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GAO: Owned Federal Space More Cost-Effective Than Leasing

Not Everyone Agrees With Oversight Agency Findings Suggesting That Acquiring Rather Than Leasing Buildings Is A Better Strategy For Govt, But Current Rules Are Resulting In Glut of Costly Leased Space
September 21, 2011
Federal budget scoring rules make acquiring buildings more difficult even though owning property is often more cost effective than leasing, the Government Accountability Office (GAO) found in a report. As a result, federal agency tenants have over-relied on costly leased space to meet expansion needs in recent years.

Many of the 900,000 buildings in the federal real estate portfolio are leased from private-sector owners -- often at costs that would exceed what the government would pay for owning the building, David J. Wise, GAO director of physical infrastructure issues, recently testified before the Senate subcommittee on Federal Financial Management, Government Information, Federal Services and International Security.

The GAO has shown federal building ownership often costs less than operating leases, particularly for long-term space needs, and could often save millions of dollars. However, decisions to lease rather than own space are often driven by budget-scoring issues rather than long-term cost-effectiveness.

Under current federal guidelines, departments and agencies must record the acquisition cost of a building fully up front in the budget. In contrast, leases executed by the General Services Administration (GSA), the central leasing agent for most agencies, only require budget authority to cover the annual lease payments.

In California last year, Gov. Jerry Brown used a similar rationale, that owning buildings usually saves money over the long term, to cancel the planned sale of 11 state buildings as a budget shortfall solution by his predecessor, Arnold Schwarzenegger. Brown called the sale and planned leaseback of the buildings a shortsighted move that would cost taxpayers $6 billion over 35 years.

GSA leases more than 8,000 assets and since 2008, it has leased more space than it owns. In fiscal year 2010, the government leased a total of 191 million square feet compared to 179 million square feet of owned space. This reliance on leased space was among several factors that led the GAO to designate the management of federal real estate as a "high-risk area," prompting the Obama Administration in May 2011 to propose the Civilian Property Realignment Act (CPRA) to reform federal property management and disposal regulations. Different property reform legislation has also been introduced in the House of Representatives.

"Building ownership through construction or purchase is often one of the least expensive ways to meet agencies’ long-term requirements," Wise said. "Alternatively, operating leases, in which periodic lease payments are made over the specified length of the lease, are often the most expensive way to meet long-term space needs."

Wise noted in testimony and in the report that GSA has relied heavily on leases to meet new long-term needs because it lacks funds to acquire buildings. In 2008, for example, the GAO reported that if the government had pursued ownership for the FBI building in Chicago instead of an operating lease, it could have saved $40.3 million over 30 years.

In certain situations, such as the Commerce Department’s cyclical growth due to the short-term needs of the Census, leasing makes more sense, GAO acknowledged. Operational requirements such as immediate space needs, security requirements, or a desire for flexibility, as well as short-term or smaller space needs, are other examples of where leasing may be more advantageous than ownership.

For instance, Hurricane Katrina damaged more than 200 GSA-owned and leased buildings in 2005, necessitating the relocation of 2,600 federal employees from 28 agencies, many of which were GSA tenant agencies. GSA expanded its use of leases to fill the short-term need.

However, in general it's more fiscally prudent to own buildings, Wise said. GSA’s goal is to break even on the administrative costs of the facilities it leases from private-sector owners, but recent years have seen significant losses, raising concerns about the agency’s management of its leases.

Under current rules, tenant agencies pass lease payments plus a fee to GSA, which retains the fee and then passes the lease payment on to the private sector owner. However, GSA losses within its leased portfolio increased dramatically to $102.9 million in fiscal year 2009 before falling to $64.8 million in fiscal year 2010, according to GAO.

GSA told the accountability office that the losses are partially attributable to the differing accounting treatment of rent payments and fees in financial statement reporting requirements, but GAO maintains that the agency should still be able to cover the extra costs with the fee it charges tenant agencies.

Kurt Stout, head of the government services group with Colliers International, contends that GAO is making an unfair comparison. He noted that GSA-leased properties are generally newer, of higher quality and often more efficient than owned buildings, and often allow much more flexibility in terms of expansion and operations.

Also, GSA’s lease structure puts substantial risk on property owners, inflating leasing costs. In an ownership situation, those risks would reside with the government.

"If GSA wanted to reduce leasing costs they could do it with the stroke of a pen: agree to execute triple-net leases and eliminate termination rights," according to Stout.

"There are certainly good reasons for the federal government to own property. But there is a reason most of corporate America leases space," Stout said. "It provides flexibility to acquire space quickly, in blocks that are right-sized to interface with government needs. It’s a protection for the federal government against capital expenditures, which tenants don’t have to pay for."

Comparing costs for federally owned space to leased space is an apple-to-oranges exercise, Stout said. Ironically, federally owned buildings are on average 45 years old and so inefficient in space and energy usage that many would not quality for a government lease under its own Energy Star or seismic requirements.

"GSA doesn’t have the flexibility to negotiate creatively. They have to treat every landlord the same when they negotiate. If I were a corporate tenant and I thought I might have future expansion needs, or want to downsize in the future and have the flexibility to ensure I’m not overpaying for space, I could negotiate to match my goals with those of each of each individual landlord," Stout said.

"That sort of flexibility does not exist in the federal leasing process. If the government were to focus on changing that, they could reduce costs."
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