Military Housing Privatization: DOD Should Take Steps to Improve Monitoring, Reporting, and Risk Assessment

In 1996 Congress provided DOD with authorities enabling it to obtain private-sector financing and management to repair, renovate, construct, and operate military housing. DOD has since privatized 99 percent of its domestic housing.

The Senate Report accompanying a bill for the National Defense Authorization Act for 2017 included a provision that GAO review privatized military housing projects and the effect of recent changes in the basic allowance for housing on long-term project sustainability. This report examines the extent to which DOD has (1) assessed and reported the financial condition of each privatized housing project; (2) assessed the effects of recent reductions in the basic allowance for housing on privatized housing; and (3) defined notification requirements for project changes and risk tolerances relative to privatized housing goals. GAO reviewed policies, project oversight reports, and financial statements, and interviewed DOD officials and privatized housing developers.

The Department of Defense (DOD) has regularly assessed the financial condition of its privatized housing projects; however, it has not used consistent measures or consistently assessed future sustainment (that is, the ability to maintain the housing in good condition), or issued required reports to Congress in a timely manner. Specifically:

Some data used to report on privatized housing across the military services are not comparable. For example, there are inconsistencies among the projects in the measurements of current financial condition (for example, the ability to pay debts and maintain quality housing).These differences have not been identified in reports to Congress.

The military departments vary in the extent to which they use measures of future sustainment, and information regarding the sustainment of each of the privatized housing projects has not been included in the reports to Congress.

DOD's reporting to Congress has not been timely. DOD is statutorily required to report to Congress the financial condition of privatized housing projects on a semiannual basis, but it has not reported on any fiscal year since 2014.

By taking steps to improve the consistency of the information provided and meet the reporting requirement, DOD would provide decision makers in Congress with useful, timely information about the financial condition of the privatized housing projects as they provide required oversight.

DOD has not fully assessed the effects of reductions, relative to calculations of market rates for rent and utilities, in servicemembers' basic allowance for housing payments on the financial condition of its privatized housing projects. In August 2015, DOD required the military departments to review their privatized housing portfolios and outline any effects of the reductions. Each military department reported that the reductions would decrease cash flows to their long-term sustainment accounts. However, the reports did not specify the significance of the reductions on each project's future sustainment or identify specific actions to respond to shortfalls at individual projects. If DOD fully assesses the effects of the basic allowance for housing reductions on privatized housing and identifies actions to respond to any risks, DOD and Congress will be better informed to make decisions affecting the projects.

DOD has not defined when project changes require prior notice to the Assistant Secretary of Defense for Energy, Installations, and Environment or its tolerance for risk relative to its goal of providing servicemembers with quality housing, including the risk from reduced sustainment funding. Specifically, the military departments had different understandings of when project changes, such as financial restructurings, required prior notice. Additionally, DOD has not required the military departments to define their risk tolerances—the acceptable level of variation in performance relative to the objectives—regarding the future sustainability of the projects. By clearly defining the conditions that require advance notification and developing risk tolerance levels, DOD would have consistent information that would improve its oversight of privatized housing and inform its response to any future sustainment challenges.

GAO is making eight recommendations, including that DOD improve the consistency and timeliness of the information reported on the financial condition of its privatized housing projects, fully assess the effects of the reductions in basic allowance for housing on the projects, clarify when project changes require notice, and define tolerances for project risks. DOD concurred with each of our recommendations and identified actions it plans to take to implement them.

In the mid-1990s, the Department of Defense (DOD) had designated  nearly two-thirds of its domestic family housing inventory as needing  repair or complete replacement. At the time, DOD estimated that it would  need about $20 billion in appropriated funds and up to 40 years to  eliminate the poor quality housing through new construction or renovation  using the traditional military construction approach. DOD became  concerned that the poor quality of its housing was having a negative  effect on servicemembers’ quality of life and detracting from readiness by  contributing to servicemembers’ decisions to leave the military. To enable  DOD to privatize its housing, Congress provided the department with a  variety of authorities to obtain private-sector financing and management  to repair, renovate, construct, and operate military housing. In more than  a decade since, the military departments have worked with private-sector  developers who have rebuilt and renovated the housing. These  developers now operate 99 percent of domestic military family housing,  as well as a limited amount of housing for unaccompanied military  personnel. The developers rely on servicemembers’ basic allowance for  housing payments as a key revenue source for this privatized housing,  but DOD began reducing these payments in 2015.

Since 1998, we have conducted various reviews related to military  housing privatization and the basic allowance for housing. In 2009, we  reported, among other things, that some privatization projects with  occupancy rates below 90 percent were challenged in generating enough  revenue to fund construction, make debt payments, and set aside funds  for future major renovations and rebuilds. We also stated that turmoil in  the financial markets had reduced available construction funds, resulting  in more renovations relative to new construction and reduced amenities at  some projects. We recommended, among other things, that DOD include  information in its reports to Congress on the effects that current financial  market conditions have on housing projects. DOD agreed with our  recommendations, and in its February 2010 semiannual status report to  Congress included more detailed information on the financial  performance of ongoing projects. In 2011, we reported that DOD uses a  data-intensive process to set housing allowance rates, but that  enhancements related to data collection and definitions for data  collection, as well as cost estimating for budget estimates, could enhance  the process. We recommended, among other things, that DOD assess  the benefits and drawbacks of revising its definition of “available” housing  for data collection purposes, and that it develop a communications  process for installations to share information on housing tools. DOD  generally concurred with our recommendations and took steps to  implement them. In 2014, we reported, among other things, that the  military services conducted several analyses and considered several  other factors to determine whether to privatize housing for  unaccompanied personnel. The Army and Navy concluded that  privatization could be used under a narrow set of circumstances at  specific installations, and the Air Force and Marine Corps concluded that  privatization was not suitable for meeting any of their unaccompanied  housing needs. We did not make any recommendations in that report.

The Senate Armed Services Committee report accompanying a bill for the  National Defense Authorization Act for Fiscal Year 2017 included a  provision for us to review privatized military housing projects and the  effect of recent changes in servicemembers’ basic allowance for housing  on the long-term sustainability of the projects. In this report, we examine  the extent to which DOD has (1) assessed and reported the financial  condition of each privatized housing project; (2) assessed the effects of  recent reductions in the basic allowance for housing on privatized  housing, and identified any other challenges and options to address those  challenges; and (3) defined notification requirements for project changes  and risk tolerances relative to privatized housing goals.

For objective one, we reviewed DOD guidance on the oversight and  management of privatized military housing and documentation used by  each military department to oversee the financial condition of each of their  privatized housing projects. This included documentation on each of their  portfolios as a whole through portfolio-wide oversight reports, monthly  and quarterly reports on each privatized housing project, and the projects’  audited financial statements from fiscal years 2013 to 2016. We also  reviewed DOD’s annual report to Congress on privatized housing, as well  as data for privatized housing projects from fiscal years 2013 through  2016. We met with officials involved in the oversight and management of  privatized housing to discuss their oversight and management of the  financial condition of privatized housing projects. Additionally, we  examined the differences among and within the military departments in  determining the financial condition of their projects. We compared the  extent of DOD’s actions to assess and report the financial condition of  each privatized housing project with DOD’s housing policy and federal  internal control standards related to quality information. For this and  each of our objectives, we visited a non-generalizable sample of  privatized housing projects.

For objective two, we reviewed DOD guidance on applying reductions in  the basic allowance for housing to privatized military housing, as well as  other documentation on DOD’s reductions in basic allowance for housing  payments. Specifically, we reviewed the military departments’ reports on  the projected effects of the reductions in basic allowance for housing on  their portfolios and quarterly project oversight reports from fiscal years  2016 and 2017 to identify challenges and options to address challenges.  We interviewed officials from each military department involved with  privatized housing, officials at the installations in our non-generalizable  sample involved in privatized housing, and officials of five leading  privatized housing developers for their perspectives on challenges to their  privatized housing and options to address them. We reported examples of  challenges that were identified by at least two of the three military  departments. Additionally, we interviewed officials at the Defense Travel  Management Office for information on the basic allowance for housing  calculations and military department officials for their perspectives on the  reductions in the basic allowance for housing. We compared military  department reports on the projected effects of the reductions in the basic  allowance for housing with federal internal control standards related to  risk assessment. We also reviewed policy guidance on DOD’s privatized  housing responsibilities to determine the level of authority needed for the  options to address challenges.

For objective three, we reviewed DOD guidance on oversight and  management of privatized military housing, interviewed DOD and  developer officials responsible for privatized housing, and reviewed DOD  documentation. Specifically, we reviewed DOD housing policies and  guidance and military department guidance on overseeing privatized  housing. We also interviewed officials familiar with notification processes  for changes to privatized housing projects and with approaches to  managing risks to privatized housing projects, and officials in the Office of  Management and Budget familiar with privatized military housing. We  compared the extent to which DOD has defined notification requirements  for project changes and the extent to which DOD has defined risk  tolerance for privatized housing with federal internal control standards  related to internal communication and risk assessment. Further details  on our scope and methodology can be found in appendix I.

We conducted this performance audit from December 2016 to March  2018 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.

