Spotlight: USAID

Since its heyday in the Kennedy Administration more than half a century ago, nonmilitary foreign aid has had detractors and defenders in roughly equal measure. On the con side, critics urge that money spent building power plants in some tropical nation across the ocean would be better spent mending broken infrastructure here at home. On the pro side, champions of aid hold that it’s an inexpensive investment to secure friendship—and with it access to resources and future markets—while at the same time performing humanitarian service, doing well, in other words, by doing good.

In 1961, early in his term, President John F. Kennedy created the US Agency for International Development (USAID) as an omnibus vehicle for delivering foreign aid, supplanting several smaller agencies created in the first and second terms of his predecessor, Dwight D. Eisenhower. USAID was first housed within the State Department. It has since evolved into a nominally independent agency under the authority of the executive, although it coordinates closely with State—and an estimated third of USAID staff come from the Foreign Service, itself housed under State. USAID also coordinates with other departments and agencies, including Commerce and Agriculture, as well as the National Security Council.

In the bargain, USAID has evolved from a catchall foreign-aid clearinghouse to an agency that, in the words of an informal mission statement, works primarily “to end extreme global poverty and enable resilient, democratic societies to realize their potential.” In that work, USAID efforts are almost always government-to-government, providing direct financial assistance as well as expertise. Recent USAID initiatives include the eradication of tropical diseases, the development of projects to encourage renewable energy sustainability, and disaster-relief training. Always, the emphasis is on local solutions, with a preference given to hiring local workers whenever possible, though supplemented and trained by American experts in such things as energy production, agriculture, and public health.

As of FY 2015, the annual budget of USAID was $35.6 billion. A recent Government Accountability Office review of USAID found that the agency was effective and responsible in handling funds allocated to it for assistance purposes, though, as is so often the case, it also held that the agency could stand to improve its standards for measuring the progress and performance of the projects it sponsors. Of particular importance have been efforts to curb funds falling into the hands of corrupt foreign officials or, worse, terrorist organizations. A pilot “Partner Vetting System” is now being tested to enhance the agency’s due diligence practices.

USAID has grown substantially over the years, with headquarters in Washington, regional centers in the United States, and scores of outposts abroad, most of these last located in embassies. At present, it has about 4,000 career employees, housed under both the federal civil service and Foreign Service, and several hundred short-term contract employees. So large is it that offices are scattered across the District of Columbia and neighboring Arlington, Virginia; the agency’s large global health bureau, for instance, moved to Crystal City from Washington proper in November 2014, its 500 employees forced to leave the Ronald Reagan Building during large-scale renovations. As of March 2016, the agency’s plan is to centralize in two buildings: the Ronald Reagan Building and International Trade Center, and a building yet to be acquired through lease.

Though USAID has independent leasing authority granted through Section 636 of the through the Foreign Assistance Act, it has self-imposed limitations to its ability to exercise this authority. Most notably, it will acquire space only when no suitable GSA-controlled property is available and it is more efficient or cost-effective for USAID to do so. Perhaps this explains why GSA is now leading the effort to acquire a 355,000 RSF lease in the District of Columbia with occupancy slated no later than May 2020. This lease will consolidate USAID staff who are currently located at 400 C Street SW, Washington, DC; 2100 Crystal Drive, Arlington, VA; and 2733 Crystal Drive, Arlington, VA.

Spotlight: CFTC

Founded in 1974, the U.S. Commodity Futures Trading Commission (CFTC) is an independent agency charged with regulating the futures and options markets. As these markets have grown with the “financialization” of the economy, the scope and work of the CFTC have grown accordingly—no surprise, since it’s estimated that some two-thirds of the leading hedge funds are commodity pools, falling under its direct purview. If occasionally the CFTC has come under criticism for perceived failures in detecting and preventing fraud cases such as the infamous Bernie Madoff swindle, more often it is a quiet overseer of the futures market, pursuing the goals and mandates of Dodd-Frank and other regulatory acts.

The main offices of the CFTC are in Washington, D.C. The agency has a large presence in New York and somewhat smaller offices in Chicago and Kansas City, the last of which is increasingly emerging as a financial center of world importance. The number of offices corresponds neatly with the number of officers, or commissioners, who comprise the CFTC: four, as well as a fifth commissioner who, appointed by the President with the consent of the Senate, serves as chair and directs the group. To avoid any political overweighting and assure independence, the CFTC mandate requires that no more than three of the five may belong to any given political party.

