Category Archives: Hawaii Business

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Nonprofit Boards: Confused, or M.I.A.

BY DENNIS HOLLIER

     Photo: iStock

“When I look back on it,” says John D., the former executive director of a small but prominent nonprofit in Honolulu, “the board of directors just really didn’t understand what their role was.” He pauses for a moment, his face assuming a pained expression. “In some cases, they made their job more difficult by micromanaging the staff. But they also didn’t take care of their basic responsibilities, like raising funds or strategic planning. In the end, they made it impossible for me to do my job.”

His is a common sentiment among the leaders of Hawaii’s nonprofits, particularly those from small- and mid-sized organizations. Many executive directors, CEOs and even some maverick board members say privately that their boards are poorly prepared, misinformed and often burdened with damaging misconceptions about their roles. The result is a lack of clarity about the relationship between the board and the executive director, and about their respective responsibilities. Inevitably, this confusion leads to conflict and limits nonprofits’ effectiveness. And if you listen to Hawaii’s community of executive directors, it’s the boards of directors that are mostly to blame.

It’s true, some nonprofit experts are more circumspect. For example, Holly Henderson, who, as executive director of the Weinberg Fellows and Castle Colleagues, has helped train hundreds of executive directors and board members in Hawaii, believes these problems are an inevitable part of the evolution of a nonprofit. “What I see a lot of,” Henderson says, “are boards that aren’t working anymore. And although there are individuals who want to blame somebody, sometimes it’s just the same as blaming a kid of for growing out of a pair of shoes. Because, what works at one point in an organization’s life doesn’t work at another point. And it’s not necessarily anybody’s fault.”

She also notes that business people make up the bulk of nonprofit board members, and that they’re volunteers, often taking valuable time away from their companies and families. “You have people who want to help the community by volunteering their time,” she says, “and they’re not happy to be told they’re not doing a good job.”

Henderson’s perspective draws on the work of the nonprofit expert Karl Mathiasen, who divided nonprofits and their boards into three stages of development:

  • Small, informal “organizational boards,” dominated by the nonprofit’s founders;
  • Larger, more independent “governing boards” that begin the process of formalizing rules and procedures; and
  • Large, sophisticated “institutional boards,” replete with standing committees and many of the attributes of a for-profit corporation.

     Holly Henderson, who helps train nonprofit leaders, says conflicts 
     arise when nonprofits evolve, but their boards do not change with 
     them. 
     Photo: Rae Huo

According to Mathiasen, these transitions, particularly from an organizing board to a governing board, are often fraught with conflict. To make matters worse, as Henderson points out, executive directors and board members may evolve at different rates. This, she says, is why so many executive directors complain about their boards.

To some extent, it was always so. Several years ago, the Hawaii Community Foundation did a survey of executive directors to understand why turnover was so high among nonprofit leaders. “The No. 1 complaint that came out was the board,” says Christine van Bergeijk, the foundation’s vice president for programs. “There was really a great deal of sentiment that executive directors were all by themselves, and the board members were merely cheerleaders. The EDs said they needed the board to roll up their sleeves and do some of the hard work.” Board members, in other words, aren’t living up to their end of the bargain.

Of course, that’s only one side of the problem. Executive directors, for example, deserve a share of the blame. Many, particularly if they founded the organization, preserve their power by keeping their board members in the dark. And there’s a whole other story to be told about the level of professionalism among the leaders of the nonprofit community. So, the incompetence of board members isn’t the only problem facing nonprofits. “It’s true that our board is kind of passive,” says a board member from a small educational organization, “but I think the members would work with the executive director if she really needed help.”

It’s certainly telling, though, that although many executive directors were willing to share their complaints, none were willing to do so on the record, citing a fear of reprisals from their board or the inability to get nonprofit jobs in the future. Many also worried that public criticism would damage their ability to raise funds. For that reason, we’ve disguised the identities of most of the executive directors cited in this article as well as the organizations they run. Of course, this anonymity makes it difficult to gauge the validity of their complaints. But the striking uniformity of their criticism gives them credence.

For this story, we interviewed the executive directors, staff members, and members of the boards of more than a dozen nonprofits. We also spoke with some of Hawaii’s most respected nonprofit experts and consultants. Over and over, they brought up the same tales of board members who didn’t understand their roles or failed to embrace their responsibilities. Here are the three major areas where Hawaii’s nonprofit boards come up short:

     This chart from the Aloha United Way shows the responsibilities 
     of a nonprofit organization.

Board Development


“All my board members are just friends of one another. For ‘board orientation’ all they get is a pat on the back and a copy of our last annual report.” —Noelani K., executive director of a social services provider.


 “Too often, board members treat meetings like a social club. They don’t seem to take the work or the mission seriously.” —Tom K., executive director of a nonprofit intermediary organization.

 “We’ve had the same chairman of the board for 10 years.” —Mary N., CEO of a cultural organization.

 

“The board members absolutely refuse to attend any kind of board training. Even though none of them have any experience, they all say they already know everything there is to know about how to run a nonprofit.” —Amy L., executive director of an environmental organization.

It starts by picking the right board members. All too often, executive directors complain, new members are selected because they’re friends of other members. Except on some large institutional boards, little strategic thinking goes into identifying candidates and courting them to see if they’re a good fit. The result is often undersized, homogeneous boards that lack the skills needed to govern an organization responsibly.

This also poses problems for potential board members. For business executives contemplating joining the board of a nonprofit, it’s not simply a matter of whether you want to serve, but whether you’re a good fit. Amy Hennessey, a former board member for Community Links, a Honolulu organization that served as a sort of incubator for nonprofits until it closed earlier this year, says that means asking questions. “You want to ask about their expectations: ‘What’s your fiscal structure? Are you in financial difficulty? What’s your plan for the future? What are your expectations for my involvement on this board? How much of my time do you really need? In other words, what do you need from me in terms of time, money, intellect – all that?”

Of course, those questions rarely arise from new board members. Even worse, board members, even after they’ve been selected, are rarely told what’s expected of them or given an adequate orientation to the board’s duties. And, as one executive director pointed out, “There’s never any discussion of the division of labor between the board and the ED.” Clearly, there needs to be a more thorough education of board members.

But, as Henderson points out, board members aren’t necessarily going to embrace this education. “These are often prominent people,” she says. “A lot of them don’t take well to the idea that they need training. In fact, I rarely use the word ‘training’; I usually say ‘briefing.’ ” Whatever you call it, though, board training should be an ongoing process, not just for new members. Henderson gives the example of board rotation, the use of term limits to systematically replace board members. “One of the wonderful things about board rotation is it gives you the opportunity to get the board together and to do some orientation. Ostensibly, it’s for new board members, but long-serving board members can hear it as well.”

 

     Robbie Alm, VP at HECO and a member of several nonprofit 
     boards, says most boards offer only a basic orientation for 
     new members. 
     Photo: Olivier Koning

In most cases, though, there’s little or no orientation, and both executive directors and board members can share in the blame. “What I’ve seen a lot of, over the years,” says Robbie Alm, “is a failure on the part of everybody – executive directors, board members, board chairs – to really work out and understand what their roles are. It’s almost as if we assume we know, so we never really talk it out.” In the nonprofit literature, this is sometimes referred to as “blurred roles.” A board member from one local nonprofit put it another way: “Nobody knows a damned thing.”

Not everyone believes that boards are the problem. Tim Johns, CEO of Bishop Museum, for example, says there’s been a trend toward more and better training, so board members today have a better understanding of their roles. (It’s worth noting, though, that most of Johns’ board experience has been on mature, institutional boards.) He does note, however, that the pool talent in a community of this size is limited. “We do have a lot of nonprofits, so we may not have as many potential board members as you have in a larger community.” As a result, he says, people might be sitting on boards earlier in their careers. “If you were in San Francisco or Chicago, you might not be sitting on that type of board at that point in your career.”

Fundraising

“When I started our first capital campaign, my board chair said to me, ‘Why do I have to fundraise, isn’t that why we hired a development director?’ ” 
—Mary N., CEO of a cultural organization.

“When I tell the board that funders often require 100 percent board participation, they say, ‘Isn’t our time enough? We’re all professionals; our time is worth something.’ 
—John D., executive director of a human services agency.

“Several of my board members actually told me they would never ask their friends to support our agency; it would be too embarrassing.” 
—Amy L., executive director of an environmental organization.

“Our board chair said flatly he won’t donate, won’t raise funds, and won’t quit.” 
—Mike T., CEO of an arts group.
 

Money is king. And for most nonprofits, fundraising is the single most important responsibility of the board of directors. That’s because it almost always takes cash for organization to accomplish its mission. It’s true that board members are often recruited for other reasons – financial or legal skills, for example, or cultural or technical knowledge – but these attributes are rarely sufficient. A board member’s time and talent are useful, of course, but they don’t pay the rent or insurance, they don’t cover the salaries and benefits of employees, and most importantly, they don’t pay for food for the hungry, educational programs for the environment, medical treatment for the sick, or any of the countless other programs that fall within the missions of Hawaii’s nonprofits. That takes cash, says van Bergeijk of the Hawaii Community Foundation. And it’s the board members’ role to donate or, better still, raise that cash from the community.

“I think the prevailing expectation today,” van Bergeijk says, “is that, if you’re on a board, you must make sure the organization has the resources they need to do the job. That equals fundraising. It shouldn’t be only fundraising, but that’s the prevailing expectation. If you’re on a board, you’ve got to help raise money. And not everybody’s cut out to do that.”

This judgment is nearly universal among nonprofit professionals. And yet the board members of many nonprofits often fail to participate in fundraising in any meaningful sense, leaving it to the executive director or to one or two more committed board members. Christine Valles, a member of numerous nonprofit boards herself, and owner of Silver Lining Consulting, a company that advises nonprofit organizations, believes this problem, like many of those facing nonprofit governance, is another outcome from how board members are recruited in the first place. No one tells them what’s expected of them.

“It has to be clear to the new board member that they’re responsible for fundraising,” Valles says. “That’s universally agreed upon in the nonprofit world. They have to provide some means for the financial stability of the organization. But that part is really underplayed when board members are recruited. No one takes the time to say, ‘You know, you’re going to have to take the lead at raising money. You’re going to have to make a personal donation, and you’re going to have to ask your friends for their support.’ Even though that’s simply saying what boards do. You’ve got to say, ‘As board members, we’re all responsible for fundraising. So if you’re not actively asking people to give money, you probably shouldn’t be on a board.’ ”

This reliance on the board for fundraising isn’t universally true. Many organizations that provide social services, for example, rely mostly on government contracts for their funding. Other nonprofits depend largely on grants, either from government sources or from private foundations. And because the agency staff usually writes and prepares grant proposals, that relieves the board of some of its responsibility to raise funds.

It’s worth noting, though, that many private foundations and wealthy individuals will not support an organization unless every board member has contributed money. And the vast majority of Hawaii’s 6,000 or so 501.c3 nonprofit organizations depend on financial support from the community for their survival. In some ways, that’s the theory of having a board in the first place: to provide a link to the community, a way to ask the public for its support.

At large nonprofits with institutional boards, this concept is generally (though not universally) understood. One of the reasons the boards of organizations like the Aloha United Way or the Easter Seals are so large (Easter Seals Hawaii, for example, has more than 30 board members) is to spread out the burden for raising funds. In fact, new board members are often selected as much for their ability to attract financial support as for any contacts or skills. This is why most institutional boards try to attract bank executives as members. Robbie Alm, vice president of Hawaiian Electric Company, and a board member for more than 20 nonprofits over the years, points out that senior business executives recruited this way usually understand their role.

“Certainly, many of the large nonprofits are very deliberate in their efforts to do that,” Alm says. “And it works. If I agree to go on the board of an organization, not only am I going to give, but most likely my company will have a table at that fundraiser dinner, that we’ll be at that luncheon or attend that ball.”

The problem is that the board members of smaller and mid-sized organizations often fail to make that assumption. These nonprofits are frequently stuck at the organizing board stage of their evolution, and their members are either unable or unwilling to actively raise funds.

The solution is clear. Executive directors say their nonprofit boards need to be much more engaged in the organization’s fundraising. Members should donate according to their means and actively solicit donations from their friends and contacts. Holly Henderson offers perhaps the best advice for potential board members: “Pick an organization doing something you’re passionate about. That way, you won’t feel uncomfortable asking people to support its mission.”

Oversight

“We’re not responsible for the financial filings, we’re just an advisory body.” 
—James K., board chair of a cultural organization.

“The board has always refused to pay for an independent audit of our finances.” 
—Donna T., board member of a community development organization.

“The ED of my former agency never filed a grant report on time, and used the agency’s accounts like a personal slush fund.” 
—Tom G., staff member at a Honolulu social services organization.

Most nonprofit boards understand that they’re responsible for oversight of the organization. The problem is that, all too frequently, they believe this is limited to hiring and firing the executive director. In fact, their oversight responsibilities are more comprehensive. For example, it’s the board, rather than the executive director, that’s legally liable for much of the financial regulation of the organization.

Partly, this is the result of the Sarbanes-Oxley Act, Congress’s response to scandals at Enron and WorldCom. “Even though it was primarily targeted at publicly traded companies,” says Anna Elento-Sneed, an attorney at Alston Hunt Floyd & Ing specializing in nonprofit law, “there’s a section that applies to nonprofits. Basically, it says, ‘Thou shalt have transparency. Thou shalt have no conflict of interest.’ ”

That gets to the heart of a board’s function. Few board responsibilities seem as obvious as those that generally fall under the heading, governance. Executive directors say (some of them reluctantly) that these includes basic functions: assuring that the organization complies with legal requirements, like making its IRS filings on time; making sure there are adequate policies to prevent issues like self-dealing and conflicts of interest; and recognizing that the board is the organization’s primary vehicle for public relations. These responsibilities aren’t all that different from those that for-profit boards assume.

When you talk to executive directors, especially those that have been successful, they almost uniformly say that nonprofits and their boards need to be more “businesslike.” For the board, that means making sure your executive director and staff perform their duties as professionally as possible given their resources. It also means being accountable for your own responsibilities, which ultimately are the health and welfare of the whole organization. Because the board of directors isn’t simply an advisory body added as an afterthought. The board is the legal embodiment of the organization.

It’s a concept that flies in the face of the egalitarian ethics of most nonprofits. “You want it to be all cordial relationships,” Holly Henderson says. “You want everyone to be equal. But in the end, you can’t get around the fact that the board is the boss.”

Now, if they’d just act like one.

 

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The High Cost of Affordable Housing

BY DENNIS HOLLIER

     Makani Maeva, Hawaii director for the VitusGroup, knows from 
     experience that the financing for an affordable housing project 
     can change dramatically before it is finished. 
     Photo: Rae Huo

“Building affordable housing is complicated,” says Makani Maeva.

She should know. As Hawaii director for the VitusGroup, an affordable-housing developer, she recently completed the Lokahi Apartments, 307 rentals in Kona. Between January 2007, when another developer laid the project in her lap, and July 2010, when the apartments first were offered for rent, almost all the financial and technical details of the deal changed dramatically: The permanent loan went from $16.4 million to $19.2 million; the original equity investors – GMAC, Wachovia and others – had to be replaced; $7.8 million in affordable-housing credits from the County of Hawaii became unavailable, replaced by a soft mortgage of $11.75 million from the state’s rental housing trust fund; and the cost of construction rose from $53 million to $60.6 million, largely due to interest costs.

“It’s like fried rice,” she says. “Because I thought I had one thing in the refrigerator, I thought the project was going to be structured one way.” In the end, though, the recipe changed completely.

