With net absorption down and vacancy rates up for the second consecutive year, 2002 was tense for many owners and investors in the Washington, D.C., office market. Many market participants hoped that the creation of the Department of Homeland Security (DHS) — and more importantly, an office lease large enough to accommodate the headquarters of an agency that will measure more than 180,000 federal employees employed in 22 government entities — would act as a catalyst for the market in 2003.
Unfortunately, these hopes went unfulfilled. In connection with the formal creation of the DHS on Jan. 24, 2003, the U.S General Services Administration (GSA) issued a solicitation for offers, seeking approximately 275,000 sq. ft. of office space with potential for expansion of an additional 250,000 sq. ft. But after considering several private sector sites in northern Virginia, the DHS decided to locate its initial headquarters at a government-owned, militarily controlled location on Nebraska Avenue in northwest Washington, D.C.
Needless to say, the decision was disappointing to many. An analysis of the Homeland Security Act and recent GSA trends reveals, however, that the real estate industry should still benefit substantially from the DHS's creation.
DHS Spurs Job Growth
The creation of the DHS has broader real estate implications than merely the location of its headquarters site — it calls for the most significant reorganization of the federal government since World War II. This reorganization inevitably will lead to an expansion of the budget and mission of the agencies under the DHS umbrella, which will lead to more government personnel and increased government demand for office space. Within the DHS, there will be four major divisions, or directorates, including: border and transportation security, which will be home to the Transportation Security Administration (TSA), U.S. Customs Service and the former Immigration and Naturalization Service; emergency preparedness and response; science and technology; and information analysis and infrastructure protection.
Any governmental component within these divisions, and any contractor or private sector industry that supports them, likely will experience significant demand for additional office space. Although the D.C. market is probably the greatest beneficiary of this growth, developers and owners in other GSA markets also should find new opportunities.
In fact, the creation of the DHS should only accelerate a trend that became apparent in the D.C. office market in 2002 — that the government can be a major stabilizing force in the face of otherwise tepid demand. Studies have demonstrated that in the Washington area, the federal government created more net jobs in 2002 than most other industries combined. This growth translated into more demand for government office space and opportunities for developers to provide that space.
For example, GSA deals comprised many of D.C.'s largest transactions in the fourth quarter of 2002, including a 480,000 sq. ft. lease signed by the Transportation Security Administration for two buildings in the Pentagon City submarket in Arlington, Va. The Securities and Exchange Commission leased an additional 360,000 sq. ft. at Station Place, adjacent to Union Station in D.C. More GSA leasing activity is slated for 2003 and may lead to further opportunities for landlords.
Capitalizing on Opportunities
So how does an owner of an office property market its space to take advantage of the DHS and other increased GSA activity? As may be expected, the marketing, structuring and negotiation of federal real estate agreements are very different from private sector deals.
The GSA follows a well-defined process in accordance with applicable regulations, involving extensive portfolio planning, establishment of an acceptable delineated geographic area for the location of particular agencies, and approval by the Office of Management of Budget. When structuring real estate agreements, the GSA often requires the following:
the landlord retains most of the responsibility for maintenance of the building; increases in operating expense pass-throughs are based on a Consumer Price Index rather than actual increases;
the GSA has the right to terminate the lease after a fire or other casualty; and
the government has broad rights to make alterations to the building structure and systems.
If private owners can meet these GSA criteria, the creation of the DHS and other related government expansion may represent an uncommon opportunity. The decision to locate the initial headquarters on government land did not close the book on the potential for future DHS and GSA transactions.
Robert MacKichan, top, is counsel, and Adam Walsh is an attorney, in the Washington, D.C., office of Powell, Goldstein, Frazer & Murphy LLP. MacKichan is a former general counsel of the General Services Administration. For more information, visit www.pgfm.com