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INTRODUCTION
The purpose of this analysis is to determine the most cost effective
way to acquire an office and warehouse complex to house the High Desert
Interagency Partnership (HDIP) in Hines, Oregon. The options available
are Lease and Purchase. Either option will require construction of a new
facility as there is not one in the Burns/Hines area which meets the requirements.
The analysis follows the Office of Management and Budget
(OMB) Guidelines Circular A?94 dated October 29, 1992. Discounted constant
dollar values are used to compare present and future dollar values.
OMB GUIDELINES
The Office of Management and Budget (OMB) in their Circular A?94, "Guidelines
and Discount Rates for Benefit?Cost Analysis of Federal Programs", provides
guidance for Lease?Purchase analyses which is to be followed for all analyses
submitted to OMB in support of legislative and budget programs. The direction
is summarized as follows:
Life Cycle Costs - Use the net present value of the
life?cycle costs as the basis for economic comparisons. For this study,
present and future costs are compared using
constant?dollar values.
Discount Rates - OMB's 20 year discount rate for FY96
is 6.0 percent which is to be used in calculating the net present values.
The rate is OMB's projection
of the nominal interest rates for Treasury notes and bonds at specific
maturities for the coming year.
Lease Period - All renewal options are to be included
when determining the lease period.
Imputed Costs for Government-owned
Assets - The following costs are
to be imputed when the Government owns an asset that is part of the
analysis:
Property value - Use the current market value.
Property Taxes - Use the tax rate of comparable properties
in the locality.
Insurance Premiums - Use the rate for standard commercial
coverage.
Residual Values
- Estimated price the property can be sold for at the end of its economic
life, measured in discounted, present value terms.
BENCHMARK
For this study, the benchmark for new office construction cost in the
private sector for the coming year is $90 per gross square foot including
site work and parking. Estimates for completing the new Forest Service
lease building in John Day, Oregon (65 miles north of Burns) already exceed
$87 per gross square foot, and the project isn't completed yet.
ALTERNATIVES
Lease
The Government will lease a commercial facility from
a private developer who will built it on private property expressly for
the HDIP. All operation and ownership costs will be reflected in the lease
rates.
Purchase
The Government will contract for the construction of
the HDIP facility on existing government-owned property in Hines. The
Federal Government through direct appropriation and/or other authorizations
by Congress will pay for all construction expenses. Operation and maintenance
costs will be paid from Agency operating funds.
ECONOMIC ANALYSIS
The economic model used to calculate life-cycle costs, net present values,
and annual costs is shown in Table 1, Lease-Purchase Comparison According
to OMB A-94. The operation of the model is described below:
Life-Cycle Costs
Construction Costs
The Purchase cost for the HDIP complex is $5.8 million. This is the
estimate of the Government's cost to build the complex. It includes
design, contract
administration,agency overhead, and an imputed cost for the government
property on which it will be located.
The Lessor's construction
cost was adjusted to the benchmark
value of $90 per gross square foot for office construction. This equates
to $114 per GSF for Purchase or Government construction cost.
Thus, the
Lessor has a cost advantage of 79 percent compared to government construction.
The Lessor's costs are lower because of less overhead, lower
design costs,
and absence of a prevailing wage rate requirement.
Residual Values
The residual value of the improvements is their depreciated value based
on the Lessor's cost of construction. Depreciation factors were taken
from the Marshall Valuation Service, August 1994, published by Marshall
and Swift. Life expectancies for the office and warehouse are estimated
at 50 years and 40 years, respectively. Subsequently, the tables give
the depreciation of the office at 17 percent, and the warehouses at 30
percent. All other site improvements are expected to depreciate 90 percent
over the 20 years period.
Debt Service
The debt costs were calculated assuming the Lessor would invest an amount
equal to 25 percent of the project cost from their own funds, and borrow
the remainder on a mortgage. The mortgage rate was assumed to be 2 percent
above the Treasury rate. The Lessor's rate of return on investment was
assumed to be 1.5 percent above the mortgage rate.
Ownership Costs
Ownership costs include property taxes, insurance, maintenance reserves,
and management. Hines property taxes are $15 per $1000. The other costs
were calculated as a percentage of the Lessor's construction cost, and
are based on unit costs that are average for Forest Service lease office
space in Oregon and Washington.
