, which provides flexibility in the
structure and terms of the transactions with the private sector. This
flexibility has resulted in a number of different kinds of transaction
structures using different combinations of these authorities.
In a typical privatized military housing project, the developer is a
limited liability company or partnership which has been formed for the
purpose of acquiring debt, leasing land, and building and managing a
specific project or projects. The limited liability company is
typically composed of one or several private sector members, such as
construction firms, real estate managers, or other entities with
expertise in housing construction and renovation. In those cases where
the secretary of a military department has made an investment in the
limited liability company, the department may also be a member of the
limited liability company.[Footnote 5] In a typical privatized military
housing project, a military department leases land to a developer for a
term of 50 years. The military department generally conveys existing
homes located on the leased land to the developer for the duration of
the lease.[Footnote 6] The developer is responsible for constructing
new homes or renovating existing houses and then leasing this housing,
giving preference to servicemembers and their families.[Footnote 7]
Although the developers enter into agreements to construct or renovate
military housing, the developer normally enters into various contracts
with design builders and subcontractors to carry out the actual
construction and renovation.
Typical Financing of Military Family Housing Privatization Projects:
In addition to any government or private sector investment in the
developer, the majority of the project financing is obtained from
financial institutions in the form of construction loans or military
housing bonds. The developers issue military housing bonds in the
private financial markets to fund new home construction or renovation
of existing homes, with the servicemembers' basic allowance for housing
serving as the primary security for the funds obtained through bonds.
Although the servicemember's housing allowance is subject to the
defense budget, which is supported through annual appropriations, we
were told most bond investors believe it to be a highly reliable
revenue stream given the history of stable congressional funding of
servicemembers' housing. In addition, because developers issue military
housing bonds in the financial markets, several other financial
entities are involved in the process of obtaining bond financing of
military family housing privatization projects, as shown in figure 1.
Figure 1: Typical Entities Involved in Bond Financing of Military
Family Housing Privatization Projects:
[Refer to PDF for image: illustration]
Typical bond financing of military housing privatization initiative
(MPHI) project:
Developer/bond issuer: Sells bonds to Bank/underwriter;
Developer carrying out MHPI project or projects issues bonds to finance
construction. Some private sector companies participating in MHPI
program are Actus Lend Lease, Balfour Beatty, and Hunt Development
Group.
Bank/underwriter: Sells bonds to Investor/bondholder;
Investment or commercial bank purchases MHPI bonds from developer
carrying out projects and sells them to institutions in the financial
markets. Some banks who act as underwriters for MHPI bonds are Bank of
America, Citigroup, Goldman Sachs and J.P. Morgan.
Investor/bondholder:
Large institutional firms, such as national and international insurance
companies, purchase MHPI bonds in the financial markets. Some investors
who buy MHPI bonds are AFLAC, AIG, Allstate, and Fannie Mae.
Bond insurer: Provides a security for bonds to Bank/underwriter;
Bond insurers provide a guarantee that they will pay debt obligations
of the MHPI bonds if developer cannot. Some bond insurers are AMBAC,
CIFG, and MBIA.
Rating agencies: Rates the bonds for Bank/underwriter;
The three rating agencies that rate MHPI bonds are Standard & Poor‘s,
Moody‘s, and the Fitch Group.
Source: GAO analysis of DOD documents on military housing privatization
initiative.
[End of figure]
In addition to the housing bond financing obtained through the
financial markets, the services can also provide some financing to the
privatization projects through other approaches. On one hand, the Army
and Navy have typically chosen to invest limited amounts of
appropriated funds in developers carrying out projects to renovate
existing housing or construct new housing for use by servicemembers and
their families. On the other hand, the Air Force has typically chosen
to provide direct loans to developers carrying out projects on Air
Force installations. Generally, the type of government financial
involvement--whether it be an investment or direct loan--determines the
structure of the project's ownership. For example, because the Army and
Navy typically make investments in developers, they may have a
membership interest in the developer. Although the private sector
company that is the managing member of the developer maintains day-to-
day operational decision making and manages the project, the Army and
Navy enter into an operating agreement with the managing member that
describes the governance, terms, and structure of the developer. The
operating agreement will typically specify certain major decisions that
must be made with the consent of the government. While these major
decisions may differ from project to project, they often include, for
example, certain changes to the project scope including changes in the
number of houses in the project, the number of new homes versus
renovated homes in the project, and the project's financing such as
increases or decreases in the project's debt. Conversely, because the
Air Force does not generally make investments in the developer carrying
out the privatization projects but instead provides direct loans, it
does not generally become a member or partner of the developer and is
not part of the project ownership.
DOD contributions, either in the form of cash investments or direct
loans, are often made to close gaps in construction funding that
materialize when the developer is unable to obtain adequate financing
necessary for the project size. Funding gaps occur when the estimated
cost of the project exceeds the amount the project can support, meaning
that the developer cannot obtain all the financing needed to build the
project for the defense installation or installations. To maintain the
needed project size, DOD can either provide a direct loan or an
investment to the developer to bridge the gap between the estimated
project cost and the amount of money the developer is able to obtain
through the private financial markets, although this also increases the
amount of appropriated funds provided to the project. DOD does not
provide funds to cover the private developer's debt payments associated
with the project.
DOD's Family Housing Policy and Basic Allowance for Housing:
DOD's policy is to rely on private sector housing in the local
communities near military installations as the primary source of family
housing. As a result, about two-thirds of all military families in the
United States live in local community housing and receive a cash
housing allowance, known as basic allowance for housing, to help defray
the cost of renting or purchasing a home. Each year, DOD sets the
monthly basic allowance for housing rates. This allowance is based on
the median local monthly cost of housing, including current market
rents, utilities, and renter's insurance. The allowance can fluctuate
from year to year as demand in some housing markets varies over time.
The housing allowance is generally based on servicemembers' pay grades
and whether or not they have dependents. Furthermore, while the housing
allowance is calculated on the basis of the housing rental market,
servicemembers may choose to apply their allowance toward purchasing a
home, and are free to spend more or less than their allowance on
housing. Servicemembers are permitted to keep any portion of their
basic allowance for housing not spent on rent and conversely will have
to use other funds if their rents exceed their allowance.
The basic allowance for housing rates has increased since 2000 as DOD
has implemented an initiative to reduce military servicemembers' out-of-
pocket housing costs. However, in certain areas, higher housing
allowance rates may make it more feasible for military servicemembers
to consider off-base rental housing if the homes are deemed more
desirable in the community or the amount of the housing allowance
exceeds the cost of the rent, permitting the servicemember to keep the
difference. Similarly, higher housing allowances may prompt some off-
installation housing developers to directly compete with privatized
housing at the installation by building more housing to compete for
servicemembers as tenants. Thus, increased housing allowances and
increased housing choices can provide servicemembers and their families
with more housing options and potentially lead to lower rates of
occupancy for privatized housing at an installation. We reported in
April 2006 that increases in housing allowances have made it possible
for more servicemembers to afford private housing in the local market,
thus reducing the need for privatized housing at installations.
[Footnote 8]
When a servicemember chooses to live in a family housing privatization
project, the servicemember pays rent to the developer, often through
the establishment of an allotment. The rent is usually, but not always,
equal to the basic allowance for housing. In turn, the developer uses
the rental income to help pay for housing improvements, home
maintenance and property management expenses, and other costs such as
utilities and the developer's management fees. In addition, while
privatized housing is meant to be an attractive alternative for
military servicemembers looking for a place to live, DOD does not
require servicemembers, other than certain key personnel, to live on
the installation and thus in military privatized housing.
DOD Conducts Oversight of the Housing Privatization Project:
Within the Office of the Secretary of Defense, the Housing and
Competitive Sourcing Office, which reports to the Deputy Under
Secretary of Defense (Installations and Environment), provides policy
and oversight of the housing privatization program, although
responsibility for implementing the statutory authority granted under
the Military Housing Privatization Initiative is primarily with the
military departments. To help oversee the military housing
privatization program and provide status information on project
performance, OSD prepares a report, known as the Military Housing
Privatization Initiative Program Evaluation Plan Executive Report, and
provides it to the four congressional defense committees. This report,
which is prepared semiannually for the periods ending June 30 and
December 31, compiles various financial and program progress data
submitted by the military services for each awarded privatization
project. It provides information on deal structures, government costs,
use of statutory authorities, program and financial performance, home
construction and renovation progress, occupancy rates, and results of
surveys on military servicemember's satisfaction with privatized
housing. The congressional defense committees and OSD use this
information to monitor the program's progress and conduct financial and
performance oversight.
