The State of the GSA Office Market
Basic Terms Of GSA Leases
For those who may not be aware, the federal government only owns some of the real estate that they are occupants in. In many cases, they lease space to public enterprises. As of March 2024, the federal government currently leased 176 million square feet of real estate space across the United States. Most of this space is office and industrial properties. The agency that helps the federal government manage federal property and provide contracting services to the public is called the GSA or General Services Administration. GSA is then split into two service categories known as the Federal Acquisition Service and the Public Buildings Service. The Federal Acquisition Service procures goods and services for the federal government, while the Public Buildings Service helps to manage federal property and leases.
Regarding GSA real estate property, some of this information will come from the standard GSA lease, but almost all GSA properties are modified gross leases. While each lease can be different, typically, the landlord oversees all expenses except for the increases in property taxes over the base year. The base year is determined by the first full calendar year of the lease. For example, if the lease starts in September 2021, then the base year is the taxes set in 2022. With that being said, specific responsibilities for the landlord can vary. These are the most commonly found terms in federal GSA real estate leases:
Firm Term
The part of the lease that is not subject to termination rights. This is a portion of years usually found at the beginning of the lease, during which the tenant is subject to the terms outlined in the lease.
Soft Term / Non-Firm Term
The part of the lease that the tenant is allowed to vacate the terms set in the lease. Usually, the tenant has 60-120 days’ to tell the landlord they are vacating.
Tenant Improvement (TI) Rent
A certain amount of money that the owner agrees to pay upfront to renovate the building to GSA’s needs. This money is then reimbursed in a lump sum or throughout the lease term as part of the rent and includes interest negotiated for a certain number of years.
Building Specific Amortized Capital (BSAC)
Rent that is charged for specific security items and is a separate capital investment from TI. This money is also paid in a lump sum or as part of the rent that includes interest for a certain number of years.
Request for Proposal (RFP)
This document is used to negotiate with the government to allow them to lease space inside your facility.
Current State Of The Office Market And How GSA Is Affected
While most product types are struggling to sell on the secondary market in 2024 due to the significant rise in interest rates since mid-2022, the office sector has seen the biggest impact. According to Ycharts, the commercial real estate market has seen the fastest increase in interest rates in U.S. history: The federal funds rate in March 2022 was 0.20%, and in the last two years has jumped to 5.33%.
Since then, the office market has seen the highest vacancy rate of all other commercial real estate product types, reaching 20% in the first quarter of 2024, according to Statista. While GSA assets have fared significantly better than other private sector office space, there still has been a trend showing slight consolidation of leased space in the industry. Whether this means holdovers – where the tenant is currently occupying the property beyond the expiration date of the lease – or it means negotiating shorter firm terms for new leases, the need for office space has started to decline. Overall, this explains why institutional and quasi-institutional investors are wearier of certain tenants and very bullish with others.
Dispositions on the Secondary Market
When buying and selling property in the government lease asset space, whether federal, state, or county, there is a significant advantage to working with someone who specializes in acquiring and disposing of government-leased assets in a particularly niche industry. GSA owners are typically repeat buyers who have very specific acquisition criteria and know exactly what they are looking for. At the same time, new buyers enter the space regularly. Still, they are typically looking for higher cash-flowing properties over traditional triple net leases where the tenant does all the work. Here are some trends being tracked in the space over the last 12 months from an examination of the market:
- Average cap rate on assets sold: 8.06%
- Average firm lease term of properties on market: 6.31 years
- Average lease size: 23,160 SF
- Total number of current leases: 7,612
- Average total yearly rent per lease: $764,992
- Average sales price of deals sold (YTD): $5,226,092
It should be noted that state and county government lease properties typically do not have a firm term. Instead, they have funding appropriations clauses, where the tenant can leave if they do not receive funding for the next fiscal year. While this usually is not an issue, it can affect financing from a lending standpoint. If the asset has a firm term remaining, it is typically sold based on a cap rate in accordance with whatever the remaining firm term is.
Mission Critical vs. Non-Mission Critical Facilities
Mission-critical and non-mission-critical facilities are terms commonly thrown around in the GSA space, and while there is some standard acceptance of what is considered mission-critical and what is not, there is some variance. For example, SSA or the Social Security Administration field office buildings are typically considered non-mission critical facilities because there is not a specific need for them to be in the building that they are currently in. They may need to be in a defined area in that specific market and have a specific criterion in the RFP, such as needing to be a minimal distance away from a bus stop, but the tenant does not need to be in a specific building. Still, most SSA buildings are typically general office space properties. On the other hand, a regional 80,000-square-foot single-tenant FBI facility with sensitive compartmented information facility (SCIF) requirements and specific security measures will require a tremendous amount of TI, making it harder for the tenant to find other spaces that work for their needs.
This often creates a double-edged sword for landlords of these properties, as mission-critical facilities mean there is a very low probability that the tenant will leave. Still, if they ever do, it becomes increasingly harder to find a replacement tenant. It also explains why mission-critical facilities can trade for more aggressive cap rates. Sometimes, they trade 50-75 basis points more aggressively than like-kind assets that are non-mission critical. First-generation leased properties are another common indicator for assets that trade more aggressively among GSA properties. GSA has stated that they stay in one location on average for 22.5 years. This means that it’s a first-generation leased property, there is an extremely high probability that the tenant will renew.
The other reason certain groups look for specific properties is that at the end of each lease with GSA, they will mostly bid to the public to see what is available for them in the marketplace. This does not mean they do not like a facility, but it is an opportunity for the tenant to find what is considered competitive in their market. That said, GSA typically favors incumbent leases, as the costs associated with building a new facility or renovating a new one are typically more expensive than just negotiating a new lease with the current landlord at a market rate rent. Also, it should be noted that GSA frequently uses a source selection process called “lowest price technically accepted” to find the cheapest opportunity that still fits their criteria in the marketplace. Even still, the GSA boasts close to a 95% renewal percentage on their current leases.
Conclusion
Matthews has worked with all types of government-leased assets and has experience managing and tracking these transactions. From the U.S. Department of Veterans Affairs, the U.S. Postal Service, and GSA to all different types of county and state agencies as well, the agents have experience managing these transactions and working with these buyers. The team continues to pursue further learning opportunities and networking opportunities within the government lease space.
