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Saturday, August 21, 2021

Feds May Soon Give Back Millions Of Square Feet Of Office Space

 The federal government, the largest occupier of commercial office space in the U.S., is re-evaluating its post-pandemic workplace strategy in a process that could lead to reduced footprints and depressed office demand in Washington, D.C., and across the country. 

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One of the buildings on the Patent and Trademark Office headquarters campus in Alexandria, the GSA's largest office lease.

President Joe Biden's administration in June directed federal agencies to draft long-term policies for their workplace and remote work strategies, and it told them to provide maximum flexibility. 

Several real estate professionals who work with the federal government, including two former heads of the General Services Administration's Public Buildings Service, told Bisnow they expect this directive will lead agencies to shrink their leased office footprints, a trend that could have massive ripple effects across the U.S. commercial real estate market. 

"There are going to be a lot of instances where the government will either vacate buildings outright and consolidate into other locations or simply downsize as a function of the pandemic," said Colliers Executive Vice President Kurt Stout, who leads the brokerage firm's Government Solutions group. 

The GSA manages more than 7,800 federal office leases totaling more than 181M SF in markets across the country, according to lease inventory data it published in July. That inventory includes 40 leases of more than 400K SF and 114 leases of 200K SF or more, according to a Bisnow analysis of the data. 

The D.C. area has the largest concentration of those offices, but it is far from the only market with large federal office leases. Federal agencies have leases larger than 400K SF in Atlanta, Kansas City, Philadelphia, Chicago and San Antonio.

"They're big drivers of leasing activity beyond the Beltway," said FD Stonewater Managing Director Norman Dong, who led the Public Building Service as commissioner from 2014 to 2017. "It's often underappreciated. People don't recognize the magnitude of the federal presence in these other markets."

Of the 114 leases of more than 200K SF, 37 have expiration dates before the end of 2024, according to Bisnow's analysis of the lease inventory data.

The agencies with those expiration dates will soon have to decide if they still need as much office space as they did before the coronavirus pandemic. The ones with the most immediate expirations may kick the can down the road with short-term extensions as they evaluate their long-term strategy, but experts believe this evaluation process will eventually lead to less government office demand. 

"I think we're going to see some delays, and in the long run, some reductions," said Gensler principal Bob Peck, who served as PBS commissioner from 2009 to 2012.

Planning For The Post-Pandemic Workplace

The pandemic forced the federal government to shift thousands of employees to remote work, and like many private sector companies, agencies found they were still able to function. That discovery will lead them to incorporate more flexibility into their future workplace plans.

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The General Services Administration's headquarters at 1800 F St. NW

On June 10, the acting heads of the Office of Management and Budget, the Office of Personnel Management and the GSA sent a 20-page memo to the heads of federal agencies providing guidance for their near-term return to the office and their long-term workplace strategy. 

The memo pushed agencies to move quickly. It directed them to provide OMB with a draft of their post-reentry workplace policies by June 18 and to work with OMB to finalize their phased plans by no later than July 19.

"Agency plans for reentry and post-reentry should be informed by lessons learned during the past 15 months," the memo said. "The agency’s eventual post-pandemic operating state may differ in significant ways from the agency’s pre-pandemic operating state."

An OMB spokesperson, in emailed responses to Bisnow questions, said agencies are in the process of communicating their plans to employees and are implementing a variety of flexible workplace strategies. The spokesperson said it is premature for OMB, GSA or the agencies to determine the impact of the flexible work policies on an agency's real estate needs.

These agency plans haven't been made public, but brokers who work with the GSA say they see signs that the plans will lead to reduced office footprints. 

"It's clear to me, just from the street level, that agencies are going to downsize significantly," Stout said. "The current plans as they're evolving call for significant downsizing among many agencies."

While the private sector is also dealing with questions around whether to cut office space, experts said government agencies are under more pressure because they are taxpayer-funded and they must justify their expenditures to Congress. The government could also view remote work policies as a benefit to help recruit and retain employees.

