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.