Currently, the focus of the military housing privatization program and
OSD oversight is to ensure that all construction is completed on
schedule and within budget, projects are financially viable and address
the changing requirements of the military services, and servicemembers
and their families have access to adequate, affordable, well-
maintained, and safe housing. OSD credits housing privatization with
greatly improving the state of its housing for servicemembers and their
families. Figures 2 through 4 show photographs of older and newly
constructed privatized housing at selected installations we visited.
Figure 2: Older and Newly Constructed Housing at Fort Meade, Maryland:
[Refer to PDF for image: photographs]
Photograph #1: Older privatized housing at Fort Meade, Maryland;
Photograph #2: New privatized housing at Fort Meade, Maryland.
Source: GAO.
[End of figure]
Figure 3: Older and Newly Constructed Housing at Holloman Air Force
Base, New Mexico:
[Refer to PDF for image: photographs]
Photograph #1: Older privatized housing at Holloman Air Force Base, New
Mexico;
Photograph #2: New privatized housing at Holloman Air Force Base, New
Mexico.
Source: GAO.
[End of figure]
Figure 4: Older and Newly Constructed Housing at Navy's San Diego
Complex, California:
[Refer to PDF for image: photographs]
Photograph #1: Older privatized housing at Navy's San Diego Complex,
California;
Photograph #2: New privatized housing at Navy's San Diego Complex,
California.
Source: GAO.
[End of figure]
DOD Has Made Progress in Transferring Inadequate Family Housing to
Developers Although Actual Replacement Will Take Several Years:
Since Congress authorized the Military Housing Privatization Initiative
in 1996, DOD has made significant progress in transferring inadequate
military family housing from its inventory by privatizing these homes.
However, it will be several more years before developers are able to
replace or renovate all of the inadequate houses as expected because
developers cannot complete all needed construction and renovation at
once. Developers had replaced or renovated about 67 percent of the
inadequate privatized houses as of February 2009.
DOD Has Made Progress in Transferring Inadequate Family Housing to
Developers through Privatization:
DOD has made significant progress in transferring ownership of
inadequate family housing to developers who are to replace or renovate
them. Because DOD typically conveys the homes it owns on military
installations to the developer for the duration of the ground lease,
such homes are no longer accounted for on DOD's property inventory. At
the start of the housing privatization program in fiscal year 1996, DOD
identified approximately 180,000 inadequate houses based on specific
criteria established by each service. Since then, DOD has used
privatization as its primary means of removing inadequate houses
because it allows for more rapid demolition, replacement, and
renovation of homes than DOD has stated it could do on its own.
According to DOD, as of February 2009, it had privatized almost 188,000
houses and most of its inadequate family housing had been transferred
out of its inventory. During the years 2009 through the end of 2012,
DOD plans to privatize about 31,000 more homes, as shown in table 1.
Table 1: Actual and Projected Number of Military Family Houses
Privatized:
Military services: Army;
Houses privatized as of February 2009: 86,802;
House estimated to be privatized 2009 through 2012: 9,857;
Total houses to be privatized: 96,659.
Military services: Navy and Marines;
Houses privatized as of February 2009: 62,934;
House estimated to be privatized 2009 through 2012: 4,293;
Total houses to be privatized: 67,227.
Military services: Air Force;
Houses privatized as of February 2009: 38,168;
House estimated to be privatized 2009 through 2012: 16,903;
Total houses to be privatized: 55,071.
Military services: Total;
Houses privatized as of February 2009: 187,904;
House estimated to be privatized 2009 through 2012: 31,053;
Total houses to be privatized: 218,957.
Source: GAO analysis of data obtained from OSD's housing privatization
Web site and the services.
[End of table]
In addition, by the end of fiscal year 2009, DOD's data shows that it
plans to have privatized over 197,000 houses. At that point, according
to DOD, it will have transferred all of its inadequate family housing
from its inventory to developers.
Actual Replacement of Inadequate Houses by Developers Will Take Several
More Years:
Although DOD has transferred most of its inadequate housing to
developers for the duration of the ground leases through privatization,
actual replacement of these homes through new construction or
renovation will take several more years. The lag occurs because
developers can not complete all needed construction at the same time.
According to DOD's best available data on construction progress,
housing developers had replaced or renovated about 67 percent of the
inadequate houses scheduled to be replaced or renovated. Importantly,
since DOD wants to transfer military family housing operations to the
private sector to the greatest extent possible, some privatization
projects include the transfer of houses that are adequate and need
little or no renovation at the time of transfer. At the time of our
report, DOD's data show that out of 187,904 total homes privatized as
of February 2009, 47,502, or 25 percent, were in adequate condition and
did not need replacement or renovation. In contrast, 140,402 homes, or
75 percent, were in inadequate condition and in need of replacement or
renovation. As figure 5 shows, of the 75 percent of privatized homes in
inadequate condition, private developers have replaced 93,854 of these
homes, or 67 percent, with new construction or renovation.
Figure 5: Percentage of Construction and Renovation Completed by
Military Family Housing Privatization Developers (as of February 28,
2009):
[Refer to PDF for image: two pie-charts]
Total homes privatized as of February 28, 2009:
Homes privatized in adequate condition: 47,502 homes (25%);
Homes privatized in inadequate condition: 140,402 homes (75%).
Of the homes in inadequate condition requiring new construction or
renovation (75% of total):
Inadequate homes completed with construction and renovation: 93,854
homes (67%);
Inadequate homes not completed with construction and renovation: 46,548
homes; (33%).
Source: GAO analysis of DOD documents.
[End of figure]
Although a Majority of Privatization Projects Exceed DOD's Generally
Expected Occupancy Rate, Certain Projects Are Not Meeting This Rate:
While the majority of DOD's privatization projects are exceeding DOD's
generally expected occupancy rate of 90 percent, each service has some
projects that are not meeting this rate. Our analysis of DOD's data as
of September 2008 shows that about 70 percent of DOD's privatization
projects had achieved the generally expected occupancy rate, while
about 30 percent were below the generally expected rate. Although many
of these projects are only slightly below the 90 percent rate,
occupancy is an important factor in ensuring sufficient revenue
generation since the developers' rental receipts are used to fund
additional construction, make debt payments, invest in reserve accounts
for future maintenance, and provide management fees. When a
servicemember chooses to live in a family housing privatization
project, the servicemember pays rent to the developer, often through
the establishment of an allotment. The rent is usually, but not always,
equal to the basic allowance for housing. In turn, the developer uses
the rental income to help pay for housing improvements, home
maintenance and property management expenses, and other costs such as
utilities and the developer's management fees. The developer cannot
raise or lower the dollar amount of the member's basic allowance for
housing, as DOD sets this rate each year.[Footnote 9]
About a Third of Privatization Projects Are Not Maintaining Generally
Expected Occupancy Rates:
While the majority of DOD's privatization projects are exceeding DOD's
generally expected occupancy rate of 90 percent, each service has some
projects that are not meeting this rate. As of September 2008, about 70
percent of DOD's privatization projects were maintaining the expected
occupancy, while about 30 percent of the projects were below the 90
percent occupancy rate. Specifically, occupancy was below the 90
percent rate in 12 of the Air Force's 29 projects; 7 of the Army's 30
projects; and 3 of the Navy and Marine Corps' 15 projects.[Footnote 10]
This represents a decrease in the percentage of projects with low
occupancy rates we found at the time of our 2006 report, at which time
36 percent of privatization projects (16 out of 44) were below 90
percent. Table 2 lists the privatization projects with occupancy rates
under 90 percent as September 2008.
Table 2: Military Family Housing Privatization Projects with Occupancy
Rates below 90 Percent as of September 2008:
Air Force:
Project name: Dyess; Air Force:
Occupancy rate as a percentage: 89.
Project name: Robins II;
Occupancy rate as a percentage: 89.
Project name: Vandenberg;
Occupancy rate as a percentage: 87.
Project name: Wright-Patterson;
Occupancy rate as a percentage: 87.
Project name: Tri-Group;
Occupancy rate as a percentage: 87.
