Federal Warehouses: Assets in Need of Better Management

Vacant GSA Warehouse in Washington, DC (photo from GAO Report 15-41)

Vacant GSA Warehouse in Washington, DC (photo from GAO Report 15-41)

Ninety million square feet. That’s about three times the size of Manhattan’s Central Park. According to a new report to Congress from the US Government Accountability Office, that’s also the amount of warehouse space the federal government leases or owns for its civilian agencies, warehouse space comprising some 19,000 buildings across the country and its territories.

Foremost among these agencies are the General Services Administration (29,293,442 square feet), the Department of Interior (15,266,082 square feet), and the Department of Energy (11,475,630 square feet). GSA, of course, acts as a sort of landlord for the government, dispensing warehouse space to other agencies. Most of this space is considered “utilized” and “active,” though the GAO did note that among the warehouses were numerous unused buildings, some having been vacant for several years. “This discrepancy,” notes the GAO report, “raises questions about the transparency and usefulness of the Federal Real Property Portfolio (FRPP) warehouse data, which could be misinterpreted by decision makers, including Congress and the Office of Management and Budget.”

GAO Report Table 1

What is being stored in those warehouses? Having no statutory obligation to ask, the GSA has no answers. Individual agencies have a better idea; the Department of Interior, for instance, reports that its 10,000-odd warehouses, most owned rather than leased, are mostly used to store government records or equipment such as snowplows and firefighting gear, in keeping with its mission to safeguard natural resource and cultural assets. Some aspects of that mission require special facilities—for instance, as the report notes, the US Geological Survey holds ice core samples brought up from deep below the surface in places such as Greenland and Antarctica and are kept in deep-freeze units in an industrial warehouse in metropolitan Denver. Similarly, the Department of Energy has facilities storing such things as windmill blades for use in testing wind turbines, as well as warehousing nuclear waste and other unusual materials.

The report identifies challenges in acquiring, managing, and disposing of federal warehouses. Owing to atypical needs such as DOE’s ice core storage, for instance, warehouse spaces must sometimes be custom-designed; maintaining them can be costly, especially as they age; and disposing of them can be difficult, especially if a warehouse is so specialized that it cannot find a civilian user, has outlived its usefulness generally, or has been used for unusual and sensitive purposes such as storing hazardous materials. In such cases, disposal usually equates to demolition.

More, though, the report notes that many federal agencies have long misinterpreted FRPP standards for measuring utilization, a key factor in deciding whether the government has too much or too little warehouse space. Before 2013, the operative categories were simply “utilized” and “unutilized,” defined as a percentage of occupied space. The guidelines have now been made more rigorous with the addition of an “underutilized” category and definitions for each class: a utilization score of 40 or more is required for “utilization,” while 1 percent or less constitutes “unutilized.” By this measure, about 15 percent of GSA-held warehouse space is considered unutilized for the purposes of the report, adjusting for property that had been incorrectly categorized by the various agencies.

Of particular interest to our readers, the GAO report notes in passing that civilian agencies leased more than 1,100 warehouses nationwide, covering about 24 million square feet of space. This figure diverges from FRPP data, which puts the figure (as of 2013) at 600 warehouses—a discrepancy, to be sure. Whatever the case, the report calculates that rent for this space amounted to $170 million in 2013.

Confusion surrounds much of the present discussion in part because, as the report adds, GSA has not developed firm strategies for the best use of warehouse space, most of its efforts having gone to office space instead. “As agencies work to reduce their footprint,” the report notes, “this could be an ideal time to develop a strategic approach that would capitalize on broader trends, economies of scale, leading practices, and private industry experience in the warehouse area. The report concludes by noting that GSA agrees with its recommendation that it should “develop a government-wide strategy to promote effective and efficient practices in warehouse management.”

The Positive Result of the Mid-Term Election

A Republican Wave

In last week’s election, the Republicans won majority control of the Senate and further solidified their control of the House of Representatives. This means that the Republicans will lead the 114th Congress when it convenes next year.

Is this event positive for federal property investors? The answer is a resounding yes, but not necessarily for any ideological reason. It is simply that the Republicans’ victory reconciles a split Congress. In the last two Congresses (the 112th and 113th), the House was controlled by a Republican majority and the Senate controlled by a Democratic majority.

As we shall explore in this article, growing partisanship guarantees gridlock in our legislative branch unless both chambers of Congress are in alignment. This gridlock has had negative consequences for the government-leased property market, which should therefore benefit from last week’s election results.

Unified Control of Congress Matters

Split majority control of the two chambers is a rare but significant occurrence. In the past 100 years only three Presidents (Obama, Reagan and Wilson) have had to endure this split, as depicted in the chart below (clipped from Wikipedia and modified by me).*

Updated_congress_map

Perhaps for this reason, Congress’s power and influence–and thus the perils of a divided Congress–are underappreciated. In the U.S. form of government, only Congress is authorized to write laws and to appropriate the budget, powers that have tremendous impact on nearly everything, including federal real estate.

As evidence that the split matters, the 111th Congress was the last unified Congress and it’s generally regarded as among the most productive in U.S. history. It was also among the most partisan–members of its House Democratic majority voted with their own party 94% of the time (with similar results in the Senate).

In the 112th Congress, the Republicans wrested majority control of the House but not the Senate, splitting party leadership of the two chambers. The split, compounded by the growing partisan divide, was enough to flip the switch from a hyper-productive legislature to the least productive (as measured by laws enacted) in U.S. history. The split continued into the current 113th Congress, which is on pace to edge out the prior session for the ignominious title of “least productive Congress ever”.

