:
Thank you, Madam Chair and committee members.
Thank you for the opportunity to appear before you today on behalf of the Public Service Alliance of Canada. Joining me this afternoon, as Madam Chair mentioned, is Mike McCracken. Mike is the chairman and CEO of Informetrica. His firm is a privately owned Canadian company specializing in quantitative economic research.
PSAC commissioned Mike's firm to analyze phase one of the real estate plan. It will surprise no one that we think the sale and leaseback of several properties owned by the people of Canada was a bad deal for citizens. Mike has also concluded that it is a bad deal for taxpayers.
In a moment, Mike will brief you on the highlights of his analysis, but first let me outline some of our general concerns with the sale and leaseback of the initial set of properties. Because virtually no details are publicly available about phase two of the real estate plan, it is difficult to comment on it. All we can do is examine the recent transaction and anticipate what phase two might bring.
Our concerns are rooted in the belief that the sale of these assets is akin to the privatization of public space. In a world where Canadians are bombarded virtually every waking moment by commercial messages, images, and values, the loss of any public space is a very serious matter.
In a real sense, these buildings are the bricks and mortar of public services PSAC members deliver to Canadians. It is our view that the sale of these properties further diminishes the role in leadership of the Canadian government in our communities and is in keeping with the view that less government is better government.
The properties in question belong to the people of Canada. As our representatives, your committee has properly objected to the secrecy adopted by the government when it came to conducting the sale of these buildings. Your call for a moratorium on the sale was entirely appropriate and prescient, given the Federal Court injunction in relation to the Musqueam Band's objection concerning its unresolved land claim.
Information this committee demanded was withheld. Canadians were kept in the dark about the government's plans to sell our property. Some but not all details related to the sale have since been released, but only after the transaction was announced. If one is to encourage good behaviour through praise, then the government deserves credit for this limited release, but key documents remain secret, the Larco lease among them.
In fact, the most important details, the real numbers contained in a prospectus prepared for bidders called “The Confidential Information Memorandum”, continue to be withheld to this day. The confidential information memorandum contains a description of every property. It provides the details a potential bidder would need to craft an offer to purchase. It includes a statement of net operating income. It outlines operating expenses, taxes, management fees, parking income, and the like. It also includes a detailed schedule of capital improvements the new owners will pay for.
Without the details contained in the confidential information memorandum, it is impossible to properly evaluate the sale. I dare say, Public Works has probably withheld this confidential document even from government members of this committee.
Vague assurances that this is a good deal are not good enough. When you see the numbers, I believe you will quickly come to the same conclusion that Informetrica has reached: that taxpayers lost big time in this transaction.
You might be wondering, “How does she know?” The truth is PSAC obtained a copy of the confidential information memorandum. We were given the document on the condition that we keep it secret. For this reason, unless the Minister of Public Works releases us from this undertaking, I cannot at this time give you the document, but we can and will brief you on our analysis of it, and I will now ask Mike to do just that.
The handout I've given you is just a summary I'll speak to. If you have further questions, we'll try to handle them as they come up.
Essentially, the deal is one in which there is a turnover of buildings for cash and in which the new owners make a commitment to make certain capital improvements, not all, but those that are published in a schedule that the lessors were told they would have to commit to doing. These run to about 60% to 70% of the known, expected capital expenditures. They vary by building.
The government, at the same time, commits to pay the lease on the space for 25 years, indexed at 2%, although it's not clear whether that's 2% or the CPI, which could be different, and has an option to renew for two ten-year periods at market rates at that point. But the starting point on this is a set of lease amounts. It is interesting to note, from looking at earlier drafts of the discussion in some of the earlier studies, that the lease amounts per square foot in the final documents appear to have gone up an average of about $2 per square foot in the parts on which people actually finally bid.
The lessee, the government, as part of its leasing operation, is expected to pay all operating costs and any capital costs not specified as the responsibility of the lessor. So the risk--and a lot of the discussion around this, in general, was a discussion of the transfer of risk--of operating cost overruns and the risk of additional capital requirements is still being carried by the government.
There is an option at the end of 25 years, also, for the government to give up the buildings and not continue leasing them at market rates or to continue leasing them. They can also buy the buildings at the end of the 25-year period. That is done on the basis of the lease value at the end of the period. So it's the index value moved forward 25 years divided by what's called the capitalization rate, or the cap rate. That cap rate is specified in the lease. That's not been made public. We have made the assumption that it appears to be about 6%, but some of the other documents and commentary that have been released use numbers that are substantially higher than that, and if they are, of course that will affect that out-year cost.
There are a number of different ways of looking at it. You can just look at it on the basis of what happens in the first year, in 2008, say. In the Hays Building, it was previously $5 million net that was being paid by the government for operating costs and a net of their parking revenue. They will now pay $20 million, which is the lease payment, and they will lose the parking in the process, and so on.