The complexity of Lokahi’s financial arrangements is hardly unique. In fact, the average affordable-housing project in Hawaii is funded by at least seven financial instruments – industry insiders say some projects require as many as 14 – each of which comes with its own rules. That’s just the financing. The truth is everything about affordable housing is complicated and constantly changing – the money, politics, regulations, ethics. If you want to “fix” the system, you have to consider them all.

What is ‘affordable housing’?

Too often, affordable housing is equated with public housing and poverty. But the affordable-housing crisis affects a broad swath of the middle class. Developer Chuck Wathen, who recently founded the Hawaii Housing Alliance and is a longtime advocate for affordable housing, notes it would take 3.19 firemen to be able to afford the median-priced home on Oahu. It would take 3.63 school teachers or 5.2 hotel front desk clerks. “What we have isn’t just an affordable-housing problem,” Wathen says. “We have an income problem.”

He also notes that the shortage of “workforce housing” is most acute in the rental market: “A Mainland city of this size would probably have 400 apartment communities of over 300 units.” Yet there’s no financial incentive to fill this gap.

Kevin Carney, Hawaii vice president of EAH, a nonprofit affordable housing developer, explains the math. “It just doesn’t pencil out to do a rental project,” he says. “Let’s say you’re serving a market segment at 100 percent AMI (area median income) – a family of four that makes $80,000 a year or so. The rents you can charge at that income level just aren’t going to cover your debt and operating expenses. So you can’t build it. Instead, you build a condo and you sell those units to people with incomes of, say, 200 percent AMI or more. Then they turn around and rent them out as long-term investments.

“That’s our ‘shadow’ apartment market in Hawaii.”

    The VitusGroup recently completed the Lokahi Apartments, 
     307 affordable rentals in Kona. 
     Photo: Vitusgroup

The financial puzzle

Government programs account for almost all affordable-housing development, either through subsidies or by regulations that require developers to include affordable units in their market-priced developments. But neither approach has supplied much housing in the past two decades.

The centerpiece of affordable-housing finance is HUD’s Low Income Housing Tax Credit, which is administered in Hawaii by the Hawaii Housing Finance & Development Corp. LIHTC (pronounced Lie-Tech) was created to spur the private development of affordable housing, awarding dollar-for-dollar tax credits in exchange for guaranteeing a project will remain affordable for at least 20 years. By some estimates, LIHTC has played a role in the development of as much as 90 percent of all affordable-housing units in the country. Hawaii is no different.

Darren Ueki, HHFDC’s finance manager, explains that there are two kinds of LIHTC credits, one worth 9 percent and the other 4 percent of a project’s development costs. “We’re basically giving out anywhere from $27 million to $28 million in (9 percent) tax credits a year.” Yet he acknowledges that demand for affordable housing is much greater than that. In 2007, an HHFDC report projected the state would need to create more than 28,000 rental units over the following five years. Even by the most liberal estimates, the LIHTC program creates fewer than 300 units a year in Hawaii. That’s not surprising, since those credits only account for a small fraction of the cost of development.

For example, the credits don’t cover the cost of the land or predevelopment planning. (Developers say that, for an affordable-housing project to work in Hawaii, the land must essentially be free.) In addition, the developer must find investors with tax liabilities to purchase the tax credits. During the housing bubble, developers sold credits at nearly face value, and sometimes higher. Once the credit markets crashed, the prices plummeted to 60 cents on the dollar, though they are back to about 90 cents. Typically, the proceeds from these sales account for nearly all the equity in an affordable-housing project. “The problem,” says Carney, “is that will only produce between 30 to 40 percent of your equity needs. So you’ve still got to come up with the other 60 to 70 percent.” That, too, is affected by LIHTC rules.

For example, there’s the property’s income stream, the money earned from rents or sales. As in a market-price project, the affordable-housing developer can borrow money against this revenue, but the project’s income is restricted by HUD regulations, which limits the amount of rent (or mortgage payments) the developer can charge to 28 percent of the customer’s monthly income. At 60 percent AMI, for example, a two-bedroom unit at the Lokahi Apartments rents for only $833. That’s what makes it affordable. But these rent rules limit the property’s income and the debt it can support. Moreover, the lender will usually only permit an 85 percent debt-to-income ratio, reserving the remaining 15 percent as cash flow to cover operating costs and profit. Thus, the $60.6 million Lokahi Apartment project could only secure $19.2 million in permanent financing, less than a third of the development’s total cost. The balance had to be painstakingly cobbled together from federal and state subsidies and loans. In fact, for the typical two-bedroom affordable rental unit, the state has to kick in another $150,000.

Putting the financing together is a slow process. One EAH project in Ewa has been in planning for 10 years. Maeva eschewed the cumbersome 9 percent LIHTC credits altogether, opting instead for the state’s low-interest Hula Mae loan program, in which HHFDC issues tax-exempt bonds to help finance affordable-housing projects. An added bonus is that participants automatically qualify for 4 percent LIHTC tax credits.

Regulatory dance

Government regulations also provide incentives for and hindrances to development. For rental properties, the most important are the federal, state and county regulations that affect the affordability period of a development. Since any affordable-housing project exists only because of public subsidies, it seems fair to require the developer to keep the project affordable for a reasonable period. Of course, “reasonable” means different things to different people, and today it ranges from 20 years to 60 or more.

The need for these rules became clear in 2006 when the owners of the state’s largest affordable-housing project announced plans to sell when it came out of its 20-year affordability period in 2011. The planned sale of Kukui Gardens by the Clarence T. C. Ching Foundation would have put nearly 2,500 tenants out of affordable housing. Only the investment of more than $50 million by the state – along with extensive tax breaks and bond support and a partnership with nonprofit developer EAH – preserved the project. But EAH vice president Carney acknowledges Kukui Gardens is just the tip of the iceberg. “The low-income rental industry loses two apartments for every one that’s being built.”

Some affordability advocates, like Chuck Wathen, argue that the affordability period for rental housing shouldn’t end. Maeva isn’t one of them. “I say things shouldn’t be affordable in perpetuity,” she says, “because, if there’s no risk the thing will become market (rentals), then there’s no incentive to go in and rehabilitate it. What you’re then creating are really ghettos and public housing. You need to identify and recognize the finite lifecycle of a piece of wood and the termites’ appetite for that. If there’s no risk it’s going to turn into condos, then it’s not going to get any political attention. It’s not going to get any attention from new developers. And, at some point in time, everything needs to get redeveloped.”

Although Wathen clearly admires Maeva, he’s not convinced by her arguments. “Let me explain it to you this way,” he says. “When you develop these projects and you sell the tax credits to the investor, after 10 years, when they’ve got their write-off, they don’t want to hear about this project anymore. They want it off their balance sheet. They want to get rid of it. That means the developer gets the residuals of whatever you make after 15 years.” He says the Ching Foundation got a $148 million windfall from Kukui Gardens. Wathen asks, “Should private developers profit from public investment?”

The affordability period of rental housing has its analogs on the for-sale side. There, in exchange for opportunity to purchase below market-rate housing, the buyer agrees to terms like buy-back provisions and shared appreciation equity. Buy-back provisions give HHFTC the right to buy the property back at a designated price if the owner chooses to sell within 10 years. This strategy prevents flipping. Similarly, the shared-appreciation equity program requires the owner to share any appreciation in equity with HHFTC when the property is sold. The percentage share is established in the sales contract, and unlike the buy-back clause, never lapses. Like the affordability period, these tools are designed to preserve affordable housing.

In many ways, though, the availability of for-sale affordable housing is much more affected by state and county regulations that require a developer include a certain percentage of affordable housing in market-rate development plans. In Honolulu, this so-called inclusionary housing requirement is usually 20 percent. For the most part, these rules apply to any developer seeking rezoning or a variance, and the logic is clear: In exchange for the public’s permission to build, you must contribute affordable housing. But it’s not clear at all that inclusionary housing has resulted in more affordables.

Even Carney notes: “The tradition in Hawaii has been for major developers – your Castle & Cookes, your Gentrys – to supply the for-sale product of workforce housing. But nothing is free. They pay for that by increasing the cost of market housing.” Which raises an ethical question: If we, as a state, decide that affordable housing serves a critical community need, shouldn’t the costs of that service be born by the community at large? Yet, as Carney notes, under the current system of inclusionary housing, those costs are placed only on the other residents of the new development. This not only puts an unfair burden on new buyers (or renters,) the added cost is also a disincentive to building affordable housing. If 20 percent of your units have to be subsidized (to the tune of $150,000 each), it’s hard to make enough profit on the remaining units to justify the investment.

Is there another way?

Other strategies have been tried. During the Fasi administration, the city was a successful developer of affordable housing. Projects like Chinatown Gateway Plaza, Hale Pauahi Towers and Marin Tower in Chinatown are testaments to the viability of mixed-income development. Similarly, the controversial project proposed for River Street is also on city land. It’s true that those earlier projects were built when the city was flush and there was a civic commitment to affordable housing. Nevertheless, city development might be updated to suit the needs of today. Certainly, spreading the cost of affordable housing across the tax base is more equitable than foisting it on a few new buyers. It’s also less likely to discourage market-rate development.

The state has also been an affordable housing developer. Twenty years ago, when it began development of the Villages of Kapolei, it built out the infrastructure and provided developers with ready-to-build sites. In exchange, the state required those developers to make 60 percent of their units affordables. This project created thousands of affordable units, although, in practice, the 60/40 split didn’t work out financially for the developers. Nevertheless, the process might help circumvent some of the lengthy and costly aspects of getting permits and entitlements.

It may be that the best hope for increasing affordable housing is simply to make it easier for developers, even market-rate developers, to build. If you ask affordable-housing developers – whether specialists, like EAH and the VitusGroup, or large-scale community developers like Castle & Cooke and Stanford Carr – what’s the biggest problem in creating affordable housing, almost unanimously they say it’s the shortage of entitled land. That’s why there simply aren’t enough homes being built. Bruce Barrett, executive vice president for Castle & Cooke, puts it this way, “From a developer’s perspective, the lack of supply is the major issue that limits affordability.” He points out that, during the last housing bubble, the median home price on Oahu essentially doubled. “Why did it double? Because we’re building less housing stock now than we did in the 1950s.”

Which is not to say that subsidies don’t have a role to play. Jesse Wu, vice president at Stanford Carr Development, which has major affordable-housing projects in both Kakaako and Ewa, says, “The production of affordable housing is really limited by the amount of subsidy available. For most of these units, even when the land is free, we’re putting together $80,000 to $100,000 per unit to bridge the differential between what it costs to build the unit and what we charge as affordable rent.”

Courage of their convictions

Another impediment to affordable housing is when politicians and bureaucrats get in the way. During the early stages of the Lokahi Apartments project, Maeva voiced two common frustrations when the Hawaii County Council considered delaying a rezoning vote. “I said, ‘Pardon me, but everyone here acts like you’re into affordable housing, acts like you think it’s a need. Everybody got a bruddah bruddah who lives in a car, everybody got somebody no more job, everybody got a story. I say, to do nothing is a vote ‘No.’ It should go on the record that you’re against affordable housing.’

“ ‘You’re trying to make me solve all kinds of other problems. Saying, ‘Oh, there’s going to be increased traffic because of this affordable housing;’ ‘Oh, you need to increase the sewer system;’ ‘Are you sure we don’t need more parking?’ But I’m not here to solve every problem you have in the County of Hawaii. I didn’t create them and I’m not making that kind of money. I’m saying I can help you solve your affordable-housing problem; if there are other problems, that’s your kuleana.’ ”

In other words, shut up and let me build.

 

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Hawaiian Electric Transformers

BY DENNIS HOLLIER

     From left: Lynne Unemori, Darcy Endo-Omoto, 
     Tayne Sekimura and Dave Waller 
     Photos: Rae Huo

“You can’t run an operational company like this without leadership that’s experienced in operational issues,” says Robbie Alm, executive vice president for Hawaiian Electric Co. “That’s not me. That was never going to be me.”

Alm isn’t being modest. He’s trying to explain the origins of the Clean Energy Team, a small cadre of company engineers, planners and policy wonks who are behind the greatest corporate transformation the Islands have seen in decades. The changes began two years ago, Alm says. That’s when the utility signed the historic Hawaii Clean Energy Initiative (HCEI) with the governor, and agreed to some audacious goals, including a legal commitment that, by 2030, 40 percent of its power generation would come from renewable energy.

It was the technological, structural and regulatory challenges of meeting these goals that gave birth to the Clean Energy Team. But Alm believes that the leaders of this group, 10 mid-level managers and young vice presidents, will lead the company far into the future. He also believes one of them is likely to be its next CEO.

A Top 250 Leader

Hawaiian Electric Industries – parent company of the electric utilities HECO, MECO and HELCO, and American Savings Bank – has been in the first, second or third spot on the Top 250 since 1990. In the 1980s, the parent company always ranked fourth or fifth.

 How it Started

In the years leading up to the Clean Energy Initiative, HECO (along with its Neighbor Island partners, MECO and HELCO) found itself increasingly beleaguered. Its public image had been battered by a series of highly publicized conflicts over issues like the construction of transmission lines on Waahila Ridge and the expansion of power plants at Kahe and Keahole. There was also a sense among the public that the company’s existing clean-energy programs were just empty gestures. “The company found itself in fairly unhappy straits,” Alm says. “The editorial writers were against us, the Legislature wasn’t happy about us, and the environmental and historic preservation groups were against us.”

The company also had built-in financial problems. As HECO chair Connie Lau points out, the company’s efficiency programs and changes in technology meant that even when the economy was expanding, and costs increasing, sales declined steadily. In fact, net revenues have declined in each of the last six years. And, as Lau notes, although the company is allowed by statute to earn 10 percent profits, by 2008 they had fallen below 4 percent.

“If you look at the late 1990s,” says Alm, “we were kind of booming. By the 2000s, though, the economy’s not doing so well. The stock market took that tech dive, interest rates went way down, and we hadn’t been in for a rate case in quite awhile. Financially, the company was challenged. And we weren’t helped at all by being so unpopular with the public. People used words like ‘arrogant,’ ‘monolithic’ and ‘oil-addicted’ to describe us.

“And then, Linda Lingle comes in,” Alm adds, “and she clearly doesn’t like us. If you go back and read her speeches, particularly those leading up to the 2006 legislative session, we were sort of public enemy No. 1. Again, it was our addiction to oil and unwillingness to change.” It wasn’t just idle complaining; the Lingle administration was clearly taking Hawaii’s dependence on fossil fuels seriously. “So, in the 2006 legislative session,” Alm says, “she had those big bills to alter the playing field. And a lot of it passed.”

Maurice Kaya, the former state energy administrator and one of the original authors of the HCEI, points out that some of those laws were transformational. “One,” he says, “was the recognition that the efficiency programs, which were run by the electric utility, were sort of the fox guarding the henhouse. So that was taken away from them. In that same context, we were able to convince the Legislature that there was really no business motivation for the utility to change their ways and get off oil.” In short, Kaya paints a picture of a company financially and structurally unprepared for a clean energy future. It was hard to avoid the perception that the 109-year-old utility was in decline.

So in 2007, when Kaya and Bill Parks, the Department of Energy official who helped write the HCEI, came to Alm with a proposal to radically transform the state’s energy system, it’s not surprising that the utility was interested. In the fall of 2008, after its due diligence, Hawaiian Electric signed on. All that was left was the execution.

     Dan Giovanni (left) and Robert YoungOperations Team

Operations Team

The nuts and bolts of utility work are in operations. That’s what happens in the big power plants, on the vast networks of transmission lines, on the distribution grids that feed electricity to the customer, and in the master control room that oversees it all. Operations is also usually the lair of the most conservative, risk-averse engineers.