The Growing Partisan Divide

As noted above, the problems created by a split Congress are amplified by growing partisanship. Over the past half century, Democratic and Republican congressional members have grown a bit further apart ideologically but, more significantly, they’ve become much more partisan in their voting patterns, rarely breaking rank with their own party. With House and Senate control divided among the parties, increased partisanship has made a difficult situation much worse.

Thomas Mann and Raffaela Wakeman at the Brookings Institution put together a fascinating study of this emerging partisanship, including a series of scattergraphs that measure both ideology and the frequency with which Democratic and Republican members of the House of Representatives vote with their own parties. Their graphs plot the voting behavior of each member of the House of Representatives for each congressional term in U.S. history. Each Representative’s ideology is plotted on the horizontal axis (left side of the scale is more liberal and right side is more conservative). The frequency with which that person voted with the majority of his or her own party is plotted on the vertical axis. The selected graphs below demonstrate the House’s voting trend since the start of the Nixon Administration, almost a half century ago.

At the start of the Nixon administration, the House demonstrated ideological diversity and also less partisan voting than is evident among today’s lawmakers. For example, as shown on the horizontal axis, the voting records of some Democratic members of the House were more conservative than many members who identified with the Republican party. Most of these were Southern Democrats who not only voted conservatively but also showed a willingness to vote apart from the rest of their party.

Partisanship 91st Congress

By the second congressional term of Reagan’s presidency, some partisan separation had begun, though there were still Democratic and Republican Representatives who identified ideologically with the other party and who were willing to join in votes across the aisle. It is also interesting to note that Reagan’s was, until the Obama presidency, the last truly split Congress. The Republicans controlled the Senate but the Democrats (led by Speaker Tip O’Neil) held majority control of the House.

Partisanship 98th Congress

By the end of the George H.W. Bush presidency, Representatives routinely voted with their own parties, and the ideological gap between Republicans and Democrats had widened a bit further.

Partisanship 102nd Congress

Both trends continued through the Clinton Administration to the start of the George W. Bush presidency, as shown below. By this point–both in reaction to the eight years under Clinton’s liberal leadership and the 9/11 terrorist attacks–the Republican party, in particular, had shifted further to the right, and Representatives on both sides of the aisle were voting almost exclusively along party lines.

Partisanship 107th Congress

By the start of the Obama presidency, the parties that comprised the 111th Congress were now fully separated ideologically. At least as evidenced by voting behavior, the most conservative Democrat was now more liberal than the most liberal Republican. Further, most Representatives were voting almost exclusively with their party majority. The Democrats controlled both chambers of this Congress and wielded that control to issue landmark legislation, including the $814 billion stimulus, the Affordable Care Act, climate change law, a slew of tougher regulations on Wall Street and also the creation of a consumer protection watchdog agency. The Republican opposition was effectively rebuffed in this most partisan Congress in U.S. history, with the Democrats victorious on partisan votes well more than 90% of the time in both the Senate and the House.

Partisanship 111th Congress

The 111th Congress is generally regarded as the most productive Congress since the era of LBJ’s Great Society so it is shocking that this uber-productive Congress would be followed by one that was, by most measures, including legislative output, the least productive in U.S. history.

In fact, as measured by party unity and ideology, the 112th Congress looked a lot like the 111th. So what caused the dramatic decline in productivity in a single term of Congress? The answer is simple: The 112th Congress was split. The Republicans had taken majority control of the House but the Democrats still controlled the Senate. That internal division, coupled with growing partisanship, resulted in gridlock.

Partisanship 112th Congress


Partisan Voting Trends

The real significance of the growing partisanship that is evident in the Brookings study charts is its effect on voting behavior. The graphs below (created by Gregory Koger, a professor at the University of Miami) illustrate in dramatic fashion the increase in partisan voting pattens. For each vote in the House of Representatives, Koger plotted the percentage of Republican and Democratic members who voted for the measure. In the Koger graphs, votes plotted in the upper right corner indicate consensus because the measures received an overwhelming majority of “ayes” from members of both parties. Clusters of votes in the upper left or lower right corners, however, indicate partisan voting behavior because those measures received an overwhelming number of “ayes” from one party with very little (if any) agreement from the opposing party.

For example, in the graph below, it is clear that there was no strong partisan voting behavior in the 95th Congress (convened at the start of the Carter Administration), but a significant number of measures received consensus support.

95th Congress (1977-1978):

95th House maj votes only

By the start of the Clinton Administration in 1993, partisan voting had become more common.

103rd Congress (1993-1994):

103rd House maj votes only

By the third and fourth years of the George W. Bush presidency, the partisan trend in the House had progressed even further with very tight clusters at the extreme corners of this graph.

108th Congress (2003-2004):

108th House maj votes only

And, by the beginning of the Obama administration, in the 111th Congress, the hardening of partisan lines was essentially complete. Most votes were partisan, few votes achieved consensus and almost all votes attracted the near-complete support of one party or the other, drawing all voting behavior out to the edges of the scattergraph below.

111th Congress (2009-2010):

111th House maj votes only

The following Congress, the 112th, had similar voting behavior in the House, and so will the current Congress, the 113th, once its record is tallied. Yet both the 112th and 113th Congresses were rendered largely ineffective by partisan gridlock between the House and Senate. With Republican control of the House and Democratic control of the Senate, legislation proffered by either chamber had no hope of passage through the other.

Does Gridlock Really Matter?

Do we really care if Congress is split and therefore gridlocked? Federal property investors certainly should. When the chambers of Congress are unable to agree and take action, the federal agencies are caught in the middle–they lack the budget clarity and confidence to engage in long-term planning. As a result, during recent split Congresses agencies have become reluctant to execute long-term leases. In the past few years, nearly half of GSA leases were for terms of three years or fewer as agencies kicked the can. This pattern is not welcome to property investors.

