Saving Energy and Tax Dollars: A New Report from the CBO Wrestles with Accounting for Both


At FDA’s White Oak campus in suburban Maryland, Honeywell has been awarded Energy Savings Performance Contracts totaling $195 million. Improvements designed and implemented by Honeywell over the past several years 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.

In 2012, Reps. Peter Welch (D-VT) and Cory Gardner (R-CO), bridging the partisan divide in Congress, created the House Energy Savings Performance Caucus, a group within the House that advocates for federal service contracts that emphasize energy savings.

Gardner moved to the Senate in January, his place at the head of the HESPC taken by Adam Kinziger (R-IL). Noting that the federal government is the single largest user of energy in the country, Kinziger immediately announced redoubled efforts to push an ESPC program, even as President Obama has outlined a goal of $4 billion in energy-cost savings by the end of 2016, when he leaves office.

Under the terms of the present Energy Savings Performance Contract (ESPC) system, to quote the Department of Energy (DOE), “a private party agrees to pay to design, acquire, install, and, in some cases, operate and maintain energy-conservation equipment—such as new windows, lighting, or heating, ventilation, and air conditioning (HVAC) systems—in a federal facility. In return, the federal agency agrees to pay for those services and equipment over time, as well as for the vendor’s financing costs, on the basis of anticipated and realized reductions in the agency’s energy costs.”

Put another way, an energy service company (ESCO) would pay for a new energy-saving installation—say, retrofitting an existing office complex with a geothermal heating and cooling system—and then would be repaid with most of the energy savings thus realized. The DOE assures vendors that “if the installed equipment is effective and is used at anticipated levels, and if energy prices remain close to projections, the value of the energy saved over the life of the equipment will more than cover the costs of the contract.”

The DOE is finalizing IDIQ (indefinite delivery/indefinite quantity) contract standards incorporating ESPC guidelines. It notes that since the contractors are providing funding, the program allows some relief from the limits of annual appropriations. Financing costs would naturally be higher under the ESPC system, since the contractor is assuming the risk and burden and may not be able to attain the most favorable borrowing rates, as the government would.

The savings may well be realized long after the typical cost estimate framework has expired. Whereas the Congressional Budget Office (CBO) measures costs on a ten-year horizon, the savings in an energy-efficient system may not come until several years later, after the system has been paid for. Measuring costs and savings is further complicated by the fact that they are split into two categories, mandatory and discretionary spending, that are governed by two sets of rules. A new report from the CBO notes that for the time being, “projected savings in energy costs and related costs are shown as potential future reductions in agencies’ discretionary appropriations.”

The ESPC concept is not new. In the 1980s, working under the rubric of shared energy savings (SES), the US Postal Service awarded a contract to the Co-Energy Group to retrofit the lighting at the 1.7-million-square-foot General Mail Facility in San Diego, California. San Diego Gas & Electric, the local ESCO, provided energy rebates to reduce the installation cost, while the contractor invested $164,714. Over seven years, the facility saved nearly $600,000 in lighting costs alone, a good return on investment that led the Post Office to develop other SES projects of several kinds.

Recently, the Food and Drug Administration White Oak Campus, near Silver Spring, Maryland, the General Services Administration (GSA) partnered with Honeywell under an ESPC to construct a heat and power plant that will cost some $71 million—but will also save $5.8 million a year in energy costs and $6.5 million in operating and maintenance costs. Similarly, reports the DOE, Camp Pendleton, the huge Marine Corps base in southern California, reduced its energy consumption by 44 percent even as it added 2 million square feet in facility spaces.

Camp Pendleton achieved this with a program of ESPCs, as well as a range of energy-savings measures including retrofitting light fixtures and adding roof-mounted solar energy systems to the mix. At another military base, the large naval station at Guantanamo Bay, Cuba, a contractor built a $12 million wind turbine project under the terms of an ESPC. The direct annualized savings are $1.2 million, meaning that payback will take ten years, just at the end of the CBO horizon. But, notes the Navy, other cost savings come into play as well, not least by removing more than 40 tons of pollutants from the atmosphere each year.

The savings from ESPCs are very real. Measuring and accounting for them remain matters of discussion.

