Wednesday, January 31, 2007

Economics

I remember Scott Brison floated this idea when he was in public works. It didn't make much sense to me then and it still doesn't today:

TORONTO AND OTTAWA — Ottawa is preparing to sell $1.5-billion worth of office properties across the country as part of the first phase of a plan that will see dozens of federal buildings go to the private sector with the government as a long-term tenant, sources say.

[...]

The government is expected to use a process known as a “sale-leaseback,” by which it sells the buildings to the private sector and then rents them. The government is expected to use 25-year leases, sources said.

Show of hands by everyone out there who is considering selling their house and then renting it back? Anyone? Anyone? Bueller?

Presumably the businesses who purchasing these buildings will only buy them if they can make money off the government by doing it. So...uhh...the government must be, by definition, losing money in the process.

Stay tuned for Michael Fortier's next announcement where he reveals that he will pay for this plan by buying lottery tickets!

32 Comments:

  • CG: Not necessarily. As it stands now, the cost to the fed government for these buildings is some combination of the cost of upkeep and evemtual replacement of the building. If the private sector can achieve upkeep at a cheaper rate (I know, it's hard to believe that they could do this) and you hold replacement cost constant, then over the life of the contract they can realize a profit from the rent and the federal government can realize savings if its rent cost is less than its upkeep cost. My head hurts, but it is possible.

    By Blogger Peter Loewen, at 4:05 PM  

  • can you say corporate welfare??? anyone, bueller ;-).

    By Blogger canuckistanian, at 4:12 PM  

  • Actually Lease back arrangements are very common.

    RBC actually did this with their head office in Toronto. Airlines regularly did this in the past (although today they are just outright leasing from the outset).

    The major rationale for doing this is that selling a building immediately releases the cash that is 'frozen' by virtue of having it tied up in an asset. That cash can then go for capital reinvestment projects.

    Yes, there are a series of payments to make in leasing back your buildings, but the rationale is that the capital will be reinvested in projects and generate more cash with which to pay the lease payments.

    However, is this money is going to spending as opposed to infrastructure rebuilding (or some other projects which would increase overall tax receipts) then it is a foolish waste of money.

    If the large lump of capital will go towards increasing tax receipts then it's actually a good move.

    However, I'm always wary of Government's best intentions of making good moves...

    By Blogger Ivan, at 4:21 PM  

  • Also, this is based on the assumption that the gov't is using 100% of the building.

    If they aren't, then for the same reasons already posted, it's quite reasonable to lower the costs via leasing the space that is used.

    Another point is that perhaps those gov't staffers currently in the buildings may not be there in the future.

    Cheers,
    lance

    By Blogger lance, at 4:42 PM  

  • Additionally, the market is good right now, as far as I understand it. There a tonne of other costs associated with managing real estate.

    And if your core business is running unemployment offices or courts, it's probably best to leave real estate to the experts.

    By Blogger David MacLean, at 4:59 PM  

  • I agree w David.
    Leave property management to the experts and keep government hands away as far as possible.
    Good on the CPC for borrowing Brison's idea to unload these assets and make some cash.

    By Blogger WestmountLiberal, at 5:21 PM  

  • Do we really need the cash? What happened to the surplus? Has it already been spent?

    Real estate is an investment. Let's sell it when we have to. Once it's gone it can never be resold. And its not like real estate prices will EVER go down.

    Plus, its not like the government will be closing its property management division. They still have hundreds of buildings.

    I just can't see this saving money in the long run. (Even though the studies say it will.)

    By Blogger docsanchez, at 7:02 PM  

  • Real estate prices will never go down? Oh, ok, perfect. I guess all those analysts who are constantly worried real estate bubbles are just crazy.

    By Blogger Peter Loewen, at 7:07 PM  

  • I saw that too and wondered the same. But, it does happen and seems to work - apparently. Like Peter said, it makes my head hurt to understand it.

    You know, I've always interrogated a friend at Magna as to how Frank Stronach makes money. Why would anyone PAY him to manufacture parts? When you figure the profit that he is making, why don't they just cut him out and employ the same people he does??? Seems to work for them all, though - somehow. I guess this is similar?

    I suck at finance.... :(

    By Blogger Jason Bo Green, at 7:37 PM  

  • Now we know what cost Scott Brison the Liberal leadership-his idea to sell off government buildings. Oh, how his ears must be burning as his fellow Liberals rip the Brison/Fortier plan.

