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STATEMENT OF

RANDALL A. YIM
DEPUTY UNDER SECRETARY OF DEFENSE
(INSTALLATIONS)
BEFORE THE SUBCOMMITTEE ON 
MILITARY INSTALLATIONS AND FACILITIES
OF THE HOUSE ARMED SERVICES COMMITTEE

May 3, 2001 
INTRODUCTION

Mr. Chairman and distinguished members of this Subcommittee, thank you for the opportunity to discuss the Military Housing Privatization Initiative. The quality of housing for Service members and their families continues to be a critical element in supporting and retaining the high caliber personnel who make our armed forces the best in the world. But the majority of our military housing is old, below contemporary standards, and in need of extensive repair. Accordingly, the President and Secretary Rumsfeld have made improving housing one of their top priorities. As you may recall, the President visited Fort Stewart, Georgia a few months ago and made note of the conditions Service members face on military bases, observing: "many live in aging houses and work in aging buildings." The President has stated that one of his top priorities is to improve the salaries and benefits of our men and women in uniform and their families, and has requested an additional $400 million in the FY 2002 budget submission to make more quality housing available to military families.. 

To that end, the Department will continue to aggressively pursue a major 3-prong initiative to benefit all Service members and improve their quality of life: 

1.     Increasing housing allowances to eliminate the out-of-pocket costs paid by Service members for private sector housing in the United States -- Higher allowances will help members who live off-base to afford good quality housing. Both the quality and availability of their off-base housing options will immediately increase. By 2005, the typical member living off-base will have no out-of-pocket housing expenses - the same as their counterparts living in government quarters on base.

2.     Increasing reliance upon the private sector through privatization -- Higher allowances will increase and enhance housing privatization, further improving Service member access to quality housing. Higher allowances will increase the income available to private sector developers, facilitating increases in the quantity and quality of privatized housing. 

3.     Maintaining military construction funding -- The combination of increased allowances and continued use of privatization will permit more efficient use of current military construction funding. Increased availability of quality private sector options will ease pressure on on-base housing, reduce the need to maintain old, costly housing, and allow us to spend our operations and maintenance funding more wisely.

My testimony today focuses on the second prong of this initiative - increasing reliance on the private sector through privatization.

NEED FOR HOUSING PRIVATIZATION

About sixty percent or two-thirds of DoD's housing inventory in the Continental United States is substandard, totaling over 180,000 units. Fixing this problem using only traditional military construction would take over 30 years and cost as much as $16 billion. Recognizing this problem, Congress, in 1996, provided the Department with significant new authorities to use private sector expertise and capital to accelerate improvement of government-owned housing and help in eliminating a serious shortage of quality affordable housing. I appreciate the support we received last year from you and other Committee members in the successful extension of our housing privatization authorities to December 31, 2004.

Using these privatization authorities, we can continue to develop projects that provide higher quality housing both on and off-base, faster and at less cost than traditional methods. Our housing privatization policies require that privatization yield at least three times the amount of housing as traditional military construction for the same amount of appropriated dollars. As our recent projects have demonstrated, this leveraging is normally much higher. In fact, the seven most recent projects awarded leveraged military construction dollars at a combined rate of approximately 11:1. Tapping this demonstrated potential through continued use of housing privatization is essential in order to achieve our 2010 goal to revitalize inadequate housing.

PROGRESS IN HOUSING PRIVATIZATION

Awarded Housing Privatization Projects

The Department has awarded ten housing privatization projects to date:

·       Naval Air Station Corpus Christi, Texas/Naval Air Station Kingsville, Texas -- The Navy used the investment authority to construct 404 new units off-base in the Corpus Christi area. A $32 million project, the Navy invested $9.5 million and will share in the profits upon sale. During the term of the project agreement, Service members have priority access to the units and occupy the housing at preferential rents. The project was awarded in July 1996, and has been completed. 

·       Naval Station Everett, Washington -- The Navy used the investment authority to construct 185 units off-base at NS Everett. A $20 million project, the Navy invested $5.9 million and will share in the profits upon sale. During the term of the project agreement, Service members have priority access to the units and occupy the housing at preferential rents. The project was awarded in March 1997, and has been completed. 

·       Lackland AFB, Texas -- The Air Force used the land lease authority and will provide a direct loan and limited guarantee of the private first mortgage to construct 420 new units on Lackland AFB. This is a $41.9 million project with a scored amount to the Air Force of $6.2 million. The Air Force guaranteed the first mortgage against default caused by a base closure, downsizing, or significant deployment. The leverage was approximately 8:1 compared to military construction. Military members will occupy the units at rents equal to their Basic Allowance for Housing (BAH). The project was awarded in August 1998, and will reach final completion in July 2001. 