Cutting the Federal Workforce

The federal government is big. That is something about which few people of whatever political stripe would disagree. Excluding members of the armed services (but including Postal Service workers), there are about 2.7 million federal employees—as many people as live in Chicago.

Yet, as the Wall Street Journal reports, this is the smallest number since 1966, and the federal government represents the only job sector to decrease in 2014—one reason, as we noted last week, that President Obama’s FY 2016 budget includes provisions to hire another 34,000 employees.

For some in Congress, however, that 2.7 million count is still far too large. Last month, Cynthia Lummis, a Republican U.S. Representative from Wyoming, joined with Mick Mulvaney, a colleague from South Carolina, to introduce a bill entitled the Federal Workforce Reduction Through Attrition Act. It demands that the federal workforce be reduced by 10 percent by September 30, 2016. As the Congressional abstract states, it “requires that compliance with such workforce limitation be made through attrition, or through both attrition and a freeze on appointments if the total number of federal employees exceeds the applicable maximum for a quarter.” It also requires that the Office of Management and Budget certify that this requirement has been met, though at the same time it allows the President to waive the limitation as necessary in “(1) a state of war or for reasons of national security; or (2) an extraordinary emergency threatening life, health, safety, or property.”

Lummis adds in a statement, “Instead of blindly filling empty desks, this bill forces agencies to take a step back, consider which positions are crucial, and make decisions based on necessity rather than luxury.” Her bill also requires that contractor jobs be cut in proportion to workforce reductions, presumably to avoid a kind of stealth, under-the-radar restaffing to make up for lost positions.

Whether any federal agency operates on a basis of luxury is a subject for debate, but this is not the first time that Lummis’s bill has been aired. Under the same title, she proposed it early in the 113th Congress—and two years ago, in February 2013, her colleagues referred it to the House Committee on Oversight and Government Reform, where it quietly languished and then expired.

Mulvaney, too, has introduced similar bills, including HR 3029 in 2011, which would have directed agencies to hire only one new employee for every three who retired or left government service. That was but one of a dozen federal-workforce-reduction acts before the 112th Congress, most aiming at a 10 percent reduction. None survived committee. Nonetheless, a report issued in that year from the office of Sen. Ron Johnson (R-WI), “$1.4 Trillion in Savings,” has remained influential—and now that Johnson heads the Senate Homeland Security and Governmental Affairs Committee, which oversees the federal workforce, proposals to make further cuts are likely to find a sympathetic ear.

Indeed, Lummis and Mulvaney’s latest effort arises in a time of increased antifederal sentiment on the Hill. At the same time that Lummis reintroduced it before the 114th Congress, a Republican colleague, Ken Calvert of California, introduced a bill that would cut the civilian defense workforce by 15 percent by 2023. Calvert argues that cuts in the civilian workforce should mirror those suffered by the military side of the Department of Defense, though he has not specified whether they would be accomplished principally by attrition or instead by layoffs.

How far both bills will travel in the 114th Congress remains to be seen. But critics of the proposed reduction, noting the historically low level of federal employment and the added burden it would place on already beleaguered agencies, have been quick to voice their opposition to the Federal Workforce Reduction Through Attrition Act. Said J. David Cox, president of the American Federation of Government Employees, “If Reps. Lummis and Mulvaney believe the federal government can afford to lose another 200,000 employees in the span of a single year, then they should explain to the American public where they think these cuts should occur and what services they think we can do without.”

Obama’s FY 2016 Budget: Higher Wages, More Spending, Less Real Estate


There’s good news if you’re a federal employee, assuming that President Obama’s proposed 2016 budget is enacted intact: It will come with a 1.3 percent pay increase.

Now, 1.3 percent isn’t a big hike, but it’s better than the 1 percent that came in FY 2015, and certainly better than the years that were leaner than that.

There’s good news, too, for several beleaguered agencies: the FY 2016 budget allows for hiring increases totaling some 34,000 jobs. About a third of those jobs will fall under the aegis of the Department of Veterans Affairs, and another 3,800 will be within the Department of Homeland Security, with other increases going to Health and Human Services.

All that may be a bright spot for the construction and property sectors. In the immediate term, this centers on Washington, where many of these jobs—especially those at DHS—will be located. Even allowing for the ever smaller office space allotted for federal workers, which now ranges from 80 to 150 square feet, these new workers will need to be housed somewhere.