Much of the fundamental disagreement between Democrats and Republicans relates to the critical issues of federal spending and increasing national debt. The U.S. Debt Held by the Public now stands at almost $12.9 trillion the highest level since World War II. Despite a reduction in deficit to $483 billion (a substantial recovery from the 2009 through 2012 period when annual deficits exceeded $1 trillion) deficit spending is expected to continue to fuel the debt. The reason for this is that two-thirds of the federal budget funds mandatory spending, primarily comprised entitlement programs such as Medicare, Medicaid and Social Security, and, to a growing degree, interest on the national debt. Congress, therefore, only has appropriations control over one-third of the federal budget. No matter how hard Congress works to throttle back discretionary spending, its efforts are doomed to be overwhelmed by ever-growing mandatory spending.

Increasing spending and debt are structural issues that Congress can resolve only through some form of Grand Bargain that includes tax reform (to improve revenue) and/or entitlements reform (to reduce spending). This is why a functioning Congress is so important. Congress is the branch of our federal government that writes laws and authorizes and appropriates the budget. Only Congress can legislate to address these critical issues. Yet the split Congresses of recent years have been rendered completely incapable of action due to their internal conflict.

We do not expect partisanship to fade any time soon–it took a half-century for these party lines to harden. Yet, Congress has proven itself effective when both chambers are unified under one party. This is why the recent election results and unification of Congress under Republican control holds promise for federal property investors.

Of course, the outstanding question is whether the Republicans will use the next two years to implement tax and spending legislation that will ultimately create some headroom in the discretionary budget (which is where rent is paid), or whether they will simply use this time to posture for advantage in the 2016 presidential election. The answer will do much to shape the federal real estate market.

* At the start of George W. Bush’s first presidential term the Senate was split evenly. Eventually, Jim Jeffords (R-VT) changed his party affiliation to Independent and caucused with the Democrats, effectively giving them control of the Senate and splitting control of the two chambers of Congress. In any case, the 9/11 terrorist attacks occurred shortly thereafter, shaping the agenda and unifying that 107th Congress on most issues through the remainder of its term.

Continuing Resolutions, Continuing Crisis

If you think getting an immigration bill, say, or healthcare reform through a bitterly divided Congress is hard, try an annual budget. In mid-September, Congress, having been unable to agree on that budget, passed what is called a continuing resolution (CR), an instrument that, absent just such an agreed-upon budget, allows for the ongoing funding of federal agencies at current levels. The current CR expires on December 11, making provision for funding in that first part of FY 2015 at FY 2014 appropriations levels.

Though an agency such as the Department of Defense may not be funded with all the dotted eyes and crossed tees of formal legislation, the use of the CR means that the planes do not have to stop flying and soldiers shooting until Congress works out the details. What it can and often does mean, however, is that the Pentagon cannot plan with confidence for any growth in its budget, or generally any budgetary change at all beyond the possibility of reduced spending. For some programs, this uncertainty has proven more an inconvenience than a hobble, but large and small agencies alike find it difficult to plan realistically in the face of the uncertainty the use of the CR yields.

For instance, problems in securing realistic appropriations and full, multiyear funding with timely payment have hampered plans to build a permanent headquarters for the Department of Homeland Security in Washington. Even so critical a branch of government as Defense, as the Congressional Quarterly notes, is rendered less effective by the CR, since it relies on multiyear contracts with suppliers and spending can change dramatically within any given phase of the development of a weapons system—or, for that matter, a boots-on-the-ground operation. Unless Congress soon authorizes a yearlong CR, much less a budget, the Pentagon will not be able to make new procurements in 2015, at least not without much internal juggling.

The specter of government shutdown is bound up in the funding battle and the question of the CR as well. We saw as much in the 16-day hiatus of 2013, when, among other effects, certain benefit programs for military families were suspended and the national park system was forced to shut down.

Use of the continuing resolution is nothing new. Its use has increased over the course of the new century, but we are still a far cry from 2001, when 21 CRs were passed over a year that saw tremendous economic and political turmoil. Even the still more economically tumultuous year of 2008 saw only four CRs. The disparity can be explained in part by the fact that many of the 2001 CRs lasted for a single day, whereas, according to a 2009 GAO report, most CRs hold, on average, for about three months. The most recent CR before the present one lasted nearly six months in FY 2013, that notorious year of government shutdown.

Indeed, while the CR is common, agreeing on a yearlong budget is increasingly rare. Between 1985 and the present, only three years—1998, 1995, and 1997—have seen that concord.

Still, critics worry that reliance on the CR instead of an agreed-upon budget lends a provisional, ad hoc quality to the workings of government. Champions of a limited federal budget, however, argue that the CR denies free-spending legislators the wherewithal to do so. One thing seems certain, however: now that legislators have determined how to make political hay from it, the instrument is not likely to be shelved anytime soon.

The current CR makes allowance for some spending beyond the 2014 appropriation, including battling ISIS/ISIL in Syria and Iraq, combatting the spread of the Ebola virus, and supporting the government of Ukraine in its current crisis, now at a stalemate, with neighboring Russia. Stalemate is the operative word, and now that a single party is in control of Congress, there is some prospect for a little more smoothness in the appropriations process. We’ll all need to stay tuned to see what happens next—as soon as December 12, that is—with respect to the flow of federal dollars.

