Market-led proposals

Tabled: 27 November 2019

4 Victoria Police Centre: uniqueness and value for money

In May 2015, Cbus and Australia Post submitted an MLP to the state. They proposed to build a new Victoria Police headquarters, the VPC, on a vacant site at 311 Spencer Street in Melbourne's CBD. This site is next to the existing City West Police Complex.

The proposal was timely because Victoria Police's lease on its existing secure headquarters accommodation at the WTC expires in July 2020. Before receiving the VPC proposal, Victoria Police and DTF's SSP discussed undertaking a standard procurement process through releasing an expression of interest to the market in late 2015 or early 2016.

The government approved the VPC proposal in December 2016 and the state signed a lease agreement with Cbus/Australia Post for the VPC in January 2017. The VPC will include 39 floors and more than 60 000 square meters of net lettable area. The lease term is 30 years with options for three further term extensions of five years each. The state's total estimated nominal rental liability over the initial 30-year lease term is $1.8 billion, with a present value of $851 million.

Victoria Police advised the government that it would sublease about 32 per cent of VPC space to other government law enforcement or support agencies. At the time of VPC proposal approval, these subtenants were expected to pay about $15.6 million in total annual rental, including car parking and other costs, or 35 per cent of the total annual rental costs under the lease of $44.6 million.

In this Part, we examine the adequacy of DTF and Victoria Police assessments and advice to the government on the VPC proposal for a new Victoria Police headquarters.

4.1 Conclusion

DTF and Victoria Police assessments and advice to the government on the VPC proposal did not sufficiently demonstrate that the VPC proposal met the uniqueness criteria in the MLP guideline.

In the Stage 2 assessment, DTF and Victoria Police advised the government that the security benefits offered by the site at 311 Spencer Street were unique and could not be achieved through a standard competitive process within acceptable time frames. However, while evidence supporting the assessment found that the site had security benefits, it identified other sites that could also meet Victoria Police security needs, making the site not unique.

DTF and Victoria Police also relied on the benefits of co-locating the VPC next to the City West Police Complex when advising the government that the proposal met the uniqueness criteria. However, neither agency specified or measured these benefits in any detail, despite Victoria Police subsequently describing the co‑location benefits as the primary source of uniqueness for the VPC.

There were clearly other options to obtain a new secure headquarters and Victoria Police could have achieved the benefits offered by this proposal through a standard competitive process. There was a clear expectation that Cbus/Australia Post would participate in any open-market competitive process and the receipt of two alternative proposals for the VPC indicates that an open, market-based process could have elicited competitive bids and potentially provided greater VFM.

The government's VFM benchmarks for the VPC specified annual rental costs in total and on a per-square-metre basis, rather than as whole-of-life costs. Victoria Police and DTF provided accurate advice to the government on the Stage 4 assessment that the government VFM benchmarks were met. However, the factors that most significantly contributed to this outcome were the:

  • increase of the lease term from 20 to 30 years
  • increase of the building size from about 42 000 square metres in net lettable area to more than 60 000 to accommodate potential, unconfirmed subtenants.

These adjustments increased the risk and whole-of-life costs of the VPC proposal for the state. Two of the three proposed subtenants withdrew after the state signed the lease agreement. This has left the state exposed to meeting any shortfall in rental costs for the entire VPC building. Victoria Police continues to work with the SSP to seek other tenants. There is a risk that other tenants will also diminish the security benefits sought by Victoria Police.

4.2 Uniqueness

Assessment

For a proposal to be considered outside a usual competitive process, it must have 'unique characteristics'. Under the 2015 MLP guideline this meant that the government could not reasonably engage another party to deliver the proposal, or an equivalent outcome, and achieve similar benefits.

Cbus and Australia Post asserted that 311 Spencer Street was the only opportunity Victoria Police would have to acquire a highly secure location in the Melbourne CBD adjacent to the existing City West Police Complex at 313 Spencer Street.

DTF assessed the VPC proposal at Stage 2 (due diligence and strategic assessment) against the February 2015 MLP interim guideline. The guideline requirements made it clear that for an MLP to progress to exclusive negotiations, the uniqueness criterion must first be satisfied.

In September 2015, DTF advised the government that the security benefits offered by the site at 311 Spencer Street, combined with the benefits of co‑locating with the City West Police Complex, were unique. DTF recommended, and the government agreed, that the proposal proceed to Stage 3 (procurement preparation) of the MLP process in an exclusive negotiation.

Adequacy of the assessment

DTF and Victoria Police did not sufficiently demonstrate that the VPC proposal met the uniqueness test in the MLP guideline:

  • Evidence supporting the uniqueness assessment clearly indicated that other sites could meet Victoria Police's security needs.
  • Victoria Police could have achieved the outcomes offered by the proposal through a standard competitive process.
  • With expiry of the current lease five years away, there was no time pressure in 2015 that called for sole negotiations with a single proponent.

The IDC, the body overseeing the MLP assessment process, agreed with the recommendation to the government that the proposal proceed to Stage 3 in an exclusive negotiation. Our review of IDC meeting documentation found that DTF and the IDC initially expressed doubts about whether the Cbus/Australia Post proposal satisfied the uniqueness criteria and obtained additional information and advice on this.

Security characteristics

The SSP advised DTF in June 2015 that Victoria Police needed to clearly document the security specifications for the police headquarters to be able to determine whether there were alternative sites that could meet the desired security attributes. Victoria Police did not finalise the security specification until October 2016.

However, without specified security needs, Victoria Police obtained advice from a property consultant in mid-2015 about potential sites, which it used in the Stage 2 assessment.

There is little doubt that the site at 311 Spencer Street has security benefits due to its shared boundaries with the City West Police Complex to the north and rail lines to the west, and it would be difficult to identify a site with the same characteristics in the CBD. However, Victoria Police's property consultant identified other sites that could potentially meet its security and other service requirements.

The search by the property consultant was limited and at that point there was no policy decision that the location needed to be a greenfield, purpose-built facility. A less restricted search may have identified more options.

The terms of reference limited the search to properties that were …

This meant that the search …

Site type

Timing

Vacant and cleared or easily clearable

Able to be procured by the end of 2016, and redeveloped by the end of 2019

Did not include existing buildings that may have been be able to accommodate Victoria Police requirements.

