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Audit Act - Auditor-General - Audit reports - 1994-95 - No. 4 - Project audit - Special investigation into Casseldon Place building, Melbourne: Department of Administrative Services


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A u s t r a l i a n N a t i o n a l A u d i t O f f i c e

The Auditor-General

Audit Report No.4 1994-95

Project Audit

Special Investigation into Casselden Place Building, Melbourne

Department of Administrative Services

John Bowden Allan Millican

A u s t r a I i n G o v e r n m e n t P u b l i s h i n g S e r v i c e , C a n b e r r a

^Commonwealth of Australia 1994

ISSN 1036-7632

ISBN 0 644 35098 9

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Australian Government Publishing Service. Requests and inquiries concerning reproduction and rights should be addressed to the Manager, Commonwealth Information Services, Australian Government Publishing Service, GPO Box 84, Canberra ACT 2601.

Produced by the Australian Government Publishing Service

A Australian National Audit OfficeCanberra ACT 19 October 1994 Dear Mr President Dear Mr Speaker

In accordance with the authority contained in the Audit Act 1901, the AN AO has undertaken a special investigation of the Department of Administrative Services and I now present this report to Parliament. The report is titled Special Investigation into Casselden

Place Building, Melbourne.

The Honourable the President of the Senate The Honourable the Speaker of the House of Representatives

Parliament House Canberra ACT

Yours sincerely

W.G. Nelson

A/g Auditor-General

AUDITING FOR AUSTRALIA

The Auditor-G eneral is head of live Australian National Audit Office. He and the ANAO arc

independent o f the Government. The ANA O assists the Auditor-G eneral to carry out his duties

u n d e r th e A u d i t A c t to u n d e r t a k e a u d i t s o f p e r f o r m a n c e and f i n a n c i a l s t a te m e n ts of

C om m onw ealth public sector bodies and to provide independent reports and advice for the

Parliament, the Government and the community. The aim is to improve Com m onwealth public

sector administration and accountability.

A uditor-G eneral's reports arc available from Commonwealth Government Bookshops. Recent

titles are show n at the back of this report. For further information please contact:

The Reports and Publications Officer

A u s t r a l i a n N a t i o n a l A u d i t O f f i c e

G P O B o x 7 0 7

C a n b e r r a A C T 2 6 0 1

p h o n e ( 0 6 ) 2 0 3 7 5 3 7 , f a x ( 0 6 ) 2 0 3 7 7 7 7

iv

Rent discounting or subsidisation 23

Commercial behaviour of the units 26

Appendix A Terms of Reference 30

Appendix B Casselden Place Tenancy Schedule 32

Appendix C General Guide to the Evaluation of each Building 33

Appendix D Principles for the Operation of Services to Government Agencies 34

Appendix E DAS Common Services Reform - Chronology 38

Series Titles 44

Tables

Table 1 Summary of business units 5

Table 2 Construction milestones 7

Table 3 Chronology of DAS tenants 8

Table 4 Construction and Vacancy - Melbourne CBD 10

Table 5 Gross Prime Office Rents - Melbourne CBD 10

Table 6 Prime Office Yields - Melbourne CBD 10

Table 7 Changes to occupancy space 17

Table 8 Impact of PAP payments 21

vi

Acronyms and Abbreviations

ACS Australian Construction Services

AEC Australian Electoral Commission

AEM Australian Estate Management

ANAO Australian National Audit Office

APG Australian Property Group

ATO Australian Taxation Office

AVO Australian Valuation Office

BOMA Building Owners and Managers Association

BSTA Business Services Trust Account

CBD Central Business District

DAS Department of Administrative Services

DCSH Department of Community Services and Health

DIR Department of Industrial Relations

DoF Department of Finance

ExCom Executive Committee

GBE government business enterprise

MOU Memorandum of Understanding

NLA Net lettable area

p.a. per annum

PAP Property Adjustment Program

PWC Parliamentary Standing Committee on Public Works

SAP Staffing Adjustment Program

vii

Glossary of Terms

Net Rent

Gross Rent

Effective Rent

Face Rent

Incentive

A rent that excludes outgoings

A rent that includes outgoings (net rent plus outgoings)

JLW Research (Issue No.22) defines it as ‘Effective rentals allows for the value of concessions or incentives used in leasing of an office space.

A rent, net or gross, inclusive of any incentive package (i.e. effective rent plus incentive) disclosed on the face of a tenancy contract

Any inducement offered to attract a tenant to lease part or all of a building

Reconciliation of Terms

Face or Gross Rent Less: Outgoings Net Rent Less: Incentive Effective Rent

viii

Key Points

This special investigation report resulted from an Order of the Senate of 22 June 1994.

The key findings are:

• tenancy arrangements between Australian Estate Management (AEM), Assets, Interiors and Australian Construction Services (ACS) were unsatisfactory in many regards resulting in disputation between AEM and the business units regarding tenancy

arrangements

• Property Adjustment Program (PAP) payments of $l .lm from which the three units derived benefit in the form of reduced rental expense paid to AEM are considered by ANAO to be

inappropriate. PAP distorts the business units’ commercial behaviour

• AEM should disclose the effect of payments on the capital value of its property portfolio

• the business units did not receive incentives in the context of receiving inducements to behave differently in relation to entering or not entering this tenancy

• AEM provided benefits to the three business units valued at $747 000. The benefits were in the form of occupation of the rental space at no cost during a move-in period from September to 30 November 1992

• the units also benefited from a financial arrangement whereby fitout costing $3.1m was provided at no cost to the three business units. This arrangement was sanctioned by the Department of Finance (DoF) as a special case in view of the overlap of previous

and new charging regimes. DAS has commented that the transfer of fitout arose from a Department of Finance determination and applied to all tenants in all Commonwealth buildings then under construction, and

• the three business units are engaged in commercial activities and would be classed as quasi-commercial, in that they are commercial units operating within a Commonwealth Department of State, and exhibit a number of unique feamres that distinguish them from

their private sector peers.

The ANAO made eight recommendations in response to matters observed.

ix

Report Summary

Introduction

The Department of Administrative Services (DAS) was created in July 1987 from parts of eight previous portfolios. The express intention was to place within one Commonwealth department almost all common service providers to the Commonwealth public sector and other public

agencies.

In 1988 DAS commenced commercialisation of many of its operations under the sanction of 23 operating principles determined by Cabinet. Commencing in 1989, all the DAS business units now operate through trust accounts and the majority are self-funding. Commonwealth clients

are in the main no longer tied to DAS for specific services. Appendix E outlines the major departmental milestones that have occurred since the creation of DAS.

This special investigation focuses on fourteen specific questions regarding tenancy arrangements within Casselden Place for three of the business units, namely Interiors Australia, Assets Services and Australian Construction Services.

The plan for the building in Melbourne named Casselden Place was conceived in 1987 during a period of low vacancy rates and escalating rents. It was cost-justified on the basis of expected rent savings of $22.5m per annum in 1991 prices, as well as administrative savings front

collocation of dispersed tenant departments. From 1 July 1989, the property operating expenses (POE) of Commonwealth agencies were for the first time funded directly and agencies became liable to pay rents and associated property costs, including rent in Commonwealth buildings.

The Casselden Place building cost $194m to construct, with an additional $22.7m spent as part of the construction costs for fitout. As at 30 June 1994, it was 84% tenanted and generated cash rental income of $14.7nr for the financial year, including $ l .l m in PAP payments. Due to a severe decline in the Melbourne CDB property market commencing in

1989 (Table 4, page 10), the building is currently valued at $123m, $71m less than its construction costs.

DAS has commented that the construction of Casselden Place was intended as a long term investment and that the fall in the value of the building is expected to be reversed in the medium to long term.

The major conclusions from the investigation are:

• tenancy arrangements between Australian Estate Management, Assets, Interiors and ACS were unsatisfactory in many regards which are specified in the body of this report. AEM should settle longstanding tenancy disagreement with the three business units who

xi

are the focus of this investigation and conclude satisfactory arrangements with them forthwith

• PAP distorts the business units' commercial behaviour but was provided in accordance with DoF instructions

DAS comment

The Department wishes to draw attention to the fact that during this period, specific programs were put in place to address the sizeable transitional costs to be incurred. They included the Property Adjustment Program (PAP). PAP is a transitional program which forms part of the

broader framework fo r the commercialisation o f the DAS business units, and will cease by the end o f 1995-96. Its purpose is to facilitate adjustment from a traditional Departmental operation to a commercial business operation and reflects transitional costs incurred over and above

those faced by a commercial organisation. These costs are a direct result o f the historical location o f the business units within a Department of State servicing tied customers only.