Rolling Termination Rights Now Extend to AAAP Program

AAAPAs of last month, the Automated Advanced Acquisition Program (AAAP) still allowed GSA and interested landlords to enter into leases of 5 years, 10 years or 5 years with a fixed-price five-year renewal option. However, this month saw the most significant revision to the AAAP program in many years – no longer will landlords have the ability to secure this 5+5 lease structure through AAAP. Instead, GSA amended the Request for Lease Proposals (RLP) to now solicit proposals for a 10-year lease with GSA having rolling termination rights after the 5th lease year. The basic 5-year firm (which is hardly ever used) and 10-year firm alternatives remain unchanged, but this AAAP revision is noteworthy because it introduces cancelable lease term into the AAAP for the first time.

The 10 year/5 firm structure has been GSA’s default approach to its non-AAAP lease procurements for many years. Despite congressional pressure on GSA to secure longer lease terms and resistance from private industry, this latest evolution of the AAAP demonstrates GSA’s desire to have the AAAP program “fall in line” with its longstanding national leasing policies and it’s aligned with GSA’s apparent attempt to remove the human element from the business of real estate leasing by automating as much of it as possible. GSA’s continued reliance on cancelable leases is one of the reasons GSA’s average remaining lease term, across its national portfolio, continues to decrease.

Because this 10/5 structure is already familiar territory for virtually all of GSA’s contracting officers, and because AAAP transactions are less susceptible to protests, it is quite likely this latest change will result in an uptick in AAAP leasing activity and further establish the AAAP as GSA’s preferred lease acquisition method for the major metropolitan markets in the United States.

District of Columbia: LEEDing by Example

leed-plaquesRecently adopted standards in the District of Columbia now require new buildings to meet LEED standards. That is, they must meet the Green Building Council’s energy-efficient, environmentally friendly requirements of building design and construction, operation and maintenance, and, what is less easy to control, interaction with the surrounding neighborhood. All new buildings in the District of Columbia must now meet LEED standards or their close equivalents, according to regulations established last spring, while those in neighboring Maryland must conform to less rigid but still challenging environmental requirements, also endorsed by the Green Building Council. Virginia is likely to follow suit soon.

Relatively few projects aim for LEED Gold or Platinum certification, more elite designations. Part has to do with reasons of cost, since meeting those standards can involve layering on all sorts of unanticipated expenses; one gets bragging rights for the special LEED status, but not much else tangible in the way of payback, since building codes are generally in line with LEED in many costly details of the physical plant, such as how much water a toilet uses or whether lights are programmed to go off when a room is not in use. (Most LEED regulations have to do with mechanical and electrical components of buildings.) Part, too, has to do with LEED’s difficult demands, especially in that fitting-in-with-the-neighborhood component. For example, we spoke with one architect who said he lost Gold certification in one outlying county because the schedule of municipal buses bringing workers to the building was not printed to LEED’s liking.

“We had one building that got Gold certification with no problem,” he said. “It sailed right through the process. We had another one, designed exactly the same, that was a nightmare getting approval for. Same standards, same firm, different inspectors, different outcomes. The system isn’t foolproof, and I’m not really convinced that there’s a need to have the merit badge. It adds so much cost and so much energy to any building effort.”

Still, that cost and energy is a requisite in much building work for the federal government. That will even be more so when, on November 13, new regulations by the Department of Energy go into effect that require that new and retrofitted federal buildings meet energy and mechanical requirements according to Green Building standards. The regulations are in concord with Executive Order 13514 and the Energy Independence and Security Act (EISA), and they are being followed by the GSA, which has overall responsibility for federal properties, whether in the District or far beyond.

The relevant DOE document states, in a somewhat circular fashion, “Under the regulations established today, if a Federal agency chooses to use a green building certification system for a new building or major renovation covered by today’s rule, the green building certification system for Federal buildings must meet the certification standards established in today’s rule.”

Dodgy phrasing aside, there has been some resistance to LEED standards on the part of firms and organizations within the building and construction materials industries, largely because of the increased expenses meeting those standards entails. Some of the resistance has to do with inadequate grandfathering of existing stocks of materials such as adhesives and flooring that met standards yesterday, but not today; some, of course, has to do with dislike of federal authority generally. Still, builders and architects have found LEED certification to be a widely understood stamp of approval, and even if it costs a client more, it’s a selling point on the part of those seeking to sell buildings, whether to the government or to private buyers.

Nonetheless, it’s not unusual for builders to choose to exceed the code, functionally meeting LEED standards without the paperwork. It appears, though, that paperwork may become increasingly difficult to avoid. In the case of the District of Columbia, the government requires the rating—a requirement that, all signs now suggest, is likely to become more widespread.

The Trouble with Rising U.S. Debt

Federal Debt Held By The Public

The federal debt held by the public in the second quarter of 2014 was $12.57 trillion. That equates to 72.6% of GDP, down slightly from the post-WWII peak of 74.0% that was recorded in the first quarter of this year. This slight reduction is the only good news that will be reported for the remainder of this article.

Rapidly rising U.S. debt is a problem for all of the reasons normally cited by economists, but for investors of federal government-leased properties there is an additional cause for concern: efforts to contain or reduce the growing debt through spending restrictions have come at the expense of the federal discretionary budget. Unfortunately, this is the same budget from which rent is paid.

In fact, we’ve already seen the early effects of these cuts. In response to historically high deficits and the resultant rapidly increasing debt, the White House and Congress have both begun imposing austerity measures on the federal inventory. The first of these were space utilization restrictions established by the House of Representatives as part of its prospectus approval process. Shortly thereafter, the White House issued its “Freeze The Footprint” policy, which prohibits agencies from increasing the size of their real estate inventories above the level established in FY 2012. Both of these measures have blunted GSA’s leased inventory growth and we are beginning to see downsizing in the works.

