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Privatization: the sale of the century.

"Privatization. Pretty ugly word to describe a vibrant and growing trend the world over. In countries that are lesser developed and in countries that are greater developed, the dead hand of government is being pried from enterprises and institutions of every imaginable kind. We are witnessing, in fact, one of the great revolutions in history, the rout of the bureaucrats by citizen-entrepreneurs."(1)

Privatization is the full or partial transfer of select government responsibilities to the private sector. It can further be defined as the contracting of public services to the private sector, or, of greater interest to real estate professionals, the sale of government-owned assets. Nearly $50 billion in state-owned enterprises were sold to the private sector in 1991, double the amount sold in 1990. From a government's perspective, the basic stimulus behind privatization is a lack of funds. The United States lags the rest of the world in the global privatization movement, but not for long; privatization is finally coming to the United States.

Several arguments can be advanced both for and against privatization. Among the arguments in favor are the following:

* Less government involvement is better.

* Privatization can help stimulate the economy and lower taxes.

* Government agencies are less efficient than private firms.

* Private sector managers manage better than government managers.

* Being monopolies, government agencies do not have incentives to manage well.

* Governments should not deliver services provided by the private sector.

* Government agencies, being politically oriented, are less efficient than firms providing economically oriented outputs.(2)

Arguments against privatization include the following:

* Private companies are less accountable to citizens than governments are.

* Service interruptions may occur as a result of labor strikes or profit declines.

* Fraud and corruption are possible in private organizations.

* Governments lose the benefits of capital investments.

* Governments lose control over service quality.

* A lack of competition can lead to increased costs.

* Taxes and liability insurance increase the costs of services.(3)


Governments need money. At the local level, governments are required to fund programs that combat social problems such as a growing homeless population or the spread of AIDS. The U.S. government also faces an increasing need to rehabilitate or replace existing public facilities and infrastructures as well as to construct new facilities to meet population growth.

Cities depend on real estate taxes for approximately half of their revenue, counties for three-quarters, and townships for almost 100%. But many local governments have raised tax rates as high as legally allowed. Tax-raising efforts are further hampered by declining property assessments. With property and income taxes stretched to their limits, governments are being forced to re-examine their role in providing services.

Municipal governments are questioning the wisdom of owning and operating facilities ranging from schools to prisons, and providing services ranging from mail delivery to trash pickup. A city is not required to be in the airport business, nor is it required to own utilities.

Governments find privatization appealing because upon sale of municipally owned assets they 1) realize a major onetime windfall; 2) place properties on the tax rolls; and 3) begin collecting corporate income taxes.


A significant amount of privatization is generated by the economic developments that result from political changes throughout the world. In Eastern Europe, for example, after a few frenetic years of establishing new political and legal frameworks, many governments are eager to restructure their economies and transfer enterprises--including buildings--from public to private ownership. A significant volume of privatization activity has also been generated in Western Europe, Latin America, and South America.

The biggest sale in the history of state property was announced in January 1993 by the Russian government. All small- and medium-sized enterprises, as well as 5,000 large ones including the famous GUM department store, are scheduled to be privatized by the end of the year.

The demand for advisory services related to privatization efforts soared in 1991. "Big Six" accounting firms were involved in more than 1,000 engagements, quadruple the volume of 1990. Similarly, investment banks were involved in twice as many privatization assignments in 1991 as they were in 1990.

Many privatizations are financed by government agencies such as the World Bank, although it is generally more lucrative to obtain financing from the private sector.


Airports and roadways

Airports and roadways have been among the most popular areas of privatization. The major airports in London, Heathrow and Gatwick, were sold in 1987 for about $2.5 billion; five years later their market value was calculated at $4 billion. The market value of New York's Kennedy and LaGuardia Airports was recently estimated at about $2.2 billion. Private companies developing California's new toll roads have devised the world's first "no-toll-booth toll road," and they instituted the country's first use of peak-hour pricing to alleviate traffic congestion. In suburban Washington, D.C., private builders have proposed a $400 million, 17-mile toll road between Leesburg and Dulles International Airport. Investors are betting that commuters will gladly pay the suggested $1.75 toll to avoid congestion on public roads. More recently, an investment bank offered $4 billion for the Massachusetts Turnpike.