But reading the tea leaves, within the budget is bigger good news for construction nationwide in the longer term. That news lies in its strong emphasis on infrastructure spending. Remarks a senior administration official, “The President goes very big on infrastructure in the budget to repair roads, bridges, freight, and our rail systems. . . . It’s $480 billion, which allows us to fund at about 40 percent above the current level of spending.” That amount of money will allow for some significant projects and development, and there seems to be a stirring of bipartisan support for the notion of long-overdue infrastructure improvement.

At the same time, it’s worth noting that the President’s commentary on the budget offers a long side note on “shrinking the federal real property footprint,” as the report puts it. Observing that more than $21 billion annually is spent on upkeep of the government’s 300,000-plus properties and that lease costs amount to another $6.8 billion, the Administration “proposes to use $200 million in annual rental payments collected from agencies, $130 million over the 2015 enacted level, to execute additional office space consolidations.” The goal is to reduce the federal footprint by about 500,000 square feet over the fiscal year.

Additionally, the budget includes a proposed $57 million to enact the Civilian Property Realignment Act (CPRA), which would create an independent board to review the government’s property portfolio and recommend to Congress properties to dispose of or reconfigure. It is estimated that this will save more than $1.2 billion over ten years.

Congress can always kill the pay raise, though it will have to do so by directly imposing a pay freeze, never a popular move among the best of circumstances. (Government workers vote, and there are a lot of them.) But Congress can also thwart President Obama’s budget plans in any number of ways, especially given the reigning antitaxation climate—and the infrastructure spending package hinges on business tax reform, especially on taxing assets that are now parked overseas. Observers on the Hill are expecting a fight. We’ll let you know as specifics develop.

The Executive Order of January 30, 2015: A Flood of Costly Regulations?

This FEMA flood hazard map produced two years ago shows the floodplain delineation for lower Manhattan.

This FEMA map produced two years ago compares 2007 and 2013 flood plains in lower Manhattan.

The figures are still being calculated for the costs of Hurricane Sandy, which swept up the East Coast of the United States in the fall of 2012, but at the moment they stand at $68 billion. That makes Sandy the second costliest hurricane in the nation’s history. Hurricane Andrew, which ripped across Florida and then crossed the Gulf of Mexico to Louisiana in 1992, caused $40 billion in damages, while Ike (2008), Rita (2005), Wilma (2005), Charley (2004), and Ivan (2004) cost a combined $91 billion. Hurricane Katrina, the devastating category-5 storm of 2005, holds its place as the single most costly weather disaster in American history at $138 billion.

Most of the damage wrought by those storms came not from wind and flying debris, the sorts of things that can be guarded against with plywood and duct tape, but instead by storm surges and inland flooding. The trends indicate that these are increasing in intensity and reach owing to a global pattern of climate change whose hallmark feature, besides climbing temperatures and melting Arctic ice caps, is a rise in sea levels around the world. Climatological forecasts vary widely, but many posit that sea levels will be anywhere from 1 to 8 feet higher than at present by the year 2100, affecting billions of people most of whom are yet to be born and entailing costs that could rise into the untold trillions of dollars. Meanwhile, more than half of the population of the United States lives near the ocean coasts and Great Lakes, and by all accounts, that percentage is likely to rise in the coming decades.

It’s for all those reasons that on January 30, President Obama issued an executive order requiring that all federal agencies employ strict building standards that take into account the likelihood of future flooding. The order follows a report from the U.S. Army Corps of Engineers that warns that increased flooding is 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—which many climate models assume will happen sooner rather than later.

The order allows agencies three options in determining how to measure flood elevations and hazard areas in siting and building federal projects. The first assesses them using “the best-available, actionable hydrologic and hydraulic data and methods that integrate current and future changes in flooding based on climate science.” The second adds from 2 to 3 feet to the current baseline of the so-called 100-year flood elevation (that is, the high water mark for major floods that in theory occur only once a century, but in practice happen more often), the lower figure for ordinary structures and the higher one for “critical” buildings such as VA hospitals, military installations, and the like. The third defines the floodplain as “the area subject to flooding by the 0.2 percent annual chance flood,” that is, the area inundated by not a 100-year but a 500-year flood.