    By Blogger nuna d. above, at 7:51 PM  

  • "Presumably the businesses who purchasing these buildings will only buy them if they can make money off the government by doing it. So...uhh...the government must be, by definition, losing money in the process."


    That statement is wrong in so many ways. The transaction is not a zero sum proposition.

    Owning and managing large buildings is expensive and complex. It is not within the core competencies of any government. Buildings are a depreciating asset that must be carefully managed to ensure that maximum benefit accrues to the owner who still has to plan for the eventual replacement of the asset.

    Property management firms are more flexible and can respond easier to changing market conditions than a government. The government as tenant is free to write a monthly cheque for the rent and then go about its business. That is cheaper than tendering contracts for services, hiring janitors, paying for security...

    In business, deals are win-win out of necessity. The concept of winner/loser is wrong.

    By Blogger renegadejet, at 8:25 PM  

  • You save money on maintenance by using regular buillding service firms rather than paying civil service wages. You also sell out at a very high price (to make money on investments you do have to sell).

    Another point is that rather than having to pay a lump sum to rehabilitate the buildings they can reap a lump sum from the sale and then pay a reasonable lease rate over time. The nature of government budgeting makes it very hard to do reasonable planning and budgeting for capital improvements, mostly thanks to the cash accounting procedures rather than using GAAP.

    While not exactly identical, the budgeting issue resembles the reasons that firms prefer leases - lease is a cost that is fully deductible while a capital purchase can only be depreciated over the life of the asset, making capital investments eat cash but not help with taxes.

    Why would you ever ask a lefty for their opinion on financial transactions? They don't even believe that inflation is a problem, and want to run the world with 5 year plans. Getting them to explain a sale and lease back is an excercise in stupidity.

    By Blogger Hey, at 8:28 PM  

  • This is not a finance issue.

    It is simply an acknowledgement (whether well founded or not) that sometimes, the gov't is not very good at doing things.

    Ever watch Holmes on Homes? Do you ever, in your wildest dreams, think that he and his crew would work for a gov't bureaucracy? More likely they'd be in pulling down all the renos and redoing the work that the gov't contractors had previously done. (and yes, there is a different class of contractors that work for the gov't than the private sector - ever had a car accident and the body shop asks whether this is an insurance job or a personal expense?)

    On the surface, it seems reasonable. The fact that it will be managed by gov't bureaucrats, however, still should cause some concern.

    Good in theory. In practice?

    Dunno

    By Blogger The Anonymous Green, at 8:54 PM  

  • Also, this is based on the assumption that the gov't is using 100% of the building.

    If they aren't, then for the same reasons already posted, it's quite reasonable to lower the costs via leasing the space that is used.

    Another point is that perhaps those gov't staffers currently in the buildings may not be there in the future.


    What? Among the buildings on this list are the Pearson building - which houses DFAIT - and Place du Portage over in Hull, which is a sprawling complex filled with civil servants. And if the government is not using 100% of the building, they can lease unused space to interested tenants, i.e. obtain income from these rather valuable assets.

    Owning and managing large buildings is expensive and complex. It is not within the core competencies of any government. Buildings are a depreciating asset that must be carefully managed to ensure that maximum benefit accrues to the owner who still has to plan for the eventual replacement of the asset.

    Property management firms are more flexible and can respond easier to changing market conditions than a government. The government as tenant is free to write a monthly cheque for the rent and then go about its business. That is cheaper than tendering contracts for services, hiring janitors, paying for security...


    So the government can contract out the management of the buildings - that doesn't mean they need to be sold, and since contracts for services such as sanitation and security will have to made regardless, there seems little rationale for this. As the saying in economics goes, there's no such thing as a free lunch.

    You save money on maintenance by using regular buillding service firms rather than paying civil service wages.

    It's already quite common in the public sector to outsource things like janitorial service to private firms - my university employs Sodexho Marriot, for example. Once again, however, if lowering maintenance costs is desired (and I'm not keen to support policies that'll cut the wages of all those fat cat janitors and security guards), then find ways of doing it. It's NOT necessary in the slightest to sell off public assets for this. If space is not being used, then sell the empty buildings - there's no rationale to sell the heavily occupied ones.

    Of course, by this rationale, why not sell the Centre Block? Or Rideau Hall? Or National Parks? Museums? Why not lease the House of Commons?