"If you can't pay as much as the private sector, at least you can offer flexibility, and for reasons like that, I can see the government actually maybe going further in that direction toward distributed work," Stout said.

The prospect of federal agencies downsizing isn't a new one, as administrations have for years sought to use footprint cuts as a way to save taxpayer money. Former President Barack Obama's administration in 2013 launched a policy called Freeze The Footprint, and in 2015, it changed that to Reduce the Footprint, a policy that called for prioritizing actions to consolidate and dispose of properties. 

Dong, who led the Public Buildings Service while those policies were in place, said he saw them as an effort to improve space utilization. He said he sees this post-pandemic workplace planning as a continuation of those efforts, but the reasons for them have changed. 

"The impetus was driven by fiscal imperative," he said. "What you're seeing now is a shift in that impetus. There's an awareness of the fiscal benefits of doing this, but you're also seeing other factors come into play. You're seeing an increased receptivity to remote work and telework because of the proof of concept we saw over the past 17 months. You're also seeing issues of increased employee benefit, in some cases increased productivity, and there's issues of equity."

The GSA will be helping agencies plan their future office needs under the leadership of new officials. In April, Biden nominated former Missouri Secretary of State Robin Carnahan to serve as GSA administrator. In July, the administration tapped Nina Albert, the former head of real estate for the Washington Metropolitan Area Transit Authority, to lead the Public Buildings Service. 

The new leaders haven't given many public statements on their plans for the government's real estate footprint, and the GSA declined to make them available, directing Bisnow's questions to OMB.

But last month, GSA Assistant Commissioner for Facilities Management Andrew Heller said at a virtual conference that the agency has gathered survey responses that indicate other government departments will need less office space in the future. 

"Based on the survey information that we’re getting, we think that reliance on the physical workplace is going to decrease in the future," Heller said at the Association of Government Accountants Conference, according to Federal News Network. "So it’s really on us to restack our buildings and rightsize our portfolio in a smart way that makes sense for our customers, for the taxpayers and for GSA."

The most immediate implications of this shift could be a surge of short-term lease renewals, as agencies may not want to commit to long-term leases until they have a clearer picture of their office needs. This would be a change from the GSA's previous efforts to focus on signing long-term leases that create better value for the government. 

"The tradeoff here is going to be, 'I don't want to renew a 100K SF lease for 10 years if I find out two years from now I only needed 50K,'" Peck said. "So I believe there are going to be some short-term extensions."

'This Is Going To Happen Everywhere' 

Once agencies have had time to make their decisions, government leasing experts believe the market will start to see federal leasing demand shrink dramatically. 

Cushman & Wakefield Executive Vice Chairman Darian LeBlanc, who leads the firm's Government Services Group, said that unless something changes with work-from-home strategies, he predicts that starting in 2023, the government will shed about 1M SF of leased space in the D.C. area every year for the next three to five years.

"The D.C.-area bears greater exposure proportionately than everywhere in the country, but this is going to happen everywhere," Leblanc said. "Agencies across the country that are going to adopt work-from-home are going to do it across the board, and they're going to be shedding space wherever it is that they have space."

Of the 37 leases set to expire by the end of 2024 that are 200K SF or larger, 18 are in the D.C. area, which the GSA calls the National Capital Region, according to the lease inventory data. 

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The GSA divides the U.S. into 11 regions, and its office leases are spread across the country.

The largest lease in the GSA's inventory is set to expire in August 2024: the 2.4M SF Patent and Trademark Office headquarters in Alexandria, Virginia. The Washington Business Journal reported in March that PTO is working with the GSA on a plan to shed excess space as more employees continue to work remotely. LCOR is the agency's landlord. 

Four of the 200K SF-plus expiring leases are in the Mid-Atlantic Region, including offices in Cumberland, Maryland; Falls Church, Virginia; Parkersburg, West Virginia; and Philadelphia. 

The region the GSA calls The Heartland Region also has four expiring leases larger than 200K SF. Two of those leases are in Kanasas City, Missouri, and the others are in Lexena, Kansas, and Lee's Summit, Missouri. 