·       Fort Carson, Colorado -- DoD's first whole base project is located at Fort Carson, Colorado. The Army leased its land at nominal rent and transferred 1,823 existing housing units to the private sector developer who will renovate those units and also construct 840 new units. The Army will provide a limited guarantee of the private loan against a default caused by base closure, downsizing, or significant deployment. The private sector will own and operate the project. This is a $228.6 million project with a scored amount to the Army of $10 million. The leverage is approximately 22:1 compared to military construction. Military members will occupy the units at rents equal to their BAH. The project was awarded in September 1999, and residents are now occupying new and renovated homes.

·       Robins AFB, Georgia -- The Air Force is privatizing a total of 670 units, including constructing 370 new units and renovating 300 existing units that it transferred to the private sector developer. The Air Force provided 66 acres of land which the developer will exchange with the City of Warner Robins for an 88.5-acre parcel to support the new housing. The Air Force will provide a direct loan, as well as a loan guarantee for this project. This is a $54.3 million project with a scored amount to the Air Force of $12.8 million. The leverage is approximately 4.3:1 compared to military construction. Military members will have priority access to the units at rents equal to their BAH less a reasonable amount to cover average utility usage. The project was awarded in September 2000, and is now under construction.

·       Dyess AFB, Texas -- This project will provide the Air Force with 402 new units off-base at Dyess AFB. The Air Force will provide a first mortgage loan and the developer will provide the land and cash equity. This is a $35.3 million project with a scored cost to the Air Force of $16.2 million. The leverage is approximately 3:1 compared to military construction. Military members will have priority access to the units at rents equal to their BAH less a reasonable amount to cover average utility usage. The project was awarded in September 2000, and is now under construction.

·       Marine Corps Base - Camp Pendleton, California (Phase 1) -- This project involves the renovation of 512 existing units and the construction of 200 new units. The Marines will lease approximately 92 acres of land improved with 512 units that will become the property of the developer, and approximately 37 acres of vacant land for construction of the new units. The Marines will also provide a direct loan second in priority to the private financing. This is a $83.3 million project with a scored cost to the Marines of $19.4 million. The leverage for this project is 4.5:1. Military members will have priority access to the units at rents equal to their BAH less a reasonable amount to cover average utility usage. The project was awarded in November 2000, and is now under construction.

·       Naval Air Station Kingsville II, Texas -- The Navy entered into a limited partnership with a private developer to obtain 150 new units for 30 years (government option to terminate after 15 years) on developer-owned land. The Navy invested $4.3 million and provided a $2.4 million Government second mortgage. The total cost of this project is $14.5 million. The leverage for this project is 3.3:1. Military members will have priority access to the units at rents equal to their BAH less a reasonable amount to cover average utility usage. The project was awarded in November 2000, and is now under construction.

·       Naval Station Everett II, Washington -- The Navy entered into a limited partnership with a private developer to obtain 288 new units off base in Everett, Washington for 30 years. The Navy invested $12.2 million. The total cost of this project is $42.2 million. The leverage for this project is 3:1. Military members will have priority access to the units at rents equal to there BAH less a reasonable amount to cover average utility usage. The project was awarded in December 2000.

·       Elemendorf AFB, Alaska -- The Air Force will utilize its land lease authority and will provide a direct loan and a limited guarantee of the private first mortgage to support the renovation, demolition and new construction of 828 units on-base at Elemendorf. This is a $91.7 million project with a scored amount to the Air Force of $23.2 million. The leverage is approximately 5.1 compared to military construction. The project was awarded on March 15, 2001. 

Projects in Solicitation and Planning

In addition to the projects already awarded, the Department has 12 projects currently in solicitation and numerous projects planned for the near future. A list of these projects is provided below:

PROJECTS in SOLICITATION
Installation	Scope (Units)
Fort Hood, TX	5,912
Fort Lewis, WA	3,955
Fort Meade, MD	3,170
Kirtland AFB, NM	1,164
Goodfellow AFB, TX	258
NC San Diego, CA	3,248
NC South Texas, TX	661
NAS New Orleans, LA	935
MCLB Albany, GA/MCB Camp Lejeune, NC	100
Hampton Roads, VA	80
Stewart Army Subpost, NY	171
Pennsylvania Regional, PA	339
Total	19,993