At HECO, though, operations is a hotbed of experimentation. It’s the crucible for the schemes and analyses of planners. It’s where the formulations of policy makers and regulators are put to the test. It’s also the site of a remarkable little research and development program into the use of biofuels in traditional steam generators. It’s a good thing, too, because renewable biofuels are a critical part of the company’s clean-energy plans, and it’s hard to see any of those plans without the strong support of operations.

Dan Giovanni
Age:
 62
Title: Manager, Generation Department

 

Clean-Energy Responsibilities: Conducting R&D and developing operational plans to convert HECO’s existing fleet of generators to use biofuels.

“The devil’s in the details,” says Giovanni, explaining some of the difficulties of converting from fossil fuels to biofuel. “It means a lot more than asking: ‘What’s the price?’ ‘Does it meet sustainability criteria?’ ‘Can we get it here in time and in volume?’ Those are the simple questions.” The more important questions, at least for an operations guy like Giovanni, are the technical ones. “ ‘How will it behave once we commit to it operationally within our infrastructure?’ ”

Giovanni is leading the utility’s own little R&D program into that question. “We’re going to take one of our largest and most important generating units and operate it for a month on biofuels – 30 days, 24/7. It’s a $12 million test: $5 million worth of equipment, $5 million worth of biofuel, and about $2 million worth of experts from around the world to do the testing and analysis. They’ll look at the environmental impacts, the combustion impacts, the thermal and performance impacts, and the fuel stability question. There’s no shortage of technical questions. But I can tell you this: Six months from now, our team will be the most informed people in the world on how to use biofuels in a conventional steam power plant.”

Robert Young
Age: 
55
Title: Manager, Systems Operations

 

Clean-Energy Responsibilities: Run the operations center so the grid can reliably incorporate the most renewable energy possible.

Part of the idea of the Clean Energy Team is the inclusion of operations guys like Young and Giovanni in the mix. Like all the engineers on the team, they have a fundamental grasp of the tension inherent between adding more and more intermittent energy sources, like wind and solar, and maintaining inexpensive, reliable power for customers.

“There’s this conflict,” Young says. “We have to protect the system, but we know that if we don’t do anything, eventually we’ll be subject to higher and higher fuel prices that will drive the cost of electricity up.” He points out that this tension chaffs the fundamental conservatism of engineers.

“Being in operations, I’d like to see more stable resources,” he says. Like Giovanni, he sees biofuels as a critical part of dealing with the intermittency of most renewables. “The fallback really is that some generation sources have to burn some form of fuel. Biofuel is a way to get off crude oil.” And Giovanni’s research program has provided him some hope for clean energy.

“In the beginning, there was a pretty high level of anxiety for us engineers,” he says. “The unknown is always daunting. But, from the operating side, as we’re working through things, the comfort level is getting better.”

The Planners

For nearly 100 years, the basic model of an electric-power utility has been relatively simple: Produce electricity in power plants and send it to customers through transmission and distribution lines owned by the utility. If customers need more electricity, fire up another generator. If demand drops, reduce production. This model fit well with the physics of electricity, which require that production and demand move in unison.

But the clean-energy future is less predictable. It’s going to include generation, like wind and solar power, that can’t be fired up at will, and won’t be controlled by the utility anyway. The same opacity will apply to customers as well, many of whom will generate some of their own power. This intermittent, unpredictable power is the bugbear for modern utility engineers, whose principal objective is to produce reliable, high-quality power for their customers.

Some of the key players on the Clean Energy Team are the planners who struggle to cope with this conundrum. It’s their job to design the systems and acquire the resources that will allow the company to integrate ever more renewable energy sources onto the grid without the customer – that’s you and me – even noticing.

Colton Ching
Age:
 43
Title: Manager, Corporate Planning

Clean-Energy Responsibilities: Long-range planning to ensure the company has the generation, transmission and program resources to meet its renewable-energy goals and maintain reliability.

“My group has a hodge-podge of responsibilities,” Ching says. “Part if it is internally focused: We do strategic planning for the company. That includes a lot of internal reporting and risk assessment. But the other half of my department is externally focused: planning – we’re talking 20-year planning – related to long-term use of resources in the system. What are our future needs going to be for transmission? For new generation? What kinds of new demand-side management programs should be deployed? And, most important, how would those resources work together so that we can develop some long-range plans to serve our customers?”

Ching describes how the work of his group dovetails with the work of Leon Roose and Scott Seu, the other key planners on the Clean Energy Team. “I’m going to oversimplify this, but the real focus of Leon’s group is to look at the integration of these new resources on our grid, to look at the math, science and actual day-to-day, minute-to-minute, second-to-second type of solutions to answer the question of how you connect a large wind farm or a lot of PV (photovoltaic solar) power to the grid. How do you make use of their energy, but maintain reliability to the customer. It’s very technical, very focused on shorter time frames.

“My planners look at a broader time scale – from an hours perspective up to a multiyear perspective. And because our time frames are so different, the tools that we use and the analyses we perform are very different. But Leon and his folks and me and my folks, we’re literally joined at the hip. Because we have to look at all these time scales when we plan our system.”

Ching also notes that members of the Clean Energy Team have a responsibility to help change the culture within the company. “Aside from the technical, operational and planning things that all of us are tasked with, we have to affect that sort of change in the rest of the employees as well. We’re the saints that have to spread that gospel.”

Leon Roose
Age:
 44
Title: Manager, System Integration Department

Clean-Energy Responsibilities: Analyzes the potential effects of integrating new renewable-energy sources into the grid, and develops implementation strategies using technologies like the interisland cable, smart grid and advanced metering systems.

Roose’s role on the Clean Energy Team is to figure out what it will take to add new, renewable generation to the system. That turns out to be much more complicated than it seems. “Some people think: ‘It’s a small island system; it must be simple,’ ” Roose says. “But it’s completely the opposite. When you’re a small grid, the physics of electricity are actually more complex, because it’s easier to upset the grid when a small disturbance happens.” It’s his job to make sure that doesn’t happen.

It helps that over the years he’s held most of the planning positions in the company. Now, with systems integration, he is responsible for transmission planning and generation planning. “And I’ve added to those functions the planning for what we call our distribution grid,” he says. “Which means I’m responsible for system protection. That’s how we put in relays and other things on our lines so, when you have a problem, it protects the equipment as well as the public.” These kinds of devices and strategies are also going to be a big part of the smart grid, he says, and that’s the real future of integrating the dramatic amounts of renewables on the grid.

Scott Seu
Age: 44
Title: Manager, Resource Acquisition Department

Clean-Energy Responsibilities: Using tools like power-purchase agreements and feed-in tariffs to negotiate and purchase as much renewable energy as possible.
 

If it’s Roose’s job to figure out how to integrate renewable energy sources onto the grid, it’s Seu’s to actually go out and buy it. That means everything from putting out the requests for proposals and negotiating the power-purchase agreements, to actually administering the contracts. It’s a remarkable commitment to clean energy. “People say ‘seamless,’ ” Seu jokes, “But we’ve still got a few seams to work on.”

In many ways, the leading edge of the clean-energy future is the relationship between the utility and the independent wind farms and photovoltaic arrays and other renewable-energy sources that the HCEI envisions. As Seu points out, feed-in tariffs will help to formalize that relationship, and he’s been a key member of the negotiations on the docket now before the PUC. “As we got into details,” he says, “it quickly became about much more than just distribution issues. It got into talking about all the details of how you develop contracts for renewable-energy resources.”

After all, one of the principal tenets of a feed-in tariff is that the price of these new sources should no longer be tied to the price of oil. “So what should be the appropriate price?” Seu asks. “We want to come up with a fare that will be fair to the developer and pay them a reasonable profit. Yet, at the same time, all that is going to be paid by our customers.”

His point, though, is clear: “I don’t think we’re ever going to build a brand new fossil-fuel power plant again.”

Ron Cox
Age: 53
Title: Manager, Energy Solutions Department

Clean-Energy Responsibilities: Help customers minimize energy use and reduce their bills through programs like demand-side management and the application of advanced technologies.

 Although renewable-energy sources, like solar, wind and biofuels, may seem sexy, in the short term, conservation and greater efficiency will likely play a greater role in helping the state reach its clean-energy goals. It’s Cox’s role to expand and reinforce programs like Energy Scout that help customers reduce the energy they need from HECO.

But like many on the team, Cox brings a breadth of experience that’s invaluable in the group’s customary give and take. He came to the utility after a career in the nuclear Navy. “My first year with the company, I was in operations doing strategic planning,” he says. Then he moved into power purchasing and fuel contracts, including going through the regulatory approval process for critical issues, like biofuels. In fact, this expansion of responsibilities gets to the heart of the Clean Energy Team, Cox says. “This is just the recognition that we needed to make some organizational changes. Today, we literally have three managers doing what I used to do. One manager does nothing but buy biofuels, another manager does traditional fuels and another does power purchase contracts.”

According to Cox, this is a sign of the company’s commitment to clean energy “We’re out there on the leading – sometimes bleeding – edge of trying to implement change. For example, I don’t think any other state has set a target of 40 percent renewables as early as 2030.”

Public Face of Change

Of course, careful planning and resourceful operations are essential to the company meeting its clean-energy goals. But they’re not sufficient. The ambitions enshrined in the HCEI will require a partnership between the utility and the community. It means going out and engaging the public. It means accounting for people’s skepticism and managing their expectations. And it means focusing on customers and service as much as technology and policy.

In some ways, this perspective is built into all parts of the Clean Energy Team. Operations and planners, for example, are already obsessed with reliability and customer service programs. But the team also includes members whose principal focus is how the company’s clean-energy plans impact public and customer relations.

Lynne Unemori
Age: 50
Title: Vice President, Corporate Relations

Clean-Energy Responsibilities: Communicate the company’s green objectives, to both employees and the public.

Unemori points out that there’s both an internal and external aspect to communicating the company’s clean energy goals. Internally, she says, it’s important that employees realize these goals aren’t just window dressing; they represent the utility’s future. “It’s critical to make sure they understand our mission, our vision of what the goals are, how we’re going to stay focused. Most important: making it clear that every employee has a role to play in our future.” Unemori also acknowledges that the company has to communicate that same sense of conviction and commitment to a skeptical public.

That public – the ratepayers and taxpayers who will ultimately underwrite the goals of the HCEI – has to know they have a stake in the process. “Another key message,” Unemori says, “One, I think isn’t always easy – is that we have to make investments in order to harvest this energy, to get the infrastructure in place, to be able to reliably include renewables. This investment will come with a price tag, too. But, if you look at it in a bigger context, it makes a lot of sense.”

Dave Waller
Age: 61
Title: Vice President, Customer Service

Clean-Energy Responsibilities: Ensure that the company’s clean-energy programs, like demand-side management or net metering, operate seamlessly for customers.

Waller, who had an earlier career in the petroleum industry, brings a unique perspective to the team. Ultimately, he says, clean energy, like anything else the company does, has to benefit the customer. “Really, to affect all the change that we’re looking for, the customer plays a very important role in that process. What we really want to do is make sure that, in every product, every service, every interaction with the customer, we execute that with clean energy in mind.”

Although it’s tempting to envision the work of the Clean Energy Team in a technological or regulatory framework, Waller notes, “The effects and the work of clean energy really don’t happen until they happen in the customer’s place of business or at the customer’s home.”

Regulatory Dance

In large measure, the future of the utility is in the hands of the Public Utilities Commission. Its shape will be decided through an unprecedented welter of dockets before the commission. The most important – the feed-in tariff and decoupling – which the commission has already agreed to in principle, represent revolutionary changes in the way the company does business. The feed-in tariff will encourage the development of ever more renewable power by establishing in advance the price the utility will pay independent producers. Decoupling removes the perverse incentive to sell more, not less power. It does this by decoupling the company’s income from sales; instead, the company will be rewarded for encouraging conservation and adopting more renewable-energy sources.

Of course, that’s the theory. But figuring out the details of these regulatory changes is the primary responsibility of a couple of members of the Clean Energy Team. In fact, the regulatory framework is so important that almost every member of the team has participated in planning and negotiating the PUC’s final ruling.

Darcy Endo-Omoto
Age: 46
Title: Vice President, Government and Community Affairs

Clean-Energy Responsibilities: Work with the Public Utilities Commission and Hawaii’s consumer advocate to develop a sound, clean-energy regulatory structure.

As a regulated utility, none of HECO’s ambitious plans can happen without the approval of the PUC. That’s the bailiwick of Endo-Omoto. “When you put the whole puzzle together, I have the regulatory part,” she says. “I’m also responsible for government relations, which is the liaison between us and the Legislature, the (state) administration, the City Council and the federal side. Also under my area: We do all community relations – neighborhood boards, etc.”

“I think we have to take these aggressive steps, not only because of what state law requires of us in terms of our renewable portfolio standards, but also because of what I can see happening on a national level with respect to climate change and global warming.”

Tayne Sekimura
Age: 48
Title: Senior Vice President and Chief Financial Officer

Clean-Energy Responsibilities: Ensure that clean-energy plans, especially decoupling and feed-in tariffs, leave the company on a sound financial footing.

For regulated industries like HECO, it’s sometimes easy to forget they’re publicly traded companies that still have to make a profit for their investors. As CFO, Sekimura’s role on the team is largely to ensure that, in the rush to meet the company’s clean-energy goals, they don’t lose sight of those basic corporate responsibilities. “I’ve still got to be able to recover costs,” she says. “I can’t give away the candy store.”

The clean-energy agreement inevitably will mean new structures, new financial models for the company. But, as Sekimura notes, they still have to make economic sense. “It’s my job, as financial steward of this company, to make sure, when we go down these paths, that it’s not devastating from a financial standpoint,” she says. It’s a perspective that colors how she negotiates issues like decoupling and feed-in tariffs. “These are not just financial instruments for the sake of increasing profits,” she says. “They’re really the underpinnings of a financially healthy utility that’s able to do these new things and, at the same time, be a supplier of reliable electric power.”

 

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Building Wealth: A broker’s guide to real estate investment

BY DENNIS HOLLIER

So you want to be a real estate tycoon?

     (27) 1 Bedroom Units $3,9750,000 (FS)
     Photo: Kevin BlitzSo, you want to be a real estate tycoon?

If there’s one thing we’ve learned from two years of stagnation in Hawaii’s real estate market, it’s that there’s more to investing than simply buying low and selling high. That’s speculation. Experts will tell you investment is much more calculated. That means if you want to be a real estate investor, you’ll need to know a lot more. More about the property. More about the market. And, especially, more about yourself. Which is why the brokers who specialize in advising investors often start by asking, “Why do you want to invest in real estate?” In the end, your success as an investor probably depends on the answer to this question.

What Size Investor Are You?

It’s sometimes convenient to think of real estate investors in three categories: beginners – often successful businesspeople – who have saved up money and are looking for a place to park it; medium-size investors who are beginning to see that it’s possible to make a living in real estate; and large, sophisticated investors who sometimes preside over a diverse portfolio of property.

Real estate professionals often elaborate on this theme. For example, Matt Bittick, a prominent local broker who recently founded Bishop Street Commercial, sketches out a matrix of these three kinds of investors. Along one axis, he places investors A, B and C, and along the other axis he puts corresponding larger levels of investments. Of the smaller, A-level investor, he says, “Maybe it’s their first one, or first couple of transactions. They’re definitely putting in less than 50 percent of the equity in a large investment, or buying a much smaller property for a much smaller price.” In any case, they’re usually unsophisticated and acting alone.

