By most accounts, this first decade of the Department of Defense's Military Housing Privatization Initiative has been quite a success.
From the department's perspective, MHPI has accomplished its main objectives: over 134,000 rundown military family housing units have been revitalized or replaced, the deficit of needed family housing is almost eliminated, and privatization can pave the way for the 186,000-unit military housing inventory to remain in good condition over the long run.
From the private sector's perspective, a viable and profitable new commercial real estate industry and investment asset class has emerged, one which offers considerable business opportunities in construction, property management, and real estate finance.
Key performance metrics have met or exceeded pro forma expectations: new construction and renovations are at or ahead of schedule, stabilized occupancy is at over 94%, and annual rental increases have averaged over 5.2% over the last five years, exceeding pro forma estimates.
To date, MHPI has generated about $28 billion worth of construction. The upfront cost to the federal budget has been only about $3 billion, with private capital being the primary source of upfront funding. DOD estimates that by transferring ownership and management of military family housing to the private sector, the long-term savings to the government will be about 10% compared to traditional military construction and management.
As the first decade of the initiative comes to a close, DOD and the private sector acknowledge the program's success and what it took to get there, but we must also acknowledge and prepare for the changes and challenges that will undoubtedly occur over the next 40 years of these 50-year arrangements.
Like all commercial real estate, privatized military housing is affected by the market. Owners of MHPI housing face normal risks associated with occupancy, revenue, and the cost of operations. Owners have to compete for tenants and must keep up with rising community standards in furnishings and hook-ups.
The Internet was not around 50 years ago, but today Internet hook-ups are a standard feature in privatized houses. One wrinkle MHPI owners face — which is not common in the market — is the certainty that national strategic objectives and military missions will change. Changing military missions will determine where service members need to work and live.
These changes in the market and in the mission will likely mean that some privatized housing projects must be restructured in terms of scope, technology, or financing. The fact that housing is privatized should make restructuring more flexible, expeditious, and efficient. The private sector is in the driver's seat here, as the government is only a limited partner or ground-lessor in these transactions.
For its part, the government will need to act deliberately and diligently to support the private sector responses. However, any involvement by the government in the restructuring process must be conducted within the government's legal authority. Beyond that, the same principles that applied to the first 10 years of awards must apply to any restructuring:
- A restructuring must ensure that the government receives a sufficiently certain scope of available rental housing with only the minimum necessary government subsidy.
- The government must continue to only protect its interests without participating in the day-to-day management of the project.
- The private developer must continue to own the property with all the attributes, benefits, and risks of that ownership.
- The private sector must remain responsible for all risks common in the market, including insuring its property against fire, flood, and other acts of providence.
- To the extent possible, competition must drive the selection of new owners, lenders, and other service providers.
One change in the market that has tested these principles is the credit crisis, which has affected all asset classes and limited the ability of MHPI projects to secure competitive private-sector financing. Downgrading of bond insurers and surety providers has left a third of MHPI bonds either with ratings below A or with no ratings at all.
The value of those bonds, when marked to market, have resulted in substantial discounts to MHPI bond investors, reducing their appetite for further investments. The alternative is for the projects to cash-fund a 12- month reserve, which is an expensive and inefficient way to address the problem and ultimately results in less funding available to fix homes.
The DOD is therefore exploring ways to avoid having to cash-fund the debt service reserve by using existing MHPI authorities to replace the sureties. In accordance with the principles listed above, this new product would satisfy the needs of lenders and rating agencies without adding significant risk to the government.
Restructuring is not a dirty word if it is conducted in the proper manner. The world will no doubt change over the next 40 years, and such change will impact the military's housing requirements as well as the privatized housing projects.
Successful restructuring will require a focused response by the private sector and a principled approach by the government to ensure that our military families continue to enjoy quality, safe, and affordable housing.