Net of Utilities: A Savings Model for VA Clinic Operations Oh, I miss the days when the Department of Veterans Affairs, or the VA’s, Solicitation for Offers (now Request for Lease Proposals or RLP) were “net of utilities” meaning the VA paid actual incurred utility costs and, more importantly, could exercise some control over these expenses. Today’s RLP is written to include utilities as a fully serviced expense provided by the Lessor. As a financier for many VA medical facilities (including HCCs, MS CBOCs and CBOCs – Clinics), I am amazed how onerous it is to properly put together operational pro-forma’s for our clients building and leasing these Clinics to the VA. For utilities, if a potential owner bids too low, then any cash flow is wiped out upon lease commencement. Bid too high, then the VA is paying much more than it should for this line item in its rent. Now environmental concerns, including energy usage and conservation, have moved to a front and center position in both public and private sector projects. Additionally, the U.S. Government is requiring that all leasing of federal projects be in buildings with “net zero emissions” beginning in 2030. How do we get there? For recently awarded VA leased projects, a base utility guestimate is included in a serviced rent calculation. Though the Clinic facility owner has no control over utility usage, they are fully responsible for significant changes or swings in utility costs. Since the VA doesn’t see these expenses, there is little incentive to manage utility costs. These issues were raised in a recent virtual industry event between the NFDA and senior leasing and construction executives at the VA. The VA is aware of industry concerns with the current utilities rent structure. As the “net zero emissions” lease is a recent development, the VA (like other agencies) is just getting its arms around this as investments in energy efficiency for both real estate owners and VA operators will be a required outcome of this mandate. Some of the factors impacting utilities that should be considered in pursuing an equitable balance in future VA leasing agreements with the owners and operators of Clinics and facilities include: By under-bidding utilities expenses in the RLP, the asset’s operations could be underwater financially, from the day it opens.
Potential fixes to the current system, which should pave the way for the VA to fully embrace “net zero emissions” in its leases well before 2030.
Depending on jurisdiction, utility expenses are among the top three expenses in managing commercial properties including Clinics (generally behind property taxes and roughly the same as janitorial and labor expenses). This reality makes getting utilities costs right in an RLP response critical to the success of a real estate operator’s business model, encouraging high side estimates to mitigate potential downside outcomes over the life of a lease. For VA Facilities Management officials, this area is also a compelling target for overall cost savings and operational efficiency across a growing portfolio of Clinic facilities nationwide through its ability to reduce rents across its portfolio. By shifting from a high side estimate to an actual net of utilities model, both parties in future lease agreements will be better served in the long run and encouraged to invest in meeting energy efficiency goals and related mandates. *The NFDA Board of Directors has reviewed and published this article, and endorses the opinion and position advocated therein for consideration and possible adoption by the Department of Veterans Affairs. About the Author: As a member of The Urban Land Institute and International Council of Shopping Centers, Mark has spoken on various real estate finance topics for these organizations. He is past President and Co-founder of the UCLA Real Estate Alumni Group, a Ziman Associate at the UCLA Ziman Center For Real Estate, and has been a guest lecturer at the UCLA Anderson School of Management. Mark is on the Board of Governors of the Commercial Real Estate Finance Council and is a Board Member of the National Federal Development Association. |