     Matt Bittick, Bishop Street Commercial 
     “The B-level investor has also learned a key tool: leveraging the 
     equity in one building to buy others.”
     Photo Courtesy: Matt Bittick

If they continue to invest in real estate, as they accumulate property or experience, they become more efficient. “The B-level investor,” Bittick says, “is the category where you have enough property to handle property management in-house. This investor is kind of developing a team that he can support from the income that the property produces.” The B-level investor has also learned a key tool: leveraging the equity in one building to buy others.

“At the C level,” Bittick says, “you have the capacity to sell and buy any kind of product. You’re able to compete at all levels: It’s being able to buy, sell and close multiple deals with multiple resources on financing, and the capacity to take down larger assets.” To do this usually means having a well-developed professional staff. More importantly, it implies a network of relationships in the investment community. “You may have the relationships to bring in equity partners, relationships with debt partners.” Typically, C-level investors weave an elaborate pattern of corporations, limited partnerships and holding companies out of these relationships.

Bittick sums it up this way: “A, you’re on your own; B, you’ve got managers; C, you’ve got partners.”

Not everyone subscribes to this outline. Some, like Eric Smith, president of local brokerage The Kaulana Corp., thinks the truth is simpler. “I think there are really only two kinds of investors,” he says. “There are active investors who are trying to upgrade or increase the value, or otherwise create more than they bought. And then there are passive investors who buy products that have a cash flow. They’re not looking to dramatically change the property one way or the other.”

Smith, like many brokers, is also an investor and developer. And although he, like many of his peers, prefers to hold his cards close to the vest, he gives a short list of examples from Kaulana’s portfolio: “We had a building in Kaimuki. We fixed it up, re-tenanted it, held it for a long time, and then we sold it. We have a property in Kalihi that we renovated and we’re looking to redevelop, to add value. We have a property in Waipahu that we increased the value on; now we’re asset managing it. We did a small deal up in Kunia where we changed the use of a retail building and then we sold it.” In other words, there are many ways to approach real estate, but, as an active investor, Kaulana’s strategy is always to add value.

Other brokers see investors as a more diverse group. “I see many more levels than that, personally,” says Ray Hulick, president of Commercial Real Estate Services. “I’m a real transactional commercial broker, so I see a lot of transactions.” He points out that people invest in real estate for many different reasons. “There are some people who may make a living at it, who invest in themselves, and are very successful at it,” Hulick says. These people correspond neatly with Bittick’s A- and B-level investors. Hulick also describes some of the C-level investors: “There are larger companies that need larger acquisitions to fuel the corporate structure. They have to constantly make acquisitions.” But he notes that there are other investors who blur the lines: wealthy, sophisticated businessmen who decide to take a stab at real estate; kamaaina families trying to diversify their portfolios; or serial investors who buy one property, fix it up, sell it, and move on to the next. “And I represent a lot of business people who just want to buy a building to move their business into,” Hulick says.

But he agrees with Smith’s distinction between active and passive investors. “Most sophisticated investors are looking to convert the property to create value,” he says. Real estate professionals call this yielding. “Some of the stuff that was really successful several years ago was when people were buying warehouses and converting them into retail space.” This kind of change means you can charge higher rents, raising the building’s income stream – in effect, increasing its yield. “And when you’re dealing with sophisticated investors in larger acquisitions, they’re looking at several different ways to create profit centers so it works for them,” Hulick says. Frequently, for example, they know their experience and economies of scale mean they can manage the building better and cheaper. One thing is certain, though: They run their numbers scrupulously.

Anatomy of an Investment

Most brokers say that inexperienced investors have no idea how much work goes into real estate investment. “The biggest area they don’t understand,” says Hulick, “is the due-diligence side – what it takes to thoroughly analyze a property to make sure you minimize your risk. That means really understanding what it’s all about: knowing if the building has economic problems, obsolescence problems or environmental problems, what its intended use is for the investor.” He points out that all of this information comes with a price. “If you’re really going to do an acquisition correctly, you really need to hire some people and spend some money during what they call the inspection period. So it costs you money. It may cost you thousands of dollars to inspect it to make sure what you’re buying is real.”

Much of this means relying on other professionals. “That means you’re probably going to buy a Phase-I environmental report to make sure there’s no bad dirt,” Hulick says. “You may or may not need that for financing from a bank. You’ll want to have an architect walk through to make sure there are no code violations. You’ll want to make sure you understand the condition and shape of the building – what they call its functional obsolescence – when a building needs a new roof, or it’s not laid out correctly for the market, and what it’s going to cost to convert it.”

Hulick adds that the same kind of due diligence goes into the existing tenants, if any. They represent the building’s prospective cash flow. “You want to understand if the rent is above or below market, what’s going to happen when the lease reopens, and how your investment is going to be treated. So the strength of the tenant is critical. And in a downtown office building, you might have 40 to 100 tenants in your portfolio. You’d have to look at each one and make sure each is meeting its objectives, paying its rent on time. You have to consider all of this to understand how this investment is going to yield over the next five to 10 years.”

All this effort separates the true investor from the dabbler. But it’s expensive. “You’re probably going to spend between $5,000 and $15,000 to consider buying a building,” Hulick says. Maybe more important is the cost in time, and serious investors must balance these costs with the potential rewards. Developers like Kaulana, for example, receive numerous offers over the transom. “We get sent maybe 100 properties a month,” Smith says. “Of the 100, maybe 10 are worth a second look. And of these 10, maybe one deserves serious investigation.” There is, in other words, a lot of weeding in the garden of real estate investment.

That means investors have to be disciplined. “I don’t think you can be successful by just doing the shotgun approach,” says Bittick. “You need to be more calculated. Focus on certain price-range parameters, certain market segments, maybe a certain market area.” With some admiration, he points to Kaulana’s investment strategy. “They wouldn’t bid for large assets. If it’s over $5 million, forget it; I don’t care what the return on investment is. They want to own and operate the asset themselves. It’s got to be on Oahu, probably east of the airport, but not in Hawaii Kai. And it cannot be industrial.” This kind of focus, Bittick points out, is the essence of expertise. “They can learn about that particular kind of real estate and become a mile deep and an inch wide,” he says. “And they can save themselves a lot of time and money.”

Bittick also points out that, as investors grow more sophisticated and add to their team, scale is important. “If you start doing that,” he says, “and you have mouths to feed and salaries to pay, you need a larger property to support that.” In other words, growth usually implies larger, not more, investments.

Hulick puts it another way: “Over time, you realize that it takes just as much work to buy a $3 million building as it does to buy a $25 million building. Same amount of work; same amount of time. So, as you rise through levels of sophistication from a single acquisition to several acquisitions, you realize what bite, or what size, investment fits your needs or your growth criteria.”

One result of this phenomenon is the tendency for Hawaii investors to look to the Mainland once they reach a certain size. In part, this is a way to manage risk. “Their decision is to diversify from just having all their eggs in one Hawaii real estate basket,” Hulick says. But there also simply may not be enough options for them in the Islands. “As investors become more sophisticated, it’s harder and harder for them to find more of the same property in Hawaii. There’s more competition, and the yields may be different. To solve their growth requirements, they may have to go to the Mainland.” That’s certainly been the case for most prominent local investors, from Alexander & Baldwin, to the Shidler Group, to kamaaina family companies such as Watumull Properties.

Why Hawaii is Different

Part of the problem for local investors is that there really are no bargains in Hawaii. In depressed markets like Las Vegas, Southern California, Florida and Phoenix, cash-rich investors are buying foreclosed commercial property at 30 percent or 40 percent discounts. Even given the considerable decline in rents in Hawaii, local investors haven’t seen those kinds of opportunities. One reason is that most large Hawaii landlords have deep pockets. “A lot of these guys are not in any hurry,” says Al Kauwe, president of Kauwe & Associates brokerage. “They’ve paid down their building quite a bit; their debt service is light; and even with a falling income, they can still pay their mortgage. So they’re thinking: ‘Why should I sell?’ It’s still what they call a cash cow.”

Even as prices remain high, cap rates – the income properties generate – are declining. This further dampens enthusiasm for investment. “The big investors,” Kauwe says, “they’re kind of holding off because they’re watching rents drop. Rents in every aspect of commercial real estate – industrial, office and retail – are off, maybe by an average of 30 percent, over the last two years. A lot of the investors are standing by because they don’t want to pay $5 million for a building based on office rents at $1.50 a square foot, and then a year from now find their rents are only $1.25. So they’re waiting for rents to stabilize.”

So, for all you would-be real estate tycoons, these are challenging times. Yet, many brokers evince a strange optimism. Real estate, after all, follows an inevitable cycle of ups and downs – even in Hawaii. Within those cycles lurk tremendous opportunities for those with the means and smarts and daring to exploit them.

“I think we’re in that kind of cyclical path,” says Ray Hulick. “And whether you’re a 50-year-old person or a 20-year-old person, you only have so many cycles of up and down in the stock market or up and down in the real estate market, so you really have to be sensitive to those cycles.” Half in warning, he adds, “Because each cycle may last 10 to 12 years.”

     Photo Courtesy: Peter Savio

Peter Savio’s Seven Creators of Wealth

By Dennis Hollier

Peter Savio, one of Hawaii’s biggest and best-known real estate investors, offers these seven steps to wealth.

“I’m going to tell you how wealth is created in real estate,” Savio says. “If you understand these principles, you’ll know why you want to buy real estate. You’ll know how you can make money when the market is going up, and when the market is going down, because you’ll know where the value is being created.

“Just to put this in context: When I first came into real estate 40 years ago, the house was a brand-new, three-bedroom, two-bath home in Hawaii Kai for $25,000. It was unaffordable. People couldn’t qualify for the loan; they couldn’t save up the down payment, which was an astonishing $2,500; and the monthly payment was an unaffordable $250. Forty years later, that same house is worth $600,000 to $700,000. It was a real struggle to buy that house, but the people who bought it, if they managed their wealth correctly, they’re multimillionaires.

“So, what are the creators of wealth?

“The first wealth creator is the concept of appreciation. That’s the one everyone knows. To use our Hawaii Kai example, our house went from $25,000 to $600,000, so it increased in value $575,000. Almost everyone will tell you we buy real estate because of this appreciation. But that’s not true. Appreciation is simply not the greatest wealth creator; it’s superceded by one of the others by five, 10, 15 times.

“The second wealth creator is the savings account called mortgage. When you think about it, your mortgage is basically a forced savings account. If you take out a $400,000 loan, you’re making a legal promise to save $400,000 over the next 30 years. It’s like a giant piggy bank.

“The next wealth creator is the constant monthly payment. The constant monthly payment is the fact that, when you buy real estate, in effect, you lock in your biggest one-time expense – housing – for 30 years. So, as rents go up, your mortgage payment tends to go up much more slowly. (Although your mortgage stays the same, your insurance and taxes still go up.) So, the person who bought that house for $250 a month in Hawaii Kai, 30 years later is probably only paying $300 a month. But the person who rented for $200 a month because he or she couldn’t afford the $2,500 down payment or the $250 a month mortgage is probably paying $2,000 a month in rent now.

“The fourth creator of wealth is the ability to prepay on the principal on the loan. A lot of people don’t realize that, if you make additional payments on the loan every month – or even just occasionally: $50 here, $100 there, take your $2,000 tax refund and pay it on your principal – it will actually save you tens of thousands of dollars in interest. If you pay an extra $50 or $60 a month, you could take a 30-year loan and bring it down to a 15- or 20-year loan, which means you could save $70,000 to $80,000 in interest. You’re making money by paying it off sooner.

“The next wealth creator is tax savings – the fact that, when you buy real estate, the federal government gives you certain tax advantages. The government subsidizes you anywhere from 15 percent to 25 percent, let’s say, in terms of your monthly payment. So, if you’re renting for $1,000 a month, and struggling, you can probably buy for $1,250 a month and be in the same position. A lot of people don’t understand, that when you pay rent, you’re actually paying twice: You pay rent to the landlord of $1,000, but you also pay $250 in additional taxes to Uncle Sam.

“The sixth creator of wealth is the concept of leverage. Basically, in real estate, you can control a valuable asset for very little cash. Let’s assume you buy a property for $100,000, and you put 10 percent down. That’s $10,000. If you had that $10,000 in the bank at 2 percent, you’d be earning $200 a year. If you take the same $10,000 and buy that $100,000 property and it appreciates the same 2 percent, you earn $2,000. Which deal do you want? Leverage allows you to magnify the return.

“The seventh wealth creator is more complex and it’s going to confuse the hell out of you. Because of the way mortgages are amortized, in effect, when you make principal payments, you’re actually receiving interest, tax-free, on the principal you’ve paid. That’s because, although the amount of your mortgage payment is fixed, each month the amount of interest you pay goes down, and the amount of principal goes up. That’s because you only pay interest on the principal you still owe. Let’s say you borrow $212,400 at 5 percent with a 30-year amortization. Your monthly payment of $1,140 is constant for the whole 30 years. On your first monthly payment, you pay $885 in interest and $255 in principal. The next month, your interest goes to $883, and your principal goes to $257. That extra two dollars added to your principal payment amounts to 5 percent annual interest on the $255 in principal you’ve already paid, tax-free. Every month, this amount goes up, so that, on the last payment, in 2040, you still pay $1,140, but your interest payment is just $5, and your principal payment is $1138. Basically, you’re just paying that to yourself.

“The wealth creators are the same whether you’re buying a home or investing. But, on the investing side, the tax savings is even greater. That’s because, in addition to being able to deduct the interest, the property taxes, and the mortgage insurance, if any, you now get to deduct the maintenance, the advertising, the repairs, even the gas you use to drive over to check on the unit – all the expenses you get to deduct because it’s a business.

“On top of all those deductions, the government also tells you that, by law, your unit is losing value because it’s getting older. So, you depreciate it on your taxes, which gives you another three, four, five thousand dollars. So, the investor has an eighth and ninth wealth creator: additional tax savings and depreciation.

So, of all those wealth creators, which one do you think is the most important? The greatest wealth creator is the constant monthly payment. Because you’ve locked in your rent, as your income goes up, you can use that money to buy stocks, buy bonds, save up and buy real estate, pay off your loan sooner – it will all create wealth for you.”

 

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The Billion Dollar Gamble: State Investment

BY DENNIS HOLLIER

Photo: istockphoto.com

What a difference a billion dollars makes.

Until recently, the state treasury – officially, the Treasury Management Branch of the Financial Administration Division of the Department of Budget and Finance – has operated in relative obscurity. With its staff of seven or eight employees, the treasury acts as cash manager for the state government. Its primary responsibility is to make sure the state always has enough cash reserves to meet its ongoing obligations: payroll, debt service, pension contributions, etc.

The treasury also manages the day-to-day investment of so-called excess funds: monies collected, but not yet spent, by state agencies. As it happens, that’s a lot of money – more than $3 billion at last count. Even so, these investments are hardly sexy, consisting mostly of safe, low-yield, highly liquid instruments like U.S Treasury securities, Federal Agency securities, collateralized CDs and something called SLARS, student loan auction rate securities. In other words: boring, boring, boring.

Then, in February 2008, the market for those auction rate securities collapsed. Overnight, the state’s $1 billion investment in SLARS ceased to be either safe or liquid. And suddenly, the treasury didn’t seem so boring after all.