DOD Goals, Roles, and Responsibilities for the Privatized Housing Program

DOD’s policy is to ensure that eligible personnel and their families have  access to affordable, quality housing facilities and services consistent  with grade and dependent status, and that the housing should generally  reflect contemporary community living standards. It is also DOD’s policy  to rely on the local private sector as the primary source of housing for  servicemembers who are normally eligible to draw a housing allowance,  whether unaccompanied or accompanied by family. About a third of  eligible servicemembers generally live on an installation, with the rest  living in the surrounding local communities.

The Assistant Secretary of Defense for Energy, Installations, and  Environment (ASD (EI&E)) is the program manager for all DOD housing,  whether DOD-owned or privatized. In this capacity, the ASD (EI&E)  provides guidance and general procedures related to military housing  privatization. One responsibility of ASD (EI&E) is to provide required  reports to Congress on privatized military housing projects. However, it is  the responsibility of the military departments, rather than ASD (EI&E), to  execute and manage privatized housing projects, including conducting  financial management and monitoring their portfolio of projects. Each  military department has issued guidance that outlines its responsibilities  for privatized housing, such as key offices responsible for overseeing  privatized housing projects. For each privatized military housing project,  developers maintain day-to-day operational decision making and manage  each project.

Military Housing Privatization Authorities and Project Structures

The military housing privatization initiative provided DOD with various  authorities to obtain private-sector financing and management to repair,  renovate, construct, and operate military housing. These authorities  included the ability to make direct loans to and invest limited amounts of  funds in projects for the construction and renovation of housing units for  servicemembers and their families. The projects were generally  financed through both private-sector financing and funds provided by the  military departments. Specifically, projects obtained private-sector  financing by obtaining bank loans and by issuing bonds, which are held  by the public. In addition, the military departments provided additional  financing. The Army and the Navy generally structured their privatized  housing projects as limited liability companies in which the military  departments formed partnerships with the developers and invested funds  into the partnership. The Air Force generally provided direct loans to the  developers. Because privatized housing projects involve budgetary  commitments of the federal government, each project was scored at  inception by the Office of Management and Budget to determine the  amount of funds that needed to be budgeted for that particular project.

The number of projects can change over time. For example, a project  may be sold, and new projects can be created. As of October 2017, there  were 82 privatized military housing projects, each of which can consist of  one or multiple installations. The Army has 35 projects, the Navy and  Marine Corps together have 15, and the Air Force has 32. Most of these  are family housing projects, but the Army and Navy have created a small  number of privatized housing projects for servicemembers without  families (that is, unaccompanied housing).

The military departments have flexibility in how they structure their  privatized housing projects, but project structures share certain  similarities. For a typical project, a military department leased land to a  developer for a 50-year term and conveyed existing homes located on the  leased land to the developer for the duration of the lease. The developer  then became responsible for leasing renovated and newly constructed  homes, giving preference to servicemembers and their families.

Each privatized housing project is a separate and distinct entity governed  by a series of legal agreements that are specific to that project. These  agreements include, among others, an operating agreement, a property  management agreement, and an agreement that describes the  management of funds in the project, including the order in which funds  are allocated within the project. However, while each project is distinct,  there are some common elements in how projects invest and utilize  funds. Every project takes in revenue, which consists mostly of rent  payments. Projects then pay for operating expenses, including  administrative costs, day-to-day maintenance, and utilities, among other  things. After that, projects generally allocate funds for taxes and  insurance, followed by debt payments. Figure 1 shows a typical funding  structure for a privatized housing project.

In the typical privatized housing project depicted in figure 1, once debt  payments are made, funds are allocated to accounts that fund scheduled  maintenance. These accounts exist to fund repair and replacement of  items such as roofs, heating and cooling systems, and infrastructure.  After that, funds are allocated to a series of management incentive fees,  such as the property management fee. Finally, the project divides these  remaining funds according to a fixed percentage between accounts that  fund major renovations and rebuilds on the one hand and go the  developer on the other hand. The percentages may vary, but the majority  of funds go toward the accounts funding major renovations and rebuilds.

Housing Allowance and Occupancy of Privatized Housing

DOD’s Defense Travel Management Office annually calculates rent and  utility rates for locations across the United States based on estimates of  local market conditions, which are then adjusted for an individual’s pay  grade and dependency status. These calculations, which can fluctuate  from year to year, are then used to determine individual servicemembers’  monthly basic allowance for housing payments. DOD does not require  servicemembers, other than certain key personnel and junior  unaccompanied personnel, to live on an installation and thus in military  privatized housing. Because only about a third of eligible servicemembers  generally live on an installation, the basic allowance for housing payment  is designed to enable servicemembers to live off-base comparably to their  civilian counterparts. Servicemembers pay their rent—whether living on  the installation or off—with their basic allowance for housing payments.  Therefore, DOD’s privatized housing competes with available housing  options in the local market.

Active-duty servicemembers are given priority for privatized military  housing. However, projects can advertise and lease to tenants other than  active-duty servicemembers, including civilians in some cases, generally  once occupancy dips below a specific level. For example, the Air Force  has approved leasing to other tenants when any given project’s  occupancy rate falls below 98 percent.

DOD Regularly Assesses Projects’ Financial Conditions but Has Not Consistently Assessed Future Sustainment Needs or Issued Required Reports to Congress

DOD regularly assesses the financial condition of its privatized housing  projects through recurring internal reporting by the military departments  on each of their projects; however, key data on current financial  conditions are not mutually comparable. Moreover, the military  departments vary in the extent to which they use measures of future  sustainment needs and funding to assess project sustainability. In  addition, DOD has not consistently issued required reports to Congress  on the financial condition of privatized housing projects in a timely  manner.

The Military Departments Regularly Assess the Financial Condition of Their Privatized Housing Projects

The military departments regularly assess the current financial condition  of their privatized housing projects through internal, recurring monthly or  quarterly financial reporting. DOD policy requires the military departments  to manage their housing, including privatized housing, through financial  management and reporting. DOD’s housing manual states that because  housing privatization projects create a long-term governmental interest in  privatized housing, it is essential that projects be monitored attentively,  and that the military departments monitor their portfolios of projects.  Specifically, each military department produces—based on information  provided by each project—or receives from each project quarterly or  monthly reports detailing the financial condition of each individual  privatized housing project. Each military department also produces  periodic reports on the condition of its portfolio as a whole. These reports  include financial measures such as revenue and operating expenses, as  well as a measure of the ability to make required debt payments, referred  to as debt coverage ratio or debt service coverage ratio.

In their assessments, each military department emphasizes somewhat  different measures of current financial condition, although each uses debt  coverage ratio as a key measure of the current financial condition of  privatized military housing projects. Specifically, in its portfolio-wide  reports, the Army uses three key performance metrics to measure  financial condition—a measure of revenue, net operating income, and the  debt coverage ratio. The Air Force also rates projects’ financial  condition based on three metrics, but the metrics differ from those used  by the Army. The Air Force’s metrics are operating expenses compared  with budgets, net operating income compared with the original project  plan, and debt coverage ratio. In its portfolio-wide reports, the Navy  provides debt coverage ratio as its measure of current financial condition.  Regardless of the different metrics used, the military departments rated  almost all of the privatized housing projects as having acceptable current  financial conditions. Specifically:

Army: For the quarter ending June 30, 2017, all 34 Army projects  generated enough cash to continue operations and make required  debt payments, according to the Army’s portfolio-wide reporting.  However, the Army rated 8 family housing and 4 unaccompanied  housing projects as below or well below expectations, in terms of  current finances. For example, the Army rated the project at Fort  Bragg, North Carolina, as being well below expectations, due to  occupancy challenges resulting from off-post competition and higher- than-expected expenses.

Navy and Marine Corps: For the 6 months ending June 30, 2017, all  16 Navy and Marine Corps projects were generating enough cash to  continue operations and make required debt payments, according to  the Navy’s portfolio-wide reporting. However, 5 of the 16 projects  were on a watch list, due to financial challenges. For example, the  Marine Corps’ project comprising Camp Lejeune, North Carolina;  Marine Corps Air Station Cherry Point, North Carolina; and Stewart  Air National Guard Base, New York was experiencing low  occupancy rates due to local market competition, and as such was  included on the watch list.

Air Force: For the quarter ending June 30, 2017, the Air Force rated  27 of its 32 projects’ current finances as acceptable or exceptional.  However, the Air Force rated 2 of its 32 projects as unacceptable, and  3 as marginal, for current finances, according to Air Force portfolio- wide reporting. For example, the Air Force rated the Nellis Air Force  Base project in Nevada as having an unacceptable current financial  condition as of June 2017. In March 2017, the Office of Management  and Budget approved the budgetary scoring of a financial  restructuring of the project. In the restructuring, the Air Force reduced  the interest rate on the government’s direct loan to the project and  extended the loan’s maturity date, redistributed residual project cash  flows, and reduced certain returns due to the developer. In another  example, the Air Force rated the Air Combat Command II project,  which comprises Holloman Air Force Base, New Mexico, and Davis- Monthan Air Force Base, Arizona, as having a marginal current  financial condition as of June 2017. Specifically, basic allowance for  housing rates for the project were only 85 percent of original  expectations, and the project was unable to compensate for that  shortfall by controlling expenses. The Office of Management and  Budget has approved the budgetary scoring of a financial restructure  of the project, including a reduction in the interest rate on the  government’s loan to the project and a reduction in certain returns and  fees previously owed to the developer.

