Agencies Pay Lip Service to the Virtues of Long-Term Leases

Witnesses 7-30-14 House Hearing

Senior realty officers from GSA and six federal agencies face congressional members to address leasing challenges.

On July 30th the House Transportation and Infrastructure Committee hosted a subcommittee hearing entitled: “GSA Tenant Agencies: Challenges and Opportunities in Reducing Costs of Leased Space”. The assembled witnesses included Norman Dong, the Commissioner of GSA’s Public Buildings Service, along with senior real property officers from several Departments including Defense, State, Justice, Homeland Security, Health and Human Services, and the Social Security Administration.

Subcommittee Chairman Rep. Lou Barletta (R-PA) opened the hearing with the observation that 50% of GSA’s leases are due to expire in the next five years. He also noted that real estate conditions across much of the U.S. present a tenant’s market (that is certainly true in much of the Washington, D.C. area, where the federal government maintains its largest presence). The conclusion, therefore, is that market conditions are ripe for GSA to strike attractive lease deals and, with 100 MSF of leases due to expire in the next few years, GSA can achieve cost reduction quickly.

In his opening statement, Barletta also noted that the government gets the best rates when it obligates itself to long-term leases: “Why is the length of the lease so important?  At the most basic level, a longer lease lowers risk, lowers finance costs, and provides certainty for the landlord who can then offer lower rents. GSA pays a 20% premium for short-term leases of three years or less compared to longer leases.” He went on to note that “long-term leases do much more than lower rental rates. They allow the government and the building owner to spread out the upfront costs of moving or reconfiguring space to accommodate more people. You can’t do this with short-term leases.”

With all of these realty executives assembled at the witness table, Barletta went down the line and challenged each with two questions:

1. “Will you work with our committee to seize this opportunity, replace these leases on time and achieve the President’s savings goal?”

2. “Will you commit to [addressing] your long-term lease requirements with leases that are at least 10 years?”

The witnesses universally recognized that the only acceptable answer to each question was “yes”, so that’s how they responded. Yet, that answer can charitably be regarded as aspirational. As a practical matter, agencies are not obligating themselves to long-term leases–in fact, quite the opposite. In the three weeks following this hearing, GSA posted 28 new lease requirements to its FedBizOpps website. Only four of those allowed more than five years of firm term.

Though they may see the same long-term leasing benefits as Barletta, the agencies’ facilities plans are in flux as they attempt to comply with various cost reduction and space utilization mandates, leading GSA to be reluctant to enter into long-term lease contracts on their behalf. This is because most of GSA’s Occupancy Agreements (essentially subleases) with the tenant agencies are written such that the agencies can terminate at any time with 120 days notice, leaving GSA paying rent on empty space. GSA’s default response has been to approach lessors for short-term extensions. In fact, when we looked recently at GSA leases that expired in the previous 12 months we found that nearly half were extended for no more than three years (often with cancellation rights).

So, despite pressure from Congress to execute longer leases to take advantage of the current tenant’s market, GSA remains unable to expedite because it must rely on the tenant agencies to first sort out their facilities plans. It also seems that GSA is unwilling to expedite due to its own inflexible policies. This was evident in testimony from GSA Commissioner Dong who expressed his intent to host open competitions to achieve the “best value for the taxpayer” and also his desire to engage agencies three years prior to lease expirations. The problem, of course, is that GSA doesn’t have the luxury of early planning. The lease expirations have already piled up.

Rather than adapt to reality, the federal government is increasingly exercising its sovereign might to simply squat in place–without penalty and without any agreement to ultimately extend long-term. This can be frustrating to the lessors but I would expect it to distress Barletta as well since, as the government engages in its stoic and glacial process, the market pendulum nationally is swinging back to the landlord’s favor.