Project name: Hanscom;
Occupancy rate as a percentage: 86.
McGuire/Fort Dix;
Occupancy rate as a percentage: 84.
Project name: Air Education and Training Command Group I;
Occupancy rate as a percentage: 84.
Project name: Dover;
Occupancy rate as a percentage: 83.
Project name: Scott;
Occupancy rate as a percentage: 76.
Project name: Little Rock;
Occupancy rate as a percentage: 73.
Project name: Patrick;
Occupancy rate as a percentage: 53.
12 Air Force projects below DOD's expected occupancy rate.
Army:
Project name: Fort Polk;
Occupancy rate as a percentage: 87.
Project name: Fort Hamilton;
Occupancy rate as a percentage: 85.
Project name: Fort Leonard Wood;
Occupancy rate as a percentage: 82.
Project name: Fort Benning;
Occupancy rate as a percentage: 82.
Project name: Fort Rucker;
Occupancy rate as a percentage: 81.
Project name: Fort Leavenworth;
Occupancy rate as a percentage: 79.
Project name: Fort Jackson;
Occupancy rate as a percentage: 51.
7 Army projects below DOD's expected occupancy rate.
Navy/Marine Corps:
Project name: Northeast; Navy/Marine Corps:
Occupancy rate as a percentage: 88.
Project name: New Orleans Complex;
Occupancy rate as a percentage: 86.
Project name: Southeast;
Occupancy rate as a percentage: 84.
3 Navy/Marine Corps projects below DOD's expected occupancy rate.
Source: Service project performance reports, September 2008.
Note: Occupancy rate is the number of houses occupied divided by number
of houses available. To maintain expected occupancy rates, DOD allows
developers to rent to nonmilitary families. As a result, some of these
projects are occupied by a mix of military families and other tenants
such as unaccompanied servicemembers and nonmilitary personnel.
[End of table]
Although many of these projects are only slightly below DOD's generally
expected occupancy rate, service officials told us they are still
watching the financial aspects of these projects closely since even
slightly lower-than-expected occupancy rates can lead to insufficient
revenue generation to meet necessary project expenses. In such cases,
DOD officials told us that they would look more closely at other
indicators of the project's financial health such as operating income,
home construction progress, and the ability of the developer to
continue to make debt payments and pay operation and maintenance
expenses.
Many factors can contribute to each specific privatization project's
occupancy rate and these factors may vary from one location to another
and may be specific to the location. For example, off-installation
housing options in the surrounding community can influence whether
military servicemembers desire to live in the military privatized
housing at their base or elsewhere in the community. Specifically, the
quality and affordability of both off-base rentals and for-sale housing
and the nature of the off-installation communities where available
housing exists are some factors that can influence a servicemember's
decision where to live while stationed at a particular installation. In
addition, other factors such as the quality of the military privatized
housing in comparison to the competing housing options, the
availability of certain amenities such as community centers and
swimming pools on the installation or in the off-installation
community, the location and quality of elementary and secondary
schools, commuting distances, and the quality of property management
service provided by the privatization project owner may influence a
servicemember's decision where to live. Some examples of the reasons
for below 90 percent occupancy at selected bases as of September 2008
follow:
* At the Navy's New Orleans Complex, Louisiana, occupancy was 86
percent. According to the Navy, the primary reason for this occupancy
rate was military members moving away from Naval Air Station Joint
Reserve Base New Orleans as a result of base realignment and closure
actions.
* At Fort Hamilton, New York, occupancy was 85 percent. Army officials
attribute this to last year's higher-than-anticipated 22 percent
increase in the basic allowance for housing, which according to the
Army, has made off-installation housing options more affordable for
servicemembers and their families.
* At Fort Benning, Georgia, occupancy was 82 percent. According to Army
officials, extended deployments prompted some family members left
behind to vacate their on-installation privatized houses and move to be
closer to other family members.
* At Fort Jackson, South Carolina, occupancy was 51 percent. This
project was awarded in August 2008 and much of the existing inventory
of houses transferred to the private developer was older and had not
yet been renovated, making the houses relatively less attractive and
marketable, according to Army officials. The Army expects occupancy
rates to increase considerably as the developer replaces the older
housing with newly constructed or renovated homes.
Lower-than-Expected Occupancy Can Cause Financial Distress for Some
Projects:
Due to lower-than-expected occupancy, some privatization projects are
generating insufficient revenue to meet income projections which, in
some cases, is affecting the developers' ability to fund construction,
make debt payments, and provide funds for future maintenance and
recapitalization. Developers generate revenue from the privatization
project by renting out privatized housing at the installation to
tenants, giving preference to servicemembers and their families. The
member's basic allowance for housing goes directly to the developers as
rent, and the developer, in turn, uses the allowance to help pay for
housing improvements, home maintenance and property management
expenses, and other costs such as utilities. The developer cannot raise
or lower the member's basic allowance for housing, given that DOD sets
the basic allowance rates each year. DOD determines these allowance
rates based on the median local monthly cost of housing, including
current market rents, utilities, and renter's insurance. The allowance
can fluctuate from year to year as demand in some housing markets
varies over time. The relationship of maintaining sufficient occupancy
to generate needed revenue to maintain the project's financial health
is shown in figure 6.
Figure 6: Relationship between Occupancy and Finances of a Typical
Military Family Housing Privatization Project:
[Refer to PDF for image: illustration]
Homes occupied: produce:
Revenue (basic allowance for housing and interest earnings): pays for:
* Operating expenses (routine maintenance, insurance, taxes, utilities,
etc.);
* Debt payments;
* Management incentive fees.
Remaining funds are used for:
* Construction;
* Recapitalization.
Source: GAO analysis of DOD documents.
Note: Remaining funds mostly go to recapitalization although some funds
can go to housing construction. However, developers mostly obtain
housing construction financing in the private market through bonds and
direct loans.
[End of figure]
If project occupancy is lower than the 90 percent generally expected
rate, then rents for the homes may not generate enough revenue to
permit completion of all planned construction. For example, lower-than-
projected occupancy (76 percent) at Scott Air Force Base, Illinois, was
contributing to an unexpected funding shortfall. The project only
generated $14 million of the projected $24.7 million in net operating
income as of September 2008, resulting in an almost $11 million
shortfall in funds needed to complete home construction. According to
the Air Force, the supply of newly constructed homes and the growing
number of available competing rental properties in the community around
Scott Air Force Base has provided effective competition by providing
military servicemembers and their families with numerous off-
installation housing alternatives. Thus, the Scott Air Force
privatization project was generating insufficient revenue to cover its
expenses at the time of our report.
Lower-than-expected occupancy can affect a developer's ability to
generate adequate revenue to meet income projections if rental receipts
are insufficient to meet the developer's obligations, which can
undermine the developer's ability to make required debt payments to
repay the construction bond. This situation can also undermine the
developer's ability to adequately maintain or modernize the homes when
needed, potentially leading to future deterioration of the homes and an
increasing inability to compete with off-base alternatives. For
example, due to low occupancy (87 percent) at the Wright-Patterson Air
Force Base project in Ohio, revenue was insufficient at the time of our
review to fund project obligations such as debt service and management
fees, thus the Air Force and developer agreed to pay these obligations
with other project funds. According to the Air Force, without continued
increased occupancy, the project is not expected to have sufficient
funds to invest in and maintain the quality of the housing inventory
over the life of the 50-year lease.
To help minimize the negative financial impact of low occupancy and
maintain project revenue and financial viability, some developers have
begun renting houses to parties other than military families, such as
unaccompanied servicemembers, active National Guard and Reserve
personnel, military retirees, federal government civilians, and in some
projects, private civilians.[Footnote 11] For example, the occupancy
rate for military families has been considerably lower than expected
for the last 5 years at the Army Presidio of Monterey/Naval Post
Graduate School Monterey project in California. As a result, the
project has been renting to personnel other than active-duty military
servicemembers with families. About 22 percent of the tenants at the
project were not active-duty servicemembers with families as of August
2008. According to Army officials, factors contributing to low
occupancy for active-duty servicemembers with families for this project
included the poor condition of existing housing that had not yet been
renovated and significantly higher-than-expected housing allowances,
which have made it financially possible for more military families to
afford housing in the surrounding community. These two factors have
made it difficult for the project to maintain an occupancy rate
sufficient to generate enough revenue to cover expenses. However, our
analysis of DOD's June 2008 data shows that programwide, 4.1 percent or
nearly 5,950 privatized homes are rented by parties other than active-
duty servicemembers with families. About half of these homes are rented
by unaccompanied active-duty servicemembers and active National Guard
and Reserves members, while the other half are rented by military
retirees, federal government civilians, and civilians.
