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February 8, 2012

Are Government Agencies Still Desirable Tenants?

February 8, 2012
By Scott Baltic, Contributing Editor

A few sizable recent deals involving federal, state and county government agencies as office tenants has been trending of late, and Commercial Property Executive wanted to know more. With the severe budget cuts, and in many cases outright downsizing, hitting all levels of government, are government tenants as desirable to office building managers and owners as they were pre–Great Recession?

Conversations with brokers who specialize in such tenants indicate that although government agencies are not loved less these days, office landlords will continue to see less of them to love. Reductions in the sizes of government agencies, compounded by a push to use less space per worker, mean that, although these agencies remain credit tenants, their space requirements will in many cases shrink significantly.

Ripples into Waterfalls

“I’ve never seen the federal government under so much pressure from so many angles,” says Chris Roth, managing director and national project manager for Jones Lang LaSalle’s National Broker Contract, where he works primarily with the General Services Administration and other federal agencies. This pressure is coming both from Congress and from within individual agencies, he says.

“There is this move toward rationalization of costs” at various levels of government, and real estate is part of that, agrees Vineet Sahgal, executive vice president of Tenant Advisory Services for Transwestern.

For example, he says, pressure is being exerted on government to get its office use metrics in line with private-sector standards. One upshot is what Sahgal describes as “a more fluid situation” for governmental office tenants than in past years.

The prolonged recession isn’t causing a ripple effect, “it is a waterfall effect” on governments, says Kurt Little, a managing director at Jones Lang LaSalle, Chicago, who works exclusively with state, county and local governments nationwide.

Saving money is more of a priority now than ever for public entities, he says, and states are looking to cut costs by reviewing their entire real estate portfolios and downsizing as advisable. By and large, states “took longer to make tough decisions” about real estate than the private sector did, Little says, and are now trying to catch up.

Roth adds that the states often lag the federal government in having the data to identify all the space in their portfolios, but that once that has been pulled together, the effects will be seen in lease negotiations and transactions.

Substantial Cuts

So that’s the “why,” now for a look at the “how” and “how much.”

Little says that a 10 percent saving in space from restacking is “nearly a slam-dunk,” with up to a 30 percent reduction possible in some cases. These space savings come from such changes as decreasing the numbers of private offices, conference rooms, and copiers and printers a government tenant has.

“It’s a methodical process,” Little says, and typically takes 12 to 36 months.

Because government agencies are looking at tactics like new layouts, more efficient furniture and hoteling, says Roth, landlords these days are concerned that a government tenant will come back with proposal for 10 percent to 30 percent less space.

“If anything makes them less desirable” as tenants, Roth says, “it’s that.”

He adds, however, that in some cases, if their headcount projections are uncertain, agencies are looking for the flexibility to grow during the lease term. For this and other reasons, Roth says he wouldn’t be surprised to see shorter lease terms for governmental tenants, with fewer 15s and more fives, sevens and 10s.

On an even more strategic level, Little says, governments are carrying out occupancy assessments, evaluating issues such as leasing versus owning. He notes that although governments can be tempted to focus on selling surplus real estate, there’s usually greater long-term value from optimizing day-to-day operating costs like utilities and janitorial services.

Many county and state agencies, Little says, are spending twice as much per square foot on office space as a typical private-sector tenant.

Still Looking Good, Regardless

Because of regulatory changes and/or shifts in government’s role, Sahgal says, government demand for space fluctuates in ways that aren’t necessarily in synch with the rest of the economy. He cites as an example the establishment and growth of the Department of Homeland Security.

Some investors, he says, therefore see government-leased space as a business cycle–neutral play, although this can depend on the specific agency. The IRS, for one example, Sahgal guesses, is unlikely to be shrinking.

And if governments these days are more interested in sale-leasebacks, he says, there’s “a whole swath of investors” looking for such fully leased buildings. Even if a government entity were to vacate such a building, Sahgal says, a CBD location would still be a viable investment.

(Sahgal does mention one unique aspect to government office tenants. Some private-sector tenants dislike co-locating with certain governmental offices, such as the IRS, state or federal law enforcement agencies, or state unemployment agencies, because of the potential for business disruption from the occasional bomb threat to the building. It happens.)

Federal agencies are still credit or better-than-credit tenants, concludes Roth, and they still have plenty of negotiating leverage just because of their sheer size.

And that’s also true at the state level. One state client of Little’s will be vacating about 30 percent of a building they currently lease all of, and he’s confident that their new lease will nonetheless be for a lower rate.

“The federal government negotiates very aggressively,” says Roth. “They benchmark commercial rates,” which creates “marks on the wall” for companies like JLL.

“They’re pretty cutting-edge on that stuff,” he adds. “As a taxpayer, that’s good to hear.”

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