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.

Lease Patterns, and What They Tell Us

Yr Blt x Remain Term
Looking at remaining term of federal leases relative to building age, an interesting pattern emerges: the leases appear in “waves”. The scattergraph above shows office buildings that are at least 85% leased by federal tenants. We’ve plotted every building based on its age and the remaining term of its government-leased space. The size of each dot corresponds with the overall amount of leased SF in the building it represents.

One can see that the government-leased buildings are generally oriented in three distinct diagonal lines, and if you stare a bit longer you begin to see the possibility of a fourth and maybe even a truncated fifth line of data points.  There’s a pretty simple reason for the trend that also has interesting implications for investors.

Understanding the trend
GSA leases tend to occur in 5-year increments. Especially among newly built buildings and lease-construct projects, the lease terms are usually 10, 15 or 20 years. Look back at the graph and you will clearly see that trend. Follow along the very top of the graph, which includes data for buildings built this year, 2014, and you will see each of the waves starts with dots at 10, 15 and 20 years. Those are fresh leases in new buildings.

Each year as these new buildings age, the remaining term of their leases decreases. Each building ages one year and its remaining lease term gets a year shorter. The building ages another year and the remaining term decreases another year, and so forth. This explains why the lines develop into diagonal trails. Yet, when we look further down the vertical axis at buildings that are more than 15 to 20 years old (ie. when their original leases have expired) the orderly trails now become more jumbled. This is because the government is not as consistent in its renewals. They may often renew space for 5, 10 or 15-year increments, but increasingly they also lapse into short term leases (or, more rarely, superseding leases). These soften the well-defined trend we see among newer buildings but vestiges of the trend still exist in the data where the government engages in traditional renewals, most often 5- or 10-year terms.

Implications for investors
This is kind of interesting, but what does it mean? First, it suggests that many of the government-leased buildings in the inventory were originally leased when they were new. This is especially true of buildings originally leased for 15 or 20 years. Leases that long are generally reserved for lease-construct projects. Looking back at the graph, it is apparent that older buildings rarely have remaining lease terms of 15 or more years.

Second, the government favors new buildings (who doesn’t?). This doesn’t mean that federal tenants won’t remain in-place for decades but the lease terms will usually never again reach the length of the original term. More significantly, the trend suggests that when government relocates it usually doesn’t move older buildings. Though we view the federal government as the quintessential “price-driven” tenant it is fairly rare for them to trade down in building quality, especially for their long-term leases.

The trend also indicates why investors can very nearly guess the vintage of fully leased government properties. Wonder why so many buildings built in 1994, 1999 and 2004 are up for renewal now? It’s probably because they were built 10, 15 or 20 years ago, respectively. Next year we’ll work on leases from the class of 1995, 2000 and 2005. You can reliably guess at the provenance of most federally leased buildings.

Most importantly, we get a glimpse of what will begin to occur once the pipeline of lease-construct projects is fully exhausted. If the lease-construct spigot remains shut off (as it is now, by policy) then average lease terms will get ever-shorter and eventually the leasing cycle will begin churning a bit faster. Further, with leasing no longer focused on new buildings, the pattern of long waves will be broken. As leases grow shorter, the availability of long-term leased investments will also dwindle. For a while, capital will aggressively chase this dwindling number of long-term leased properties leading, possibly, to more cap rate compression.

One final implication (and an important point of note for GSA): Investors certainly do not invest in government-leased assets because they like the underlying lease structure.  They do it because they like the underlying credit. Long-term federally leased buildings are a relative safe haven for risk-averse capital, viewed as a better return than investing in T-bills, but with similar risk profile. Short-term leases, however, don’t provide the safety investors seek, regardless of the credit quality. Decreasing availability of long-term leased product will send cheap capital off to explore other property sectors. For GSA, that means that rent could ultimately become more expensive.**

* There are some interesting exceptions to the wave pattern. Among them is 1275 First Street, NE, a brand new building in Washington, DC that was leased to GSA for a short-term swing space related to the Stimulus-funded renovations of GSA’s headquarters. I think that lessor hoped that momentum would set in if they could get the government into their building (and they may eventually be proven correct). Also, a new lease-construct project to house NOAA in College Park, Maryland, was restricted to an unusual 13-year lease term to keep it from budget scoring as a capital lease. Further, due to unique complications, this new building sat vacant for a few years before it was ultimately occupied. 