Data on Current Financial Condition of Privatized Housing Projects Reported to the Office of the Secretary of Defense and Congress Are Not Comparable

Based on our analysis, data on the current financial condition of privatized  housing projects that have been reported by the military departments to  ASD (EI&E) and Congress have not been comparable because (1) there  are inconsistencies in the calculation of the reported debt coverage ratios,  and (2) the data requested have not followed consistent time periods.  Debt coverage ratios are a key measure used by the military departments  to report on the current financial condition of privatized housing projects,  and the measures are also the main financial measure for privatized  housing projects that DOD has previously reported to Congress.  However, we found the following inconsistencies in the debt coverage  ratio data reported to ASD (EI&E):

Adjustments made to income for the purposes of calculating debt  coverage ratios affect the ratios’ consistency: The expenses that are  or are not included in a project’s calculation of the debt coverage ratio  are dictated by each project’s business agreements. ASD (EI&E)  defines debt coverage ratio as the project’s net operating income— income remaining after all project expenses are paid, but before debt  service and depreciation—divided by its required debt payments.  However, we found that in practice, projects make various  adjustments to net operating income for the purposes of calculating  debt coverage ratios. These adjustments may include adding or  subtracting from net operating income any of the following:  sustainment fund deposits; various types of management fees,  including performance incentive fees and asset management fees;  certain utility costs; and taxes. Military department officials stated that  the debt coverage ratios calculated using these adjustments, while  different for different projects, are accurate and appropriate. However,  while the calculation methods may be sufficient for any given project,  the differences in calculation methods reduce the comparability of the  data.

Different project accounting methods affect the comparability of debt  coverage ratios: Some projects conduct financial accounting based on  the amount of cash received or paid during the period (referred to as  cash basis accounting), while other projects do so based on when  revenue is earned and when expenses are incurred, regardless of  when cash is received or paid (called accrual basis accounting).  These accounting differences can significantly affect the debt  coverage ratio. For example, a cash basis project may have cash on  hand to pay its debt obligations, but not enough to cover future  expenses that would have been recognized under an accrual project.  The specific accounting method used reflects each project’s particular  business agreements, but the differences in accounting methods  reduce the comparability of the debt coverage ratios across the  projects.

Moreover, as the program manager for all DOD housing, ASD (EI&E)  requested debt coverage ratio data across varying time frames for  required reports to Congress on privatized housing projects. Specifically,  ASD (EI&E) has alternated between requesting annual average debt  coverage ratio data and requesting data as of the end of the reporting  period, thus reducing the comparability of the data over time. In  instructions for its fiscal year 2014 data collection, the office requested  the average debt coverage ratio over the full fiscal year; in instructions for  its fiscal year 2015 data collection, it requested data as of the end of the  reporting period; and in its fiscal year 2016 data collection, the office  again requested data for the average over the full fiscal year.

Furthermore, the instructions provided by ASD (EI&E) to the military  departments for fiscal year 2015 did not specify the time period of the  data to be reported. Therefore, each military department provided a  different time period of data in response, further reducing the  comparability of the data. Specifically, one of the military departments  provided quarterly data, another military department provided data for the  full year, and the other military department provided one-month data,  according to military department officials.

Using data from different time periods not only reduces their  comparability, but also can produce a different outlook on a project’s  financial condition. For example, we found that debt coverage ratios for a  single fiscal quarter can be significantly different from the ratio for the  same project for the full fiscal year. In some cases, a quarterly ratio  showed insufficient funds to continue operations and make required debt  payments, while the full-year ratio showed sufficient funds for that  purpose. Conversely, another project’s ratios showed the single quarter  as having sufficient funds, but the full year as having insufficient funds.  ASD (EI&E) officials stated that data for previous reports were collected  by different staff in that office and that the current officials were not sure  why the time period for fiscal year 2015 data collection was different from  that of the other two fiscal years.

Standards for Internal Control in the Federal Government states that  management should use quality information and externally communicate  the necessary quality information to achieve the entity’s objectives.  Information, among other things, should be complete and  understandable. This involves processing data into information and then  evaluating the processed information so that it is quality information. The  standards also state that management should obtain relevant data from  reliable sources, which provide data that are reasonably free from error  and faithfully represent what they purport to represent.

However, in prior reports to Congress, ASD (EI&E) did not clarify the  differences in how debt coverage ratios were calculated, resulting in  information that lacked full context. Moreover, the information provided by  the military departments to ASD (EI&E) and to Congress to conduct their  oversight activities has not been consistent and comparable because  ASD (EI&E) has not revised its guidance on privatized housing to ensure  that data reported to Congress, such as data on debt coverage ratios, are  consistent in terms of time periods. Officials in ASD (EI&E) acknowledged  that the differences in debt coverage ratio calculation methods and  project account methods can affect the comparability of the data. They  also noted that in the future they plan to continue the annual time period  for data collection and reporting, though they did not identify any  additional steps they plan to take to ensure consistent and comparable  data. Without contextual information on how the military departments  calculate debt coverage ratios—a key measure of the current financial  condition of privatized housing projects—and on the effect these  differences have on comparing the data across projects, data reported to  Congress may not be fully useful in supporting congressional oversight of  privatized military housing. Additionally, by revising guidance to ensure  that data reported to Congress are comparable (that is, across the same  time frames), ASD (EI&E) will provide additional assurance that DOD and  Congress will have quality information on which to base decisions  regarding privatized housing projects.

The Military Departments Have Varying Methods of Assessing a Project’s Sustainability

During the course of our review, we found that the military departments  take different approaches in assessing a project’s sustainability (that is,  future sustainment needs and funding). Army officials stated that the  Army validates project sustainment plans, and is developing, but has not  yet implemented, a model to independently assess project sustainability.  The Navy validates sustainment plans generated by the developers  managing its projects. In addition to reviewing developers’ sustainment  plans, the Air Force conducts an independent analysis of each project’s  sustainment needs by conducting site tours of each project location and  by using its own financial model to forecast sustainment needs, according  to Air Force officials. The Air Force then compares its analysis with that of  the developer. In most cases, according to Air Force officials, this  comparison has shown that the Air Force’s estimates of sustainment  needs were greater than the developer’s original estimates, which would  require additional sustainment funding beyond what the developer  estimated.

Moreover, the military departments do not all use measures of future  sustainment for their internal portfolio-wide reports on privatized housing  projects. Specifically:

Army: The Army does not include a measure of future sustainability  among the key finance performance metrics it emphasizes in its  portfolio-wide oversight reports. The Army tracks the balance of funds  for long-term major renovations and rebuilds as compared with  expectations, but it does not include a measure of expected future  sustainment needs versus funding in its portfolio-wide reports. As of  June 2017, seven Army projects had fallen below expectations in  current funding levels for long-term major renovations and rebuilds,  according to the Army’s portfolio-wide report for the quarter ending  June 2017.

Navy: In its portfolio-wide reports, the Navy includes a measure of  sustainability. Specifically, the reports show modeled surpluses or  shortfalls in sustainment funding through the term of each project. As  of June 30, 2017, the Navy reported five projects expecting shortfalls  in sustainment funding, four of which the Navy anticipated would  require project plan modifications to address the shortfalls.

Air Force: In its portfolio-wide reporting, the Air Force has adopted  measures of long-term financial condition, including measures of  future sustainment funding. Specifically, the Air Force gives each  project a “long-term outlook” rating. This rating includes measures of  projected sustainment funding levels relative to projected needs,  among other measures. As of June 30, 2017, the Air Force rated 6 of  its 32 projects as having “unacceptable” long-term outlooks, and  another 6 as having “marginal” long-term outlooks. For example, the  Air Force considered the Air Combat Command II project, which  comprises Holloman Air Force Base, New Mexico, and Davis- Monthan Air Force Base, Arizona, to have severely underfunded  planned maintenance funds and a projected inability to meet any  future needs for major renovations and rebuilds, due to lower-than- expected basic allowance for housing levels.

DOD guidance states that because privatization creates a long-term  governmental interest in privatized housing, it is essential that projects be  attentively monitored. DOD has recognized that a lack of sustainment  funding can decrease the desirability of housing over time, thus reducing  occupancy and further jeopardizing financial stability. However, DOD has  not required the military departments to incorporate measures of future  sustainment into their assessments of privatized housing projects.  Measures of current financial condition, such as the ability to make debt  payments, do not necessarily indicate the ability of a project to fund its  sustainment accounts sufficiently to maintain housing quality in the future.  A project may generate enough revenue to cover operating expenses and  make required debt payments, but the level of projected funding available  for planned renovations over the course of the project may still be  insufficient, as shown by Navy and Air Force portfolio-wide oversight  reports. The Navy and Air Force include measures of future sustainment  needs and funding in their portfolio-wide oversight. While Army officials  stated that the Army regularly reviews sustainment funding levels, the  Army does not include forecasts of future sustainment needs and funding  in its portfolio-wide assessment reports because they are not required by  ASD (EI&E). Without a requirement to include sustainment measures in  their oversight of privatized housing projects, military department officials  may choose to review such measures or not. If ASD (EI&E) does not  require the military departments to include measures of future  sustainment in their assessments of privatized housing projects, the  military departments may not consistently incorporate such measures into  their portfolio-wide assessments, and therefore the military departments  and ASD (EI&E) may not have sufficient oversight of the projects’ future  sustainability. ASD (EI&E) officials agreed that such a requirement would  help ensure that the military departments are consistent in their oversight  of future sustainment.