These options are clearly open to some degree of interpretation, as is the wrinkle that an agency head can make exceptions to the order if the project is “a mission-critical requirement related to a national security interest or an emergency action.” In some instances, local codes for new buildings are more stringent than the federal government’s, even with these changes, and in any event the new regulations have no effect on existing structures and infrastructure that are increasingly more vulnerable to flood damage.

To all of these, concerns are sure to arise about the costs that will be added to projects as a result of the order, even if they lead to future savings in damage avoided. Thus was the case when GSA initially implemented seismic policy that, in effect, rendered huge numbers of federally leased buildings functionally ineligible to renew their long-time tenants. Similarly, GSA’s early attempts to convert the Energy Independence and Security Act into leasing policy were fraught with unintended consequences that (ironically) limited the ability of the newest and most energy efficient buildings to compete for federal tenants.

We know from practical experience managing leases across the nation that even minor changes to GSA’s interpretation of flood plain maps could adversely impact many buildings currently leased by federal tenants. We’ll be watching as policy is developed around this presidential mandate. The annals of government are full of well-intended laws and executive orders that have been drowned by burdensome policy. It remains to be seen whether President Obama’s latest executive order will be one of them.

Spotlight: CIA

CIAThanks to extensive media coverage, both positive and negative, and to countless spy novels and movies, the Central Intelligence Agency (CIA) is the best-known intelligence unit within the U.S. government, virtually synonymous with intelligence generally. In fact, CIA (it’s “the Agency,” or “Central Intelligence,” or “the Central Intelligence Agency,” but never “the CIA”) is only one of many intelligence agencies within the federal government, all of which contribute to the development and analysis of information used by government leaders to formulate foreign policy.

CIA, an independent federal agency, was created in 1947 at the dawn of the Cold War. The Agency was initially charged with coordinating the work of military and civilian intelligence analysts around the world. That mission continues today, though more specialized, separate units such as the National Security Agency have taken on some of CIA’s former responsibilities. Its current charge is to “preempt threats and further US national security objectives by collecting intelligence that matters, producing objective all-source analysis, conducting effective covert action as directed by the President, and safeguarding the secrets that help keep our Nation safe.” Among its concerns are the monitoring of nuclear-arms proliferation, terrorism, international organized crime, and drug trafficking, all of which are rightly seen as threats to national security.

CIA itself does not make policy decisions. Neither, contrary to widespread opinion, does it routinely spy on American citizens. Its mandate is largely to collect information related to foreign intelligence and counterintelligence, and only if an American citizen is suspected of working for outside governments or terrorist organizations does the Agency have interest in his or her doings.

CIA, naturally enough, does not widely advertise its activities, particularly those of a covert nature, and its staff and budget are classified. However, based on documents leaked by Eric Snowden, the Washington Post reported last year that the Agency’s budget was $14.7 billion, a 56% increase from the prior decade. If the information is correct, CIA’s discretionary budget is larger than each of of the Departments of Commerce, Labor, Interior and Treasury.

The Agency employs an estimated 21,000 workers, including specialists such as scientists, electrical engineers, mathematicians, linguists, and computer analysts, as well as field operatives. A survey conducted by the Washington Post in 2010 holds that the overall intelligence community occupies office space totaling more than 17 million square feet, the equivalent of nearly three Pentagons. On CIA’s main campus, which comprises 258 acres, the headquarters complex contains at least 2.5 million square feet of office space.

The Agency owns and leases buildings elsewhere in the District of Columbia, the country, and the world, though, for obvious reasons, no good figures are available as to their location and extent. Even the details of the Agency’s office space in the World Trade Center, destroyed in the terrorist attacks of September 11, 2001, remain unknown outside the halls of Langley.

CIA does not allow general access to its headquarters in the Virginia suburbs of Washington, D.C., which the Agency’s first director, Allen Dulles, selected precisely because it was private and secure. It maintains a public presence, however, through the publication of the highly useful and readily available World Factbook, a frequently updated almanac of information on world events, as well as of millions of other pages of documents that are released each year.

For more information, visit the Agency’s website at

Building Cybersecurity, Homeland Security, and the GAO

GAO-15-6Think of the many ways in which computers control buildings, from HVAC systems to electronic door locks and the flow of gas, water, and electricity. Now think of the many ways in which those computers can go haywire, from corrupt software to a power surge. Finally, think of what a person with bad intentions might do to a building’s computer system by means of another computer—with results ranging from mere inconvenience to outright destruction.

