Monthly Archives: March 2011

We’re From the Government and We’re Here to Help!

By Ken Ashley

(ATLANTA) March 24th, 2011
The government giveth and the government taketh away. Whether federal, state 

What you lookin' at?

or local, government action – or lack thereof – can sometimes impact the office market. As a tenant in the jungle, it pays to watch the big monkey with all the bananas.

Brother, Can you Spare a Dime? Um, $60 million?

In this article by Rachel Tobin in Sunday’s Atlanta Journal-Constitution, the Georgia State government committed $60 million in a public/private partnership to help convert a  “forlorn” area in Atlanta. If successful, the development in the railroad “Gulch” in Atlanta, Georgia would transform a long festering sore on Atlanta’s central business district landscape into a revitalized and bustling area. The plan is to build mixed use retail, residential and office. And it would add a nice source of new property taxes to local governments and spur job growth according to boosters of the project.

It would also result in new office product, which will hit the scene many years from now.  This can have unintended consequences in future years; when it finally delivers, it will be the first new product in nearly three decades in the central business district. However, with government dollars stimulating and focusing developers, hope springs eternal that public investments can spur vertical improvements with private developers.

Who’s yo’ Uncle?

In another example of government influence on real estate markets, an article in Wednesday’s Wall Street Journal by Anton Troianovski explains that the government is tightening its belt like everyone else. As Anton suggests, the

That's Mr. Sam to you

government can many times “prop” up demand in down cycles. However, in many cases government entities, especially state and local departments, occupy class B space that lots of  corporate users wouldn’t even consider.  While the WSJ article shows pictures of class A buildings, I would bet that much of the General Services Administration portfolio is either class B or properties owned by the government. The state occupancies that may have the biggest impact according to the Journal are almost certainly class B or even C.

While the movement of any large tenant affects markets, we believe that the new conservative face of government won’t have a huge impact on the class A office markets traditionally occupied by corporate America, with the possible exception of Washington D.C. and Northern Virginia. In those areas, expect a real estate bonanza and lots of wonderful sublease opportunities.

If the government moves do change things, they will likely be to the benefit of corporate tenants through what is called “class compression.” In other words, class C product will lower rates to attract class B uses, which will do the same to attract class A users. The ball stops bouncing in class A when those landlords feel pressure to lower rates to retain tenants.

And hey, maybe you can get your own corporate stimulus package with a nice, attractive sublease from Uncle Sam or his little brothers in state and city  government. Perhaps you can get a favorable designation or incentives that will help lower your cost of occupancy. Just make sure you get the paperwork filled out right and be nice, because Uncle Sam is the biggest gorilla in the real estate jungle and you can bet he has more bananas than you do.

(WSJ) Government Cuts Clip Office Market



Smaller government means less demand for office space, and that is acting as a drag on the recovery of the commercial-real-estate market.

In Washington and elsewhere, government leasing has helped prop up demand in tough times. But now cash-strapped governments are moving to cut back on office space, even as commercial real estate struggles to recover.


CREDIT: Piedmont Office Realty TrustThe Office of the Comptroller of the Currency is vacating One Independence Square in Washington, owned by Piedmont Office Realty Trust.


In Washington, which has benefited from a surge in space rented by government agencies, the Securities and Exchange Commission renegotiated a 900,000-square-foot lease for new office space down to about 300,000 square feet because the agency didn’t get the congressional funding it had counted on to hire new employees.

“We’re starting to see the impact of a very, very difficult fiscal situation in the government trickling down to decisions being made for leasing,” said Don Miller, chief executive of national landlord Piedmont Office Realty Trust, which will lose the Office of the Comptroller of the Currency as a tenant in at least one building in the wake of the agency’s decision to move into some of the space no longer being leased by the SEC.

The biggest impact is likely to come on state and local levels. The states of Illinois, Missouri and Kansas recently hired brokerage firm Jones Lang LaSalle Inc. to reduce real-estate costs, and other states, from California to Florida to South Carolina, are examining ways to pare back their use of space, brokers said.