Only identified sites that were known to the market or currently for sale (due to their immediate development potential).

Did not identify 'unknown' sites, existing buildings or leased premises that may be offered if the market was approached with a request for interest or tender process to meet the service need.

Source: VAGO from information provided by Victoria Police.

The site search was followed by an assessment of the security characteristics of the five 'short listed' site options by consulting engineers with security expertise. The criteria for the security assessment focused on 17 areas of physical security controls under five threat categories including terrorism, crime and civil disturbance. These were generic physical security control characteristics and not a security specification prepared by Victoria Police for its headquarters.

Figure 4A shows the information and advice resulting from the search and security assessments.

Figure 4A
Property search and security assessment advice

Source

Identified/assessed

Recommendations

Report from a property consultant based on site requirements specified by Victoria Police

165 possible sites

Narrowed to five site options, including 311 Spencer Street

In initial advice, the five 'short listed' sites were not ranked

In subsequent advice, 311 Spencer Street was ranked first

Report from consulting engineers with security expertise based on generic physical security control characteristics

Assessed top five options as identified by the property consultant

311 Spencer Street:

  • scored highest overall, but
  • did not score higher than all other sites in any specific security attributes cited by Victoria Police, indicating it was not uniquely secure in any of these areas

Source: VAGO, from information provided by Victoria Police.

In July 2015, the IDC considered an initial draft Stage 2 assessment report and advice that DTF and Victoria Police did not agree on whether the proposal should proceed to Stage 3. Discussion centred on the availability of comparable CBD sites and the evidence to support the uniqueness criteria. The IDC agreed to Victoria Police further investigating available sites and reporting back to the IDC on a comparative site assessment and commercial strategy to achieve an affordable outcome relative to current costs.

In August 2015, Victoria Police gave DTF and the IDC its summarised interpretation of the site search and security assessment. Victoria Police advice stated that the property:

… analysis indicated that the site offered by Cbus/Australia Post is the most suitable for Victoria Police particularly with regard to security and proximity to existing Victoria Police key infrastructure at 313 Spencer Street.

and claimed that the security assessment identified the 311 Spencer Street site as:

… particularly unique with regard to its extensive natural surveillance capabilities, ability of territorial reinforcement, limited oversight by neighbours, diversified utilities and vehicular access.

This advice from Victoria Police was important evidence in persuading DTF and the IDC that the proposal met the MLP uniqueness criteria. However, it was inaccurate and insufficient as:

  • proximity to existing Victoria Police infrastructure was not in the consultant's property search criteria
  • the security assessment did not identify the 311 Spencer Street site as unique
  • Victoria Police did not advise DTF that the security assessment also gave two other sites positive scores across all evaluation criteria.

While Victoria Police did provide DTF and the IDC with the detailed property consultant and security assessment reports, it appears that the contradictory information in the underpinning reports was either not noticed or not discussed.

The IDC accepted Victoria Police's advice and DTF's updated Stage 2 assessment report and agreed that:

  • the Stage 2 assessment report would recommend proceeding to Stage 3 in exclusive negotiation, subject to achieving assurance on VFM by the end of October 2015.
  • Victoria Police should continue to develop an expression of interest in conjunction with the SSP, concurrent to the exclusive negotiations with the proponents, so that it would be ready to go to market in November 2015 if exclusive negotiations failed.
Victoria Police advice to the SSP on its requirements in September 2015

Security was the primary factor cited by Victoria Police during mid-2015 when arguing that the Cbus/Australia Post proposal met the uniqueness criteria in the MLP guideline. However, other evidence indicates that security was not necessarily the paramount consideration for Victoria Police at the time.

In August 2015, the SSP sought details from Victoria Police on its specific requirements for a new headquarters to inform development of an expression of interest document if exclusive negotiations with Cbus/Australia Post did not proceed.

Victoria Police's response to this request in September 2015 did not detail any specific security concerns or requirements and indicated that:

  • security was important, but not a paramount consideration
  • they would be satisfied with CBD fringe locations near public transport and major roads
  • they did not require sole occupancy.

We found no evidence that Victoria Police and the SSP further developed the expression of interest document after September 2015. The SSP advised us that it received verbal advice from Victoria Police in late September 2015 to stop further development of the document.

Co-location benefits

DTF and Victoria Police advice to the government at the Stage 2 and Stage 3 assessments indicated that the VPC proposal would deliver benefits that were unique and could not be achieved through a competitive tender process.

This advice emphasised the co-location benefits offered by the site at 311 Spencer Street due to its shared boundaries with the City West Police Complex. However, this advice:

  • included superficial untested assertions from Victoria Police about the basis for claimed co-location benefits
  • did not specify or quantify the claimed benefits in any detail.

Further, when responding to the SSP request for its requirements for an expression of interest in September 2015, Victoria Police did not mention the need for co-location with other police facilities.

The content of DTF's Stage 2 assessment report to support the existence of material co-location or integration benefits is largely a direct copy of advice Victoria Police provided to DTF on 25 August 2015. That Victoria Police advice comprises superficial references to relevant literature and high-level assertions about benefits that could eventuate from co-locating the VPC next to the City West Police Complex. The advice indicated that such benefits were difficult to quantify, but made no effort to demonstrate the benefits in any detail.

There is no evidence that DTF tested the accuracy or reliability of Victoria Police's advice before including it in the Stage 2 assessment report and claiming that the integration benefits of co-locating with City West Police Complex were material. This report was part of advice provided to the government supporting the assessment of the proposal as unique.

We examined the literature referenced by Victoria Police and DTF to support their claims about co-location benefits and found that this material:

  • does not provide unqualified endorsements of co-location
  • clearly suggests the need for more work on identifying and measuring co‑location benefits than was undertaken by Victoria Police or DTF.

Victoria Police confirmed that it did not undertake any detailed analysis to quantify the potential savings and other benefits expected from co-locating the VPC with the City West Police Complex.

In addition, maintaining the claimed co-location and security benefits associated with situating the VPC next to the City West Police Complex for the full 30‑year term of the proposed VPC lease would involve extending the City West Police Complex lease. However, DTF and Victoria Police did not examine and provide advice to the government on the cost implications of extending the City West Police Complex lease.