Much of this downsizing is being accomplished through reconfiguration of offices to achieve better space utilization. Occasionally this is taken to the extreme, transforming workplaces into telework environments where most employees don’t come into the office, and those who do are provided temporary workspaces to conduct that day’s activities. The net result is that there is slightly less GSA-leased space now than a year ago.

Discretionary Share of Income

The Heritage Foundation included this graph in its “Federal Spending By The Numbers” report last year, using data from the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB) to forecast the squeeze put on the discretionary budget by entitlement spending and interest on the national debt.

Is this a temporary problem or a persistent one?

Ever optimistic, real estate investors hold out hope that the Ryan-Murray budget agreement and last year’s deficit reduction are signs that the economy is righting itself and that we will soon shift back into growth mode. Yet, that is unlikely.

According to the Congressional Budget Office (CBO) Extended Baseline forecast the national debt is expected to decline over the next few years, but then it will rise again (see chart below). The Extended Baseline estimate is CBO’s rosiest view of future debt because it is based on current law, which includes the expiration of certain tax breaks and medicare reimbursements. In reality, those revenue-reducing provisions are consistently renewed. The Alternative Fiscal Scenario model, which is designed to consider past behavior in anticipating future results, yields a more worrisome trend. The most realistic forecast probably lies somewhere between these two measures but, in any case, the results show that within the next ten years debt will begin to grow again, exceeding current levels and ultimately surpassing the entire size of the U.S. economy.

Federal Debt Trend

From “The 2014 Long-Term Budget Outlook” published July 2014 by the Congressional Budget Office (CBO).

Both parties recognize that the root cause of ever-increasing debt is growth in entitlement spending (primarily Medicare, Medicaid and Social Security) and, to a lesser degree, increased net interest on the national debt. Currently, discretionary spending is a bit less than one-third of the federal budget, and mandatory spending (including net interest) is the other two-thirds. Though the Tea Party and other fiscal conservatives have waged relentless efforts to reduce discretionary spending, those gains toward debt reduction have been easily overwhelmed by entitlement spending. Part of the problem relates to lackluster GDP growth, which limits available revenues, but the big-picture math is pretty simple: bringing the federal budget under control will require statutory changes to contain entitlement spending and/or increase taxes. Looking into the future, Fred Hiatt, Washington Post editorial editor, assessed the situation in an op-ed article last week: “the government will be spending on entitlement programs and interest alone just about what it spends today on the entire budget. Everything else—schools, pre-K, Pell grants, national parks, mass transit, housing subsidies—will get squeezed, or taxes will soar, or both.”

This is why we are unlikely to see a return to inventory growth anytime soon. Creating headroom in the discretionary budget is not possible without entitlement and tax reform, legislation requiring seemingly impossible congressional agreement in the current hyper-partisan political environment. Further, with a presidential election ahead in 2016, any legislative effort at deficit reduction is more likely to be a political statement than a real effort at compromise.

How can this get better?

The Ryan-Murray budget agreement was a two-year resolution. That provides about the most budget stability we’ve seen in the past several years. Further, it’s possible that the Republicans will capture both houses of Congress next month. If that occurs, the result for the federal-leased property market is likely to be positive simply because it consolidates control of the legislative branch with a single party. Split control of 112th and 113th Congress (Republican majority in the House and Democratic majority in the Senate) is a fairly rare circumstance, one that has manifest itself in legislative gridlock. The resulting state of limbo, paired with a slow and fragile economic recovery, has put agencies into a holding pattern, kicking the can with short term leases.

The irony for the feds is that intensifying budget pressure on leasing can be resolved through downsizing and consolidation, yet the budget is too tight to fund those activities. If the November mid-term election unifies congressional control it may provide a clearer path for agencies simply by providing greater predictability to the budgeting process. However, any improvement would be incremental–the government takes a shockingly long time to plan and execute even the simplest of leasing actions.

The trouble with rising debt cannot be enduringly addressed without landmark revisions to tax and spending legislation. Without action it is a certainty that federal real estate will remain subject to cost-cutting. Property investors must hope that our future political leadership finds a solution to this important issue.

Funding Controversy Leaves DHS’s Consolidation Plan in Doubt

master_plan_site_map_2St. Elizabeth’s Hospital, perhaps best known as the psychiatric facility in which the poet Ezra Pound was held for thirteen years after having been convicted of treason, and where would-be presidential assassin John Hinckley has been confined since June 1982, is choice real estate. Occupying more than 180 acres of federal property with a sweeping view of the Capitol, the Tidal Basin, National Airport, and other Washington landmarks, it lies squarely in the path of the District’s eastern development expansion.

After serving for more than a century to the treatment of troubled psyches, much of the campus is disused and in disrepair. After having been deemed “endangered” by the National Trust for Historic Preservation, the site has been slated for more than a decade as the future consolidated headquarters of the Department of Homeland Security, an omnibus agency that itself consolidated 22 smaller agencies in the wake of the terrorist attacks of September 11, 2001. The headquarters consolidation effort would entail significant renovation, rebuilding, and new construction, and it is one of the most complex and costly building projects in in the works in Washington, DC.

A report recently issued by the U.S. Senate Committee on Homeland Security and Governmental Affairs notes that DHS is now scattered across more than 50 facilities in Washington, Maryland, and Virginia, “many of which are physically inadequate.” Its authors add that this dispersal makes it difficult for DHS to act in a cohesive, collaborative manner—the very rationale for establishing the department so that diverse law enforcement and national intelligence functions could be brought under one roof to foster what former Secretary Michael Chertoff called a “one-DHS culture.”

When the master plan for the renovation of St. Elizabeth’s was effected in 2009, the total cost was estimated to be $3.4 billion, with a projected move-in date of 2016. That cost has risen to $4.5 billion, the Washington Post reports, and the move-in date, already far behind schedule, is now projected to stretch into 2026—ten years late—if funding trends hold.