• AEM agreed to occupation of space by the three business units from September to December 1992, i.e. during move-in and set-up of premises, without payment of rent for that space. The cost to AEM in terms of revenue forgone during this period was $747 000

• the units also benefited from a financial arrangement whereby ft tout costing $3.1m for the areas occupied by the three business units was provided at no cost to the units. This arrangement was sanctioned by the Department of Finance as a special case in view of the overlap of

the old and new charging regimes

• the units did not receive any incentives to occupy the space as they had been committed to the space since 1988, and

• the three business units are engaged in commercial activities and would be classed as quasi-commercial. They are commercial units operating within a Commonwealth Department of State, namely DAS, and exhibit a number of unique features that distinguish them

from their private sector peers and incur an estimated financial disadvantage of 2 % to 3 % of turnover.

A number of administrative improvements and additional gross income up to $l.lm attributable to fully renting reserved areas were identified by the investigation.

The investigation received full cooperation from DAS officers.

xii

Recommendations and Responses

N 1 The ANAO recommends that AEM look to tenanting all vacant space in Casselden Place, including the space held in reserve for DAS units which may or may not move from the Rialto building in mid to late 1996.

DAS response

Agreed, although it should be noted that AEM has actively marketed all space in Casselden Place since 1992 to prospective tenants. This has resulted in the occupancy rates increasing from 69% at the time the building was completed to the current rate of 85%. AEM will continue

to seek 100% occupancy rates for the building.

N°2 The business units which are required to operate commercially

should be allowed to negotiate for commercial market rents.

DAS response

Agreed.

N°3 The ANAO recommends that MOUs be concluded forthwith between AEM and Assets Services, Interiors and ACS as required by the relevant Department of Finance circular of January 1993 and the DAS Executive Committee decisions of March and July 1994.

DAS response

Agreed. Negotiations on MOU’s are now well advanced for Asset Services, Interiors Australia and ACS.

N°4 The ANAO recommends that the specific areas for which tenants are responsible should be defined forthwith and the agreed areas included in a schedule to a competent MOU.

DAS response

Agreed.

N°5 The ANAO recommends that ACS, Interiors Australia and Assets

Services forthwith settle tenancy arrangements with whomever they deem appropriate and in accordance with their business needs.

DAS response

Agreed.

N°6 The ANAO recommends that PAP payments and arrangements be

publically reported and further that AEM as a recipient of PAP payments disclose the effect of PAP payment on the capital value of its property portfolio.

xiii

DAS response

Agreed. PAP payments and arrangements are publicly disclosed in the DAS Annual Report and the Program Performance Statements each year. DAS further notes that:

• rental streams are only one of the factors taken into account in determining capital valuations, and

• the PAP expires by 30 June 1996. Short term variations in the rental flow do not have a significant impact on capital valuations.

N°7 The ANAO recommends that DAS assume corporate responsibility for the ACS area allocated to the staff adjustment program.

DAS response

Agreed. Negotiations to establish a tenancy arrangement between AEM and the Staffing Adjustment Program are taking place.

N°8 The ANAO recommends that financial benefits outlined at

paragraph 9.72 et seq be acknowledged within the relevant MOU documents and further that AEM be accountable for and amortise fitout costs of $22.7m for the whole of the facility over an

appropriate period of time.

DAS response

Not agreed. DAS does not believe that this recommendation is consistent with the arrangements outlined by Department of Finance in Estimates Memorandum 1989/2 and 1989/32 for tenant sponsored fitout. In respect to the DAS business units, fitout costs will be brought to account in the appropriate manner in their 1994-95 financial statements. Other tenants will be advised accordingly.

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1. Introduction

Origin and nature of the investigation

1.1 On 22 June 1994, the Senate agreed to an order requesting the Auditor-General to investigate and table a report on fourteen specific matters relating to tenancy arrangements in the Casselden Place building in Melbourne. Appendix A outlines the Senate’s Order, which was applied as the terms of reference for this investigation. The Auditor-

General consented to the Order and has now completed the investigation. This report of the findings of the investigation is tabled in accordance with the Order for production of the document.

1.2 The Department of Administrative Services cooperated fully with the investigation and its officers provided all information required.

Objectives

1.3 The objective of the investigation was to obtain the information required to respond to the fourteen questions within the body of the Order, report the findings and conclusions and provide recommendations where relevant to improve weaknesses identified.

Approach

1.4 In addition to examination of relevant departmental documentation, documentation external to the department, inspection of the building and discussions with tenants, discussions were also held with:

• Victorian Government property management officials from the Valuer General’s Office and the Victorian Government’s Department of Finance

• Telecom’s property manager for Victoria. Telecom is a significant tenant in the Victorian CBD market, and

• a registered valuer with expertise in the Melbourne CBD.

Scope and limit of the investigation

1.5 The investigation focused on the tenancies of Casselden Place named in the Order, namely, Australian Construction Services, Interiors Australia and Assets Services, and the specific impact of property adjustment program payments on those businesses. However, the scope

included obtaining relevant comparable data for other CBD properties, other tenancies, the operation of the Casselden Place building, and the broader operations of the property adjustment program and the calculation of rents.

1

1.6 Advice, comments, input and evidence were also derived from a number of Commonwealth Government and private sector sources.

Consultation arrangements

1.7 To facilitate final reporting arrangements draft versions of this report were provided to the department on 21 August 1994, 30 August 1994, 27 September 1994 and 13 October 1994. The Department provided their final comments on 14 October 1994.

Cost

1.8 The ANAO cost of the investigation was $58 000.

2

2. Cabinet Approval of the Casselden Place Project

2.1 In September 1987, Cabinet approved the construction of 60 000 m2 of office accommodation in Melbourne at an estimated construction cost of $143m excluding fitout costs at 1987 prices. Approval was subject to a reference to the Parliamentary Standing Committee on Public Works.

Fitout was to be undertaken as a separate contract after the main contract had been let.

Parliamentary Standing Committee on Public Works

2.2 An inquiry into the proposed Casselden Place project by the Parliamentary Standing Committee on Public Works (PWC) was held during February 1988.

2.3 DAS submissions to the Committee cited a number of justifications for the proposed project, including:

• the need to consolidate and co-locate fragmented Commonwealth tenancy holdings

• administration savings following the consolidation and collocation of several Commonwealth departments of state

• low CBD vacancy rates expected to last for a number of years leading to an expected escalation in property rental costs, and

• expected rental costs savings of $22.5m at 1991 prices from consolidation of property holdings.

2.4 The Australian Taxation Office (ATO) was identified as the principal tenant along with a number of other agencies whose leases were due to expire about the time of completion of Casselden Place. The Construction Group of DAS was one of the agencies considered as a

possible tenant for the building.

2.5 In its report dated 21 April 1988, the PWC:

• recognised a need for a purpose-designed office building in the Melbourne CBD providing office accommodation of 60 000 m2 net, and

• recommended, among other things, the construction of the Commonwealth facility at an estimated cost of $143m and $20m for fitout costs at April 1987 prices.

3

3. DAS History

3.1 The Department of Administrative Services was established in July 1987 as part of a major Government reorganisation. The new department brought together parts of eight portfolios. DAS was required to reappraise the provision of common services to government agencies regarding efficient utilisation of resources and effective delivery of services.

3.2 In 1988 the Commonwealth Government endorsed a set of 23 principles (Appendix D) under which proposed progress toward commercialisation of DAS services was to be considered. Over the

following period to 1991, the former Budget-funded divisions subject to this investigation commenced conversion to self-funding ‘commercial business units’ operating within a Department of State. Asset Services, Interiors Australia and ACS now operate through a trust account, the

Business Services Trust Account (BSTA), into which all fee income is deposited and from which all expenditure is paid.

3.3 In early 1991 the commercialisation of DAS was reviewed [Appendix E], Changes following this review included:

• moving the DAS business units to the point where they can operate at a full commercial level by 1995-96

• further untying of government departments, and

• principles for funding redundancy costs arising from the

commercialisation process.

3.4 The significant environmental changes within which the business units now operate have resulted in significant reorganisation, restructuring and staff downsizing.

Appendix E outlines the major reform milestones for the department since its creation in 1987.

Summary of business units’ operational environment

3.5 Table 1 outlines the status of the commercial units which were the subject of this inquiry.

4

Table 1

Summary of business units

B usiness S e rvice s o ffe re d S u pply o f services te

fo rm e r tie d c lie n ts

F u n ding arra n g e m e n ts

A s s e ts S e rv ic e s P ro p e rty m a in te n a n ce Freedom o f supp lie r S e lf-fu n d e d th ro u g h the

and re p a irs sin ce 1 J u ly 199 3 B S T A

A u s tr a lia n C o n s tru c tio n se rvice s Freedom o f supp lie r S e lf-fu n d e d th ro u g h the

C o n s tr u c tio n

S e rv ic e s

sin ce 1 J u ly 1991 B S TA

In te r io r s D esign o f fit o u t Freedom o f su p p lie r

sin ce 1 J u ly 1991

S e lf-fu n d e d th ro u g h the

B S T A

History of Australian Estate Management

3.6 DAS provided the following comments in relation to the history of AEM.

3.7 In July 1988, the Government agreed to reaffirm the role of Australian Property Group as the Commonwealth’s central property agency, with estate management responsibility for all interests in real property used by all departments and Budget-funded statutory authorities.