** This is primarily true of secondary and tertiary markets that aren’t normally the focus of institutional capital investors. In the largest major metropolitan areas, investor interest is unlikely to subside.

GSA Swap-Construct Exchanges

GAO Swap-Construct Report CoverIt’s a simple proposition: Build us a new building, even something as simple as a parking garage, and you can have the old one.

That old building might be an office tower, a courthouse, or some other large public structure. It might even be another parking garage. We say “might be” because, to judge by three current projects of the Government Services Agency, the rules for what it calls “swap-construct exchanges” are just beginning to be formulated—and the agency has much work to do in improving the processes these exchanges entail.

Notes the Government Accountability Office in its recent report “Federal Real Property: GSA Should Better Target Its Use of Swap-Construct Exchanges,” there is an ever-increasing need to replace and modernize federal buildings of many kinds. Because of a tightening budget, among other considerations, the resources to do so are not always available. A swap-construct exchange is thus a vehicle by which agencies can transfer title to certain federal properties in return either for new buildings or “constructed assets” or, in some cases, for construction services in building new properties or renovating existing ones.

The GSA has conducted two swap-construct exchanges since 2000, one in San Antonio and one in Atlanta, using properties that were determined to be underutilized in exchange for much-needed new parking garages. The exchanges, according to their recipients, took longer than expected—three years and five years, respectively—to complete, which the GSA explains as the result of “lack of experience” with this novel arrangement. Admittedly, as the report notes, the decision-making process is elaborate, involving requests for proposals, solicitations, property appraisals, studies, reviews, and then—if all has gone well—the award of a contract “for a swap-construct exchange where the property recipient will provide constructed asset or perform prescribed construction services for the federal government in return for the title to one or more federal properties.”

Swap-Construct Profiles

Since 2012, the GSA has issued calls for proposals for six swap-construct exchanges. Three are now active, and three are no longer being pursued actively. The most ambitious is a projected exchange of the Federal Bureau of Investigation headquarters in Washington, DC, built in 1971. Even at some 2 million square feet, it is not large enough to house all headquarters staff, with the result that the FBI is seeking a new headquarters building with sufficient space for all. The GSA proposes to exchange federal buildings and land in exchange for this new headquarters, whose location is yet to be determined.

Another active project is also set in the District of Columbia, this one involving the exchange of property in the Federal Triangle South area, including two buildings housing the Federal Aviation Administration and one housing units of the GSA itself, for construction services. The third is in Colorado, entailing the exchange of undeveloped federal property in Lakewood for construction services at the Denver Federal Center.

Other swaps in Baltimore, Los Angeles, and Miami are on hold because of a perceived lack of market interest. The GAO observes that this may reflect a weakness of swap-construct in areas that have plentiful real estate alternatives to underutilized federal facilities, but the report also notes that the GSA’s expectations may not have been clearly stated in floating proposals for the exchanges, with no clear indication given of what would be expected in return for the transfer of those properties.

The two projects that have been completed were initiated by private companies and not by the GSA itself. The GAO report recommends that the GSA better identify its needs and expectations before a swap is proposed, that these details be made part of any request for information, and that the agency “develop criteria for determining when to solicit market interest in a swap-construct exchange.”

The GAO report notes that the GSA has ample statutory authority to exchange federal property, and that in 2005 it was specifically charged with exchanging federal property for construction services. Nearly ten years later, the GSA is just embarking on that swap-construct mission. Indeed, as the report notes, the agency is still preparing “guidance specific to exchanges for services,” suggesting that it may be some time before the report’s recommendations can be put into place. Stay tuned.

