San Diego Navy privatization costly, audit says

As newly elected GOP mayor Kevin Faulconer begins his behind-the-scenes ramp-up of what is expected to be a sweeping privatization at San Diego's city hall, a federal audit cautions that rampant outsourcing is not necessarily a cheap cure-all for shortcomings of big government.

That word comes in a March 18 U.S. Government Accountability Office report entitled "Military Housing, Information on the Privatization of Unaccompanied Housing."

Congress authorized privatizing military housing in 1996, the report says, but the idea got less than an enthusiastic reception from the brass.

The Navy and Army concluded that privatization could be used under a narrow set of circumstances at specific installations, such as where unaccompanied service members were already receiving the basic allowance for housing.

The Air Force and Marine Corps concluded that privatization was not suitable for meeting any of their housing needs. For example, an April 2000 Air Force memorandum indicated that privatization could have a negative effect on building unit cohesion.

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Despite the military’s reluctance, in 2002, Congress amended the military housing act to fund pilot projects.

In December 2006, the Navy awarded its first pilot project to privatize housing for junior unaccompanied personnel at Naval Station San Diego, California. The project included the privatization of one existing building and the construction of three new buildings.

The new buildings include 941 “market-style” two-bedroom apartments, and, in total, the San Diego project provides 2,398 bedrooms.

The private-sector developer’s cost for the project was about $321 million, with the Navy providing a cash equity investment of about $43 million for a total of about $364 million.

Though taxpayers didn't put up the bulk of the cash used to build the project, they have been paying dearly ever since, according to the audit, and the tab has lately been escalating, in the form of increased housing allowances paid to service members.

Personnel eligible for the housing allowance typically are not required to live in any particular location; they can elect to live at their military service’s privatized housing project (if one exists on or off the installation) or to live elsewhere.

"Navy officials told us that delivering 1,882 new beds within 4 months caused significant occupancy challenges," the auditors said, adding that the "target population" of "junior and mid-level unaccompanied personnel" spurned the project due to its on-base location.

While the sailors recognize the superior facilities and amenities, they are reluctant to return to quarters inside the installation’s fence line with restricted access for their friends and family.

Therefore, the private-sector developer and the Navy decided to temporarily expand the target demographic from E-4 with more than 4 years of service through E-6 to now include Homeport Ashore sailors and junior shore-based sailors (E-4 and below).

The problem with that, the audit report continued, was that the newly targeted tenants received a lower housing allowance, throwing the original income expectations for the project out of whack.

According to Navy officials, this shift has largely solved the occupancy challenges, yet it has strained revenues for the private developer, as Homeport Ashore sailors receive only a partial [housing allowance] rate based on the market rent for the existing building, but the private-sector developer’s financial projections were based on the market rent for the new buildings.

The Navy’s evaluation of the developer’s proposed budget for 2013 noted that although the overall occupancy rate for the San Diego project at the end of 2012 was about 96 percent, the revenues being received were insufficient to sustain the project over the long term.

What to do? Raise the housing allowance, which was done in September of last year, the report says, noting, "The higher partial rate of [housing allowance] requested would be equivalent to the market rents for the new buildings."

The costly pilot projects appear unlikely to be repeated, says the audit, which concludes, "according to Office of the Secretary of Defense and military service housing officials, none of the services have plans to pursue any future privatized housing projects for unaccompanied personnel."

The San Diego project, called Pacific Beacon, LLC was built by a subsidiary of Arlington, Virginia's Clark Realty Capital, which raised $300 million for its share of the project in a November 2006 taxable-bond sale.

In October of last year, Clark executive Bryan Lamb told the San Diego Business Journal "Clark made an equity investment in the project and has yet to see a return on that investment," adding, "Whatever the company receives at the end of the investment will not be a windfall."