Where the money goes

So, where did it go wrong? Georgina Kawamura, director of the Department of Budget and Finance, and the official state treasurer, describes treasury operations as a juggling act. “Here’s the day,” she says. “We get daily reports from the banks to let us know our ‘checking account’ balance. We also know, on a daily basis, what investments will mature.” These figures, combined with information about payments that will go out, constitute the calculus of the day’s excess funds, the funds available for investment. This begins yet another juggling act.

For the most part, treasury investments are scheduled to mature around large payments. Scott Kami, administrator of the Financial Administration Division (FAD), which oversees day-to-day operations of the treasury, gives the example of payday. Payroll, he says, averages about $8 million per pay period. “Normally, we schedule about half of that to mature on Friday, and the other half to mature on the following Monday. Because, historically, that’s how the checks clear.”

Armed with that information, treasury accountants can now contact brokers, banks and other financial institutions to find investment opportunities. In this way, the treasury’s responsibilities of cash management and investing are always intertwined. Every debt obligation and every dollar of excess cash must be meticulously tracked because, as Kawamura points out, “All the money is invested. All of it is earning interest.”

And yet, in a scathing report on the Department of Budget and Finance released in March, state auditor Marion Higa turns most of these mundane details on their head. For example, the treasury uses an almost indecipherable, handwritten, color-coded monthly calendar to monitor its investments. It calculates excess cash from manually prepared worksheets rather than electronic spreadsheets like Excel. And it deals with brokers through a decidedly informal system of e-mail and faxes.

Still worse, Higa says, is the treasury’s lack of oversight. The report notes that the FAD failed to prepare and review bank reconciliations, failed to produce a monthly investment report, and routinely allowed investment classes to exceed their statutory limits. In her view, it was this lax supervision that allowed the SLARS calamity. When the independent accounting firm Accuity conducted the state’s fiscal year 2008 certified annual financial report, it also said flawed internal controls led to the SLARS purchase. In her report, Higa points out that treasury staff never even saw the offering documents for these investments. Those documents clearly state many of the risks pertaining to SLARS.

The state uses a handwritten monthly calendar to monitor the
treasury’s $3 billion portfolio.

What Are SLARS?

Auction rate securities are basically debt instruments consisting of bundles of securities – in this case, student loans. The interest rates are set through periodic auctions: sellers offer securities at the lowest rate they’re willing to accept; buyers indicate the highest rate they’re willing to pay and how many they want to buy at that rate. This process is designed to determine the lowest interest rate at which all available shares of a security can be sold at par. This is called the clearing rate, and it serves as the interest rate for that entire issue of SLARS until the next auction. In the event an auction fails, the rate is set based on a pre-established relationship to some benchmark, usually the London Interbank Offered Rate, or LIBOR. Naturally, brokers assure buyers that auctions never fail.

To be fair, these auctions appeared to work efficiently for more than 20 years. And because the auctions usually happened every seven, 28 or 35 days, investors like the state treasury could treat SLARS as liquid investments, even though the underlying securities might not mature for 35 years. But sustaining that liquidity meant that all the available SLARS had to sell at every auction. That didn’t always happen, but the underwriting broker quietly bought enough to keep the auction from failing. Between auctions, brokers often tried to unload these securities on their customers.

Nevertheless, in 2007, when the financial markets began to implode, these securities began to accumulate on the wire-houses’ books, and brokers regarded them nervously. They encouraged their sales divisions to push ARS aggressively, even though insiders knew the auctions were becoming tenuous. Another sign of some distress in the market was the steady increase in interest rates, which, in the case of SLARS, eventually reached 7.35 percent (compared with 2.07 percent for two-year CDs.) For most investors, higher interest rates reflect higher risk. And yet, in the six months leading up to the market failure, the Hawaii treasury’s holdings in SLARS went from $427 million to over $1 billion, and from just 14 percent of the state’s portfolio to nearly 30 percent.

Of course, the state of Hawaii wasn’t the only investor surprised by the failure of the ARS market. Thousands of individuals and hundreds of institutional investors were caught off guard. A diverse group of government entities – states, counties, water-district boards, et al. – now found themselves stuck with these now long-term investments. Although most individual investors eventually recouped their investments through settlements with the wire houses that underwrote the auctions and government regulators, institutional investors have been obliged to write down their ARS as part of the “mark to market” standards of generally accepted accounting practices. In the summer of 2008, for example, the state acknowledged a $114 million impairment on its certified annual financial report as a result of its SLARS holdings. Though Hawaii may have the largest holdings, it hasn’t taken the worst blow. Jefferson County, Ala., is verging on bankruptcy due to the failure of the auctions.

Closer to home, Maui County found itself stuck with more than $30 million in SLARS when the market crashed. Like the state, Maui seems to have relied on assurances by a broker, in this case, Merrill Lynch, that these were highly liquid securities. Also like the state, Maui invested heavily in SLARS in the months leading up to the market failure.

Different Responses

Despite the similarities between Maui and the state, there have been striking differences in how they responded to the SLARS debacle. For example, the state continues to defend its investment. “The one thing that gets lost in this whole discussion about ARS,” says Scott Kami, “is that the securities themselves are very sound investments. There hasn’t been any default on them, and we continue to get all our interest paid when it comes due.” Moreover, he says, the yield on the state’s ARS, approximately 1.9 percent, is higher than that earned by the state’s other investments. He points out the yield on 30-day CDs is almost zero.

Kawamura takes another tack. “I think people have put too much emphasis on the write-down,” she says. “Everyone thinks we’ve lost money. We have not.” She acknowledges that accounting principles required the state to estimate an impairment on its SLARS holdings. She also admits that if the state were to sell its holdings today, it would likely incur an additional $250 million loss. But Kawamura views these as purely paper losses. “That’s assuming that you’re going to sell,” she says. “Of course, we haven’t sold, and we don’t intend to.”

But Maui County treasurer Suzanne Doodan is not convinced by the state’s arguments. “I spouted those same lines for the first few months,” she says. “But these are no longer short-term instruments; you have to compare them to 30-year investments.” So, while the state’s 1.9 percent yields on SLARS may look good compared to current rates for bank repos or short-term CDs, they’re low even compared to the 4.75 percent yield on a 30-year U.S. Treasury note. SLARS might have been attractive as short-term investments, but they are liabilities as long-term investments.

This difference in perspective led Maui to pursue a different strategy than the state. This January, the Maui County filed a federal lawsuit against Merrill Lynch, the broker that sold them the SLARS. (To see Maui’s lawsuit filing, click here to download the PDF file.) Like other institutional investors around the country, Maui alleges Merrill sold SLARS as “cash equivalents” even though it knew, or should have known, these investments were unsuitable for Maui’s needs.

The state declines to discuss whether it’s pursuing legal action related to SLARS. “We’re obviously letting our attorneys take care of reviewing our options,” says Kawamura. Tung Chan, commissioner of securities at the Department of Commerce and Consumer Affairs, acknowledges receiving complaints “against these companies – Citi and Merrill – related to ARS.” DCCA policy, though, is not to disclose the name of the complainant. It remains to be seen if the state, in steadfastly defending its investment in SLARS, has lost its opportunity for legal recourse.

“I wonder if they missed the date to file,” Doodan says. “I think it’s a two-year statute of limitations.”

A Better Way

There are other important differences between Maui and the state, according to Doodan. “To my knowledge, the state has only used two brokers for years and years and years,” she says. “In contrast, we go out to at least five, six, seven, eight brokers. And every few years, we go out and solicit new brokers.” It’s also interesting, she notes, that, while Maui has suspended doing business with Merrill, the state continues to use the same broker who sold them the SLARS as bond underwriters. (This same broker, Pete Thompson, of Morgan Stanley Smith Barney, played a key role in persuading the Legislature in 1998 to add SLARS to the list of acceptable investments for the state treasury.)

There is another difference between Maui and the state. To coordinate its investments and cash-management obligations, Maui uses sophisticated, Web-based software called QED. This program was specifically designed for treasury operations and automates many basic functions of a treasury. It continuously updates the status of investments, including the current value of securities. It also provides templates for more than 600 different reports, most of which can be produced almost instantaneously. This ease of reporting simplifies the supervision and oversight of the county treasury. That’s probably why more than 40 states and thousands of counties and smaller government entities use QED.

For its part, the state relies upon a software program called Microsoft Dynamics, which is primarily a program for enterprise solutions or customer contact management. Although it has been adapted to be used for financial purposes, it doesn’t address many of the specific needs of a state treasury. As one expert put it, “This is like hunting an elephant with a shotgun.” This may help explain the treasury’s failure to routinely produce the reports called for by its own investment policies. It may also explain why the state’s investment activities are largely tracked on manual worksheets or even handwritten calendars.

Most state treasuries are far more transparent and seem to sustain much more oversight than Hawaii’s. New Mexico – an apt comparison with Hawaii because of its population of 2 million people and treasury of about $5 billion – offers an excellent model for an efficiently run treasury. “I can tell you,” says chief investment officer Sheila Duffy, “we have a lot of oversight in New Mexico. And we like it.”

Structurally, that oversight takes the form of two standing committees. The Treasury Investment Committee, Duffy says, consists of treasury officials and two securities experts from private industry. The other oversight group, the Board of Finance, supervises the broader activities of the state treasury, which corresponds roughly with Hawaii’s Department of Budget and Finance. Neither group is passive.

“We have a once-a-month report, a book really, that we deliver to the Treasury Committee” and to Board of Finance, Duffy says. This substantial report – produced automatically using QED software – summarizes the treasury’s existing investments, including asset details, yields, and trends compared to a benchmark. These reports and the minutes from committee meetings are available on the treasury’s Web site, along with numerous other reports and resources. In contrast, although Hawaii’s state treasury policy requires monthly status reports for the director of the Department of Budget and Finance, this report hasn’t been prepared since 2007, according to the state auditor. Moreover, there’s no outside authority to review such a report.

The Cure

How can Hawaii improve its often informally structured, poorly supervised and cloistered state treasury? And what can we do about its extraordinary burden of SLARS?

As for the auction rate securities, the answer may be nothing. “For now, our liquidity issue is covered,” says Kawamura, by which she means that, as the treasury’s longer-term investments mature – and they’re allowed by statute to carry some investments out to five years – these are gradually replaced with the SLARS. And the state seems intent on either holding onto them until maturity – another 35 years, in some cases – or waiting until it’s possible to sell them at par. That might seem farfetched. After all, the allegations of fraud, negligence and collusion that have been leveled at the wire houses have stigmatized SLARS as an investment. But some believe the SLARS market will revive; Kami said as much in his Dec. 27 testimony at the state Legislature. Even Maui County finance director Kalbert Young holds out hope.

“I would point out,” Young says, “since the SLARS market failed in February 2008, there’s been a slow return of activity in this market.” He doesn’t mean the actual resumption of successful auctions – not yet, anyway – but that the underlying securities have started looking increasingly attractive to investors. “We’ve been getting calls from other institutions interested in buying our ARS,” he says. “Not at par, of course, but better than it was. Even Merrill Lynch was willing to purchase some.” Nevertheless, Young says, “we still want to pursue our legal filings.”

Improving Hawaii’s treasury operations may prove easier. It’s simple enough to look to the examples of other states, like New Mexico and New Jersey, that have modernized their treasuries. Software solutions typically come with extensive consulting services and are cost effective. (QED costs less than $100,000 a year, after the initial setup.) But the most important lessons probably come from history.

After the disastrous 1994 bankruptcy of Orange County, when the county treasurer’s wild, unsupervised speculation in risky derivatives cost the county over $2 billion, the California state auditor issued some familiar-sounding recommendations: Have a Board of Supervisors approve the treasury’s investment policies; appoint a committee to oversee investment decisions; require frequent, detailed reports from the treasurer; and establish stricter rules governing the selection of brokers and investment advisers.
Those sound a lot like the recommendations of the Hawaii state auditor. They’re also suspiciously close to the kinds of best practices employed in New Mexico. In other words: boring, boring, boring.

Risky Strategies

State’s mix of risky & safe, traditional investments

CASh

Demand Deposits1
$229,770,000

Cash with Fiscal Agents
$5,980,000

U.S. Unemployment Trust
$265,499,000

Investments

Investments Time Certificates of Deposit2
$618,192,000

U.S. Government Securities
$528,130,000

Student Loan Auction Rate Securities3
$1,006,975,000

Repurchase Agreements4
$1,151,620,000

Total Investments
$3,304,917,000

Total Cash and Investments
$3,806,166,000

1. The state routinely failed to reconcile bank statements. In addition, funds were often left in sub-accounts that did not earn interest.

2. At least five times, the state exceeded the 50 percent limit on CDs from a single issuer.

3. The state’s portfolio of SLARS remains at roughly 30 percent of its total investments.

4. Repurchase agreements exceeded the 70 percent statutory limit in four out of 12 months.

Source: State auditor’s report

 

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Using Lasers to Measure the Wind

BY DENNIS HOLLIER

Chris Sullivan
Program Manager and senior Aerospace Engineer 
Photo: Kevin Blitz, Oceanit

Idea

Engineers used to rely on meteorological towers to measure wind speed. But “met towers” only give you data for one location; they don’t tell you anything about wind velocities around a valley or along a ridge. Wind 3D, a product being developed by Oceanit, creates three-dimensional maps of wind velocities within a radius of three miles.

Technology

Wind 3D uses LIDAR — light detecting and ranging — a laser technology that bounces light off particles in the air, or even off air molecules themselves, to measure wind velocity. “It’s quite mind boggling,” says principal investigator Chris Sullivan. “The design of the system is to get back like one-billionth of the light that you sent out.”

History

LIDAR isn’t new, but Oceanit innovations have created a smaller, cheaper and more reliable package. According to marketing manager Ian Kitajima, Oceanit originally developed LIDAR systems under government contract to help unmanned airplanes drop propaganda leaflets accurately. Later, they used similar technology to measure cloud heights above airports and aircraft carriers.

Market

Oceanit believes the first market for Wind 3D will be wind prospectors who want to correctly site expensive wind turbines. “If you can get 5 percent to 10 percent better efficiency based on the layout, over a 20- or 30-year period, that could be tens of millions of dollars,” Kitajima says.

 

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Roadblocks on the Road to Hawaii’s Smart Grid

BY DENNIS HOLLIER

The Kaheawa wind farm is not being fully used because of 
limitations imposed by an aging power grid on Maui.
Photo: David Croxford

High on a ridge overlooking Maalaea Bay, a small group of students from the Horizons Academy scramble out of vans into the vast open space at the top of the Kaheawa wind farm. They gape for a moment in the brilliant morning light. It’s an impressive sight: the giant white turbines of Kaheawa – 20 in all – standing majestically along the ridge that slopes to the sea, as astonishing as the heads of Easter Island.

“Cool,” says one of the young students.

Noe Kalipi, a spokeswoman for First Wind, the company that built the wind farm, tells the students that each turbine is 168 feet tall. Taken together, the 20 turbines have a capacity of 30 megawatts, or more than 10 percent of Maui’s peak load. That combination of majesty and power capacity makes the Kaheawa wind farm a symbol of the state’s rush to meet the goals of the Hawaii Clean Energy Initiative: 70 percent clean energy and 40 percent renewables by 2030.

Cool, indeed.

But Kaheawa poses as many questions as it answers. How do you integrate variable electricity generation from wind farms and photovoltaic systems into the electrical grid without compromising reliability? How do we pay the enormous cost of modernizing the grid to accommodate these renewables? And how do we monitor and regulate these changes to make sure the grid is ready for the 21st century? Most experts believe that the answer to these questions lies in a collection of new technologies and practices known collectively as the “smart grid.” In fact, Maui Electric Co. (a division of Hawaiian Electric Industries) has joined the Hawaii Renewable Energy Institute, the U.S. Department of Energy, General Electric and a few other partners in a smart grid pilot project in Wailea. But it’s not clear that MECO (or the rest of the state) is fully ready for the smart grid.