Timelines

The MLP guidelines include 'time frame' as a relevant factor when assessing uniqueness.

The SSP had discussed a competitive market approach with Victoria Police in early 2015. In 2015 there was no time pressure on the state that warranted exclusive negotiations with a single proponent for this proposal. Victoria Police's lease at the WTC was not due to expire until July 2020.

The IDC directed Victoria Police to continue to work with the SSP during 2015 and 2016 to keep the competitive market approach open as a viable alternative.

However, in October 2015, the government noted advice from DTF that alternative end of lease options would be developed if the exclusive negotiations with Cbus/Australia Post did not demonstrate VFM by the end of 2015.

Other options

DTF's Stage 1 assessment of the VPC proposal noted it had potential to meet the uniqueness criteria for an MLP subject to further investigation on alternative locations, given the competitive market for property development.

In June 2015, the SSP advised DTF that, given the competitive nature of property development in Melbourne, it was very possible that the state could achieve better VFM at other sites if it pursued a competitive approach.

However, DTF and Victoria Police advice to the government in the Stage 2 and Stage 3 assessments did not sufficiently emphasise that:

  • other sites that could potentially meet Victoria Police's security and other requirements had been identified
  • further sites may emerge in response to a competitive approach
  • there was a clear expectation that Cbus/Australia Post would participate in any open-market competitive process for the provision of office accommodation to Victoria Police after July 2020
  • there was clear potential for other proponents to meet Victoria Police's service needs in response to a competitive procurement process.

The potential for other proponents to respond to the service need was demonstrated by the state receiving two alternative MLPs to provide new headquarters for Victoria Police before it signed the lease agreement with Cbus/Australia Post in January 2017.

Both alternative proposals claimed the potential to meet Victoria Police's service need and security requirements but were rejected at Stage 1 of the MLP process.

Advice to government on uniqueness

DTF's October 2015 advice to government on the outcomes of the Stage 2 assessment of the uniqueness attributes of the Cbus/Australia Post proposal did not make a convincing case for the uniqueness of the proposal.

The DTF and Victoria Police advice to the government on the outcomes of the Stage 3 (February 2016) and Stage 4 (November 2016) assessments indicated:

'that the proposal maintains unique benefits of a secure site and integration with the existing City West Police Centre that are not substitutable and cannot be achieved through market competition'.

The Stage 3 and Stage 4 assessments continued to emphasise the same security and other benefits identified at Stage 2 without adding any evidence to demonstrate these benefits. These assessments also gave no emphasis to other information that raised doubts about the validity of the claimed benefits.

For example, the report obtained by Victoria Police examining the security attributes of alternative site options as part of the Stage 2 assessment did not assess or raise the potential for heightened security risks arising from concentrating critical Victoria Police resources at a single location at 311 and 313 Spencer Street.

In August 2016, Victoria Police obtained further expert advice on security risks for the new police precinct comprising the VPC and City West Police Complex. This advice clearly indicates that security risks to the new police headquarters are increased as a result of integration with the City West Police Complex. The adviser reported that the combined precinct represented a highly visible and desirable target for threat actors, noting that the risks could be mitigated.

4.3 Service need and benefits

In 2015, with approximately five years left on its lease at the WTC, Victoria Police needed to secure ongoing accommodation for its headquarters.

Victoria Police considered its existing headquarters at the WTC to be deficient due to the spread of personnel across multiple towers and security vulnerabilities due to its location and design. There was also credible information suggesting an increased security threat level for police resources.

DTF and Victoria Police's assessments clearly demonstrated that the VPC proposal met a service need given the impending WTC lease expiry and that it offered potential security and other benefits.

The VPC proposal's initial 2019 commencement date was based on Cbus/Australia Post's stated assumption that the state would exercise its early termination provisions in the WTC lease, which was otherwise due to expire on 31 July 2020. It is unclear how the proponents knew that the WTC lease allowed lease termination at 31 July 2019.

The Stage 2 assessment of the VPC proposal established the service need for a replacement headquarters and identified that Victoria Police:

  • did not consider the WTC a viable option beyond the existing lease term
  • did not have a current options analysis or business case for new headquarters but that previous work was being updated
  • already had an intention to reduce their space at the WTC, with potential to further reduce this if it could relocate to a new custom-designed facility.

The Stage 3 assessment report on the VPC proposal confirmed the service need and placed greater emphasis on Victoria Police's advice that the WTC accommodation did not meet its key security requirements.

The VPC proposal allowed for approximately 42 000 square metres of net lettable area, which would meet Victoria Police's requirements and allow for modest growth in workforce and operational requirements.

In addition, there were related parties that were interested in, or could be approached, about co-locating:

  • The Australian Federal Police (AFP) had interest in co-locating with Victoria Police to increase collaboration across jurisdictions to improve responses to issues such as organised crime. The AFP had indicated interest in about 10000 square metres of net lettable area.
  • The Emergency Services Telecommunications Authority (ESTA) occupied part of the WTC and could be approached to take space in the VPC.

Figure 4B shows the space requirements identified in the assessment.

Figure 4B
Identified space requirements

Location

Requirements

Net lettable area (m2)

WTC

Current (in 2015)

48 000

Intended (reduced) requirement

42 000

Potential (reduced) requirement

35 000–37 000

VPC

Proposed requirement

42 000

Potential co-locator requirements

AFP: 10 000

ESTA: not defined

Source: VAGO, from information provided by Victoria Police.

4.4 Value for money

Public sector agencies usually seek VFM outcomes when buying or leasing office accommodation by approaching the market in an open competitive process. Initially, this was also the case for the proposed new Victoria Police accommodation. In early 2015, Victoria Police discussed plans for a competitive process to obtain new accommodation with the SSP and would have run an expression of interest in the absence of the VPC proposal from Cbus/Australia Post.

In November 2016, the government authorised the Treasurer and Minister for Police to approve the VPC proposal and lease agreement. This was based on DTF and Victoria Police advice that the proposal provided VFM, including meeting the VFM benchmarks set by the government. The lease agreement commits the state to a 30-year lease with a starting total lease cost of $44.6 million a year.