The estate management function was exercised by a Budget-funded branch within APG, subject to the direction of the General Manager APG.

3.8 Early in 1991, the Estate Management Branch was separated from APG and established within another program of DAS as AEM. From this point on, APG continued as AEM’s agent with responsibility for day-to-day management of Commonwealth-owned property. The

strategic function of estate management was now exercised by AEM.

3.9 By 1 July 1992, AEM had absorbed all functions associated with the management of Commonwealth-owned real estate.

4. Property Operating Expenses

Cabinet decision

4.1 From 1 July 1989 Commonwealth agencies for the first time became liable for payments of rents and associated property costs in that POE expenditure was transferred to agencies from DAS. Budget-funded agencies were supplemented to cover these new costs. DAS business units were required to meet such costs from their earnings. The liability to pay rent also extended to Commonwealth-owned buildings, including Casselden Place, which was then under construction.

4.2 From 1 July 1991, with the exception of the ACT property arrangements, all departments became free to choose their property service provider.

4.3 In August 1992, the Commonwealth Government decided that Commonwealth agencies, as tenants, would be required to honour tenancy lease commitments, including Commonwealth-owned accommodation they occupied. In January 1993, the DoF informed all agencies occupying Commonwealth office space that, as a result of the Government decision, they were expected to conclude a Memorandum of Understanding (MOU) with AEM. This document would acknowledge the binding nature of the commercial relationship between AEM and the tenant and would be comparable to a lease with a private landlord. Where no tenancy agreement was in place at that time a minimum tenancy period was assumed to be in operation until 30 June 1994.

4.4 In this regard Commonwealth departments were to approach AEM to ascertain whether suitable Commonwealth-owned space was available. They were further encouraged to afford preference to Commonwealth- owned accommodation in consideration against equally suitable privately owned alternatives.

6

5. Building Process

5.1 Three companies submitted tenders to build the facility. Baulderstone Pty Ltd was assessed as the lowest cost tender. A fixed price contract of $186m including $22m for fitout subject to rise and fall was executed in December 1988. The time elapsed to build was

estimated at 169 weeks, with completion expected 28 March 1992.

5.2 Milestones to complete the facility were as follows:

Table 2

Construction milestones

C om pleted

c o m p o n e n t ^

C o n tra c tu a l

co m p le tio n

P ra c tic a l

h a n d o ve r

Podium 7 A u g u st 1891 8 A p ril 1 9 9 2

L o w rise 2 4 A p ril 1991 2 0 M a rc h 198 2

M ediu m rise 2 5 S e p te m b e r 1991 18 A p ril 1 8 9 2

High rise 2 5 M a rc h 19 9 2 10 A u g u s t 1 9 9 2

5.3 Occupancy by tenants commenced in July 1992, with the official opening of the building on 1 December 1993.

Construction costs

5.4 The final construction costs were $194.2m. Additional costs of $22.7m were incurred for an integrated fitout installed as the building was being constructed. This cost was within budget when the rise and fall contract components were included.

5.5 Casselden Place is generally considered by Building Owners and Managers Association (BOMA) to be classified as an ‘A Grade or prime building’ which means it can command premium rent. The BOM A classifications for buildings are outlined at Appendix C.

7

6. History leading to Occupancy of Casselden

6.1 A chronology of initially proposed DAS tenants and changes to DAS space requirements from 1988 to June 1994 are detailed at Table 3.

Table 3

Chronology of DAS ten an ts

D a te Proposed

te n a n t

Space

re q u ire m e n ts

L a ta 1 9 8 8 DA S (to ta l) 2 4 5 0 0 m2

E arly 188 9 DA S (to ta l) 2 4 0 0 0 m2 (1)

DA S (to ta l) 2 0 0 0 0 m2 (2)

M a y 1 9 9 0 AC S (Group) 1 0 2 3 5 m2

D ecem ber 1 9 9 2 to P rojects/A C S 8 2 8 7 m2

Ju n e 1 9 9 4

In te rio rs 8 8 0 m2

A sse ts Services 1 4 8 4 m 2

' -

T o t a l 8 6 1 1 m 2

(1) of which ACS would occupy 16000 m2

(2) of which ACS would occupy 15800 m2

6.2 In February 1990 ACS separated into two distinct business units, namely Projects and Asset Services. In July 1991 Projects further divided into Projects and Interiors Australia. Subsequently, Projects changed its name to ACS.

6.3 Appendix B lists current tenants and utilisation of Casselden Place.

8

7. The Victorian Property Market 1980 to 1994

7.1 The Casselden Place project was conceived in 1986-87 at a time of significantly escalating rents and an historically low vacancy rate in the Melbourne CBD.

7.2 This very quickly changed with the recent recession. The construction and tenanting of the facility coincided with rapidly escalating vacancy rates and its consequential outcomes, namely:

• significant vacancy rates in the CBD drawing area for potential Casselden Place tenants. This is expected to continue for a number of years. A number of other prime or A grade buildings in the heart of the Melbourne CBD have never been tenanted following

construction (Table 4)

• rapidly declining face rents and effective rents. The current impact of incentive packages is equivalent to 54 months rent-free for a major new tenant of a ten-year lease. The current market impact is reflected in the rentals being negotiated by AEM for space in

Casselden (Table 5), and

• softening yields for prime office facilities resulting in a decline in value of Casselden from its construction cost to current valuation indicated at paragraph 8.1, namely a $71m unrealised capital loss, reflects the financial outcome of this decline (Table 6).

7.3 It should be noted that face rents for the three commercial DAS units subject to this inquiry were determined by the Australian Valuation Office (AVO) at near the market peak for face rents in July 1991. The three tenants moved into Casselden Place in September 1992 and paid

their first rentals in December 1992.

7.4 By this latter date, effective rentals had declined materially for new tenants in the market. Common and well-known incentives then being offered included free fitout, significant rent-free periods, cash payments or a combination of the three. The DAS commercial tenants were, however, not regarded as new tenants but rather were considered by

AEM to have been committed by DAS at the July 1991 rates as determined by AVO.

DAS comment

7.5 The decision to commit the DAS business units as tenants, which AEM relied on in not regarding them as new tenants, did not specify a rent. The rates were then determined by AVO at the request o f AEM.

9

Table 4

Construction and Vacancy ■ Melbourne CBD Square Metres COOOs) Total Stock Vacancy

500 -

400 -

300 -

- 10% 2 0 0 -

100 -

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99

O Constructed 1 Under Construction E2Possible Construction -V acancy N.B. '94 figures as at March JLW Research

Table 5

Gross Prime Office Rents · Melbourne CBD Per Square Metre

$ 5 0 0 -

AVERAGE FACE RENT

$ 4 0 0 -

$300 -

EFFECTIVE RENT

$ 200 -

$ 100-

4?· -jf" 4? f 4? 4? 4? 4? 4? 4? 4? 4" 4? 4? 4?

Table 6 JLW Research

JLW Research

10

8. Financial and Operational Performance of Casselden Place

8.1 The building was valued at 30 June 1993 and again at 30 June 1994 at $ 123.7m and attracted cash rental payments of $14.7m for 1993-94, including $ l . lm of payments from the property adjustment program.

8.2 Of Casselden’s total net lettable area (NLA) of 61 218 m2, 84% or 51 684 m2 is currently tenanted. The vacant 16% of the NLA, 9535 m2, includes 5955 m2 of the vacant space held in reserve for DAS units and other prospective tenants until 1996 when their current tenancy leases

expire. The AEM has based this reservation decision on its assumption that the DAS units will then move to Casselden in the absence of a competitive bid from the Rialto manager and, further, that they will then require the total space reserved for them.

Opportunity cost of reserved space

8.3 The reserved spaces have been fitted out to 1989-90 requirements of the proposed tenants. To avoid damaging the fitout and degrading the ‘new and unused nature of the space’, AEM is reluctant to let the space to alternative short term tenants.

DAS comment

8.4 AEM has been actively marketing space in Casselden Place since June 1990. As prospective tenants find empty, vacant floors most attractive, those floors have been the first occupied by new incoming tenants. AEM ’s marketing o f the building has resulted in the building

now being 85% occupied, compared to a 69% occupancy when originally completed.

8.5 It is felt by the ANAO that:

• based on the experience of other tenants, the fitout will be

functionally obsolete in 1996 and will no longer fit the needs of those tenants if indeed they take up occupancy

• there is a high probability that eventual space requirements by the potential DAS tenants will be less than that predicted in 1989 and currently reserved for them, and

• the decision not to rent the reserved space (5955 m2) in the interim incurs a significant opportunity cost to the Commonwealth of at least the current gross market rent of approximately $ 170/m2 gross or $1. lm p.a.