Investors have taken notice. J.P. Morgan Chase & Co. analysts said in a note to clients recently that real-estate investment trusts, or REITs, with a lot of government exposure “should be watched more closely in a budget-tightening environment as renewals may not be the lay-ups they once were.” And REITs with lots of government leases have lagged behind peers in recent months.

After the financial crisis first hit, buildings with government tenants were a safer bet. Washington emerged as the healthiest office market in the country, with rents falling much less than other cities.

Buying stocks of landlords with government tenants “was a less risky way of gaining office exposure, especially in an environment where capital was still very constrained for the private sector,” said Al Otero, a REIT portfolio manager at European Investors Inc. “The roles have somewhat reversed.”

Brokers and investors expect government demand to slow down. Research firm Reis Inc. predicts occupied office space in Washington will increase by one million square feet this year and about 800,000 square feet next year, compared with a jump of 2.8 million square feet in 2010.

The New York City government has vacated 380,000 square feet since last year when Mayor Michael Bloomberg launched a push to move out of 1.2 million square feet of city-leased space by 2014, for a projected annual savings of $36 million. The program involves consolidation as well as moving toward more open work spaces.

Florida’s portfolio of leased office space, at 8.3 million square feet in 2008, has shrunk about 5% since then, said Ann Duncan, president of Vertical Integration, a Tampa, Fla., firm that advises governments, including the state of Florida, on real-estate use. She predicts another decline of roughly 500,000 square feet this year.

Rents have been rising in some prime markets since the depths of the downturn. In Washington’s Georgetown market, effective rents were up 2.2% in 2010, according to Reis. In Midtown Manhattan, rents rose 0.2% during the year.


But in many markets rents actually fell last year, with net effective rents down 1.5% nationally, according to Reis. If government agencies contract without the private sector expanding more, downward pressure will continue, some predict.

For landlords who saw government leases as stable components of their portfolio, more aggressive moves to cut spending inject a new degree of uncertainty. For example, Florida’s Department of Corrections terminated a lease by invoking a clause that allows the state government to move out of a building if state-owned space becomes available in the same county.

“Traditionally, we would tell landlords that only a handful of times had it ever happened, but it’s clearly being used more now,” Ms. Duncan said. “Downsizing and taking less space is going to be a very prevalent activity this year.”

Corporate Office Properties Trust, which owns buildings in the Washington area that cater to federal-government contractors, assured investors on a recent conference call that most of its tenants weren’t at risk of seeing major cuts. But the temporary spending resolutions passed by Congress to keep the government operating “limit new contract starts and push back programs and spending opportunities, which defer leasing decisions by tenants,” company President Roger Waesche said. “We are experiencing this firsthand.”

Some analysts, such as Green Street’s Michael Knott, said investors have overly discounted the consequences of federal spending cuts. “There’s no doubt this alters the trajectory, but I don’t think it drives it into the ground,” Mr. Knott said.


By Ken Ashley

(ATLANTA) March 7th, 2011

No matter what market conditions are, we frequently get questions about what is “fair” for a term or length of lease commitment. If corporate users

"Like sands through the hourglass, so are the days of our lives."

could get landlords to commit to a scenario where they could unilaterally terminate every year, every month or even every day, then that would be just dandy. Wouldn’t that flexibility make the corporate real estate game easy? This would be the equivalent of writing in pencil; you could erase your mistakes and start over.

As a corporate officer or real estate director, you know well that the more flexibility a company can gain in its real estate portfolio, the better. It’s hard enough to forecast the future without having to worry about a super long-term lease (witness the Middle East unrest of recent weeks).

So what are the major reasons that landlords insist on such long term commitments from their tenants – AKA customers? We see situations where corporate users have never had to think like a landlord. They don’t understand the risk, the capital, return metrics or the vagaries of the financing markets for holders of real assets. Real estate is a great mystery that goes unsolved and uninvestigated.

Many tenants simply assume that a landlord is out to get them. While this certainly could be the case, many if not most landlords are fair capitalists like you and me. They allocate capital, take market risk and hope for a market return.