We've gone over the seven properties. We did the analysis originally on the nine properties, but the two Vancouver properties have been removed from this presentation, given that they are in a state of limbo. I guess that would be the best way of describing it at the moment. With some of the recent claims on some of the Ottawa buildings, limbo may get bigger over time, as well, if others see this as an opportunity to put forward their requirements or demands.
This gap will widen over time from what you see here in the first year. Because of indexing, the operating costs covered by the tenant, we're assuming in the two cases, before and after, would be the same. Again, one can argue as to whether that will be the case or not.
Without the sale, the government faced a capital cost of about $105 million over the 25-year period for what has to be done in terms of major repairs. The lessor has indicated a willingness to accept $70 million of that, or about 68% in aggregate. This varies from between 50% and 90%, or 50% and 89%, depending on the building you are looking at.
The only thing I would make sure you keep in mind is that these are for the capital costs identified in the schedule. Anything that is not identified will be at the cost to the government as the tenant, as it would be in the case where they still held it, so we've not tried to raise that in the analysis as a differential element.
What we call the net present value of this lessor portion—in other words, what is the value if you were to try to put aside something to finance all these changes today—is about $54 million. So that's the value of that particular item.
In summary, the numbers around these projects, for the seven buildings, the revenue in what we call this net present value, is about $1.2 billion. There's a residual value on the buildings at the point at which there is an option available in 25 years. We estimate that to be $522 million. The capital being provided by the lessor is a $54-million reduction in cost to government. The total of that is $1.7 billion. The sale price, as near as we can determine it, is $1.4 billion for the seven buildings. This gives you a loss to the taxpayer of about $366 million, again, in net present-value dollars today.
This loss, of course, is over a 25-year period. We went out only 25 years, because after 25 years, the arrangements are such that the lease is on the basis of market value at that time, and one would normally take the market value to be one that would represent the balance between the value of the buildings and the payments for the use of that building, but it's in this first 25 years that the lease amount is fixed and where there is this indexing provision that's been put in place.
So that gives you at least an overview of the numbers. I think the general sense that one has is that the payments are generous. The risks are still on behalf of the tenant in terms of net operating costs and in terms of additional capital costs. The reason the values that came out of some of the studies that were tabled—particularly the Deutsche Bank study, and the Bank of Montreal studies as well—seem so low is based on a view that the residual value of these buildings is essentially very low, so much so that one wonders why they even bothered putting the number into it.
Of course, if they are in fact worth so little, then presumably the government will find it profitable to buy them back at that very low cost and return the situation to what it is today. But our view is that the value of those buildings, properly kept up, as they would be, is substantially higher than they were in these other studies. That represents a situation in which the value of this transaction is quite a bit more, because not only are you committing to these lease costs for 25 years as a government, but you're saying, “We're also going to throw in any claim we have on that building by surrendering it to you today rather than holding onto it.”
Let me turn it back over to Patty for some closing comments.
Ms. Patricia Ducharme: Were you going to talk about the efficiency of the private sector?
Mr. Michael McCracken: I can.
Let me just raise one issue that did come up. One of the claims was that the private sector, if they were operating this, would be able to deliver a 20% improvement in operating costs. The evidence of that has not been forthcoming. We've asked to see a study that was reportedly looking at that issue, from DPW some years back, but we should understand—or at least, my understanding of the current situation is—that the private sector is already being contracted, in most cases, to provide the ongoing maintenance of these buildings. So one has to ask, where have they been hiding their gains, because these operating costs that we are seeing are supposedly the actual operating costs that are there.
The second issue, though, is if they in fact are in a position to realize those through their expertise, etc., then I would suggest building that into your estimates. Then why don't you assume the liability for the operating costs--and those aren't. This is a net-net-net lease, the netting out being anything that they can still leave on the hands of the government will be there. But if you really believed you could operate the thing at 20% less, you would offer a gross lease; then you would show the economies that you can attain, because then you would retain those economies.
In this case, where every incentive I see is one in which there is an incentive to raise the operating costs on the part of the owner, you can pass them on to the tenant, you can maintain the value of his asset, which you will own immediately, and enhance its value in 25, 35, or 45 years. Oh yes, by the way, there is also a management fee that's a percentage of those operating costs as well. All of those things would make me ask why these are going to be lower in this situation.
That's the story on the operating costs. And as I say, we haven't seen this study that supports the view that they will be 20% more efficient than the current situation.
Thank you.
The first thing is that we had no guidance on what they were using, so we used what we thought was the appropriate rate, which was the borrowing cost to the federal government at the time. So most of the work we did in the first round of our support to the group was actually at 4%. We tried a variety, though, at 4.5%, 5%, and so on.