11

I

Recommendation No.l

8.6 The AN AO recommends that AEM look to tenanting all vacant space in Casselden Place, including the space held in reserve for DAS units which may or may not move from the Rialto building in mid to late 1996.

12

9. Specific Responses to the Questions in the Senate Order

9.1 This section of the report will address those matters in the Senate Order concerning tenancy agreement matters.

Tenancy agreement matters

a. when was an agreement reached between Projects (ACS), Interiors and Assets Services on the one hand and the lessor of office space now occupied by those businesses at Casselden Place Melbourne on the other

Opinion/conclusion

9.2 As at conclusion of the investigation, agreement had not been reached between ACS, Interiors, Assets Services and AEM, with all parties disputing each party’s understanding of tenancy arrangements. Negotiations are, however, continuing.

b. how was the agreement documented

Opinion/conclusion

9.3 As detailed above, agreement has not yet been reached between the parties and the agencies concerned dispute each other’s understanding of tenancy arrangements.

9.4 There is no agreed, written and arms-length tenancy agreement or MOU between the parties. Negotiations to conclude and agree mutually acceptable tenancy agreements between Assets Services, Interiors Australia and ACS have yet to reach finality.

Background analysis

9.5 Correspondence dated 25 August 1992 between AEM and ACS with a copy to the Australian Property Group outlined AEM’s understanding of the proposed tenancies with Interiors Australia, Assets Services and ACS. The document included:

• for floors 15 to 21, details on NLA, rental costs per square metre, office, storage and basement areas, details on car spaces e.g. costs and the number of bays allocated

• rent commencement from 1 December 1992

• term of the tenancy - ten years from rent commencement

• rent review - 1 July 1995 then two-yearly thereafter based on market rents, and

• general terms and conditions regarding costs of shared areas.

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9.6 Express and written consent or agreement by the tenants to the above was not obtained. It was noted that APG, acting in the capacity of tenants’ agent, in August 1992 sought to have tenancy matters finalised and documented within the body of an MOU. Negotiations to finalise

relevant MOUs have yet to be concluded.

9.7 ACS, Interiors and Assets Services disagree with AEM that they have ever consented to the above rudimentary ‘tenancy agreement’.

c. at the time of the agreement was the agreed net rent to be paid by these businesses above or below average per square metre rental being paid in respect of comparable office accommodation in Melbourne

d. from 1 December 1992, was the rent that was actually paid by these businesses above or below average per square metre rental being paid in respect of comparable office accommodation in Melbourne since that date

e. to what extent does the rental paid since December 1992 vary from a comparable fair market rent

Opinion/conclusion

9.8 The rental rates to which the units are being held are at least 20% above gross market rates as at June 1994.

9.9 There is no agreed tenancy agreement and/or MOU in place under which the parties consent to rental terms and conditions, including the rate per square metre to be charged.

9.10 Notwithstanding this, the actual rents per square metre being charged and paid were the market face rates applicable for prime buildings including Casselden Place at December 1992. These rents were at least 40% above effective rents being charged in the market in December 1992 after allowing for the effect of commonly included and well-known incentive packages.

9.11 When transfer payments from the property adjustment program are deducted from the gross rents paid, the effective rent paid by these units approximates the effective market rate as at December 1992.

Background analysis

9.12 Table 5 at page 10 details the JLW Research’s history of market rentals from 1980 to March 1994 for prime buildings. Casselden is classified as a prime building.

14

Determination of rental rates

9.13 The rates to be charged tenants of Casselden Place were determined by AVO in July 1991. These rates were still being applied at the date of the investigation. The basis of the valuation was:

• market rental valuations in comparable buildings on a floor-by-floor basis

• market incentives would be part of the rental package, with the rates therefore conditional on the payment of incentives to incoming tenants, and

• Casselden Place was not regarded by the valuer as a landmark building in a prime location.

9.14 AEM modified the rental assessments by averaging the floor- by-floor assessment to an average per rise, i.e. Podium, Low Rise, Medium Rise, High Rise, and adjustments to the valuer’s assessments for

outlays.

DAS comment

9.15 No incentives were provided to the business units even though the rental rates were based on the use o f market incentives.

Face rents being charged

9.16 The rental rates struck by AEM in late 1991 which commenced in December 1992 were the average market face rents (A rent, net or gross, inclusive of any incentive package (i.e. effective rent plus incentive) disclosed on the face of a tenancy contract) at December 1992 for prime

office buildings.

Effective rents in the market

9.17 Notwithstanding that the rent rates for Assets Services, Interiors and ACS which commenced in December 1992 were the face market rates at that time, they were and are considerably above effective rents then being charged in the market. Effective rates are rental rates after

incentives are taken into account. The units were not offered incentives by AEM, as they were considered to be committed tenants. Widi property adjustment program payments (Table 8) the effective rates for the businesses approximate the effective market rate as at December

1992. However, as outlined at paragraphs 9.70 to 9.74 the units also benefited from a financial arrangement costing $3.9m. The units have not had to pay for this arrangement in their rental or other expenses.

DAS comment

9.18 The Department advised that the decision to provide the business units with a fitout at no cost was fully consistent with Department of Finance Estimates Memorandum 1989/32: 'To assist a smooth and equitable transition to this new user-pays arrangement fo r fitout work,

15

previous funding arrangements (i.e. non-recovery o f fitout costs appropriated to DAS) will apply to all Commonwealth office projects for which contracts have already been signed. ’

9.19 If the business units had been free agents in the market at August 1992, they would have been able to attract the average market incentives available as indicated by the effective rents outlined at Table 5, page 10. By this time the availability of incentives was commonly known to informed market participants. This action would have resulted

in the units paying comparable market rents and removed the need for category A payments under the property adjustment program.

9.20 It is noted, however, that unilateral reductions to the rates were instigated by Interiors in early 1994. They reduced the rate paid by them to an effective market rate determined by AVO for AEM in late 1993. It is further noted that the Interiors justification for this action was a DAS ExCom decision in March 1994 the effect of which was disputed by AEM. The decision was subsequently confirmed by ExCom in July 1994 whereby the tenants were not to be treated as committed tenants and further that AEM should negotiate rental rates to be paid. This has yet to be concluded.

Recommendation No.2

9.21 The business units which are required to operate commercially should be allowed to negotiate commercial effective market rents.

g. how have the alterations in the areas agreed to be occupied prior to construction and the areas occupied on completion been negotiated and documented

h. how have the areas agreed to be leased as at I December 1992 and the areas occupied as at 1 June 1994 been changed, and, if they have been changed, how was that change negotiated and documented.

Opinion/conclusion

9.22 The lack of an agreed MOU between AEM and Assets Services, Interiors Australia and ACS, and dissent regarding AEM’s understanding of the August 1992 ‘tenancy agreements* led to an uncertain and unsatisfactory situation in relation to changes in tenancy areas.

9.23 This situation causes an unnecessary administrative burden to fall on Interiors and ACS to manage sub-tenancies, creates uncertainty in relation to the validity and standing of such sub-tenancies, and restricts future tenancy options for the units concerned.

9.24 A negotiated settlement to determine the responsibilities of the three businesses in relation to specified areas for their tenancies is required forthwith for inclusion in an attachment to a competent MOU.

16

Background analysis

9.25 Table 3, page 8 outlines a chronology leading to the

commencement of tenancy by the units.

9.26 The extract from Table 3 below outlines the situation from December 1992 until June 1994.

December 1992 ACS, 6267 m2

to June 1994 Interiors 860 m2

Assets Service 1484 m2

Total 8611 m2

9.27 AEM confirmed that the above areas are areas for which the designated tenants are responsible, including the payment of the rents since December 1992.

9.28 A more detailed examination of the areas occupied by the three business units is outlined at Table 7 below.

Negotiations between AEM and tenants

9.29 The ACS areas occupied by ATO have been sub-tenanted by agreement with AEM.

9.30 The Interiors Australia area of 150 m2 occupied by the AEC is subject to dispute between AEM and Interiors Australia as to who has responsibility for executing a sub-tenancy with AEC.

9.31 Interiors Australia ceased payment of rent for the space in March 1994 until the matter is resolved. AEC has yet to pay rent until the sub­ tenancy matter is resolved.

9.32 There is also another dispute between Interiors and AEM regarding responsibility for a shared reception and conference area.

9.33 The lack of initial agreement between AEM and Interiors Australia documented in a MOU led to this unsatisfactory situation. It is noted that AEM has resolved in principle [September 1994] to negotiate an agreement.

MOUs and the three DAS commercial tenants

9.34 The three tenants dispute the AEM understanding of the tenancy arrangements and deny that they have ever consented to such arrangements. In addition, they consider the rents being charged by AEM to be significantly higher than the market, resulting in financial

stress to their individual businesses.

