The Federal Housing Finance Agency has been lax in its duties as the overseer of Fannie Mae, and needs to do far more to address the dramatically rising cost of Fannie Mae’s new Washington, D.C. headquarters, the FHFA’s watchdog said in a new report.
According to a new report from the Federal Housing Finance Agency Office of Inspector General, the projected cost of Fannie Mae’s new Washington headquarters, which would consolidate several office locations in the D.C. area into one main location, has risen 53.35% from $164.32 per square foot to $252.81 per square foot since Jan. 26, 2015.
And while that cost has been on the rise, the FHFA hasn’t exercised the proper oversight over Fannie Mae and its relocation process, the FHFA-OIG said in its report.
According to the FHFA-OIG report, its review of Fannie Mae’s relocation stemmed from an “anonymous hotline complaint” that accused Fannie Mae of engaging in “excessive spending” in the construction of its new headquarters.
The FHFA-OIG conducted a review of the entire relocation process, from the initial decision to either relocate or renovate Fannie Mae’s current office location all the way through selecting a new location and through the beginning stages of construction, which began last month.
And according to the FHFA-OIG, the results of that review were less than positive.
“Based on facts learned during that review, we believe there are significant financial and reputational risks from the projected costs associated with Fannie Mae’s relocation of its headquarters that warrant immediate, sustained, and comprehensive oversight from FHFA,” the FHFA-OIG states in its report.
According to the FHFA-OIG report, the construction cost is estimated using a Net Present Value, which considers future cash flows associated with leases, and the timing of the lease payments, over a specified period of time. The cash flows are discounted back to present value using a discount rate that reflects the lease period borrowing cost.
The original construction cost for Fannie Mae’s headquarters, which are to built on the site where the Washington Post’s headquarters once stood, were estimated to be a NPV of $770,481,598, which included 15-year lease for approximately 700,000 square feet at $48.15 per square foot in rent (with annual increases of 2.5%); a 4% discount rate; rent abatements by Carr Properties (the building’s construction company); and build-out costs of $164.32 per square foot to give Fannie Mae a “turnkey” office space.
That price included the design costs, office configurations, and furniture, fixtures, and equipment.
Of the $164.32 per square foot, $120 per square foot was to be paid for by Carr Properties through a tenant improvement allowance, and Fannie Mae would pay for the remaining $44.32 per square foot.
But over the course of the construction preparation process, those costs rose.
According to the FHFA-OIG report, an updated budget for the construction dated March 10, 2016 showed that the estimated cost to build-out the leased space in the building had risen to $252.81 per square foot, an increase of $88 per square foot, or 53.35%.
The same budget document showed that the estimated square footage for Fannie Mae’s offices decreased from 700,000 square feet to 679,000 square feet, but despite the increased cost per square foot, the total NPV remained at $770,481,598.
Then in May, the budget was revised again, with the projected build-out costs falling to $223.35 per square foot, which is $29.46 per square foot lower than the March 10, 2016, estimate of $252.81 per square foot.
What makes matters worse, from the FHFA-OIG’s perspective, is the fact that the person identified by the FHFA as being responsible for overseeing the construction efforts was unaware, at times, of the rising construction costs.
“We advised this (FHFA Division of Conservatorship) employee that, as of March 2016, Hines (the construction management firm) had projected Fannie Mae’s build-out costs had increased to $252.81/square foot,” the FHFA-OIG report states.
“He responded that he had not received a copy of the March 2016 budget and was unaware of that estimate, but stated that Fannie Mae should have informed him of the change,” the report continues. “From the materials we reviewed and the employees of Fannie Mae, Hines, and DOC whom we interviewed, it does not appear to us that anyone in DOC was aware of the projected 53% increase in estimated build-out costs for Fannie Mae’s new office space.”
When the budget was revised down in May, the FHFA-OIG reached back out to the DOC employee in charge to determine if he was aware of the budget revision. The employee told the FHFA-OIG that he was aware of the May 2016 revised budget but had not been provided with a copy of it.
One of the main issues driving the cost increases is architectural improvements and features that have been added to the plans, including: three enclosed glass bridges that connect different parts of the building to each other; “town centers” at the end of each bridge; spiral staircases; and rooftop viewing decks.