At present , the chair of the CFTC is Timothy G. Massad, who oversaw the Troubled Asset Relief Program (TARP) for the Department of Treasury during the financial crisis of 2007–2008. He has served in that capacity since June 2014, along with two other commissioners appointed at the same time. The remaining two seats are vacant, though this does not appear to have any political subtext.

That political dimension is important. As of the summer of 2016, the CFTC had approximately 675 employees, a marked increase from a low of 430 during the last years of the Bush administration. Since the Republicans gained control of Congress in 2014, there have been several efforts to diminish the role and power of the CFTC and other agencies with regulatory oversight over the financial industry. If nothing else, this opposition has prevented the agency from growing to the 1,100 or so positions that the Obama administration had projected in earlier budgets. Since Dodd-Frank went into force, in fact, CFTC has had trouble holding on to staffers—not because of a work overload or any other stressor, but because the financial industry itself has been recruiting CFTC veterans to help walk it through regulatory reforms, leaving the agency understaffed.

Most recently, the CFTC has been in the news because of its role in the prosecution of former New Jersey Governor and U.S. Senator Jon S. Corzine, a Democrat, whose Wall Street brokerage was accused of improprieties following its collapse and the loss of more than $1 billion in investor funds. In 2013, the CFTC sued Corzine; last month, details of a settlement were revealed that require Corzine to pay $5 million in penalties out of his own pocket (as opposed to through insurance) and would ban him from the trading industry for life.

The agency has also made news for the wrong reasons. In February 2016, the US Government Accountability Office (GAO) reported that the CFTC had not fulfilled its requirement to record the government’s obligation on properties it had leased in multiyear agreements—in Chicago alone, a lease valued at more than $20 million. A subsequent GAO report, filed in April, noted that the agency had made ambitious expansion plans to increase leased space in accord with plans for new hires, resulting in a notable underuse of leased space—in Kansas City, with leases at more than $575,000 a year, only 43 percent of CFTC office space was occupied, while in New York, significantly more expensive quarters were only 68 percent occupied. Washington did better, but even its leased spaces were only 80 percent occupied.

The GAO has suggested that the CFTC put itself in alignment with General Services Administration (GSA) guidelines for leasing space for federal agencies, guidelines that we have written about at several points in this blog. The second GAO report concludes that “CFTC generally concurred with GAO’s recommendations”—but that it also said that “it would not be able to take actions to reduce lease costs in the near term.”

It all speaks to the old Latin tag, Quis custodiet ipsos custodes? Who will guard the guards? We’ll be keeping an eye out for developments.

GSA Lease and Sales Market Trends

It is well-documented that since Freeze The Footprint began in 2012, the GSA and its tenant agencies have been actively pursuing consolidation and downsizing in order to meet these requirements.  The question is – how has this dynamic impacted the investment market for GSA and other Federal-leased properties during the past 4+ years?

The table below compares year-end (December) GSA Lease Inventory statistics from 2011 to 2015, along with year-to-date (August) statistics for 2016.  The red line in the chart between 2011 and 2012 is placed there to represent the end of the build-to-suit construction boom along with the start of the Freeze the Footprint mandate.

2011 to 2012 shows the peak of the GSA leased square footage inventory that resulted from the post-Oklahoma City bombing / 9/11 construction boom.  From there the dynamics of the past 4+ years play out:

  • Since Year-End 2012, GSA has decreased the total number of leases by 7%, but square footage has only decreased by 4% – which illustrates how GSA has been managing their square footage primarily through consolidation.
  • Average remaining lease terms increased as new construction projects came online, peaking in 2013, and decreasing since then.
  • Although there has been only a 3% decrease in the average remaining lease term from 2012 to YTD 2016, the average remaining FIRM term for the GSA lease portfolio shortened by over 13%.
  • Comparing the various tranches of remaining lease term on the right side of the chart, the number of leases with 3 to 10 years of remaining firm term has decreased significantly, while leases with less than 3 years of firm term or no firm term have decreased minimally.
  • This illustrates the proliferation of short term extensions and holdovers as GSA struggles to manage its leased portfolio, along with the lack of manpower to address all of these expiring leases.

So what effect has this had on the sales side?