Adequacy of assessment

VFM benchmarks and assessments

Figure 4C shows the quantitative VFM benchmarks that the government set for the MLP assessment of the VPC proposal.

Figure 4C
VFM benchmarks for the VPC proposal

Timing

Context

Benchmark: Annual rental costs for the VPC should not exceed…

October 2015 (Stage 2)

The government indicated it was not willing to provide Victoria Police with significant budget supplementation to meet annual lease costs for new headquarters

The comparable annual rental costs of remaining at the WTC

February 2016 (Stage 3)

The government endorsed the VPC proposal progressing to Stage 4 of the MLP process (exclusive negotiation)

$424 per square metre—reflecting the outcome of Stage 3 negotiations with the proponents

Source: VAGO.

Victoria Police prepared the Stage 4 assessment report in consultation with DTF. In November 2016, Victoria Police advised the government that the VPC proposal provided VFM and met the government's VFM benchmarks.

Figure 4D shows the information Victoria Police and DTF provided to the government as part of their Stage 4 assessment advice on:

  • costs for Victoria Police and its proposed subtenants under the negotiated VPC lease terms
  • estimated VFM benchmark comparator costs of remaining at WTC.

Figure 4D
Stage 4 assessment: Advice to the government on WTC and VPC lease costs

 

VFM benchmark WTC costs 2020

VPC lease costs

Victoria Police

AFP

ESTA

Other subtenant

Total for VPC

Leased area (m2)

46 784

41 423

15 411

1 739

2 211

60 784

Lease costs ($/m2)

408

418

530

429

461

445

Base annual rental costs ($ million)

19.1

18.4

8.9

0.8

1.1

29.2

Parking and storage costs ($ million)

2.7

3.6

1.2

0.0

0.2

5.0

Other 'outgoing' costs including cleaning ($ million)

8.0

7.0

2.7

0.3

0.4

10.4

Total annual lease costs ($ million)

29.8

29.0

12.8

1.1

1.7

44.6

Note: The other subtenant was another law enforcement agency.
Source: VAGO, based on information from Victoria Police and DTF.

The information provided to the government indicated that the cost outcome negotiated by Victoria Police bettered the government's VFM benchmarks in terms of total annual rental costs and rental rate per square metre.

Reliance on subtenants

During Stage 3 negotiations with the MLP proponents, Victoria Police explored the potential for other government law enforcement agencies to take space in the VPC. The proponents were open to this and agreed to amend the building size and design to accommodate them.

Victoria Police advised the proponents that it wanted to sign a single lease agreement for the entire building to maintain control over other tenancies for security purposes.

The proponents accepted this position. They may have seen commercial advantages in the arrangement, as it meant signing a 30-year lease with a single government tenant. Risk relating to subtenants rested with Victoria Police and the state.

The advice to the government acknowledged that VFM relied on all expected VPC subtenants committing to leasing space in the VPC building before it was completed. This was significant because Victoria Police had committed to covering the cost shortfall for any subtenancies that did not eventuate. The proposed AFP subtenancy was the most significant and DTF emphasised the importance of obtaining a binding commitment from this agency.

DTF and Victoria Police's advice to the government at Stage 3 indicated that the main risk was gaining formal commitment from the AFP and another proposed law enforcement agency subtenant to take space in the VPC. The advice expressed this as a very low risk and that Victoria Police would meet the additional costs, estimated at up to $2.5 million per year, if the proposed subtenants did not commit. At that point the estimated annual rental cost for the space allocated to these proposed subtenants was $10.3 million.

In November 2016, none of the proposed subtenants had provided a binding commitment to take space in the VPC. Figure 4E shows Victoria Police's advice on costs and comparisons with and without tenants.

Figure 4E
Annual costs to Victoria Police with and without sub-tenants

 

Annual costs to Victoria Police of …

 

Remaining at the WTC

Moving to the VPC

Government benchmark

Total lease cost with subtenants

$29.8 million

$29 million

$29.8 million

Total lease cost without subtenants

$29.8 million

$44.6 million

$29.8 million

Lease costs with subtenants

 

$418/m2

$424/m2

Lease costs without subtenants

 

$445/m2

$424/m2

Source: VAGO, based on information from Victoria Police and DTF.

Without tenants, the first-year lease costs would be $14.8 million more than the relevant VFM benchmark.

At Stage 4, Victoria Police and DTF's advice to the government stated that:

  • Victoria Police planned to lease out more than 30 per cent of the floor space in the VPC to subtenants at higher rental rates than it would pay
  • the annual lease cost for the entire building was about 50 per cent more than the advised annual lease costs for Victoria Police.

Victoria Police had significantly increased risk to the state associated with accepting the VPC proposal. However, the advice provided continued to indicate only a low risk that proposed subtenants would not commit to leases. It advised that this risk could be mitigated at little cost to the state by:

  • reducing floor space or fit-out requirements
  • identifying other Victoria Police units or state government tenants to take up the space.

Victoria Police's Stage 4 assessment report indicates that it liaised with the SSP to identify suitable potential state government tenants for the VPC building and that the SSP identified multiple leases terminating between 2019 and 2021.

The advice to the government on the Stage 4 assessment should have clearly informed the government about the extent to which the VFM benchmarks for Victoria Police would be breached if one or more of the proposed subtenants did not sign on.

Since November 2016, only one subtenant has committed to take space in the VPC. This tenant will pay about $1.7 million of the $44.6 million payable by the state in the first year of the lease. Victoria Police is currently working with the SSP to secure replacement tenants for the building.

VFM implications of co-locating with 313 Spencer Street

Victoria Police and DTF's advice to the government on the Stage 4 assessment emphasised the benefits of the VPC at 311 Spencer Street co-locating with the City West Police Complex at 313 Spencer Street. However, it did not examine, or provide advice on, the VFM implications of fully aligning the lease terms.

The rental of $534 per square metre that Victoria Police were paying for the City West Police Complex was about 28 per cent higher than proposed VPC costs. The annual rental escalation rate of 4 per cent at the City West Police Complex was also higher than the 3.65 per cent negotiated for the VPC.