In the view of the Government Accountability Office (GAO), the Department of Homeland Security (DHS) and the General Services Administration (GSA) have not been thinking nearly hard enough about these matters, which clearly fall under their purview. In a report publicly issued on January 12, GAO observes that DHS lacks a coherent strategy to the problem of assessing threats and countering risks to federal buildings and access control systems. So absent is this strategy, in fact, that no one within DHS has even begun the work of assessing those risks in the 9,000-odd federal facilities that fall under the oversight of the Federal Protective Service (FPS).

Meanwhile, the GAO continues, the Interagency Security Committee within DHS has failed even to identify cybersecurity issues in its official report on the broad topic of “design-basis threat,” contrary to directives within the Federal Information Security Management Act (FISMA) of 2002. The ISC counters that it has been busy addressing the problems of shooters and workplace violence that have so prominently announced themselves at federal facilities, but as the GAO report puts it in so many words, if building cybersecurity is not listed as an area of concern, then no one will be concerned with it.

The GAO report observes that access control systems—“computers that monitor and control building operations such as elevators, electrical power, and heating, ventilation, and air conditioning,” by its definition—are increasingly connected to the Internet, and thus vulnerable to cyber attack. “Cyber threat sources include corrupt employees, criminal groups, hackers, and terrorists,” the report notes. “These threat sources vary in terms of the capabilities of the actors, their willingness to act, and their motives, which can include monetary or political gain or mischief, among other things.”

That threat requires strong countermeasures, and strong leadership in the face of the vaguely delineated responses that are now in place. As the GAO study notes, for instance, in a survey of federal security assessment reports, about a quarter give some indication that GSA has examined how users can gain access to those systems, but only to the extent that a user name and password are required—and not whether federal rules on password complexity are being met.

The GAO report concludes with three recommendations for executive action, the first two concerning DHS and the last concerning GSA. We quote verbatim:

  • Recommendation: The Secretary of Homeland Security, in consultation with GSA, should develop and implement a strategy to address cyber risk to building and access control systems that, among other things: (1) defines the problem; (2) identifies roles and responsibilities; (3) analyzes the resources needed; and (4) identifies a methodology for assessing this cyber risk.
  1. Recommendation: The Secretary of Homeland Security should direct ISC to incorporate the cyber threat to building and access control systems into ISC’s list of undesirable events in its Design-Basis Threat report.
  2. Recommendation: The Administrator of the General Services Administration should assess the building and access control systems that it owns in FPS- protected facilities in a manner that is fully consistent with FISMA and its implementation guidelines.

According to GAO, both DHS and GSA concur that these measures need to be put in place. The full GAO report is available here.

Better Late Than Never: Congress Reauthorizes TRIA

On January 8th, as anticipated at the close of the 113th Congress, the House of Representatives and Senate voted overwhelmingly to reauthorize the Terrorism Risk Insurance Act (TRIA).

In one of the first pieces of legislative business to be conducted since the convocation of the 114th Congress, the House voted 416–5 on January 7 to extend TRIA for six years. The substance of the bill is identical to the one passed in the House in December: it includes provisions to reimburse insurers for any costs above $200 million in the event of an act of terrorism. (This is double the amount provided for under the terms of the original TRIA, which expired on December 31.) At the same time, it raises co-payments on the part of those insurers from 15 percent to 20 percent.

In less than 24 hours, the Senate passed its own version of the bill by a vote of 93–4. As passed, the bill, which also reauthorizes TRIA for six years, adds several provisions. One is to remove Dodd-Frank Act restrictions so that agricultural and energy companies are exempted from the derivative regulations that banks must follow. The new TRIA legislation also provides for the establishment of the National Association of Registered Agents and Brokers (NARAB), which would allow agents and brokers to apply to a central clearinghouse, administered by state insurance commissioners, that would in turn streamline multi-state licensing.

It was an objection to that final provision on the part of now retired Senator Tom Coburn (R-Okla.) that led him to successfully block the vote on December 16, thus allowing TRIA to expire. Political observers consider the speed with which TRIA cleared both chambers of Congress to be a hopeful sign that a long-standing pattern of gridlock may be at an end. It’s worth noting, too, that while opposition to TRIA in the House was confined to Republicans, that on the Senate side was bipartisan—and saw an unlikely agreement of Senators Elizabeth Warren and Marco Rubio in voting nay.