The following table and graph shows GSA and federal-leased sales from 2012 through July 2016 that are taken from our Colliers Government Solutions database.  These sales only represent properties in which the GSA/Federal agency is the primary or 100% tenant in the building (at least 75% occupant), and exclude sales within the Washington, D.C. core.

The highlights from the table and graph are:

  • 2012 shows the beginning of the end of new build-to-suit projects trading in the market – the peak in terms of average remaining lease term and firm term of deals trading.
  • The drop in volume from 2012 to 2013 shows less new build-to-suit product trading, which lowered the average remaining lease term of deals trading, and correspondingly, increasing the average cap rate.
  • From 2013 to 2014, volume picks back up as more sellers take advantage of decreasing cap rates for the same average remaining lease terms.
  • Since 2014, volume is constant, but average deal size decreases and average remaining lease term drops dramatically as the market chases smaller deals with shorter lease terms, at slightly lower cap rates overall. In addition, buyers show a willingness to take on more “risk” in terms of shorter lease terms with the perception that renewal probabilities are higher as the lack of new construction persists.

In our view, as long as interest rates remain low, and this dynamic within the Federal-leased property inventory continues to play out, cap rates for properties with medium-term leases will continue to trend downward – making it an ideal time for owners of these properties to sell.

Is the 100-Year Floodplain Now Obsolete?

The water is rising. So scientists working with the National Oceanic and Atmospheric Administration (NOAA) recently reported. Regardless of one’s point of view about ultimate causes, they note that the eastern and southern coastlines of the United States are increasingly subject to flooding as sea levels rise.

On January 30 last year, President Obama issued an executive order requiring that federal agencies employ strict building standards that take into account the likelihood of future flooding. That order followed a report from the US Army Corps of Engineers warning that increased flooding was likely on the Atlantic and Gulf coasts, as well as the National Climate Assessment’s findings that at least a trillion dollars of property damage would ensue from flooding brought about by a 2-foot rise in sea level.

Almost all climate models assume that rise. At the same time, some old tried-and-true measures used by climate scientists are being revised in the face of current realities. Storms and floods, for example, are spoken of in scientific shorthand as “100-year,” “500-year,” and even “1,000-year” events, meaning, in the case of the former, that there is a 1 percent chance of a significant flood occurring in any given year with a 100-year period.

Yet, the numbers can get confusing in this shorthand. Consider that in early August 2016, in Louisiana, a 1,000-year flood occurred as a result of two days of intense rain in which nearly 2 feet of water fell from the sky. This would be notable enough on its own, but this particular storm was bracketed by storms of similar ferocity, intense enough that by those old measures the region experienced no fewer than eight 500-year flood events in the space of just a couple of months. That would seem to render terms such as “100-year flood” nearly meaningless, especially if it’s assumed that there is some static standard attached to them.

Altogether, emergency-management specialists calculate, these storms were far more damaging than the previous recordholder, which caused more than $3 billion in damage in 1995—and then there was Hurricane Katrina in between. That speaks to the emerging reality that storms are indeed increasing in intensity, and with them, in the coastal regions of the eastern and southern United States, so are floods. Indeed, notes the Federal Emergency Management Agency (FEMA), “Flooding is the most common and costly type of natural disaster in the United States, and floods are expected to be more frequent and more severe over the next century due in part to the projected effects of climate change.”

FEMA has consequently proposed revising federal regulations for new buildings such that they must stand 2 feet freeboard—that is to say, two feet above flood level on a 100-year floodplain. That figure is twice as high as the current mandated level in most jurisdictions, a figure that in turn was set by a post–Hurricane Sandy reevaluation of the 100-year standard. The minimum rises to 3 feet freeboard in the case of “critical actions,” activities that take place in structures in which, for example, chemicals are stored. Such structures include laboratory facilities, data centers, elderly housing, and hospitals.

The new FEMA regulations set the 500-year floodplain as “the minimum floodplain of concern for critical actions.” More precisely, the FEMA plan mandates that “there will be no new construction or substantial improvement of structures unless the lowest floor of the structures (including basement) is at or above the level of the base [that is, 100-year] flood, and there will be no new construction or substantial improvement of structures involving a critical action unless the lowest floor of the structure (including the basement) is at or above the level of the 500-year flood.”