DOD Has Not Met the Requirement for Financial Oversight Reports to Congress in a Timely Manner and Has Not Included Sustainability Information on Each Privatized Housing Project

DOD has not consistently provided required reports to Congress in a  timely manner, and as a result Congress does not have up-to-date  information on the financial condition of privatized housing. Section  2884(c) of Title 10 of the United States Code requires the Secretary of  Defense to report semiannually an evaluation of the status of oversight  and accountability measures for military housing privatization projects,  including, among other things, information about financial health and  performance and the backlog of maintenance and repair. DOD provided a  report covering fiscal year 2013 to Congress in November 2014, and then  did not provide another report, covering fiscal year 2014, until October  2017. ASD (EI&E) officials stated that they have not provided the  reports in a timely manner in recent years due to staff turnover and limited  resources, as well as efforts to ensure the quality of the data included in  the reports. An ASD (EI&E) official stated that DOD is planning to resume  timely reporting, with a consolidated report covering fiscal years 2015 and  2016 to be submitted to Congress in the second quarter of fiscal year  2018, and a report covering fiscal year 2017 to be submitted in late fiscal  year 2018.

Furthermore, in prior reports submitted to Congress, ASD (EI&E) has not  reported information on the future sustainment of each privatized housing  project. The statute does not require the reporting of information on future  sustainability for each project. However, ASD (EI&E) has noted that long- term sustainability has become a priority as projects have completed their  initial development periods, and therefore information on future  sustainment has become more critical to understanding the projects’  financial health.

Standards for Internal Control in the Federal Government states that  management should use quality information and externally communicate  the necessary quality information to achieve the entity’s objectives. In  the past, DOD has not consistently reported on the financial condition of  privatized housing projects to Congress and in cases where data were  reported, the department focused its reports on measures of current  financial health such as debt coverage ratios, which do not provide  information about the future sustainment of the projects. An ASD (EI&E)  official stated that the office will streamline the report’s narrative while  adding additional details to figures as a means to expedite future report  submission, but the official did not provide additional details of how future  reports will be completed in a more timely fashion. ASD (EI&E) officials  also stated that in the past they were focused on the initial  implementation phases of the privatized housing projects and are now  shifting to focus on sustainment, but they have not provided sustainment  information on each project to Congress. ASD (EI&E) officials agreed that  it would be beneficial to include information on sustainment in their  reports to Congress. If DOD does not take steps to comply with statutory  time frames for reporting on the financial condition of privatized housing  projects moving forward, decision makers in Congress will not have up-to- date information about financial conditions of projects as they provide  oversight of a program that represents a long-term commitment for the  department. Furthermore, reporting financial information on the future  sustainability of projects will help provide Congress a complete picture of  the financial condition of each project.

DOD Has Not Fully Assessed the Effects of the Basic Allowance for Housing Reductions but Has Identified Other Privatized Housing Challenges and Options to Address Them

DOD has completed some analysis of the projected effects of recent  reductions in the basic allowance for housing on its privatized housing  portfolios, but it has not fully assessed the significance of the effects on  the future sustainment of each of its privatized housing projects.  Moreover, DOD has not identified a course of action to address possible  shortfalls resulting from the reductions in the basic allowance for housing.  The military departments have also identified a variety of other challenges  that could affect the financial condition of their privatized housing projects,  including reductions in assigned personnel and the higher-than-expected  cost of utility infrastructure. The military departments have identified  options to address potential financial challenges to their privatized  housing projects, including actions to increase revenue, actions to reduce  expenses, and extraordinary measures to improve project financial  conditions.

Reductions in the Basic Allowance for Housing Could Decrease Privatized Housing Projects’ Revenue and Future Sustainment Funding

According to the military departments, reductions in the basic allowance  for housing relative to market rent and utility calculations by the Defense  Travel Management Office—a 4 percent reduction as of 2018—will  decrease funding for future sustainment and could affect the privatized  housing projects’ ability to continue operations and make required debt  payments. Specifically, housing developers stated that declines in  revenue have already been felt by certain projects, and that any reduction  in their ability to sustain the privatized housing projects over the term of  their 50-year leases will result in the degradation of the housing, leaving  the homes less marketable. Unlike challenges that may affect one or a  few projects, the reductions in the basic allowance for housing affect all  projects, since basic allowance for housing is a basis for revenue for all of  the projects.

DOD has established that the amount charged to servicemembers for  renting housing on base was equal to their basic allowance for housing  rate. Thus, the privatized housing projects were developed with the  assumption that they would receive full basic allowance for housing  payments as rent, according to officials from each military department.  However, at DOD’s request, Congress included provisions in the Carl  Levin and Howard P. “Buck” McKeon National Defense Authorization Act  for Fiscal Year 2015 and National Defense Authorization Act for Fiscal  Year 2016 that authorized the department to reduce the housing  allowance to servicemembers below the Defense Travel Management  Office’s typical basic allowance for housing calculations, starting with a 1  percent reduction in 2015 and reaching a 5 percent total reduction by  2019. As of 2018, the department has reduced basic allowance for  housing payments by 4 percent. Because of this reduction, the revenue  that projects receive from rent payments has decreased at certain  projects. However, according to officials representing the military  departments, the reductions in the basic allowance for housing will not be  the sole reason that any project is struggling. A project may be struggling  due to other challenges the military departments identified, examples of  which we describe in this report, such as aging utility infrastructure.  However, officials representing each military department stated that the  reductions will have a compounding effect on projects that are facing  other challenges.

DOD Has Not Fully Assessed the Effects of the Reductions in the Basic Allowance for Housing That Began in 2015

An August 2015 memorandum issued by ASD (EI&E) directed the military  departments to complete a thorough review of their privatized housing  portfolios. Additionally, the military departments were to provide a report  outlining any effects of changes in the basic allowance for housing on  their portfolios. However, the military departments have not fully assessed  the effects of the basic allowance for housing reductions. Instead, in  response to this memorandum, the military departments completed some  analysis on the effects of the reductions in the basic allowance for  housing and provided reports outlining the projected effects of the  reductions on their privatized housing portfolios. Each military department  reported that the reductions in the basic allowance for housing would  decrease project revenue, and each provided estimates across multiple  scenarios. Specifically:

The Army’s September 2015 report projected an average decrease in  long-term sustainment accounts of $104 million per project through  2039 based on a 5 percent reduction in basic allowance for housing  rates. Out of the 35 projects in the Army’s privatized housing  portfolio, the report looked at the 15 projects projected to lose 5  percent or more of their assigned personnel and estimated the funds  available to support each project from 2015 until the end of 2039.

The Navy’s October 2015 report projected a decrease in long-term  sustainment accounts across the portfolio of privatized housing  projects of $2 billion based on a 5 percent reduction in basic  allowance for housing rates. The report also summarized any  projected effects in the first year of reductions on the debt coverage  ratio and specified the calendar years when sustainment shortfalls  could begin to occur per project.

The Air Force’s November 2015 report projected a decrease of $48  million per year across the portfolio based on a 5 percent reduction in  basic allowance for housing rates. The report indicated that project  ratings could begin to be affected in the same year as the reductions  in the basic allowance for housing were implemented, and that  funding for long-term sustainment would be diminished.

However, DOD does not have the information needed to fully assess the  effects of the reductions that began in 2015, because it did not direct the  military departments to specify in their reports the significance of the  effects of the reductions on each individual project. The August 2015 ASD  (EI&E) memorandum directed the military departments to provide reports  with a “thorough review,” but it did not specify the inclusion of information  that would detail the extent of the effects on the sustainment of each  individual project. As a result, the reports did not fully assess specific  effects on each project to enable the identification of and response to  specific risks. For example, generally, the reports did not include certain  information for the full term of all projects, as detailed below:  two of the reports did not include information on when deficits related  to reductions in the basic allowance for housing will occur per  project;  two of the reports did not include information on the decrease in the  sustainment accounts due to reductions in the basic allowance for  housing versus the amount that the project requires for planned  sustainment per project; and none of the reports included information on the likely effects of  particular sustainment funding deficits (for example, how many units  will forgo needed renovations or rebuilds).

In addition, the military departments did not identify specific actions in the  reports to respond to particular, identified shortfalls for individual projects  resulting from reductions in the basic allowance for housing. In its August  2015 memorandum, ASD (EI&E) noted that individual projects may have  different solutions to address the effect of the reductions in the basic  allowance for housing. The military departments did not outline solutions  for each individual project but, as requested by ASD (EI&E), proposed  recommendations in their reports to mitigate the overall effects of the  reductions in the basic allowance for housing by charging  servicemembers the out-of-pocket rate. The out-of-pocket rate reflects a  servicemember cost-sharing adjustment that would require the  servicemember to pay the amount by which his or her allowance was  reduced.