Maintenance reserves refer to the funds the owner sets
aside for replacement of furnishing, equipment, exterior finishes, pavements,
etc. that will be replaced over the life of the lease. The costs of ownership
and operation were assumed to be the same for Lease or Purchase given
the requirement that taxes and insurance be imputed on government?owned
assets.
Operating Costs
Operating costs include janitorial services, utilities, maintenance, building
manager, security, and landscape upkeep. Costs were calculated for the
leasable building areas using rates typical for Forest Service leases
in Oregon and Washington.
Net Present Value Analysis
Net Present Value (NPV) is useful for comparing the
benefits and costs of competing alternatives that have incomes and expenses
distributed over time. Future cash flows are discounted to present values
using an appropriate discount rate. The method recognizes the time?value
of money, and provides a common basis for comparing alternatives. NPV
is the method preferred by OMB because it displays the total opportunity
cost of a particular course of action. A way to visualize PNV is to think
of it as the Sum of money needed to be invested today at
the discount rate to produce a cash flow over time as proposed by the
alternative.
Economic Life
The economic life for each alternative is 20 years, the maximum lease
period.
Purchaser Construction and
Interest Expense Schedule Under the
Purchase option, interest payments are calculated during the construction
period and added to the construction costs to determine the construction
NPV at the date of occupancy. The construction period is assumed to be
3 years, with cost percentages assigned as follows:
| ITEM |
YEAR |
PERCENT |
| Preliminary Design |
1 |
2% |
| Design |
2 |
12% |
| Construction |
3 |
86% |
Appreciation of Improvements
It is anticipated that buildings and property will appreciate faster than
the general rate of inflation. For this analysis, buildings are assumed
to appreciate at 1.5 percent, and land at 0.5 percent per year.
Annual Costs
Another way to compare the Purchase and Lease options
is to reduce their costs to an annual basis. This data is displayed in
Part C of Table I. Construction and interest payments along with the residual
value for the Purchase alternative were reduced to equal yearly payments
using the appropriate capital recovery factor.
COMPARISON OF ALTERNATIVES
The Life Cycle Cost of each alternative, as reduced to a Net Present Cost
in Table I, is listed below and displayed in Figure 1. The results are
displayed as Costs rather than Values that changed the sign of the numbers
(from negative to positive).
| ALTERNATIVE |
NET PRESENT COST |
SAVINGS |
| Purchase |
$7,021,000 |
$621,000 |
| Lease |
$7,642,000 |
|
Purchase has the lower Net Present
Cost, and therefore is the preferred alternative.
SENSITIVITY ANALYSIS
In order to determine the effects on the economic model of Table I to
changes in the assumptions, scenarios were run using different variables.
In each scenario, the variable being tested was adjusted so that the Lease
vs. Purchase decision became neutral.
Depreciation
The average depreciation in the model is 27 percent.
The residual value can drop to 41 percent of the Lessor's initial cost
that equates to a depreciation factor of 59 percent before Lease becomes
the preferred alternative.
Discount Rate
The discount rate has a significant
impact on the amount of savings Purchase will produce as shown in Figure
1. If the discount rate drops to 5 percent, savings will jump to $946,000.
At 8.5 percent, the Purchase-Lease decision becomes neutral.
Appreciation
The model used 1.5 percent for buildings, and 0.5 percent
for land. These values can drop to a negative 1.4 percent before the lease-purchase
decision becomes neutral.
Lessor's Cost Advantage
This variable is defined as the cost advantage a private
contractor has over the Government due to lower overhead, lower design
costs, and absence of a prevailing wage rate requirement. The economic
model determined this rate to be 79 percent using a benchmark of $90 for
new office construction. Under the scenario, the rate can drop to 71.5
percent before the lease-purchase decision becomes neutral. This equates
to a contractor's office construction cost of $82 per gross square foot,
which is below current costs for office construction.
CONCLUSIONS
Purchase will save $621,000 or 8 percent in life cycle
costs over 20 years when compared to Lease.
The Sensitivity analysis shows
that normal variations in the economic variables will not change Purchase
as the preferred alternative. |