That delay is puzzling, given that DHS has long cited headquarters consolidation as a pressing national security need. But for the time being, only one DHS unit, the U.S. Coast Guard headquarters, has taken up residence on the campus.

Meanwhile, the Senate Committee report continues, that pressing need for consolidation remains unaddressed, at least in part because Congress has consistently allocated less funding than requested—$1.2 billion less, in fact, since 2006. This shortfall has led to construction delays and increased costs of various kinds.

The authors observe that in a time of constantly shrinking budgets and economic instability, the temptation exists to shelve “long-term investments that have yet to bear fruit.” They add, though, that conversely, consolidation stands to save millions in taxpayer dollars in the long term through realized efficiencies. Indeed, the authors claim, the savings over the next 30 years could reach a billion dollars: $700 million in saved rent, $210 million in housing more employees in more efficiently designed, morale-boosting new space, and $132 million in the saved cost of having to maintain St. Elizabeth’s as a historic property.

For that and other reasons, the report recommends that the St. Elizabeth’s DHS consolidation project be considered a funding priority. The authors urge that the 2015 request of $323 million for renovation of St. Elizabeth’s be funded. They add that if the allocation is not made, the $348 million that has already been spent will go to waste. At the same time, they note that a revised plan is required to be sure that the project is “well managed and implemented.”

The report also emphasizes the Government Accountability Office’s insistence that property ownership is far less expensive than leasing property to house federal agencies, a stance that has obvious implications for our readership. “Delays in construction at St. Elizabeths have required DHS to continue to lease office space throughout the region,” the authors write. “Most of those offices are paid for through increasingly more expensive operating leases, meaning fewer dollars can be spent on mission operations.”

The Office of Management and Budget is now reviewing a draft revision of the DHS consolidation project. Meanwhile, a report from the GAO released on September 19 suggests that the General Services Administration and DHS consider alternatives to St. Elizabeth’s. It also faults the agencies for poor management of schedules and budgets, calling current estimates unreliable. “Creating reliable cost and schedule estimates for the headquarters consolidation project should be an integral part of DHS and GSA efforts to reassess the project,’’ the report scolds. “Without this information . . . the project risks potential cost overruns, missed deadlines, and performance shortfalls.’’

Congressional Democrats and Republicans, predictably, are divided: Many Republicans are pressing to divert funds from the consolidation to such matters as border security, while many Democrats are urging that the St. Elizabeth’s project be fully funded and completed.

In short, this unfinished business is business as usual, leaving us to continue our speculation as to whether this project will ever be completed.

How to Tell the King Snakes from the Coral Snakes: Due Diligence Tips for GSA-Leased Property Investors

Only one of these illustrations depicts the venomous coral snake. The rest are harmless. (Answer: A…if you are in North America)

You’ve inspected the building and it appears sound. You’ve interviewed the tenants and they seem happy. You’ve toured the market and it triggers no alarms. You’ve done all of your normal due diligence, so you buy. Then, later, when you expect to glide through an easy and lucrative lease renewal, everything goes to hell.

Could you have seen it coming? Maybe.

GSA-leased assets may appear similar but they are often very different. Learning to distinguish good investments from dangerous ones requires a practiced eye. Here are several items every property investor should address when evaluating GSA-leased property investments:

Watch out for consolidation
If your tenant agency is housed in several buildings in the same market area then it may be vulnerable to a future consolidation action. Sometimes that’s a good thing–like when an agency occupies all of your building and a small piece of a building next door. That is a situation where it’s likely (in the current budget environment) that the agency will chose to reduce its footprint and consolidate into your building. Yet, it’s also common for an agency spread among several locations to ultimately consolidate into a separate, new one. In that instance, you may be the one holding vacant space.

Everyone prefers new buildings (even the feds)
As a follow-on to the point above, the federal government exhibits a demonstrated bias towards new properties, especially when it can be the primary occupant. This is usually because, over time, federal inventory growth eventually necessitates consolidation. Emerging federal mandates, including those aiming to achieve improved space utilization and energy efficient design, naturally favor newer buildings. This doesn’t mean that older buildings cannot be competitive (especially historic buildings that enjoy certain price advantages). If they meet the technical criteria presented by the government’s lease, then it’s simply a price competition. Yet, everyone likes new space–including the feds–so it’s a mistake to assume that they are a lock for renewal in markets where newer space is plentiful. It’s easy for GSA to cast a procurement such that it disadvantages older buildings.

Make sure the space utilization is tight–really tight
If you walk the building and note center corridors and lots of spacious hard-walled offices, you have good reason to be concerned. Even open plan layouts may not meet the agencies’ increasingly strict utilization measures. Most federal tenants now aim to achieve space utilization of 170 USF per person or less (sometimes substantially less). If your building doesn’t offer that, expect that you will have to invest more capital upon renewal. If you must compete to renew the tenant, this means that your price advantage may be eroded as well. It pays to know what space design mandates the tenant agency is implementing across the rest of its portfolio.

Space utilization goes beyond just the tenant buildout. The core factor also matters because, though GSA pays rent on a rentable square foot basis it compares lease proposals on a usable square foot basis. Larger core factors can substantially inflate the rent per usable (more technically the “ANSI-BOMA Office Area”) square foot, substantially impeding the building’s competitiveness.

Federal tenants attract one another…except when they don’t
The GSA tends to want to locate its tenant agencies in buildings it can control, which provides obvious security benefits. In “multi-tenant” federal buildings that are home to several government agencies, GSA enjoys the additional benefit of being able to control all space within the building envelope to accommodate individual tenant expansions and contractions.