We then repeated the work after they had released some of their studies, because at one place in there it was stipulated that the lessor was supposed to use 4.7%. So we said, “Let's see what it looks like with that and see if we get the kinds of numbers that they're getting on this.” But then what you observe is that it's used only for discounting the lease amounts that are paid out, and that for other purposes much higher rates are used—in particular, in trying to put a value on the residual value of the property after 25 years.
The Deutsche Bank was suggesting that should be discounted back to the present at 9%, which makes it essentially valueless in the analysis that anyone is doing. They don't justify where that rate comes from, although that is a number that a real estate developer would no doubt like to get on anything that he's doing.
The other term or the other amount that comes in is a 6% discount rate, and this is based on the valuation of the building. This is based on the private sector experience, over a long period of time, of properties where people are not always occupying them on a steady basis, not necessarily always paying, so there is a discount on the value of a building. When you're trying to buy a building, you say, “What's the lease amount that I have and can expect? What is that divided by--let's say, 0.06 versus 0.045 or 0.047?” In that case, it would have the net effect of lowering that residual value or the value of the building more generally.
Again, it's not clear that in this case you should be using that kind of discount rate, for two reasons. One is that if you believe the central bank, we are in a new world of inflation at 2% or less. So much of the experience in the past, going back into the 1980s and early 1990s, of much higher inflation rates would have coloured your view of what would be the appropriate discount rate to use.
The other thing in this whole transaction that is not brought front and centre and we thought should be is that we're talking about the government here. We're talking about a government that can borrow funds more cheaply than anyone else in Canada. So it struck us that this really represents the alternative.
If they're selling this, the purpose of which is to raise some money, to get $1.4 billion, why don't you just go out and borrow $1.4 billion? What does that cost you? Currently, that costs you between 4% and 5% to borrow, depending on the term and the nature of the structure of the deal you have. Why would you want to be selling the stuff off and doing so on the basis of someone else borrowing money at 6% or 9% in order to buy it from you?
The discount rate in transactions of a government strike me as requiring special treatment, because they are special. They are in a position to provide that risk-free financing and borrowing, well beyond the capacities of any of the people on the other side of the transaction.
:
To me, and this is just my own personal interpretation of it, there was a lot of criticism early on about the value of the property, and if you recall, there were estimates that were put out in
The Globe and Mail about what they thought the properties were worth.
If you look at the documents that were around, like the BMO and Royal Bank study, you can find numbers that are fairly close to those in The Globe and Mail, and they were probably the source of them. But the government was, of course, aware that they wanted to be seen to be making a good deal, and making more money than what had been anticipated in this earlier item.
So what they did was to make a very simple adjustment, which is perhaps the best way of putting it. I wouldn't call it a trick. The lease price was revised upward by about $2 a square foot on all of the properties between the time the offer was put out for bid and the earlier studies that were the basis for the Royal Bank and BMO studies and the leaks to The Globe and Mail, etc.
So already they had set themselves up to do better, because they were saying “We'll give you more money, and you should pay more money. We're going to give you another $2 a square foot for 25 years. That's worth something to you, isn't it?” Of course it is, and that's why the bid prices that came in were at or even slightly above some of the prices that had appeared in those earlier articles. But in the interim, the value of the lease had gone up by $2 a square foot on average.
I don't have them with me, but we have those two columns of leases, the amounts in the two different documents. If you don't have them in the documents already provided to you, we'd be happy to make them available. I believe we can do that.
:
Thank you, Madam Chair.
I have presented a motion to the clerk--because I think the details are very important--that we ask the minister to release all the relevant documents surrounding the confidential information memorandum. That would include the operating expenses, the taxes, the management fees, and the detailed schedule of capital improvements. I have submitted that to the clerk. I just thought I would bring that to your attention.
I would like to pick up on my colleague's question, because I think it is a big issue--what we are going to do at the end of 25 years. I don't think we need a professor to tell us this is a great time to sell--of course it's a great time to sell. But what about having to buy it back?
Since I haven't seen a plan to get rid of the public service in 25 years, I'd like to talk about what happens at the end of this deal. It looks to me like we're looking at an elaborate accounting shell game here. This government will get an incredible one-year boost in their bottom line and look like they're managing our assets well--they'll have amortized the loss to the taxpayers over the 25 years--until the moment comes when key pieces of urban real estate are no longer in our hands and we have to find a place to put our staff.
I don't know if this was in the purview of your study or not, but if we go back to 1982 and look at the real estate value of federal buildings in key urban markets like Calgary, Toronto, Montreal, and Vancouver, what the value of those buildings would have been in 1982 compared to what they are in 2007, we'd see they've probably jumped fivefold to tenfold.
Have you looked at any of the realistic costs, the real estate values, given the previous 25 years and what we would be expecting in the next 25 years?