Several Defense Initiatives Are Adding to the Challenge in Providing
Affordable and Adequate Housing and the Services Are Taking Steps to
Mitigate That Challenge:
Several ongoing defense force structure and infrastructure initiatives,
such as implementing base realignment and closure recommendations,
returning some military forces based overseas to defense installations
in the United States, converting Army units to modular brigade combat
teams under the Army modularity initiative, and increasing the size of
the Army and Marine Corps force structure, are collectively compounding
the challenge DOD faces in ensuring military servicemembers and their
families have affordable and adequate family housing. However, the
services have taken several steps to mitigate that challenge.
DOD's Force Structure and Infrastructure Initiatives Are Increasing
Family Housing Needs at Some Installations:
DOD's force structures and infrastructure initiatives are leading to
increasing family housing needs due to the relocation of servicemembers
and their families under:
* Grow-the-Force: In January 2007, the President announced and Congress
approved a permanent increase in the Army end strength by more than
74,000 soldiers and the Marine Corps' end strength by 27,000 Marines
through the Grow-the-Force initiative over the next several years.
* Base Realignment and Closure: Several Army installations will
experience growth due to implementation of the 2005 base realignment
and closure round. Under the 2005 round, DOD is implementing 182
recommendations which must be completed by the statutory deadline of
September 15, 2011. These recommendations encompass a large number of
realignments, prompting significant personnel movements among
installations.
* Global Defense Posture Realignment: DOD plans to realign its overseas
basing structure and reduce its overseas presence by transferring about
70,000 servicemembers and civilian personnel from overseas bases to
bases in the United States by 2011.
* Army Modularity: The Army is undergoing a major force restructuring
as it implements its force modularity, which entails converting units
to brigade combat teams. Many Army installations with housing
privatization projects either have received or are slated to receive
one or more of these brigade combat teams.
Collectively, DOD's initiatives are affecting Army installations to a
greater degree than those of the other services and are generating
increased family housing requirements for certain installations that
may be met with privatized housing. For example, the privatized housing
requirement at Fort Bliss, Texas, has increased by about 600 houses
from 6,332 houses to 6,946 houses. Fort Bliss officials are also
working with El Paso city officials to increase off-base residential
housing in the local community to meet the expected growth of military
families stationed at Fort Bliss. According to Army officials, because
the Army's growth plans are exceeding the pace at which military family
housing will be made available, it will be difficult to completely meet
this need by the time additional servicemembers and their families
arrive.
Services Have Taken Steps to Address the Impact of Various Defense
Initiatives on Their Ability to Provide Adequate and Affordable Family
Housing:
The services have taken or plan to take certain steps to ensure that
adequate family housing exists for military servicemembers and their
families. The Army plans to invest more appropriated funds into some
privatized family housing projects at several installations expecting
growth in the numbers of military personnel. Specifically, the Army has
provided almost $600 million more to developers carrying out five
projects to provide additional project funding to meet the need for
more homes. Army officials told us that the additional funding will
make it easier for these developers to obtain additional financing as
well. Table 3 displays the installations at which Army is providing
additional funds to developers and the amount of the funds.
Table 3: Army's Planned Grow-the-Force Investments for Military Family
Housing Privatization Projects at Certain Growth Installations (Fiscal
Years 2008 and 2009) (Dollars in millions):
Growth installation: Fort Bliss, Texas;
Fiscal year 2008: $35.6;
Fiscal year 2009: $127.0;
Total: $162.6.
Growth installation: Fort Bragg, N.C.;
Fiscal year 2008: $44.4;
Fiscal year 2009: 0;
Total: $44.4.
Growth installation: Fort Carson, Colorado;
Fiscal year 2008: $98.3;
Fiscal year 2009: $103.0;
Total: $201.3.
Growth installation: Fort Lewis, Washington;
Fiscal year 2008: $72.7;
Fiscal year 2009: $0;
Total: $72.7.
Growth installation: Fort Stewart, Georgia;
Fiscal year 2008: $0;
Fiscal year 2009: $103.8;
Total: $103.8.
Growth installations: Total;
Fiscal year 2008: $251.0;
Fiscal year 2009: $333.8;
Total: $584.8.
Source: Army.
[End of table]
Despite the additional funding to increase the availability of family
housing at certain installations, Army's growth plans may still exceed
the pace at which military family housing will be made available at
some installations. This, in turn, is prompting the Army to choose to
invest more appropriated funds into some privatization projects.
Recently, the Army has "retrofitted" a few military housing
privatization projects after financial closing and actual housing
turnover to the developer. Section 2875 of Title 10, U.S. Code requires
the secretary of a military department to limit the investment in an
"eligible entity" to not more than 33 percent cash, or 45 percent if
land or facilities are all or part of the investment, of the capital
cost of the project or projects that the "eligible entity" proposes to
carry out.[Footnote 12] DOD officials explained that when an already
awarded project that is being carried out by one developer is
retrofitted with either a new project or another already awarded
project, the Army's total investment in the developer carrying out the
combined retrofitted projects must stay below a certain percentage of
the capital cost of both projects combined, not a percentage of each
project separately.[Footnote 13] However, had those projects not been
retrofitted, the amount of funds allocated towards any one pre-
retrofitted project may have exceeded the statutory investment cap.
Army officials told us that this model has been used several times to
retrofit projects, and that they plan to continue to use this model in
the future. For example, the Army retrofitted a project located at Fort
Sill, Oklahoma, with an ongoing project located at Fort Meade,
Maryland. As a result of retrofitting these projects, the Army's total
cumulative investment in the developer carrying out the retrofitted
Fort Sill/Fort Meade projects was 28.8 percent, well below the 45
percent statutory cap. However, the Army's total investment towards the
Fort Sill phase alone is 55.8 percent of the capital costs of that
phase, which would have exceeded the allowable statutory investment cap
had it not been retrofitted with the Fort Meade project. Army officials
stated that they intend to continue to use this retrofitting model for
future projects. For example, at Fort Bliss, Texas, and White Sands
Missile Range, New Mexico, the Army cannot invest any more appropriated
funds for the project after its fiscal year 2008 and 2009 investments
of nearly $163 million because it will have reached the statutory
investment cap. Nonetheless, according to Army officials, the $163
million will not be enough to ensure that adequate and affordable
housing is available given the planned growth in military personnel at
these two installations. Fort Bliss is expected to experience a gain of
about 38,000 military families from 2005 to 2012. Thus, the Army is
considering retrofitting the already awarded projects at Fort Bliss/
White Sands Missile Range with one at West Point, New York, as a way to
invest more into the Fort Bliss project and still be in compliance with
the statutory investment cap. By retrofitting these two projects, the
Army's total cumulative investment in the retrofitted projects would
remain below the statutory investment cap. Army officials told us that
the total investment in the Fort Bliss phase may increase by about $77
million, which if the projects were not retrofitted, this amount would
exceed the statutory investment cap. Thus, the service's overall
percentage of appropriated funds invested in carrying out the
retrofitted projects declines, while the actual amount of appropriated
funds contributed increases. Army officials stated they developed this
approach as a way to comply with the statutory investment caps while
trying to ensure that adequate and affordable military family housing
is available when needed. OSD stated that it had no reason to believe
that Congress intended the investment limitation to be more restrictive
on projects retrofitted after award than on projects combined prior to
award. Accordingly, OSD officials told us that the use of the
retrofitting model represents the Army's rational use of statutory
authority to invest in projects structured to optimize the use of
private and public resources. The Army's retrofitting practice, as
described by Army and OSD officials, appears to be consistent with
Section 2875 of Title 10, U.S. Code.
In many cases, a developer is awarded a project that involves multiple
installations. Of the 94 projects awarded under the military housing
privatization initiative as of March 2009, approximately a third of
these projects have combined privatization efforts at multiple
installations under the ownership of one developer. The military
services' investments in developers owning combined projects have been
within statutory limitations, though the developer' allocations of
funds to individual installations may have exceeded 33 or 45 percent.