Yet, some government tenants don’t co-exist very well. High security, law enforcement tenants, such as FBI, usually want to be segregated–preferably in their own building. Other times, the missions of federal agencies are at odds. For example, Citizenship and Immigration Services (CIS) and Immigration and Customs Enforcement (ICE) have historically been co-located because they are both successor agencies to INS. Now these agencies are being separated so that immigrants seeking to pursue citizenship status don’t have to scurry past the offices of the people that might detain and deport them(!).

Public access facilities are on the wane
Under intense budget pressure, public access functions like Social Security field offices and IRS Taxpayer Assistance Centers are increasingly in danger of closure. Take the Social Security Administration (SSA), for example: that agency has closed more than 65 field offices since 2010. SSA is replacing these bricks and mortar outlets with telephone and internet support in an effort to reduce real estate costs. Since SSA doesn’t have a firm plan for how many additional field offices it will close (or downsize) and the timing of those actions, GSA consistently insists on leases with no more than five years of firm term. While the renewal may be certain, asset valuation can be damaged by the relatively short term.

Be wary when the # of tenants is not equal to the # of leases
GSA leases space from lessors and then subleases it to individual federal agencies via occupancy agreements. Sometimes a single lease may accommodate several federal tenants. That’s fine, except that it has recently become common for GSA to demand that the lessor negotiate leases for each individual agency upon renewal. So, a single, full building government lease could later convert to multiple leases. GSA would then have the ability in the future to determine whether it will renew these leases individually, possibly with varying terms. Among other complications, this functionally provides GSA with partial termination rights.

The same can occur in reverse too. Multiple leases may be combined into one, which is often preferable, except that the effort to combine the leases may require short-term extensions to align the expiration dates, delaying the larger lease action and possibly complicating financing. Further, if the combined lease is large enough it may also require congressional prospectus approval. Prospectus approvals include restrictions on maximum rent, maximum size and space utilization. They may also require GSA to establish broad geographies for competition and to negotiate purchase options.

Whether multiple leases are combined into one, or one lease is split into many, the resulting terms may not be what the purchaser bargained for when buying the asset.

Distinguish between contractors and employees
Many GSA offices house contractors, but that is vulnerable to change because decreasing the size of the real estate inventory is the government’s overriding goal right now. Certainly the feds have to provide space for their own people, but they don’t necessarily need to do that for private-sector federal contractors. In an effort to downsize, realign and consolidate, contractors may be asked to find their own space, enabling the government to lease less space in your building.

In GSA’s view, all buildings are equal (when it comes to negotiating rent)
GSA employs blunt tools and metrics like “Bullseye” and the Lease Cost Relative to Market (LCRM) measure to determine the rent it should pay. These were originally meant simply to provide guidance to contracting officers but, predictably, some regions have now established policies requiring that its negotiators match or improve upon the rent goals established by these automated measures. That’s a problem for property owners for two reasons: 1) the tools don’t evaluate actual competition (or lack thereof) they simply establish rent goals based upon prevailing market rent, and; 2) The prevailing market rent is often established based upon a market geography drawn broadly. For example if your property is downtown and the Bullseye tool establishes a rent negotiation goal based upon prevailing metro area rents, you’re probably in for a frustrating negotiation.

The Contracting Officer matters
GSA gives lots of responsibility to its contracting officers. Even though federal leasing is heavily governed by regulation, law and policy, the skill and attitude of the Contracting Officer (CO) makes a big difference. Unfortunately, there isn’t much consistency in the approach or ability of various COs. Some just aren’t up to the task, can’t control their tenant, won’t think outside the box or, perhaps, they are quick to bully you with the U.S. government’s sovereign rights of holdover and condemnation. Others will happily engage with you to craft creative deals. Knowing something about the COs, how they operate and what results they seek to achieve, is important.

Colliers Releases 2Q’14 North American Office Report

Colliers NA 2Q14 Office Report CoverColliers today released its mid-year report profiling activity in North American office markets. The results are mostly bullish:

Following the negative weather impact on most economic metrics earlier in the year, the U.S. economy rebounded well in subsequent months, adding more than 200,000 jobs per month between February and July and registering real GDP growth of 4.2% in Q2. Increased hiring and rising business confidence bode well for the office market during the remainder of 2014.

The economic and office market recoveries are broadening to include more markets, including many of those hit particularly hard by the housing bust and financial crisis (e.g. Las Vegas, Orange County, Miami). Half of the U.S. metro areas tracked by Colliers have recovered all of the office-using jobs lost during the recession, and more than three-quarters of the North American office markets posted positive absorption in both Q2 2014 and year-to-date 2014.

Continuing the trend of recent quarters, the North American vacancy rate decreased modestly, by 15 basis points to 13.36% in Q2 2014, and we anticipate a similar trend during the remainder of the year. Once again, the U.S. vacancy rate decreased, by 21 basis points to 13.72%, and the Canadian vacancy rate increased, by 52 basis points to 8.52%. New supply is contributing to the rise in Canadian vacancies, although the overall vacancy rate remains below the 10% level considered indicative of a balanced market.

North American absorption totaled 16.9 MSF in Q2 2014 (17.0 MSF in the US, -83,530 sq. ft. in Canada). In the U.S., the four-quarter trailing quarterly average of more than 17.6 MSF of absorption in Q2 2014 was the highest level during the current recovery. The leading markets in Q2 2014 were Houston, San Francisco, Downtown Manhattan, Orange County, Midtown Manhattan, Atlanta, Dallas, Seattle/Puget Sound, Chicago and Kansas City.