    While not exactly identical, the budgeting issue resembles the reasons that firms prefer leases - lease is a cost that is fully deductible while a capital purchase can only be depreciated over the life of the asset, making capital investments eat cash but not help with taxes.

    Not exactly identical? Does the government pay *tax* on its assets? To itself?

    Why would you ever ask a lefty for their opinion on financial transactions? They don't even believe that inflation is a problem, and want to run the world with 5 year plans. Getting them to explain a sale and lease back is an excercise in stupidity.

    I understand it fully, thanks, now take your straw men elsewhere.

    By Blogger Josh Gould, at 9:57 PM  

  • "Do we really need the cash? What happened to the surplus? Has it already been spent?"

    Remember, surplus != national debt. Even with an annual surplus, it may make sense to replace some of the current debt with the capitaized lease obligation - so long as it is at a lower rate, or the operating savings can cover the difference. Wells linked to Brison's explanation from two years ago - if he is right, and the cost per foot and the feet per employee are higher for the feds than for comparable market-provided space, then this could be a benefit. Now who will capture most of the benefit is another story, of course...

    By Blogger deaner, at 11:03 PM  

  • The government should not be in the business of building management. The private sector can do this much more effectively, ensuring that proper maintenance and repairs are done without going through the labourous and political hassles of government.

    Sales and leaseback is standard. All the banks have sold their major assets and now lease them back - they are not in the business of property management.

    Some liberals lack of business understanding disturbs me, but then again as a Liberal, I'm in the minority on bay street.

    By Blogger Ramsey, at 11:14 PM  

  • "The government should not be in the business of building management."

    I don't know if you can make that as a flat statement (although I tend to agree): my recollection is that the federal government is the largest property holder in the country. That gives them the opportunity to capture economies of scale - the issue is whether they have been able to do so.

    By Blogger deaner, at 12:19 AM  

  • I don't know if you can make that as a flat statement (although I tend to agree): my recollection is that the federal government is the largest property holder in the country. That gives them the opportunity to capture economies of scale - the issue is whether they have been able to do so.

    Moreover, it seems that property management is not exactly equivalent to ownership - if there are efficiencies to be gained, then look for them, but selling off assets (especially when handled by the likes of Fortier!) seems rather drastic. I think too many assumptions are being made about what the government's needs may be in the future and about the property market generally. We're not talking about some random downtown office towers with many different firms inside.

    By Blogger Josh Gould, at 12:35 AM  

  • There is another aspect too.

    Given the focus on environment, can building environment be far behind?

    What if the rehabilition of the buildings means a huge outlay?

    Cheers,
    lance

    By Blogger lance, at 1:00 AM  

  • err, rehabilitation, darn my spelling sucks today.

    By Blogger lance, at 1:00 AM  

  • Ok, I hate posting on these things, but this issue and the analysis thereof is bordering on the absurd. Before I explain it to you, note two things. One, almost all journalists are inumerate. Two, same thing seems to hold for parliamentarians (see that Pablo Rodriguez idiot).

    Ok, the realities are this. I'll use your house analogy.

    You buy a home for, say, $300,000 with 1/3 down. You now have a $200,000 mortgage at, say, 5.25%. Your home will generally appreciate in value. History suggets that, over the long term, you likley earn about 5% a year in urban centres (I am in Toronto and that is the case here). That growth rate would be less in a rural or suburban setting.

    You will have other carrying costs attached to your ownership of the home. Property tax. Maintenance costs. Repair costs. If, on your $300,000 home, you can do this for less than $10,000 per year, you are making out like a bandit. So, let's say your looking at 3-5% per year of dead cost. Remember - these are not costs you will incur if you rent or lease the home.

    If it's not clear yet, it should be. The proposition that home ownership is the way to go is, at best, a dubious one. To recap - you are carrying at, say, 7-10% per year (this will decline as you pay off your loan) for an asset that will return you about 5%.

    Can it work otherwise? Of course. Marktes (housing, stock, resource, etc...) do fluctuate. Does it generally? No. Generally you will fall around the mean. Sometimes you can even lose money (ie. your home depreciates from when you bought it to when you sell it).

    Let me put this another way. If you had $100,000 to spend, would you spend it on an asset that returns you 5% or something that returned you more (lots of safe things do)? Work out the numbers - if you do this over 25 years (and, yes, account for lease payments) and apply my assumptions (they are reflective of current reality) you will have more money in your pocket at the end if you rent.

