Spotlight: Secret Service

SecretServiceHow much office and other space does the US Secret Service occupy? That turns out to be a difficult question with a simple answer: It’s secret. Its Washington headquarters, a building on H Street, looks nondescript, save for the radio antennas and microwave dishes studding the roof, and its interior tells the casual visitor at once that the best thing to do is turn around and leave: The agency shield is visible, but there are no lobby displays, no tours, no brochures, no public access to speak of.

We have clues, though, through the budgetary process. In the immediate aftermath of the 9/11 terror attacks, the agency was allocated $918 million for total expenses, including a fleet of vehicles carefully restricted to 755 automobiles and motorcycles “for police-type use.” As of FY 2015, that figure had increased to more than $1.6 billion, with concomitant growth in vehicle use, rental space, and other categories (including, broken out, guard booths in several locations throughout the capital). That said, a congressional report published on December 9, 2015, observed that the agency is both underfunded and inconsistently funded, owing to on-the-fly budget cuts, as well as understaffed. The report criticizes agency leaders for not being proactive in stating the case for staff upgrades and other needs, as well as being insufficiently attentive to how existing funds are allocated and spent.

The Secret Service, which currently has a little more than 6,300 employees, has two overall purposes. The first, for which it is best known, is to protect the President of the United States from threats against his (or her) person. That protection extends to the vice president, former presidents, visiting heads of state, and other dignitaries. The second purpose, the more secret of the Secret Service’s raison d’être, is to guard against financial crimes such as counterfeiting, securities fraud, and other misdeeds—including, increasingly, cybercrimes of a financial nature. Once part of the Treasury Department, the Secret Service is now under the aegis of Homeland Security, though it operates with broad independence. It is unlikely, for example, has not been revealed whether its headquarters will move when the DHS consolidates its offices at the former St. Elizabeths Hospital campus in southeast Washington.

The Secret Service also maintains offices throughout the country and the world—at last count, at least 136 (the “at least” qualifier being because some offices may not be known to the public). These are of varying sizes; the Boston office is estimated to house some 40 officers, about half the number of the New York office, while the office in Pretoria, South Africa, has just a few agents. Wherever they are located, agents tend not to spend much time at their desks, constantly employed in the field or traveling to protect the dignitaries under their charge. Famously, for instance, the New York offices, then located adjacent to the north and south towers of the World Trade Center, were destroyed in the 9/11 terrorist attack. Even so, within 48 hours of being relocated, the Electronic Crimes Task Force, headquartered there, had tracked cell phone traffic among several of the terrorists involved in the conspiracy, providing essential evidence in determining a connection to Al Qaeda and Osama Bin Laden.

Because of the recent bad behavior of a handful of field agents, the Secret Service has come under scrutiny and criticism. That congressional report, for instance, was meaningfully subtitled “An Agency in Crisis.” The report recommends that Congress support the President’s fiscal year 2016 request for the agency, especially because presidential candidates come under protection in election years, though with the proviso, “provided that there are adequate controls in place to ensure that the funds are used to address ongoing hiring challenges.” That request is substantial: for FY 2016, President Obama requested more than $1.9 billion for the agency.

It has often been remarked that the Secret Service makes news only when it does wrong, never when it does right—as it does every day. That is because, unlike its shortcomings, the successes of the agency are not advertised. In short, they’re secret.

Notable Transactions of 2015

Though the federal lease inventory continued to shrink in 2015, there was plenty of action, especially in the Washington, DC area where most of the big federal tenants reside. Here is a selection of the most notable transaction activity this past year:

The Largest New Lease

In October, GSA announced the award of a 839,000 RSF lease to Stonebridge Carras to house a Department of Justice (DOJ) consolidation at Constitution Square. This was the largest lease of the year and when it commences (in phases ending in 2018) it will be the 10th largest lease in GSA’s national inventory.

Three Constitution Square and the adjacent, to-be-built Four Constitution Square will house the 839,000 RSF DOJ consolidation lease. (photo: CoStar)

Three Constitution Square and the adjacent to-be-built Four Constitution Square will house the 839,000 RSF DOJ consolidation lease. (Photo: CoStar)

The Largest Lease (That Wasn’t)

Had it stuck, the second-largest lease of the year would have been the TSA headquarters deal at Victory Center, 5001 Eisenhower Avenue, Alexandria, Virginia. In August, GSA executed a 625,000 RSF, 15 year lease at this property. Yet, a subsequent protest by a competing bidder led the U.S. Court of Federal Claims to issue a decision voiding the lease, noting that it included “free space” that was a violation of GSA’s congressional appropriation.

GSA award the _______ RSF TSA lease to Victory Center, though that lease was later voided by a _____ Court judge. (photo: CoStar)

GSA award the 625,000 RSF TSA headquarters lease to Victory Center, though that lease was later voided by a U.S. Court of Federal Claims judge. (Photo: CoStar)

The Largest Sale

Based solely on dollar volume, the biggest sale of the year was Jamestown’s $298 million purchase of Stafford Place I and II in Arlington, Virginia. These buildings are primarily occupied by the National Science Foundation (NSF), though Jamestown’s purchase anticipates re-positioning both buildings since NSF is slated to vacate by the end of 2017.

Stafford Place I and the adjacent Stafford Place II, both home to the National Science Foundation, were purchased by Jamestown in September for $220 million. (photo: CoStar)

Stafford Place I and the adjacent Stafford Place II, both home to the National Science Foundation, were purchased by Jamestown in September for $298 million. (Photo: CoStar)

If we focus instead on the largest sale of a true (i.e. long-term leased) federal asset, then the winner is the $96.7 million sale of the Suffolk Building, a 258,000 RSF, high-security facility in Falls Church, Virginia. NGP purchased this building from Carr Properties after GSA executed a 10-year renewal on behalf of the Dept. of Defense.

The high-security Suffolk Building was the largest long-term leased property sale of the year.  (photo: Google Maps)

The high-security Suffolk Building was the largest long-term leased property sale of the year. (Photo: Google Maps)

UPDATE: One additional notable sale we originally missed was the end of year transfer of a 49% interest in Patriots Plaza, a 3-building, 981,000 RSF project that is primarily leased to federal government tenants.  The 49% interest sold for $223.9 million, based on a total project valuation of $457 million.