It is also significant that the lease terms for the two organisations overlap but do not fully align. The VPC 30-year lease begins in 2020 and expires in 2050 while the City West Police Complex 20-year lease began in April 2015 and expires in 2035. Victoria Police will need to renew the City West Police Complex lease for a further 15 years to deliver the claimed co-location benefits.

If Victoria Police do not exercise lease renewal options for the City West Police Complex, the claimed co-location benefits will only be realised for half of the 30-year VPC lease term.

Given the intention to align the lease terms and prolong the claimed co-location benefits, DTF and Victoria Police should have examined the cost implications of extending the City West Police Complex lease and provided advice to government accordingly.

Reliability of the WTC benchmark comparator

In February 2016, the owners of the WTC submitted an MLP to offer Victoria Police a new lease on the WTC for between $360 and $385 per square metre.

In October 2016, when DTF reviewed the draft Stage 4 assessment report, it recognised the importance of the 'remain option' costs. That is, the estimated annual lease costs if the Victoria Police stayed at the WTC.

DTF asked the SSP to review the Victoria Police estimate of these costs.

The Victoria Police estimate of total annual lease costs at the WTC in 2020 was about $5.6 million or 23 per cent higher than the SSP's estimate of the same lease costs. The SSP agreed with Victoria Police's calculation of the WTC VFM benchmark comparator following discussions on specific assumptions adopted by Victoria Police. These assumptions included increased rental charges to reflect expected refurbishments, and increased costs for security and car parking.

However, the highest end of the WTC owner offer in their earlier MLP was about 6.5 per cent lower than Victoria Police's estimate of the WTC rental rate.

Challenges to VFM estimates

Throughout the assessment process, the IDC and DTF, including the SSP, challenged whether the VPC proposal represented VFM for the state. These challenges prompted ongoing negotiations with the proponents on the VFM of key commercial terms and led to changes in the offer.

IDC oversight, input and issues raised

There is clear evidence that the IDC highlighted concerns about the extent to which the Cbus/Australia Post proposal represented VFM.

Date

The IDC …

August 2016

  • Noted delays in finalising negotiations with the VPC proponents
  • Noted the 30-year lease term created an obsolescence risk for the state

September 2016

  • Noted that negotiations were still continuing with the VPC proponents
  • Noted that DTF had concerns with the proposed 30-year lease term and 'fit for use' obligations in the lease (these issues related to the risk that Victoria Police could not reliably assess whether the building would continue to meet its service needs for a 30-year period)

October 2016

Discussed a draft Stage 4 VFM assessment report and raised the following concerns:

  • the potential that Victoria Police's rent would be cross‑subsidised by the proposed subtenants
  • the need for formal written commitments from proposed subtenants, as verbal commitments were not sufficient to proceed
  • a lack of transparent assumptions in Victoria Police's commercial adviser's draft VFM assessment report
  • whether Victoria Police could secure the Valuer‑General report and relevant approvals in time for the scheduled advice to government in October 2016

Source: VAGO based on information from DTF.

The IDC sought additional advice, information and assurances from Victoria Police to address their concerns. Victoria Police responded and the IDC subsequently supported the recommendation to the government that the proposal proceed to Stage 5, subject to resolution of specific issues raised by the Valuer-General.

SSP input and issues

When DTF requested feedback on a draft Stage 2 assessment report and a range of specific questions in June 2015, the SSP's responses raised some important issues:

  • Potential for the state to achieve better value for money at an alternativesite—this was very possible particularly at more fringe CBD locations such as Docklands or West Melbourne that could also meet Victoria Police's service and locational needs
  • Market rental comparison—the rental in the VPC proposal appeared to be within the range ($400 to $550 per square metre exclusive of fit-out) for equivalent accommodation but the SSP cautioned that a valuation would be required to more accurately determine whether the proposal reflected current market levels
  • WTC rent comparison—the proposed VPC rent was about $4.5 million higher than at the WTC but the WTC premises were 20 years old and required updating and renovation
  • Cbus' performance in completing the City West Police Complex at 313 Spencer Street on time and on budget—the City West Police Complex project was delivered on time, but Victoria Police and Cbus made alterations to the building and fit-out design, which meant the final net lettable area was larger than that agreed to by the state and approved by the Minister. These changes meant the final rental commitment exceeded the amount allowed under the lease agreement, requiring a Deed of Variation. As a result, ministerial approval had to be sought retrospectively for changes that had already occurred.
Response to issues: changes in key terms

During 2015 and 2016, Victoria Police negotiated changes to key parameters of the proposed leasing arrangement with the VPC proponents. This was in response to issues raised by the IDC, DTF and the SSP and aimed to deliver outcomes that met the government's VFM requirements.

The main changes were increasing the lease term from 20 to 30 years and meeting the proponents' proposal for an upfront capital contribution from the state by building this into the annual lease charges.

Figure 4F shows advice given to the government at the various stages of the MLP assessment process. It covers lease costs to Victoria Police under the Cbus/Australia Post proposal and the final outcome for the state based on the lease agreement signed with the proponents.

Figure 4F
Summary of advice to the government on lease costs

Item

Stage 2 Victoria Police costs

Stage 3 Victoria Police costs

Stage 4 Victoria Police costs

Outcome for the state at June 2019

Initial term (years)

20

30

30

30

Office space (m2)

41 392

41 392

41 423

60 784

Net effective rent ($/m2)

455

424

418

445

Rental cost total ($ million/year) (including car parking and storage costs but excluding outgoings and cleaning)

22.2

21

22

34.2

Annual rent escalation rate (%)

4.0

4.0

3.75

3.65

Up-front fit-out contribution ($ million)

75.0

0

0

0

Total annual lease costs ($ million) (inclusive of outgoings and cleaning)

27.4

26.9

29.0

44.6

Source: VAGO, based on information from DTF and Victoria Police.

The key changes negotiated with the proponents did not demonstrably improve the whole-of-life VFM of the proposal for the state and created additional risk for the state, but contributed to Victoria Police meeting the government's VFM benchmarks, which were only specified in terms of annual costs.

DTF, the IDC and the government agreed to these changes, which means that, in substance, the state will finance the construction and maintenance of a purpose-built asset, but not obtain ownership of the asset at the end of the lease period.

