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General government > 21. Financing of Improvements to Federally Leased Space

In order to achieve millions in potential cost savings, the General Services Administration should explore the benefits and risks of loaning unobligated Federal Buildings Fund balances to tenant agencies to cover the costs of improving newly leased space, which would otherwise be financed by private lessors at private-sector interest rates.

Why This Area Is Important

Within the federal government’s portfolio of civilian real property holdings—which costs billions of dollars annually to rent, operate, and maintain—the General Services Administration (GSA) plays the role of broker and property manager to many civilian agencies. Although some agencies have independent authority to lease real property, others lease space through GSA. As of fiscal year 2014, the most recent year for which GSA published portfolio information, GSA had a total of 377 million rentable square feet of space in its inventory—slightly more than half of which was leased from the private sector.[1] Due to complex and long-standing issues related to the federal government’s management of real property, including an overreliance on leasing of privately-owned space in situations where ownership for stable agency needs would be more cost- efficient in the long run, the issue remains on GAO’s high-risk list.[2]

Because leasing is likely to be a stable or growing part of agencies’ building portfolios—due in part to capital limitations—it is important to identify opportunities that could increase the efficiency of the GSA leasing process and result in federal cost savings. One such opportunity would be to reduce the amount of interest that agencies pay to private lessors to cover the costs of improving newly leased space.



[1]GSA’s government-owned properties constitute the remaining 183 million rentable square feet in the Public Buildings Service portfolio. GSA Public Buildings Service, FY2014 State of the Portfolio (Washington, D.C.: 2014).

[2]GAO, High-Risk Series: An Update, GAO‑15‑290 (Washington, D.C.: Feb. 11, 2015).

What GAO Found

In January 2016, GAO found that new GSA leases often involve costs related to the customization of a space for an agency to fulfill its mission, such as changes to walls, electrical outlets, and secure rooms. These changes are made by a lessor—typically the private-sector owner of a property—between GSA’s execution of a lease and the point when a tenant agency takes occupancy. These tenant improvement costs are usually amortized over the term of the lease and are paid by the tenant to the lessor through GSA. Tenant agencies can fund these costs in two ways: (1) pay for the improvements at the outset, prior to moving into the space, when negotiations between GSA and a property owner permit,[1] or (2) amortize the costs of the improvements over time, during the lease, with costs being financed by the property owner.

GSA regional officials have stated that nearly all tenants choose to amortize their basic tenant improvements over the firm term of the lease, and GAO’s January 2016 analysis of GSA leases supports this assertion.[2] Nearly 60 percent of leases in a sample of 4,285 leases analyzed by GAO involved tenant improvement costs, and all of these tenants opted to amortize at least some of these costs during the lease. Because private owners that lease to the federal government assume this responsibility and obtain the resources required to construct, operate, and maintain the space being altered, they charge federal agencies private-sector interest rates over the firm term of their GSA lease.

The federal government’s overall cost of leasing space increases considerably when agencies opt to amortize their tenant improvement costs instead of paying them at the outset. When agencies amortize their tenant improvements during their lease, they pay substantial sums to private lessors in the form of interest based on the rates that GSA negotiates with private lessors on agencies’ behalf. In this approach, tenant agencies pay the principal, interest, and additional GSA fees—either 5 or 7 percent—typically over the firm term of the lease.[3] Nine of the 11 leases GAO reviewed in detail had tenant improvement costs, and more than one-third of the improvement costs will be due to interest fees over the lease term, as the tenants in all 9 cases amortized these costs. In total, these 9 leases will incur a total of $39 million in tenant improvement costs, of which nearly 40 percent ($15 million) will be due to interest paid to private lessors. For example, in one lease GAO reviewed, the tenant agency chose to amortize its $2.1 million of tenant improvement costs over the life of a 15-year lease at a 9 percent interest rate, which will ultimately cost $4.0 million after including both the $1.7 million to be paid in interest charges and GSA’s 5 percent fee on those charges. The agency could have saved 45 percent, more than $1.8 million, over the term of its GSA lease if these costs had been paid at the outset. Additional examples from GAO’s analysis are illustrated in the figure below.

Total Tenant Improvement Costs If Not Paid at the Outset of the Lease for Three Selected General Services Administration (GSA) Leases Executed between 2000 and 2014

Total Tenant Improvement Costs If Not Paid at the Outset of the Lease for Three Selected General Services Administration (GSA) Leases Executed between 2000 and 2014

 

Although GSA officials stated that agencies typically lack the resources to fund improvements at the outset of a lease, opportunities may exist to reduce overall federal leasing costs by identifying funds to reduce the amount of interest paid to private lessors. The Federal Management Regulation states that the basic real estate acquisition policy is to acquire real estate in an efficient and cost-effective manner.[4] GAO reported in January 2008 that lack of capital to finance real property investments has been a long-standing challenge for GSA and other federal agencies.[5] However, identifying sources of capital to fund tenant improvement costs at the outset of leases would reduce federal agencies’ costs.

