The following is an excerpt from a presentation I gave at the National Federal Development Association conference earlier this month in Washington, D.C. The presentation covered three themes: 1) The size of the federally leased property market is small; 2) It is getting smaller, and; 3) There are five factors that could return the market to future growth. This article provides an overview of the first part of that presentation. Part two can be found here and part three will be posted soon.
U.S. Commercial and Investment Inventory (88 BSF)
To get a sense of how small the federally leased property niche is, let’s start by imagining that this rectangle represents the entire 88 BSF commercial and investment property market in the United States. This includes all types of properties including office, industrial, retail, multifamily, mixed-use, etc.
Government Occupied Inventory (6 BSF)
The government occupied portion of the national property inventory is estimated to be roughly 7%, or a little more than 6 BSF (this is, admittedly a pretty rough estimate).
Federal Inventory (3 BSF)
Federal property investors don’t care much about properties leased by states, counties and municipalities. If I peel those off, we are left with the federal property inventory, which is estimated to be a bit more than 3 BSF. I derive this by taking the 2.8 BSF catalogued by the Federal Real Property Profile and then I add a factor for agencies that report doesn’t track–most notably the U.S. Postal Service. Among the real estate the FRPP doesn’t fully capture is the fast-growing cadre of spooky projects occupied by the intelligence community, so it’s possible I undercount the federal inventory slightly, but this is close enough.
Federal Leased Inventory (400 MSF)
Most federal property is owned, but investors really only care about that portion of the inventory that is leased. I put that figure at about 400 million square feet. Yet, not all federal leased space is of much interest to property investors. So, let’s drill into this 400 MSF leased inventory to get a better sense of the leased inventory composition…
Inventory by Lessee Agency
About half of federal leases are with the U.S. General Services Administration (GSA). GSA is familiar to us because its enabling legislation, the Federal Property and Administrative Services Act of 1949, includes broad authorities to provide real property services to federal agencies. As a result, most of the “rank and file” federal leases we see in the U.S. are leased by GSA and subleased to federal agencies. This is enabled by the Federal Buildings Fund, the revolving fund that enables the federal government to enter into multi-year lease contracts without violating the Antideficiency Act.
Without the Federal Buildings Fund or some special appropriations, leases would need to be structured as a series of one-year obligations–either a one-year base lease with multiple one-year options or, conversely, a lease with annual termination rights. This “one year” structure is pretty typical of many lease contracts executed by the Department of Defense through its primary real property agencies, the U.S. Army Corps of Engineers and the Naval Facilities Engineering Command (NAVFAC). Often there are compelling reasons to invest in these properties, but, by and large, the cancelable lease structure is not very palatable. Further, many DoD leases are more exotic structures for military housing, lodging and so forth. We can assume, therefore, that only a portion of DoD leases are attractive to the typical federal property investor.
The U.S. Postal Service (USPS) is a different story. USPS leases roughly 93 million square feet of property in the United States; yet, that comprises roughly 24,000 properties. So, the median size of a USPS-leased property is well under 10,000 SF, making them not particularly attractive to most government property investors.
USPS is the largest independent agency from a real property perspective, but there are dozens of others. Most independent agencies use GSA to acquire leases on their behalf, yet some utilize statutory authority to execute leases directly. Examples of these agencies include the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, and the Export-Import Bank of the United States. Some of these agencies don’t sign their leases as the “United States of America” making credit due diligence a bit more complex.
Finally, there are a number of leases executed under delegation of contracting authority from GSA. In this instance certain agencies are granted the authority to execute contracts on behalf of the United States of America, yet GSA must approve that delegation.
Delegated leases are similar to those signed by GSA itself except that there is often good reason GSA delegated its leasing authority. Many delegated leases are used to acquire facilities that are remote or for very special purposes. Examples include cotton classing labs, weather monitoring stations, hospitals, dock facilities and park ranger stations. Some of these properties are attractive to investors and some aren’t. On the whole, probably about 2/3 of all federal leases are going to attract the interest of the traditional federal property investor.
Leases in Properties That Are Predominantly Federally Leased
The federal property sector gets even smaller when we consider that many federal leases are located in multi-tenanted buildings. Federal property investors are focused only on those properties that are single-tenant or primarily leased by federal agencies. Of the 2/3 of investment-worthy properties described above, only 58% of those are buildings that are fully or primarily leased by federal tenants.
Federal Leased Inventory Attractive to Investors (170 MSF)
So, if we accept that only about 2/3 of federal leases fit the profile for typical investor interest, and that a little more than half of those are in properties fully or mostly leased by the federal government, then the remaining inventory is @170 MSF–less than 0.2% of the property market. It’s a very small sandbox.
So, why do we bother? Why suffer the aggravation of dealing with the federal tenants? Why deal with the unusual construct of federal leases? The reason, of course, is the credit. U.S. credit (despite Standard & Poor’s 2011 downgrade) is arguably the best in the world.
There is a tremendous amount of capital in search of this credit but, as described above, a relatively small number of properties to invest in. This is one reason why pricing for federally leased properties remains so dear.
Unfortunately, the inventory of federal properties is shrinking, as we’ll see in the next part of this presentation.