Potential Impact of Sequestration on CRE

Now that the March 1 sequestration deadline has come and gone without any solution to the budget crisis, John Guinee, a REIT analyst with Stifel Nicolaus, is expecting significant rent cuts by major Washington, D.C., office players.

John Guinee

Now that the March 1 sequestration deadline has come and gone without any solution to the budget crisis, John Guinee, a REIT analyst with Stifel Nicolaus, is expecting significant rent cuts by major Washington, D.C., office players.

“In any market throughout the country, whenever an industry is in growth mode, tenants take more space than they need in anticipation of growth and they aren’t very price sensitive. When an industry is in contraction mode, they give back that extra space, try to give back even more space, and become very price sensitive,” Guinee told Commercial Property Executive. “The D.C. marketplace, in my mind, is going through the bad part of that cycle.”

In his opinion, Wall Street is not taking the implications of the $85 billion in automatic government spending cuts seriously enough and with the contraction in spending will come a downsizing of the industry.

According to Guinee, the impact of the government rent cuts will be significant and there will be big drops in net effective rents to fill up space. The reason this didn’t happen last year, he explained, was because there were not enough tenants in the market and the landlords just sat firm. Now, he expects names with commodity products like First Potomac and Vornado to make aggressive cuts in rents to bring in tenants.

“What happened in D.C. is because of big government and big spending in 2009 and 2010. You had the classic take more space than I need and D.C. was the best market in the country,” Guinee said.  “In 2011, things slowed down considerably. The leasing community until the budget resolution ended up as it did that year was clearly in denial that there was an issue, and landlords were the same.”

This action caused a state of flux in the industry and according to Guinee, the percentage of short-term rentals in the past 18 months were at historic highs, with very few relocations. Now, with D.C. experiencing a 15 percent vacancy in the office market, resulting in 70 million square feet of available space, he expects landlords to go into “action mode,” where concessions will go up and base rates will go down.

Vornado, Corporate Office, First Potomac and Washington Real Estate Investment Trust will most likely be the worst-performing REIT names this quarter due to their exposure to the city, according to Guinee. Conversely, he names Highwoods Properties Inc., Cousins Properties Inc., Parkway Properties Inc. and Kilroy Realty Corp., as those expected to do well.