How “Smart” Works

There are many definitions of a smart grid. “No two people can agree on what that means,” says Robbie Alm, senior vice president of HECO. But for the purposes of MECO and what they want out of the Wailea pilot project, the smart grid is all about communication. In some cases, that communication empowers consumers with smart meters and advanced metering infrastructure, which let utility customers monitor their energy use in real time. In combination with time-of-use rates, smart meters may reduce peak load on the grid by encouraging consumers to move some of their consumption to off-peak times, when rates are cheaper.

Probably more important is to have more data about the grid itself. “For example,” says Chris Reynolds, MECO’s superintendent of operations, “if we could see that power was being injected into the system from a PV (photovoltaic) system, then we’d know what was going on. Then we could find ways to mitigate that if it should drop off all of the sudden.”

Speaking to Power

It sounds easy enough. The problem is that even the traditional grid – a model that’s nearly 100 years old – is surprisingly complicated. Sure, its basic elements are familiar: a power plant that generates electricity, high-voltage transmission lines that carry the power long distances, substations and transformers that step the voltage down to useful levels, and a network of distribution lines to deliver electricity to the end user. This generic view of the electrical grid makes it seem almost mechanical: add fuel – oil, coal, bagasse – to the hoppers at one end, and 120-volt electricity comes out the wall sockets on the other. In its particulars, though, the grid is complex; more like an organism than a machine, it’s full of fidgets and sensitivity. The utility is constantly monitoring its vital signs, especially frequency and voltage.

Reynolds points out that the pulse of the modern grid throbs at the remarkably consistent frequency of 60 hertz. Maintaining this frequency depends upon a fairly steady balance of power generation and load. If MECO loses a generator, or the wind dies suddenly at Kaheawa, the frequency falters.

Most utilities handle these problems with what’s called “spinning reserve,” having extra generators up and running and ready to come online. “In place of spinning reserve, MECO uses load-shedding,” Reynolds says, basically cutting power to prearranged customers. “At 59.3 hertz, there are some pump leads at HC&S that will come off-line. Below 58.7 hertz, then we’ll start opening up distribution points on our customers.” In other words, a 2 percent drop in frequency can mean localized blackouts. It can also fry customers’ electronics.

The traditional grid has evolved tools to deal with normal fluctuations in load. MECO’s power plant at Maalaea, for example, isn’t just one generator; it’s 21 generators of various sizes and types. They range from small, “fast-start” generators to deal with sudden outages, to enormous combustion turbines that are much more efficient, but take longer to start. An automatic system controls the generators’ output based on variations in load.

These controls work fine for a grid dominated by consistent power, like diesel generators or hydroelectric, but they’re not responsive enough to handle Maui’s increasing suite of wind and PV power. Instead, MECO has to limit renewables.

For example, through a process known as curtailment, the utility routinely dials back power generation at Kaheawa. Sometimes curtailment at the wind farm is partial; sometimes it is 100 percent. Similarly, MECO restricts the installation of PV systems to less than 3 percent of the system’s peak load, or less than 10 percent of the load on any one circuit. Although these strategies run counter to the utility’s own preferences, probably nothing short of a smart grid will ease the restrictions.

Technical Problems

One of the challenges facing MECO’s smart-grid aspirations is an aging infrastructure. Over the past several years, the utility has modernized its systems, particularly by improving its SCADA, the supervisory control and data acquisition system it uses to control critical elements on the grid.

But the utility still has many substations that haven’t been integrated into its SCADA system, and the system has no means to see beyond the substations to monitor the load of its customers (or the production of most independent PV systems). Also, many of MECO’s generators are aging and inefficient – the oldest, a steam generator in the Kahului plant, was first put online in 1947 – meaning MECO’s high-voltage transmission lines carry 69,000 volts in some areas and 23,000 volts in others. These are all challenges on the journey from existing infrastructure to smart grid.

But the greatest technical challenge is isolation. On the Mainland, most local grids are linked to one another in a super-grid. It’s possible, for example, for a customer on the East Coast to buy electricity from a power provider in Texas or even Canada. That’s important because this interconnectedness makes it easier for utilities to provide some of the ancillary services that are essential to an effective electrical system. As Carl Freedman, one of Hawaii’s most respected experts on utility regulation, likes to point out, an electric company provides customers much more than kilowatt-hours of electricity.

“For example,” Freedman says, “they also have to provide reliability,” a quality that includes things like operational and spinning reserves. Operational reserves ensure the grid has the capacity to supply the maximum load. Freedman explains: “If somebody turns on a 1,000 horsepower motor or turns off a 1,000 horsepower motor, operational reserves mean it isn’t going to shut lights off and destabilize the grid.” Spinning reserves, on the other hand, represent the utility’s ability to handle the loss of a generator (or wind on a wind farm). “On Oahu,” he says, “they have a spinning reserve sufficient for the loss of their largest unit. In other words, they would have enough units up and spinning so that they could lose that unit without dropping load.

“Spinning reserves and operational reserves are both identifiable services,” Freedman says, as are basic utility functions like voltage regulation, transmission and power generation. “On the Mainland, there’s a huge market for all this stuff. If you don’t have something, you can go out and get it.” Freedman points out how this simplifies the way a utility operates. “Each utility, for example, needs to carry sufficient capacity – or contracts for capacity – to meet its loads. But they don’t need to provide the emergency capacity of the largest load like we do here, because they can buy that. In fact, they can buy it for free by having a bilateral agreement with somebody else, saying, ‘You cover me, and I’ll cover you.’ ”

This highlights the challenges facing MECO and HECO as they build their smart grids. Because they’re island grids, they’re completely isolated. Freedman notes: “Each one of these systems has to supply all the ancillary services: all the generators, all the reserve capacity, all the reliability. We have to do it all on each system. So, the job of a smart grid here is a tall order.”

Capital Problems

Not all the challenges facing the smart grid are technical. Rebuilding something as complex as the grid – even a small one like MECO – will be fabulously expensive. “As an example,” says Chris Reynolds, “the meter that’s on a typical home costs about $25. For the smart grid demonstration project in Wailea, we’re looking at a cost of about $400 per meter.” He adds that MECO has about 67,000 meters.

Freedman takes an even broader perspective. “According to DBEDT,” he says, “we’re about to spend $16 billion – that’s billion with a ‘B’ – on capitalization for this energy transition.” He notes that, although the goal is to reduce our $7 billion annual expenditure on fossil fuel, that’s still a fantastic upfront investment. “The question is how are we going to capitalize this. This is a major issue for the state that hasn’t been addressed by anyone, really.”

It’s certainly hard to see how the Hawaiian Electric companies can afford it. “I don’t know what we’re counting in the smart grid,” Freedman says, “but if you include the (undersea, interisland) cable, then you’re talking a billion dollars just to hook up Lanai and Molokai. If you’re talking, like the utilities, about hooking up Maui as well, then you’re talking several billion dollars. Well, the whole capitalization of all the electrical infrastructure right now is something on the order of $3 or $4 billion.” Even if, as now seems likely, the state decides to finance the construction of the cable, Freedman points out, ratepayers will have to repay the debt. It’s still a capital liability on the utilities books.

One of the ironies in this smart grid bagatelle is that many of the policy initiatives intended to promote more renewables further aggravate the capital problems for the utility. For example, the financial arrangements that underpin distributed generation – power-purchase agreements, net-energy metering, feed-in tariffs –all appear on the utility’s books as liabilities. Each, after all, is a commitment to purchase power from customers. The feed-in tariff, at least, also shows up on the income side of the books because the customer still buys the same amount of energy as before. With net metering, the customer’s PV output simply rolls his meter backwards, reducing his bill.

Also, most of the utility’s assets – and collateral – traditionally were in its physical plant: generators, power lines, substations. “Looking forward,” Freedman says, “it looks like they’re not going to be increasing generation anymore. The new generation is going to be in renewables, it’s going to be distributed, and loads are going to met by energy efficiency. And none of those things have the utility’s own capitalization.” Hawaiian Electric Industries is publicly traded; it’s hard to see how these changes in capitalization won’t affect the company’s market valuation. “In the long run,” Freedman says, “the utility’s business model is being challenged a little bit by the whole move to renewables.”

A local smart grid is thus far from inevitable, even with Hawaii’s incomparable resources for renewable energy; even with an ambitious agenda for reform in the Hawaii Clean Energy Initiative; and even with a cadre of utilities and citizens committed to the idea of a clean, distributed power generation.

Up at the Kaheawa wind farm, the students from Horizons Academy gather in the scant shade of a giant turbine to pose for a group photograph. Squinting into the late morning sun, the children smile for the camera. It’s supposed to be a picture of Hawaii’s future – the children and the energy that will power their adult lives – but that future is not yet fully in focus.Kaheawa Wind Farm

• Minimum: As little as 6 mph of wind will turn the long, elegant blades of the Kaheawa turbines.

• Maximum: When the wind reaches 55 mph, the blades feather and each turbine stops spinning.

• RPMs: Regardless of the wind speed, the turbines top out at 21 rpm – slow enough for nene to fly through in formation.

• Best wind: At 23 knots, the optimum wind speed, each turbine produces 1.5 megawatts of electricity.

source: first wind inc.

 

P.A.C.E.: Supercharging the Solar-Energy Industry

Many homeowners and businesses want solar energy to lower their electric bills but can’t afford the upfront cost – as much as $25,000 for a standard residential installation. But a new form of funding called PACE – property-assessed clean energy – offers a nearly painless solution.

How PACE Works

People who want to purchase clean-energy technology, such as solar water heating or photovoltaic systems, for their homes or businesses will be able to borrow from a special revolving fund established by the state. In return, they agree to pay the money back (plus interest and administrative costs) through an added assessment on their property taxes. In most scenarios, PACE funding will have no effect on the availability of federal or state tax credits.

How It’s Funded

To establish the PACE revolving fund, the state would issue general-obligation bonds. These would be guaranteed by the incremental increase in property taxes. In theory, PACE shouldn’t add any costs to the state budget. It’s even possible that federal grants would pay for the administrative costs of setting up the program and establishing a certification process.

Who Would Be Eligible?

One of the charms about PACE funding is that it’s tied to the house, not the homeowner’s credit. As long as you can afford to keep up with the property taxes, you would be eligible to borrow money for any qualified clean-energy system. What’s more, when you sell your home or business, the obligation to pay goes with the property. That makes sense, because an investment like a PV system adds value to your home, but is worthless to you when you sell.

Will It Happen Here?

The Sierra Club and Blue Planet Foundation are advocating strongly for PACE. It also enjoys broad support in the Legislature and with Gov. Linda Lingle. Legislation introducing the program, HB 2643, has already passed unanimously in the state House, but it still faces challenges in the Senate and in conference. Advocates such as Sen. Kalani English warn that, given the state’s fiscal troubles, it may take more than one session to pass.

 

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School Procurement Scandals

BY DENNIS HOLLIER

“It’s OK as long as it’s for the children,” says Marion Higa.

Photo: Kevin Blitz“It’s OK as long as it’s for the children,” says Marion Higa.

The state auditor smiles wanly to show she’s being sarcastic while commenting on her office’s two-part 2009 audit of procurement at the Department of Education. That’s because she’s a stickler for law and order, and the report describes a Wild West of procurement improprieties and contracting schemes. It’s a story of imperious leadership and old-fashioned cronyism. It may also be a parable for what’s wrong with state government. But we’re getting ahead of ourselves. Let’s start at the beginning …

In 2006, the Legislature appropriated $160 million to the DOE for the renovation and repair of 96 schools, the final portion of the department’s Whole School Classroom Renovation Program. Years of neglect had left the public schools with leaking roofs and antiquated plumbing, and in desperate need of paint – facts well known to the DOE. Yet, when the department finally received the appropriation, it apparently had no idea how to spend that $160 million. It had no scopes of work, no budgets, and no timetables for the necessary construction and repairs. Instead, the state auditor’s report reveals that the department spent $18 million to $20 million of the Whole School appropriation to contract out these basic government responsibilities to consultants. The result is a baffling, multilayered system of program-management contractors and construction-management contractors that is the key to understanding how DOE went astray.

Pay attention, this part is confusing: The bottom layer of DOE’s system for orchestrating the Whole School program consists of the contractors at the individual schools, those coordinating the actual work of roofers, plumbers and painters. These contractors, however, are overseen by three companies with contracts ranging from $4.4 million to $7.3 million. These overseers are responsible for providing design- and construction-management services to the lower-level contractors. The construction management contractors, in turn, are overseen by yet another company, a long-time DOE consultant with a $2.3 million contract for primary management over the $160 million program. In all, the department has managed to insert three levels of middlemen between the subcontractors who actually perform the repairs and the DOE officials who are theoretically in charge.

As the report notes, the department – in particular, the Office of School Facilities, which is supposed to oversee construction and maintenance – appears to have outsourced its fundamental responsibilities. Instead, its elaborate system of contracts “provides consultants with the ability to monitor each other, review each other’s proposals, negotiate fees and modifications with each other, and evaluate each other’s performance, all at the department’s expense.” By surrendering these functions, DOE loses some of its most important tools for preventing fraud and abuse. It also exposes itself to a kind of Alice in Wonderland version of procurement.

Some of the effects are outrageous. For example, in DOE’s upside-down world of contracting, it is the construction-management consultants, rather than the department, who determine which projects at each school will be funded, the timetable for the work and how much the construction managers will be paid. In addition, the program-management consultant appears to exercise “excessive control” over contracting: negotiating fees, making award decisions, drafting documents and even directing department staff. At one point, the program-management consultant was allowed to submit a proposal on a construction-management contract, which would have put the company in charge of supervising itself. Under this system, it’s impossible to assure a competitive bidding process or to determine whether the state is getting good value for its money.

To understand how the department got to this point, we have to back up a bit. Although DOE has always handled some procurement, historically the Department of Accounting and General Services was in charge of procuring construction, repairs and maintenance. For years, DOE officials complained that this arrangement was dysfunctional. In 2004, then-superintendent Pat Hamamoto successfully lobbied the Legislature to move this procurement to DOE as well.

The irony is that moving procurement from DAGS to DOE hardly changed anything. For example, DOE did not have staff to handle the increased workload; so more than 200 DAGS employees – nearly all of those who formerly handled DOE procurement – became employees of the DOE. And because DOE did not have the space to accommodate them, those employees simply remained at their desks at DAGS. Only the names at the top of the procurement chain changed.

Despite the superficial nature of the move, DOE officials still tout its advantages. “It has definitely been a benefit to the DOE to have those functions in-house instead of at DAGS,” says Randy Moore, assistant superintendent of the Office of School Facilities, which is responsible for construction and repairs. However, Moore acknowledges that the change might have been less than expected. “Part of it, in hindsight,” he says, “was that we were able to reduce and pretty much eliminate what had been the historic view on the part of DOE – that all of our problems were DAGS. That ‘us-and-them’ attitude is greatly reduced.” Moore also admits that the old criticisms leveled at DAGS were exaggerated. He notes, “With the benefit of hindsight, DAGS did very good work.”

In contrast, the auditor’s report is highly critical of the Office of School Facilities. Although the department’s handling of management consultants may be the most egregious of its findings, the report offers a litany of detailed accusations. A quick scan of some of its headings is instructive: “Solicitation and selection process manipulated to award contract to predetermined contractor”; “Selected contractor given unfair advantage due to improper communications and apparent bias”; “Recently awarded study contract displays apparent lapses in ethics and judgment”; “Subcontractors are used to evade the procurement process.” The criticisms are so many and so intertwined, it’s hard to keep track.

