The GSA property market has been characterized by a relative scarcity of long-term leases. This unwillingness of federal agencies to commit to long-term contracts is due to budget distress, mission uncertainty and challenges complying with OMB mandates to reconfigure workplaces, consolidate and downsize. Though all of those factors still persist, GSA, as acquisition authority for these agencies, now appears to be pursuing longer leases.
To prove it, we analyzed 1,653 pre-solicitation notices posted to the Federal Business Opportunities website (www.fbo.gov) from the beginning of 2011 to the present. These pre-solicitation notices, as the name suggests, provide public notification of planned lease procurements, including the proposed total and non-cancelable (“firm”) lease term.
Analyzing these lease procurements by date of their FBO postings, we can see that pre-solicitation notices posted last year and through the start of this year are, on average, requesting longer leases than in previous years. Just as important, they are also requesting longer firm terms. This is good news for lessors because longer lease terms should improve building valuations and ease financing.
Yet, let’s pause to insert a reality check: This doesn’t mean that average term in the leased inventory is growing. That’s far from the case, due largely to the fact that short-term extensions are still the norm (much to the continued exasperation of property owners).
Nonetheless, the FBO postings show us that when new leases are ultimately executed, they will generally be longer-term contracts. As illustrated in the following graph, the average total and firm terms of lease requirements posted to FBO increased by more than a year, on average, in calendar year 2016. Through April of this year the average term has dropped off a bit but it is still an improvement from past years.
This trend stems from congressional pressure dating back at least as far as July 30, 2014. On that date Rep. Lou Barletta, acting as Chairman of the House Subcommittee on Economic Development, Public Buildings, and Emergency Management, held a hearing entitled “GSA Tenant Agencies: Challenges and Opportunities in Reducing Costs of Leased Space.” It was at this hearing that he made his first pitch for long-term leases, noting in his opening statement how the federal government has tremendous potential to save money through real estate cost reduction:
So what is the key to realizing this potential? Long-term leases of 10 years or more. Why is the length of the lease so important? At the most basic level, a longer lease lowers risk, lowers finance costs, and provides certainty for the landlord who can then offer lower rents. GSA pays a 20% premium for short-term leases of three years or less compared to longer leases. But long-term leases do much more than lower rental rates. They allow the government and the building owner to spread out the upfront costs of moving or reconfiguring space to accommodate more people.
Despite congressional pressure, the wheels of the bureaucracy turn slowly and following that meeting there was little indication that agencies were moving to embrace long-term leases, eschewing them for the usual short-term, cancelable contracts. So, Congress proposed legislation in May 2016 that would compel GSA to pursue longer lease terms. The Public Buildings Reform and Savings Act (H.R. 4487) legislated the goal that GSA would “execut(e) long-term leases with firm terms of 10 years or more…reducing costly holdover and short-term lease extensions, including short firm term leases.”
Perhaps anticipating this bill, the month prior to its introduction GSA produced its own Leasing Alert setting forth a strategy to “obtain lower rental rates by better leveraging GSA’s financial strength and its 20 year lease acquisition authority by entering into longer leases where appropriate.” GSA’s analysis recognized that tenant agencies stayed in the same location an average of 23.3 years, yet the typical GSA lease is for 10 years with just 5 years of non-cancelable term. GSA is now proposing to harness more of its leasing authority, which allows for the agency to execute leases up to 20 years in length.
In fact, there is some evidence that this leasing strategy is already taking hold. According to analysis provided to me by GSA, there appears to be a slight uptick among long-term leases. The charts below show the number of new lease commencements (not to be confused with lease executions) by fiscal year. Though long-term leases are still a relatively small portion of overall new leasing activity, there has been some recent improvement to the number of leases that are at least 15 years in total length and those that have at least 10 years of non-cancelable term.
Despite the encouraging uptick in long-term leasing, don’t expect watershed change in the government’s leasing behavior. Termination clauses will persist and only select leases will become longer. Since tenant agencies–in many instances–will retain their right to cancel Occupancy Agreements, GSA will remain on the hook to pay rent through the entire lease term. Therefore, we can be sure that GSA will be prudent when determining whether to enter into longer non-cancelable contracts. Generally we can expect GSA to execute long-term non-cancelable leases for high-quality assets in markets where the federal government already has a sizable presence, allowing for greater ease of backfilling vacated space, if necessary.
On the whole, however, the outlook appears brighter for property investors. Not only is there emerging evidence that GSA’s recent leasing has resulted more often in long-term contracts, but pre-solicitation notices indicate that upcoming leasing activity will continue this trend. Equally encouraging is GSA’s recognition that it can better leverage its credit through longer leases and it is implementing this more enlightened policy to push for better deals. That feels like a win-win, especially in this capital markets environment where the length of the underlying (non-cancelable) lease term is the primary driver of improved property valuations.