Legislature(2003 - 2004)
04/14/2004 03:28 PM House L&C
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
HB 545-STATE REAL PROPERTY LEASE EXTENSIONS CHAIR ANDERSON announced that the next order of business would be HOUSE BILL NO. 545, "An Act relating to the extension under the State Procurement Code of terms for leases for real estate and certain terms for certain state contracts for goods and services; and providing for an effective date." Number 0417 VERN JONES, Chief Procurement Officer, Division of General Services, Department of Administration, explained that currently the procurement code allows the [division] to negotiate extensions of office space leases for up to 10 years in exchange for rent reductions. This legislation would increase the state's ability to negotiate such by changing the current required threshold from a 10 to 15 percent reduction off the existing lease rate to a 5 percent reduction from the current market rate for the area. Mr. Jones informed the committee that existing statutory restrictions on the negotiations have hampered [the division's] ability to negotiate lease extensions with the lessors. "The increase in the real estate market in Alaska combined with the way we structure our leases, often makes a 15 percent reduction from existing rental rates unattainable," he explained. Therefore, tying the reduced rate to a percentage of the current market is a more reasonable approach that he believes will allow the negotiation of reduced rates more frequently while avoiding the lengthy and expensive re-procurement process. Such an approach will avoid the costs and disruption of moving state offices and large numbers of state employees. MR. JONES turned attention to a chart, which illustrated that lease costs consist of several elements, including lessor profit, ongoing lessor costs, and the upfront construction and tenant improvement costs. He explained that the upfront construction and tenant improvement costs are generally financed and amortized over the initial firm term period of a lease. The lessor is afforded an opportunity to bid a different price during the option periods of a lease. Generally, there is a dramatic decrease in prices after the initial firm period is over. A rate below the already-reduced option year cost is often unattainable [to the division] as opposed to a percentage below a market rate, which many more lessors are willing to negotiate. Mr. Jones said that the more often these submarket rates can be negotiated and avoid the costs of re-procurement and moving expenses the more the state saves. Mr. Jones mentioned that HB 545 would also allow extensions for other nonlease contracts. Number 0652 REPRESENTATIVE ROKEBERG commented that the changes in the market have driven the need for some modification to this successful program. He inquired as to the methodology that would be used in order to establish the prevailing market rates. MR. JONES answered that in the large metropolitan area of Anchorage there are independent third-party market watch services available. However, the difficulty is in regard to the rural areas for which the bill isn't specific. Mr. Jones related that the intent is to develop as many "comps" as available in order to determine what the market would be in that area. In some cases, [the state] is the only lessor in an area, which means that [the state] may set the market. REPRESENTATIVE ROKEBERG pointed out that in area such as Anchorage one can utilize a broker's opinion of value (BOV) as opposed to an appraisal done by a licensed real estate appraiser, which is the more costly of the two. However, he acknowledged that an appraisal by a licensed real estate appraiser lessens the ability for any mischief. Representative Rokeberg said that he was concerned with regard to accomplishing a baseline. A 5 percent reduction isn't a large margin, he noted. The existing statute is clear because there is a baseline of the existing rental rate. However, he recognized that the market conditions in an up market don't allow for "those types of things typically" unless the landlord has the "sunk" costs recovered or amortized costs of the tenant improvement allowances. "Presumably, there would be an incentive of an existing landlord to bargain for a reduced rate if he has recovered those costs. Is that not the case sometimes," he asked. MR. JONES confirmed that is the case sometimes. However, in a market such as the current one 15 percent below an existing rate is often impossible because [the division and the lessors] feel the existing law is too restrictive. Number 0868 REPRESENTATIVE ROKEBERG informed the committee that part of the reason for the aforementioned is the Little Davis-Bacon Act, which requires any refitting to be done under the prevailing wage laws. Therefore, the costs to the landlord are increased such that it's above the prevailing market rate. Representative Rokeberg asked whether the communications or "CAT 5" type wiring requirements have any impact on the space acquisition costs. MR. JONES acknowledged that [the communications requirements] are a substantial cost. However, he opined that it seems to be turning into an industry standard. REPRESENTATIVE ROKEBERG highlighted that recently the legislature renewed its lease at the Anchorage Legislative Information Office. In that case, the legislature agreed to capitalize and pay for the costs [for refitting]. He recalled that the original performer for the bid was about $180,000, which, after going out to bid, was lowered to about $125,000. The aforementioned was merely the cost for rewiring. Representative Rokeberg reiterated his discomfort with the way in which the prevailing market rate is established when dynamics are present that provide the incumbent landlord a significant advantage. MR. JONES, in response to Chair Anderson, said that he could work on addressing Representative Rokeberg's concerns. REPRESENTATIVE ROKEBERG turned attention to Section 1(a)(2) of the legislation. He questioned why the [state] would want to extend a contract for goods or services up to a maximum of five years "if a minimum cost savings of at least 5 percent can be achieved on the price of goods or services established in the contract." He further questioned why the aforementioned would be chosen rather than go out in the market and re-bid it. MR. JONES specified that the [language in Section 1(a)(2)] was included as an additional tool, and he didn't anticipate widespread use of it. Mr. Jones related that [the division] is in the process of brainstorming with regard to developing ideas to reduce the costs of goods and services as well as the leases. From a procurement standpoint, the first option is always to go out and obtain competition in the market place. The approach under discussion would probably only be used when it is felt that the open market would result in higher costs. Mr. Jones said that since [the division] doesn't have experience in the approach [laid out in Section 1(a)(2)], he could only relate that the ability to negotiate leases will be used much more often than the ability to negotiate procurement contracts. REPRESENTATIVE ROKEBERG asked if the typical contract for goods or services is five years for procurement of materials and services. MR. JONES said that often there are long-term contracts for items such as copiers and fax machines or office supplies. However, those are shorter contracts and less frequent than are the leasing contracts. REPRESENTATIVE ROKEBERG said that he did agree with the department with regard to the lease premise. However, he maintained his concern with the other option that must show only a 5 percent cost savings because of the substantial opportunity for mischief. MR. JONES said that it's not the intent to do mischief. Furthermore, 5 percent was utilized as a reasonable starting point and [the division] isn't married to it. In fact, the contract for goods or services is the lesser part of this legislation. If the committee is uncomfortable with the 5 percent in Section 1(a)(2), the [division] is amenable to increasing the percentage or removing it altogether. Number 1216 REPRESENTATIVE ROKEBERG, with regard to the leasing contract, inquired as to reallocation costs and other costs that would be incurred. He also asked if there are any examples that illustrate the 5 percent may have saved the [department] money. MR. JONES informed the committee that moving costs are generally estimated at $1 per foot. Tenant improvements and upfront construction are generally substantial for a large-size lease. There are also telephone relocations and CAT-5 cables are expensive. He said he could provide the committee with specific numbers later. Furthermore, the disruption of a relocation is difficult to quantify. He noted that there are other things, such as the changes required for letterhead, business cards, and signage, that generate costs. With regard to the 5 percent, Mr. Jones reiterated that it's just an idea and [the division] has no particular plans for it. In virtually every aspect of the business in General Services, the division has attempted to develop ways to cut costs. Number 1350 REPRESENTATIVE ROKEBERG noted that HB 545 has a House Judiciary Standing Committee referral. Although there are some savings to be had with this legislation, he requested that the administration develop a tighter definition with regard to establishing the prevailing market rates. He further requested that the administration review the concept embodied in Section 1(a)(2) in order to develop a better argument for its need. MR. JONES said that he would have the aforementioned done by Friday. CHAIR ANDERSON announced that HB 545 would be held over.