    The same principles hold for a business or a government owning real estate. Except there are other factors. All neagtive...

    Like this - should the government of Canada be in the business of real estate speculation with tax dollars?

    Or this - who owns commercial buildings (the big ones that house large operations)? People who are in the business of owning commercial buildings (ie they're good at it). I have no data to back this up (though I suspect it is easy to get), but I would estimate that 99% of Canadian businesses rent their premises. For a reason. It makes almost no sense to buy.

    Selling these building is not, by almost any definition, a bad idea. It is a good idea. And, as a tax payer, I would much rather see my government monetize an investment it should never have made instead of rasing my tax dollars to pay for something.

    By Blogger Michael, at 9:42 AM  

  • "We are led by lawyers who do not understand either technology or balance sheets."
    -Thomas Friedman

    By Blogger In_The_Centre, at 2:57 PM  

  • "Remember - these are not costs you will incur if you rent or lease the home."

    No - but someone will incur them, and will seek to recover them somehow. Since the only other person around is you they will seek to recover them from, ummm... you. In a residential rental they will be implicit in the rent charged. In a commercial lease, they will be included in the "Common Area Costs" that are recovered from tenants. There is no free lunch here; to reduce overall occupancy costs either the buildings have to be run more efficiently, the square footage occupied has to be reduced, or somebody has to accept a lower return on capital. Note that none of these are mutually-exclusive, and all of them were claimed as the drivers of the deal when Brison was talking about it a couple of years ago.

    Whether any (let alone all) will materialize is obviously the big question.

    By Blogger deaner, at 3:27 PM  

  • Even as a Liberal supporter, I support the party's orginal position under Brison rather than the current one. Real Estate is not an easy job and requires a high degree of specialization. Very few private firms own their own buildings and you would think they would own them if it were cheaper. Leasing it allows the government to focus on its core role while let those who have a better understanding of real estate manage the buildings. The government should keep core buildings like courthouses, military bases, parliament, museums etc., while sell the non-core ones.

    I also as a Liberal don't believe government generally does a good job at running everything. You do a better job when you focus on doing a few things well rather than many things poorly. This is not to say I support radical downsizing of government, but the government should focus on its core roles and leave everything else to the private sector and individuals.

    By Blogger Miles Lunn, at 6:23 PM  

  • "I also as a Liberal don't believe government generally does a good job at running everything."

    Just daycares?
    ;)

    Are you sure you're a Liberal?

    By Blogger deaner, at 7:14 PM  

  • Deaner - I am actually a former Progressive Conservative and generally have moderate libertarian leanings meaning I am right leaning on economic issues but left wing on social issues. I am a Liberal since I don't like the extreme ideology many Conservatives believe in.

    As for daycares, those should be a mix of government ones for those who need them, but also private ones too and governments should not show favouritism towards stay at home parents (as the Tories do) or to parents who send their kids to daycare (as the Liberals do). Instead create a system that benefits both of these groups, which neither the Tory or Liberal plan does.

    By Blogger Miles Lunn, at 1:08 AM  

  • It gives the Harper government a lot of cash that they can use right now. Paying for the leases is a future government's problem.

    By Blogger Jose, at 4:17 AM  

  • "I am a Liberal since I don't like the extreme ideology many Conservatives believe in."

    Interesting - I think we have a similar philosophical view, but I would say I am a Tory by default, since I 'don't like the extreme ideology many Liberals believe in.' As for Conservative extremism, I think it is more seen in Liberal (and Dipper) fearmongering than in practice - but to each their own.

    As for government-run daycares; we are discussing whether the government should continue to own buildings, largely on the basis that they should stick to their core competencies - what makes you think that includes daycare?

    By Blogger deaner, at 11:35 AM  

  • Interesting - I think we have a similar philosophical view, but I would say I am a Tory by default, since I 'don't like the extreme ideology many Liberals believe in.' As for Conservative extremism, I think it is more seen in Liberal (and Dipper) fearmongering than in practice - but to each their own

    I would say it has less to do with fearmongering and more to do with being more cautious. I prefer to stick with what I know than risk what I don't.

    As for government-run daycares; we are discussing whether the government should continue to own buildings, largely on the basis that they should stick to their core competencies - what makes you think that includes daycare?

    I don't think the government should run daycares, but I do think they should fund them. Much like with health care, the government doesn't own any doctor's office or for a matter fact even most hospitals, but rather our health care system is publicly funded but privately delivered and this is what should be done with daycare.