The Southeast Sunbelt Region has three of the large, expiring leases. Two of these offices are in Atlanta, and the other is in Covington, Kentucky. The Pacific Rim region has two expiring leases of over 200K SF in Fresno and Sacramento, California. The Greater Southwest Region has one 200K SF-plus expiring lease each in San Antonio and Dallas. 

The Great Lakes Region has two large, expiring leases in Detroit and Jeffersonville, Indiana. The Northwest Arctic and Northeast and Caribbean Region each have one expiring lease of over 200K SF, in Sumner, Washington, and Newark, New Jersey.

Dong said he thinks the agency decisions about whether or not to reduce footprints won't change based on the location of the offices but rather on the function that each office performs for the agency and the level of in-person work it requires. 

"As the policy setting and the decision-making is taking place in agencies, it's really not taking place with a lens toward one part of the country versus another," Dong said. "It's more of a functional lens versus a geographic lens."

Stout said he thinks the government will be more likely to vacate leases in the D.C. area because the region has the largest concentration of owned office buildings in which it can consolidate agency functions. 

"Downsizing is occurring throughout the inventory in owned buildings and leased buildings, and when it occurs in owned buildings, the government is going to try to backfill that space, and it's going to siphon demand off leased space," he said.

Landlords with large portfolios of government leases could be at risk of occupancy losses in their buildings as a result of the shift, but they are publicly deflecting concerns. 

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JBG Smith's 1235 South Clark St. in Crystal City, an office building that has multiple GSA leases.

JBG Smith, a REIT with its portfolio concentrated in the D.C. area, has 60 leases with the GSA totaling 2.3M SF, according to its Q2 investor filing. These leases bring in $91.3M annually for the REIT, comprising 20.5% of its total office rental income. 

The REIT has analyzed the specific federal agencies within its portfolio and determined that many of them are defense and national security-related functions that are less likely to shift to remote work, JBG Smith Executive Vice President Dave Ritchey said.

He said this is particularly true in the National Landing area, the neighborhood where Amazon is partnering with JBG Smith to build its second headquarters. The area, in the shadow of the Pentagon, has historically had a concentration of defense-related agencies, but many of them cut their footprints dramatically after the Base Realignment and Closure Act of 2005, setting that office submarket back years. 

"In National Landing, for example, we still have a significant GSA presence," Ritchey said. "We have a presence that is largely what we consider mission-critical types of agencies such as the Department of Defense, and there, we're very optimistic in the continued need for office space."

Ritchey said some government leases in Class-B office buildings in D.C. may be more likely to experience contraction, potentially affecting the overall dynamics of the office market. 

"It could create some headwinds at the macro level, but we're very focused on the property level and what's occurring within the spaces in our portfolio themselves, which gives us some comfort," Ritchey said. 

The District's office vacancy last quarter reached a record-high 17.8%, according to CBRE, and it experienced negative 472K SF of quarterly absorption. CBRE's Q2 report said the government has created the largest occupancy loss in the District so far this year, shrinking its footprint by 700K SF. 

"The federal government has been a source of contraction this quarter," CBRE Research Director Wei Xie told Bisnow in July. "A disadvantage of D.C. is that the GSA has a lot of mobility to move agencies around, so there's a higher chance of consolidation."

Office Properties Income Trust, a REIT formed in 2018 from the merger of Government Properties Income Trust and Select Income REIT, has 5M SF of GSA leases totaling 23.5% of its portfolio, according to its Q2 investor filing

In response to an analyst's question on the REIT's Q2 earnings call, OPI Chief Operating Officer Chris Bilotto said about half of the firm's GSA footprint is secure defense facilities that he sees as less likely candidates for consolidation. And he said the government may be hesitant to make significant cuts across its portfolio. 

"Our experience with the government is that it's much more difficult to get space, given the process, if you give space back," Bilotta said, according to a Motley Fool transcript. "So I think they'll be very mindful of how they roll out that plan and how much they elect to give back, if any."

https://www.bisnow.com/national/news/office/federal-remote-work-shift-could-hurt-office-markets-nationwide-109928

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