However, neither DOD nor the military departments have taken action to  address the reports’ recommendations, nor have they determined any  other courses of action for individual projects in response to the  reductions in basic allowance for housing. While the Army has a policy  that would allow individual projects to propose charging servicemembers  the out-of-pocket amount, subject to Army approval, the policy states that  the Army strongly prefers that projects not charge servicemembers.  According to Army officials, none of the projects had done so as of  August 2017. Further, according to privatized housing developers  representing Army projects, they have not proposed charging the out-of- pocket rate because doing so could result in a reduction in occupancy at  that project, as servicemembers would begin to look for other housing.  Unlike the Army, the Navy and Air Force do not have a policy that would  allow developers to charge the out-of-pocket amount. According to ASD  (EI&E), Navy and Air Force officials stated that their lack of policy is  based in large part on the fact that servicemembers from all three military  departments reside at nearly every installation, and that without having  written assurance that the other military departments will also charge the  out-of-pocket rate, the Air Force and Navy cannot agree to do so.

Standards for Internal Control in the Federal Government states that  management should analyze the identified risks to estimate their  significance, which provides a basis for responding to the risks, and  design responses to the analyzed risks so that risks are within the defined  risk tolerance for the defined objective. In its August 2015  memorandum, ASD (EI&E) noted that the reductions in the basic  allowance for housing could create shortfalls that in turn could lower the  quality of homes in privatized housing communities. However, DOD has  not fully assessed the significance of this risk by considering the  magnitude of impact, the likelihood of occurrence, and the nature of the  risk because, generally, the reports do not include certain information for  the full term of all projects, as detailed above. Specifically, DOD has not  fully assessed the significance of the risk of the reductions in the basic  allowance for housing by considering how the reductions will affect the  quality of its housing. If DOD does not fully assess the effects of the  reductions in the basic allowance for housing, DOD and Congress will not  be fully informed before making decisions that could affect all of the  projects. Furthermore, if DOD does not respond to the risk of reduced  sustainment funds by designing specific actions, DOD and the military  departments may not be well positioned to reduce any risks and meet  their objective of providing quality housing for servicemembers.

The Military Departments Have Identified Various Challenges to Sustaining Their Privatized Housing Projects

The military departments have identified various challenges that could  affect the financial condition and future sustainment of their privatized  housing projects. Examples of these challenges include the following:

Reductions in assigned personnel at installations have reduced  occupancy rates: Information from military department officials shows  that the loss of personnel assigned to an installation has reduced  occupancy at some projects. Reductions in assigned personnel can  occur at an installation because of large-scale troop reductions or the  inactivation of units. The decrease in occupancy at some projects has  led to revenue and cash flow challenges. For example, Army officials  noted that the occupancy rate dropped from about 95 percent to about  70 percent at the Fort Knox project in Kentucky in 2014 when a unit  was inactivated. This drop in occupancy resulted in challenges for the  privatized housing project because the number and type of housing  units originally built were determined on the basis of the unit’s  remaining at the installation.

Aging utility infrastructure has increased sustainment costs, resulting  in reduced cash flows for some projects: According to DOD and  officials representing the military departments, the costs of  maintaining infrastructure for utilities has reduced cash flows for some  projects. In some privatized housing agreements, the military  departments transferred responsibility for utility infrastructure to the  projects. According to DOD and military department officials, this  oversight and maintenance have been more costly than project  owners had expected. Air Force officials stated that aging utility  infrastructure is not something the projects are equipped to handle  because there is not enough revenue in their project structures to  cover the costs of maintaining the infrastructure. Air Force officials  said that they noticed the challenges related to transferring utility  infrastructure in the earlier projects and that they made a decision to  stop transferring infrastructure to developers in later projects.  Moreover, according to Air Force officials, some project owners are  now asking for the military departments to take back the  infrastructure. For example, the Air Force agreed to take back some  of the gas and electric infrastructure at the Air Force Academy project  in Colorado as part of a financial restructuring.

Perceived disconnects between basic allowance for housing  calculations and market rates: Military department officials and  privatized housing developers perceive the Defense Travel  Management Office’s basic allowance for housing calculations as  challenging because they believe that the calculations are  unpredictable and do not always reflect the realities of local markets.  Officials in each military department stated that the data used for the  calculations sometimes do not accurately reflect the local market  surrounding the project. For example, officials from the Navy’s  Midwest project noted that the calculation for Millington, Tennessee— an area covered by the Midwest project—was higher than that for the  Chicago area of the project in 2014—an area that they felt should  have had the higher costs of the two. Additionally, according to  Army officials, basic allowance for housing rates fluctuate at certain  projects from year to year and do not reflect the local market. For  example, the average basic allowance for housing rate for Fort  Huachuca in Arizona dropped 11 percent from 2014 to 2015,  increased 4.6 percent in 2016, and dropped 9 percent in 2017. Army  officials stated that these fluctuations did not match rental costs in the  local market.

Actual costs of utilities in some locations are not covered by the basic  allowance for housing utility rates: Officials representing two military  departments stated that the Defense Travel Management Office’s  basic allowance for housing calculations do not accurately reflect the  actual costs of utilities. According to Army officials, the utility  component of the Defense Travel Management Office’s calculations  does not cover the actual cost of utilities for project homes at some  locations. This difference can result when the surveys for utility costs  are from homes in the local community that are not comparable to  those on base. For example, in Fairbanks, Alaska—where the  Army’s Fort Wainwright/Greely project is located—off-base homes get  the majority of their heat from wood stoves that report no cost element  to the surveys used by the Defense Travel Management Office. By  underreporting or not otherwise adjusting for these costs, according to  Army officials, the basic allowance for housing calculations fail to  account for the funds necessary to cover the costs of traditional,  metered utilities.

Unexpected project expenses can reduce cash flows for some  projects: Officials representing two military departments stated that  unexpected expenses can be a challenge for some projects. These  expenses can occur because of unexpected events, such as weather  events, environmental damage, or unexpected litigation. For example,  the Navy’s Mid-Atlantic project has experienced unexpected expenses  related to water intrusion and mold issues and the ensuing litigation,  causing fewer funds to flow to the project’s sustainment accounts.  There are also expenses for snow removal, hurricanes, and flooding.  Navy officials stated that they did not anticipate a lot of sustainment  work in the first 5 to 10 years of the projects, but needs have arisen  due to these unexpected events. Additionally, according to information  from the Navy’s New Orleans project in Louisiana, hurricane and  tropical storm damage may drain $1.5 million to $2 million from the  project’s sustainment accounts every 3 to 4 years.

Determining the amount DOD must budget for a project may affect  future expansions or changes to existing projects: Military department  officials also noted potential challenges with the way that the Office of  Management and Budget will be scoring future projects. Scoring  seeks to determine the cost that should be recognized and recorded  as an obligation of DOD for budgeting purposes at the time a contract  is signed. When the privatized housing initiative began, developers  sought private borrowing, knowing that only the government funding  would be scored because a 1997 Office of Management and Budget  memorandum established that private funds for the projects would not  be scored as government participation or activity. However,  according to a 2005 Office of Management and Budget memorandum,  as of September 30, 2010, new privatized housing projects and  expansions to existing projects using the limited liability or corporation  approach are subject to traditional scoring rules. These rules require  projects proposing the use of a purely private entity to be scored as a  private activity, and projects proposing the use of a co-owned limited  liability corporation to be scored as government activity. Some  military department and developer officials have expressed concern  with the uncertainties surrounding future scoring. Specifically, military  department officials and developers are concerned that the reversion  to traditional scoring will affect any plans for obtaining mid-term loans  and any potential expansions or other changes to existing projects.  Office of Management and Budget officials stated that any future  federal government contributions to privatized housing projects in the  form of direct loans or loan guarantees will be fully scored at the value  of the loan or loan guarantee.

Privatized Housing Projects Have Various Options to Mitigate Financial Challenges

Military department and developer officials have identified various options  to address financial challenges such as those previously discussed in this  report. These include actions to increase revenues, actions to reduce  expenses, and extraordinary measures to improve project financial  conditions. As the project manager, the developer may act unilaterally in  some cases, and other actions may require approval from the military  department, coordination with ASD (EI&E), or notification to the Office of  Management and Budget. Although these actions may improve a  project’s financial condition, there are limitations, such as the potential to  reduce tenant satisfaction and therefore occupancy levels, or costs to the  government. The extent to which any of these options will be sufficient to  address a particular project’s financial challenges depends on the degree  of the financial challenge and the effectiveness of the option. For  example, a project may seek to raise revenue by advertising to tenants to  increase occupancy, but the response may be insufficient. Likewise, a  project may engage in a financial restructuring to return the project to a  healthy financial footing, but ongoing low occupancy or unexpectedly high  expenses may continue to challenge the project financially.