The estimated costs of the glass bridges to Fannie Mae? $15 million.
As construction of the building itself has just begun, many of the plans are not yet finalized, as the FHFA-OIG notes.
“At this juncture, the future of Fannie Mae cannot be predicted,” the FHFA-OIG report states.
“At our meeting on June 8, 2016, (the FHFA) represented to us that no plans for the build-out of Fannie Mae’s space have been finalized and that plans will continue to evolve and change until Carr Properties begins work on the interior of the building,” the FHFA-OIG report continues.
“To the best of our knowledge, FHFA has not approved any of the proposed features in Fannie Mae’s architectural and engineering plans nor has it reviewed or approved proposed expenditures by Fannie Mae for these features,” the report continues. “We do not know—nor, we believe, does the Agency know—the extent to which proposed features in Fannie Mae’s architectural and engineering plans can be altered, or what costs may be attendant upon the removal of proposed architectural features that FHFA does not approve.”
The FHFA-OIG goes on to state that it is the FHFA’s responsibility as the conservator of Fannie Mae to determine if the construction of this building, as it currently designed, the best course of action for the government-sponsored enterprise.
“Because Fannie Mae is an entity in the conservatorship of the U.S. government and is leasing space in a building owned by Carr Properties, FHFA, as conservator, will need to assess the anticipated efficiencies of specific proposed features against the estimated costs of those features and determine whether the efficiencies warrant the costs,” the FHFA-OIG report states. “FHFA will also need to determine whether the proposed features for leased space in a building that is not owned by Fannie Mae or the U.S. government are appropriate for an entity in conservatorship.”
Perhaps the most damning of the report’s findings and suggestions is the report’s conclusion, which calls Fannie Mae’s motivation for funding the construction costs.
“Pursuant to the terms of the Third Amendment to the Senior Preferred Stock Purchase Agreement, Fannie Mae’s net worth less the amount of its capital reserve, is swept into the U.S. Treasury each quarter,” the OIG report notes.
“Fannie Mae arguably has little incentive to cabin its costs for the build-out of its new headquarters because any positive net worth it does not spend on itself will be swept into the Treasury as a dividend,” the OIG report continues. “Excessive or unnecessary spending by Fannie Mae may be seen as monies that ought to have been swept to the U.S. Treasury as a dividend for the $116.1 billion investment by U.S. taxpayers.”
FHFA Director Mel Watt “strongly disagrees” with those allegations, stating in a letter of response that in his time with the FHFA he has seen “absolutely nothing that would support that, or any similar assumption.”
It’s exactly the opposite, according to Watt.
For more on Watt’s response to the OIG’s report, click here.
Watt also notes that the FHFA “fully considered and vetted” the decision to relocate prior to any agreements being signed.
Watt also counters the OIG’s accusations about the seeming overindulgence of the building’s planned glass walkways, etc.
“While spiral staircases may sound extravagant, they take up significantly less space that regular staircases and taking the stairs generally leads to better employee fitness and efficiency that taking elevators,” Watt writes. “Additionally, bridges that connect tenant spaces in different office towers facilitate employee collaboration by allowing employees to move efficiently throughout the space, and ‘town centers’ are an essential part of the new ‘open-office’ design concept that has proven to both save space and encourage employee collaboration and efficiency.”
The OIG’s report closes with two suggestions. First is that the FHFA ensures that it has “adequate internal staff, outside contractors, or both, who have the professional expertise and experience in commercial construction to oversee the build-out plans and associated budgets” of the project.
And second, the OIG recommends that the FHFA direct Fannie Mae to provide “regular updates and formal budgetary reports” to the DOC for its review and to the FHA for its approval throughout the process.
Watt closes his response letter by acknowledging that the FHFA is aware of the “significant financial and reputational risks” associated with this project.
Watt said that the FHFA respectfully seeks to ensure that the OIG’s report and the “inferences” that may be drawn from it will not add to the “inherent risks” of the project.
“Despite these responses and context, FHFA believes that the recommendations contained in the (OIG report) are constructive and warranted, and that they suggest additional means and provide additional incentive for FHFA to provide more rigorous and appropriate oversight throughout the construction process,” Watt states. “We accept them and will implement them to the extent that we are not already doing so.”
For the full report from the FHFA-OIG, click here.