Federal guidelines already instruct agencies to avoid building in floodplains “to the extent possible.” The proposed FEMA plan requires that construction within the floodplain be analyzed with respect to the “natural environment, social concerns, economic aspects, and legal constraints,” as well as the effect the structure might have on the floodplain. If practical alternatives exist to building within a floodplain in the first place, then they should be preferred to any construction within a floodplain. The regulations, in other words, strengthen previous guidelines, and they add rigor to the slippery definition of what constitutes a 100-year floodplain.

Federal Lessors know that federal lease procurements restrict competition from buildings that are not outside the 100-year floodplain, and in some instances these procurement require locations outside the 500-year floodplain. With rising sea levels, floodplains are expanding in many coastal locations. Further, the freeboard requirements of FEMA’s proposed regulations may further restrict some buildings from competing for federal leases. They may even disqualify certain existing federal buildings.

The public comment period for the FEMA proposal closes on October 21.

Top Federal Property Owners (2016)

The federal property sector remains a small niche in the overall investment market, but it is also dynamic. Despite the fact that the overall federal real property inventory is shrinking, sales over the past 12 months have remained active. Remarkably, slightly more than half of all federally leased properties purchased in the past year were acquired by just four firms–further evidence that the Pareto Principle is alive and well.

As in last year’s edition of our “top 10” list, this tally includes ownership of all federal properties except those occupied by the US Postal Service (though adding USPS properties would have little effect on these rankings). Otherwise, our methodology is as follows:

  • We have ranked owners by square footage and not by rent or any other measure because square footage is the most unimpeachable metric available to us.
  • We only tallied leases that have commenced. If a lease has been awarded but not yet commenced (as in a lease-construct project, for example) we haven’t counted that in this list.
  • Determining “ownership” can be tricky business. We have typically defined the owners as those operating partners who are the face of these properties–the people who ultimately manage the assets. However, we recognize that for some properties there may be behind-the-scenes equity partners whose ownership stake is substantial. We have not attempted to identify these equity partners in this list.
  • If you think we’ve mis-counted your portfolio, email me or leave a comment below.

Here is this year’s ranking:

1. Government Properties Income Trust

Government Properties Income Trust (NYSE: GOV) has been at the top of this list since our first edition in 2013. The investor should remain the industry leader for a while longer, even though it has not bought a single federally leased property since May 2014. GOV owns 67 federally leased buildings.

2.  The JBG Companies

Washington, DC-based JBG Companies has been, hands-down, the most active developer of new GSA-leased properties in the U.S., especially as measured by square footage. Yet, the marked slowdown in new construction has halted JBG’s growth in this sector. The firm is now selectively disposing of many of its assets, including the sale of an NIH-occupied, 491,000 RSF office building earlier this month. We expect JBG to continue to be a seller over the next year.

3.  Boyd Watterson

Boyd Watterson Asset Management is a Cleveland-based investment advisory firm that has emerged as the most prolific investor of federally leased properties on this list. Since purchasing its first government property in 2010, Boyd Watterson has amassed nearly 90 properties leased by GSA and other federal tenants. At its current pace of acquisitions, Boyd Watterson is poised to become the top U.S. government property investor in just a couple years.

4.  Corporate Office Properties Trust (COPT)

The COPT (NYSE: OFC) business model has focused less on GSA-leased properties and more on those leased by the U.S. Army Corps of Engineers on behalf of military and intelligence agencies. Though these agencies grew at a phenomenal rate following 9/11, that rate of expansion has cooled, at least as relates to leased space. COPT’s federally leased inventory stands exactly where it was a year ago.

5.  Vornado Realty Trust

Vornado (NYSE: VNO) continues to aggressively pursue federal tenants to improve occupancy in its Northern Virginia portfolio. Yet, Vornado’s federal lease inventory will decline sharply later this year once a receiver is formally engaged to take over the firm’s Skyline portfolio in Falls Church, Virginia. Skyline includes seven buildings that house 869,000 RSF of GSA-leased space.

6.  NGP

No firm on this list has been dedicated to government property investment longer than NGP. Now investing its sixth fund, NGP has amassed a total of 51 buildings and it is actively buying. If history is any guide, we expect NGP to continue to move up this ranking next year.

7.  Easterly Government Properties

Easterly (NYSE: DEA) was founded in 2011 as a federal fund investor and and in early 2015 the firm merged with Western Devcon and went public. Western Devcon also brought development expertise, positioning Easterly to grow both through acquisitions and new construction. Easterly debuts on our Top 10 list this year due to rapid post-IPO growth totaling a dozen property acquisitions.