    By Blogger Miles Lunn, at 10:47 PM  

  • Check this out for FREE...

    This opportunity says:

    "Your Ad" Will Be Instantly Displayed on Thousands of Websites and Read By Over 10 Million People Per Week For FREE, and It Only Takes 60 Seconds To Get Started!

    To find out more visit: financial independence site. It successfully exposes FREE information covering Traffic and financial independence related stuff.

    By Blogger Scott A. Edwards, at 6:55 AM  

  • Check this out... Dear friends, Now you can help yourself take advantage of the huge surpluses of FREE advertising in your spare time, in the comfort of your own home. Hook up NOW with this exiting program. Click here: FREE INFORMATION

    By Blogger Scott A. Edwards, at 7:29 AM  

  • You buy a home for, say, $300,000 with 1/3 down. You now have a $200,000 mortgage at, say, 5.25%. Your home will generally appreciate in value. History suggets that, over the long term, you likley earn about 5% a year in urban centres (I am in Toronto and that is the case here). That growth rate would be less in a rural or suburban setting.

    You will have other carrying costs attached to your ownership of the home. Property tax. Maintenance costs. Repair costs. If, on your $300,000 home, you can do this for less than $10,000 per year, you are making out like a bandit. So, let's say your looking at 3-5% per year of dead cost. Remember - these are not costs you will incur if you rent or lease the home.

    If it's not clear yet, it should be. The proposition that home ownership is the way to go is, at best, a dubious one. To recap - you are carrying at, say, 7-10% per year (this will decline as you pay off your loan) for an asset that will return you about 5%.


    1) Your entire argument presupposes that many government buildings are mortgaged (a dubious notion in the case of many buildings, certaily) and, moreover, that property tax is paid on them. I don't know the answer to the second part offhand, but my guess is that the federal government isn't paying tax to the City of Ottawa on 24 Sussex Drive or the Pearson Building.

    2) Yes, there are carrying costs attached to home ownership, but the major advantage is that with each mortgage payment you are adding equity to your investment, i.e., you're not just paying rent or making lease payments for years with nothing to show for it. I mean, come on, you're not seriously suggesting we'd all be better off renting forever, complete with the hidden costs of having to deal with landlords, having to deal indirectly to get repairs, and otherwise not having the freedom that comes with being maître chez vous. In other words, your analogy is crap in and of itself.

    Even as a Liberal supporter, I support the party's orginal position under Brison rather than the current one. Real Estate is not an easy job and requires a high degree of specialization. Very few private firms own their own buildings and you would think they would own them if it were cheaper. Leasing it allows the government to focus on its core role while let those who have a better understanding of real estate manage the buildings. The government should keep core buildings like courthouses, military bases, parliament, museums etc., while sell the non-core ones.

    There is no valid a priori reasoning that makes property management - in contrast to courts, police, military, national parks, museums, etc. - inherently more "specialized" or somehow out of the scope of managers in the public sector. It's further hardly the case that "very few" private firms do not own their own buildings - leasing office space in a big downtown office tower is certainly common, but you seem to be implying that GM does not own its own factories or that RIM or Aventis do not own their own facilities.

    Certainly it makes sense for the government to assess on a continual basis whether a particular property is being utilized sufficiently to justify continued ownership - that is distinct from selling off major federal office buildings in downtown Ottawa and Hull - how exactly does the building housing (uniquely) the Department of Foreign Affairs and International Trade fall outside the "core role"? In any event, the federal government does not own every property in which it has offices as it stands - there's little rationale to sell off existing ones on the generalized assumption that it'd be cheaper that way. Leasing certainly isn't cheaper in the long run - it makes financial sense only when a particular item is turned over rapidly (e.g. computers, cars in many cases), and that is simply not the case with most government office buildings.

    Insofar as the actual management of the properties is concerned, there is no reason not to explore alternative management schemes, whether it involves the use of a Crown agency or corporation or a private autonomous entity along the lines of all our various airport authorities. That sort of semi-privatization has worked fairly well so far, but selling off government assets wholesale has not - see Highway 407 for a textbook case of what happens when an overly ideological government sells off public assets. Coincidentally, can you name the current members of cabinet who were ministers in Ontario in 1999?

    By Blogger Josh Gould, at 8:09 PM  

Post a Comment

Links to this post:

Create a Link

<< Home