The federal government has some big decisions to make about real estate
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The pandemic has caused vacancy rates in office buildings to rise in many markets, in some cases to double-digit percentages. As the largest tenant in the country, the federal government will have to make some important decisions about real estate. Ending up with an evaluation were the executives for Government Investor Services at Jones Lang LaSalle, Art Russell and Lucy Kitchin Federal Drive with Tom Temin.
Tom Available: First, give us the macro effect of what the pandemic did to commercial real estate in the big cities, where the government is also a prime tenant.
Kind Russell: Tom, I’ll start this. I think what you are seeing is – we can start in New York and a few other cities in the country – extremely high vacancy rates. You will likely see 20, towards 30% vacancy rates, no activity going on. If I look here in DC we see probably around 17% vacant.
Tom Available: Impressive.
Kind Russell: I wouldn’t say it stalled. But money is waiting on the edge. We’re waiting for a vaccine. And I think once that happens, and once that happens, you will start to see economic activity. Many economists are pointing to likely a ’22, late ’21, maybe even a late ’22 recovery, but it is happening.
Tom Available: And Lucy?
Lucy Kitchin: So what is happening is the government is not stepping in to fill the void like they did in the 2009/2010 economic recession, Tom. We all waited on the sidelines, as Art said, and looked to see where our demand would come from. And the government was a very good manager of commercial real estate in 2009 and ’10. You grew a lot and saved the Washington DC area. And that kind of growth just isn’t happening, and mostly because federal spending isn’t geared towards growth. It focuses on bringing money to consumers and small businesses. So the different kind of stimulus we see from the capital is really having an impact on real estate.
Tom Available: And in those buildings in which the government is not the only tenant, is there currently the possibility for government agencies to perhaps merge into a single building, in which they are scattered in several half-empty buildings? And could they do that and get some good deals now? Is that even a possibility?
Kind Russell: Tom, you must have been a real estate agent in your previous life because that is exactly what is going on. You see a lot of consolidation. COVID forced people to look at staffing levels. You see a lot of people right now who are obviously teleworking. Nobody is in the cities. People come in just as they need them, critical staff. And for example, you can see 150,000 square feet shared by two leases, located in two separate demographic areas, and consolidate to 100,000 square feet. And you could see these people go to the bigger place in the 50’s and lose that second place. In terms of deals, at the moment in terms of government leases, I would say that owners who normally had people from the private sector now want government leases. That increases competition. And this also increases the concession packages.
Tom Available: Because there has long been admonition from GAO and Congress to some extent and from various regulators that federal agencies should do better on leasing to get some of the long-term benefits as the government tends to be a short-term renter. Is there a chance to maybe change this model now? A unique opportunity?
Lucy Kitchin: Yes, I would absolutely say. There was a mandate within the GSA to do more with the economic terms they must have – it’s a buyer’s market, to use a term for residential property. And so the government actually came into the market when it signed leases. And when they have demand, they have looked for longer terms. You are absolutely right, Tom. They did stop gap leasing because they thought they should end up in a federally owned, consolidated building. But they started to really change that model and say, “You know what? We can get really, really good deals if we go 10 or 15 years. “And we see that this is confirmed. We just want to see more of it.
Tom Available: For sure. And let me just ask one bigger real estate question: the expectation in commercial real estate that the occupancy that we saw at its peak, like in San Francisco and all those tech companies, has gone crazy, or New York. will never quite get to these levels because organizations, governmental or non-governmental organizations, have embraced this idea that a certain percentage will now always be teleworking?
Kind Russell: That’s the $ 69,000 question, Tom. I think what you are going to find right now is critical staff, headquarters, you will see people using this space. But the Googles, the bigger 500 companies, won’t see them again until the vaccine has likely been distributed and the logistics in place. So maybe this is April, May, early spring, early summer, spring, around 2021. Most people talk about staying away until June, July. And even now what you are seeing in the private sector are people doing short term leases, smaller, flexible spaces. You want more flexibility in figuring out what’s coming out over the next year, 18 months. You come back. What it looks like and I think it’s still to be found out. But it’s definitely coming back. Will it be pre-COVID levels? I think we all hope so. I think a lot of forecasters are saying 80/90% of what it was the next two years. And I think there will be a huge release of finance and a huge release of energy because this is such a consumer-centric economy. People will be able to get out there and do what they couldn’t before last year or so.
Tom Available: We speak to Art Russell and Lucy Kitchin, Directors, Government Investor Services, Jones Lang LaSalle. So basically, rather than trying to shorten the real estate market in the long term, act now while you have the chance?
Lucy Kitchin: I would absolutely agree with that. Right.
Tom Available: Well. Let me ask about energy, that is, electricity, electricity, water and so on. I expect that with the introduction of a new Biden government, energy use targets for federal institutions will resume – you hear it already. And I think they’re mostly talking about state owned buildings like the State Department or something. Even so, they have this leverage for landlords. Do you think this will be a factor a. When choosing a building and then choosing a building’s terms and conditions in terms of energy efficiency, investments or upgrades that they may require from landlords?
Kind Russell: You know what? That’s definitely something about Biden’s first 100 days. Our understanding from some of the feedback we receive is that the Biden Administration plans to examine approximately 4 to 5 million commercial buildings across the country. And they’ll be hit by regulations, likely ventilation, HVAC requirements and standards, which hopefully, once we get back from this pandemic, will meet more of those requirements. Obviously the EPA will be concerned, energy, these types of agencies are likely to receive high funding. So will all be under one kind of what are the requirements? How is it really affected? Will you be grandfather? Because this is all about money. How does it affect my ability to be a successful landlord to truly serve my clients? And how can I really work hand in hand with the government? I think these are questions Biden will be asking in the first three to four months of his term in office.
Tom Available: So it’s good to be a Carrier or Honeywell at this point, if not necessarily a landlord.
Kind Russell: Yes, you want to buy a lot of stocks. 3M. Honeywell. You have the right attitude.
Tom Available: Okay, what else should government real estate agents do and think about now? What is your best advice for them to go on strike while a new administration comes in and while the iron is kind of hot because of this vacancy market?
Lucy Kitchin: I would say follow the money, be honest with the Georgia race to include politics. Because if the Democrats do the Senate races down there, you’re going to have a Democrat in the White House, a Democratically controlled Senate, and a Democratically controlled House, and then you’ll likely see that translate into whether it’s a Republican or whether it’s a Republican all three places is a democrat. You will see growth, and you will see growth in Washington, DC. So I’d say watch out for the news. Pay attention to the budget. Take a look at the deal that has been made and see where the money is going and you will be able to see where the growth will be.
Tom Available: Lucy Kitchen and Art Russell are Directors, Government Investor Services for Jones Lang LaSalle. Thank you for joining me.
Lucy Kitchin: Thanks, Tom. Always a pleasure.