Greetings From Kansas City

The Colliers Government Solutions team represents owners of government-leased properties nationally. So, we travel a lot. This slideshow profiles my trip earlier this year to Kansas City–both Missouri and Kansas.  Yes, there is snow on the ground because I took these photos several months ago and I’m just now posting them to the blog. (Use arrow buttons to advance slides)

 

Social Security Office Closings Under Scrutiny

From Quincy, Florida, to Ketchikan, Alaska, field offices of the Social Security Administration (SSA) are being shuttered. Since 2010, 64 field offices have closed around the country, the largest number in the agency’s 79-year history. In addition, 533 temporary mobile offices have been shut down, and, in 2013, office hours were reduced in remaining locations. The closures and service reductions coincide with escalating demands from the aging baby boom generation, alarming the Senate Special Committee on Aging enough to commission a bipartisan investigation of the closures. The committee held a hearing on June 18 to discuss the findings.

In his opening remarks, Committee Chairman Bill Nelson (D-FL) emphasized that senior Americans rely heavily on Social Security benefits—about ¼ of married couples and ½ of single adults receive 90% or more of their retirement income from the program. In the past decade, the number of Social Security retirement beneficiaries has increased 20%, and the number of disability recipients has grown 38%. Created as part of the New Deal in 1935, the first SSA office opened in Austin, Texas, in 1936 and has grown into the world’s largest social insurance program.

SSA facilities now include headquarters in Woodlawn, Maryland, 10 regional offices, 8 processing centers, 37 teleservice centers and about 1,245 field offices. Although almost half of benefit applications were filed online last year, SSA logged 46 million field-office calls and 56 million call-center interactions, reflecting the continuing significance of person-to-person contacts to resolve problems and fulfill beneficiary requests.

Critics of the closures, including Chairman Nelson and the committee’s ranking member, Senator Susan Collins (ME-R), contend that cutbacks threaten to undermine service in rural areas and have been made without a systematic process that assesses local considerations. For example, witness Brenda Holt (a county commissioner in Gadsden County, Florida), outlined hardships resulting from closing a field office in low-income Quincy, Florida, where residents often lack Internet access, computers or public transportation. Beneficiaries’ vision and hearing problems can further reduce the efficacy of in-person alternatives, such as library-based video interfaces. Senator Nelson acknowledged the risks to vulnerable populations of failing to investigate impacted communities, saying, “In sum, it’s a process that lacks rigor, transparence and frankly sufficient information to make a real decision.”

It fell to Nancy Berryhill, SSA’s Deputy Commissioner for Operations, to defend agency closure practices. Berryhill reiterated the scale of SSA responsibilities, painting a picture of tough times at field offices where overburdened employees struggle daily to meet complex public needs. Budget constraints, resulting in the loss of 11,000 agency employees in recent years, have exacerbated the situation, and sometimes require hard choices such as field office consolidation. According to Berryhill, however, the agency’s decision-making process is careful, evidence-based and collaborative, engaging local stakeholders and respecting constituent concerns. Further, the agency is looking ahead as technology and demographics change customer expectations. While remaining committed to the field office structure, says Berryhill, online, phone and video deliver routine service efficiently while freeing employees to assist with more complicated issues. In 2013, the agency added a mobile app to its interface options. “Throughout our history,” said Berryhill, “Social Security services have been dynamic, shifting to meet the changing needs and expectations of the American people. Standing still is not an option.”

Senator Snow concluded her statement with an additional caution. A draft strategic plan, “Vision 2025,” proposes that the agency shift from person-to-person to online service as the primary approach within 11 years. Senator Snow called the plan “completely unrealistic,” saying it ignores the preferences and capabilities of elderly, disabled and other SSN applicants and recipients. Not scheduled for public release for several months, the plan’s implications for further SSA closings throughout the country will warrant scrutiny this fall.