:
Let me be brief, though, given the hour.
If someone can take and buy the property and do something with it that is not going to be otherwise done, and that new use of that property is a positive contribution to the town they're in or to the businesses they're running, then you might say that it was a worthwhile transaction. And it may well be that the tenant of that building, who had previously been the owner, sold it but didn't want to make that change, and now the new owner can and the old owner can have that residual place of residence.
A very good example of this is what's gone on in many major cities where the air rights of certain buildings have effectively been sold. People have extended a building upward, or they've taken the air over the railroad tracks and built a building, and the train goes underneath it. CN would never have developed the building above it, so you're therefore getting better value out of the whole piece of real estate.
In this case, to my knowledge, we have not seen on the table any proposals for changing the configuration of the buildings. We have the same tenant in the same space for 25 years. So it's not clear that there's this opportunity for innovation or change, the hallmark of which, in the past, has been the assembling of a number of pieces property and the creation of some new, major structure. We don't see that happening here. Now maybe we don't see it because they don't want us to know it's going on, and the people who are buying all this stuff will eventually reveal the grand plan they have. And that's fine, because it's in their interest to keep people in the dark if they're going to be buying up other pieces of property that are related to this area.
The other reason it happens is that you have someone who is cash-strapped. So you may have an organization that owns a building. They can't borrow any more from the bank, so they say, “What can we do? Well, let's sell it. We have someone who wants that real estate. Maybe they want the property it's on and will eventually do something with it. Maybe we can get a good deal to lease it back cheaply and then, effectively, have some financing to continue our operation. And anyway, we're not in the real estate business.” That's the other term that is often raised by someone like that.
Now, you can imagine some governments being in that position. You know, some of the provinces in the thirties were on the verge of bankruptcy. Maybe, if they'd been such financial innovators as we are today, they would have had opportunities to sell off some of their properties and lease them back. But by and large, the current position of the federal government would not appear to be that of a cash-strapped entity. Certainly the surpluses that have been appearing now for a number of years would suggest that there's no major financial constraint that they're trying to appease through this particular transaction. They're not going to be able to borrow as a result of this transaction at a significantly lower rate than if they had not undertaken this transaction, and they haven't told us that this is a sale for some purpose. It isn't a case of telling us what they are going to spend the $1.4 billion on. It will just go into general revenues and will be parcelled out in tax cuts or in other actions or as debt reduction at some later point in time. So I don't see that innovation, that imagination, and the application of the funds as being evident in this transaction. Those would be the kinds of things you would look for.
I mean, people buy and sell real estate. It's not an odd thing. It's a huge market, and it's happening all the time. But in this particular case you ask them again to explain why they're doing this when the value they're getting for this seems to be a low value. That's all we're asking.
:
Thank you, Madam Chair.
I just want to make one comment and ask Mr. McCracken two questions.
My comment is for everyone. We have to be careful when we try at times to undermine the credibility of people who come to give evidence.
A document we received today says that Public Works and Government Services Canada, PWGSC, and the CB Richard Ellis group are not able to establish the value of the buildings. That is what Mr. McGrath asked. Nor were they able to do so in 2004, because no one at PWGSC had the skills to do it and the documents they had there were full of errors. You can read it in the document.
My question is for Mr. McCracken. A document from BMO and RBC says that PWGSC stated that its capital costs are higher than the private sector's because the elaborate process of internal approvals takes a lot of time. In addition, it says that internal standards often lead to specifications that are too stringent in comparison to those in the private sector, meaning less than optimal performance.
So that means that government standards are so high that, as I understand it, even the private sector would not meet them.
You must have seen this kind of thing. Can you tell me if it is normal in your world? Then, is it normal, supposedly to protect future deals, to have no information about the deals that took place with these seven buildings?
:
Madam Chair, I'd like to present a motion to the committee due to conversations we've heard today.
May I just preface it with a statement? We've had many witnesses at this committee on this very issue; as a matter of fact, I'm not even sure of the number. But, regretfully, not all the members here today were able to participate in all of those discussions, talks, inquiries, and questions and answers. I would certainly urge the committee members to, as best as possible, have a chance to review the blues and try to refresh themselves on some of the commentary that has happened and some of the testimony and statements.
It's normal to have differences of opinion, and I certainly understand and respect that. That's the nature of committees: conflicting opinions, directions, and thoughts. They abound here, and that's the nature of democracy and government. I think it's wonderful that we have the luxury of being able to have a difference of opinion.
But I was concerned today about the statement by Mr. McCracken that potentially we have wrong information. I concur with Mr. Holland's thoughts on this matter that we have to have accurate information.
As such, I would like to propose this motion: That this committee invite representatives from Deutsche Bank, BMO, and RBC to respond to the claims by Mr. McCracken.