Developers and military departments cited several options for increasing  project revenues, including the following examples:  Renting to tenants other than active-duty servicemembers: The military  departments have the option to increase project revenues by allowing  projects to rent to tenants other than active-duty servicemembers. The  Navy and Air Force have policies that determine the priority ordering of  types of tenants to whom a project can rent. An Army official stated that  the Army does not have a department policy, but allows projects to rent to  tenants other than active-duty servicemembers based on project  agreements. For example, a project may offer to rent to tenant groups in  the following order: active-duty personnel, reserve-duty personnel, DOD  civilian employees, military retirees, and general public tenants. As of  June 2017, 33 of 35 Army privatized housing projects were renting to  tenants other than active-duty servicemembers; 14 of 16 Navy and  Marine Corps projects were renting to tenants other than active-duty  servicemembers; and 28 of 32 Air Force projects were renting to tenants  other than active-duty servicemembers. While renting to tenants other  than active-duty servicemembers can increase revenue, the usefulness of  this action is limited when a project is already operating at a high rate of  occupancy or when additional demand is limited.

Other steps to increase occupancy: Developers can take other actions to  increase project occupancy, to include increased advertising, promotions,  or offering rent concessions. While these actions can increase  occupancy, advertising adds costs to project operations, and rent  concessions lower the per-unit revenue earned for the project. Figure 2  shows an advertisement by a privatized housing project seeking tenants  outside of Naval Station Norfolk in Virginia.

Charging fees for services: Developers stated that they have considered  charging fees for services that had previously been provided free of  charge—such as community center rentals and pet fees—as another  means of increasing project revenue. However, a developer’s ability to  charge fees varies based on project agreements and military department  policies. Developers also need to consider potentially negative effects on  tenant satisfaction.

Developers and military departments cited several options for reducing  project expenses, including the following examples:  Reducing or eliminating services: Projects can reduce or eliminate project  services as a means of reducing operating expenses. Officials have taken  these steps at certain Army, Navy, and Air Force projects. For example,  Navy officials told us that the developer cut portions of the landscaping  program at the Navy’s Midwest project in Illinois, Indiana, and Tennessee  and eliminated one 24-hour service desk at the Navy’s Hampton Roads  Unaccompanied Housing project in Virginia in order to reduce  expenses. While these actions reduce operating expenses, providing  reduced or fewer services may make a project less marketable or  desirable to tenants and can lead to declines in tenant satisfaction and  occupancy.

Deferring routine maintenance: In response to financial distress, projects  can curtail routine maintenance to realize savings. For example, when  Nellis Air Force Base in Nevada was facing cash flow challenges, officials  told us that the project curtailed its preventive maintenance program that  includes the inspection and repair of heating, ventilation, and air  conditioning systems; water heaters; plumbing and plumbing fixtures;  roofs; and carpeting. These expense-saving measures help operating  costs in the near term, but deferring maintenance can reduce the quality  of the housing, reduce tenant satisfaction, and increase expenses over  time by reducing the effective life of the items not being maintained.

Delaying sustainment: Another option to reduce project expenses is to  delay certain sustainment actions. At the Army’s Fort Knox project in  Kentucky, officials stated that the sustainment plan initially included the  demolition and rebuild of each unit or full renovation of historic units over  the 50-year project lease; however, they no longer project that there will  be funds to complete those improvements. Instead of full rebuilds,  officials stated that they expect to conduct piecemeal renovations. Over  time, deferred sustainment can lead to reduced housing quality, in turn  reducing occupancy levels and tenant satisfaction, and thereby reducing  project revenues.

Developers and the military departments can also take various  extraordinary measures to improve the financial condition of a project.  Extraordinary measures are options that can alter project agreements or  project financial arrangements with the military department. These  options may require approval from the military department, coordination  with ASD (EI&E), or notification to the Office of Management and Budget.  Examples of such actions include the following:  Retaining and renting excess units: Projects can earn additional revenue  by retaining and renting units that were originally slated for demolition.  Some project plans included the transfer of existing housing units,  deemed in excess of project needs, to the developer with the intention of  demolishing them. For retaining and renting excess units to be an option,  a project must have some excess units slated for demolition and sufficient  demand for their rental.

Reducing project scope: Projects may reduce the scope of planned work  to reduce potential expenditures or improve the project’s financial state.  Reductions in scope may be in the form of the number of units to be built,  renovated, or demolished. For example, following the inactivation of a  brigade combat team at Fort Knox in Kentucky, the project made plans to  eliminate 280 units due to changes in servicemember housing needs from  when the project originally started construction.

Deferring fees: Developers can defer project fees due to them, such as  fees for construction or management services, so that more funds are  available for other project needs. Developers agreed to defer fees for  several Navy and Air Force projects as a means to ensure adequate  funding for the completion of project construction. Projects can defer fees  to meet shortfalls in project funding, but the deferral can place additional  financial strain on a project, as funds later must be used to repay the  deferred fees.

Making additional investment contributions: Developers can make  additional financial investments in the project to cover underfunded  project expenses. For example, Air Force officials stated that developers  have made additional financial investments at the Robins Air Force Base I  project in Georgia to ensure that the project had sufficient funds to make  debt payments. According to officials, the Air Force agreed to the  additional investment contributions on the basis that they be repaid from  any future excess cash flows.

Returning assets: In some instances, project assets can cost the  developer more than anticipated due to the expenses necessary to  maintain the asset. To alleviate the resulting financial challenges, projects  can transfer ownership of the assets back to the military departments. For  example, the Air Force took back five historic units from the Robins II  project in Georgia that, according to officials, were not financially viable  within the project and that the Air Force wanted for purposes other than  housing. When assets are returned to a military department, the military  department may have to begin budgeting for their costs through its annual  budgeting process.

Transferring assets: The military department can transfer assets to a  project that developers can sell to fund projects. For example, the Navy  transferred land and units to the Navy’s Midwest project with the intention  that the developer would sell the land and units to supplement project  funding. Asset sales can be unreliable funding sources if assets sell for  less than the project expected.

Financial restructurings: Military departments can seek to financially  restructure projects to improve their financial condition. This process  requires the military departments to renegotiate project agreements with  the developer to improve financial condition. For example, the Air Force  recently completed financial restructurings of the Nellis Air Force Base  project in Nevada and the Air Combat Command Group II project, which  comprises Davis-Monthan Air Force Base in Arizona and Holloman Air  Force Base in New Mexico. Air Force and developer officials stated that  the Nellis Air Force Base project began to have problems making debt  payments because of declines in basic allowance for housing payments  associated with falling local rental market prices. For Nellis, the Air Force  and the developer negotiated a financial restructuring whereby the Air  Force reduced the interest rate on the government’s loan to the project  and extended the loan’s maturity date. The Air Force also gave the  developer an additional portion of project profits. In exchange, the  developer agreed to forgive an outstanding balance of payments due to  them.

An ASD (EI&E) official stated that financial restructuring agreements may  require notification to the Office of Management and Budget, which  scores changes to privatized military housing projects. Restructurings can  provide relief to projects that are facing imminent default or longer-term  sustainment funding shortfalls, but they can also add financial costs to the  military department. The ability to financially restructure also may be  limited by the willingness of the developer to give concessions during  negotiations and the ability to obtain the approvals necessary to complete  the restructure.

DOD Has Not Defined When Project Changes Require Advance Notice or Defined Risk Tolerance Levels for Not Achieving Housing Goals

DOD has not clearly defined in its policy the circumstances in which ASD  (EI&E), as the DOD-wide housing program manager, should receive  advance notice of changes to address financial challenges in privatized  military housing projects. In addition, DOD has not defined its risk  tolerance levels for achieving its goal of providing quality housing to  servicemembers that reflects community living standards—in particular,  its tolerance for declining levels of funding for future sustainment that can  pose a risk to this goal.

The Military Departments Have Varied Understandings of When Privatized Military Housing Project Changes Require Notification

The military departments have varied understandings of what changes to  privatizing housing projects require notification to ASD (EI&E)—DOD’s  program manager for privatized housing. Military department officials  provided somewhat differing explanations when asked about the types of  project changes that require notification to ASD (EI&E). Specifically:

Army officials stated that the Army provides notice any time there is a  planned use of or change to a project involving privatized military  housing authorities related to government loans and loan guarantees,  the leasing of housing units, or government investments in privatized  housing projects, as well as any action that requires congressional  notification. The Army also notifies the office if a project’s number of  units is expanded relative to its approved plan.

Navy officials stated that they provide notice any time there is an  action that requires congressional notification, any time there are  project changes with a potential effect on military housing privatization  authorities, any time new projects or project phases are considered,  and any changes to a project’s previously approved scope, as well as  any time ASD (EI&E) requests notification.

Air Force officials stated that notification is required when the military  department makes a material change to a project that has a financial  or scope effect relative to the details that were originally approved.

Officials added that any project changes that require approval from  the Office of Management and Budget would require ASD (EI&E)  concurrence.