17

9.35 AEM agrees that MOUs are not in place but contends that the tenants did approve their specific fitout plans submitted to the builder during construction.

Table 7 Changes to occupancy space

B u s in · #

u n it

Level of

building

S p ic e

m2

O c c u p a n t o f

th e s p ic e

A C S 15 5 1 0 V a ca n t space su rp lu s to re q u ire m e n ts

a ttra c tin g T yp e B PAP p a ym e n ts

18 1 4 2 5 DAS s t a f f a d ju s tm e n t p ro g ra m (no fo rm a l su b ­

te n a n c y agreem ent)

17 4 9 8 N o rm al w o rk area a ttra c tin g C a te g o ry A PAP

p a ym e n ts

17 9 0 7 ATO u n d e r a sub lease b e tw e e n ACS and ATO

18 1 4 4 4

N o rm al w o r t area a ttra c tin g C a te g o ry A PAP

p a ym e n ts

19 1 4 8 4

N o rm al w o rk area a ttra c tin g C a te g o ry A PAP

p a ym e n ts

T o ta l

I n t e r io r *

A u e tr a lia

15

6 2 6 6 ·

8 3 5

U nilateraU y p a yin g a reduced re n t on a reduced

space o f 5 5 0 m2 a ttra c tin g C a te g o ry A PAP

p a y m e n ts * '

15 150

Space occu p ie d b y AEC w h ic h is n o t y e t p a yin g rent

u n til In te rio rs and AEM re so lve th e m a tte r o f

re sp o n s ib ility f o r co m p le tio n o f a sub le a s e **

15 85

D isp u te w ith AEM re g a rd in g re sp o n s ib ility fo r shared

re ce p tio n /

c o n fe re n ce a r e a * *

A s s e ts

S e rv ic e s

2 0 1 4 8 4 N o rm al w o r t area a ttra c tin g C a te g o ry A PAP

p a ym e n ts

N o t· : R e fe f to paragraph 9 .4 9 fo r PAR p iy m e n t types.

* Includ es sto ra g e

* * These issues w e re resolve d b e tw e e n AE M . In te rio rs A u s tra lia and AEC in A u g u st and

S e p te m b e r 1994.

18

9.36 It was noted that the three tenants have occupied their designated areas since 1992, they have continued to pay the assessed rent (until recently in relation to Interiors) and have unsuccessfully sought negotiations with AEM since August 1992 to finalise their specific MOUs

or move to accommodation more suitable for their business needs.

9.37 In March and again in July 1994 the DAS ExCom, following a long period of dissatisfaction by the units with the tenancies, concluded that DAS agencies should no longer be considered as committed to tenancy of Casselden Place and that AEM should negotiate with

individual DAS agencies in that context, with date of effect from 1 March 1994.

9.38 At the date of the investigation, 31 August 1994, MOUs had not been finalised and in addition the adjusted rates are not yet finalised.

9.39 AEM and APG are nearing finalisation of the development and release of a standard MOU tenancy agreement. This MOU is proposed as the basis for renegotiation of subsequent tenancy agreements with ACS, Assets Services and Interiors Australia. This matter has been outstanding since early 1993 and should be expedited.

9.40 It was noted that one of the businesses - Interiors - was sufficiently concerned with this situation that, using the ExCom decision as its authority, it has unilaterally reduced the amount of rent per square metre paid to AEM.

9.41 Interiors has also ceased payment for 150 m2 and 85 m2 of floor space within the area initially allocated to it. The former area is ‘sub-leased’ to the Australian Electoral Commission (AEC) whereas the latter area is a disputed reception and conference area. Interiors advised

the ANAO that it did not require the total area allocated to it and attracted a sub-tenant to the surplus unused area. Interiors Australia was in dispute with AEM until September 1994 regarding who was responsible, namely Interiors or AEM, for executing a sub-lease with

AEC.

9.42 The unsatisfactory tenancy situation is attributable to the lack of an agreed tenancy agreement (MOU) outlining terms, conditions, obligations and responsibilities of the parties to the agreement.

Recommendation No.3

9.43 The ANAO recommends that MOUs be concluded forthwith between AEM and Assets Services, Interiors and ACS as required by the DAS Executive Committee decision of July 1994. In the absence of agreeable terms, ACS, Interiors and Assets Services should be at liberty

to move to premises suitable to their business needs.

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Recommendation No.4

9.44 The AN AO recommends that the specific areas for which tenants are responsible be determined forthwith and the agreed areas included in a schedule to a competent MOU.

Property Adjustment Program payments

9.45 This section of the report addresses questions raised in the Senate Order relating to property adjustment program payments matters.

f. do the payments received by the agencies under the property adjustment program fairly compensate them for the variations in rental and if not did the amounts vary and why

i. were any property adjustment program payments paid in respect of any area included in any of the leases but in feet in excess of space requirements for the agency

m. has the use of the property adjustment program in these instances allowed the agencies concerned to enjoy any unfair commercial advantage over the private sector competitors

n. has the use of the property adjustment program in these instances been consistent with the objectives of that program

Opinion/conclusion

9.46 Payment of PAP to AEM is consistent with the aims of the program. The effect of PAP payments is to reduce the rent paid to AEM directly by the units. The units are continuing to be compensated for non-commercial, tenancy decisions taken prior to 1989, by being subsidised by Category A PAP payment for post August 1992 tenancy arrangements in this Commonwealth owned facility.

9.47 ACS also received Type B property adjustment program payments of $212 000 for 510 m2 of vacant and unused space in Casselden Place caused by downsizing of ACS staff numbers.

9.48 Continuing to receive property adjustment program payments beyond a short transitional period is not appropriate for ACS, Interiors and Assets. They are competing in markets against the private sector who do not have access to such financial arrangements. The PAP payments could be perceived as providing the businesses with an

inappropriate advantage which reduces a normal commercial expense for which enterprises would normally be liable. Private sector competitors could therefore be seen to be disadvantaged to the extent of the benefit.

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9.49 However, the result of the PAP is to reduce the market face rate to the level of the effective market rate which is the market rate after allowance for incentives is taken into account.

9.50 PAP payments and arrangement should be transparent with payments publically reported. This is to ensure that tax payers are fully informed in relation to this application of Commonwealth funds. In addition AEM should disclose the effect that such payments have on the

capital values of their property portfolio.

9.51 The Department has advised that the aim of the program is to provide transitional payments to compensate the business units for pre­ commercialisation decisions taken prior to 1989.

9.52 The intent of the program is to clearly assist the business units establish themselves as commercial bodies rather than to afford them any commercial advantage over their private sector counterparts who do not have to contend with such transitional problems.

DAS comment

9.53 The Department considers that as PAP payments solely compensate for pre commercialisation decisions which disadvantage the business units, the adjusted rentals provide no competitive advantage over their private sector counterparts. DAS also notes that capital valuation of

buildings is complex matter which takes into account factors other than the current rental stream. Short term variations in rental flow do not have a significant impact on capital valuations.

Background analysis

9.54 There are two PAP payment categories relevant to Assets Services, Interiors Australia and ACS. These payment types are:

Category A Paid where the rent paid exceeds the rents that would have been paid if a commercial decision on property location had been made

Category B Paid where space has been vacated due to downsizing.

9.55 These payments are transitional and are not expected to continue beyond June 1996.

9.56 Determination of the quantum of payment to be provided is undertaken by the Department of Finance.

PAP benefits received by the three businesses

9.57 To assess the impact of PAP payments on the businesses, the payments are assessed against their rent expense and against their operating results. PAP is material in terms of its impact on the rent expense for each business and is material for Interiors with respect to its

impact on the past two years’ operating results. Table 8 below outlines the financial impact of PAP payments.

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9.58 In typical tenancy situations, anns-length and commercial tenancy transactions are determined on the basis of commercial criteria maximising the benefit to both parties to the transaction. For some years now in the Melbourne CBD this has included the requesting and granting of incentives. Page 9 and table 5 on page 10 outline the aggregate

impact of incentives such as rent-free periods, provision of free fitouts and cash payments. Private sector tenants entering tenancy agreements in August 1992 would be bound by those agreements to the end of the lease terms regardless of property market movements in the interim.

DAS comment

9.59 The Department has advised that the material nature o f the PAP on the results o f Interiors Australia demonstrates how essential the PAP payments are as transitional arrangements in commercialisation.

9.60 With respect to arrangements between AEM and Interiors, ACS and Assets, Type A PAP payments funded by the Department of Finance bridge the difference between face and effective rates for these commercial business units. While not intended as incentives but rather as subsidies, the A type PAP payments, in bridging the gap between face and effective rents, have the same effect as incentives.

DAS comment

9.61 The Department advised that the PAP payments occurred after the decision to commit the tenants to the building and did not influence that decision. The payments are therefore not comparable to incentives.