Lease term

Increasing the lease term from 20 to 30 years lowered the rental costs (annual and per square metre) and improved the risk profile of the development for the proponents. However, the SSP advised us that lease terms of 10 to 15 years are standard for government-occupied buildings. Longer-term leases are generally avoided because they limit the tenant's flexibility.

The SSP said that where a longer lease term, such as 30 years, is needed, the preferred approach is to use renewal options. That is, 10+10+10 years or 15+15 years. Multiple shorter renewal options enable better risk management than a fixed single lease term because they:

  • keep pressure on the landlord to ensure the premises remain fit for purpose by undertaking required upgrades/renovation
  • enable the tenant to reassess and renegotiate their accommodation size and configuration requirements based on changing business needs
  • give the tenant an option to end the lease and move to new premises if business needs change
  • increase the tenant's leverage to renegotiate the lease in line with market levels over shorter periods of time.
Up-front state capital contribution

The VPC proponents' initial proposal included options on the configuration of key commercial terms. This included the length of the lease and rental costs with and without a provision for the state to make an up-front capital contribution towards building fit-out costs in exchange for lower annual rental charges.

If the state …

Then the cost would be …

Funded fit-out costs of $75 million with an up-front capital contribution

$580/m2, inclusive of all fit-out costs

Agreed to a 30-year rental term

$550/m2, inclusive of fit-out costs

Agreed to a 30-year rental term and funded $75 million estimated fixed tenant costs

$435/m2

Source: VAGO, based on information from Victoria Police and DTF.

During Stage 3 negotiations, the requirement for the state to make an up-front capital contribution towards fit-out costs was taken out of the proposed lease terms. However, this did not eliminate the cost from the overall costs to the state. Instead, the fit-out contribution was incorporated into the annual rental charges, meaning it will be escalated annually as part of the rent.

DTF's advice to the government on the Stage 3 assessment pointed this out, noting that this approach was potentially less cost-efficient for the state because it allowed the capital contribution to increase as part of the lease's annual rental increases. However, DTF did not provide a comparative analysis in NPV terms of the costs of paying the fit-out contribution in an up-front payment or as part of the annual lease payments.

Advice to government on MLP assessment stages

Outcomes of MLP Stage 2 assessment

DTF's Stage 2 assessment report and advice to the government in October 2015 recommended that the VPC proposal proceed to Stage 3 in an exclusive negotiation. It also proposed that the Stage 3 negotiations with the proponents focus on determining if VFM could be demonstrated.

However, there were some issues with DTF's advice on the VFM of the VPC proposal.

The Stage 2 advice …

But this advice …

Stated that the VPC proposal had "… potential to provide value for money as the proposed commencing rent is within the benchmarked range ($400–$550 m2 exclusive of fit-out rates) for equivalent accommodation to the proposed VPC as identified by DTF Shared Service Provider"

Did not include the qualifications the SSP attached cautioning that a valuation was needed to confirm VFM.

Did not disclose relevant advice from the SSP on the potential for the state to obtain better VFM at alternative locations.

Indicated that Cbus/Australia Post completed the development of the City West Police Complex at 313 Spencer Street on budget

Was inconsistent with the SSP's earlier advice to DTF that Victoria Police and Cbus had increased the net lettable area on the City West Police Complex development in breach of the terms agreed by the state and relevant Minister, resulting in additional rental costs to the government and the need for a variation to the lease.

Noted that the proponents had identified project risks and were accepting most of these risks

Included little other substantive commentary on risks despite the MLP guideline identifying risk as a key consideration when examining VFM.

Source: VAGO.

Outcomes of MLP Stage 3 assessment

DTF and Victoria Police prepared the Stage 3 assessment report and in February 2016 recommended to the government that the proposal proceed to Stage 4 in an exclusive negotiation.

The advice indicated that negotiations with the proponents had achieved an outcome that met the government's VFM benchmark. This was accurate but relied on:

  • the lease term of 30 years
  • proposed subtenants taking space in the VPC.

Without the 30-year lease and subtenants, the costs to Victoria Police would have exceeded the VFM benchmark.

However, as shown below, there were some issues with the revised VPC proposal and the advice given to the government.

The Stage 3 advice (on the revised VPC proposal) …

But this advice …

Showed the annual lease costs to Victoria Police as below the costs of remaining at the WTC

Did not make sufficiently clear that the total lease costs had increased to cover the fact that the state would not make an up-front capital contribution of $75 million for fit-out costs.

Showed that the government's VFM benchmark of not exceeding WTC annual rental costs was achieved by increasing the lease term from 20 to 30 years

Did not transparently discuss the potential risks associated with a 30-year lease.

Indicated that the negotiations reduced the original offer by 18 per cent

Did not transparently explain the basis for the claimed 18 per cent cost saving. Victoria Police calculated the saving with reference to the 'initial offer' for the VPC proposal but used a different and higher cost variant of the initial offer than it had used when advising the government at Stage 2.

  • At Stage 2, it presented the initial offer to the government with a total annual cost of $27.4 million based on a 20 year lease, annual rent of $455/m2 plus an upfront state contribution to fit-out costs of $7 5million and claimed that this was about 12 per cent higher than the WTC benchmark annual lease costs
  • At Stage 3, when calculating the cost saving, it compared the Stage 3 offer that was based on a 30-year lease term and therefore a lower annual rental rate of $424/m2, to a variant of the initial offer that was based on a 20 year lease and annual rent of $580/m2 due to no up-front state contribution to fit-out costs. This resulted in a total annual cost of $33.4 million for the initial offer, which was about 37 per cent higher than the WTC benchmark. The different assumptions on lease term and up‑front contribution to fit-out costs drove the annual cost saving.

Indicated that the revised offer was effectively a cap on costs going forward

Was unrealistic because Victoria Police subsequently expanded the size and overall lease costs for the VPC development to accommodate subtenants that had not provided binding commitments.

Indicated that the rental costs under the VPC proposal were consistent with market benchmarks and represented VFM because the SSP was consulted and verified benchmarking data used in the assessment

Not sufficiently comprehensive because the SSP had not verified all of the market rental cost benchmarking data relied on in the Stage 3 assessment report.

