Report 2011-127 Summary - August 2012

Metropolitan Transportation Commission:

The Use of Toll Revenues to Purchase a New Headquarters Building Is Likely Legal, but the Transaction Exposes Toll Payers to Undisclosed Financial Risk

HIGHLIGHTS

Our audit of the Bay Area Headquarters Authority's acquisition of a new regional headquarters and the Bay Area Toll Authority's (toll authority) administration and use of toll bridge revenues, revealed the following:

  • Using toll revenues to acquire a new headquarters building likely was legally permissible.
  • The Metropolitan Transportation Commission (transportation commission) and the toll authority could have done more to clearly articulate to both their board and the public the financial risks.
    • In today's dollars, the transportation commission's expected cash flows would fall short of repaying contributed toll revenues by roughly $30 million.
  • The financial risk of repaying toll funds increased following plans in May 2012 to reduce the building's rentable space.
  • The transportation commission and the Bay Area Air Quality Management District (air district) had valid reasons for wanting to leave their current facilities.
    • The transportation commission stated that it wanted to ensure sufficient room for growth over the long term.
    • The air district faced spending between $12 million and $30 million to fix its aging building.
  • The specified criterion for overall building size, at 350,000 square feet, was roughly twice the amount originally shared with the board.
    • The transportation commission's space needs were based on anticipated future responsibilities the specifics of which are unknown.

RESULTS IN BRIEF

In October 2011 the Bay Area Headquarters Authority (headquarters authority)—an entity created by the Metropolitan Transportation Commission (transportation commission) and the Bay Area Toll Authority (toll authority)—purchased a building located at 390 Main Street in downtown San Francisco, using revenues from seven state-owned toll bridges in the San Francisco Bay Area (Bay Area). The building purchase was the culmination of nearly two years of planning among the transportation commission, the toll authority, the Bay Area Air Quality Management District (air district), and the Association of Bay Area Governments (association) to colocate, and the site is intended to serve as their regional headquarters. The transportation commission and toll authority share the same governing board (board), which has authorized the toll authority to contribute more than $167 million in toll revenues toward the estimated $180 million cost to purchase, renovate, and prepare the building for occupancy by fall 2013.

The board's September 2011 decision to authorize the purchase of a new headquarters building has been controversial. At a board meeting in September 2011, members of the public questioned why public toll revenues were being used to purchase a building that is larger than the amount of office space the colocating agencies need, effectively causing the toll authority, using public toll revenues, to enter the real estate business and become a commercial landlord. Others have questioned whether it was even permissible for the toll authority to use toll revenues for this purpose.

Although a court would ultimately decide the legality of the purchase, our legal counsel advised that the board's decision to use toll revenues to acquire a new headquarters building likely was legally permissible. State law expressly authorizes the toll authority to pay its direct and administrative costs from gross annual bridge revenues and to contribute funding to the transportation commission. Therefore, our legal counsel advised that a court would likely conclude that costs to plan for, acquire, and develop facilities and office space for the toll authority and transportation commission and its staff are direct costs that can be paid from gross annual bridge revenues. Our legal counsel also advised that a court would likely conclude that the sole fact that the building exceeds the needs of the toll authority and transportation commission would not adversely affect that authority, because a court would defer to reasonable decisions made by the board, and our legal counsel believes a court would likely find that the board's decision was reasonable. Ultimately, we note that under state law, the toll authority may do all that is necessary or convenient to exercise its powers, including, but not limited to, the acquisition, management, and operation of any public facility or improvements.

During the decision-making process, the transportation commission and the toll authority could have done more to clearly articulate to both their board and the public the financial risks associated with purchasing the building. The transportation commission's presentation to the board in September 2011 stated that toll payers were protected because the projected net income, or cash flows, from the building would offset contributed toll revenues. However, in its projection the transportation commission did not discount the value of the future cash flows from the rental income, thus preventing a comparison of the expected toll fund contributions to the building's expected income in today's dollars. We converted the transportation commission's cash-flow projection based on its September 2011 space plan to today's dollars and determined that, in the most conservative combination of rental and occupancy rates, cash flows would fall short of repaying contributed toll revenues by a total of roughly $30 million. The income the building generates is largely dependent on the rental and occupancy rates that can be achieved. The future values of these rates are uncertain, and thus there is uncertainty as to whether and when toll revenues will be repaid.