8. USAA Real Estate Company

USAA debuts in the Top 10 for the first time this year, primarily due to its growing “US Government Building Fund”. USAA’s focus has been primarily on larger, newer properties, all with long-term leases. The firm purchased two buildings in the past year, totaling 647,000 RSF and USAA is still actively buying and funding new developments. It owns the 668,000 RSF National Science Foundation HQ project, which will deliver late next year. Expect its position in the Top 10 to improve over each of the next two years.

9. LCOR

LCOR remains in the top 10 based on its role as asset manager for the high net worth individuals that own the 2.4 MSF headquarters of the U.S. Patent and Trademark Office (PTO), the largest GSA lease in the United States. The PTO lease spans five office buildings in Alexandria, Virginia. LCOR developed this campus in 2003.

10. Brookfield Office Properties

The Brookfield Office Properties (NYSE: BPO) portfolio of federal leases has remained fairly steady since last year. Eventually, however, Brookfield’s federal inventory is likely to shrink. Its largest tenant, TSA, is expected to vacate as early as 2018 and its second-largest tenant, PBGC, recently began its market survey process in anticipation of a potential relocation in the 2018-2021 timeframe.

Colliers is pleased to have served eight of these ten leading federal property investors. To learn how we can assist you, please contact me here.

Long-Term Leased Investment Properties Are Becoming More Scarce

It is a well-accepted fact that the federal leased space market is shrinking. This is troublesome, yet for investors the real question has been whether the shrinking inventory has also made investment opportunities more scarce. The answer, unfortunately, is yes.

The graph above shows the total number of buildings at each point in time over the past decade that: 1) had at least 15,000 RSF of GSA-leased space; 2) were at least 85% leased by the federal government, and; 3) had more than 10 years of remaining lease term (without regard for cancelation rights). This analysis focuses only on the GSA-leased portion of the federal portfolio, but we believe this is a valid representation of the federally leased property sector on the whole.

We found that the overall number of these “long-term” GSA-leased buildings has been declining for more than three years. In January 2013, an investor looking for the types of properties described above would find 222 buildings in the U.S. At July of this year, that number has dropped to 169 buildings.

In large part, the selection of prime federal investment properties is dwindling due to the fact that GSA is now very rarely engaging in new lease-construct (i.e. build-to-suit) projects. Lease-constructs yield the longest leases, typically 15 to 20 years, whereas leases in existing buildings are generally capped at 15 years, and more likely at 10.

Budgetary austerity is the driving influence in federal real estate, and GSA, as a matter of policy, has substantially slowed its pursuit of new construction. So, as the lease terms on lease-construct properties burn off, there are few new projects to replenish the supply. The effect of this is apparent in the graph above. The reduction in the number of long-term leased investment properties has been fueled entirely by the dwindling number of lease-constructs. Based upon the paltry number of new buildings under construction currently, it’s easy to project that long-term leased properties will become even more scarce.

None of this suggests, however, that GSA doesn’t have need for long-term leases. It does, and it will, especially as agencies attempt to reduce their footprint by improving space utilization. Increasing utilization generally requires substantial workplace reconfiguration–and that requires tenant improvement capital, something that is only available from lessors in exchange for long-term leases. In fact, the number of long-term leases in existing (non build-to-suit) buildings has increased. This is clear if we take the graph above and reverse the stacking.

What does it all mean?

The chief reason to invest in GSA-leased properties is to harness the underlying United States of America credit. Yet, that credit isn’t worth much unless coupled with substantial lease term. This explains the allure of lease-construct projects. They are attractive to investors because they typically have longer leases and those contracts are more often non-cancelable, a feature that is otherwise uncommon among the rank-and-file GSA leases. Another reason lease-constructs are so important is that they are purpose-built buildings, often with mission-critical features. It is widely assumed that lease-construct properties benefit from higher renewal probability.

With lease-constructs growing scarce, traditional credit-driven investors are being nudged out of their comfort zone. The growing scarcity of long-term leased buildings has served to substantially compress cap rates for that tranche of product, making them far more expensive than they were just a few years ago. Further, the declining number of these buildings has made it difficult to stay true to an investment strategy focused solely on such assets.

Increasingly, investors are now searching for good buys with high renewal probabilities, even if they have shorter remaining lease terms currently. These properties are also more plentiful. For example, investors willing to purchase buildings with at least seven years of lease term remaining will find that there are twice as many as those with ten years.