The Longest Renewal

We complain a lot about the federal government’s predilection for kicking the can with short term extensions, and their insistence on termination rights. So it’s notable when the government executes a long-term lease, especially one that is a renewal. GSA did exactly that this year when it renewed a lease on behalf of the U.S. Fish and Wildlife Service at 1011 E. Tudor Road in Anchorage, Alaska for a term of 20 years (with cancellation rights after the 15th year). GSA was encouraged to enter into a long term renewal based upon substantial renovations the owner agreed to implement.

GSA renewed its lease for this 98,000 RSF building in Anchorage, Alaska for 20 years.

GSA renewed its lease for this 98,000 RSF building in Anchorage, Alaska for 20 years. (Photo: CoStar)

The Largest Government Purchase(s)

GSA rarely exercises renewal options but it is hard to resist when the purchase costs just $1.00. In Detroit earlier this year, GSA exercised its $1.00 purchase option to acquire 985 Michigan Avenue. The building was built for the federal government in 1995 and has been occupied by IRS for the ensuing 20 years. GSA now plans to spend $75 million to renovate the building, downsize IRS and consolidate multiple federal agencies from other leased locations in the Detroit area.

985 Michigan Avenue was built for IRS and includes a The building was built for IRS and includes a three-level computing and data center. Now, with IRS downsizing, GSA will renovate the building and backfill with other federal tenants. (photo: CoStar)

985 Michigan Avenue was built for IRS and includes a three-level computing and data center. Now, with IRS downsizing, GSA will renovate the building and backfill with other federal tenants. (Photo: CoStar)

If we instead look at the largest purchase as measured by the dollar amount of the transaction, the nod goes to 4700 River Road, a 337,500 RSF building occupied by the FDA in Riverdale, Maryland. GSA exercised its option to purchase the building for $30.6 million ($90.67/RSF).

4700 River Road, Riverdale, Maryland was purchased this year by GSA for $30.6 million (photo: CoStar)

4700 River Road, Riverdale, Maryland was purchased this year by GSA for $30.6 million (Photo: CoStar)

The Biggest Exit

The biggest tenant to vacate this year was the U.S. Navy, from the Transpoint Building at the tip of Buzzard’s Point in Washington, DC.  The Navy occupied the 600,000 SF Transpoint Building in order to facilitate renovations planned at the nearby Navy Yard in the wake of the September 2014 shooting on that installation. Transpoint had been earlier vacated by the U.S. Coast Guard when that agency’s new headquarters was completed at St. Elizabeths. However, it was still under lease after Coast Guard’s departure. Now it is vacated for good.

The Transpoint Building, 2100 2nd St, SW, Washington, DC is the largest block of space vacated by the federal government this year (photo: CoStar)

The Transpoint Building, 2100 2nd St, SW, Washington, DC is the largest block of space vacated by the federal government this year.  (Photo: CoStar)

The Largest Build-to-Suit Award
(Outside of Washington, DC)

Technically, the largest build-to-suit lease to be awarded this year is the DOJ lease described at the top of this article. This is true even if we account for the fact that roughly 360,000 RSF of the 839,000 RSF required by DOJ will be accommodated in an existing building.

But what if we look outside of Washington, DC? Well, then we would have to look all the way across the country to the other Washington–Washington State, that is. In April, GSA awarded a 300,000 RSF build-to-suit lease to Panattoni Development Company for the construction of a new FAA regional headquarters in Des Moines, Washington, near SeaTac Airport. The 20-year lease is slated to commence in mid-2017.

The FAA Northwest Mountain Regional Headquarters will be built in Des Moines, WA by Panattoni Development Corp. (Rendering: CollinsWoerman Architects)

The FAA Northwest Mountain Regional Headquarters will be built in Des Moines, Washington by Panattoni Development Corp. (Rendering: CollinsWoerman Architects)

The Biggest Tenant in the Market

The biggest new prospective federal tenant to emerge this year is the consolidation of several NIH functions in North Bethesda, Maryland. The proposed transaction would combine two prospectus approvals into one lease that may be as large as 539,000 RSF. Despite its size, this consolidation would yield a net space reduction of approximately 155,000 (22%). The new lease should be awarded in mid-2016 with occupancy projected for late 2017 (pretty tight timing).

One and Two Rockledge Centre are currently home to the bulk of the NIH tenancy contemplated under the new consolidation lease.

One and Two Rockledge Centre are currently home to the bulk of the NIH tenancy contemplated under the new consolidation lease. (Photo: CoStar)

The Highest New Rent

The highest* rent negotiated for a new lease this year (according to GSA data) is $63.56/RSF for laboratory space housing DEA’s Western Region lab. The DEA lab is located in Pleasanton, California, in a a renovated flex building that formerly housed a Nissan training center. The developer, Western Devcon, transferred the property to Easterly REIT shortly after the lease commenced.

* I identified the “highest” rent based on non-airport leases >3,000 SF that commenced this year. I omitted any leases outside the 50 U.S. States.

This former Nissan training facility in Pleasanton, California was been converted to a DEA regional lab.

This former Nissan training facility in Pleasanton, California was converted to a DEA regional lab. (Photo: CoStar)

Five Ways the Federally Leased Property Market Might Grow Again

The following is an excerpt from a presentation I gave at the National Federal Development Association conference last month in Washington, D.C. The presentation covered three themes: 1) The size of the federally leased property market is small; 2) It is getting smaller, and; 3) There are five factors that could return the market to future growth. This article profiles the final theme. To read about the first click here and to read about the second click here.

In the previous part of this series of articles I noted that the federally leased property market is shrinking due to mandates such as Freeze the Footprint and, more recently, Reduce the Footprint. It is not just the square footage that is getting smaller but also the investment potential. Is there any hope for future growth? In this article I will profile five ways the federal real estate market could grow again.