Not sufficiently comprehensive because the benchmarking information relied on was not 'like-for-like'. Rather, it comprised market rental comparisons against Melbourne CBD projects with 10 to 15-year lease terms Unsurprisingly, the lease costs for shorter-term leases were higher than would be expected for a 30-year lease term, given the advantages of such a long lease to the landlord.

Source: VAGO.

Outcomes of MLP Stage 4 assessment

DTF and Victoria Police advice to government on the outcomes of the Stage 4 assessment in November 2016 indicated that the proposal demonstrated VFM. This was on the basis of three key measures:

  • independent opinion—the Valuer-General had independently verified VFM
  • achievement of the government's lease cost benchmark ($424 per square metre)—under the proposed VPC lease, Victoria Police's net rental was $418 per square metre, less than the benchmark set by the government at Stage 3
  • risk allocation—under the proposed VPC lease the risk allocation was better than a standard state accommodation lease.

Despite advising the government that VFM had been demonstrated, DTF and Victoria Police did not recommend that the proposal proceed to contract approval. This was because Victoria Police first needed to address issues raised by the Valuer-General as well as addressing subtenancy issues including:

  • negotiating a commitment from the AFP to co-locate at the VPC
  • negotiating with the proponents on issues relating to subtenancy areas and costs
  • obtaining commercial advice on the appropriateness of proposed rental charges for subtenants.

Given these unresolved issues, DTF and Victoria Police recommended that the government authorise the Treasurer and Minister for Police to approve the proposal to move to Stage 5 (contract award), subject to the resolution of all outstanding issues to the satisfaction of DTF. The government agreed.

A detailed Stage 4 assessment report completed by Victoria Police in consultation with DTF supported this advice. The report referenced supporting evidence in appendices including the Valuer-General advice, commercial advice and a business case. However, DTF and Victoria Police did not provide these appendices to the government. The advice indicated that the Stage 4 assessment report would be finalised and all appendices attached once all outstanding issues were resolved. We have not seen evidence that this occurred.

In particular, the business case referred to was an incomplete draft. Victoria Police had not approved it and we saw no evidence that DTF reviewed it.

DTF advises that references to the business case were removed from the final Stage 4 assessment report and it was not relied on in advice to the Treasurer to approve the lease. However, the business case was cited as part of the evidence to support DTF's assertion that there had been a comprehensive assessment of the proposal.

The business case was flawed because:

  • the executive summary incorrectly stated that the VPC proposal was the only option to have a lower NPV compared to the base case. Two of the other three options also had lower costs than the base case.
  • Victoria Police incorrectly calculated the scores for the financial analysis of two of the four options. While these errors did not result in an incorrect ranking of the options assessed, they increased the margin by which the VPC proposal option outscored the others. This resulted in the VPC being shown as the only option with a positive unweighted score and the only option with a weighted score above 1.0.
Valuer-General opinion on VFM

The Valuer-General provided valuation advice on the proposed VPC lease terms in October 2016. A contracted valuer performed the valuation in response to instructions issued by the SSP in August 2016.

The valuation advice issued by the Valuer-General had important caveats, including that:

  • there was no market evidence available for 30-year lease terms, with market evidence showing the majority of lease terms were 10 to 12 years with a maximum lease term of 15 years
  • the site location was not seen as attractive in the market for commercial office development and had an estimated site value of $64.2 million
  • the market evidence relied on to establish a benchmark rental related to properties that were all considered to be in significantly superior locations to 311 Spencer Street
  • the valuation of market rental rates did not account for the potential opportunity for the proponents to gain significant added value by creating a de facto government-backed indexed security while retaining ownership of the underlying real estate.

The Valuer-General advised that the commencing annual rental cost was acceptable in VFM terms but that:

  • the annual rental increase of 3.75 per cent should be renegotiated 'to assist with maintaining the integrity of the office rental market', suggesting that the escalation rate was significantly out of step with the market
  • further advice was needed on the potential for the proponents to securitise and market the long-term rental income stream associated with the 30‑year lease.

In their detailed advice to the government on the Stage 4 VFM assessment, DTF and Victoria Police accurately reflected the issues raised by the Valuer-General and made a commitment that they would be resolved before a contract was signed with the proponents.

Issue Valuer-General raised

Valuer-General advice

Resolution/recommendation

Annual rental escalation rate of 3.75 per cent out of step with the market

Seek renegotiation of annual rental escalation rate

Victoria Police negotiated a revised escalation rate down to 3.65 per cent.

Additional benefits to proponents from 30-year lease:

  • lowered risk profile of the development for the proponents

Direct benefits from the long-term lease term could be given an estimated value and the rental negotiated with the proponents provided the state with a reasonable share of these benefits

No further action required.

Additional benefits to proponents from 30-year lease:

  • the long lease length may enable securitisation of the lease, impacting on the state's VFM

Obtain commercial advice on the viability of the proponents securitising and putting to the market what was effectively a government‑guaranteed income stream for the lease term

Note: The valuer indicated that this would be attractive to risk-averse investors as the state's lease commitment removed a significant amount of risk normally associated with major office accommodation property developments, such as risks around vacant tenancies and re-leasing expenses removed

Victoria Police obtained commercial advice in November 2016 indicating it was highly unlikely that the proponents could secure additional value by securitising the lease. This was because the underlying investment was still commercial real estate and subject to the risks and uncertainties of that asset class. It was not an institution such as government under a long-term bond.

Source: VAGO from information provided by DTF and Victoria Police.

Property yield represents the annual return on the investment in the property typically calculated by expressing annual rental income as a percentage of the property value.

The valuer calculated a property yield on the VPC development of 4.65 per cent. This was seen as reasonable because the 30-year lease term significantly lowered the risks for the developers. The market evidence suggested a benchmark yield of 5.5 per cent for similar grade commercial property developments without the benefit of 30-year leases.

Stage 5 and resolution of outstanding VFM issues

The government agreed to authorise the Treasurer and Minister for Police to approve the VPC proposal to move to Stage 5, in which the contract is awarded, subject to the resolution of all outstanding issues to DTF's satisfaction.

In late December 2016, DTF provided the Treasurer with comprehensive advice that the outstanding issues were resolved and recommended that the VPC proposal progress to Stage 5 with signing of the lease.