The reduced availability of long-term leased investments is wringing passive investors out of the market and favoring those that understand how to properly assess renewal probability. It is also making it more difficult for new investors to enter the sector because their capital generally requires them to acquire a base of long-term, stabilized assets before exploring “riskier” territory.

On the whole, this is producing consolidation of ownership among a relative few, experienced investors. But even those investors will have to adapt to this evolving market, at least for a while.

The Supreme Court and the Rule of Two

In mid-June of this year, the US Supreme Court issued a rare unanimous decision directed at the Department of Veterans Affairs—but that may affect all federal agencies in time as they engage with private contractors for goods and services.

In the case of Kingdomware Technologies, Inc., v. United States, a Maryland supplier sued in the belief that it had been illegally excluded from the procurement procedure for an emergency-notification system for four VA medical centers. Kingdomware is owned by disabled veterans, and thus was eligible for consideration under the so-called Rule of Two. By that rule, a set-aside provision widely followed within the government, if two or more qualified small contractors can respond to the requirements of a given bid, then the contract will be awarded to one of them—a clause known in shorthand as “shall award.”

But at the VA, the rule was more a rule of thumb, it seems, given another bit of procedural streamlining under the Federal Supply Schedule (FSS), which allows an agency to award a noncompetitive bid to a sole source when a contract falls below a specific dollar threshold. So the emergency-notification bid did, and so the VA turned to a supplier of earlier services to fulfill the contract.

Kingdomware objected that the contract violated the “shall award” provision of the Rule of Two. The Government Accountability Office (GAO) concurred, saying that the VA had behaved unlawfully but venturing only a recommendation that the VA reconsider its award. The VA did not, and Kingdomware began legal proceedings.

The case ended on June 16, when the Court, led in the decision by Justice Clarence Thomas, ruled that the Rule of Two is not a suggestion but a mandate. The text of that decision, noting that “the word ‘shall’ usually connotes a requirement, unlike the word ‘may,’ which implies discretion,” further orders the VA to follow the Rule of Two over the FSS in most matters, admonishing that the latter was meant to be used in “contracts concerning complex information technology services over a multiyear period,” not for less challenging applications—in this case, one that the winning bidder completed within two years.

The VA is thus enjoined to apply the Rule of Two to all contract determinations and to award contracts to veteran owned and other small businesses whenever contractors with such qualifications are able to respond to bids.

Already the VA is feeling the implications of this ruling, revamping the assessment process, for instance, for Green Building Initiative certification assessments of VA buildings. Commentators have noted that the likely result of the ruling will be a flourishing of small businesses connected with environmental remediation and sustainable building, enterprises in which the VA—the nation’s largest healthcare system—has been at the forefront.

But students of federal policy also expect that the “shall award” provision, applied when two or more businesses submit offers to provide goods or services at “a fair and reasonable price that offers best value to the United States,” will extend beyond the VA. The Supreme Court decision does not say so directly, naming only the VA specifically, but it stands to reason that similar legal challenges in the future will be judged against this precedent—which, naturally, will eventually affect all federal contracting.

Moreover, the case holds implications for contending definitions of what a contract actually is, at least as distinct from a purchase order. The Court ruled that “an FSS order is a ‘contract’ within the ordinary meaning of that term,” removing a fine distinction that the VA had argued in claiming that it had been following the rules, and holding that a contract is a contract no matter what it might be called.

Trimming Data Centers: A New Initiative Aims to Trim and Optimize Federal Computer Hives

This is the age of Big Data. Given the flood of information, it is also the age of the big data center. Most of us don’t think much about these out-of-sight, out-of-mind hives of humming computers, but they are central to the modern wired economy, and they eat up energy in proportion to their importance—an annual energy consumption equivalent to the output of 35 large coal-fired power plants.

Data centers are everywhere, some of them massive (think Google, Amazon and other giants of and in the cloud), some of them small-scale operations that service retail operations and home businesses. Many do business with the federal government, and the government operates many more—which brings us to the nut of our story.

By the federal government’s estimation, based on a policy memorandum released on August 1 by Federal CIO Tony Scott, there are entirely too many of these data centers operating entirely too inefficiently, many well under 50 percent of capacity. As long ago as 2010, the Obama administration was considering ways in which to reduce their number, both to make the federal footprint more manageable and to reduce energy consumption, to say nothing of easing the way toward comprehensive security plans made possible only by knowing just how many of the things were out there—and where.