Top GSA Property Owners (2014 Edition)

Top 10 Owners 2014

Last year we published our inaugural list of the ten largest owners of GSA-leased properties. In this article we chronicle the top 10 list again, along with a few new honorable mentions. The ranking looks a lot like last year’s but we see some pending property trades that could shake things up in 2015.

Some notes regarding this list:

  • We have ranked owners by square footage and not rent or any other measure because square footage is the most unimpeachable metric available to us.
  • Our ranking is based solely on GSA-leased properties, so it doesn’t include owners of buildings leased directly by agencies under their delegated, statutory or independent authority. However, we track those leases too and in some instances we’ve noted how the rankings might change if we took this analysis further.
  • We have only tallied leases that have commenced. If a lease has been awarded but not yet commenced (as in a lease-construct project, for example) we haven’t counted that in this list.
  • Determining “ownership” is tricky business. We have typically defined the owners as those operating partners who are the face of these properties–the people who ultimately manage the assets. However, we recognize that in most instances there are behind-the-scenes equity partners whose ownership stake is far larger than the operating partners’. We have not attempted to identify these equity partners in this list.
  • If you think we’ve mis-counted your portfolio, email me or leave a comment below.

THE OWNERS:

1. Government Properties Income Trust (NYSE:GOV)
Government Properties Income Trust remains the undisputed leader in the government-leased property sector. The REIT owns 91 buildings totaling 11 MSF. Some of this space is leased to state agencies and non-GSA federal agencies so, for the purposes of this ranking, GOV controls 5.75 MSF of GSA-leased space in 52 buildings. The firm remains an active buyer of government properties.

2. JBG Companies
JBG is, hands-down, the most active property developer in the Washington, DC area so it is no surprise that it would also be an active builder and owner of GSA-leased buildings. Though JBG sold four GSA-leased office buildings over the past year, it also delivered new build-to-suit projects for the National Institute for Allergy and Infectious Diseases (491,000 SF) and the Social Security Administration (538,000 SF).

3. Vornado Realty Trust (NYSE: VNO)
If there is an award for resilience, Vornado would win it. The firm, which has significant holdings near the Pentagon, was one of the worst to suffer from Department of Defense relocations due to BRAC.  Though BRAC was enacted into law in 2005, most of the space vacated by DoD went dark last year. In response, Vornado has been aggressively courting new GSA tenants.  Earlier this year it was awarded the 183,000 SF U.S. Fish and Wildlife Service lease in Falls Church, Virginia, and it was also awarded a 75,000 SF Department of Labor lease in Crystal City, Virginia. We don’t yet count these in our ranking stats, but they should further solidify Vornado’s position on this list as those awarded leases become active.

4. UrbanAmerica Advisors
Since 2007 UrbanAmerica has owned a portfolio 14 properties that are primarily leased by GSA. The firm is now moving to dispose of those assets and next year we can expect the contract purchaser, Princeton Holdings to replace UrbanAmerica on this list.

5. NGP V
NGP (formerly National Government Properties) returns again to our ranking based upon their ownership of 40 GSA-leased properties. These properties are owned by NGP’s fifth fund (thus the roman numeral “V” in their name), which has been pretty much completed.  The firm is completing fundraising on its 6th fund, and should be ready to begin buying properties again before the end of this year.

6. LCOR
LCOR makes this list again based on its role as the face of investment group of high net worth individuals that own the 2.4 MSF headquarters of the U.S. Patent and Trademark Office, the largest GSA lease in the United States. Last year, LCOR was also credited with the new 358,000 SF lease-construct project for the Nuclear Regulatory Commission (NRC) in Montgomery County, Maryland. That building has since traded to its equity partner, USAA Realty (see below).