Energy Savings Performance Contracts Leverage Scarce Federal Dollars

The GSA reinforced its role as a key partner in achieving President Obama’s greenhouse gas and energy efficiency goals in an announcement on June 11 in Lanham, Maryland. Agency Administrator Dan Tangherlini revealed a major Energy Savings Performance Contract (ESPC) to install energy-saving retrofits and renewable energy sources at the IRS New Carrollton Financial Service Center. Improvements will include LED lighting, geothermal wells in the parking lot, efficient chilled water plant, solar canopies and solar thermal heating systems. The $43 million project, expected to reduce energy use overall by 60%, will be financed by Ameresco at no cost to taxpayers; ESPCs create public-private partnerships in which a contractor provides energy efficiency and renewable upgrades and receives payment from the resulting savings. The IRS facility upgrades, plus improvements at the adjacent Silver Spring Metro Center 1, are expected to generate $3 million in savings in the first year.

The first ESPCs were awarded in 1998, authorized by Congress to accelerate energy conservation investments in existing federal buildings. The regulations were created by a Department of Energy (DOE) program, Federal Energy Management Program (FEMP), as required by the Energy Policy Act of 1992 and reauthorized in the Energy Policy Act of 2005 (EPACT) and Energy Independence and Security Act of 2007 (EISA) (summarized recently here). Since the program’s inception, DOE has awarded 315 ESPCs, resulting in more than $3.23 billion in sustainability investments and $7.88 billion in cumulative energy costs savings to the government.

The contracts, as alternative procurement methods, are popular with federal agencies because operating funds, not capital dollars, fund building improvements. No allocations are required from Congress. The process does require establishment of a long-term partnership between an agency and a private consulting Energy Service Company (ESCO). ESCO experts audit the federal facility, identify potential efficiency improvements and, in consultation with the agency, design and construct the project. The ESCO also obtains the needed financing and guarantees that the energy cost savings to the agency will cover payments to the ESCO over the term of the contract not to exceed 25 years.

The largest ESPC contract to date is a $195 million project for the FDA’s White Oak campus in suburban Maryland. Improvements there, designed and implemented by Honeywell, include heating, ventilation and lighting upgrades and a more efficient central utility plant to power the 1.2 million-square-foot expansion of the Center for Biologics Evaluation and Research. The annual emissions savings from the FDA White Oak project are expected to be equivalent to removing 4,000 cars from the road.

Helpful information and tools are provided by the FEMP to facilitate the sometimes-daunting ESPC process. Especially useful may be a 12-month timeline template for planning, scheduling and tracking a project, and suggestions on how to select an ESCO. FEMP emphasizes that measurement and verification are required for ESPCs to ensure consistent savings over the term of the contract. By allowing agencies to leverage savings from improvements to pay for facility upgrades, these contracts may well contribute ever-more-significantly as the administration continues to raise the bar for energy efficiency. In a one-minute House speech last June advocating ESPCs, Representative Peter Welch (D-VT) notes that the federal government spends about $6 billion per year to heat, cool and power roughly 500,000 facilities. Deploying ESPCs to fund upgrades without upfront appropriations not only preserves capital and decreases carbon emissions but generates jobs and supports local economies. Said Welch to his Senate colleagues, “This is something we can and should do together: save money, create jobs, improve the environment.”

AAAP Program Expanded Even Further (It’s Time to Get on Board!)

The U.S. General Services Administration (GSA), which leases office space on behalf of most federal agencies, has begun using a streamlined lease acquisition program in several markets across the nation and will continue to expand into new markets. We’ve profiled this program, known as the Automated Advanced Acquisition Program (AAAP), previously on this blog; and we also noted it’s initial multi-city expansion last year.

In summary, AAAP allows property owners/agents to submit offers into GSA’s procurement system. GSA then selects the lowest priced offer that meets the particular needs of a tenant agency. If a space is selected from the AAAP system for lease award, GSA can proceed with lease execution much more expeditiously than in a traditional competitive procurement (because almost all of the business terms are pre-negotiated). The AAAP is also widely used to renew existing GSA leases.

The AAAP has been in effect in the Washington, DC area for more than 20 years, during which time we’ve prepared hundreds of offers and successfully closed several hundred thousand square feet of lease transactions through the program. Our experience with the program, and the program managers, has been positive–though the program does have its pitfalls.