Telephone services

Telephone companies are also frequent targets of privatization efforts. Such efforts have been successful in Argentina, Spain, and Mexico. Shares in Telefonica de Espana, Spain's telephone company, now trade on the New York Stock Exchange. While under pure government ownership, service was notoriously poor. Telefonica tried in vain to keep up with the strong demand in a country where only two-thirds of all households had a telephone. Now, under public/private ownership (the government still owns about 35% of the stock), rate increases have been granted and dividends are tied to profits. The stock has performed well, increasing by 40% to $35 per share in early 1993 up from about $25 per share in October 1990.

By the end of 1990, the Mexican government eliminated, merged, transferred, or sold 822 of 1,555 state-owned companies and authorized the privatization of 137 more; this effort generated about $14 billion in revenue by the end of 1991. Prior to being privatized, companies were frequently restructured to make them more attractive to prospective purchasers. As a result of favorable union negotiations, retirement of outstanding debt, and other changes, the market value of Telefonos de Mexico increased to $8.6 billion in 1990, the year it was privatized, from $1.6 billion in December 1988.

In Singapore, where there are 40 telephones for every 100 people, the proposed privatization of Telecom is eagerly awaited by investors. It marks the country's first major privatization since the sale of a 46% interest in Singapore Airlines in the 1980s. Telecom has a 15-year monopoly on domestic and long distance service, and a 5-year monopoly on mobile service. Singapore's other privatization candidates include the electric and gas utilities, the Port of Singapore Authority, and the country's subway system.

Other types of service

Home to the Toronto Blue Jays baseball team, Canada's SkyDome complex consists of a 50,000-seat stadium (reportedly the most profitable in North America, before interest, taxes, and depreciation), a 346-room hotel, a health club, and numerous restaurants including the world's biggest McDonald's. Completed in 1989 at a cost of nearly $600 million (Canadian dollars), it had a net operating income of about $27.5 (Canadian) million, but a cash flow after debt service of negative $39 (Canadian) million. Owned by the province of Ontario, the complex may be sold to a group of private investors if the $330 (Canadian) million in debt and $60 (Canadian) million in contractor liens can be restructured.

In case readers are shocked at the thought of privatizing such services, perhaps the following historical perspective will put minds at ease:

Many of the functions which today are taken for granted as being "inherently governmental" were originally contracted for--a notable exception being tax collection. At the turn of the century it was common for local governments to contract for the provision of services such as garbage collection, transportation and fire protection. Largely private provision of services was rescinded and taken back by government entities in response to charges of corruption and scandals. But by the early 1980s, privatization had again become popular at the local level.(4)


Cities are using competition in the daily chores of running buses, collecting garbage, mowing grass, sweeping streets, plowing snow, pruning trees, maintaining vehicles, feeding school children and hospital patients, operating computers, and doing hundreds of other common municipal activities. This is prudent privatization. The basic issue is not public versus private, but monopoly versus competition. Cities everywhere are taking advantage of the capabilities of the private sector and introducing competition to cut costs and improve services at the same time. Among the most active has been Newark, New Jersey, which, since the late 1970s, has privatized garbage collection, street cleaning, demolition, computer services, and construction design.

Local governments possess a huge pool of untapped capital investment, for which they earn a zero economic rate of return. For example, Los Angeles owns four airports, a giant port, a water system, an electric power company, and several waste-water plants. And because these resources are publicly owned, the city hasn't had a financial incentive to keep many of these assets productive and up-to-date. Selling select assets would net billions of dollars and lead to better management.