#1 GDP Growth

Presidential candidates stumping on the campaign circuit often tout GDP growth as the magic elixir that will cure all of our economic ills. A faster growing economy would create more tax revenue, reducing deficits and allowing for easing of austerity measures (though rising GDP will also likely cause inflation, which will increase expenses, but that’s a matter for a different article). On the whole, GDP growth would be great, primarily because it would also decrease debt relative to GDP, which is the measure we care about.

The problem is that most economists share a pretty dour outlook on GDP growth. Gross Domestic Product is, simply put, Employment x Productivity. Unfortunately, labor force participation in the United States has been declining for years, hampering employment growth. Now that the first Baby Boomers have reached retirement age, the labor force is destined for weak growth, at best.

Productivity growth holds better promise for GDP recovery but annual productivity growth would need to be twice that forecasted by the Congressional Budget Office (CBO) to cause an appreciable long-term reduction in the national debt. In fact, it would take sustained productivity growth between 2.5% and 4.0% for 25 consecutive years to whittle the debt-to-GDP ratio down to the historic average by 2040. In context, the record average annual productivity growth for any 25-year period since 1950 is 1.9%.

GDP growth in the United States has been on the decline for decades. While modest recovery seems achievable, GDP faces demographic headwinds. Economic growth will help, but it will not fully resolve the austerity measures imposed upon the federal property market.

#2 Tax and/or Entitlement Reform

More likely, we will need to get down to the difficult business of tax and entitlement reform. As demonstrated in the graph below, federal spending, even in inflation-adjusted dollars, has been steadily rising for decades and the reason is mandatory spending (primarily entitlements such as Medicare, Medicaid and Social Security). Those expenses are obligated by law and, with the population aging and health care costs rising, mandatory spending is forecasted to continue growing.

Congress now has appropriations control over only about 30% of the nation’s spending. As you can see in the trend graph below, Congress has kept discretionary spending largely in check over the decades but, even so, it cannot keep overall spending from increasing.

If the trend continues, the discretionary share of the federal budget will get smaller and smaller, squeezed both by growing entitlement spending and also an inevitable increase in net interest payments on the national debt. As the discretionary budget is where rent is paid, we must expect that austerity measures in the federal property market will persist.

The only way to reverse this trend is to to either create more revenue (increase taxes) or reduce expenses (reform entitlement programs). More likely, some combination of both will be necessary.

With the next presidential election drawing closer, there is new optimism that it may be possible to hammer out some sort of Grand Bargain in 2017. Yet, if history is any guide, it won’t happen. Congress hasn’t enacted major tax reform legislation since 1986 and efforts at entitlement reform legislation have only nibbled at the problem.

If Congress is successful enacting meaningful reform legislation then it may create headroom for future recovery of the federal property market. Yet, it will take tremendous political will that has, so far, been lacking.

#3 Bigger Government

Earlier this year, the Wall Street Journal calculated that federal spending growth under Bernie Sanders’ plan would be $18 trillion over 10 years.  $18 trillion is roughly the size of the entire U.S. economy. Put another way, it’s a 50% increase in annual federal spending.

Very, very roughly, if spending growth correlates to inventory growth, that level of spending would lead to about another 100 MM SF of growth in GSA’s leased inventory. It kind of makes you want to vote for the guy (except that any profits would probably be taxed back to the government!).

Bernie’s camp is quick to point out that they are simply proposing to nationalize functions that are currently provided by the private-sector. Overall goods and services spending would, therefore, be unchanged, but the federal government’s role would grow substantially.

I don’t expect that Bernie Sander’s platform will carry the day, but it is entirely possible that a more subdued version of his plan is implemented, especially in a Democratic regime. What if, for example, the federal government determined that it would insource more of its functions? Overall federal spending would not necessarily change but more of that spending would flow to agencies and not to contractors. That would certainly create growth in the government’s appetite for federal real property.

So, whether it is President Bernie Sanders, or someone else, there is the possibility that the federal government’s role could grow, even if its budget doesn’t.

#4 Crisis!

Nine days after the 9/11 attacks, Congress committed $40 billion to launch a global offensive against Al-Qaeda. The following year it appropriated an additional $36.5 billion and the year after that another $44 billion. As we know now, that was just the beginning.

This spending found its way into the federally leased property inventory as many of the federal buildings built since 9/11 accommodate the newly created Department of Homeland Security, tremendous growth in the Department of Defense and in the Intelligence Community, rapid growth in federal law enforcement–especially the FBI, and growth in Veterans Affairs clinics and hospitals.

9/11 accelerated a federal construction boom that had, in fact, already started due to an earlier crisis: the Murrah Building bombing in 1995. Shortly after that event, President Clinton created the Interagency Security Committee, which established new federal security standards that were the catalyst for construction of a host of new physically secure leased facilities. As an example, nearly four dozen new, highly secure FBI field offices built since that time are the product of design standards established after the Murrah bombing.

Yet, not every crisis accrues to growth in the federal lease inventory. The Global Financial Collapse was a major economic crisis that led to the American Recovery and Reinvestment Act, which ultimately totaled $831 billion in stimulus spending to stabilize the economy. A $5.5 billion slug of that money was spent by GSA to modernize its federally owned facilities and we are now seeing that the completion of those improvements is siphoning demand from leased buildings.

We don’t wish for crises, and they can cause unpredictable results. But they do sometimes provide a catalyst for growth in the federal real property inventory.

#5 Longer-Term Leases

It is a fact that, over the long run, lease terms have generally become shorter in GSA’s lease inventory, primarily as a result of kicking the can due to budget distress and the difficulties planning for downsizing. Now, half of all leases expire in the next five years so, logically, there are relatively few long-term leases. This has made the market feel especially small for property investors because the purpose of investing in federally leased properties is to access the outstanding credit afforded by the U.S. Government. Yet, that credit isn’t worth much with a short term lease.

Perhaps the most realistic prospect for growth is not in growing the size of the federal property inventory but rather in the investment potential of that property inventory. The market can grow for investors if GSA begins signing more long-term leases.

Fortunately, there are signals that the government will do exactly that. As agencies determine how they will comply with OMB’s “Reduce the Footprint” mandate they will find that they must completely redesign and reconstruct their workplaces. That will cost money and they will seek tenant improvement allowances from property owners. In turn, they will need to agree to longer-term leases. These long-term leases will also yield better rents, so in most respects long-term leasing is a symbiotic effort.