The primary benefits of the AAAP are speed and efficiency. For new leases, the ranking of competing offers is already established when a tenant’s space request progresses to the selection of a property, which eliminates the need for all parties to go through several months of offer revisions and clarifications. And for leases that have an extremely high probability of renewal, the AAAP can save, literally, hundreds of hours of work by GSA and the many landlords that are unnecessarily exercised to compile lease proposals that only serve as stalking horses. The relatively small TI allowance in the standard AAAP (at least here in the National Capital Region) is also a benefit from the Lessor’s perspective; and, as the program does not require participation from GSA’s tenant brokers, commissions are minimized.

On the other hand, there are some potential drawbacks with the AAAP. For example, the cookie-cutter approach limits the parties’ ability to negotiate or clarify aspects of the standard GSA lease. From GSA’s perspective, there may also be a lingering question of whether or not competition was truly maximized, as it’s possible the owner of the perfect building for a particular tenant agency may not have submitted space to the AAAP or failed to update a proposal to make it more competitive when they were capable of doing so.

Lessors that adopt this program during the earlier stages of national roll-out are likely to gain an advantage. Lessors with office availabilities in the following markets should include the AAAP as a standard feature of any space marketing program:

  • Atlanta
  • Boston
  • Chicago
  • Dallas/Ft. Worth
  • Denver
  • Kansas City
  • Los Angeles
  • New York
  • Philadelphia
  • Seattle
  • Washington, DC

Colliers Government Solutions develops AAAP strategies and submits offers on behalf of property owners across the nation. For more information, please contact Keith Lavey.

Single-Tenant GSA-Leased Property Sales

While tracking sales of single-tenant GSA-leased properties over the last several years, we’ve noticed some interesting trends which won’t come as a surprise to experienced GSA investors, but may be of interest to new entrants to this specialized market.

We catalogued a total of 183 transactions for the period 2011-13. The map below shows the regional distribution by number of deals. Region 4 (Southeast) had the most sales with 52 transactions during this period. Region 11 (National Capital Region) ranked second with 37 transactions and Region 7 (Southwest) followed in third place with 27 sales. Collectively, these three regions accounted for more than 63%. It’s no secret which regions have garnered the most attention from GSA investors.

Num of Sales

Those same 183 transactions resulted in a total sales volume of more than $4.26 billion for the period 2001-13. If we look below at the same map with sales distributed by transaction volume, not surprisingly the National Capital Region (NCR) dominated the market with the highest sales volume of GSA-leased product, completing over $2.5 billion in sales during this three year period. The Southeast Region had the next highest transaction volume with just over $508 million. Although the Southeast Region sold over 40% more properties than the NCR, the average sale in Region 11 was approximately seven times higher; $9.8 million vs. $67.9 million, respectively. With the continued slowdown in construction of new GSA facilities, it will certainly be interesting to see the impact on sales over the next three years.

Vol of Sales

Spotlight: TSA

TSA SealTraveling as much as we do to represent national owners of government-leased properties, it’s inevitable that one of the federal agencies we encounter most is the Transportation Security Administration (TSA). The agency’s current procurement for a long term lease to consolidate its headquarters in Northern Virginia has brought it to mind even more than usual lately. A component of the Department of Homeland Security, TSA defines its primary mission as protecting the nation’s transportation system to ensure freedom of movement for people and commerce. Though 97% of its budget ($7.39 billion in 2014) focuses on air transportation, TSA is also tasked with protecting mass transit, rail, highway, and pipeline transportation systems. About 640 million passengers and 1.5 billion checked and carry-on bags are screened by TSA each year.

The TSA was created in response to the terrorist attacks of September 11, 2001. Later that fall, Congress passed the Aviation Transportation and Security Act, which shifted the responsibility of screening passengers from private airlines to the federal government. Originally within the Department of Transportation, TSA moved to the new Department of Homeland Security in 2003. Within a year, TSA agents were functioning around the country, applying a multi-layered approach to security that involves worker training, intelligence analysis, information sharing with partner agencies, behavior detection, explosive detection by canine teams, Federal Air Marshalls and enforcement of regulations.