To this end, in 2014, President Obama signed into law the Federal Information Technology Acquisition Reform Act (FITARA), which requires federal agencies to undertake a comprehensive data center inventory, develop performance metrics, and provide an annual report detailing costs and savings measures. As of August 1, a new policy measure, the Data Center Optimization Initiative (DCOI), supplants a similar directive from 2010, requiring federal agencies to “develop and report on data center strategies to consolidate inefficient infrastructure, optimize existing facilities, improve security posture, achieve cost savings, and transition to more efficient infrastructure.”

As of April 2017, by the terms of the DCOI, federal agencies will not be able to budget for the construction of new data centers or “significantly” increase the size of existing ones. Instead, agencies, whether needing more space or not, will be required to analyze data needs and consider alternatives such as pooling resources with other agencies, using cloud services, or working with a third party, the last two of which would seem to offer opportunities to data entrepreneurs in the private sector.

The General Services Administration (GSA) and Office of Management and Budget (OMB) will develop standards for interagency cooperation, while GSA will develop a 
shared services marketplace, to include outside service providers. All these efforts are meant to work toward a set of larger goals, including optimizing existing data centers, closing about half of them, and arriving at inarguably significant savings, paring the data budget by at least 25 percent of the 2016 figure by the end of FY 2018 and taking costs down by half, $2.7 billion, of the $5.4 billion expenditure in FY 2014.

All of this is a tall order, reining in agencies across the government in a relatively short time, certainly shorter than most reform initiatives. To top it off, the effort must be transparent: Beginning this year, OMB will publish progress reports detailing planned and realized data center closings, cost savings, and other metrics. Updated information on the DCOI and FITARA will be made available here at the OMB website “Management and Oversight of Federal Information Technology,” and we will report on developments as they become known.

Who Really Has Leasing Authority?

Which federal agencies are authorized to lease property from the private sector? If you had asked that question of any federal official before last month, you might have drawn no more than an educated guess, if not an outright blank.

Certainly there is the General Services Administration (GSA), which acts as a kind of super-landlord and property-management authority for the federal government overall. Currently, GSA leases about 192 million square feet of property from the private sector, comprising nearly 7,000 office and warehouse spaces, a vast set of holdings. But many other federal agencies and entities have the ability and authority to rent space independently of the GSA—the US Postal Service, for instance, and the Federal Aviation Administration (FAA)—whether by virtue of their enabling legislation or by some appropriations act giving them the power to do so.

Until July, no one could say for sure just how many agencies had such leasing authorization. The reason for that is that not all federal agencies, as of now, are required to submit data to the Federal Real Property Council (FRPC), which falls under the aegis of the Office of Management and Budget (OMB). To multiply acronyms, as part of this effort, GSA has been charged with creating a comprehensive inventory of federal properties, an effort known as the Federal Real Property Profile (FRPP). An agency not governed by the FRPC—and there are many loopholes—is not required to file data with the FRPP.

All this came to the fore in a recent report prepared by the US Government Accountability Office (GAO) at the direction of the House of Representatives. In hearings before the Subcommittee on Economic Development, Public Buildings, and Emergency Management of the Committee on Transportation and Infrastructure early in July, the GAO report offers testimony that much work remains to be done to “enhance information and coordination,” as the report’s title has it, “among federal entities with leasing authority.”

What the report turns up may be surprising even to those inured to problems of coordination among federal entities. The GAO surveyed 103 of them, and 52, fully half, had independent authority to lease office and warehouse space. Nearly half of them were not bound by the FRPC and so had no reason to provide information to the FRPP, even though the collective holdings of these independent authorities were significant: 944 offices and 164 warehouses, or about 16.6 million square feet of rentable space. Among these agencies were the FAA, the National Aeronautics and Space Administration (NASA), the Coast Guard, the National Oceanic and Atmospheric Administration (NOAA), and the US Patent and Trademark Office.  These specific agencies normally lease space through the GSA…except when they do it through their own leasing authorities.