Already we’ve begun to see a little improvement in the weighted average lease term but that is primarily due to deliveries of the last buildings in the previous wave of build-to-suits. The dwindling pipeline of new buildings will be a challenge for property investors but, even in lieu of a pick-up in the pace of new construction (which generally yields the longest leases), we see ample evidence that leases generally will get longer and that 10 year non-cancelable leases will become more prevalent.

Outlook

In the near term, I expect GSA’s leased inventory to continue to shrink. The most likely positive outcome–all other factors remaining status quo–is growth in the number of long-term leases. These “long-term” leases will be shorter than those delivered through the build-to-suit process but they will serve to grow the investment market, hopefully providing enough new investment opportunity to keep capital focused on the sector. Long-term, sustainable inventory growth, if it arrives, will probably result from an amalgam of the other trends described above.

Continued White House Efforts at Clean Energy

Photo: Whitehouse.gov

Photo: Whitehouse.gov

President Barack Obama has just returned from a United Nations conference on global climate change in Paris, where he held forth for a program of legally binding agreements to reduce carbon emissions in the atmosphere. That slate is likely to face opposition at home—Congressional Republican leaders have already indicated that they will not pass the supporting legislation—but in numerous important ways the administration has already put reductions into place, building on the George W. Bush–era Energy Independence and Security Act of 2007 to reduce the federal government’s carbon footprint through measures, as we have reported, that have direct bearing on leased and purchased federal buildings.

Last summer, following its announcement, and through the Fall, the Obama administration has been putting in place a comprehensive Clean Power Plan. Noting that since 2008 federal agencies have reduced greenhouse gas pollution by more than 17 percent (roughly equivalent to removing 1.8 million cars from service), it has set a goal of reducing federal emissions by 40 percent by 2025.

At a macro level, the CPP targets reducing carbon emissions from existing power plants, which produce about a third of the US output of so-called greenhouse gases—gases, that is, that trap heat in the atmosphere and are thus agents of atmospheric warming. New power plants have had to operate under stringent emissions standards since the EPA promulgated new regulations in 2013. The CPP adds to those standards somewhat less demanding but still strict requirements for existing power plants, whose working lives can span decades. These measures will require investment in sequestration and scrubbing technology, costs that will directly or indirectly be passed along to energy consumers.

Those consumers, however, will also have cleaner energy sources to choose from, if current trends in the diversification of the nation’s energy portfolio hold. One plank of the CPP mandates that the federal government buy at least 20 percent of its electricity from renewable sources by 2020. In the current energy economy, and given the federal government’s heavy concentration along the eastern seaboard, this translates to mostly solar power. The administration has supported the solar sector with several initiatives since 2009, including funding “clean energy” utilities on public and tribal lands, with an expected gain of 20,000 jobs, and training military veterans to work in the solar energy sector, adding another 75,000 jobs to the economy.

Of direct interest to the federal real property sector are several additional initiatives. One is the Energy Star’s Energy Performance Contracting service, which provides customers with a comprehensive set of energy efficiency and renewable energy measures and with financing calculations to see that the cost savings realized by, say, energy-saving new construction will cover the cost of the project. The Obama administration recently expanded EPC financing from $2 billion to $4 billion.

Along with the EPC service, the Better Buildings Challenge has provided funding and a clearinghouse of information for partner programs with municipal governments, public utilities, school districts, and other entities, so far saving an estimated $840 million in energy costs. Programs run through the Departments of Energy, Housing and Urban Development, and Agriculture have promoted energy efficiency and renewable energy development in private homes and public buildings alike, while new DOE standards announced in 2014 for appliances, HVAC systems, and manufacturing equipment are intended to reduce energy consumption throughout the economy.

There has been a piecemeal quality to these disparate efforts, to date, to achieving desired reforms and updated performance standards. The finalized CPP is intended to improve the situation by providing a means for coordinating climate change, carbon reduction, and green energy initiatives. How successful it will be remains to be seen—and, of course, it is all subject to legislative cooperation, or the lack thereof, to say nothing of the outcome of the 2016 election.

The Federally Leased Property Market is Getting Smaller

The following is an excerpt from a presentation I gave at the National Federal Development Association conference earlier this month in Washington, D.C. The presentation covered three themes: 1) The size of the federally leased property market is small; 2) It is getting smaller, and; 3) There are five factors that could return the market to future growth. This article profiles the second theme. To read about the first, click here. The final segment will be posted soon.

GSA Lease Inventory Trend

GSA Lease Inventory Trend

After a half-century of consistent growth, the federally leased property market is now getting smaller. From its peak at the end of 2012, the GSA-leased inventory has declined by 5.1 MSF. That’s only about a 2.5% reduction, but it is still the most significant downturn in the 50 years for which inventory data is available.

The graph’s modest downturn belies a steeper decline because, all things being equal, the GSA lease inventory would naturally grow. This is because in 2007 the agency dramatically restricted leasing delegations and since then GSA’s leasing responsibilities have expanded. Many of the leases previously leased directly by agencies are now transferring to GSA’s control upon their expiration. Further, some agencies have relinquished their statutory leasing authority (contracting authority provided by law).

One such recent example is the Transportation Security Agency (TSA). TSA was formed in 2001 by the Aviation and Transportation Security Act. That same legislation also provided TSA with the authority to acquire real estate, an authority TSA used to sign a 545,000 direct lease for its new headquarters in Arlington, Virginia. With that lease now approaching expiration, TSA has relinquished its leasing authority and engaged GSA to procure its replacing lease. When GSA finally completes this transaction, TSA will consolidate and downsize slightly into its new location, however, the net impact on the GSA lease inventory will be growth. Despite this, we will probably see the overall GSA lease inventory decline.

Anecdotally this seems especially probable when we look at the lease procurements that are just beginning because, in nearly all cases, some form of downsizing is planned. What’s causing this? The most direct answer is “Freeze The Footprint” and now “Reduce The Footprint” policy mandates from the Office of Management and Budget (OMB).