Construction activity continues to trend upward, with 101.8 MSF under construction at mid-year 2014, up from 88.2 MSF at year-end 2013 and 75.7 MSF at mid-year 2013. Oversupply is generally not yet a concern in the U.S., with development activity concentrated primarily in the strongest markets and submarkets. The top markets for construction under way at mid-year 2014 were Houston, Toronto, Calgary, Washington, DC, Dallas, San Jose/Silicon Valley, San Francisco, Seattle/Puget Sound, Boston and Midtown South Manhattan.

North American office investment increased by 25% year-over-year in H1 2014 to $52.9 billion. Interest rates are expected to rise with the end of the Fed’s QE3 bond-buying program in October 2014 and likely rate hikes in 2015.  Nonetheless, spreads between the 10-year Treasury and cap rates for suburban properties and secondary and tertiary markets generally remain wide, which, coupled with improving economic and office market conditions in these areas, should attract a greater amount of investor interest in the coming quarters.  The relative stability and transparency of the North American real estate markets should continue to attract foreign investors to gateway cities and, increasingly, secondary markets in search of higher yields and less competition.

To download the full report, click here.

Spotlight: Smithsonian Institution

SI LogoWhere would you go to see The Spirit of St. Louis, the monoplane that, in 1927, bore Charles Lindbergh on the first nonstop flight from New York to Paris? How about Tony Hawk’s skateboard, which carried him to dozens of victories, to say nothing of a substantial fortune? The skull of a harbor seal sent from Oregon to President Thomas Jefferson by Meriwether Lewis and William Clark’s Corps of Discovery? Tito Puentes’s drums? Julia Child’s kitchen? Dorothy Gale’s ruby slippers?

To see all these things, among millions of other artifacts—more than 176 million, at last count—you would travel to the Smithsonian Institution, an amalgamation of 19 museums and art galleries in the District of Columbia. To that number are added the sprawling National Zoo, as well as numerous research facilities and ancillary museums and storage facilities within and outside the District. The Smithsonian Institution is also first among equals in a network of affiliated museums that now numbers more than 175 institutions throughout the United States, as well as Puerto Rico and Panama.

The Smithsonian Institution (never, properly, Institute) is a place of superlatives. Collectively, it is the most heavily visited museum in the country, with more than 30 million visitors in 2012. Visitors to the most popular destination, the Air and Space Museum, inside which Lindbergh’s plane hangs from the ceiling, numbered more than 8 million in that year. That makes Air and Space the single most visited museum in North America, and though it sometimes vies with another Smithsonian branch, the Museum of Natural History, for that top honor, both usually stand within the top ten most visited museums anywhere in the world, their numbers not far behind the longtime winner, the Louvre in Paris.

The Smithsonian has a curious history to match those superlatives. Its origins lie in an unexpected bequest on the part of an English naturalist, James Smithson, who died in 1829. With no children of his own, and with no prior indication that he was going to do so, he gave the entirety of his estate—a sum amounting to about $500,000 today—to the United States of America, “to found at Washington, under the name of the Smithsonian Institution, an establishment for the increase and diffusion of knowledge.” It took 17 years to organize that establishment, but James Polk finally authorized the legislation that formally brought the Smithsonian into being it in 1846. (Smithson’s tomb, incidentally, is itself one of the exhibits on display.)

Those private origins have bearing on the Smithsonian today. The federal government funds the Smithsonian, but only partially: Its appropriation in 2013 was $775 million, and in 2014 it was $805 million—about 5 percent less than the amount requested of Congress. Admission to the Smithsonian is free, but a combination of commercial enterprises (including a magazine and cable network) and private donations brings in about a third again as much money. The Smithsonian typically returns a small surplus, with its reported earnings in 2013 about $1.3 billion.

This operational blend of private and public sources of funding is of long standing, reflecting the Smithsonian’s historic status as an “independent establishment in the executive branch,” as it is referred to in the Federal Property and Administrative Services Act of 1988. In practice, however, the Smithsonian is a charitable trust that operates more or less independently of the three branches of government, causing Supreme Court Chief Justice William Howard Taft to deem it “a private institution under the guardianship of the government.” Wise lawyers and jurists have despaired of placing the Smithsonian more precisely within the web of departments and agencies within the government, and though the Smithsonian is widely considered a federal agency, it is not entirely subject to the regulations governing federal property under the terms of that Act.

To be sure, it works closely with the General Services Administration in matters such as procuring physical plant improvements, building new structures and renovating existing ones, and the like. “We have to assume that we’re operating according to federal guidelines in things like awarding contracts to the lowest bidder,” remarks one Smithsonian official. “But then there are all sorts of variations in how we do things that come about precisely because we’re a trust. It really depends on what we’re doing, what we’re spending money on, and how much we’re spending. Getting clarity on this just isn’t easy, and it never has been.”

If clarity isn’t easy to attain, there’s much to administer: The Smithsonian employs more than 6,750 full-time workers, occupies at least 2.7 million square feet of space (the precise figure varies depending on whom you ask) in dozens of buildings, and generates annual revenues that would make many a corporation happy. Plus, it’s open every day but Christmas, so that there’s always something going on at the Smithsonian—a constant hub of activity, all devoted to that increase and diffusion of knowledge of which Mr. Smithson spoke.

The Smithsonian "castle" building was designed by the famed architect James Renwick and completed in 1855. Today it houses the Institution's administrative offices and the Smithsonian Information Center. Located inside the north entrance is the crypt of James Smithson.

The Smithsonian Institution “Castle” Building was the first Smithsonian building, designed by James Renwick and completed in 1855. Today it houses the Institution’s administrative offices and the Smithsonian Information Center. Located inside the north entrance is the crypt of James Smithson.