The GAO report, built on data covering the period between 2001 and 2015, makes a number of interesting observations that need to be teased out further. Among them is the fact that, though the possibilities for overcharging would seem to be rife, in general the spaces leased outside GSA purview are fairly priced and in fully 38 percent of cases cost less than GSA leases, while another 30 percent were about the same. Independently leased spaces also tend to be roomier than their GSA-leased counterparts; GSA recommends that federal agencies allow 150 square feet per employee (though this metric varies widely across their agency customers), but most of the independent spaces are at least twice as big.

“The FRPP’s incomplete data set reduces its effectiveness as an oversight and accountability mechanism for entities with independent leasing authority,” the GAO report notes. More actions are surely in the offing, but at a minimum, the report recommends that non-FRPC entities be required to provide information to FRPP and that federal agencies figure out tighter standards to govern leasing.

The GSA Market Continues to Shrink

GSA Leased Inventory Trend

We have written a lot on this blog about how the GSA-leased property market is getting smaller, a trend we expect to continue easily for the next few years. Yes, one day this trend may reverse itself but there are really only a few ways that might happen, and none of them seem likely right now (and some we would not wish for). Ultimately, the investment community will need to adjust to the fact that a half-century of consistent inventory growth began to fall back in 2012 and austerity is the “new normal”.

The GSA lease inventory reached its all-time peak size in December 2012. In that month, GSA leased 198.9 million rentable square feet (RSF) across the United States and its territories. Since then, the leased space inventory has declined by 6.7 million RSF to 192.2 million RSF in March of this year (the most recent data available). It’s really not a substantial decline–just 3.4%–but it has only just begun.

GSA is driving this reduction largely through improvements in space utilization. Our team of federal leasing specialists sees this every day in virtually every transaction we work on. In fact, there is a lot of street-level evidence that the pace of downsizing will accelerate based upon lease transactions that are in procurement or recently signed.

None of this is a surprise. The early indicators date back to 2011, well before the market peak, when fiscal conservatives took control of the House of Representatives and began exerting their control of prospectus leases to force cost reductions. Prospectus-level leases, while relatively few in number (a little more than 200 at any given time), comprise roughly 1/3 of the leased square footage in GSA’s inventory. So, Congress alone has the power to make meaningful cuts to the leased space inventory. Yet, OMB removed any doubt about the direction the market was headed when it issued formal guidance to all executive agencies to freeze the size of their civilian real property inventories and, ultimately, reduce costs.

The challenge for the feds is that their workforce has not changed much since the early 1970s. Though there is a lot of pressure from Congress to reduce the size of the federal workforce, it is unlikely that the agencies will accomplish much of a decrease in headcount. The answer instead has been to transform the workplace to embrace mobile work (i.e. work from home) and reduce the square footage allocated per person in new office designs. Often, these efforts to reduce have also resulted in consolidation into fewer locations.

On the consolidation front, Washington, DC has been especially impacted. There is almost 100 MSF of leased and owned property in the National Capital Region, providing lots of opportunities to consolidate offices. There are many instances of this happening in recently completed and in-progress transactions that are not yet reflected in the inventory reduction stats. One such example is last year’s 839,000 RSF Department of Justice lease of Constitution Square 3 and 4. By the time DOJ fully occupies these new buildings in 2018 they will have vacated four downtown buildings, yielding a net space reduction of more than 200,000 RSF.

The DOJ deal also underscores the fact that not only is GSA’s leased square footage getting smaller but also the number of leases. The count of GSA leases has also declined steadily since year-end 2012. There were 8,872 GSA leases nationally in December 2012 and by March 2016 that number was reduced to 8,279 leases–a decline of 6.7%. The decline in the number of leases is happening at twice the rate of square footage reduction, which suggests that consolidation is a big factor in shrinking the government’s footprint. As anecdotal evidence, our team is working on a downtown Washington, DC building where we have agreed to terminate three GSA leases so that the tenant agencies can be consolidated into other existing leased locations (a fourth tenant consolidated last year upon the natural expiration of its lease).

There is a silver lining to all of this. Though the leased inventory is clearly getting smaller, lease terms are likely to grow longer. This is because workplace transformations require capital, which necessitates long-term lease contracts. Having engaged heavily in short-term leasing over the past several years creating a pile-up of near-term lease expirations, we can expect GSA to more often execute long-term contracts going forward. Don’t expect a watershed change–GSA lacks the leasing capacity to tackle its entire backlog at once. Yet, in the long run we anticipate a shift towards long-term leasing and, ultimately, a stabler federal leasing environment.