“Freeze The Footprint” is the name given to OMB’s May 11, 2012 memorandum, which ordered that agencies may not increase their inventory of civilian real estate above the level established in FY 2012. Earlier this year, OMB refined its guidance, requiring agencies to reduce their real property holdings by “prioritizing actions to consolidate, co-locate and dispose of properties.”

We can trace the roots of this austerity back even further to 2011 when the fiscal conservatives took control of the House of Representatives and wielded their prospectus approval authority to demand cost reduction of the nation’s largest leases. Now, whether due to congressional or executive action, the federal property market is beginning to react to these edicts.

Tightsizing

Tactically, how is the government accomplishing this downsizing? This photo of the renovated 7th floor of GSA’s headquarters tells it all…

Tightsizing

Before it was renovated, this space was laid out in typical government fashion, with a center corridor flanked by private offices. The renovation caused two workplace transformations: First, you can see in the photo that there are no walled offices anywhere. Even GSA’s Administrator and her senior staff all work in open plan workstations. Second, if you look just beyond the people sitting in the foreground you see that those many of those workstations aren’t traditional cubicles. They are benching stations to accommodate mobile workers who may check in for a day–or part of a day–of in-office work. In fact, at GSA’s headquarters, if everyone showed up for work on the same day there would not be enough desks for them. Now, that is tightsizing! GSA achieved space utilization of just 82 USF per person with its redesign, which marks the extreme end of the efficiency scale. Yet, implementation of telework is one of the primary techniques the government is using to whittle at its space needs.

This brings us to the other way the market is getting smaller: lease terms are shorter. Implementing a tighter–and increasingly mobile–work environment is difficult to plan, it requires a challenging cultural shift in most federal workplaces and it is expensive to build from scratch. These planning and funding challenges have overwhelmed GSA and their tenant agencies causing them to kick the can with short-term lease extensions.

GSA Lease Expirations

GSA Lease Expirations

Lease expirations have now piled up such that 25% of all GSA leases are expire this year and next, and half of all leases will expire in the next five years. So, logically, there are relatively few long-term leases that we can invest in.

Remaining Lease Term

Remaining Lease Term 1

This is especially evident when we go back and look at properties that are at least 85% leased by federal tenants. Of the 2,100 such buildings we track (comprising the entire GSA inventory and a portion of those other buildings leased under delegated or statutory authority) about 250 have 10 or more years of remaining lease term–this without regard for termination rights, which, generally speaking, exist in the vast majority of GSA leases.

Remaining Lease Term 2

Ignoring the smattering of really large leases in the first graph, we can zoom in a bit and also see that the bulk of federally leased buildings are 25,000 SF and smaller. If you are an investor that is interested in larger buildings with long-term leases, your investment possibilities become much more limited. There are only 157 properties that are at least 85% leased to the federal government, larger than 25,000 SF and have 10+ years of remaining lease term. Increase the property size to 50,000 SF and the number drops to 100. Move it to 75,000 SF and there are just 78 properties you can invest in. And so on.

This is a key observation because federal credit is worthless without substantial remaining lease term. Yet, this most crucial segment of the federally leased marketplace–long-term leased properties–is getting smaller.

Kicking the can among existing leases is a big part of the reason lease terms have generally grown shorter but another reason for the scarcity of long-term leased properties is that the build-to-suit pipeline has been reduced to a trickle.

Dwindling Pipeline

Dwindling Pipeline

The graph above shows the volume of federal leases in properties built or substantially renovated between 1990 and the present. The graph probably undercounts leasing volume in 1990s-era buildings where the tenants have since vacated and it probably also undercounts leasing in newer buildings that may occur in future years. Nonetheless, it is a pretty accurate representation of the trend.

Clearly, the volume of federal leases in new properties has fallen off dramatically. Among buildings built in the 2000s, GSA’s occupancy averages 6.8 MSF each year. Since 2010 that figure has dropped to 3.2 MSF. This is primarily due to a marked decline in build-to-suit activity. It is unfortunate because build-to-suits are the lifeblood of the federal investment sector. They yield generally longer lease terms than leases in existing buildings and the buildings themselves tend to be single-tenant and specialized, and they enjoy higher probability of renewal. Now they are disappearing and, without this pipeline of new long-term leased product to feed investors’ appetite for U.S.-backed credit, the market is feeling considerably smaller.

Federal Debt Held By the Public


Federal Debt

What is the root cause of this downsizing? For this austerity? It is in reaction to the growing U.S. national debt. The graph above, produced in August by the Congressional Budget Office (CBO), illustrates three things: 1) Debt has increased rapidly in recent years; 2) It is now the highest level since World War II, and; 3) Though it will decrease slightly in the near term, the long-term forecast is for continuous growth.

Today, the federal debt held by the public equals about 74% of GDP. In the short term that figure may decline slightly; however, over the next decade, CBO forecasts debt to rise to about 77% of GDP. From there the vector bends upward. In its long-term forecast published this Summer, CBO expects debt to eclipse the size of the economy in less than 25 years. And this forecast is the more optimistic of the two that CBO provides. The reasons for this dismal trend are unimpeachable structural factors including the aging workforce, increasing healthcare costs and rising net interest on the debt.

Maybe this doesn’t alarm you. Perhaps you are a faithful Keynesian who believes that more spending is the answer, even if it increases debt. There are many arguments for and against further spending and debt increases. Yet, none of it matters because, as long as there remains an influential contingent of fiscal hawks in Congress who view worsening debt as a threat to the nation, austerity measures will be imposed throughout government–including real estate leasing.

So, if debt is the real driver of the austerity that is negatively impacting the federal property market, how will property investors find relief? There are five ways the market can begin growing again. These are discussed in the next article.

The Federally Leased Property Market is Pretty Small

The following is an excerpt from a presentation I gave at the National Federal Development Association conference earlier this month in Washington, D.C. The presentation covered three themes: 1) The size of the federally leased property market is small; 2) It is getting smaller, and; 3) There are five factors that could return the market to future growth. This article provides an overview of the first part of that presentation. Part two can be found here and part three will be posted soon.

