On June 27th, the House Transportation and Infrastructure Committee considered and ordered to be reported H.R. 6194, the Real Estate Assets and Leasing (REAL) Reform Act of 2018. The bill is a mostly recycled grab-bag of initiatives aimed at real property reform. If signed into law, some of these changes will be welcomed by government lessors and some pose concerns.
The most encouraging component of the bill is that it establishes the goal of “executing long-term leases with firm terms of 10 years or more and reducing costly holdover and short-term lease extensions, including short firm term leases.” As a practical matter, the General Services Administration (GSA) has already started moving in this direction but this legislation would nudge things along. In its summary of the Act, the House committee noted that its proposed legislation would accomplish this through a “Streamlined Leasing Pilot Program that would reduce the administrative red tape on most GSA leases and allow for and encourage space consolidations.” This statement is a bit of an oxymoron since the government’s on-going edict to reduce its real property inventory is one of the chief reasons it has had so much difficulty executing long-term lease deals. Planning and budgeting for massive workplace reconfiguration take effort and financial planning, with both factors conspiring to lead agencies into short-term extensions or holdovers. How the proposed legislation would resolve this conundrum remains unclear.
Nonetheless, we must view the effort as positive. The Streamlined Leasing Pilot Program, though not described in any depth in the legislation, should enable the GSA to dispense with small leases more easily. Since small leases comprise most of the GSA leased inventory (57% of GSA leases are less than 10,000 rentable square feet), a streamlined process could free up bandwidth for GSA to apply more determined focus on the larger leases. It’s these larger transactions that “move the needle” for most lessors and property investors. Further, in its summary of the proposed legislation, the House committee observed that the bulk of GSA’s leases expire in the next few years, and market conditions still remain generally favorable to tenants in much of the United States. The bill seeks to ignite leasing activity that would take advantage of current market opportunities.
The bill also aims to make large lease transactions more efficient by reducing the amount of information the GSA must provide in order to receive congressional prospectus authority. It would implement a pilot program to allow the GSA to consolidate more than one project into a single prospectus where it can be demonstrated that the combined project will yield improved space efficiency and reduced square footage.
Yet, the actual mechanics of how this expedited process will work aren’t well defined, and there is good reason to be concerned with unintended consequences. This alternative approach may only be used where the prospectus “will facilitate efficiencies and reductions in overall space and improved utilization rates.” The problem here is the word “and.” It leads us back to the current problem, where the primary metric is simply footprint reduction and not cost efficiency, value or any other more meaningful measure. As a practical matter, footprint reduction is easy to measure (as is space utilization) so the government keeps gravitating in this direction. However, when the GSA strives only for footprint reduction, it often makes a host of other costly decisions that defy logic. For example, a modest downsizing, that triggers an agency relocation and complete re-build of its space, could net more cost than savings. Regarding this aspect of the bill, I’m adopting a posture of tempered optimism because much will depend upon GSA’s implementation.
Regrettably, I cannot find much cause for optimism with one of the bill’s amendments, which includes a section entitled “Disclosure of Beneficial Ownership by Foreign Persons of High-Security Leased Space for Federal Agencies.” This measure, as currently written, would require the GSA to determine the “beneficial owner(s)” of any entity seeking to lease space to the federal government. Specifically, the proposed lessor for any federal lease must identify each beneficial owner (as defined in the bill) in the entity’s structure and provide the government with that person’s name, address, passport or driver’s license number and disclosure as to whether that person is a foreign individual. Further, the Act stipulates that this information must be provided when first submitting a proposal in response to a solicitation for offers issued by the federal lessee. This requirement would apply to all “high-security” buildings, which the Act identifies as ISC Level III, IV or V. Most of our clients’ leases fall into this very broad category.
The purpose of this section is noble enough — the government seeks to limit opportunities for foreign espionage and money laundering. Yet, the implementation would be clumsy and complex. GSA’s offer process is already a confounding and arduous cliff climb. Layer on the weight of this new requirement and some property investors won’t bother. Rank-and-file real estate ownership structures typically include funds, REITS, both operating and equity partners, overseas partners, nested entities and so on, and all groups would need to be forensically examined to determine which individuals in the structure constitute beneficial owners. Then those individuals will be asked to expose these structures and divulge personal information for the purpose of merely making an offer to the government. In many cases, determining who receives “substantial economic benefit” from an asset or who, “as a practical matter” is able “directly or indirectly, to control, manage, or direct” the ownership entity is going to require extraordinary scrutiny. And, yet, the effort does not end there because the Act also requires that this information shall be updated within 60 days following each change in beneficial ownership. This could become a real and constant burden that will benefit only the attorneys.
In any case, none of the aforementioned legislative initiatives are unprecedented and, therefore, are also not unexpected. The House has made previous efforts to establish all of these goals. Among them, the Public Buildings Reform and Savings Act was passed in the House in 2016 but never received consideration by the Senate. The current, very similar bill may have a better chance of becoming law, in part because the primary goals centered on cost saving and streamlining have become increasingly urgent and they have bipartisan support. Success will largely depend on whether Congress has the bandwidth to move the legislation through before the end of this session. However, even if it fails to be ratified, this bill provides excellent insight into the mindset of GSA’s appropriators, which will nonetheless influence leasing policy.
Among the major initiatives of the proposed legislation, lessors have reason to be encouraged, especially as relates to long-term leasing. In my view, however, I hope more work is done to improve the Act before we get REAL Reform.
Kurt Stout is the national leader of Colliers International’s Government Solutions practice group, which provides government real estate services to private investors and federal agencies. He also writes about federal real estate on his Capitol Markets team blog. You can contact Kurt by email.