Tenants, Investors Drawn to Government-Leased Properties
- Jul 07, 2010
Sale-leasebacks–and generally, leasing rather than owning real estate–are becoming increasingly popular among our federal and state government entities. As with corporate America, government at the federal and state levels is finding that it may have better and more essential uses for their capital than having it tied up in real estate ownership, especially in these challenging times.
About half of the more than one million civilian federal employees now work in properties leased, not owned, by the government. At the state level, Arizona and California in particular have been making headlines in recent months due to their efforts to raise capital by monetizing their buildings. Arizona, for instance, raised $735 million by selling ownership interests in state office buildings and other facilities at the beginning of the year; more recently, it sought to raise $300 million by selling bonds backed by lease payments on its Supreme Court building in Phoenix. Moreover, California announced in April that it had received significant interest, including offers of more than $2 billion, in a portfolio of 11 state-owned office properties that it is seeking to monetize in a sale-leaseback transaction.
An announcement from California’s Department of General Services, the state’s business manager, stated that its properties “generated worldwide interest from numerous buyers eager for stable, leased investment properties.” At Stan Johnson Company, we’re not surprised to hear that, because we see firsthand that government-leased properties are increasingly popular among many investor types, including both institutional and high net worth investors.
Why? Mostly it has to do with tenant credit quality. Investors (and lenders, too) consider government to be among the best, if not the best, credit you can get. Assuming that it is coupled with a long-term lease and high quality real estate, you can easily see why the current flight to quality in the real estate investment community is often landing at government-leased buildings. The three-legged stool we use to evaluate traditional net-leased properties–tenant credit strength, lease economics and real estate strength–are similarly applicable to these assets.
These buildings are often, though not always, leased to single tenants, but they can differ in some significant ways from traditional net-leased assets. In the case of buildings leased to the US General Services Administration (which may, in turn, lease space for a number of federal agencies within one building), leases are typically not net but rather modified gross leases. Modified gross leases are leases in which most of the operating expenses are paid by the landlord, but the tenant will have some expense exposure, depending on the agreement made (ie: any increases in real estate taxes beyond a base year would be paid by the tenant).
As a result, investors do need to have a comfort level with being responsible for operating expenses and owning an asset that in some ways is more akin to a multi-tenant asset. A property management company will likely need to be hired to operate the facility. In addition, one common concern we hear from potential investors looking at GSA-leased buildings focuses on the fact that occasionally the leases (particularly the state leased buildings) have a cancellation clause, some even on an annual basis if state appropriations are cut back to fund specific government services. However, it is important to note that, according to the GSA, between 2001 and 2008, 96 percent of federal government-leased square footage either remained or was replaced in the same building–in other words, there is a historical pattern that they continue to use and renew their leased space rather than move.
But in general, we find that there is demand from an ample base of investors that are willing to take on these potential challenges in exchange for having what is thought of as a bulletproof credit behind the lease. And on the supply side, we expect state governments will continue to look at unlocking the value of their office buildings and other real estate assets as a way to deleverage their balance sheets and maintain liquidity in these tight economic times. In addition, the federal government is showing no signs of slowing down its growth as it expands to handle homeland security concern, immigration, and other stimulus programs being championed by the current administration.