The nation’s infrastructure funding gap—the gap between the cost of needed repairs and the funds available—is estimated at $1 trillion. Our bridges, roads, water systems, energy-related assets, airports, ports, and railroads are in desperate need of upgrades and repairs. Failure to address these infrastructure needs costs the average American household $3,400 each year. Further, it will result in the loss of $4 trillion in GDP and 2.5 million jobs between now and 2025.
As recommended by the Bipartisan Policy Center’s Executive Council on Infrastructure, to address the growing funding and financing gap, all possible tools must be on the table, including P3s. Widely used in other countries including Australia and the United Kingdom, P3s effectively transfer the risks associated with construction delays and cost overruns from cities, towns, and states to the private sector. While not an option for many projects, private capital can make the difference between proceeding or not with certain much-needed infrastructure improvements.
As with state and local governments, P3s hold great potential for the federal government. However, their use has been significantly constrained by simple accounting rules.
Importantly, the federal government both owns buildings and leases space in buildings owned by others. These buildings and leases are overseen by the General Services Administration (GSA). The Office of Management and Budget (OMB) determines the rules GSA must follow when accounting for these assets. One such rule involves how the federal government estimates the risks associated with the types of leases into which GSA and its partner agencies can enter.
Essentially, there are two types of leases into which the federal government and private companies can enter:
- An operating lease, the costs of which OMB allows to be spread out evenly over the life of the lease; and
- A capital lease, at the end of which ownership is transferred from the private entity to the federal government. In these leases, OMB requires the entirety of costs to be accounted for in the agency’s budget in the first year rather than spread out over the life of the lease.
The difference between the two types of leases primarily depends on their duration as well as how they treat ownership of the building. An operating lease cannot exceed 75 percent of the estimated economic life of the asset and ownership is retained by the private entity. A capital lease can last much longer, and ownership may transfer at the end to the government. While operating leases offer additional flexibility, capital leases provide the ability to lock in rents for a longer period of time, avoiding the need to renegotiate and potentially face costly rent increases.
A new federal building costs hundreds of millions of dollars, something few agencies have at their disposal in a single year’s budget. Therefore, many opt to enter into operational leases despite the potential for increased costs over the longer run.
An enlightening example is the federal Department of Transportation building.
An enlightening example is the federal Department of Transportation building. Over a period of 40 years, DOT outgrew its previous headquarters and found itself divided up in buildings throughout Washington. Because the agency could not secure funding in one year for the construction of a new building from Congress, it contracted with a private company to build a new headquarters and then lease it to DOT.
The site selected, in Washington’s Navy Yard neighborhood, might have made sense initially. Today, though, that building is just blocks from Nationals Park, home of Major League Baseball’s Washington Nationals, in a neighborhood where real estate values have risen 41 percent since 2009. By October 2018, DOT must renegotiate its lease on the building or buy it for fair market value. Had DOT simply bought the building at the outset or entered into a capital lease, it could have paid 2002 prices. While the neighborhood’s revitalization is surely a good thing for the city, the unfortunate side effect is that the federal government—and taxpayers—will be forced to swallow much higher costs.
At the end of the 15-year lease, with an average lease payment of approximately $50 million per year, the government will have spent $750 million to rent a building that only cost $326 million to construct, and will be left with no equity to show for it and no ability to purchase it at a bargain price.
Scope of the Problem
While the DOT building shows the downsides of OMB scoring rules, one might wonder just how big of a drain federal building are on the federal budget. According to the Government Accountability Office, GSA owns and leases over 376.9 million square feet of space in 9,600 buildings in more than 2,200 communities nationwide. In addition to office buildings, GSA properties include:
- land ports of entry,
- post offices, and
- data processing centers.
How Do We Resolve This?
Budget policy wonks are firmly opposed to reforming OMB rules, while infrastructure advocates passionately insist on the importance of reform to avoid situations like the DOT lease. Perhaps the best first step is a pilot project to demonstrate if a capital lease can be done that addresses OMB’s risk concerns while completing a long-stalled federal building project. Like DOT, the Federal Bureau of Investigation is now in need of a new building which could perhaps serve as the demonstration project.
In addition, budget rules assess the cost of action but fail to address the costs of inaction. Perhaps when DOT entered its lease agreement, had a more thorough analysis been conducted that included potential increases (or declines) in real estate values, OMB may have permitted a capital lease. Consistent with the recommendations of BPC’s Executive Council on Infrastructure, OMB should develop and evaluate a model for scoring the “cost of doing nothing” through calculating the long-term cost of deferred maintenance of federally owned assets. Additionally, federal investments in real estate assets should be evaluated on a life-cycle cost basis.
In order to address our infrastructure funding gap, all possible funding and finance options must be on the table. While federal decision-makers encourage state and local governments to enter into P3s as one means of advancing projects, they must also look at their own rules that prevent them from taking their own advice.