7. Saban Capital Group
Saban Capital is an L.A.-based private investment firm founded by billionaire Haim Saban. Though most of Saban’s investments are in the entertainment, communication and media industries, the firm made its entry into the government property sector in 2010 with the purchase of the Record Realty Trust portfolio. Saban now owns 24 GSA-leased properties.

8. Boston Properties (NYSE: BXP)
Boston Properties owns 20 GSA-leased office buildings, nearly all of them in the Washington, DC area. However, that will soon change. Its largest holding, the 700,000 SF, 3-building Patriots Park project in Reston, Virginia, is under contract to a Korean investor.

9. Space Center, Inc.
Space Center provides underground records storage in facilities carved from underground limestone formations in the Kansas City suburbs. The naturally cool, humidity-controlled environment is perfectly suited to archival storage for agencies such as the National Archives and Records Administration, IRS and the Social Security Administration. These agencies have proven to be stable, long-term tenants, maintaining Space Center’s position on this list.

10. HPI Capital
HPI Capital was #10 on the list last year, and would be again this year had it not been for the sale of a single property: a 153,000 SF NARA records facility in Pittsfield, Massachusetts. The HPI portfolio also features a number of direct agency leases that we do not count in this ranking. Overall, HPI owns 15 government-leased buildings with 1.5 MSF of GSA-leased square feet.

HONORABLE MENTIONS:

USAA Realty
USAA has been a quiet, and dominant investor, in the federal space for years.  The firm has invested equity in several GSA lease-construct projects and now it has purchased several of those outright, along with some other strategic investments. With its acquisition earlier this year of the 358,000 SF Three White Flint, leased to primarily to FDA in North Bethesda, Maryland, USAA is poised to appear in the top 10 ranking next year.

CenterPoint Properties
Centerpoint merits an honorable mention this year due to the delivery of a single, yet remarkable, build-to-suit asset: the National Nuclear Security Administration (NNSA) campus located south of Kansas City. This $750 million, 1.5 MSF facility replaces the the NNSA plant at the Bannister Federal Complex. (see “Greetings From Kansas City”)

Easterly Partners
Easterly Partners is a Washington, DC-based real estate investment firm established solely for the purpose of federal property investment. In just a few years the firm has amassed a portfolio of 15 properties, including three new purchases since we published this list last year. At the rate it is currently underwriting investments, we expect Easterly to crack the list of “top 10″ investors next year.

The Long-Term Trend of Short-Term Leased Space

Pct of leases with less than 3 yrs remaining term

UPDATE: We updated this article the day after first publishing it in order to tune up our stats. The new graph (above) tracks the percentage of leases that have less than 3 years of remaining lease term as opposed to the number of leases that were executed for total terms of less than 3 years. We found that the latter stat is not so easy to coax reliably from GSA’s data. Nonetheless, the general trend remains the same and the text of the article is updated slightly to accommodate the new data.

In recent years lessors have become troubled by the fact that lease terms appear to be getting shorter and many new leases are short-term extensions or holdovers. The graph above demonstrates that these short-term leases (defined herein as those with less than three years of remaining term) comprised about 1/5 of GSA’s leased inventory from 2000 to 2005.  But then the rate increased rapidly, more than doubling over just three years. Though the proportion of short-term leases has settled down slightly it is still almost twice as high as a decade ago.

We haven’t fully analyzed the causes of this but we can make some anecdotal observations. The first is that GSA in the mid-2000s was delivering a huge number of new lease-construct projects, many in response to government growth and new security concerns post-9/11. These new projects would frequently require short-term extensions of existing leases to sync up with the delivery dates. Yet, more often, GSA was simply finding itself unable to effectively execute the volume of leases it was faced with each year and the incidence of holdover increased dramatically. Both trends led to a greater volume of short-term extensions.