U.S. Commercial and Investment Inventory (88 BSF)

US Commercial and Investment Inventory

To get a sense of how small the federally leased property niche is, let’s start by imagining that this rectangle represents the entire 88 BSF commercial and investment property market in the United States. This includes all types of properties including office, industrial, retail, multifamily, mixed-use, etc.

Government Occupied Inventory (6 BSF)

Govt Portion

The government occupied portion of the national property inventory is estimated to be roughly 7%, or a little more than 6 BSF (this is, admittedly a pretty rough estimate).

Federal Inventory (3 BSF)

Federal Portion

Federal property investors don’t care much about properties leased by states, counties and municipalities. If I peel those off, we are left with the federal property inventory, which is estimated to be a bit more than 3 BSF.  I derive this by taking the 2.8 BSF catalogued by the Federal Real Property Profile and then I add a factor for agencies that report doesn’t track–most notably the U.S. Postal Service. Among the real estate the FRPP doesn’t fully capture is the fast-growing cadre of spooky projects occupied by the intelligence community, so it’s possible I undercount the federal inventory slightly, but this is close enough.

Federal Leased Inventory (400 MSF)

Federally Leased Portion

Most federal property is owned, but investors really only care about that portion of the inventory that is leased. I put that figure at about 400 million square feet. Yet, not all federal leased space is of much interest to property investors. So, let’s drill into this 400 MSF leased inventory to get a better sense of the leased inventory composition…

Inventory by Lessee Agency

 

Leases By Agency

About half of federal leases are with the U.S. General Services Administration (GSA). GSA is familiar to us because its enabling legislation, the Federal Property and Administrative Services Act of 1949, includes broad authorities to provide real property services to federal agencies. As a result, most of the “rank and file” federal leases we see in the U.S. are leased by GSA and subleased to federal agencies. This is enabled by the Federal Buildings Fund, the revolving fund that enables the federal government to enter into multi-year lease contracts without violating the Antideficiency Act.

Without the Federal Buildings Fund or some special appropriations, leases would need to be structured as a series of one-year obligations–either a one-year base lease with multiple one-year options or, conversely, a lease with annual termination rights. This “one year” structure is pretty typical of many lease contracts executed by the Department of Defense through its primary real property agencies, the U.S. Army Corps of Engineers and the Naval Facilities Engineering Command (NAVFAC). Often there are compelling reasons to invest in these properties, but, by and large, the cancelable lease structure is not very palatable. Further, many DoD leases are more exotic structures for military housing, lodging and so forth.  We can assume, therefore, that only a portion of DoD leases are attractive to the typical federal property investor.

The U.S. Postal Service (USPS) is a different story. USPS leases roughly 93 million square feet of property in the United States; yet, that comprises roughly 24,000 properties. So, the median size of a USPS-leased property is well under 10,000 SF, making them not particularly attractive to most government property investors.

USPS is the largest independent agency from a real property perspective, but there are dozens of others. Most independent agencies use GSA to acquire leases on their behalf, yet some utilize statutory authority to execute leases directly. Examples of these agencies include the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, and the Export-Import Bank of the United States. Some of these agencies don’t sign their leases as the “United States of America” making credit due diligence a bit more complex.

Finally, there are a number of leases executed under delegation of contracting authority from GSA. In this instance certain agencies are granted the authority to execute contracts on behalf of the United States of America, yet GSA must approve that delegation.

Delegated leases are similar to those signed by GSA itself except that there is often good reason GSA delegated its leasing authority. Many delegated leases are used to acquire facilities that are remote or for very special purposes. Examples include cotton classing labs, weather monitoring stations, hospitals, dock facilities and park ranger stations. Some of these properties are attractive to investors and some aren’t. On the whole, probably about 2/3 of all federal leases are going to attract the interest of the traditional federal property investor.

Leases in Properties That Are Predominantly Federally Leased

Leases By Pct Federally Leased

The federal property sector gets even smaller when we consider that many federal leases are located in multi-tenanted buildings. Federal property investors are focused only on those properties that are single-tenant or primarily leased by federal agencies. Of the 2/3 of investment-worthy properties described above, only 58% of those are buildings that are fully or primarily leased by federal tenants.

Federal Leased Inventory Attractive to Investors (170 MSF)

Federally Leased Niche

So, if we accept that only about 2/3 of federal leases fit the profile for typical investor interest, and that a little more than half of those are in properties fully or mostly leased by the federal government, then the remaining inventory is @170 MSF–less than 0.2% of the property market. It’s a very small sandbox.

So, why do we bother? Why suffer the aggravation of dealing with the federal tenants? Why deal with the unusual construct of federal leases? The reason, of course, is the credit. U.S. credit (despite Standard & Poor’s 2011 downgrade) is arguably the best in the world.

There is a tremendous amount of capital in search of this credit but, as described above, a relatively small number of properties to invest in. This is one reason why pricing for federally leased properties remains so dear.

Unfortunately, the inventory of federal properties is shrinking, as we’ll see in the next part of this presentation.

New Sustainability Rules Impacting Investors & Managers Leasing to the Federal Government

Colliers Federal Sustainability Mandates

The following is a guest post written by Mark Miller, the head of Colliers’ national Energy & Sustainability team. To learn more about Colliers’ Energy and Sustainability services, click here.

The Federal Government is taking aggressive steps to reduce greenhouse gas emissions and drive sustainability in its owned and leased real estate portfolio. Two new initiatives taken in the Spring of 2015 include a new law titled “The Energy Efficiency Improvement Act of 2015” and an Executive Order – “Planning for Federal Sustainability in the Next Decade”– are sure to change the landscape for those involved in leasing space to the Federal Government. The following are abbreviated highlights relevant to property investors and managers.

The Energy Efficiency Improvement Act of 2015

This bill requires the General Services Administration (GSA) to: (1) develop and publish model leasing provisions to encourage building owners and tenants to use greater cost-effective energy efficiency and water efficiency measures in commercial buildings, and (2) develop policies and practices to implement the measures for the realty services provided by the GSA to agencies.