The White House opposes the Dodd-Frank exclusion, but there is no indication that a veto is in the offing. Look for President Obama to sign the TRIA reauthorization, then, when it reaches his desk.

Common Lease Expiration Dates

Lease Expirations

The most common lease expiration dates (without regard for year of expiration) are highlighted in the chart above. To avoid confusion, note that the chart above lists the volume of leases expiring on each calendar day, regardless of the year of expiration.

Did you sense a mild “thump” today? A slight disturbance in The Force? Today, December 31st, more GSA leases expire than any other day of the year. It got me thinking why that is, and whether there is any pattern or seasonality to GSA’s leasing process.  As it turns out, there are some notable phenomena:

  • We suspect that the large volume of leases expiring on 12/31 each year is unique to GSA, which often extends leases on a short term basis while it attempts to complete lease procurements. Lessors, desperate to draw the line somewhere, typically cap such extensions at the end of the calendar year. In fact, relatively few GSA leases actually commenced on 1/1 because New Year’s Day is, of course, a federal holiday. Therefore, we can conclude that GSA’s most common lease expiration date is the product primarily of short-term extensions.
  • Most leases expire on the last day of the month (typically the 30th or the 31st and, in the case of February, the 28th or 29th). Though GSA’s policy is to commence leases at any time, as a practical matter the agency’s Contracting Officers tend to establish start dates on the first day of a month and, some number of years later, end dates on the last day of a month. It’s administratively expedient and, if nothing else, it eliminates the hassle of prorating rent.
  • What is more unusual is that the second most common expiration date is the 14th (see “Day of Lease Expirations” graph below). Why is that? Here we get to something that is purely governmental: GSA pays rent in arrears and any lease that commences on or before the 15th will be paid at the end of that same month. But any lease that commences after the 15th will be paid at the end of the following month (this policy is outlined in the General Clauses attached to your lease). It’s likely, therefore, that the unusual volume of leases expiring on the 14th is the product of an effort among GSA’s contracting officers (possibly prodded by lessors) to get leases in place before the monthly rent cut-off.
  • Contrary to the observation above, an elevated number of leases expire on the 15th too. These would generally have commenced on the 16th–immediately after the cut-off date–and perhaps that is by design.
  • Generally speaking, the number of lease expirations increases throughout the year (see “Month of Lease Expirations” graph below). I have no idea why this occurs except to observe that the trend is probably similar in the private sector too. It seems like annual leasing activity is usually backloaded.
  • December is the month in which most leases expire–no shocker for the reasons outlined above. Yet, a close second to December is September. September is the end of the federal government’s fiscal year and it is not entirely uncommon for fiscal year budgeting to influence the leasing cycle.
  • July 3rd is a very special date. Not a single lease expires on July 3rd, presumably because that would indicate a lease commencement of July 4th. Independence Day is truly sacrosanct. More so, it turns out, than Christmas.

Day of Lease Expirations

Month of Lease ExpirationsIf you see any other trends, post your comments below!

2015: The Year of Rising Interest Rates?

Fed Funds Rate Targets

This chart, presented with the September 2014 meeting of the Federal Reserve Bank’s Federal Open Market Committee (FOMC), provides each member’s forecast of the federal funds rate. Each shaded circle indicates the value (rounded to the nearest 1/8 percentage point) of an individual member’s judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run.

Over the last few months, many economists have been arguing that the U.S. economy has stabilized overall to the point that it would benefit from a hike in interest rates, allowing creditors to earn more while forcing borrowers of dollars to pay more for the privilege. So insistent have these arguments been, in fact, that many investment strategists and bankers believe that it’s not a matter of if but when in 2015 that interest rates will rise, some saying March 1, some May 1, some June 1—but no later.

An early signal that this rise was imminent came in November, when, as the Washington Post reported, Federal Reserve Chair Janet Yellen and New York Fed President William Dudley both let slip that the Fed was preparing to raise rates off the zero-point floor that has been in place for the last six years, the start of the Great Recession. “For the United States, the start of the normalization of U.S. monetary policy will be a very welcome development,” noted Dudley in his prepared remarks.