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Table 8 Impact of PAP paym ents

PAP ty p e Y e a r PAP m S

e f re n t

P A P i s a % e f

o p e ra tin g re su lt

T o ta l PAP P aym ent

provided

A s s e ts

S e rv ic e s

A 1 9 9 2 -9 3 4 3 % 7% $ 1 5 8 0 0 0

A 1 9 9 3 -9 4 39 % 2% (o f loss) $ 2 3 7 0 0 0

I n te r io r s

A u s tr a lia

A 19 9 2 -9 3 24 % 45 % $ 8 9 7 1 4

A 1 9 9 3 -9 4 35% 34 % $ 1 1 8 0 0 0 has been

AC S

A 1 9 9 2 -9 3 33% 8% o f loss

in te rn a lly allo ca te d by

DAS b u t th e a ctu a l

am ount to be claim ed

has y e t to be

determ ined.

$ 4 8 1 111

A 1 9 9 3 -9 4 32% 18% o f lo ss $ 5 1 3 0 0 0

8 1 9 9 3 -9 4 13% 7% o f loss $ 2 1 2 0 0 0

9.62 Current tenancy arrangements for ACS, Interiors Australia and Assets Services are as yet unsettled. However, these agencies have been required to pursue commercial market-driven behaviour and compete in relevant markets where they can. As such it is appropriate that, in

relation to the tenancy market, their behaviour reflect that of their private sector peers. It does not at present.

9.63 Accordingly, the units should pursue market-driven tenancy arrangements, and negotiate and execute tenancy agreements encompassing incentives in accordance with market conditions and with their business requirements. It should be noted that with respect to PAP

payments to those business units they have no direct effect on the Commonwealth Government’s Consolidated Revenue Fund as they are paid by DoF from the CRF and are paid back to the CRF by the DAS.

9.64 It was also observed that the determination and delivery of PAP payments causes a significant administrative workload and hence expense on the business units and the Commonwealth departments concerned, namely DAS and Finance. Administration cost savings will also accrue

to the parties with the cessation of PAP payments for the business units.

Recommendation No.5

9.65 The ANAO recommends that ACS, Interiors Australia and Assets Services forthwith settle tenancy arrangements with whomever they deem appropriate and in accordance with their business needs.

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Recommendation No.6

9.66 The AN AO recommends that PAP payments and arrangements be publically reported and further that AEM as a recipient of PAP payments disclose the effect of PAP payments on the capital value of its property portfolio.

Recommendation No.7

9.67 The AN AO recommends that DAS assume corporate responsibility for the ACS area allocated to the staff adjustment program.

Rent discounting or subsidisation

j. does the rent that has been paid since 1 December 1992 reflect a discounting or subsidisation outside the range of commercial dealing

k. if the answer to (j) is yes, was there any other direct or indirect subsidisation by the Commonwealth Government of these agencies in respect of their leases

Opinion/conclusion

9.68 Financial arrangements totalling $3.9m were provided to the business units during the move-in period and in the form of valuable fitout assets. The value of these arrangements is detailed at paragraphs

9.72 to 9.75 below.

9.69 Subsidy in the form of property adjustment program payments reduced the face rents paid to a level approximating the effective market rate as at December 1992. In addition, further subsidy was received by ACS in relation to 510 m2 of space attributable to downsizing of staff numbers and hence reduction in required work space. While private sector tenants can seek to renegotiate tenancy terms and conditions with their landlords payments under PAP are not available to private sector competitors and are not conducive to appropriate commercial behaviour of the units. Such payments were approved by DoF to assist the businesses convert from departmental undertakings to commercially competitive operations.

Recommendation No.8

9.70 The ANAO recommends that the financial arrangements outlined below be acknowledged within relevant MOU documents and further that AEM be accountable for and amortise fitout costs of $22.7m for the whole of the facility over an appropriate period of time.

Background analysis

9.71 Paragraph 9.61 above details benefits received by the business units under the property adjustment program. These payments had the effect

24

of reducing the impact of rent expense on the businesses. In relation to their Casselden Place tenancies, Assets Services, Interiors and ACS have derived benefit from the financial arrangements listed below.

Fitout

9.72 Fitout costs of $22.7m were expended as part of the construction costs to complete the building. Correspondence of October 1989 titled Fitout Funding Arrangements - Casselden Place between DAS and DoF noted that fitout costs would normally be recovered from tenants either

by a onee-only payment or by a series of deferred payments agreed with APG. Four Commonwealth offices then under construction including Casselden Place were to be regarded as a special case in that cost recovery need not be levied. The special case was approved because of

the overlap of the old and the new charging regimes.

9.73 Advice from AEM to AVO detailed that fitout for the space occupied by ACS, Interiors and Assets in Casselden Place totalled $3 154 153 or $364/m2 if allocated pro rata. The units have the benefit of utilising the fitout to conduct their businesses. In accordance with the

DoF advice above, AEM has not sought to recover the cost. It is noted that AEM does not account for nor is it amortising the cost of the fitout assets provided to the units and/or in relation to the building as a whole. This failure to account for a capital asset and amortise its costs over its

useful life is unacceptable in an accrual accounting environment and should be immediately remedied.

9.74 Detailed below ANAO has allocated this fitout cost to the businesses on a pro rata basis in accordance with the areas occupied:

Assets Services $

1484m2 543 573

Interiors Australia

860.25m2 315 101

ACS

6266.85m2 2 295 479

Total $3 154 153

DAS comment

9.75 DAS advised that it did not consider that AEM should be responsible fo r accounting fo r all fitout in Casselden Place. While Finance Estimates Memorandum 1989/32 provides that fitout costs appropriated to DAS were not to be recovered, it does not change the

responsibility arrangements fo r that fitout. DAS believes that in accordance with the 1989 fitout arrangements, tenants should bring the

25

fitout to account in their financial statements. This will be done fo r DAS tenants and non-DAS tenants advised accordingly.

Occupation of premises

9.76 The units occupied Casselden Place from September 1992 to 30 November 1992 at no cost to themselves. Payment of rent commenced from 1 December 1992. AN AO was advised that this situation occurred to avoid the payment by the tenants of double rent, i.e. at their previous and new locations, during the move-in and set-up period at Casselden Place. During this period ACS was under a continuing rental obligation at its previous location until restoration arrangements were concluded. A cash s e ttle m e n t^ H H H j was provided to settle restoration obligations. ANAO has calculatedthe rent income forgone by AEM during this period below:

Assets Services $

$43 019 per month September to December 129 058

Interiors Australia

$23 169 per month September to December 69 508

ACS

$182 803 per month September to December 548 410

Total $746 976

26

9.77 Packages such as this are commonly called incentives in die commercial property market and are applied to attract uncommitted tenants to vacant space. In this regard it is noted that the three units had

been pre-committed since 1988 by the Department to Casselden Place and in this situation incentives were not relevant.

9.78 The classification of these arrangements as incentives was observed to be wide spread within Victoria. For example, in correspondence from APG to AEM dated April 1993, the benefits below were classified as incentives and in other correspondence between APG and ACS dated

August 1992 as having the effect of incentives. Further, a November 1993 AVO rental valuation of Casselden Place carried out under instructions from AEM lists the fitout contribution of $3 154 153 for the floors occupied by the units as an incentive. From review of other

tenancy agreements covering the period August 1992 to June 1994, AEM applies fitout contribution and rent-free periods as an incentive to tenants.

9.79 ANAO accepts that the amounts were not incentives in the context of inducing the units to undertake something that would not have otherwise been undertaken but rather represented a package of financial benefits to the units for which they did not pay. The decision to move

from the previous premises before the end of the lease was taken in the context of minimising the cost to the Commonwealth of vacating that lease and the intention was to avoid additional cost to the units.

Commercial behaviour of the units

1. have these businesses operated on a fully commercial basis since taking up the tenancies in these premises

Opinion/conclusion

9.80 The Assets Services, Interiors Australia and ACS business units behave as their private sector peers in that they are engaged in commerce seeking a profit against competition from others and since 1991 and 1993 respectively, they have had no tied Commonwealth clients. The units

compete with private sector for business on a commercial basis of price and quality of service. They maintain internal accounts and records and provide external reporting of results on a basis that is similar to their private sector peers.

9.81 Notwithstanding many similarities, the units can be distinguished from private sector peers in a number of significant regards and incur additional costs as a result. They are business units within a

Commonwealth Department of State and hence accountable through a Minister of State to the Commonwealth Parliament. In addition, the units are bound by the Commonwealth’s legislative, regulatory and policy dictates, including freedom of information requirements, whereas private

competitors are not. In addition, staff employment conditions and personnel management provisions are governed by the Public Service Act.

27

9.82 A consultancy report dated June 1992 quantifies the cumulative disadvantage attributable to these arrangements at an estimated 2-3% of turnover.