Interestingly, Moore’s predecessor, former assistant superintendent Rae Loui, seems to be connected to many of the charges leveled in the report. Loui left DOE in December 2005 to become a vice president at M&E Pacific, a long-time contractor at DOE (and the program-management contractor overseeing the Whole School program). The auditor’s report suggests that Loui used her influence with former employees to secure a $300,000 construction-management contract for M&E Pacific in 2006, in violation of statutory standards of conduct. Similarly, officials in the Auxiliary Services Branch of the Office of School Facilities improperly offered Loui advice on how to secure playground equipment projects, providing M&E Pacific with an unfair advantage over other competitors. But Loui is not alone in exploiting her DOE connections; other former employees also seem to have used their relationships to get contracts with the department.

Loui did not respond to our requests for an interview.

The auditor’s report lays the blame for all these abuses squarely at Moore’s feet. “The lax tone from the top has unintentionally set the stage for a culture of disregard of procurement rules in the Office of School Facilities. The assistant superintendent of the Office of School Facilities exemplifies the attitude that public procurement rules just get in the way of doing the work.” In other words, Moore either invited misconduct by his outspoken disdain for procurement rules, or he tacitly encouraged a climate of “anything goes” by turning a blind eye to shady practices so long as they “got things done.”

Moore takes the criticism calmly – particularly criticism of department outsourcing. “That occurred because when all this work transferred over from DAGS. The number of people that transferred was not commensurate with the volume of work.” He adds, “Actually, our objective is to staff on a permanent basis for the steady level of work and to contract out for the peaks. And the DAGS people came over during one of those peaks. By the end of the calendar year, that level will be way down and we will no longer be contracting for those services. Actually, we haven’t had any contracts for that in a fairly long time; we’re just working off the old contracts.”

Former superintendent Pat Hamamoto responds to the accusations in the auditor’s report with much the same tone as Moore: What about Loui’s undue influence? “I think there were instances in which it didn’t come out the way it should have.” Have any employees been disciplined? “That’s a personnel matter; it’s confidential.” What has been the response to the report? “I think most of the findings, we took care of them.” It’s as if DOE officials read a different report than the one Higa wrote. Nonetheless, Hamamoto referred the auditor’s report to the Criminal Division of the Office of the Attorney General.

Of course, not everyone believes that the state auditor’s office is the last word in evaluating the effectiveness of government programs. For example, former state highway administrator Pericles Manthos (who had his own run-in with Higa several years ago) points out that the use of program management consultants isn’t unique to Hawaii. “Program management is used in a lot of Mainland states,” he says, “because they just don’t have the manpower, and they haven’t for years.” In addition, Manthos isn’t sure the “bottom line” should be measured by what’s cheapest for the agency. “It should be what’s best for the public.” By that measure, who’s to say expedience isn’t as important as good value and fair play? But Manthos’ primary complaint is that, while an auditor might be good at crunching numbers, that doesn’t mean she can assess complicated subjects like construction or engineering. “The financial finding is important,” Manthos says, “but it’s not the only thing.”

Former superintendent Hamamoto agrees. “Let me explain why,” she says. “When the auditor audits us, there are some considerations that we look at. For example, did she compare us to a large company? Did she consider manpower? etc. When she looks at it from a process standpoint, then I can understand it and put substance to what she says. But, when they get technical about either the way construction contractors are, or make broad generalized statements, yes, we do get concerned. Are they using people with expertise, who understand what’s going on, when they make those audit findings?”

For Higa, procurement rules are simply the standards of good government. “There’s something called a fraud triangle,” she says. On a scrap of paper, she sketches out an equilateral triangle, labeling the sides: opportunity, pressure and rationalization. Opportunity, she says, arises wherever there is a climate of lax enforcement. Pressure can be as simple as “I can’t pay my mortgage this month.” Rationalization, she notes, often takes the form of truisms: “Everyone does it” or “This benefits everyone.” Higa pauses and taps gently on this last leg for emphasis.

“And this is the classic rationalization,” she says. “ ‘We’re doing it for the children.’ ”

What Should Be Done

Included in the state auditor’s report on DOE’s procurement system is a long list of recommendations. Here is a selection:

The superintendent should review the use and structure of $21 million in project and construction management contracts for the Classroom Renovation Project, focusing on

  1. Inappropriate involvement and influence of project management consultants in awarding these contracts.
  2. Whether these management functions qualify as professional services and should be performed 
    in-house.
  3. Why consultants were able to influence/determine the contract and program budgets.
  4. Why consultants were responsible for determining scope, and ultimately compensation, of their own contracts.
  5. Why consultants were provided with so much authority.
  6. Determining whether these contracts violated the procurement code by allowing consultants to determine their own scopes and fees.

For the full list of recommendations, and to read the report in its entirety, visitwww.state.hi.us/auditor/Years/2009reports.htm

 

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Hawaii Procurement Wastes $200 Million

For most people, government is simply the sum of the services it provides: security and safety, for example, in the form of police and fire departments; education, in the form of schools and libraries; and transportation, in the form of roads, harbors and airports. Citizens can measure their government by how effectively it provides those services.

Businesses, though, often see another side of government. That’s because the state government relies on private contractors and consultants to provide many of these services. Contractors design and build the state’s schools and highways; consultants manage everything from state hospitals to social services. Indeed, government is the largest single customer of Hawaii businesses, spending more than a quarter of the state’s $7 billion budget on contracted goods and services. With billions at stake, clearly another measure of government is how efficiently and fairly it procures those services. And yet, by almost any measure, the state’s procurement process is broken.

The easiest way to gauge how dysfunctional the system has become is to glance through reports from the state auditor’s office. In department after department, report after report, procurement practices are found wanting. Indeed, many of the most prominent controversies faced by the state government in recent years have been procurement failures at heart: Two 2009 audits criticize the Department of Business, Economic Development and Tourism for flouting procurement laws by awarding a contract to a firm with ties to the department’s director rather than higher-ranking competitors. The latter DBEDT audit goes so far as to recommend the director’s removal.

Similarly, audits of the state Department of Education, University of Hawaii, Highway Administration, Department of Land and Natural Resources and Hawaii Tourism Authority have all found improper and incompetent procurement conduct. Most of these reports received considerable publicity when they were released, bringing a period of greater scrutiny for the agencies, but they failed to generate more general interest in procurement. Taken together, though, the auditor’s reports and a collection of related decisions by the Office of Administrative Hearings and the U.S. Circuit Courts suggest the state’s procurement difficulties are more widespread (and costly) than any single scandal.

Recent Cases of Wasteful Procurement

 
Phase II of the widening of the Big Island’s
Queen Kaahumanu Highway is supposed to run between
Kona International Airport at Kealakehe Parkway.
But poor procurement has delayed the project
for two years.

PHOTO: COURTESY GOOGLE

Photo Courtesy: Google  Phase II of the widening of the Big 
Island’s Queen Kaahumanu Highway is supposed to run 
between Kona International Airport at Kealakehe Parkway. But 
poor procurement has delayed the project for two years.

Contract No. 1: Widening of Queen Kaahumanu Highway

State Agency: Department of Transportation

Summary: In 2006, the state Legislature appropriated $40 million to widen part of Queen Kaahumanu Highway on the Big Island from two to four lanes. In December 2007, the state Department of Transportation issued a notice to bidders for a design/build contract for Phase II of the project, from Kealakehe Parkway to Keahole Airport Road, with an estimated cost of $60 million. In January 2008, DOT awarded the contract to the low bidder, Goodfellow Bros. Inc. Almost immediately, Kiewit Pacific Co., one of the other two qualified bidders, protested the award, claiming the Request for Proposals was ambiguous and Goodfellow’s bid was nonresponsive to the RFP. So, DOT rescinded the award and again put the contract out for bid. The next December, DOT again awarded the contract to Goodfellow. This time, Hawaiian Dredging, the other qualified bidder, protested that, among other things, the Goodfellow bid failed to meet the basic terms of the RFP. DOT denied the protest, and Hawaiian Dredging appealed to the Office of Administrative Hearings at DCCA. On April 3, 2009, the hearing officer found the Goodfellow bid “unresponsive” and ordered the contract to be re-bid again. This December, DOT issued a new RFP for the project, while simultaneously appealing the OAH ruling to the Circuit Court.

Findings: The inability of DOT engineers and contracting officials to write a clear, unambiguous request for proposals, or to effectively deal with the confusion of contractors during pre-bid consultations, resulted in at least a four-year delay in the highway project, greatly frustrating Kona residents. Also frustrated are the bidding contractors, who presumably all acted in good faith. All have incurred legal fees, lost time and the costs of proposal development. For taxpayers, the costs include lost time and manpower due to repeated procurements, plus extensive legal costs. It’s still unclear when construction will begin.

Contract No. 2: Electronic Voting Machines

State Agency: Office of Elections

Summary: In 2007, the Office of Elections issued an RFP for the lease of electronic voting machines and the purchase of election services for elections from 2008 through 2016. In 2008, the office awarded the contract to Texas-based Hart-InterCivic, which bid $43.4 million. The other qualified bidder, Nebraska-based Election Systems & Software, whose bid was only $18.1 million, protested on the grounds that the Office of Elections didn’t adequately justify the $25.3 million discrepancy in price between the two bids. The office denied the protest, and Election Systems & Software appealed to the Office of Administrative Hearings. The hearing officer found that it was, indeed, the duty of the Office of Elections to do a cost/price analysis. In response, the state’s chief election officer conducted a cost/price analysis himself, concluding that the Hart-InterCivic price was justified. Again, Election Systems & Software appealed to OAH, on the grounds that the chief election officer wasn’t qualified to do a cost/price analysis and that his analysis was inadequate and misleading. In issuing a summary judgment, the hearings officer agreed with Election Systems & Software, finding, among other things, that the state’s chief election officer had “acted in bad faith.” The Office of Elections appealed to Circuit Court.

Findings: The Office of Elections seems to have been predisposed to Hart-InterCivic technology, but failed to write a request for proposal reflecting this. Although the selection committee determined that ES&S technology was more than adequate, election officials were intent on selecting Hart-InterCivic, regardless of the 140 percent price difference. The Office of Elections’ failure to address the price doesn’t simply violate the State Procurement Code, it violates the ethical obligations of those entrusted with taxpayers’ money.

Moreover, it reflects the chief elections officer’s complete lack of experience in both procurement and elections. His desultory and unprofessional execution of the cost/price analysis ordered by OAH borders on criminal negligence. For example, he made no accounting for the fact that the Hart-InterCivic bid included the full purchase price of the voting machines, even though the contract was a lease. In addition, the Hart-InterCivic cost justification doesn’t account for more than $11 million, nearly 20 percent of the contract price. Even so, delays caused by the protracted litigation required the state to use Hart-InterCivic services for the 2008 elections before terminating the contract. In this settlement, taxpayers paid about $3 million more than what OAH had determined was already unreasonable.

The former chief elections officer did not return repeated calls by Hawaii Business for comment.

Contract No. 3: System to Monitor Airport Taxis

State Agency: Department of Transportation

Summary: In 2000, DOT awarded Ted’s Wiring a $1.5 million contract to develop and install a system to track if taxis paid correct fees at Honolulu
International Airport. The project was scheduled for completion by May 2003 and $1.3 million of the contract has already been invoiced and paid. However, despite numerous extensions and the threat of fines, seven years later, the work still has not been finished. In addition, the airport seems to have paid Ted’s Wiring more than $20,000 in 2005 for unrelated work completed in 1986. In May 2009, following publicity about the problem, the state initiated default proceedings against Ted’s Wiring.

Findings: Confusing RFPs and a consistent lack of follow-up or supervision plague airport contracting. The result is the potential for waste and fraud. This is exacerbated by the excessively cozy relationships between airport authorities and contractors. For example, although Ted’s Wiring, a long-time airport contractor, was threatened with fines, in the end, airport authorities assessed no penalties. The appearance of special treatment is not an idle concern: In 2007, several airport officials and contractors were convicted in a bid-rigging scandal that cost the state $4 million. With hundreds of millions of dollars in airport contracts in the works, the efficiency and fairness of the agency’s procurement process is more important than ever.

Who’s to Blame

One expert with strong views on Hawaii’s procurement mess is Terry Thomason, education chair of the Hawaii Procurement Institute, and an attorney specializing in public contracts at the law firm of Alston Hunt Floyd & Ing. (Thomason and other AHFI attorneys represent Election Systems & Software in its dispute with the Office of Elections.) Thomason divides Hawaii’s procurement troubles into three categories. There are a few “bad eggs,” he acknowledges, officials like the state’s former chief elections officer who operate in bad faith. The second kind of procurement problem, and more common, Thomason says, is like the airport official, “kind of a slow thinker – they don’t know how to do it correctly, so they give out periodic payments. But 99 percent of these are honest mistakes.” However, according to Thomason, the greatest cost to taxpayers is the third category: the state’s piecemeal approach to contracting.

“Scan the state procurement office Web site,” Thomason says, “and you will see a multitude of contracts for minor construction/repair/maintenance. For instance, you will see DOE projects for schools that include individual contracts for roofing, plumbing, painting, etc. Often, these requirements are at the same school or schools in the same area. All of those contracts were competed separately through the entire solicitation process – with potential for protests on each requirement – and separate contract awards for each.” For each procurement, he says, time is needed to issue the solicitation, perform evaluations, award a contract and resolve any protests. Each repetition, each delay adds to the cost of the project.

“It’s inefficient,” Thomason says. “It’s mowing the grass with scissors.”

Better Ways

He points out that there are much more effective ways to handle procurement. Federal contracting officers at Pearl Harbor or Schofield Barracks routinely use techniques like multiple-award-task-order contracts or indefinite-delivery/indefinite-quantity contracts to speed up procurement. “Army and Navy contracting agencies anticipate that requirements will arise,” Thomason says. MATOC or ID/IQ contracts allow them to issue solicitations in advance, even before money is appropriated, so projects can get started as soon as the need arises. With the state, that’s just the beginning of the process.

What’s more, Hawaii’s slow, incremental approach to procurement may cost the state federal money. For example, our inability to quickly award contracts for projects may be behind our poor ranking in spending federal stimulus funds – a Congressional panel ranked Hawaii 48th out of 50 states. The state’s procurement system simply can’t get contracts out the door quickly enough. For Thomason, this is particularly galling. “We should be the fastest,” he says. “We’re a tiny little state with a very defined area. And we have experts down the road who are doing many different types of contracts, more of them, and faster.”

The costs of our broken procurement system are enormous. Consider just our three case studies: millions of dollars wasted in legal fees and delayed work at the Queen Kaahumanu Highway widening; more than $25 million nearly squandered at the Office of Elections; $1.3 million spent on nothing at Honolulu Airport. At that rate, procurement looks like a primary cause of our budget shortfall. Thomason believes this waste amounts to 10 percent to 20 percent of our spending. “Are we out of money?” he asks. “I don’t think we are. If you just look at the things that are done repeatedly, you think, ‘Wait a minute; we could easily save 10 percent here.’ I think our budget for contracts is in excess of $2 billion a year. Just 10 percent would be more than $200 million. That would make breathing a lot easier for budget negotiators down at the Legislature.”

State Sen. Norman Sakamoto, who is interested in procurement issues, believes Thomason’s estimates are reasonable. “I would say 20 percent is high,” he says. “But if we look at global costs, I’m comfortable with 10 percent. It’s certainly more than a couple percent.”