Allowing that the move might cause temporary turbulence in the financial markets, Dudley also argued that in the longer term a rise in interest rates would improve financial stability overall. Some economists note that that period of turbulence could result directly from a spike in the cost of the dollar in overseas markets, inhibiting a now healthy foreign exchange market. However, argues Philadelphia Fed President Charles Prosser, the zero-point floor is itself an agent of instability. “Raising rates sooner rather than later … reduces the chance that inflation will accelerate and require policy to become fairly aggressive with perhaps unsettling consequences,” he urges.

For all Yellen and Dudley’s signaling that rates may rise soon, the Fed has been careful in its approach. In its December meeting, it simply noted that its former insistence that rates would be kept at a zero floor for a “considerable period” would give way to the possibility of a policy change after patient consideration. Said Fed Chair Yellen, “The statement that the committee can be patient should be interpreted as meaning that it is unlikely to begin the normalization process for at least the next couple of meetings,” meaning that any raise would probably not come before May 2015.

The markets responded favorably to the decision, although analysts are divided whether the 1.5 percent rise that followed the Fed meeting was an expression of relief that rates would not rise immediately or the beginnings of a run-up to be followed by a rollercoaster fall when the rise is announced. “Expect market volatility when the central bank drops its cautious tone as it paves the way for the first rate rise since the great recession,” notes the British paper The Guardian in its forecast for 2015, predicting that the ongoing uncertainty in the Eurozone and China will be to the dollar’s advantage.

The Fed predicts that 2015 will otherwise see moderate growth in the economy overall, fueled in part by lower gas prices, with little appreciable inflation and continued expansion in the job market. As for the bond market, the Financial Times encourages investors to be cautious in trying to time any move by the central bank to hike the interest rate. It’s to be noted, after all, that this time last year the smart money was on interest rates to rise in 2014—and as 2014 enters history, rates have remained at historic lows, driven south by some unexpected hiccups in the economy last year. Even if the Fed raises the rate in 2015, most analysts believe that it will be only by a point or two.

It is beyond the scope of this blog to hazard a prediction as to whether the Federal Funds Rate will actually rise and when it may do so. It seems that every expert has been wrong on this at one time or another in recent years. Nonetheless, the chatter around this subject seems to be increasingly bullish on a rate hike next year. Regardless of what occurs, the anticipation of a rising rates has been enough to influence the market for government-leased properties, especially those that are held as higher-yielding alternatives to long-term U.S. Treasuries.

With so much distress in the global and domestic capital markets, combined with ultra-low interest rates, the cap rate valuations of “safe haven” federal properties have benefitted greatly, despite the fact that the underlying rents typically do not escalate through the term. Now the looming shift back to higher rates has property owners feeling a bit more urgency in their evaluation of whether to cash-in or to refinance. Some of this capital markets activity has already begun and we expect this next year to be especially active both for investment sales and debt and equity placements.

Net Demand Has Peaked (at least for now)

GSA Lease Inventory Trend

You may have to squint to see it in the graph above but the federal lease inventory controlled by GSA has declined by a little more than a million square feet over the past year. This should be no surprise because in 2012 OMB issued its “Freeze the Footprint” memorandum making it clear that the federal real estate inventory would be capped at the level established in that fiscal year. That same policy memorandum encouraged inventory reduction as well.

Though the reduction we see in the graph appears quite modest (roughly one-half of one percent of the total lease inventory) it is more foreboding because the decline is occurring despite the fact that most agencies have been forced to relinquish their independent or delegated leasing authority to GSA. As an example, the SEC no longer leases space independently. As each of its 2+ MSF of leases expire they are transferred to GSA control. So, all other things being equal, we would expect GSA’s lease inventory to grow. Yet, clearly it isn’t.

The lease inventory is expected to become even smaller. That’s because most procurements in the works now are programmed for less space. GSA has been slow to implement these space reductions, more often kicking the can with short-term lease extensions. Yet, new leases will eventually be executed and the downsizing will occur. Even if the government lifts the cap on federal leasing, the next tranche of executed leases will serve to reduce the inventory further.

We see this trend continuing for at least the next couple of years but, if history is any guide, it should eventually reverse itself.  The GSA lease inventory has grown 400% since 1970.