Further, OSD officials told us that in a handful of cases, the services
have invested in developers that were currently operating housing
privatization projects and which have retrofitted a new set of
installations into their existing ownership structures. However, they
stated that the methodology for calculating the investment limitation
in such a retrofitted model is the same as that for calculating the
investment for projects that combine work at multiple installations
before award. Although DOD provides notification and justification of
its cash investments,[Footnote 14] and Army officials told us that they
have briefed some congressional staff members on Army's new practice of
retrofitting projects, DOD has not provided detailed information to
Congress about its use of the retrofitting model in its semiannual
report. We recognize the difficulty of the challenge DOD is facing and
the importance of providing adequate housing under compressed time and
investment constraints. Nevertheless, for Congress to maintain
oversight of the housing privatization program, the House Report
accompanying the Military Quality of Life and Veterans Affairs, and
Related Agencies Appropriations Bill of 2006 directed DOD to report on
the status of each privatization project underway, on a no less than
semiannual basis.[Footnote 15] DOD's most recent semiannual report to
the congressional defense committees did not include information on the
retrofitting model. Although several retrofitting efforts are currently
underway, and DOD officials have told us that they plan to retrofit
additional projects in the future, it is unclear whether DOD plans to
include such information in future semiannual reports. Including
information about the changed status of projects that have been
retrofitted, as the congressional defense committees have requested,
would assist congressional oversight of the program.
Collectively, although these measures mean more appropriated funds will
be spent to meet family housing needs than originally anticipated when
military housing privatization projects were awarded, these funds are
still far less than anticipated when Congress authorized the Military
Housing Privatization Initiative. For example, at the inception of the
program, DOD expected that the ratio of private funds to DOD funds
invested in the initiative would be a minimum of 3 to 1--meaning for
every $3 of private funds invested into these privatization deals, DOD
would invest $1. However, at the time of our review, the overall ratio
was actually 9 to 1--meaning for every $9 of private funds invested,
DOD had invested $1. According to Army officials, even with the Army's
approach of retrofitting projects in order to invest more appropriated
funds to meet new military personnel growth demands at certain
installations, the current 9 to 1 investment ratio is not expected to
change substantially.
DOD has also taken other measures to better ensure military
servicemembers and their families have adequate and affordable housing,
given increases in family housing requirements at certain growth
installations. For example, the Army is renovating some of its Section
801 Build-to-Lease[Footnote 16] housing even though the 20-year leases
on these homes are expiring. Officials at Fort Drum, New York, told us
that although the Army's remaining Section 801 leases are expected to
expire in 2010, they are nonetheless repairing some of their remaining
Section 801 housing to improve the condition of these homes for current
and incoming junior enlisted servicemembers to meet the current
shortage of adequate housing in the community surrounding Fort Drum.
Further, in the President's budget presentation to Congress, Army
explained its intent to temporarily use the domestic leasing program,
[Footnote 17] if necessary, at five Army installations that are
expecting to grow in military end strength and have housing
privatization projects--Fort Carson, Colorado; Fort Wainwright, Alaska;
Fort Drum, New York; Fort Bliss, Texas; and Fort Riley, Kansas.
According to the Army, the planned use of domestic leases at these
installations will continue until local housing markets, including
privatized housing, are adequate to keep pace with the Army's planned
growth. The domestic lease program is already being implemented at Fort
Drum, New York. Finally, at some locations the Army is extending the
use of the temporary lodging expense allowance. Specifically, Fort Drum
officials told us they received permission to extend temporary lodging
expenses up to 60 days, as opposed to the normal 30 days, to provide
temporary housing at local hotels for incoming military members while
they search and make arrangements for family housing.
Current Turmoil in Financial Markets Has Reduced Available Construction
Funding for Some Privatization Projects:
Several factors related to the current turmoil in the financial markets
have reduced available funds for home construction, resulting in a
larger proportion of renovations relative to new construction and
reduced scope and amenities at some military family housing
privatization projects. First, obtaining financing has become more
expensive. Second, more funds now need to be set aside to help ensure
debt repayment. Third, lower return rates are now occurring on invested
funds.
Newly Awarded Projects Have Less Funds Available for Construction
Because Obtaining Financing Has Become More Expensive:
Higher interest rates have increased the costs that some developers had
to pay at the time of our review to obtain financing from newly
obtained bonds, thus reducing the funds available for construction. In
such circumstances the services have had to reduce the number of new
homes to be constructed in favor of doing more renovations, which are
generally less costly. For example, a representative with the Hunt
Development Group, which is developing the Army's Fort Lee project in
Virginia, told us that when the project went to financial closing, the
amount of principal the developer was eligible to borrow was reduced by
$10 million because of increased interest costs to obtain bond
financing. As a result, the Army authorized the developer to build 97
fewer new homes. The developer told us that it probably could have
borrowed an additional $10 million, but the Army would not allow it to
do so due to the potential long-term financial strain it could put on
the project. In doing so, the Army stated that they, the underwriter,
and the developer applied standard conservative underwriting principles
to the Fort Lee project financing to help ensure long-term success of
the project.
Although higher interest rates have added to the cost of certain
projects, in one case the respective service was able to find
additional sources of income to offset increased interest costs in
order to maintain the original number of new homes. Specifically,
according to Air Force officials, when the developer of the Air
Mobility Command West project (consisting of Fairchild Air Force Base,
Washington; Tinker Air Force Base, Oklahoma; and Travis Air Force Base,
California) went to financial closing in July 2008, the amount of
principal the developer was eligible to borrow was reduced by about
$18.5 million because of an unanticipated increase in interest costs.
However, the Air Force did not reduce the number of new homes to be
built because, according to Air Force officials, they and the developer
were able to offset higher interest costs by reducing expenses through
the negotiation of tax relief from the local jurisdictions and by the
Air Force demolishing some houses using its own operation and
maintenance funds, although the demolition had the effect of increasing
the use of appropriated funds to complete the project.
Newly Awarded Projects Have Less Funds Available for Construction
Because Funds Now Need to be Set Aside to Help Ensure Debt Repayment:
Due to the credit rating downgrades of firms that insure bonds,
alternatives to cash funding are no longer available to satisfy debt
service reserve requirements which are causing developers to have to
set aside cash in reserves to help provide assurances that the
project's debt will be repaid in the event the developer cannot make
debt payments. This in turn is reducing the amount of funds available
for construction, according to defense officials. Traditionally, the
services and housing privatization developers have used bond insurance
to obtain lower interest rates and to make the bonds more marketable
because of the added protection of repayment the insurance provides.
For a fee, bond insurers such as American International Group (AIG),
Municipal Bond Investors Assurance (MBIA), or American Municipal Bond
Assurance Corporation (AMBAC) guarantee the timely payment of principal
and interest on the bonds if the privatization project cannot make debt
payments. Central to the business strategy of the bond insurers is the
companies' triple-A credit ratings,[Footnote 18] which help give the
bonds they insure higher ratings. For privatization projects, higher
ratings on bonds reduce borrowing costs due to investors offering lower
interest rates, making the bonds more marketable because principal and
interest payments are guaranteed. However, because many of the bond
insurers have financial investments that have fallen in value, with
some tied to troubled subprime mortgages, credit rating agencies have
currently downgraded the credit ratings of these firms. As a result,
for some projects it is no longer cost effective to carry bond
insurance because it either does not result in lower interest rates or
rates low enough to cover the costs associated with the insurance.
However, if a developer does not purchase bond insurance for its
project, then investors normally require it to maintain cash in reserve
for debt payments--usually enough to cover 6 to 12 months of debt
payments--making less money available for construction. For example,
both higher interest rates to borrow funds and the requirement to cash
fund the debt service reserve due to the diminished value of bond
insurance have impacted the Army's Fort Jackson, South Carolina,
privatization project. In this case, the Army agreed to allow the
developer to reduce the number of planned renovations resulting in
these homes receiving no work.
Additionally, because many developers for ongoing privatization
projects use bond insurance, the diminished value of bond insurance
could cause financial stress for these projects if investors require
developers to set aside cash reserves to provide greater assurance of
repayment of the debt. Although the services told us they believe bond
investors will not require ongoing projects to set aside cash for debt
repayment of the current phase of the project, Navy officials did say
that investors could potentially use this requirement as leverage when
developers try to obtain financing for additional phases of a project.