The current TSA workforce includes almost 50,000 Transportation Security Officers, responsible for screening 1.8 million passengers per day at 450 U.S. airports. TSA’s security duties include:

  • Detecting prohibited, illegal and dangerous items with advanced imagining technology;
  • Conducting 100% air cargo screening on domestic and international outbound passenger aircraft;
  • Conducting 100% terrorist watch list matching of passengers on domestic and international outbound and inbound flights;
  • Conduct background checks of over 15 million transportation-related employees; and
  • Supporting allocation of $2 billion in federal grants for mass transit security.

TSA has responded to critics of long airport wait times by initiating, in 2011, the Precheck Program. At about 100 airports, passengers can qualify for expedited screening by completing a background check, fingerprinting and payment of an $85 fee. Complaints about screening inefficiencies have been addressed, for example, through revised procedures for passengers ages 12 and under that encourage greater focus on higher risk passengers. The loudest complaints about TSA procedures usually target scanner machines introduced in 2010, sometimes known as “naked scanners.” The ACLU contends that the technologies invade personal privacy, and TSA is installing new software on millimeter wave units that can detect hidden threats but use the same outline of a person for all passengers. But in April testimony before the Senate Committee on Commerce, Science, and Transportation, TSA Administrator John Pistole emphasized that TSA must use available technology to stay ahead of constantly evolving terror threats to aviation.

Risk must be managed through multi-layered use of innovative technology, intelligence gathering and sharing, a trained workforce and appropriate legislation. Especially in a time of limited federal resources, Podesta testified, “It is not possible to eliminate risk altogether so our efforts must remain focused on managing and mitigating that risk. This is the most appropriate and sustainable model for TSA.”

GSA-Leased Properties: Why Invest?

Experienced GSA-leased property investors are quite familiar with the advantages and challenges associated with ownership of property leased to the GSA.  However, new entrants to the investment sales market for single-tenant GSA-leased property often ask why investors seek to acquire these assets. We typically answer this question by highlighting the advantages and challenges associated with such investments.  Here’s a brief rundown of some of the more notable ones.

Advantages

  • Strong credit tenancy – In an unpredictable market, a GSA-leased property offers investors a strong credit tenant under a lease contract that is guaranteed by the U.S. government.
  • High lease renewal rate – The long-term, stable tenancy of GSA-leased properties is well-documented. For the period FY 01 through FY13, GSA maintained occupancy in their leased facilities for an average of 23.3 years weighted by RSF or 14.6 years weighted by lease.*
  • Specialized facilities – Single-tenant GSA facilities are often purpose built and very specialized with extensive tenant improvement and security requirements. Think border patrol stations, DEA labs or courthouses to name a few. The unique functionality and associated replication costs of these buildings generally increases the likelihood of renewal and remaining in a facility well beyond the initial term.
  • Higher returns – GSA-leased properties typically exhibit higher returns than similar single tenant NNN investments–sometimes as much as several hundred basis points. Experienced investors that are willing to take on the risks of real estate ownership and operations find that these facilities can provide yields of more than 500 basis points over 10 year US treasuries.

Challenges

  • Full Service Gross lease structure – The typical GSA lease is full-service, which requires significant landlord responsibilities. Long-term operating expense risk is pushed primarily to the landlord, particularly as it relates to utility costs.
  • Early termination rights – Many GSA leases include a soft term whereby GSA has the right to terminate the lease based on a specified notice period. This presents significant underwriting challenges, especially as relates to debt placement.
  • Lack of product- 87% of existing GSA leases have less than 5 years of firm term remaining. 73% have less than 3 years of firm term remaining. The budget constrained environment and other factors have in effect shortened the average lease term, thus limiting the number of long term government-leased investment opportunities.
  • Lengthy lease renewal process- The GSA lease renewal process is often opaque and bureaucratic resulting in great frustration for owners who may be expecting timely action.
  • Consolidation/downsizing- As older buildings are being vacated, GSA is making a push to occupy its owned inventory to a greater extent.  Consolidations are causing tenant relocations, as is the difficulty of renovating in-place. The historically high rate of renewal may decrease. Experienced investors mitigate this risk by focusing on modern, efficient buildings, especially first-generation, specialized facilities.
  • Secondary/tertiary locations- GSA-leased facilities are often allocated in secondary or tertiary markets, at rents above the market norm. For investors unfamiliar with these specialized facilities, this is a source of concern as it relates to residual use. Many investors will underwrite the risk of the tenant vacating facility, which can lead to a wide variety of viewpoints on pricing from a prospective pool of buyers.

