Northern Virginia’s Troublesome Prospectus Rent Trend

 

It’s tough to be a government landlord in Northern Virginia these days, especially if your building is tenanted by a large federal tenant where the lease size is above the prospectus threshold.  The reason is that OMB has established its current cap (for FY’14 leases) to a maximum full service rent of just $39.00.

What is the cap?  Every time GSA has a large leasing need it must prepare a prospectus for approval by both the Office of Management and Budget (OMB) and Congress.  OMB, through its approval of GSA’s rent requests, is largely responsible for setting the prospectus rent caps nationwide. However, nowhere is its scrutiny more draconian than in the National Capital Region where OMB sets one-size-fits all caps for leasing in Northern Virginia, the District of Columbia and Suburban Maryland.   Ironically, these caps are often well below those approved in other parts of the country, despite the Washington region’s higher prevailing market rents.  For example, the National Science Foundation (currently housed in Arlington County’s Ballston submarket) is determining whether to renew or move to another location, which could include build-to-suit options.  This procurement currently has a rent cap approved by OMB at $39.00 whereas a similar lease requirement for an FAA regional office in Renton, Washington (the “other” Washington) is approved at $47.00.  Having been to Renton, we can report that it is no Ballston.  The prevailing market rents in the Renton market are nearly $20.00/SF less than Ballston, yet a similar project there is approved at a prospectus cap $8.00 higher.  There really isn’t any logic to it but that isn’t the point of this article.

We wanted to look at where the prospectus cap in Northern Virginia is headed.  Theoretically, OMB sets prospectus rents based upon market rates, but its approach is pretty blunt, looking at the region rather than the pockets of buildings that the government currently occupies.  There is no doubt that market rents in close-in Virginia – particularly Arlington’s Orange Line Corridor – have become largely uncoupled from the OMB trend.  Market rents for some buildings in Rosslyn, for example, are now exceeding $50.00, full service, and these buildings have government tenancy.  The $39.00 prospectus cap is well below market, especially when one considers that the prospectus cap is based on a non-escalating rent.

Will there be any relief?  This is the question we are asked by property investors all the time.  We’ll start by saying that there are techniques, through negotiation, to hope to achieve investor’s NOI goals in certain situations.  Contact us if you are interested in those.  But, simply speaking, it doesn’t look good overall and the graph above shows why.

If we look at the history of approved prospectus rent caps in Northern Virginia we’ll see that over 12 years the prospectus cap only grew by $5.00.  That is a growth rate of 1.29% annually which, projected forward to 2021, would yield a prospectus cap of just $42.54. That is less than the asking rent for many of the better-quality buildings in Arlington today.

Alternatively, we note that each time OMB approves a prospectus it includes a growth rate to allow the cap to increase if the lease transaction is effective in a year later than anticipated in the prospectus resolution.  That escalator has been 1.7% for the lease transactions intended in the FY’13 and FY’14 time period.  If we improve the prospectus cap by that escalator we still only get to $44.04 in FY 2021.

Yes, it’s possible that there could be a near-term bump similar to the $3.00 increase which occurred in 2009-2010 but even that doesn’t get to the current market for many quality buildings.  Ultimately, there is little historical precedent to indicate that OMB will dramatically accelerate rent cap growth.  And that spells trouble for GSA and for government property investors.

Note: the rent figures in the spreadsheet illustrate the maximum prospectus rent approved for each fiscal year.  In rare situations, some Department of Defense build-to-suits have been approved at slightly higher rents to accommodate the unique nature of those facilities and the larger site area required to accommodate DoD’s required security standoff distances.  Those special rent approvals were omitted from the trend shown.

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