I know we can all agree that profit is a good thing. However, looking at this from the tenant’s perspective, it’s like that piece of cake at a friend’s birthday party: it must be kept reasonable and proportionate.

Walk a Mile in My Shoes

One of the basic principles of negotiation is to understand the concerns and motivations of your opponent. If you can “think like a landlord” and look at your tenancy as he or she would, you will be able to not only plan your approach, but swat away bogus arguments like a pro. Fundamentally, your tenancy, and the resulting cash flow, is an asset that provides value. In order to win the prize, the landlord must have a building (think of this like a factory), then pay to put raw materials into that physical plant in order to make deals happen. In sum, they are running a business, but the decision making approach is driven by, among other things, the form of ownership and capital structure.

For example, an asset manager for a life insurance company is likely looking for long term value appreciation and is not overly worried about short term cash flow. In many cases, life insurance companies pay all cash for even the largest asset. The decision makers are salaried and usually long tenured professionals. They take a careful and deeply analytical look at deals. They are risk averse on the credit front and will wait for a company that fits their profile of perceived strength before they will commit.

Publicly traded real estate investment trusts (REIT’s) are driven by Funds from Operations (FFO) which is a figure used by to define the cash flow from their operations. It is calculated by adding depreciation and amortization expenses to earnings, and sometimes quoted on a per share basis. In other words, they are effectively focused on net profit on a per share basis.

A Man in Full

Perhaps the most stereotypical landlord is the one describe in the famous Tom Wolfe book A Man in Full. This landlord is a merchant builder and a gun slinger. He (yes, usually a man, at least up to now) will take massive risk, borrow horrid amounts of money, and in general do anything legal to make a real estate deal work out.

I respect individuals like this and some of them become very, very wealthy. I also treat them with great caution because their risk tolerance would have most people crying out in pain like little babies. The focus for entrepreneurial, highly leveraged landlords is cash flow early and cash flow often. They will say what it takes to get you to agree to a deal. As Ronald Reagan used to say, “Trust, but verify.”

What Would You Like in Your Margarita?

While we are primarily discussing term of commitment in this post (we will cover tenant improvement dollars in another post), a tenant real estate transaction is a recipe that is run through a financial blender with an answer spit out on the other side. Once again the answer depends on what kind of company you are negotiating with – IRR, Cash Flow or impact on Asset Value are a few metrics that landlords use to evaluate your transaction.

So, lease term is a major factor in how “sweet” the deal is for several reasons. A longer commitment will give the landlord a bigger period of time to amortize cash put into the deal and therefore allows ownership to achieve its objectives while keeping the lease rate low. In addition, it allows the investors to take margin over a longer period of time instead of having to cram all the profit in a shorter period of time. Term also creates tremendous value, because investors – whether in real estate or on Wall Street – look at defined cash flow with great interest.

The deal can be analyzed by MBA’s with computer models and they can tell you what flavor your Margarita will be at the end of the term. Those MBA’s may say the same thing, but insurance company asset managers hear something different than The Man in Full developer with a big hat and more of a taste for Scotch.

Rules of Term

It sometimes helps to think of your company’s tenancy in terms of where you lay your head at night:

·     A hotel room at $350 for 31 days is $10,850

·     A corporate apartment might easily be 50% of this amount at $5,425 a month

·     Your 30 year mortgage might be 50% again or $2,712.5 a month

Flexibility cost money on a per day basis, but allows you to change plans quickly. Commitment can be expensive, but if you are in an environment where  your managers have the experience and maturity to make longer term forecast, then a longer lease term, like a 30 year mortgage, is the less expensive option.

Finally, we did not discuss here but are acutely aware of market pressure when setting all terms, from length of commitment to rate and cash in the deal. But start with the basic understanding of what the landlord is thinking. Look at it through the lens of the market, and layer in your own situation. Then we bet, with a good advisor, the situation will be come clear, or at least easier to swallow. Enjoy your drink and tip your waiters.