VA Testimony of Anatolij Kushnir before Congress on October 2, 2001

United States Department of Veterans Affairs

DEPARTMENT OF VETERANS AFFAIRS
ENHANCED-USE LEASING PROGRAM
STATEMENT OF ANATOLIJ KUSHNIR
DIRECTOR, OFFICE OF ASSET ENTERPRISE MANAGEMENT
BEFORE THE SUBCOMMITTEE ON TECHNOLOGY AND PROCUREMENT POLICY
COMMITTEE ON GOVERNMENT REFORM
U.S. HOUSE OF REPRESENTATIVES

October 2, 2001

Introduction

In June 2001, Deputy Secretary, Dr. Leo Mackay formally dedicated the Mountain Home Energy Center, VA's first privately financed and operated energy plant - and the first in the Federal Government using this type of public/private development authority and financing structure. This state-of-the-art energy facility, designed in harmony with the historic Beaux Arts campus architecture at the James H. Quillen VA Medical Center at Mountain Home, will serve, for many years to come, the energy needs of the VA Medical Center, the East Tennessee State University's James H. Quillen College of Medicine and others in the local community. The lessee in this project is a special purpose entity specifically established to finance, develop and then operate the co-generation plant. Because of the structure of the public/private venture, VA is not only a purchaser of energy from, but also benefits from revenue generated from third party sales.

This unique initiative will result in a 25% reduction in energy consumption at the VA Medical Center. From a budget perspective this will save VA more than $11.5 million in discounted recurring costs and more than $17.5 million in life-cycle costs - with no capital budgeting requirements for VA (cost savings of over $35 Million). The VA Medical Center will also receive a percent of the revenues from energy sales to non-VA customers. Our projected revenues from this plant will be in excess of $5 million. The VA Medical Center plans to utilize the savings and revenues to support improved access to medical center-based primary care and community-based outpatient clinics. The plant also has dual back-up power systems, each of which can provide 100% of the VA Medical Center's power needs in an emergency - two levels of back-up power that the Medical Center does not have today. This equates to low risk, cost savings, cost avoidance and more reliable delivery of health care to veterans.

From a real estate management perspective, the results of this transaction were nothing short of spectacular. With that dedication, VA leveraged over $50 million of financial benefits from a parking lot that was appraised by the Department at $300,000. More importantly, other than leasing the site, the Department made no long-term commitments or obligations regarding the purchase of energy or future VA activities or presence at the facility. While the terms were fixed for VA purchase of energy for the entire enhanced-use lease term of 35-years, the transaction provided VA with the flexibility to purchase its future requirements based on its future needs without the need for long-term VA guarantees or termination liabilities.

The Department was able to achieve these benefits because of a unique asset management tool called the "enhanced-use leasing authority." Using this authority, VA is able to develop and then incorporate a capital asset management program into its strategic mission objectives. This capital asset management program relies upon a central principle that each VA-controlled property must be managed in a manner that promotes or enhances a VA program or mission. Such management may be either by direct VA-use or by its redevelopment by non-VA (public or private) users. I would like to take the next several minutes to tell you about the enhanced-use leasing program as it has been developed within the Department.

Background

The Department of Veterans Affairs, the second largest department in the federal government in number of employees, has as its unique mission the delivery of comprehensive assistance and benefits to the nation's veterans and their families. VA, through its Veterans Health Administration, is one of the largest direct providers of health care in the world. The Department is also a major land holding agency, with an extensive and diverse portfolio of properties including over 23,000 acres of land and over 5,000 buildings at approximately 270 locations, in addition to over 550 leased spaces nationwide.

To manage its property, VA uses all of the traditional authorities available to federal agencies. However, in many instances these authorities do not adequately address the needs of specific mission or developmental issues. Because of these limitations, exacerbated by on-going budgetary constraints, privatization and income-generation programs have become increasingly important to the Department. In an effort to obtain significant operating cost reductions and pursue alternative funding sources for veterans programs, VA is constantly developing and implementing new approaches, such as enhanced-use leasing.

Traditionally, VA properties have been viewed as cost centers. In contrast, the enhanced-use leasing concept was designed to:

encourage VA program and facility managers to view VA property holdings as program resources and potential revenue centers;
attract other public or private sector investment in VA facilities through broad-based market-based opportunities rather than upon reliance upon federal programs;
place available VA property into more productive uses;
enable VA to acquire otherwise unaffordable services or facilities; and
allow VA to realign its property holdings to reflect program requirements in a way that provides the greatest return to the Department and the Government.

What is Enhanced-Use Leasing and What Makes it Work?

Simply, enhanced-use leasing is a cooperative arrangement for the development of VA property under which:

VA property is made available to a public or private entity through a long-term lease;
the leased property may be developed for non-VA and/or VA uses; and
in return for the lease, the Department obtains fair consideration in the form of revenue, facilities, space, services, money or other "in-kind" consideration.

