As was recently reported in Real Estate Finance and Investment, MetLife is under contract to acquire Constitution Center for what could be the highest total price paid for a building in Washington, DC this year. David Nassif Associates listed the 1.4 MSF office building located at located at 400 7th Street, SW Washington, DC with Eastdil Secured in April 2011. Hines was originally in negotiations to acquire the property for approximately $800 million; however, it backed out of the deal last December. Later Commonwealth Partners, funded by CalPERS, was the rumored front-runner. Now, MetLife is expected to close at pricing anticipated to be around $750 million ($536 PSF), which equates to about a 5.7% cap rate.
The building was built in 1970; however, between 2007 and 2009 it underwent a complete renovation costing $220 million. Sitting atop the L’Enfant Metro in the heart of the Southwest federal district, Constitution Center was clearly meant to be a government-leased property. At one point, it was the odds-on favorite to attract the Department of Homeland Security. Yet, that requirement was canceled and the federal appetite for new space waned substantially.
Then along came the Securities Exchange Commission (SEC), which entered into a now-infamous unappropriated $557 million lease contract for 900,000 RSF. This lease, which also included an option on the remainder of the building, was meant to accommodate an expected surge in growth due to the passage of Dodd-Frank. SEC never occupied the space and later lost its leasing authority after an extensive congressional brow-beating. The Office of the Comptroller of Currency (690,000 RSF) and the Federal Housing Finance Agency (364,000 RSF) subsequently occupied much of the building, though SEC still retains 342,000 RSF of vacant space.
This is undoubtedly the issue that has confounded Eastdil and potential investors over these past several months. SEC, though it has executed a lease contract for the remaining space, has not begun paying rent on it. How can that be? It is due to a unique feature of government contracting that states, in layman’s terms, that the government cannot pay for a service until it has been received (this is why the feds pay rent in arrears).
In this case, the SEC has not built out its space and, in fact, does not intend to occupy it. So, even though it owes Nassif back-rent totaling about $1.3 million per month since November 2011, it won’t make that payment until it accepts the space. The space clearly won’t be accepted until another federal tenant is tapped to occupy it.
The SEC lease reportedly specifies a rental rate is $44.80 in year one, bumping to $47.00 in year 6. We would expect that SEC will eventually assign its lease to another agency or the building owner may elect to cancel the SEC lease and execute a new deal with another federal agency – possibly at a higher rent. These unknowns are at the center of the underwriting dilemma and they must also be the subject of some complex “if-then” drafting in the purchase contract.