Figure 4G shows DTF's advice to the Treasurer on the resolution of the outstanding issues.

Figure 4G
DTF advice to Treasurer on resolution of VFM issues

Outstanding issue to resolve

Summary of DTF advice on resolution

Victoria Police to obtain commercial advice addressing the following issues raised by the Valuer-General:

  • Can the proponents gain significant additional value from the offer by creating and marketing a de facto government-backed indexed security while retaining long-term ownership of the VPC?
  • Does Victoria Police have the ability to use the additional value to leverage current negotiations with the proponents regarding the proposed lease escalation rate or other lease terms?

Victoria Police's commercial adviser advised that there was no additional value available through a de facto government bond.

The Valuer-General was provided with this advice but offered no further comment or instructions on the issue.

Victoria Police to negotiate a memorandum of understanding with the AFP that provides a non-binding commitment to co-locate at the VPC.

Victoria Police signed a memorandum of understanding with the AFP including a non-binding commitment to co‑locate at the VPC.

Victoria Police expected the AFP to sign the sublease documents in mid to late 2017.

Reduce the rental escalation rate, while maintaining the current overall commencing net face rental rate and incentive amount.

Rental escalation rate reduced from 3.75 per cent to 3.65 per cent, while maintaining a commencing rental of $445/m2. The Valuer-General assessed the revised terms and indicated they provided the state with improved VFM.

Negotiate an option to reduce the floor space of the building to meet AFP requirements at a cost acceptable to the AFP.

AFP reduced its space requirement by one floor as part of negotiating the memorandum of understanding.

Victoria Police to take over this space given funding for additional resources, meaning the VPC would stay at 39 floors.

Negotiate ability to reduce subtenancy fit-outs under a revised agreement for lease regime, either to be recognised in the rent or, in the case of the AFP fit-out, compensated by a further cash incentive payment by the proponent.

Contractual documents amended to allow a 'negative variation process'. This allows the state to reduce the standard of fit-out in subtenancy areas, particularly the AFP space, with a higher standard fit-out for Victoria Police or other state government tenants.

The SSP reviewed and accepted this change and the related financial compensation for the state. The arrangements involved the rent remaining at the higher rate applicable to the AFP space with the new tenant reimbursed with a rent-free period or a cash payment.

The SSP noted it would be problematic to attract state government tenants for the space allocated to the AFP if it did not commit to a sublease as, even with compensation, rent for this space would be higher than market rent.

Victoria Police obtaining confirmation from its commercial adviser on the appropriateness of the proposed sublease rentals for the proposed subtenants.

The commercial adviser provided written advice confirming that the sublease rentals were appropriate.

Source: VAGO, based on information from DTF.

On 21 December 2016, the Treasurer accepted the advice and recommendation from DTF and wrote to the Minister for Police seeking agreement to progress the VPC proposal to Stage 5. The Treasurer requested that the Minister confirm that there was negligible risk that the AFP would not commit, given the critical impact of this subtenancy on the VPC proposal.

On 23 December 2016, the Minister advised the Treasurer that there remained a risk that the AFP would not formally commit to the subtenancy arrangements, but that Victoria Police advised the risk was very low and had mitigation strategies should it eventuate. These strategies involved reducing the standard of fit-out for the AFP-allocated areas and seeking alternative state government tenants.

On 7 January 2017, the state signed an agreement to lease the VPC with Cbus/Australia Post without binding agreements in place with the expected subtenants. The final building design and fit-out agreed on reflected the needs of these subtenants. The total annual lease costs including estimated outgoing and cleaning costs is $44.6 million.

On 11 January 2017, the Minister of Finance wrote to the Minister of Police seeking confirmation that in the event the AFP or another proposed law enforcement agency did not sign subleases that Victoria Police would cover the shortfall in rent costs until a replacement tenant(s) is secured.

Subsequent subtenancy issues

In December 2016, DTF's advice to the Treasurer and the agreement for lease indicated that the size of the VPC building would be unchanged at 39 floors. The SSP advised Victoria Police in December 2016 that the deadline for decisions to reduce the fit-out scope—a key mitigation strategy if Victoria Police did not secure tenants—was 1 December 2017.

The IDC monitored ongoing delays in securing binding agreements with the subtenants throughout 2017 and 2018.

In October 2017, Victoria Police received advice that ESTA would not relocate to the VPC. ESTA had been allocated one floor comprising about 3 per cent of the VPC at an annual cost of $1.1 million. To address this, Victoria Police intends to relocate an operational group from the City West Police Complex to take this floor in the VPC.

In early June 2018, six months after the deadline for the state to reduce the VPC fit-out scope, the AFP advised that it would not move to the VPC.

At the end of June 2018, Victoria Police advised its Chief Commissioner that:

  • the AFP had been allocated six floors and car parking at an estimated all‑inclusive annual cost of about $12 million
  • the state is obliged to cover the costs of this space at a rate of $555per square metre, which is higher than the Victoria Police rate of $418per square metre
  • Victoria Police had contacted Cbus/Australia Post about the potential to reduce scope of the AFP fit-out to reduce costs
  • Victoria Police would work with DTF to identify alternate tenants and reduce the cost exposure to the state.

In August 2018, DTF advised the IDC of the AFP withdrawal from the VPC and that Victoria Police was working with the SSP to identify other government tenants. DTF indicated that Victoria Police could lease up to a maximum of two floors of additional space in the VPC.

The IDC raised questions on whether subleasing space in the VPC to non‑Victoria Police tenants would impact on the secure nature of the facility and therefore the primary reason for assessing the VPC proposal as unique under the MLP guideline.

While we understand that the other law enforcement agency subtenant is committed to taking up its tenancy, the loss of two of the three subtenants means the state is exposed to additional costs under the lease signed with the VPC proponents and that the VFM proposition put to the government by Victoria Police and DTF has been compromised.

The extent to which the government's VFM benchmarks will be breached depends on whether Victoria Police can secure replacement tenants at rentals and lease terms equivalent to those assumed when signing the lease.

In June 2019, Victoria Police advised us that it was progressing negotiations with several organisations that had expressed interest in tenanting the vacant floors and that it expected to finalise terms once concept designs had been developed. At the time of this report, none have been confirmed.

Back to Top