Under current DOD housing policy, ASD (EI&E) is required to notify the  Office of Management and Budget of any significant changes to privatized  housing projects that may require scoring consideration. However, DOD  policy does not establish the circumstances in which the military  departments should notify ASD (EI&E) of significant project changes, and  it does not define which project changes qualify as significant. DOD  guidance requires ASD (EI&E) to provide guidance and general  procedures relating to housing privatization. An ASD (EI&E) official also  told us that the military departments are providing notification of project  changes based on limited guidance, and that ASD (EI&E) is conducting  oversight on a case-by-case basis. Moreover, Office of Management and  Budget officials stated that they will analyze project changes to determine  whether an action would constitute a project expansion significant enough  to require scoring.

Standards for Internal Control in the Federal Government states that  management should develop policies that address the entity’s objective to  achieve an effective internal control system. In addition, management  should obtain and internally communicate the necessary quality  information to achieve the entity’s objectives, while communicating quality  information down and across reporting lines to enable personnel to  perform key roles. Moreover, the standards state that the oversight body  receives quality information that flows up from the reporting lines from  management and personnel that is necessary for effective oversight of  internal control. However, DOD’s guidance does not clearly define the  types of project changes for which ASD (EI&E) requires prior notification  from the military departments, which could result in ASD (EI&E) not being  notified of project changes. ASD (EI&E) has draft guidance on oversight  and management of privatized military housing, which would define the  circumstances under which military departments should notify ASD  (EI&E) of project changes, but officials stated that they have not  established a time frame for issuing this policy. An ASD (EI&E) official  stated that the policy is being coordinated with the military departments,  and this has resulted in delays to its issuance. Without issuing guidance  to clearly define and communicate to the military departments the  conditions that require notification, the military departments will not be  able to consistently fulfill their responsibilities and ASD (EI&E) will not be  able to completely fulfill its oversight function.

DOD Has Not Defined Its Tolerance for Risk to Privatized Housing Goal

Office of Management and Budget guidance on the preparation,  submission, and execution of the federal budget suggests that public- private partnerships such as privatized military housing projects contain  some elements of risk to the government. For example, the projects are  frequently constructed on government land and they include government  financing in the form of direct investments or direct loans. However, the  military departments have not defined their risk tolerance levels for  privatized housing relative to the program’s objective of providing quality  housing that reflects community living standards. Specifically, the Army  and Navy have not identified the level of risk they are willing to accept in  their ability to fund future sustainment. Army officials stated that the Army  is not responsible for taking any actions to restore a project’s financial  condition. Navy officials stated that they do not use a risk model, and that  one is not required by DOD. The Air Force has not formally defined its  risk tolerance levels for future sustainment, but it has identified the  circumstances in which projected sustainment funding deficits will cause it  to take extraordinary measures—specifically, to seek a financial  restructuring of the project. For example, if future planned maintenance is  funded at less than 85 percent of estimated needs within the next 5-year  period, the Air Force may seek a financial restructuring, according to Air  Force officials. Likewise, according to Air Force officials, if planned major  renovations and rebuilding are funded at below 30 percent of estimated  needs, the Air Force will seek a financial restructuring.

Standards for Internal Control in the Federal Government states that  agencies need to define risk tolerance relative to their program  objectives. Risk tolerance is the acceptable level of variation in  performance relative to the achievement of objectives. However, DOD  has not required the military departments to define their risk tolerances  regarding the future sustainability of the projects. ASD (EI&E) officials told  us that they are considering establishing parameters for risk tolerance for  the military departments, but have not yet done so. Officials also noted  that DOD had been focused on the initial development periods of the  privatized housing projects, whereas it is now shifting focus to  sustainment as the projects have moved from the initial development  stage. Given this focus on sustainment, if the military departments do not  define their risk tolerances regarding the future sustainability of their  privatized housing projects, they will lack a consistent basis on which to  determine when the risks to achieving their objectives require responses,  and the nature of those responses.

DOD’s ability to maintain quality housing is critical, because housing can  affect retention, readiness, and servicemembers’ quality of life. Since  Congress provided the department with authorities to do so, DOD has  worked with private developers to improve the quality of housing available  on military installations. The military departments regularly review the  financial condition of their privatized housing projects, but they calculate a  basic measure of current financial health—the debt coverage ratio— differently among their projects, which limits the ability of ASD (EI&E),  and in turn Congress, to compare project financial health based on this  measure without additional information to give the data full context. DOD  has also previously reported such information for differing time periods in  different reports to Congress, further limiting the data’s usefulness, and  has not issued revised guidance on privatized housing to help ensure  consistent reporting. The military departments also vary in the extent and  manner in which they oversee measures of future sustainment of their  privatized housing projects. DOD has not reported measures of future  sustainment to Congress, or issued a report on the financial condition of  privatized housing projects, since the report covering fiscal year 2014.  Without consistent and up-to-date information on the financial condition of  projects, DOD and Congress will not be able to conduct informed and  effective oversight of the projects.

The military departments have identified the reductions in basic allowance  for housing as one of the various challenges affecting the financial  condition of privatized housing projects. At the request of ASD (EI&E), the  military departments have provided analysis on the effects of the  reductions on their portfolios, but they have not been required to fully  assess the significance of the effects of the reductions on the future  sustainment of each of their projects, or identified specific actions to  respond to the reductions, as detailed by federal internal control  standards related to risk assessment. Without complete assessment of  the risks of the reductions in the basic allowance for housing on each  project, and developing any appropriate courses of action, DOD and the  military departments will not be able to know when to take action to  address deficits in the funding of long-term sustainment accounts that  could lead to diminishment in the quality of military housing. Additionally,  DOD and Congress will not be fully informed of the risks and possible  effects before making decisions that affect all of the privatized housing  projects—such as approving any further reductions in the basic allowance  for housing.

The military departments have various options for attempting to improve  the financial condition of their privatized housing projects, but some of  these options require prior notice to ASD (EI&E). The absence of clearly  defined requirements as to when this office should be notified of project  changes to address financial challenges has led to varied understandings  among the military departments about when notification should occur.  Without a clear identification of when ASD (EI&E) should be notified of  project changes, the military departments will not have consistent and  clear guidance as to when this office needs to be informed prior to an  action being taken by a military department regarding its privatized  housing projects, and thus, the oversight office may not be fully informed  on the projects it intends to oversee. In addition, DOD has not required  the military departments to define their tolerances for risk to the goal of  providing quality housing to servicemembers in line with community  standards, including its ability to fund future sustainment needs. Without  doing so, DOD will not have key information needed to determine when  the risks to achieving their objectives require responses, or to determine  the nature of the responses.

We are making a total of eight recommendations to the Secretary of  Defense and the Assistant Secretary of Defense for Energy, Installations,  and Environment. The Secretary of Defense should ensure that:  The Assistant Secretary of Defense for Energy, Installations, and  Environment provides additional contextual information in future reports to  Congress on privatized military housing to identify any differences in the  calculation of debt coverage ratios and the effect of these differences on  their comparability. (Recommendation 1)

The Assistant Secretary of Defense for Energy, Installations, and  Environment revises its existing guidance on privatized housing to ensure  that financial data on privatized military housing projects reported to  Congress, such as debt coverage ratios, are consistent and comparable  in terms of the time periods of the data collected. (Recommendation 2)

The Assistant Secretary of Defense for Energy, Installations, and  Environment revises its guidance on privatized military housing to include  a requirement that the military departments incorporate measures of  future sustainment into their assessments of privatized housing projects.  (Recommendation 3)

The Assistant Secretary of Defense for Energy, Installations, and  Environment takes steps to resume issuing required reports to Congress  on the financial condition of privatized housing in a timely manner.  (Recommendation 4)

The Assistant Secretary of Defense for Energy, Installations, and  Environment reports financial information on future sustainment of each  privatized housing project in its reports to Congress. (Recommendation 5)

The Assistant Secretary of Defense for Energy, Installations, and  Environment provides guidance directing the military departments to  assess the significance of the specific risks to individual privatized  housing projects resulting from the reductions in the basic allowance for  housing and identify courses of action to respond to any risks based on  their significance. (Recommendation 6)

The Assistant Secretary of Defense for Energy, Installations, and  Environment finalizes guidance in a timely manner that clearly defines the  circumstances in which the military departments should provide  notification of project changes and which types of project changes require  prior notification or prior approval. (Recommendation 7)

The Assistant Secretary of Defense for Energy, Installations, and  Environment revises its guidance on privatized military housing to require  the military departments to define their risk tolerances regarding the  future sustainability of their privatized housing projects.  (Recommendation 8)

We provided a draft of this report for review and comment to DOD and  the Office of Management and Budget. We initially made our  recommendations to the Assistant Secretary of Defense for Energy,  Installations, and Environment. We have updated our recommendations  to also include the Secretary of Defense. In written comments, DOD  concurred with each of our recommendations and identified actions it  plans to take to implement them. DOD’s comments are reprinted in their  entirety in appendix III. DOD and the Office of Management and Budget  also provided technical comments, which we incorporated as appropriate.

We are sending copies of this report to the appropriate congressional  committees, the Secretary of Defense, and the Office of Management and  Budget. In addition, the report is available at no charge on our website at  http://www.gao.gov.

If you or your staff have any questions about this report, please contact  Brian Lepore at (202) 512-4523 or leporeb@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found  on the last page of this report. GAO staff who made key contributions to  this report are listed in appendix IV.

