The government right now is, well, it’s in turmoil. That’s voiced as an opinion but it feels like actual, quantifiable fact. The United States is still fighting its way out of a deep and prolonged recession, the government has been operating under a series of continuing resolutions for nearly two years, the budget faces sequestration, Congress is applying strict space utilization limits to approved prospectuses and agencies are expected to freeze their real estate inventory at current levels, with the anticipation that deep discretionary spending cuts are on the horizon.
All of this has conspired to create an uncertain environment leading many agencies to abandon long-term real estate planning in favor of kicking the can down the road with short term lease extensions. Or, perhaps, agencies are engaging in short term renewals until they can come up with a viable long-term plan. In either case, it’s bad news for property investors because lease terms, overall, are getting shorter, and shorter lease terms damage property values and create significant financing dilemmas.
Federal agencies seem oblivious to the fact that this is effecting their rent and their concessions. Short term lease requests create captive federal tenants, and these tenants are having to pay premium prices to mollify landlords who desperately seek the stable “core” investment profile they thought they were buying with the federal government as tenant. Many of these landlords are backed by investment funds that must close, yet there is no good way to exit a short-term leased asset. Further, investors looking to buy into the government sector are discovering that long-term leased assets are increasingly limited.
How bad is the problem? We decided to take a high-level view in constructing the graph above. The blue line illustrates remaining total lease term over the past decade. The marker for each calendar year shows the average remaining lease term at that point, weighted by lease square footage. Because GSA often negotiates termination rights we also plotted the corresponding firm-term trend, especially as this is the one of interest to many property investors.
It’s pretty evident that in either case, remaining lease term has been rapidly diminishing over the past several years. Since 2005 the overall reduction in the length of total and firm term has been 16% and 10%, respectively. The weighted average remaining total lease term in the GSA inventory today is just 5.17 years
OK, you say, but what about the leases we really care about – the ones that are 75,000 RSF and larger? After all, these are the ones where the size that can really impact property and portfolio values. Well, we looked at that trend too and the results (below) are roughly the same. Though remaining term is typically about a year longer for these larger leases, the reduction in remaining term is even more pronounced. As compared to just six years ago, total remaining lease term is 24% shorter and firm term is 14% shorter.
Will this trend reverse itself? When will we return to “normality”? That question is beyond the scope of this article but one thing is for certain: this will get worse before it gets better.