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Excess Federal Property a Game Changer for Commercial Real Estate

Reducing Federal CRE Footprint Will Impact Rents, Construction, Supply

Through an aggressive push in Washington, DC, to cut costs and improve operational efficiencies, the federal government's listings of properties for sale could balloon from less than a hundred or so to include potentially thousands of properties - and also, reduce the government's reliance on leased space.

The effort is already influencing how landlords and brokers make decisions affecting commercial real estate.

With pressure building to lower the national deficit, the government is moving into a cost-cutting mode, and excess real estate has become one of the targets of the budget ax. The federal government is already exploring ways to house federal employees more efficiently in less overall space while at the same time, creating a potential source of revenue from the divestiture of excess property.

Last week, the House subcommittee on Economic Development, Public Buildings & Emergency Management approved a bill (the Civilian Property Realignment Act) that calls for setting up a commission to identify real estate properties that would be put out for sale. Rep. Jeff Denham (R-CA), chairman of subcommittee, sponsored the bill with the full backing of the President, who has directed federal agencies to accelerate efforts to eliminate unneeded properties, setting a goal of saving $3 billion by the end of 2012.

The proposed commission would have a structure similar to the Defense Base Closure and Realignment Commission (BRAC) to help facilitate the sale of unused or unneeded government-owned real estate. This commission, whose membership will be approved by Congress, will determine which properties should be sold based on real estate fundamentals and pricing.

The same day that the White House announced its intention to push this bill, it also released a map showing some 14,000 federal properties that could be targeted for sale. Currently only 21 of them are for sale, according to federal government officials.

"These excess properties are just the tip of the iceberg," said Jeffrey Zients, the Federal Chief Performance Officer and the Deputy Director for Management at the Office of Management and Budget and who is overseeing the Obama administration's efforts to restructure the government. "There are many more opportunities to cut waste and save taxpayer dollars by downsizing the federal government's footprint."

The 14,000 properties identified are controlled or serviced by the U.S. General Services Administration (GSA). Several other federal agencies, however, have the authority to handle the disposition of their properties internally and not go through GSA. For example, the bill in its current form charges the commission with identifying which federal field offices are in close proximity to existing postal facilities, and identify where there are opportunities to combine the two separate locations into the postal facility.

The Economics of Real Estate Restructuring

Brian C. Sullivan, executive director, Federal Practice Group at Cushman & Wakefield in Washington, DC, says you can't argue with Congress for trying to figure out ways to generate additional revenue and save money.

"The sale of federal assets is a two-bagger," Sullivan said. "It generates the sale proceeds and then puts the asset back on the local jurisdiction's payroll."

That said, Sullivan added: "The BRAC-like commission should not be a process to circumvent GSA. However, it should be a process where Congress brings OMB and GSA to the table, devises a business strategy based on best practices, leverages current market conditions, and then executes its strategy on behalf of the U.S. taxpayer, rather than to take its traditional stance that the law doesn't allow us to lease office space or structure real transactions like GE, Exxon, and even many municipalities."

A stronger argument to bottom-line savings is the sale of underutilized federal assets and continuing to focus on creating a more efficient work model, Sullivan said. "Assuming it costs you a $100,000 per year, with benefits, etc. to employ a federal employee, the elimination of a duplicate job saves you a $1 million over a 10-year term. On a 50,000-square-foot transaction, elimination of just one person provides you a 5% savings on your annual rent."

The Poster Child of Irresponsible Leasing

Tom Cafferty, president and managing principal of Cafferty Commercial Real Estate Services in McLean, VA, said the Securities & Exchange Commission's 900,000-square-foot, $415 million lease of Constitution Center signed last summer has served to focus Congressional and Administration officials on bringing efficiencies to government leasing. Three months after signing the lease, the SEC decided it would not need 600,000 square feet of the space and it has been trying to find subtenants ever since.

Last week, the SEC's internal inspector general issued a 94-page report sharply criticizing the agency for "the irresponsible decisions made with respect to the Constitution Center lease" saying the decision "represents another in a long history of missteps and misguided leasing decisions made by the SEC since it was granted independent leasing authority by Congress in 1990."

Decisions such as this occurred because of record level growth at federal agencies from 2008 through 2010, Cafferty said.

"The point being, many agencies started in essence "speculating" on leasing space with again the SEC being the "poster child" for irresponsible leasing at extraordinary space allocation ratios, quadruple or more, what private sector leasing ratios are at 1 person per 200 square feet," Cafferty said, adding that "the SEC leased space leaves a space occupancy allocation of 1 SEC employee per 850 rentable square feet."

"Add to that the $140 per square foot tenant improvement allowance the SEC spent at Station Place and there is no question why Congressman Denham and others are focused on revamping federal leasing due to the misuses of the government leasing authority," Cafferty said.

Undercurrents of Federal Supply & Demand on the Private Sector

The proposed federal cutbacks already has some landlords reassessing their desire to stay in the game, said Boyd J. Campbell, managing partner-associate commercial broker for century 21 Home Center in Lanham, MD.

Landlords "are employing their attorneys and brokers to review the strength of current leases," Campbell said. "Most, if not all landlords, will look at alternative tenants for their space and how to attract them. As never before, landlords will employ best practices to move through the unsettling period, before the market returns to center. Lastly, it's conceivable that some landlords will simply shuck it off as a myth."

Ann Page, managing director of KW Commercial in McLean said she thinks it is logical to expect that fewer buildings will be built to suit for government offices as more agencies stay in place and try to reduce rents.

"Since half of the spaces used by the government are owned and half are leased, I believe that more government buildings will come on the market for sale and more leases may propose renegotiation for savings in rent, as we are finding in the private market," Page said.

Judy London Murray, a distressed property expert with Remarkable Properties Inc. in Baltimore, said the federal downsizings initiatives could exacerbate existing problems regarding federal properties.

"Having worked for government agencies in the past with property ownership responsibilities, I have found them to be restricted by budgets to adequately maintain properties and defer maintenance and needed capital improvements," Murray said. "Removing the federal government as a "demand" influence on local real estate markets, will significantly reduce rental rates, potentially below those needed to adequately maintain structures. This will inevitably be followed by a reduction in values that may also influence the ability of owners to sell their properties and pay off all bank debt."

"The federal government leases hundreds of thousands of square feet throughout state and local governments," she said. "If the government pulls out, in this economic environment, the vacant space may remain vacant for a long time. Businesses that rely on the employees working for the government as a significant customer base will experience a decline in revenues also threatening their viability."

CoStar Senior Real Estate Strategist Chris Macke said: "This is a concrete example of the increasing reliance landlords and the entire commercial real estate industry will have on corporate hiring and investment levels as opposed to government dollars. The key question is whether corporate America will pick up its rate of hiring and investment levels enough to offset the reduced demand?" 
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Posted - 3 days ago

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