There’s no sign, though, that the state is prepared to make changes. To begin with, the understaffed State Procurement Office (SPO), which should be the center for innovation and reform, has a very narrow definition of procurement. State procurement officer Aaron Fujioka likes to point out that procurement technically takes place in a very short window, usually 30 to 90 days. Strictly speaking, he says, procurement is simply the process of announcing an invitation for bids or a request for proposals, the steps used to select among bidders, and the rules for identifying winning bids. “People think the process is this big,” Fujioka says, his arms outstretched, “but really only this part is procurement,” he adds, bringing his hands close together. For instance, he says, the beginning of the process – writing accurate and unambiguous requests for proposals – is outside the scope of procurement. That’s planning. Likewise, making sure contractors fulfill their obligations in a timely manner is not procurement. That’s project management.

Many experts believe the SPO should take a more expansive view of procurement. State auditor Marion Higa argues that, because of the principles involved – creating a level playing field for contractors and getting good value for the taxpayers’ dollars – procurement should extend down to the departments and agencies writing RFPs. “He (Fujioka) is correct in that it’s not within his jurisdiction, per se; but as SPO, shouldn’t he also be promoting that the key here is how you spec out your acquisition?”

Others point out that the SPO has not done a good job conveying the importance of procurement laws to state employees. State Rep. Blake Oshiro (also an attorney at Alston Hunt Floyd & Ing) notes that government officials continually complain that the process is difficult and cumbersome. “You have to wonder if they know what the Procurement Code is supposed to accomplish,” he says. “Fairness, openness, competition. My guess is they don’t.” The result is widespread contempt for the norms of government procurement.

The irony is that Hawaii’s procurement law, patterned after the American Bar Association’s model code adopted by 27 states, is flexible and more than adequate. What’s lacking is the leadership to enforce existing rules and develop new approaches. Instead, the state seems to be moving the other way. Last year, the Legislature passed laws that limit the ability of companies to protest contract awards – a key check on procurement misbehavior. Perhaps worse, insiders say, the SPO is circulating draft legislation designed to “simplify and streamline” the procurement process by eliminating basic safeguards, like requiring pre-bid conferences and cost analyses.

The SPO’s perspective will likely be emphasized this month when a legislative task force recommends centralizing procurement once again in that office.

Given this trend, it’s hard to ignore the impression that procurement is a dirty word among state officials. Yet, at its roots, procurement law is simply about ensuring a fair playing field and getting good value for the taxpayers’ dollar. In fact, as Terry Thomason puts it, “A dynamic procurement system is the very measure of good government.”

Seven Steps to Better Procurement

  1. Develop a fulltime, professional procurement staff in all departments: For most staff, state procurement is now an added responsibility to their usual duties.
  2. Make salaries of procurement professionals competitive with private industry: You get what you pay for.
  3. Recentralize supervision of procurement in the State Procurement Office: Decentralizing, which was meant to expedite the process, resulted in waste and fraud.
  4. Remove exemptions from state procurement code: Far from promoting autonomy, granting exemptions from the code to certain agencies exposes them to litigation, waste and fraud.
  5. Encourage, rather than discourage, reasonable protests of contract awards: A lively, expeditious protest system is our most effective way to check misconduct and inefficiency in the solicitation process.
  6. Educate, educate, educate: And not only about Hawaii procurement laws, but about innovative procurement practices in the federal government and elsewhere. Remain open to novel or mainstream procurement innovations.
  7. Invest time and resources in acquisition planning: Up-front planning will make for a smooth process during the formation and administration of a contract.

 

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“Smart Growth” in Hawaii

BY DENNIS HOLLIER

Land-use planning, more than any other public policy, shapes the way you live. It’s responsible for your 60-to-90-minute commute from Kapolei or Hawaii Kai. It’s why you live in a three-bedroom, two-bath home with a two-car garage. It’s what influences you to work downtown, shop in Kakaako and spend your weekends playing on the North Shore or carousing in Waikiki. In short, the decisions of land use planners affect almost everything you do. However, land-use planners have changed their thinking in recent years and that may change the way your children live.

The Auto Age

For most of the past 50 years – call it the Auto Age – planning decisions made the car central to development. In Hawaii, these policies gave birth to new towns such as Kapolei, Mililani and Hawaii Kai. They turned sleepy villages like Kailua and Kaneohe into prosperous bedroom communities. And they stoked the development of shopping centers like Ala Moana, Pearlridge and Waikele. But they also beggared old urban villages like Kaimuki, Kapahulu and Chinatown. They gave us traffic jams, strip malls and a surfeit of parking lots. And they produced a collection of developments that stretches almost continuously from Kalihi to the Ewa Plain.

The response to this urban sprawl is “Smart Growth,” a set of principles that is the central dogma of land-use planning today. According to John Whalen, a prominent Honolulu urban planner, Smart Growth shifts the focus of development from the suburbs to the urban core. Its principles – mixing residential and commercial land use, providing a range of housing and transportation options, and increased density – are intended to create livable, walkable cities. By channeling growth and people to the core, Smart Growth also aims to “keep the country country.” These principles have broad currency on the Mainland; it remains to be seen whether they can address Hawaii’s needs.

Smart Growth seeks to be a solution to the economic, social and ecological problems associated with auto-age development. Its roots, Whalen says, can be traced to a landmark 1974 report from the federal Department of Housing and Urban Development called “The Cost of Sprawl.” Prior to this study, municipal planners generally felt that development – almost any development – amounted to sound fiscal planning. A growing population, rising property values and the arrival of more businesses led to greater tax revenues and a healthier economy. “The Cost of Sprawl” cast doubt on those assumptions. Its thesis was that, as development moves away from the urban core, the cost of building infrastructure – roads, sewers, schools and emergency services that support any development – outstrips any increase in revenue. The report argues that sprawl costs more than it’s worth.

“That was an eye-opener for a lot of communities,” says Whalen. “The message was, if you continue this pattern of sprawl, although it may seem attractive to a lot of local jurisdictions because of added revenues, there’s a cost to all this. That began a kind of reassessment.” On the Mainland, this reassessment led to a flurry of Smart Growth development, an impressive string of planned communities, urban renewals and innovative attempts at TOD, or transit-oriented development, the first cousin of Smart Growth.

Hawaiian Style

Hawaii, as usual, has been slow to catch on, but some principles of Smart Growth have been used here. Stanford Carr’s Peninsula development in Hawaii Kai, for example, was a scrupulous attempt to mix housing choices. “We used a variety of land-planning concepts and diversity of product to address a variety of household incomes and lifestyles,” Carr says. When it was completed in 2003, homes there ranged from one-bedroom apartments for under $200,000, to waterfront, detached, single-family homes priced at over $1 million. Alley parking, an eclectic mix of architecture, and careful landscaping minimized the prominence of automobiles and gave the Peninsula a human scale. A recreation center and pool, and a small public dock provided community focal points.

But the Peninsula isn’t exactly Smart Growth: It is entirely residential, not mixed use. Shaded sidewalks and a waterfront pathway make the community walkable, but there’s really nowhere to go. The only transportation option for residents, besides their cars, is a bus stop just outside the gated community. The Peninsula, despite its Smart Growth inspiration, offers no relief from rush-hour congestion on Kalanianaole Highway.

Perhaps a better example of Carr’s commitment to Smart Growth is his Royal Kunia-Phase 2 project, a proposed planned community in Central Oahu. According to Carr, “That’s 210 acres of residential, 12 acres of school and parks, 20 acres of business, and 103 acres of light industrial.” Like the Peninsula, the Kunia development will have many price points. “We designed the whole community with mixed income. That includes everything from workforce rentals, to entry-level multi-family, to single-family detached development.”

But it’s the mixed use that gets to the heart of Kunia’s Smart Growth pedigree. One of Smart Growth’s catch phrases is “live, work, play.” The inclusion of so much commercial space – combined with workforce housing – makes that concept plausible for many Kunia residents.

Another development with a commercial and residential mix is Castle and Cooke’s Koa Ridge. According to project manager Dean Minakami, plans here include setting aside about 20 acres for a Wahiawa Hospital medical facility and a “big-box” shopping center. The centerpiece of the community will be a kind of village green, a commons area surrounded by commercial space and high-density housing. “This is where you would have all your neighborhood services,” says Minakami. “Daycare, a grocery store, restaurants, a post office. … This will be the vibrant heart of the community.”

More to the point, this kind of mixed use means jobs – Castle and Cooke estimates 2,500 of them – for Koa Ridge residents. Although that may only represent about 20 percent of the population of the 3,500-unit development, it’s still a big step toward the Smart Growth ideal of a self-contained community.

Challenges and Controversies

Developers like Stanford Carr and Castle and Cooke have their critics. Environmental groups like the Sierra Club, and even many urban planners, point out that the goal of Smart Growth is to focus development on underutilized areas within the urban core – in places like Kakaako, Moiliili and Kaimuki. They believe that green-field developments like those at Kunia and Koa Ridge more closely resemble the sprawl that Smart Growth was meant to cure.

Not surprisingly, the developers disagree. Harry Saunders, president of Castle and Cooke, views Koa Ridge as an excellent example of an infill development. “If you come up about 10,000 feet to look at it,” he says, “you’ll see you’ve got Mililani, Kipapa Gulch, Gentry Homes, Waipahu, Crest View, Sea View – Koa Ridge is circled by residential communities.”

In fact, the business model of Koa Ridge relies upon its advantages as infill. “It gives us a great opportunity to kind of leverage off all those rooftops,” says Saunders. For Castle and Cooke, the 30,000 or 40,000 residents of the surrounding developments represent the initial customer base for the restaurants and retail operations in the first stage of Koa Ridge. “It gives us the base for a different kind of community, one utilizing many of the Smart Growth concepts.”

Saunders also points out that infill, especially in the urban core, has its own problems. One of the charms of Smart Growth is that it can help preserve open spaces; higher densities in developed areas make it possible to lower densities elsewhere. But high density and transit-oriented development can strain the infrastructure. “If you look at TOD and infill,” Saunders says, “you’re going into areas where the infrastructure was developed 50 to 100 years ago. That’s why we have all the broken sewers and water mains.” That means redeveloping areas like Moiliili or Kapahulu would require an enormous investment in infrastructure.

That’s true even for greenfield developments like Koa Ridge. Saunders notes that Castle and Cooke is going to build four miles of transmission line down to the sewage plant. “We could never have done that if we had a 200- or a 400-unit project. The problem with TOD and infill is that you have a lot of small owners, so you don’t have the scale of a single large owner. Here, we’re able to afford to do a lot of this because we can amortize it out over 3,500 units.”

Mainland Models

Despite the challenges, Stanford Carr believes that Portland’s Pearl District and San Diego’s Gas Light District suggest that TOD and infill are possible. “These are all urban redevelopment and renewals,” he says. “People are giving up their cars and their one- or two-hour commutes to live closer to work and services like healthcare, restaurants, arts and retail. That’s what places like Kakaako can be.” Of course, the development of Kakaako can also serve as a cautionary tale, and Carr notes that successful TOD will require a detailed review of land-use ordinances and permitting requirements.

As an example, he explains that current rules still emphasize the automobile. “If we’re committed to transit, then we need to start looking at providing relief from mandatory parking requirements,” he says. “One parking stall adds $35,000 to the price of a unit.”

One surprising voice of skepticism about Smart Growth is the city’s new director of transit-oriented development, Terrance Ware. Ware, who has done TOD in transit hotbeds like Washington, D.C., Atlanta, Denver and Dubai, has seen how TOD can transform neighborhoods, but he also knows its limits. Smart Growth proponents often point to success stories like the Fruitvale neighborhood in Oakland, or the Gas Light District in San Diego, but Ware thinks this is misleading. “This is what we all look at as the image of TOD,” he says. “But I could show you just as many, if not more, examples where nothing has happened as a result of TOD.”

He points to depressed, predominantly African-American communities in cities like Atlanta and Washington, where the areas around many transit stations are just as blighted as they were before mass transit. This is true even in San Francisco, where BART has been running for more than 30 years.

Even putative success stories often camouflage the underlying problems of Smart Growth. In some places, Smart Growth has all the trappings of gentrification, as rising property values drive out the people it was intended to accommodate. It’s also not clear that every neighborhood can absorb the increase in commercial space. Merchants in the much-ballyhooed Fruitvale development, for example, complain that foot traffic isn’t sufficient. Apparently, the Fruitvale BART station is more a point of origin than a destination, a consequence that may frustrate TOD projects in places like Waipahu. As Ware notes, it’s unrealistic to expect every station to be its own little mixed-use village.

“My point,” he says, “is let’s be cautious about our approach to TOD.”

Ware also discounts one of the primary arguments for Smart Growth and TOD: the assertion that higher-density development yields more profit. The data comparing multi-family homes, townhomes and single-family homes don’t support this idea. “In most communities,” he says, “the townhomes are the most profitable, because they’re simple, stick-built construction. In higher density projects, you’ve got fire-code issues, you’ve got vertical-circulation issues, there’s the greater cost of the foundation, higher construction costs. … It just doesn’t quite work out.”

The situation in Hawaii is only magnified. “Here, you’ve got higher land costs, higher labor costs and, quite honestly, infrastructure is a real challenge. There are tremendous infrastructural challenges that have been put off.”

Ware acknowledges that financing all the upgrades to that infrastructure – the new roads, sewers, stations and other amenities necessary to attract private development – may be the greatest impediment to TOD. The most common financing tool for this kind of development is a mechanism known as TIF – tax increment financing. This method works on the assumption that property values around a station will appreciate as a result of TOD. This means that property taxes should also increase. TIF attempts to capture that incremental increase in tax revenue and issue bonds against it to pay for the new infrastructure.

But Ware notes that TIF and similar financing tools that have been used elsewhere aren’t magic bullets. And because they rely on property taxes, they’re particularly complicated in Hawaii. “Let’s say 50 percent of the city’s budget already comes from property taxes,” Ware says. That makes it difficult for the city to forego future increases in property-tax revenues, especially while shouldering higher costs for infrastructure and debt service. He also points out that debt service is already a large percentage of the city’s budget.

His point isn’t that TOD can’t work in Hawaii, just that it won’t happen overnight. “Of course,” he says, “in this environment where we’re struggling to pay for basic services, trying to redirect that flow into infrastructure becomes a real challenge. Because, in the short term, when you’re talking about laying off police and firemen and closing libraries, that’s the citizens’ most immediate need. So, what we’re really talking about here is capturing value over the long term.”

Ware points out that the biggest problem facing Smart Growth and TOD may have nothing to do with policy or financing. It may be as simple as overcoming people’s basic conservatism. He points to a photograph of a tidy, middle-class suburban neighborhood – a world of big houses, big yards and two-car garages – and remarks on the persistence of this model for the American dream. “I would argue that people still believe that this is what America should look like,” he says.

 

Smart Growth offers a different vision for auto-oriented areas like this Pearl City stretch of Kamehameha Highway. Over the next three pages, see how the area could be transformed using Smart Growth ideas. 
Photo courtesy of urban-advantage.com

 

As the transformation begins, buildings – not parking lots – now front the streets. The addition of pedestrian-friendly sidewalks and bike lanes put the focus on people, not cars.
Photo courtesy of urban-advantage.com

 

In the next stage, infill construction and mixed uses create a more urban feel. These pictures are the work of Urban Advantages, a consulting firm that provides clients with visual tools to help explain Smart Growth. 
Photo courtesy of urban-advantage.com

 

In this final illustration, medians, narrower roads and on-street parking help create a more walkable district.
Photo courtesy of urban-advantage.com

 

 

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