As the trend continued towards its peak in 2010, the deep recession and the resulting fiscal crises and political discord created such trepidation among tenant agencies that they were reluctant to enter into long-term lease contracts (especially ones that might require costly relocation). All the while, long term leases were burning off year by year, contributing to the number of leases with short remaining terms.

More recently we are beginning to see the proportion of short-term leases throttle down a bit. Frankly, this is the most surprising part of the trend because it doesn’t square with what we are seeing in the field, where the problem of short-term extensions seems as present as ever.

In any case, a new factor threatens to disrupt the trend towards improvement: the federal government’s push to improve space utilization through downsizing and consolidation. These are real estate endeavors that require considerable advance planning and the government doesn’t have enough lead-time to execute those plans. So we are already beginning to see requests for extensions to allow the government to indulge in methodical planning, then followed by full and open procurements to execute those plans.

Short-term leases will continue to prevail for some time, yet we can hope to eventually return to a time where leases with short remaining terms comprised just 1/5 of all leasing activity.

Note:  In this analysis we only count leases that are at least 3,000 RSF in order to improve the focus on traditional leases, eliminating many TSA on-airport leases, storage leases, short-term census-related leases and other esoteric leases.

The Persistent Problem with Termination Rights

Ratio of cancelable vs non-cancelable leases

The graph above compares the percentage of leases containing termination rights to the percentage of non-cancelable leases. Data is derived from fiscal year-end snapshots of GSA data for all leases > 3,000 RSF.

It is possible that no tenant in the United States has greater fondness for termination rights than the U.S. General Services Administration (GSA). As I pointed out in a blog article more than two years ago, GSA requests termination rights in about three-fourths of its lease procurements. The reasons are understandable: GSA leases space on behalf of other federal agencies and its Occupancy Agreement (OA) with each tenant agency typically includes a clause that allows the agency to cancel its OA with GSA at any time with just 120 days notice. In an effort to hedge its exposure, GSA will routinely seek to negotiate termination rights so that it can cancel its lease with the landlord if the tenant agency cancels its OA with GSA.

In light of the blistering and routine fiscal battles that have left agencies without appropriated budgets, limping along through a series of continuing resolutions, it’s understandable that GSA would take a cautious approach to long-term lease obligations, and so would its tenant agencies.  We would expect that this is just a particularly dysfunctional phase and that the feds will eventually reboot and get back to normal business. Yet, unfortunately, this is normal business.

When we look back at more than a decade of GSA leasing we can see that at no time since 2000 did less than 71% of GSA leases contain termination rights–through two presidents and seven sessions of Congress. In times of war and peace. During prosperity and recession. Through Democratic and Republican leadership. From before the last Washington Redskins playoff victory. Even through the reign of nine GSA Public Buildings Service Commissioners.

We must conclude that this persistent problem is structural. The facts suggest that GSA is failing in its most basic role as lease negotiator because its motives are fundamentally out of alignment with those of its tenant agencies. Agencies get the best rent deal  from long-term leases, yet GSA resists executing those very lease structures. This problem is costing the federal government money because termination rights aren’t free, and while GSA achieves some measure of protection for itself by negotiating uber-cancellable leases, the costs get passed through to the tenant agencies. Either GSA must adapt its leasing policy to address this reality or the agencies must be willing to relinquish their rights to terminate for convenience.

Congress is becoming hip to this. In a recent congressional hearing Rep. Lou Barletta (R-PA) challenged several agency realty officers, including the GSA Commissioner Norman Dong, to engage in leases of 10 years or more, noting that “at the most basic level, a longer lease lowers risk, lowers finance costs, and provides certainty for the landlord who can then offer lower rents” (we must assume he intended non-cancelable leases). All of these government executives acknowledged the virtues of long-term leasing yet, if history is any guide, nothing will change.

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

Witnesses 7-30-14 House Hearing

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

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

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

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

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

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

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

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

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

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

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

Greetings From Kansas City

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

 

Social Security Office Closings Under Scrutiny

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

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

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

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

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

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