The Environmental Protection Agency (EPA) must develop a voluntary Tenant Star program within the Energy Star program to recognize tenants in commercial buildings that voluntarily achieve high levels of energy efficiency. The EPA may develop a voluntary program to recognize commercial building owners and tenants that use high-performance energy efficiency measures in the design and construction of leased spaces.

The Environmental Protection Agency (EPA) must develop a voluntary Tenant Star program within the Energy Star program to recognize tenants in commercial buildings that voluntarily achieve high levels of energy efficiency. The EPA may develop a voluntary program to recognize commercial building owners and tenants that use high-performance energy efficiency measures in the design and construction of leased spaces. A federal agency leasing space in a building without an Energy Star label must include in its lease provisions requirements that the space’s energy efficiency be measured against a nationally-recognized benchmark. The agency must also meet certain energy consumption disclosure requirements.

Executive Order 13693 – Planning for Federal Sustainability in the Next Decade

The Executive Order establishes Sustainability goals for each agency including reducing energy intensity by 2.5% and water use efficiency by 2% annually through FY 2025. Requires increasing percentages of renewable electric energy and thermal energy from alternative/clean sources by up to 30% by 2025. Beginning June 2016 implement Guiding Principles for Federal Leadership in High Performance and Sustainable Buildings 15% goal by 2025 and annual progress to 100% conformance. Identify a percentage of existing buildings for “Net-Zero Energy” and all new buildings to be “Net-Zero Energy” by 2020 and where feasible, water or waste net-zero by 2030.

In all new lease solicitations over 10,000 RSF: 1) Criteria for energy efficiency is required as a performance specification or as a sources selection evaluation factor 2) The building lessor will be required to disclose carbon emissions or energy consumption by the agency for that portion of the building occupied by the agency via sub-metering or pro-rated occupancy data. 3) Reporting building energy in FY 2016 as part of scope 3 greenhouse gas emissions will be required for newly solicited leases over 10,000 rentable sf 4) The planning of new buildings or leases must include cost-effective strategies to optimize sustainable space usage and consideration of existing community transportation planning & infrastructure including access to public transit.

Recommended Actions and Response

  • Maintain Energy Star Portfolio Manager Benchmarking
  • Utilize Optimized Lighting & HVAC Equipment Occupancy-Based Scheduling
  • Execute the Colliers REMS Sustainability Checklist
  • Perform Energy Audits & Periodic Retro-Commissioning
  • Leverage Utility Incentives & Tax Credits to Improve Cost Effectiveness
  • Implement Building Data Analytics System to Continuously Optimize Buildings
  • Utilize PACE to Fund Energy Improvements Off Balance Sheet

Spotlight: SBA

SBA“The chief business of the American people is business,” said President Calvin Coolidge, speaking before a convention of newspaper editors 90 years ago. (His bon mot is often shortened to “the business of America is business.”) But just what kind of business? Coolidge, after all, made his remark in the golden age of the American corporation, the rising era of IBM, Boeing, General Motors, Columbia Broadcasting Service, and other huge firms across the economy. Then as now, small companies accounted for as much economic activity overall as large ones, but the prevailing assumption was that the corporations would eventually dominate—an idea enshrined in James Burnham’s highly influential book The Managerial Revolution, published just after the dust of the Great Depression had settled.

Enter the federal government, some of whose leaders worried that because of the economic concentration brought on by World War II, small businesses—defined as those with fewer than 500 employees—did not have a fair chance against their corporate competitors, especially when it came to securing loans to launch new enterprises that, if encouraged, would yield a flourishing economy. Established by law on July 30, 1953, in the early months of Dwight D. Eisenhower’s first term as president, the Small Business Administration had as its stated mission “to maintain and strengthen the nation’s economy by enabling the establishment and viability of small businesses.” A secondary part of the mission statement of the SBA adds “by assisting in the economic recovery of communities after disasters,” an important but often overlooked role, but its primary purpose has since been defined as encouraging small business and entrepreneurship by guaranteeing private loans in the event of default or bankruptcy.

The SBA has effected this encouragement in numerous ways. It has been a pioneer in loans to minority-owned businesses, opening, for instance, more than a hundred Women’s Business Centers across the country, establishing Internet portals for entrepreneurial resources and guidance, and developing a program of microloans of up to $50,000 for eligible applicants. It has recently given priority to helping military veterans establish businesses, while—of particular interest to our readers—it has operated its 504 Fixed Asset Financing Program, providing funding of up to $5.5 million for the purchase or construction of real estate or the purchase of business equipment and machinery. The program has provided a clearinghouse for the sale and purchase of real properties, especially in higher risk areas such as inner-city districts undergoing redevelopment.

The most notable role of the SBA–to federal lessors, at least–is that it reviews and approves the Small Business Subcontracting Plans required in lease transactions involving lessors that are categorized as large business.  In those lease contracts where the federal contractor (i.e. lessor) is a large business, goals must be established for subcontracting a certain portion of the lease related construction and property operations to small businesses. SBA further establishes the size standards that differentiate between “big” and “small” in all business categories.

The SBA has never been widely popular in the larger business community. From the outset, organizations such as the US Chamber of Commerce and the American Bankers Association opposed its creation, protesting that the government had no proper place in the lending business. It was slated for elimination under several administrations, including those of Ronald Reagan and George W. Bush, but saved by congressional intervention—interestingly, spearheaded by the commerce committees of both houses.

Calls to abolish the agency continue today, with critics of the SBA, among them the CATO Institute, arguing that its chief assumption is outmoded, namely that small businesses have unfairly limited access to credit as compared to larger ones. Those critics add that an unintended irony is that SBA-certified banks, which buy and sell risk-free loans guaranteed by the government, are more often than not the largest financial players on the block. Finally, given looser underwriting requirements than in the normal lending sphere and our recent history with the consequences of bad loan risks in the Great Recession, to say nothing of episodes of outright fraud, even supporters of the agency have called for greater oversight.