PLANNED PROJECTS
Installation	Scope (Units)
Fort Bragg, NC	6,066
Fort Campbell, KY	5,222
Fort Stewart/Hunter, GA	3,273
Presidio of Monterey, CA	1,713
Patrick AFB, FL	552
Wright-Patterson AFB, OH	1,536
McGuire AFB/Fort Dix, NJ	TBD
Dover AFB, DE	450
Little Rock AFB, AR	1,535
Vandenberg AFB, CA	506
Moody AFB, GA	606
Offutt AFB, NE	2,415
Charleston AFB, SC	470
Hill AFB, UT	1,116
MCAS Beaufort, SC/MCRD Parris Island, SC	1,645
MCB Camp Pendleton, CA	TBD
MCB Kaneohe Bay, HI	TBD
NC Charleston, SC	TBD
NTC Great Lakes, IL	TBD
NC Long Island, NY	TBD
NSB New London, CT	TBD
NS San Diego, CA (Follow-on Ph.)	TBD
NAS Whidbey Island, WA	TBD
Total	27,105

THE PRIVATIZATION AUTHORITIES

The Military Housing Privatization Initiative (MHPI) provides the Department with a variety of authorities with different benefits and budgetary impacts. The chart below lists the twelve basic authorities and describes their benefits and budget impacts. It also indicates which of the awarded projects used those authorities. Let me briefly discuss the authorities:

Authority	Section	Description	Benefit	Upfront Budget Impact	Where Used
Direct Loan	2873	DoD can provide a direct government loan	Brings additional financing at concessional interest rates	30% - 100% of loan amount, depending on terms in the year in which a privatization contract is signed.	Lackland AFB, TX Dyess AFB, TX Robins AFB, GA Kingsville NAS, TX MCB Camp Pendleton, CA Elemendorf   AFB, AK
Investments (Joint Venture)	2875	DoD can provide equity investment	DoD obtains an   interest in the business entity that does the project	Cash equity contribution is scored at 100% upfront	NS Everett, WA Corpus Christi, TX Everett II, WA Kingsville NAS, TX
Conveyance or Lease of Land and Units	2878	DoD may transfer ownership of units and land by fee simple conveyance or long-term lease	Transfer of ownership secures private sector financing Cash flow from units allows for additional private sector debt to fill financing gap	None	Lackland AFB, TX -      land lease MCB Camp Pendleton, CA - conveyance of units and land lease Robins AFB, GA - conveyance of units and land lease Fort Carson, CO & Elmendorf AFB, AK - conveyance of units and land lease
Differential Lease Payments (DLP)	2877	DoD can provide an additional rental payment directly to the developer	Brings additional financing by increasing rental income	Net present value of DLPs over life of contract	NS Everett, WA Corpus Christi, TX
Loan Guarantees	2873	DoD can guaranty private sector loan	Lowers interest rate Ensures availability of private sector financing	4% - 7% of loan amount for limited base closure guarantee	Fort Carson, CO Lackland AFB, TX Robins AFB, GA Elmendorf AFB, AK
Unit Size and Type	2888	DoD can build to local standards	Results in more cost-effective development	None	Lackland AFB, TX Fort Carson, CO NS Everett, WA NAS Corpus Christi, TX NS Everett II, WA NAS Kingsville,   TX MCB Camp Pendleton, CA Dyess AFB, TX Robins AFB, GA Elmendorf AFB, AK
Ancillary Support Facilities	2881	DoD can allow private sector to construct ancillary support facilities for the housing development (e.g., play areas, jogging trails)	Enhances quality of life for military tenants.	None	Lackland AFB, TX Fort Carson, CO NS Everett, WA Corpus Christi, TX NS Everett II, WA NAS Kingsville,   TX MCB Camp Pendleton, CA Dyess AFB, TX Robins AFB, GA Elmendorf AFB, AK
Payments by Allotment	2882	DoD can require tenants to pay rents through allotments	Improves financing by minimizing uncertainty of late payments and non-payment of rent	None	Lackland AFB, TX Fort Carson, CO NS Everett II, WA NAS Kingsville,   TX MCB Camp Pendleton, CA Dyess AFB, TX Elmendorf AFB, AK
Assignment of Members	2882	DoD can assign members to privatized housing	Could support occupancy during downsizing or deployment	Net present value of rental stream generated by assigned members	None
Build to Lease	2874	DoD can contract for the private sector to build and maintain units for lease by DoD	Central payment by DoD in stead of tenant - analogous to 801 Program	Amount equal to asset costs	None
Rental Guaranty	2876	DoD can guaranty occupancy or rental income.	Enhances the availability of private sector financing - analogous to 802 Program	Net present value of lease payments	None
Interim Leases	2879	DoD can lease privatized units for an interim period	Technical tool to enable occupancy prior to conveyance	Net present value of lease payments during interim period	None

THE DEVELOPMENT GAP

Understanding why the Department uses a particular authority in a given project requires understanding how housing projects are financed. Basically, a private developer uses debt and equity as the sources of funds to construct and renovate housing. The amount of debt that the project can support is directly tied to the income that the project will produce. When developing housing privatization projects, experience has shown that the total funds available combining developer equity and available private sector financing is normally less than the total development cost. The development costs of a privatization project includes the costs of design, legal support and financial fees. This dynamic in financing creates a development gap, which the Department tries to fill by using the MHPI authorities. This dynamic is illustrated in the chart below.