That is, investors may require the developer to set aside cash for debt
repayment for projects already started or completed as a condition for
receiving funding for additional project phases.
Newly Awarded Projects Have Less Funds Available for Construction
Because of Lower Return Rates on Invested Funds:
The turmoil in the financial markets also has resulted in lower rates
of return on invested funds, leading to less earned interest on
invested project funds. Since developers use interest earnings to help
finance project construction (in addition to money borrowed in private
capital financial markets and military service-provided money), lower
rates of return on investment mean that the developers will have less
funds available to pay project expenses. As a consequence, the services
have in turn modified their construction plans for certain projects. In
many cases, developers invested project funds in long-term investments
with financial service firms and bond insurers that were considered
relatively safe at the time. Subsequently, however, these firms have
suffered financial difficulties and credit rating downgrades due to
their investments in subprime mortgages. Although we were told that
investment agreements between the projects and these firms usually have
protection clauses giving the project developer the right to withdraw
funds due to rating downgrades of the financial services firms,
sometimes the funds have had to be reinvested in other investment
accounts with firms that are offering lower rates of return, resulting
in reduced investment income to the developer. According to service
officials, for some projects this is not an issue because the
investment agreement has a "make whole" provision, meaning the
financial services firm in which the funds were invested is not only
obligated to return the invested funds to the project but also to pay
the project for the difference in potential interest earnings. However,
service officials said that some project investment agreements do not
have "make whole" provisions--meaning the financial services firm in
which the funds were invested is only obligated to return the invested
funds and does not have to pay for the difference in potential interest
earnings. As a result, such projects receive less interest earnings.
Since interest earnings is one of the sources of revenue that provide
income to the project to pay for operations, construction, and future
recapitalization, lower-than-anticipated interest earnings can affect
the financial health of a project, and in some projects, amenities such
as community centers could be eliminated. For example, the Air Force is
projecting a revenue shortfall for its Tri-Group family housing
privatization project comprised of Los Angeles Air Force Base,
California; Peterson Air Force Base, Colorado; and Schriever Air Force
Base, Colorado, due to the difference in return rates on invested
funds. As a result, the Air Force is negotiating with the developer a
number of changes such as eliminating two community centers and some
new housing to offset the lower-than-anticipated investment earnings.
Similarly, Navy officials told us that their family housing
privatization project in Hawaii could potentially have a $25 million to
$30 million revenue shortfall due to reduced rates of return on
investments; however, Navy does not anticipate reducing the amount of
new construction or amenities in the project. According to the Navy,
although project funds are now placed in more conservative but lower
yielding investments, decreases in interest earnings have thus far been
offset by project savings. Such changes in the size, mix of new
construction and renovations, or content of privatized military housing
projects could have an impact on the financial health of projects since
renovated homes might require increased maintenance and earlier
replacement as compared to newly constructed homes. Moreover, in some
circumstances, renovated homes, combined with fewer project amenities,
could make the houses less marketable if off-base housing from a
competing developer is seen as more desirable by servicemembers and
their families.
Collectively, a decline in available construction funds caused by
higher interest rates, increased debt repayment reserve requirements,
and lower rates of return on invested funds could have an adverse
impact on the condition and amenities of military housing privatization
projects, which could in turn reduce occupancy, and ultimately threaten
the financial viability of those projects. Over the past few years
several congressional committees have indicated interest in the
military housing privatization program.[Footnote 19] Further, a House
Conference Report directed DOD to include data on developers'
contributions to the recapitalization accounts of each ongoing family
housing privatization project in each semiannual report on the
privatization program,[Footnote 20] and the House Appropriations
Committee has directed DOD to provide a semiannual report summarizing
the results of DOD's military housing privatization initiative
monitoring tool and giving status reports on each privatization project
underway.[Footnote 21] As more homes are renovated rather than
constructed anew, privatization projects with a large number of
renovations will require more recapitalization funds than would
otherwise have been the case given the effects of the current turmoil
in financial markets. However, information about the impact that the
recent turmoil in the financial markets is having on some projects and
the resulting effects on available funds for new construction as well
as on future recapitalization funds was not included in DOD's most
recent semiannual status report to the congressional defense committees
in January 2009. By including this information on housing privatization
projects in its semiannual report, DOD could provide Congress with a
more current view of the effects of the current financial market and
enhance congressional defense committees' ability to monitor the
services' efforts to provide servicemember with quality housing over
the life of each project.
Conclusions:
DOD is implementing or is planning to implement several significant
initiatives, such as increasing the services' force structure by tens
of thousands of personnel, that will increase the number of military
servicemembers and their families who will need adequate and affordable
family housing. Although DOD is taking several measures to ensure
adequate housing exists at its installations, it still faces challenges
that could result in insufficient housing at some installations
expecting significant increases in military families over the next
several years. Including information about the changed status of
retrofitted projects would assist congressional oversight of the
program.
By enacting the Military Housing Privatization Initiative, Congress
provided DOD with a variety of authorities to obtain private sector
financing as a way to eliminate its inventory of inadequate and poor
quality family housing. This initiative brings private sector
financing, business practices, and certain flexibility to help ensure
that DOD can provide housing to military families when needed. However,
privatization is essentially a business venture, and like any business,
it carries inherent risk. If the increase in renovated houses over new
construction due to turmoil in the financial markets continues to
increase the demand for recapitalization funds over the life of the
project, developers may not be able to sustain projects in a way that
ensures adequate quality of life for military servicemembers and their
families. According to DOD, decent and affordable housing is one of the
most important factors in its ability to retain a professional force
and maintain readiness. Informing Congress about the long-term
financial health of recapitalization accounts for family housing
privatization projects will give it a more current view of the
services' efforts to provide servicemembers with quality housing over
the life of each project. Timely information on the effects of the
current financial markets on housing privatization projects--such as in
DOD's semiannual status report on housing privatization program--could,
if necessary, help congressional decision makers prevent a return to
the poor military housing conditions that led DOD to request
congressional authority to pursue the Military Housing Privatization
Initiative over a decade ago.
Recommendations for Executive Action:
For Congress to maintain oversight of the Military Housing
Privatization Initiative program, we recommend that the Secretary of
Defense direct the Under Secretary of Defense (Acquisition, Technology
and Logistics) to include, for each project that is retrofitted, an
explanation of this practice and information on DOD's total investment
in the retrofitted project in its semiannual status report to the
congressional defense committees.
To better inform Congress about the financial market factors that could
affect the privatized military family housing program's financial
health and to enhance congressional oversight, we recommend that the
Secretary of Defense direct the Under Secretary of Defense
(Acquisition, Technology and Logistics) to include information in its
semiannual report to the congressional defense committees on the
effects current conditions in the financial markets are having on
housing privatization projects.
Agency Comments and Our Evaluation:
In written comments on a draft of this report, DOD concurred with our
recommendations saying that including information on both the practice
of "retrofitting' or "integrating" projects and the effects current
conditions in the financial markets are having on privatization
projects in the Department's semiannual Program Evaluation Plan Report
to Congress would enhance Congressional oversight of the privatization
program. DOD's comments are reprinted in appendix II. DOD further
provided technical comments, which we incorporated as appropriate into
this report.
We are sending copies of this report to interested congressional
committees; the Secretary of Defense; the secretaries of the Army,
Navy, and Air Force; and the Commandant of the Marine Corps. In
addition, the report will be available at no charge on GAO's Web site
at [hyperlink http://www.gao.gov].
If you or your staff has any questions concerning this report, please
contact me on (202) 512-4523 or by e-mail at leporeb@gao.gov. Contact
points for our Offices of Congressional Relations and Public Affairs
are on the last page of this report. Key contributors to this report
are listed in appendix III.
Signed by:
Brian J. Lepore, Director:
Defense Capabilities and Management:
[End of section]
Appendix I: Scope and Methodology:
[End of section]
We performed our work at the Office of the Secretary of Defense and the
offices of the Army, Navy, Marine Corps, and Air Force responsible for
implementing the housing privatization program. We reviewed relevant
documentation including the Department of Defense (DOD) and service
guidance on the implementation of the Military Housing Privatization
Initiative, project progress and performance reports developed by the
services, and prior GAO reports. We also interviewed officials at the
Air Force's Center for Engineering and the Environment in San Antonio,
Texas, which is designated as the Air Force's military family housing
privatization center of excellence. In each instance, we met with
officials cognizant of the program and reviewed applicable policies,
procedures, and documents. Further, we visited 13 selected military
installations with housing privatization projects to review project
management at the local level, examine project performance, and
determine from installation officials and private sector developers the
challenges they face in managing their military housing privatization
projects. Table 4 lists the installations we visited.