Of course every GSA-leased investment opportunity possesses its own, unique story and investment in this sector is certainly not without challenges. Yet, it is pretty clear that investors and developers continue to aggressively pursue single-tenant GSA-leased assets.

*Source: GSA Lease Turnover Analysis.

Greetings From Corpus Christi

The Colliers Government Solutions team represents owners of government-leased properties nationally. So, we travel a lot. This slideshow profiles my trip earlier this year to Corpus Christi, Texas. (Use arrow buttons to advance slides)

Spotlight: VHA

VA SealAmong the revelations in the unfolding scandal over U.S. veterans’ health care is the sprawling size of the Veterans Health Administration (VHA). A vast component of the Department of Veterans Affairs (VA), the VHA runs the nation’s largest direct health care delivery system. It administers and operates facilities providing primary care, specialized care and social services as well as health care education and training to physicians and other professionals. VHA central office staff works in the 810 Vermont Avenue, N.W., Washington, D.C., VA headquarters, but most employees serve around the country in the VHA’s 152 hospitals, 800 outpatient clinics, 126 nursing home care units and 35 domiciliaries. A map of VHA facilities, organized by region, can be found here. More than half of the VA’s 312,841 employees (2013) work for the VHA.

States and communities provided medical care to veterans in the first decades after the American Revolution. The Naval Home in Philadelphia opened in 1812, becoming the first federal facility authorized to provide veterans with food, housing and medical care. Other facilities followed, notably the Home for Disabled Volunteer Soldiers, authorized by President Lincoln in 1865 to serve Civil War casualties. Veterans benefits expanded after World War I, and President Hoover consolidated all veterans services, including medical care in 52 hospitals, when he created the Veterans Administration in 1930. World War II, the Korean War and the Vietnam War led to further growth of veterans health care services and hospital construction. In 1988, Ronald Reagan elevated the VA to a cabinet level department, overseeing the VHA.

Concerns about the quality and efficiency of veterans’ medical care have erupted more than once. During the Clinton administration, widespread criticisms led to VHA reform and decentralization. All operating units were organized into geographic sectors, called Veterans Integrated Service Networks, each adapted to respond to regional demographics. An open source electronic medical records system was also developed to improve care efficiency at low cost.

President Obama recognized the need for further modernization when he appointed General Eric Shinseki in 2009 to lead the VHA’s next transformation. Shinseki strove to improve the leadership culture, update electronic scheduling, expand education and training and reduce veteran homelessness. Before his May 30 resignation, Shinseki also presided over an ambitious construction program, building hospitals, clinics and outpatient centers during his tenure.

But now concerns about VA leasing project finances and delays may exacerbate the scandal over VHA health care delays and falsified records. A new Government Accountability Office (GAO) study of 41 outpatient lease projects revealed delays ranging from 6 months to 13.3 years. The GAO had adequate financial data on 31 of the projects and found cost overruns for 15, with projects exceeding budget outbalancing under budget projects by $18.5 million. Upon reviewing the report, the VA agreed with the GAO’s recommendation to update VHA’s guidance for outpatient clinic leasing. Until a permanent successor for Shinseki is confirmed, Acting Secretary Sloan D. Gibson will need to determine how to implement the GAO recommendations for the VHA along with other major changes needed at the beleaguered VA.