9.83 However, the units enjoy a number of financial benefits not available to their private sector peers. For example, as Commonwealth entities they benefit from property adjustment program payments and funding for redundancy payments for surplus employees in the transition

from pre-commercial to commercial arrangements. Protection from Commonwealth and State laws and regulations is a further important distinguishing feature. However, their parent department - DAS - obtains payment from the business units of amounts that would equal the taxes and charges avoided in relation to non Commonwealth work completed.

Background analysis

9.84 Since the mid-1980s the Australian Government has pursued a general policy of introducing commercial principles to management of some departments and agencies. The policy of ‘commercialisation’ has been characterised by the introduction of fees for service based on profitable cost recovery and the opening of former captive markets to private sector competition. Appendix E outlines a chronology detailing the commercialisation process within DAS.

9.85 Assets, Interiors and ACS are commercial business units operating within DAS, which is a Department of State. As such they are accountable to the Parliament through the Minister for Administrative

Services. Appendix D below outlines 23 special principles within which the units operate.

9.86 The units’ accounting arrangements are on a full accrual basis with external reporting through annually audited financial statements. These are prepared in accordance with Australian Accounting Standards and the requirements of Guidelines for Public Authorities and Commercial Activities issued by the Minister for Finance. General policy dictates of

the Commonwealth Government, including legislation and regulations applying to the Federal Public Service as a whole, employment of staff under the Public Service Act, freedom of information and public accountability etc, distinguish the units from private sector competitors.

9.87 From examination of client lists and revenue sources, it was observed that Commonwealth departments and undertakings comprise the major source of revenue for services rendered by the units.

9.88 It was observed that some Commonwealth funding, namely PAP payments (paragraph 9.49 above) and redundancy arrangements, including payments of salary and expenses for surplus staff, is being provided to facilitate transition to fully commercial activities. These

transitional arrangements are not expected to continue indefinitely.

28

19 October 1994 Canberra ACT

9.89 As such, the units are not commercial in absolute terms; however, they are progressing to that goal while still being accountable to the Parliament through their host department.

W.G. Nelson

Acting Auditor-General

29

Appendix A Terms of Reference

(1) That a report by the Auditor-General be laid on the table, as soon as practicable, on the following questions in relation to leases in the Casselden Place building in Melbourne, which were the subject of the orders of the Senate of 5 and 10 May 1994:

(a) when was an agreement reached between Projects, Interiors and Assets Services on the one hand and the lessor of office space occupied by those businesses at Casselden Place, Melbourne on the other

(b) how was the agreement documented

(c) at the time of the agreement was the agreed net rent to be paid by these businesses above or below average per square metre rental being paid in respect of comparable office accommodation in Melbourne

(d) from 1 December 1992, was the rent that was actually paid by these businesses above or below average per square metre rental paid in respect of comparable office

accommodation in Melbourne since that date

(e) to what extent does the rental paid since December 1992 vary from a comparable fair market rental

(f) do the payments received by the agencies under the property adjustment program fairly compensate them for the variations in rental, and, if not, how did the amounts vary and why

(g) how have the alterations in the areas agreed to be occupied prior to construction and the areas occupied on completion been negotiated and documented

(h) how have the areas agreed to be leased as at 1 December 1992 and the areas occupied as at 1 June 1994 been changed, and, if they have changed, how was that change negotiated and documented

(i) were any property adjustment program payments paid in respect of any area included in any of the leases but in fact in excess of the space requirements of the agency

(j) does the rent that has been paid since 1 December 1992 reflect discounting or subsidisation outside the range of normal commercial dealing

31

(k) if the answer to (j) is yes, was there any other direct or

indirect subsidisation by the Commonwealth Government of these agencies in respect of their leases

(l) have these businesses operated on a fully commercial basis taking up tenancy in these premises

(m) has the use of the property adjustment program in these instances allowed the agencies concerned to enjoy any unfair commercial advantage over private sector competitors

(n) has the use of the property adjustment program in these instances been consistent with the objectives of that program.

(2) That the Auditor-General be provided with the information necessary to compile the report required by paragraph (1).

(3) That the Privileges Committee, in considering the Parliamentary Privileges Amendment (Enforcement of Lawful Orders) Bill 1994 referred to the committee on 12 May 1994, consider this particular instance of refusal by a Minister to produce documents in response to an order of the Senate, and the report by the Auditor-General under paragraph (1).

32

Appendix C General Guide to the Evaluation of each Building

The definitions which follow are provided as a general guide to the evaluation of each building.

BOMA Premium

NLA greater than 20 000 m2, with average floor area greater than 1100 m2. Top quality modem space which is generally a pacesetter in establishing rents and includes: the latest or a recent generation of building services; ample natural light; good views/outlook; prestige lobby

finish; and quality access to/from an attractive street environment.

BOMA A Grade

NLA greater than 6000 m2. High quality modem space including: good views/outlook, quality lobby finish; and quality access to/from an attractive street environment.

BOMA B Grade

Good quality modem space.

BOMA C Grade

Older style air-conditioned space.

BOMA D Grade

Poor quality space.

To maintain some consistency with BOMA, Hooker Research has reassessed the definition of all categories of office space used for data collection and reporting in Melbourne. Previously reported figures have

been adjusted in line with these new definitions.

CBD Prime: Approximates BOMA premium and A Grades

CBD Secondary: Approximates BOMA B and C Grades

Note: C assolden is re g a rd e d a s BOMA A G rade and/or CBD Prim e.

34

Appendix D Principles for the Operation of Services to Government Agencies

Principles applicable to all DAS services

Principle 1

Efficiency and effectiveness in the achievement or government objectives, assessed against the full range of economic and social objectives to be achieved, is the ultimate test against which arrangements for the provision of services should be judged.

Principle 2

Options and arrangements for the provision of services should be assessed on a case-by-case basis and the subject of full consultation with client agencies and relevant unions from the initial planning stage through implementation. Principles for services should provide a framework for

the conduct of such case-by-case assessments rather than seek to specify uniform delivery arrangements for all services.

Principle 3

Any changes to future service arrangements should be implemented over an appropriate period in order that service providers and client departments may be afforded an adequate adjustment period, and that government may have the opportunity for review in the light of

experience.

Principle 4

Devolution to individual departments of management responsibilities for the supply of services, whether by way of managing in-house supply or contracting supply from the private sector, should satisfy the test that service supply by individual departments is more cost effective than

supply by a central service agency from the perspective of the Commonwealth at large (as distinct from the perspective of individual departments).

Principle 5

Each service unit should be managed in accordance with a written management ‘charter’ endorsed by the responsible minister and/or cabinet as appropriate.

Principle 6

Each unit supplying a service should provide the responsible minister with a corporate plan covering periods of three to five years ahead for consideration and approval.

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If government decides that policy objectives of functions extending beyond the supply of a basic service to clients are to be pursued, these should be identified explicitly in the management charter and corporate plans for the service in question and be taken into account in assessing

the service agency’s performance.

Principle 8

All service agencies should be in a position to inform government of the cost of the services they provide, including costs which they do not fund directly under current arrangements (e.g. superannuation, rent). Program departments managing and/or providing their own services as significant undertakings in their own right should be in a position to report their costs in similar detail.

Principle 9

Services which do not contain any significant ‘public interest’ component should be charged for unless it can be demonstrated that the cost of implementing and operating charging systems exceeds the potential efficiency gains.

Principle 10

Where in accordance with Principle 9 the majority of a service agency’s services are properly chargeable, its financial objective should, in general, be to at least recover its costs from revenues after allowance for the financial effects of meeting any ‘public interest obligations’ forming part of the management charter for the service(s) in question.

Principle 11

The introduction of charges should normally be accompanied by devolution of responsibility to program departments for bidding for associated funding. However, there will for some services be a continuing requirement for policy advice to ministers regarding the expenditure and other implications of the resulting bids of individual departments for such funding.

Principle 12

Where charges are made for services, client departments should normally receive and control the appropriations available to acquire the services. However, if charges are introduced for a service subject to a tied client arrangement, case-by-case consideration should be given to the

desirability of the supplying agency having control over the funds (through appropriation or sub-warrant control arrangements).

Principle 7

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Introduction of charges for a given service with devolution of associated funding to departments should be accompanied by supplementation of clients’ budgets, the level to be decided on a case-by-case basis.

Principle 13

Principles relevant to those DAS services which government decides should operate on a quasi-commercial bask

Principle 14

Where the government considers it appropriate to commercialise a service the relevant service agency should normally be structured with a distinct identity within a departmental framework.

Principle 15

Insofar as program departments are permitted to contract services from the private sector in accordance with Principle 4, they should be required to seek price quotations for the required service from existing Commonwealth agencies.

Principle 16

The cost effectiveness of service management or provision by individual program agencies should be subject to external scrutiny no less rigorous than that applied to service provision by central service agencies.