               Why Government Contribution?

 

 

       

 

Causes of the Development Gap

There are three basic causes of this development gap. First, consistent with the Department's initiative to eliminate out-of-pocket costs, housing privatization projects require the private sector developer to fund all development and maintenance costs, based on the income provided by the rent paid by Service members using their allowances, less a reasonable amount for the member to cover average utility usage. Since these allowances are currently below market rents, an initial development gap is created. The Department's initiative to raise BAH to a level that eliminates out-of-pocket costs would eliminate this discrepancy, but not until 2005.

Secondly, junior enlisted members assigned to on-base housing, built with traditional military construction, generally occupy single or duplex family houses with bedrooms based on number of dependents. The same junior enlisted service member living in private sector housing off base may only be able to afford a rental apartment, usually with a lesser number of bedrooms. Privatization projects located on-base require that developers build housing units, using market standards, but also equivalent to existing on-base housing in type and number of bedrooms. To do otherwise would create a perception of inequity between Service members living in on-base privatized housing and those living in government constructed housing on the same base. The discrepancy in the type of housing the members' allowances pay, as compared to what the developer is required to build, further increases the development gap.

The third factor affecting the development gap is the unique risk that is inherent to financing large housing projects on military bases. Private sector lenders are experienced in assessing the normal economic risks involved in housing development. However the risk to a project based on governmental actions (e.g., base closure, downsizing, or deployment) which might reduce the number of available occupants, introduces uncertainty affecting availability, cost and amount of private sector financing. This either adds to project cost or decreases the amount of available financing, further adding to the development gap.

Directly Closing the Development Gap

The Department can close the development gap by using the tools contained in the MHPI. DoD frequently uses direct loans to close the development gap. The primary advantage of direct loans is that the amount of the loan is scored in the budget at a subsidy rate (normally 50-70%) determined by the interest rate terms of repayment and the risk of default. These loans are generally in the form of second mortgages unless the required government subsidy would exceed the available private sector financing, in which case, the government should provide a first mortgage. Early strides in the housing privatization program related to developing the complex documents necessary to use government loans.

The Department can also close the development gap by providing a government equity investment. This method avoids some of the complexity involved in creating loan documents and credit monitoring but is scored as the total amount of the investment and does not offer the same up-front budget savings that use of a loan does. However, the government becomes an equity partner in the project and has the capability to create control mechanisms not directly available through use of the loan authority. The government also has the ability to share in any profits produced by the project. This authority is a central component in Department of the Navy projects.

Another authority that is essential to making projects work financially is Section 2878, which authorizes the lease or conveyance of land and existing units. Providing good existing units to a project can increase the developer's rental income stream (and, hence, the availability of private financing) without significantly increasing the development cost. Likewise, the provision of property or housing stock can provide income to a developer, which reduces any development gap. The project at Marine Corps Logistics Base Albany is a prototype which, if successful, will allow housing to be provided on-base in exchange for excess housing off base, with no cash contribution required by the Marine Corps.

The ability to provide Differential Lease Payments (DLPs) is another authority which increases the income stream available to the developer, thus enabling more private sector financing and eliminating potential development gaps without placing a burden on the military member through higher rents. The Navy has used DLPs with some of its investment deals. DLPs are scored upfront as a net present value of the contractual commitment and can be costly in budgetary terms.

Loan guarantees covering default caused by base closure; downsizing and deployment are necessary in some markets to reduce risk of default based on these governmental actions as described earlier. When necessary, these guarantees ensure the availability of private financing and lower borrowing costs so that project income streams are sufficient to service that financing. These guarantees do not protect the lender from the standard risk of economic failure - the lender assumes and mitigates that risk through its underwriting policies. Our preference is to let market competition dictate whether such guarantees are necessary.

Using government funds to close the development gap in the ways discussed above is cost-effective because numerous studies have found that providing allowances to Service members is less costly over the long term than building and maintaining government housing. Each project life cycle analyses shows that privatization will be less costly than military construction in all cases.   