We also note that the financial risk of being unable to repay all of the toll revenues significantly increased following the board's September 2011 decision to acquire the building. In May 2012 the headquarters authority announced plans to convert 101,000 square feet of space in the new headquarters into an atrium and building support space that will reduce the rentable space available to generate income. According to the current occupancy plan, unless the three most optimistic combinations of rental and occupancy rates are used, cash flows will fall short of repaying contributed toll revenues by a range of $1.5 million to $53.7 million over 30 years.

We found that the transportation commission and the air district had valid reasons for wanting to leave their current facilities. Both identified limitations with their current facilities, and both identified the potential benefits of easier cross-agency collaboration by sharing a new headquarters building. The transportation commission determined that it needed more space to accommodate its staff count as well as for conference rooms, storage space, and other support functions. The air district's justification for moving is largely based on the cost of improving its current headquarters. In recent years consultants have concluded that the air district faced spending between $12 million and $30 million to replace key components of its aging building. In January 2010 the transportation commission, the air district, and the association began to explore the potential benefits of colocating into a single headquarters facility.

The transportation commission developed property search criteria and followed a reasonable process for evaluating potential properties based on these criteria. However, the specified criterion for overall building size, at 350,000 square feet, was roughly twice the amount originally shared with the board in November 2010. Moreover, it is not clear to us what the transportation commission's motivation was in setting this search criterion for the building's size. According to the transportation commission's executive director, he wanted to ensure that the new headquarters building has sufficient room for growth over the long term, and he also stated that income generation was not a factor when deciding on the amount of needed space. The transportation commission's chief financial officer further explained that the projected space needs were finalized in undocumented internal discussions about anticipated future projects that would affect the need for more work space. However, when asked about these projects, the chief financial officer explained it was a guess based on assumptions regarding the transportation commission's future responsibilities, the specifics of which are yet to be determined.

Once the search criteria were finalized, the transportation commission's broker solicited property proposals and made recommendations to the transportation commission regarding which proposals warranted further consideration. The transportation commission and its broker identified five finalist properties and ultimately selected the property at 390 Main Street in San Francisco, since the others had certain flaws and the 390 Main Street property had the lowest price per square foot. Since price per square foot was a key consideration in the selection process, we reviewed the five finalist property proposals and found that the price information submitted to the board for decision making was consistently developed by the transportation commission's broker.

Finally, the air district has signed a 30-year lease agreement with the headquarters authority to acquire approximately 62,500 square feet of work space in the new headquarters building. The lease agreement provides the air district with an opportunity to purchase its share of the building at any time over this 30-year period. The association and the San Francisco Bay Area Conservation and Development Commission have also demonstrated interest in relocating to the new building, having participated in space-planning meetings as recently as April 2012, but they have not executed leases. In the summer of 2012, both the transportation commission and the air district plan to begin assessing their options for disposing of their current headquarters buildings.

RECOMMENDATION

If the Legislature believes state law provides the toll authority with too much discretion over its use of toll revenues, it should consider amending state law to more narrowly define how toll revenues that are not immediately needed for bridge maintenance or debt service may be spent or invested. For example, the Legislature might consider imposing specific limitations or prohibitions on the use of toll revenues to acquire real estate for administrative or investment purposes.

AGENCY COMMENTS

The transportation commission agreed with certain conclusions in our report and disagreed with others, including the report's recommendations. Specifically, the transportation commission stated that it was pleased with the report's conclusion that a court would likely find its board's decision to purchase a new building with toll revenue was within its legal authority. The transportation commission was also pleased that our report found that its board was generally informed throughout the property search and selection process. However, the transportation commission disagreed with our report's net present value (NPV) analysis. In its view, the report's NPV analysis was incomplete because it did not include the building's residual value. Finally, the transportation commission expressed that it did not believe the recommendations to the Legislature were supported by the audit's findings.

The air district stated that it reviewed the portions of the report it was provided and did not have substantive comments.


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