Appendix I: Objectives, Scope, and Methodology

Senate Report 114-255 accompanying a bill for the National Defense  Authorization Act for Fiscal Year 2017 included a provision for us to  assess the solvency of each privatized military housing project in the  United States and the effect of recent changes in basic allowance for  housing on long-term project sustainability. This report examines the  extent to which the Department of Defense (DOD) has (1) assessed and  reported the financial condition of each privatized housing project; (2)  assessed the effects of recent reductions in the basic allowance for  housing on privatized housing, and identified any other challenges and  options to address challenges; and (3) defined notification requirements  for project changes and risk tolerances relative to privatized housing  goals.

For all objectives, we scoped our review to include all privatized housing  projects in each military department. We excluded privatized temporary  lodging because its financial structure is substantially different than all  other privatized housing projects. We reviewed relevant policies and  collected information by interviewing officials from the Office of the  Secretary of Defense (the Office of the Assistant Secretary of Defense for  Energy, Installations, and Environment); the Army (Office of the Assistant  Secretary of the Army for Installations, Energy, and Environment, and the  Office of the Assistant Chief of Staff for Installation Management); the  Navy (Office of the Deputy Assistant Secretary of the Navy for  Installations and Facilities, the Commander, Navy Installations Command,  and the Naval Facilities Engineering Command); the Marine Corps  (Marine Corps Installations Command); and the Air Force (Office of the  Deputy Assistant Secretary of the Air Force for Installations, and the Air  Force Civil Engineering Center).

Additionally, we met with the five leading developers of privatized housing  projects: Balfour Beatty, Corvias, Lend Lease, Lincoln Military Housing,  and Hunt Companies. We also visited a non-generalizable sample of five  privatized housing projects to interview on-site military department  officials and tour the housing. For this sample, we selected one or two  projects from each of the military departments, emphasizing projects that  had identified financial difficulties or were located in close proximity to  military department oversight offices. We made site visits to the following  areas and installations: Norfolk, Virginia, where we met with officials of  the Naval Facilities Engineering Command and visited the Homeport  Hampton Roads and Mid-Atlantic Military Family Communities privatized  housing projects; San Antonio, Texas, where we met with officials at the  Air Force Civil Engineer Center; Las Vegas, Nevada, where we met with  officials and visited the privatized housing project at Nellis Air Force Base;  Fort Knox, Kentucky, where we met with officials and visited the  privatized housing project at the Army’s Fort Knox; and Fort Meade,  Maryland, where we met with officials and visited the privatized housing  project at Fort Meade.

To determine the extent to which DOD has assessed and reported the  financial condition of each privatized housing project, we reviewed DOD  guidance on the oversight and management of privatized military  housing. We also reviewed documentation used by each military  department to oversee the financial condition of each of their privatized  housing projects, and each of their portfolios as a whole through portfolio- wide oversight reports, monthly and quarterly reports on each privatized  housing project, and audited project financial statements from fiscal years  2013 to 2016. We reviewed DOD’s fiscal year 2013 and 2014 annual  reports to Congress on privatized housing, as well as data for privatized  housing projects from fiscal years 2013 through 2016. We also met with  officials involved in the oversight and management of privatized housing  in the Office of the Assistant Secretary of Defense for Energy,  Installations, and Environment (ASD (EI&E)), and each of the military  departments to discuss their oversight and management of the financial  condition of privatized housing projects. Additionally, we requested data  for each privatized housing project, including audited financial statements,  and examined the differences among and within the military departments  in determining the solvency of their projects. For each military  department, we assessed the number of projects doing financially well  and those not doing financially well through correspondence with  knowledgeable officials at each military department and found those  department-level numbers sufficiently reliable to report the number of  projects in each financial category. We compared DOD’s and the military  departments’ actions to assess and report on the financial condition of  their privatized housing projects with DOD’s housing policy and with  standards for quality information in Standards for Internal Control in the  Federal Government to determine whether DOD has fully assessed and  reported the financial condition of each project.

To determine the extent to which DOD has assessed the effects of recent  reductions in the basic allowance for housing on privatized housing and  identified any other challenges and options to address those challenges,  we reviewed DOD guidance on applying reductions in basic allowance for  housing to privatized military housing and other DOD documentation on  the reductions in basic allowance for housing payments. Specifically, we  reviewed the military departments’ reports on the projected effects of the  reductions in the basic allowance for housing on their portfolios and  quarterly project oversight reports from fiscal years 2016 and 2017.  Additionally, we interviewed officials at the Defense Travel Management  Office for information on the basic allowance for housing calculations and  military department officials for their perspectives on the reductions in  basic allowance for housing. We compared the military department  reports on the projected effects of the reductions in basic allowance for  housing with standards for risk assessment in Standards for Internal  Control in the Federal Government to determine whether DOD has fully  assessed the effects of the reductions. We determined challenges  identified by DOD and the military departments and options to address  challenges through interviews with ASD (EI&E) officials, officials from  each military department involved with privatized housing, and officials at  select installations involved in privatized housing. We also met with  officials of five leading privatized housing developers for their  perspectives on challenges to their privatized housing and options to  address them. Additionally, we reviewed quarterly project oversight  reports to identify challenges associated with privatized housing. We  reported examples of challenges that were identified by at least two of the  three military departments. Additionally, we assessed the number of  projects renting to tenants other than active-duty servicemembers by  obtaining information from each military department and found those  department-level numbers sufficiently reliable to report the number of  projects that were renting to these tenants. We reviewed quarterly project  oversight reports to identify the options for addressing challenges, and  DOD’s policy guidance on privatized housing responsibilities to determine  the level of authority needed for the options.

To determine the extent to which DOD has defined notification  requirements for project changes and risk tolerances relative to privatized  housing goals, we reviewed DOD guidance on oversight and  management of privatized military housing, interviewed DOD and  developer officials responsible for privatized housing, and reviewed DOD  documentation. Specifically, we reviewed DOD housing policies and  guidance, reviewed military department guidance on overseeing  privatized housing, and interviewed military department officials familiar  with notification processes for changes to privatized housing projects and  approaches to managing risks to privatized housing projects. We also  interviewed officials in the Office of Management and Budget familiar with  privatized military housing. We compared DOD’s policy guidance on  privatized housing responsibilities with standards related to internal  communication in Standards for Internal Control in the Federal  Government to determine the level of notification needed. We also  compared the extent to which DOD has defined risk tolerance for  privatized housing with federal internal control standards related to risk  assessment.

We conducted this performance audit from December 2016 to March  2018 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.

Appendix II: Complete Listing of the Department of Defense’s Privatized Military Housing Projects as of October 2017

The following is a complete listing of the Department of Defense’s 82  privatized military housing projects, as of October 2017. The projects can  consist of one or multiple installations.

Appendix III: Comments from the Department of Defense

Appendix IV: GAO Contact and Staff Acknowledgments

Brian J. Lepore, (202) 512-4523 or leporeb@gao.gov.

In addition to the contact named above, Kristy Williams (Assistant  Director), Tracy Barnes, Ronnie Bergman, Timothy Carr, Kelly Friedman,  Simon Hirschfeld, Terence Lam, Amie Lesser, Jeffrey Love, Richard  Powelson, Nancy Santucci, Mike Silver, and Cheryl Weissman made key  contributions to this report.

Defense Infrastructure: Army Has a Process to Manage Litigation Costs  for the Military Housing Privatization Initiative. GAO-14-327. Washington,  D.C.: April 3, 2014.

Military Housing: Information on the Privatization of Unaccompanied  Personnel Housing. GAO-14-313. Washington, D.C.: March 18, 2014.

Military Housing: Enhancements Needed to Housing Allowance Process  and Information Sharing among Services. GAO-11-462. Washington,  D.C.: May 16, 2011.

Military Housing Privatization: DOD Faces New Challenges Due to  Significant Growth at Some Installations and Recent Turmoil in the  Financial Markets. GAO-09-352. Washington, D.C.: May 15, 2009.

Military Housing: Management Issues Require Attention as the  Privatization Program Matures. GAO-06-438. Washington, D.C.: April 28,  2006.

Military Housing: Further Improvement Needed in Requirements  Determination and Program Review. GAO-04-556. Washington, D.C.:  May 19, 2004.

Military Housing: Better Reporting Needed on the Status of the  Privatization Program and the Costs of Its Consultants. GAO-04-111.  Washington, D.C.: October 9, 2003.

Military Housing: Opportunities That Should Be Explored to Improve  Housing and Reduce Costs for Unmarried Junior Servicemembers.  GAO-03-602. Washington, D.C.: June 10, 2003.

Military Housing: Management Improvements Needed as the Pace of  Privatization Quickens. GAO-02-624. Washington, D.C.: June 21, 2002.

Military Housing: DOD Needs to Address Long-Standing Requirements  Determination Problems. GAO-01-889. Washington, D.C.: August 3,  2001.

Military Housing: Continued Concerns in Implementing the Privatization  Initiative. GAO/NSIAD-00-71. Washington, D.C.: March 30, 2000.

Military Housing: Privatization Off to a Slow Start and Continued  Management Attention Needed. GAO/NSIAD-98-178. Washington, D.C.:  July 17, 1998.