Earlier this week we wrote that Moodys had announced that it is considering a downgrade of U.S. sovereign debt, this following a similar downgrade by Standard & Poor’s last year. At that time, as now, federal government-leased property investors find themselves engaging in a gut-check. After all, there are only two reasons to invest in property leased by the GSA and certain other federal agencies: 1. High credit, and; 2. High probability of renewal. That’s it. There are only two reasons. No one likes the lease form, they don’t like the leasing process and they often find it cumbersome to administer the lease with the tenant agency and GSA. Simply put, investors have bought federal-leased properties because the credit can’t be beat and because of the likelihood of renewals (often accompanied by rent bumps). Both of these advantages have wilted a bit in the current budgetary and political environment and it is clearly cause for concern (we’ll address renewal probability in a future article).
Clearly, the U.S. Government’s sterling credit is a bit tarnished. Worse yet, Moody’s threat to downgrade its rating at the end of 2013 clouds our future view and threatens to blunt investor optimism. The most disappointing aspect of this is that the negative outlook is unnecessary and avoidable. It’s more an indictment of our political gridlock than it is the nation’s balance sheet.
Investment in U.S. Government-leased property is founded heavily on good credit, no doubt. Yet, perhaps more importantly, it is founded on the certainty that the U.S.’ good credit will remain so. The corporate world, by contrast, is littered with stories of once-reputable firms that, within the course of a single lease term, went from darling to donkey (think Enron or AIG). The United States of America is the one tenant that requires no credit underwriting. In 20 years or 100, all but the most jaded among us expect the U.S. Government to still be standing in substantially its current form whereas the future prospects for S&P AAA-rated corporations such as Microsoft, Johnson & Johnson, ADP, ExxonMobil and others are far less clear. This stability is why investors buy federal properties.
So, when an historic downgrade comes along there is a valid concern that it may chip at the margins of government-leased property values. Fortunately, that has not been the case so far, leading us to conclude that the real key to U.S. investment is that the country remains stable and viable as compared to other investments and to the rest of the world. Since S&P’s announced downgrade, Treasury yields have declined 80 bps in response to increased investment. Much of this is due to quantitative easing by the Fed, but the ongoing euro-zone sovereign-debt crisis has driven investors to U.S. Treasuries, securities that are relatively safe and liquid versus other sovereign debt. Owners of long-term federal-leased properties are finding that their investments are an attractive alternative to these Treasuries—same credit but far better yield. It is surprising that we haven’t yet seen more foreign investment in federal properties.
The U.S. Government needs to clean its financial house—and soon—but we don’t see the credit rating agencies having much impact on investment in government-leased properties. Not yet.