As discussed in Part 1 of this two-part series on GSA’s budget problems, Congress has screwed down the appropriations spigot, nearly shutting it off completely. That article showed how congressional appropriations for GSA’s Construction & Alterations projects and Repairs & Maintenance programs have declined dramatically over the past several years. The appropriated funds are insufficient to maintain the federal building inventory leading GSA’s assets to slowly deteriorate, increasing capital costs and weakening potential revenue. This news is good for lessors because, despite the very real and negative effects of cost reduction initiatives such as “Freeze The Footprint”, the underlying budget reality fuels demand for leased space.
Great! Except, there’s one small problem: In addition to the now predictable cuts to Construction & Alterations and Repairs & Maintenance line items (the House is proposing to approve just 30% of GSA’s budget request in these categories), this year, for the first time, the House is also proposing to cut GSA’s budget for paying rent. In fact, the House proposes to cut GSA’s budget request for the payment of rent by $687 million, or 13%.
Default?!?
$687 million is no small amount. Indeed, shortly after the House Appropriations Committee approved its Fiscal 2014 Financial Services Appropriations Bill, GSA Administrator Dan Tangherlini responded with a blog article entitled “Proposed Cuts Would Force GSA to Default on Rent”. In the article Tangherlini noted that “The bill includes a funding level that is 15 percent[*] below what is needed for us to meet our rent obligations. In order to make that work, we may have to default on leases; close facilities; or even, in some extreme cases, breach our contracts…”
It is a fact that a 13% reduction in rent appropriations would leave GSA with insufficient funds to meet its lease obligations because leases are multi-year contracts–contracts that cannot be broken unless the government has the pre-negotiated right to cancel them. As it turns out, termination rights are common in federal leases, although their primary purpose is to allow GSA to terminate the lease in the event that the tenant agency cancels its occupancy agreement (i.e. its sublease with GSA). Tenant agencies cancel their occupancy agreements on a fairly rare basis.
Fantasy and Reality
Let’s look at the numbers. Even if GSA were to decide not to renew every single lease expiring in FY2014, it would still come up $25 million short of Congress’s rent reduction goal. But wait, let’s suppose that in an unprecedented move GSA canceled every lease that has a termination right exercisable in FY2014. Remarkably, roughly 1/3 of GSA leases are cancelable before the end of FY2014. So, yeah, GSA could conceivably bend to Congress’s will but the thought of doing it is nothing but dark fantasy.
In reality, shedding leased space to accommodate a downsizing of this magnitude is improbable for a variety of reasons including the disruption to agencies’ missions, resistance from employee unions, the elimination of public access to services, etc. But, let’s just explore the most immediate reason: it can’t happen quickly enough. Even if we suspend reality and assume that the tenant agencies could actually close, downsize, realign, or consolidate their facilities to accommodate a 13% rent reduction, the fact is that these things take time, and where the federal government is involved they take a long time.
Ironically, GSA’s best opportunity to decrease its rent is to get rid of its termination rights and to extend the lease expiration dates. Many lessors would reward these lease modifications with lower rents, yet GSA has never made any serious effort at this. If Congress and GSA were to get together for a constructive discussion about reducing rent, they ought to consider “blend and extend” re-structuring, as well as the elimination of termination rights that are unlikely to ever be exercised.
What Will Happen?
To be clear, my expectation is that the proposed cuts to GSA’s budget would never make it through conference committee with the Senate (Continuing Resolution is the likely budget result in FY2014 anyway). The move by the House to reduce the rent appropriation was perhaps more of a message than an expectation. The response by Tangherlini was probably the same.
Further, even if GSA one day found itself with inadequate rent appropriations, that should not excuse the federal government from making payment. The leases are administered by GSA but they are signed on behalf of the “The United States of America”. I believe the agencies themselves could (and would) step in to make rent payments directly. They have presumably budgeted for rent, and bypassing GSA actually lowers their costs (assuming that they would not pay GSA its service fee, which is typically 7% of the rent amount).
All of this said, the private sector has reason to be wary because our nation’s leaders have proven themselves unwilling to reconcile their very different views on fiscal policy. This is the political dysfunction that produced the United States’ first-ever credit downgrade. With that milestone now well in the rear view mirror what’s to say that default isn’t possible? There are some in Congress who truly believe that defaulting on payments may be exactly what is required to put the nation’s house in order.
Will lessors find themselves beleaguered pawns in a broader fiscal power struggle? I sincerely doubt it, though the specter of default–should it linger–has the potential to needlessly damage the federal property sector.
* We know the use of both “13%” and “15%” in this paragraph could be confusing to some. GSA’s budget is cut by 13% from the requested amount required to meet rent obligations. Tangherlini’s use of “15%” (as opposed to 13%) reflects the same shortfall in reverse–GSA needs 15% more money than Congress has allotted in order to meet its rent obligations.
** In 2012 the actual rent recorded in GSA’s budget jumps up noticeably. We placed some calls to GSA to understand the increase but we haven’t yet heard back. We must assume that the rent bump recorded in 2012 is due to additional rent to accommodate the swing spaces leases necessary to execute Stimulus-related building modernizations and/or it is due to the transfer of leases from other agencies (that previously managed their own leasing, such as SEC) to GSA control.
*** Our calculation of FY 2014 rent in the graph is estimated based on GSA’s budget estimate. Our discussion of GSA’s FY 2014 rent obligation in this article includes figures estimated based on current data.