With fewer than 2,400 employees, headquartered in Washington but widely distributed in branch offices, at least one in each state, the SBA has a relatively small footprint. The outstanding loan guarantees it holds, amounting to about $100 billion, give it an outsize importance, however, which may explain why President Barack Obama elevated the SBA to the Cabinet level. Confirmed by the Senate, SBA Administrator Karen Mills thus enjoys even greater influence than her predecessors in office.

Reining in Lease Extensions: A New GAO Report Promises More Oversight on Federal Leases

GAO Lease Expirations Graph

The federal government spends too much money, and it doesn’t keep tabs on what it’s spending money on. That’s the constant complaint, especially from critics in an election cycle—but it’s also a refrain that’s coming from the federal budgetary watchdog, the Government Accountability Office, with respect to the huge portfolio of properties that the government leases.

A GAO report issued earlier this month notes that U.S. General Services Administration leases 7,435 properties from the private sector, for a total of almost 195 million square feet. Yet, in a study leases expiring in the FY 2012 to FY 2014 time period, more than half (1,455) of the leases that were set to expire in that window went into extension or holdover–or both. In addition, GAO found that 1,603 leases were already in extension or holdover status at the beginning of their study period. GSA’s liberal application of holdovers–or their close cousin, the short-term extension–can, as the report notes, understandably cause tension and ill will. The report adds that the strategy is thus risky and “should be avoided.”

Uncertainty is the chief driver for these extensions. In a climate of cutbacks and partisan division over funding, many agencies lack a clear picture of staffing and space requirements from one year to the next. “Such uncertainty can make it challenging for federal tenant agencies to effectively plan and budget for the long term,” observed GAO auditors in presenting the report to the Senate Homeland Security and Governmental Affairs Committee. Even though the government overall operates under the terms of the Office of Management and Budget’s “Freeze the Footprint” mandate, which specifies that agencies may not increase the total square footage of their domestic office and warehouse space beyond a baseline set in 2012, there is uncertainty even there, particularly as agencies are called on to do more—to serve, for example, an ever-growing number of retirees in the case of the Social Security Administration or of federal prisoners in the case of the Department of Justice.

As case studies, the GAO report focuses closely on ten instances of privately owned properties whose leases exceeded $500,000 annually. More than half of these were in the Washington, DC (National Capitol) area. GAO found that the agency most responsible for extensions or holdovers was the Department of Homeland Security, accounting for 21 percent of holdovers and 19 percent of extensions. The report does not say as much, but given the ongoing difficulties surrounding the consolidation of DHS space at the St Elizabeths Hospital site, it is not hard to see that future planning for employees and assets is a pretty fluid process.

But why worry about extensions at all? Hard feelings are one thing, but more to the point, as the report observes, federal agencies are forced into a weak bargaining position when they’re in danger of losing their space and have often responded by paying higher than the market rate to renew the lease.

Given that billions of dollars are at issue, better planning should yield better ability to bargain and reduce the need for extension, which the GSA deems “a lease action of last resort.” Even good planning cannot fully take into account the uncertainty produced by sequestration and budgetary reduction, but the GSA has announced that, effective in FY 2015, it will implement a portfolio planning initiative that is meant to ensure that leasing plans are in place before a given agreement expires. The initiative will focus on leases set to run out in the next three years.

Emerging Building Technologies and GSA

Earlier this month, the US General Services Administration (GSA) and Department of Energy (DOE) issued a joint request for information calling on vendors to propose innovative building technologies in support of federal guidelines and goals, or, as the GSA announcement puts it, “technologies that have the potential to improve economic and environmental performance in federal and commercial buildings.”

The jointly issued RFI is the outgrowth of a memorandum of understanding signed by the two agencies in February to promote cooperation in finding ways to reduce energy usage throughout the US government. The strategies encompassed by the memorandum include developing shared standards for building management systems, increasing the use of renewable energy in federal facilities, and sharing best practices for using and developing green building and clean energy technologies.

To that end, the agencies are soliciting through this RFI technologies in five categories: energy management, window attachments, fans and blowers, renewable energy, and water conservation and reuse. All these technologies are meant to support the Green Proving Ground (GPG) program of GSA and the High Impact Technology (HIT) program of the DOE. GPG coordinates with third-party evaluators to test the prerelease and early commercial stages of sustainable building technologies in federally owned building, while the HIT program supports the adoption of cost-effective energy efficiency technologies by facilitating their assessment in commercial buildings. The goal of the former program is to improve federal energy efficiencies, while the latter program is intended to influence the private marketplace to do the same

Last year’s RFI produced seven technologies that have been selected for evaluation:

  • A continuous combustion control system that optimizes the fuel mix in gas-fired boilers to increase boiler efficiency and reduce emissions (Lumec Control Products, Inc.)
  • Intelligent energy valves to reduce the energy consumed by hydronic systems by maintaining an optimal temperature difference between supply and return lines (Belimo Aircontrols USA, Inc.)
  • Daylight redirecting film, window film that redirects daylight through windows to the ceiling to extend the natural light zone (3M Company)
  • Circuit-level energy monitoring that collects and analyzes energy consumption in real time (Enertiv, Autodesk, Inc. and Panoramic Power)
  • Building integrated photovoltaics (BIPV) in windows that can improve energy efficiency while also generating electrical power (Solaria Corporation)
  • Smart ceiling fans that monitor room temperature and humidity to adjust fan speed for optimal comfort (Big Ass Solutions)
  • Smart scrubbers for HVAC load reduction, technology that reduces the volume of outside air drawn indoors by removing contaminants from HVAC airflow (enVerid Systems)

Within their specialized areas, these technologies reduce energy consumption and emissions, realizing savings of from 8 percent in the case of the gas combustion control system to 30 percent in the case of the intelligent energy valve system.

GSA and DOE note that if an applicant’s technology is selected for evaluation through the GPG program, an HIT Catalyst demonstration project, or both, it will be matched with federally owned buildings or commercial buildings for measurement and verification by independent evaluators.

The current RFI is addressed to industry stakeholders and commercial organizations, as well as educational institutions, and nonprofit organizations. The application period ends at 11:59 EST on Friday, December 11, 2015. Anyone interested in responding to the RFI can review it at FedBizOpps.gov, while any questions can be directed to gpg+2015@gsa.gov.