Principle 17

Subject to achievement of their overall financial targets and consistent with commercial practice, service agencies should retain full management discretion in relation to the structure and level of charges for their individual services to individual clients. Where service agencies retain a

degree of ‘monopoly power’ in relation to a given service, disputes regarding the level or structure of charges for that service should be referred to the responsible ministers if not resolved between the service provider and its clients.

Principle 18

Where a service agency is expected to operate as a quasi-commercial undertaking with charges for its services predominantly set on a cost recovery or commercial basis, the agency’s finances should normally be conducted through Group 2 Trust Account arrangements.

Principle 19

The disposition of the net surplus (if any) of the service agency, after payment of all costs, should be considered annually against the general principle that surpluses will often need to be retained by the agency to finance requirements of the agency.

Principle 20

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Where service agencies are established as quasi-commercial undertakings and operate through Group 2 Trust Accounts, their annual financial reports should be prepared in general accord with the Minister for Finance’s ‘Guidelines for the Form and Standard of Financial Statements for Commonwealth Undertakings’.

Principle 21

Service agencies operating in competition with the private sector should not be subjected to audit or disclosure requirements entailing disclosure of information of potential benefit to competitors.

Principle 22

As a first step in establishing any quasi-commercial service agencies, and subject to agreement regarding their ‘bottom line’ financial targets, they should be free to exercise a high degree of management discretion and flexibility by removal of controls in respect of:

• ASL (average staffing levels) and staffing profiles

• the resourcing mix to be adopted in service delivery (directions regarding the mix of in-house and contract resources)

• the use of fee receipts in meeting operating and capital expenses

• the structure and level of fees for services to individual clients, and

• reporting requirements other than those applicable to government business enterprises and to meet the reporting requirements of the Parliament.

Principle 23

Service agencies operating on a full cost recovery basis in competition with the private sector for Commonwealth business should be free, subject to the agreement of the responsible minister (if not already current practice), to compete for non-Commonwealth business.

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Appendix E DAS Common Services Reform - Chronology

1987 14 July Department of Administrative Services established. Prime

Minister requests that DAS, in consultation with Departments of Finance and Prime Minister and Cabinet, develop a set of principles for DAS Services.

The Hon Stewart West MP appointed Minister. Mr Graham Glenn appointed Secretary.

1 October Transport and Storage Group established as a primarily self­ funding organisation following a review by Department of Finance and DAS.

1988 1 January Charging arrangements introduced for survey and land

information services.

23 March Government agrees to the 23 Principles for the operation of common services in DAS and agrees to the review of thirteen DAS service providers.

from July Following the reviews of the service provides the Government decides on the introduction of user pays for nine of the DAS businesses. The decisions include:

• a timetable for partial or total untying of clients to allow market forces to test capacity of DAS businesses to meet customer needs

• funds for common services be appropriated to client agencies rather than DAS

• DAS businesses to operate on trust accounts funded by revenue raised through the sale of services, and

• funds for community service obligations be appropriated by government.

It was also decided that full commercial accrual accounting was to apply to all DAS businesses.

I July Australian Construction Services commences charging

commercial fees for design and construction services for off budget client agencies. Government decides that ACS will achieve full cost-recovery for design, construction, supervision, fitout and asset management services over a four year period

from 1 July 1988.

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1988-89

1989

Australian Property Group commences charging commercial fees for the provision of property services.

Establishment of a new more commercially-oriented top structure for the department which provided each service provider with a General Manager with overall responsibility for operations.

December Purchasing Reform Group established following the

Government’s reforms to Commonwealth purchasing arrangements.

During this financial year DAS develops the financial structures and policies necessary for the effective operation of ‘user pays’. This includes the move from cash accounting to accrual-based commercial accounting, the creation of trust account structure and the establishment of a common chart of accounts for all programs to facilitate standard and consistent reporting.

This financial year also sees extensive commercialisation training for staff at all levels: 5500 participant days achieved.

March Appointment of Mr Noel Tanzer as Secretary.

1 May In the context of the 1990-91 Budget deliberations, Government decides that the Ministers for Finance and Administrative Services are to bring forward a submission on progress in the reforms to date and on the scope for additional reforms particularly in relation to taxation, superannuation and tied clients.

30 June All businesses complete the corporate planning process and submit corporate plans to the Minister.

1 July Australian Property Group commences charging rent in

Commonwealth-owned office accommodation.

AVO commences charging commercially-based fees.

ACS commences charging commercial fees for on budget clients and its trust account arrangements were established.

AUSLIG commences operations on Trust Account.

AGPS clients untied for general printing work up to a value of $20 000.

Purchasing and Sales Group commences charging commercially- based fees.

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1990 February Individual services reorganised into three major programs -

Property Services, Sales and Services and Government and Corporate Services. The structure was intended to provide better client focus and improved management. Some rearrangement of corporate support also occurred to improve

efficiency.

The restructure included the establishment of Regional Coordinators to provide regional linkage between DAS programs and sub-programs. Their major responsibility is to coordinate, facilitate and promote the effective delivery of DAS services to

clients at the regional level.

April Senator Nick Bolkus appointed Minister for Administrative Services.

1 July Commencement of full cost recovery for AVO, including

establishment of trust account operations.

AGAL moves to full cost recovery and is placed on trust account operations.

AUSL1G clients untied for surveying and land information activities.

Purchasing and Sales Group commences operation on trust account.

1991 March Rearrangement of services within programs to better group

related services and improve client interface. Increased emphasis on marketing and coordination of service delivery.

Government decides on further untying (Accommodation Services from July 1991, Fleet and Asset Services from July 1993), agrees to relaxation of a range of APS controls to take account of DAS commercial operations (including consolidated

trust account, streamlined access to funds, no regulatory role, no external ASL or SES controls) and agrees to transitional funds for property rationalisation and debt/equity arrangements.

Consideration of tax status deferred - to take place before 1995.

Decision also affirms commercial standards of performance as the objectives for the DAS businesses.

1992 February Internal review of likely performance and commissioning of

individual business reviews. Reorganisation to clearly separate some functions to avoid perceptions of possible conflict of interest between DAS commercial services and Commonwealth

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1 July

May

August

1993 March

July

purchasing arrangements and management of Commonwealth property.

Adoption of two management streams - Government Services (including some quasi commercial units) and Commercial Services.

Functions carried out by Purchasing and Sales Group return to Budget funding.

Government decides on a review of commercialisation in DAS.

Following the review of commercialisation, the Government decides on a medium-term strategy for DAS’s commercial operations which include exposing services to increased competition through the continued untying of Government agencies from the requirement to use DAS, development of business plans (commencing with 1993-94 plans) for each business unit aimed at achieving financial viability by 1995-96, setting performance targets, including rates of return, based on commercial levels of performance. The future of individual business units was to be subject to an annual review

(commencing 1993-94) of progress against business plans.

DAS Account Manager for the Minister proposal adopted. An Account Manager from each area of DAS is to be accountable for the customer service provided to the Minister and his Office.

Staffing Adjustment Program (SAP) established to ensure an appropriate mechanism is in place to retain and redeploy staff excess to the fee earning capacity of the DAS businesses.

Department of the Arts and Administrative Services established under the Ministerial direction of Senator Bob McMullan.

1993-94 Budget papers announced that DAS would bring forward a further submission on the future of DAS

Commercialisation in consultation with DoF. It examines the commercialisation framework and other arrangements in order to preserve and enhance gains in efficiency and service already achieved and provide a basis for DAS commercial activities to achieve viability and appropriate levels of performance.

As part of the 1993-94 Budget process, four DAS businesses (ACS, AUSLIG, DAS Distribution and COMCAR) reviewed. Agreed proposals for ACS. AUSLIG and DAS Distribution envisage being profitable in 1995-96 and are currently on track. COMCAR to have operating subsidies in 1993-94 and 1994-95 with continuing subsidies for special safety and security requirements from 1993-94 onwards.

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1994 January Review of the SAP program to be completed by June 1994.

Appointment of new Secretary Mr Andrew Podger.

March

April

Department of Administrative Services re-established under the Ministerial direction of Mr Frank Walker MP.

Appointment of new Secretary Mr John Mellors.

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Series titles Titles published in the financial year 1994-95

Audit Report No. 1 Project Audit Other Titles

Commonwealth Scientific and Industrial Research Organisation Annual Report of the Australian National Audit

- Follow-up of an Efficiency Audit Office 1993-94

of External Funds Generation Tabled 24 August 1994

Audit Report No.2 Department of Defence Follow-up Audit Management of Army Training Areas Preliminary Study Acquisition of Additional F - l l l Aircraft

Audit Report No.3 Project Audit Wool Tax Australian Taxation Office

Audit Report No.4 Project Audit Special Investigation into Casselden Place Building, Melbourne ·

Department of Administrative Services

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