Indirectly Closing the Development Gap

In addition to authorities that directly close the development gap with an infusion of cash, the MHPI contains other authorities that help the Department structure the housing privatization projects in ways that reduce expenses over the life of the project either through reduced construction costs or through enhancement of the execution of the projects once they are awarded. Our ability to conform with similar local housing standards releases these projects from onerous restrictions historically associated with military construction. Many private sector developers have cited this provision as a major improvement over privatization efforts of the 1980's. Constructing to local standards results in a more cost-effective development and therefore a higher quality project. Including ancillary supporting facilities, such as play areas and jogging trails in these projects enhances the quality of life of the residents. The Department interprets the authority to provide ancillary supporting facilities narrowly to mean facilities directly related to the housing and not widespread commercial development. Requiring members to pay their rents by allotment provides stability to the rental income stream and enhances private sector financing.  

Other Authorities

The MHPI also contains authorities that the Department has not yet used: Build-to-lease; interim leasing; occupancy/ rental guarantees; and mandatory assignment of members to the units which allows us to either lease units directly from a contractor or to guarantee occupancy by military members. These authorities are similar to Sections 801 and 802 authorities of the 1980's, and require the entire life cycle value of the contract to be budgeted upfront. While we are currently not employing these authorities, we believe they could be used in limited applications.

LESSONS LEARNED

In addition to the development gap concept, the Department has learned a number of other lessons from our initial solicitations concerning how to best structure housing privatization projects. We have taken great care to ensure that the viability of the projects is protected from downturns in the project revenues while simultaneously making sure that the project shared in any increases in revenue. Many of our projects employ a "lockbox" concept, which prioritizes the use of project income to ensure that the government's interests are provided for before the developer sees any profits. All operating expenses, reserves, and debt service are paid before the developer receives any money.

 We have also learned from our first on-base projects at Fort Carson and Lackland AFB that long-term ground leases and contract terms enhance the quality of the projects. Private sector financing dictates long-term mortgages based partly on the magnitude of the loans, which require stretching out the repayment term to allow project revenues to meet debt service requirements. Additionally, by requiring projects to be maintained for 50 years, we have seen innovative solutions proposed by the private sector in our first solicitations that reduce risk of project failure. In fact, requiring the private developer to commit to providing quality affordable housing for long terms is responsible stewardship of the upfront government contribution to these projects.

MILITARY HOUSING PRIVATIZATION PROGRAM 

EVALUATION PLAN 

In order to ensure that the Department continues to efficiently and effectively apply lessons learned, the Department has developed an active process of gathering and disseminating the lessons that we have learned from our previous projects. The Military Housing Privatization Program Evaluation Plan is the cornerstone of this process. The Program Evaluation Plan will help us to evaluate the projects we have awarded and to monitor performance of ongoing projects. Under the Program Evaluation Plan, financial and management data are collected and reviewed semi-annually to identify best business practices, ensure the well-being of the program, assess the performance of individual projects, and gauge Service member satisfaction with privatized housing. This plan was reviewed and approved by the Department's Installations Policy Board, which includes the Service Deputy Assistant Secretaries responsible for housing privatization, senior Service Engineers, and senior Department financial management analysis representatives. A November 2000 workshop was held to roll out the Program Evaluation Plan to all the Services. The first semi-annual data submittal of the Program Evaluation Plan was received March 1, 2001. We are currently reviewing this information and our analysis of the data will be shared with you and other stakeholders.

We have actively encouraged different privatization approaches by the Services, particularly during the pilot phase of this program. However, I am working on standardizing methods for determining housing requirements, conducting related market surveys, and comparing the costs/benefits of housing privatization projects to traditional military construction approaches. Consistency must be achieved in evaluation so that effective comparisons may be made.

                                                NEXT STEPS

We are working to complete the projects currently in solicitation and pursue the remaining projects, subject to approval by my office, as stated in our quarterly report to Congress. The Military Departments have identified possible housing privatization projects in accordance with their family housing master plans. We intend to review the Service's housing privatization projects in light of their Family Housing Master Plans and pursue the projects subject to approval of viable concepts and will follow this with appropriate notification to Congress. I will also ensure that the lessons from our initial projects are captured and disseminated to improve our new projects.

WORKING WITH CONGRESS

As I noted earlier, I greatly appreciate the support of our Congressional committees in including language in the Fiscal Year 2001 Defense Authorization Act to extend our program authorities to December 31, 2004. This extension of program authority reinforces program confidence and private sector investment as they work with us to complete existing and future deals.   

CONCLUSION

This concludes my prepared testimony. In closing, Mr. Chairman, I sincerely thank you for giving me this opportunity to discuss the Department's Military Housing Privatization Initiative.

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