Most domestic privatizations have focused on two areas: schools and airports. For example, a consortium of three companies headed by Education Alternatives, Inc., of Minneapolis, recently announced plans to take over management of nine Baltimore public schools. The company would receive the amount currently spent by the city, about $5,500 per pupil per year, and in turn be held accountable for raising students' educational performance.

In Chicago, several detailed studies recently analyzed the difference in cost between the city's public and private schools. Under public stewardship, the cost per pupil is similar to Baltimore's. According to the Archdiocese of Chicago (Catholic schools represent more than 70% of all private schools in the United States), the average annual cost for educating each student is only about $1,800. While a direct comparison cannot be made--public school budgets must include such things as the cost of transporting children and educating those with mental and physical disabilities, and Catholic schools can employ religious personnel who may be willing to work for less monetary compensation than lay teachers--the studies conclude that the cost of providing a private education is about one-half to three-quarters that of a public education. Operating-budget savings for 1992-1993 have been estimated at $750 million citywide, $3.4 billion for the state of Illinois, and, if extrapolated to the entire United States, more than $70 billion.

Knoxville entrepreneur Christopher Whittle is among those taking the most radical approach toward school privatization. His Channel One program reportedly provides advertiser-supported televised news to 40% of U.S. middle and high schools. He envisions that 20 years from now, there will be several national education providers, each with a different design, collectively offering parents a wide choice of alternatives. Among the ideas being explored are keeping schools open 12 hours a day with staggered schedules to accommodate working parents, and eliminating the traditional school environment of an expensive, inflexible auditorium surrounded by classrooms and replacing it with office buildings purchased from the Resolution Trust Corporation. If he moves forward, Whittle expects to begin accumulating real estate as early as 1994.

The privatization of airports has been the subject of serious consideration for at least four years. The primary obstacle has been the fear that, under private ownership, a profit-motivated operator would raise fees charged to everyone, from the people who pick up passengers to the airlines themselves. Other fears include a decrease in accountability to the public, the possible loss of union jobs, and the first steps toward a complete deregulation of the airline industry. In 1989, a proposal to acquire control of Albany County Airport in New York State, the country's oldest municipal airport, for $30 million, was defeated by the Federal Aviation Administration, which ruled that airport revenue must be plowed back into the airport and could not be taken out as profit or used to retire old debts. The prospective purchasers had further promised to build a hotel and industrial and office facilities at a cost of $75 million. In the spring of 1992, however, President Bush issued an executive order allowing any local government that sells projects built with federal aid to keep most of the money rather than reimburse the federal government.


Privatization will continue to grow worldwide. Overseas, businesses are being sold. Domestic efforts probably will be focused on cities and states, particularly those that are the most troubled financially. Although privatization makes financial sense, it is not always politically popular.

America needs to invest in its infrastructure, from deteriorated bridges and potholed freeways to new sewage treatment plants. The confluence of financial difficulties in the public sector and the private sector's willingness to invest in and innovate an existing facility (without the lease-up risk, in real estate parlance), means U.S. privatization is inevitable. The United States is about to enter a new era of private investment in public facilities, and appraisers should begin preparing for it.

1. Alan Abelson, "Up & Down Wall Street," Barron's (June 15, 1992): 1.

2. Van R. Johnston, "Privatization of Prisons: Management, Productivity, and Governance Concerns," Public Productivity and Management Review (Winter 1990): 190.

3. Ibid., 192.

4. Kathleen C. Neff, "Labor-Management Relations and Privatization: A Federal Perspective," Public Administration Review (January/February 1991): 24.

Howard C. Gelbtuch, MAI, is senior director of all valuation services for Jones Lang Wootton USA. Mr. Gelbtuch currently serves on the Appraisal Institute's International Relations Committee and chairs the International Activities Committee of the American Society of Real Estate Counselors. He received a BS in finance from New York University and an MBA in real estate from The Bernard M. Baruch College of the City University of New York, and has previously published in The Appraisal Journal.
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Author:Gelbtuch, Howard C.
Publication:Appraisal Journal
Date:Oct 1, 1993
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