Table 4: Installations Visited during Our Review:
Army:
Fort Bliss, Texas;
Fort Drum, New York;
Fort Lee, Virginia;
Joint Base Lewis-McChord, Washington;
Fort Meade, Maryland;
US Army Garrison Presidio of Monterey, California;
White Sands Missile Range, New Mexico.
Navy and Marine Corps:
Marine Corps Base Camp Pendleton, California;
Navy's San Diego Complex, California;
Air Force:
Holloman Air Force Base, New Mexico.
Joint Base McGuire-Dix-Lakehurst, New Jersey.
Little Rock Air Force Base, Arkansas.
Moody Air Force Base, Georgia.
[End of table]
Source: GAO.
Together the installations contained 12 separate military housing
privatization projects, since Fort Bliss and White Sands Missile Range
are included in the same project. At each installation we spoke with
service officials managing the family housing privatization project. We
also spoke with representatives from the private sector developers in
charge of constructing and managing these projects. We chose these
installations because they contained already awarded projects,
represented each of the military services, and provided a balance of
projects with and without challenges. Additionally, we choose Fort
Bliss, White Sands, and Camp Pendleton as installations to visit
because they are expected to experience a significant influx of
military servicemembers and their families due to the planned
implementation of DOD's Grow-the-Force initiative. Joint Base McGuire-
Dix-Lakehurst and Joint Base Lewis-McChord were selected primarily
because they are 2 of 12 joint bases established by the 2005 Base
Realignment and Closure round with Joint Base McGuire-Dix-Lakehurst
being managed by the Air Force and Joint Base Lewis-McChord being
managed by the Army. Our analysis of the 13 installations we visited
cannot be generalized to other military housing privatization projects.
To assess the progress of DOD's housing privatization efforts we
obtained and analyzed performance data on each of DOD's privatization
projects. Specifically, to determine the number of units privatized we
obtained data on the number of projects awarded from OSD's Web site and
received estimated data on the number of units expected to be
privatized from the services. We obtained construction and renovation
data from OSD and the services through February 2009. Although we did
not independently validate the construction or renovation data supplied
by OSD and the services, we did however compare this data to the data
in OSD's semiannual report to Congress and the services' program
performance reports. We also discussed with officials steps they have
taken to ensure reasonable adequacy of the data. As such, we determined
the data to be sufficiently reliable for the purposes of this report.
To assess occupancy rates, we interviewed DOD and service officials to
discuss project occupancy expectations, the factors that contribute to
lower-than-expected occupancy rates, the financial and other impacts
that result from lower-than-expected occupancy rates, and the responses
normally taken when occupancy is below expectations. We obtained,
reviewed, and analyzed project occupancy rates and trends for all
privatization projects awarded as of September 30, 2008, the last
quarter for which occupancy data from all three military departments
were readily available, and compared these data to occupancy
expectations. We did not collect data for two recently awarded Army
projects--Fort Sill, Oklahoma, and Joint Base Lewis-McChord,
Washington--because data were not yet available. Also, for the 12
projects at the installations we visited, we reviewed project
justification and budget documents to determine each project's
occupancy expectations and compared actual occupancy rates with the
expectations. When occupancy rates were below expectations, we reviewed
project performance reports and interviewed local officials to
determine the causes, consequences, and any actions taken or planned in
response.
To identify challenges to the military housing privatization program
stemming from DOD's recent force structure and infrastructure
initiatives, we conducted numerous interviews with OSD, the services,
and installation commanders. In these discussions we identified the
challenges officials said these initiatives were creating for them in
providing sufficient and affordable privatized housing and noted some
measures they had taken to mitigate those challenges. In addition, we
collected and analyzed the most recent housing market analyses for
privatization projects on installations expected to experience
significant growth to determine the extent to which family housing
requirements were expected to increase. Finally, we collected and
analyzed relevant guidance and documentation regarding the measures
taken by the services to incorporate increased requirements into their
housing privatization projects, specifically the retrofitting of
already awarded projects by the Army. As such, we obtained the legal
views of the Office of the Secretary of Defense, Department of the
Army, and Department of the Navy regarding the implementation of
section 2875 of Title 10, U.S. Code.
To assess the effect the turmoil in the financial markets is having on
DOD's housing privatization portfolio, we interviewed officials from
each service and collected and analyzed internal service quarterly
portfolio summary reports and analyses. In addition, we interviewed
representatives from the Army and Air Force's real estate development
consultants to further understand the dynamics of the financial markets
and how those dynamics are affecting housing privatization projects.
Service officials identified some newly awarded projects that were more
affected by market turmoil than others. For those projects, we
interviewed service officials and consultant representatives to
determine the causes, consequences, and any actions taken or planned in
response. We also reviewed service and OSD project performance reports,
such as the semiannual program evaluation plan, to determine the extent
to which DOD is reporting impacts of the financial markets on its
housing privatization projects to Congress. Further, we attended a bond
industry conference on the financing of military housing privatization
to learn the views of the investment community regarding the impacts of
the financial market turmoil on housing privatization projects and
obtained and reviewed private sector financial analyses and reports
regarding military housing bonds and the current state of the financial
markets.
We conducted this performance audit from April 2008 to April 2009 in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings based on our audit objectives. We believe that the evidence
obtained provides a reasonable basis for our findings based on our
audit objectives.
[End of section]
Appendix II: Comments from the Department of Defense:
Office Of The Under Secretary Of Defense:
Acquisition, Technology And Logistics:
3000 Defense Pentagon:
Washington, DC 20301-3000:
May 8, 2009:
Mr. Brian Lepore:
Director, Defense Capabilities and Management:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, DC 20548:
Dear Mr. Lepore:
This is the Department of Defense (DoD) response to the GAO draft
report, GAO-09-352, "Military Housing Privatization: DoD Faces New
Challenges due to Significant Growth at Some Installations and Recent
Turmoil in the Financial Markets," April 10, 2009, (GAO CODE 351107).
Detailed comments on the report recommendations are enclosed.
The Department appreciates the opportunity to comment on the report.
Sincerely,
Signed by:
Wayne Arny:
Deputy Under Secretary of Defense (Installations and Environment):
Enclosure: As stated:
[End of letter]
GAO Draft Report - Dated April 10, 2009:
Military Housing Privatization: DoD Faces New Challenges due to
Significant Growth at Some Installations and Recent Turmoil in the
Financial Markets:
GAO Code 351107/GAO-09-352:
Department Of Defense Comments To The Recommendations:
Recommendation 1: The GAO recommends that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology and
Logistics) to include, for each project that is retrofitted, an
explanation of this practice and information on DoD's total investment
into the retrofitted project in its semi-annual status report to the
congressional defense committees. (p. 45/GAO Draft Report)
DOD Response: Concur. DoD agrees that information regarding privatized
housing projects which have been integrated or merged into existing
ownership structures and an explanation of this practice by the
Military Departments should be included in the Department's semi-annual
Program Evaluation Plan Report to Congress. This information would
enhance Congressional oversight of the military housing privatization
program by highlighting and explaining the integration of privatization
projects that share a common private developer/owner.
Recommendation 2: The GAO recommends that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology and
Logistics) to include information in its semi-annual report to the
congressional defense committees on the effects of the current
financial markets on newly-awarded projects. (pages 45-46/GAO Draft
Report)
DOD Response: Concur. DoD agrees that information on the effects of the
current financial markets on newly-awarded projects should be included
in the Department's semi-annual Program Evaluation Plan Report to
Congress. This information would enhance Congressional oversight of the
military housing privatization program, by providing Congress better
information about how financial market factors affect project finances
across the privatized military housing portfolio.
[End of section]
Appendix III: GAO Contact and Staff Acknowledgments:
GAO Contact:
Brian J. Lepore, (202) 512-4523 or leporeb@gao.gov:
Acknowledgments:
In addition to the individual named above, Laura Talbott (Assistant
Director), Shawn Arbogast, Steven Banovac, Susan Ditto, George Duncan,
Laurie Ellington, Katherine Lenane, Charles Perdue, Mathew Scire, and
Steven Westley made key contributions to this report.
