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UK: HIGH WALL OF BIDDING COSTS.
Financial Times
25 Aug 2000
The bidding process for government estates may be so expensive that it is discouraging some participants.
The UK government has just completed its search for an owner and operator of its Inland Revenue estate, a protracted process conducted over 18 months. When the dust settled over the three bidding consortiums one, led by Mapeley, had won the deal.
Winning such a contract ensures Mapeley its introduction into a growing industry as both governments and corporations realise that the ownership and servicing of property are far from their core functions.
But for the other two consortiums, one led by Trillium - manager of a similar deal for the Department of Social Security known as PRIME - and the other backed by Nomura, the Japanese investment bank, there are only bills to pay. Privately, bidders say, the cost of participating in the bidding process for the Inland Revenue estate - a project known as STEPS - the costs were in the region of �6m-�7m. And that, some participants argue, is just high enough to deter other future bidders.
Are there efforts the UK government can make to cut the costs of bidding, thus expanding the pool of applicants, increasing competition and cutting costs for taxpayers? Edward Siskind, managing director at investment bank Goldman Sachs and head of its real estate fund, Whitehall Partners Europe, says the process bears similarities to that of the US's Resolution Trust Corp.
The RTC was created in 1989 to buy distressed property assets and loan portfolios of US savings and loan and banking industries. "The RTC and others have made the bidding process more efficient," Mr Siskind says. "This reduces costs for bidders and adds certainty for sellers." Among the steps necessary for a more efficient bidding process was the need for the RTC to do as much of the due diligence work itself at the start of the process, reducing the need for bidders to do duplicative work, he says.
The UK's National Audit Office, which reviewed the PRIME project, highlighted bidding costs as one of the areas which could be addressed in future deals. Among its recommendations are that: "Departments should make strenuous efforts to assemble complete data on their estates before starting procurement in order to reduce the costs and timescale of procurement to bidders and thereby encourage competition."
The NAO report recommends that where building-specific information cannot be assembled in advance, departments should consider arranging for bidders to pool resources and retain surveyors jointly.
Thomas Horton, a principal at Ernst & Young's real estate division in Washington DC, and a former official at the RTC, says competitive bidding exercises are very difficult for the private sector. "It is difficult because of the uncertainties of the costs and the cost of the due diligence process," he says. Due diligence, he says, is invariably the big ticket item and it is generally of three types; physical, financial and legal. The RTC did not start out with a perfect bidding system, Mr Horton says, but perfected it over time. Eventually, it found a way to create a computer-based system with all the information about a properties' physical features, including a full valuation.
Appraisal information, he says, was always included in the package, but it presented some problems. Some investors were prepared to rely on the RTC-led appraisals, while others paid for it separately. Some of the legal due diligence, he says, was dealt with through title insurance which guarantees any future problems of imperfect ownership. Also, the RTC gave "representations and warranties" in respect of the assets it sold. "Say it emerged later that there was an undisclosed environmental problem or that there was a lien which was deficient," Mr Horton says. The RTC agreed to stand behind such eventualities, offering comfort to bidders.
Manish Chande, chief executive at Trillium, says that such representations and warranties would offer significant comfort in future auctions of government estates. Nor does Mr Horton feel the nature of the RTC auctions differ greatly from the service-based PRIME and STEPS deals because the distressed assets almost always had service requirements as well. Generally, Mr Horton says, the quality of the services to be provided was not specified in the auction terms, but the RTC considered service provision to be in the best interests of any bidder. After all, the buyer of the property had every interest in seeing that the tenant stayed put and paid the rent or there was every chance the loan would not remain current.
The RTC did, however, reserve the right to interpose itself as service manager if a landlord was derelict or negligent, or if the servicer was related to the original buyer who had defaulted in the first place. Advisers to the UK government on the STEPS project, Deloitte & Touche, are largely dismissive of bidders' complaints about the expense of the process. "The private sector always says that," notes one adviser, adding "We don't believe we would have had more bidders if the costs were lower."
Nevertheless, Mr Horton says, the RTC believed that bidders' costs were a very significant issue and that its efforts to minimise them smoothed the way for the efficient auction of hundreds of billions of dollars of distressed assets. Moreover, there is every incentive for the UK government to consider how to cut bidders costs because similar projects are pending. One possibility is requiring the successful bidder to cover the costs of the unsuccessful ones. That, however, creates some moral hazards. First, bidders have little incentive to keep costs down. Second, it encourages bids from parties who may not have the resources to eventually carry out the project.
Nevertheless, requiring consortiums to spend millions just to step into the ring is unlikely to be sustainable. "Everybody learns from everybody else's experience," Mr Siskind says.
Copyright Financial Times Limited 2000. All Rights Reserved.
FINANCIAL TIMES 25/08/2000 P26
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