The Department has specific authority to enter into these types of arrangements. Originally enacted in the fall of 1991, the enhanced-use leasing authority is now codified at Section 8161 through Section 8169 of title 38, United States Code. The technical elements of this authority are:

the term of an enhanced-use lease may be up to 75 years;
the site to be leased must be controlled by the Secretary;
all uses must be consistent with and not adversely affect the mission of the Department;
VA may use "minor" construction funds (up to $4 million) as a capital contribution in connection with an enhanced-use lease;
VA may purchase services, space or facilities in connection with an enhanced-use lease.
VA must hold a public hearing at the location of any proposed enhanced-use lease to obtain veteran and local community input
VA must provide two notices to its congressional oversight committees prior to entering into an enhanced-use lease.

One of the major elements of the enhanced-use leasing authority is that unlike traditional federal leasing authorities in which generated proceeds must be deposited into a general treasury account, the enhanced-use leasing authority provides that all proceeds (less any costs that can be reimbursed) are returned to medical care appropriations. The ability to keep proceeds created an economic incentive for VA and its property managers to fully utilize their existing capital assets and to begin to view these assets as potential resources to fund needed programs or facility requirements. To underscore Congress' intent to provide VA with sufficient latitude to undertake and practice asset management, the statute addresses several key legal issues commonly identified as critical to successful public/private transactions by:

providing the Department with the ability to enter into long-term agreements so as to enable amortization of private sector capital investments;
clarifying the ability of the Department to undertake this authority from the myriad of other substantive and procedural laws relating to government procurement, management and disposal of property or services;
enabling the Department to enter into these agreements in a timely fashion to address market demands;
providing the Department with the flexibility to address a broad spectrum of market and financial conditions to address specific project requirements so long as the activity was within established statutory requirements and Department mission.

Finally, central to the enhanced-use leasing authority is its close coordination with and reliance upon the local government and community as full partners in the development process. There are two aspects to this participation. First, in order to maximize project efficiencies and minimize development costs, the Department relies, to the greatest extent possible, upon local building codes, safety requirements, construction standards and local government inspection services as they pertain to any non-VA development. If the project involves direct VA control over the management and operation of a facility or if VA occupies a significant portion of the enhanced-use development, the project is considered in the context of applicable VA standards. In such instances, VA requirements are reviewed in the context of how such standards integrate with applicable local codes and standards.

The second, and perhaps the more important reason why enhanced-use leasing stresses local government and local community involvement is to assure that the development is integrated in the local planning process. Close integration enables VA to spot any potential community concerns (scope and intensity of the development, traffic impacts, business impacts, etc.) and to address those issues early on in the planning and development process.

What types of projects have worked and why?

Obviously, sound development economics are the foundation of enhanced-use projects. But some factors within VA's control can contribute to the likelihood of success.

Enhanced-use leasing works best when government requirements can be defined in private sector terms. Examples: a VA administrative facility is not significantly different from a commercial office building; and transient lodging for outpatients or families visiting a VA hospital is not unlike a typical budget hotel. This allows the private sector to construct and operate in its customary manner. VA then benefits from the efficiencies of organizations and delivery processes that have been honed over time by the developer/lessee. VA can also improve the value of its projects by working to reduce project uncertainties, private sector risk and the cost of borrowing capital. This can be achieved through a variety of means such as use of local building codes, VA participation in entitlement discussions with local authorities, or addressing the concerns of potential financing sources early in the development process.

To date, VA has successfully completed a number of project types, including:

office buildings
co-generation facilities
parking facilities
community nursing homes
senior living residential facilities
health care support facilities
child development centers / elder day care centers
single room occupancy housing (homeless shelters)
management and operation of VA golf courses

Lessons Learned

In implementing its enhanced-use leasing authority, VA has discovered several key points to developing a successful public/private development program. The single most important is the enabling statute itself. This authority must provide sufficient flexibility to allow the public entity to be innovative in its approach to secure private investment into its facilities. While preserving the integrity of governmental processes, that public entity's implementation procedures must be tempered so as to be responsive to the broad span of market, environmental, political, and legal issues that arise in large-scale development of property. The public entity officials involved in the process must be committed to the effort's success, and while attempting to be responsive to the legitimate demands of the private sector, they must remain committed to structuring each transaction in a manner that will not obligate future appropriations and federal programs. To accomplish this objective, the public entities must participate fully as equal partners with the developer/lessee in project's development, financing and local community review.

Finally, "stovepiping" project development by vesting control over program development within a single office ignores the multitude of legal, fiscal, and program issues that arise from such development. Successful implementation within an agency is enhanced by establishing project teams with representatives from all of the various departments and disciplines involved.