[End of section]
Related GAO Products:
Military Housing Privatization:
Military Housing: Management Issues Require Attention as the
Privatization Program Matures. [hyperlink,
http://www.gao.gov/products/GAO-06-438]. Washington, D.C.: April 28,
2006.
Military Housing: Further Improvements Needed in Requirements
Determination and Program Review. [hyperlink,
http://www.gao.gov/products/GAO-04-556]. Washington, D.C.: May 19,
2004.
Military Housing: Better Reporting Needed on the Status of the
Privatization Program and the Costs of Its Consultants. [hyperlink,
http://www.gao.gov/products/GAO-04-111]. Washington, D.C.: October 9,
2003.
Military Housing: Management Improvements Needed as the Pace of
Privatization Quickens. [hyperlink,
http://www.gao.gov/products/GAO-02-624]. Washington, D.C.: June 21,
2002.
Military Housing: DOD Needs to Address Long-Standing Requirements
Determination Problems. [hyperlink,
http://www.gao.gov/products/GAO-01-889]. Washington, D.C.: August 3,
2001.
Military Housing: Continued Concerns in Implementing the Privatization
Initiative. [hyperlink, http://www.gao.gov/products/GAO/NSIAD-00-71].
Washington, D.C.: March 30, 2000.
Military Housing: Privatization Off to a Slow Start and Continued
Management Attention Needed. [hyperlink,
http://www.gao.gov/products/GAO/NSIAD-98-178]. Washington, D.C.: July
17, 1998.
Financial Markets:
Troubled Asset Relief Program: Status of Efforts to Address
Transparency and Accountability Issues. [hyperlink,
http://www.gao.gov/products/GAO-09-296]. Washington, D.C.: January 30,
2009.
High Risk Series Update. [hyperlink,
http://www.gao.gov/products/GAO-09-271]. Washington, D.C.: January
2009.
Financial Regulation: A Framework for Crafting and Assessing Proposals
to Modernize the Outdated U.S. Financial Regulatory System. [hyperlink,
http://www.gao.gov/products/GAO-09-216]. Washington, D.C.: January 8,
2009.
Troubled Asset Relief Program: Additional Actions Needed to Better
Ensure Integrity, Accountability, and Transparency. [hyperlink,
http://www.gao.gov/products/GAO-09-266T]. Washington, D.C.: December
10, 2008.
Troubled Asset Relief Program: Additional Actions Needed to Better
Ensure Integrity, Accountability, and Transparency. [hyperlink,
http://www.gao.gov/products/GAO-09-161]. Washington, D.C.: December 2,
2008.
[End of section]
Footnotes:
[1] National Defense Authorization Act for Fiscal Year 1996, Pub. L.
No. 104-106, §§ 2801-2841 (1996), codified as amended at 10 U.S.C. §§
2871-2885.
[2] Section 2875 of Title 10, U.S. Code authorizes the military
departments to invest limited amounts of appropriated funds in an
"eligible entity." In this report, we use the term "developer" and
"eligible entity" synonymously to describe the special purpose limited
liability company or partnership that carries out a privatization
project or projects. A limited liability company is a company in which
the liability of each shareholder or member is limited to the amount
individually invested. A limited partnership is a partnership composed
of one or more persons who control the business and are personally
liable for the partnership's debts (called general partners), and one
or more persons who contribute capital and share profits but who cannot
manage the business and are liable only for the amount of their
contribution.
[3] GAO, Military Housing: Management Issues Require Attention as the
Privatization Program Matures, [hyperlink,
http://www.gao.gov/products/GAO-06-438] (Washington, D.C.: April 28,
2006).
[4] According to DOD, a generally expected occupancy rate during a
project's initial development period, when many homes are being
constructed or undergoing renovation is usually around 90 percent of
the homes available. However, this generally expected rate is only a
broad indicator of potential financial stress and is not meant to be a
strict metric for determining the financial stability of each project,
as each project has its own unique target occupancy rate that may be
either above or below 90 percent. For example, a project with an
occupancy rate below 90 percent may not be experiencing any financial
difficulty as its specific target rate may have been below 90 percent.
Likewise, a project with an occupancy rate above 90 percent may
experience financial difficulty if it is not meeting its specific
expected rate.
[5] The secretary of a military department may invest cash, housing, or
in some cases, land to the developer as a government investment.
[6] Typically, title to the houses that are conveyed and any
improvements made to these houses during the duration of the lease
automatically revert to the military department upon expiration or
termination of the ground lease.
[7] DOD has established at tenant "waterfall" that privatization
projects can use if occupancy falls below a certain rate. Generally,
after military families are accommodated, the order of the tenant
waterfall is unaccompanied military personnel, active National Guard
and Reserve, military retirees, federal government civilians, and
lastly civilians.
[8] [hyperlink, http://www.gao.gov/products/GAO-06-438].
[9] DOD's allowance for housing is based on the median local monthly
cost of housing, including current market rents, utilities, and
renter's insurance. The allowance can fluctuate from year to year as
demand in some housing markets can vary from year to year.
[10] Although DOD-prepared data indicates it has awarded 94 military
family housing privatization projects or project phases, DOD's data on
occupancy rates is for 74 projects because DOD incorporated or merged
some project phases into existing projects in its reporting of
occupancy rates.
[11] DOD has established a tenant "waterfall" that projects can use if
occupancy falls below a certain rate. Generally, after military
families are accommodated, the order of the tenant waterfall is
unaccompanied military personnel, active National Guard and Reserve,
military retirees, federal government civilians, and lastly civilians.
We have been told some installation commanders have expressed
reservations to private developers about having civilians living in
military privatized housing, which at some installations, had resulted
in the developer's reluctance to rent to civilians that can potentially
further constrain generating revenue.
[12] An "eligible entity" is any private person, corporation, firm,
partnership, company, state or local government, or housing authority
of a state or local government that is prepared to enter into a
contract as a partner with the Secretary concerned for the construction
of military housing units and ancillary supporting facilities. 10
U.S.C. § 2871(5). In this report, we use the term "developer" and
"eligible entity" synonymously to describe the special purpose limited
liability company or partnership that carries out a privatization
project or projects.
[13] While, prior to retrofitting, the projects were carried out by
different developers, the managing member of each developer is the same
private sector company (or its subsidiary).
[14] While Section 2875(e) of Title 10, U.S. Code, requires that the
services provide written notice and justification of any cash
investments made in a developer operating a military housing
privatization project to Congress, these notices do not provide
detailed information about the retrofitting or integration of projects.
[15] H.R. Rep. No. 109-95, pg. 25 (2005).
[16] "Section 801" housing projects were originally authorized by the
Military Construction Authorization Act, 1984, Pub. L. No. 98-115 § 801
(1983), which granted temporary authority to DOD to enter into long-
term leases of family housing when this approach is more cost-effective
when compared to alterative means of furnishing the same housing
facilities. The temporary authority was made permanent by Section
2806(a)(1) of Pub. L. No. 102-190 (1991) and is codified as amended at
10 U.S.C. 2835. Starting in 1987, the Army leased family housing units
from private sector developers for 20 years with the units being
assigned as military housing to Army families.
[17] The domestic leasing program provides temporary housing for
military families pending availability of permanent housing through DOD
payment of rent, and operating and maintenance costs of privately-owned
houses that are assigned to military families as government quarters.
[18] Issued by the three major credit rating agencies--Standard &
Poor's, Fitch Group, and Moody's Investor Services--credit ratings are
intended to provide an opinion on the relative ability of an entity to
meet financial commitments, such as interest, dividends, repayment of
principal, or insurance claims. Investors have used credit ratings as
indications of the likelihood of receiving their money back in
accordance with the terms on which they invested.
[19] See, e.g., H.R. Conf. Rep. No. 110-424, pg. 443 (2007); S. Rep.
No. 109-286, pg. 27 (2006); and S. Rep. No. 108-82, pg. 35 (2004).
[20] H.R. Conf. Rep. No. 110-424, pg. 443 (2007).
[21] H.R. Rep. No. 109-95, pg. 25 (2005).
[End of section]
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