One possible option to reduce the costs paid by tenant agencies could be to provide budget authority for GSA to finance the capital needed for tenant improvements to be paid at the outset of a new lease and have the tenant pay it back over the term, without the private interest charges that tenant agencies currently pay. GSA could potentially use available balances from the Federal Buildings Fund (FBF) to fund tenant improvement costs, with sufficient controls in place, at the outset of a lease. The FBF is administered by GSA and was established in 1972 as the primary source of funds for operating and capital costs associated with federal space. GSA collects rent from tenant agencies, deposits it into the FBF, and uses that money—as authorized by Congress—to fund real property acquisition, operation, maintenance, and disposal. The FBF has contained unobligated balances for several years and, as of February 2015, the fund had an unobligated balance of $3.6 billion.[6] However, GSA does not currently have the budget authority to use the unobligated balances in the FBF to fund tenant improvements. GSA officials said that the concept of funding agencies’ tenant improvements using unobligated FBF balances has potential, but they also said that GSA has not formally considered this approach. They said that applying unobligated balances in this way has the potential to save substantial amounts of money on interest charges that are currently passed on to federal tenants, but that the potential risks and opportunities would need to be fully studied.



[1]One tenant agency stated that GSA does not always permit them the option to make a lump sum payment for their tenant improvements; they said this is dependent upon the stage of GSA’s negotiations with the property owner.

[2]Many GSA leases have a “firm” and “soft” term. While GSA considers 80 percent of the 4,258 leases GAO reviewed to be 10-year leases or longer, many of these leases have a 5-year guaranteed (“firm”) term followed by an optional (“soft”) term. GAO found that 70 percent of the new GSA leases analyzed, finalized from 2008 through 2014, have firm terms of 5 years or less. The private sector views leases structured in this way as 5-year leases because that is the only part that is guaranteed.

[3]Included in federal agencies’ monthly rent is a monthly fee to GSA for its services related to leased space; as of 2015, tenants paid 5 or 7 percent of their lease value in a fee to GSA based on the level of flexibility the agency had in canceling the agreement. GSA officials told GAO that this fee is 7 percent when the ability to cancel the occupancy agreement prior to lease expiration—with a 120-day notice—is included in the occupancy agreement and 5 percent when it is not. Space is deemed to be non-cancelable when there is a low probability that the Public Buildings Service would be able to find a backfill tenant due to specific qualities of the space. GSA guidance states that the agency reviews each space assignment and uses certain specified criteria to designate space as cancelable or non-cancelable.

[4]41 C.F.R. § 102-73.10.

[5]GAO, Federal Real Property: Strategy Needed to Address Agencies’ Long-standing Reliance on Costly Leasing, GAO‑08‑197 (Washington, D.C.: Jan. 24, 2008).

[6]As GAO reported in 2012, this balance has primarily resulted from the growing difference between the resources deposited into the FBF and use of these funds as determined through the budgeting and appropriations process. Specifically, the total available balance is a function of the resources deposited into the fund, the amount of obligational authority requested by GSA as part of the President’s Budget Request, and the actual obligational authority provided by Congress. See GAO, Federal Real Property: GSA Could Decrease Leasing Costs by Encouraging Competition and Reducing Unneeded Fees, GAO‑12‑646 (Washington, D.C.: Jan. 13, 2016).

Actions Needed

GAO recommended in January 2016 that the Administrator of the General Services Administration take the following action:

  • Explore, with relevant stakeholders, the possibility of loaning unobligated Federal Buildings Fund balances to agencies to cover tenant improvement costs that would otherwise have to be financed for new leases. If GSA finds that, with sufficient controls in place, tenant improvements can be safely funded this way, it should participate in the development of a legislative proposal to request that Congress make the necessary budget authority available.

If GSA determines that it could safely loan unobligated FBF balances to cover tenant improvement costs for new leases that would otherwise have to be financed at private-sector rates by the owner, it could reduce costs. GAO’s review of nine GSA leases involving tenant improvement costs found that these leases will incur $15 million in interest fees to be paid to private owners—nearly 40 percent of their tenant improvement costs. The magnitude of potential government-wide savings depends on the future amount of tenant improvements. For this reason, GAO has not yet quantified the potential financial benefits associated with the recommended action.

How GAO Conducted Its Work

The information contained in this analysis is based on findings from the report listed in the related GAO products section. GAO contracted with a real estate consulting firm chosen through a competitive process to compare a sample of GSA leases executed between 2008 and 2014 with private-sector leases of similar location, size, and quality in the same markets during the same period to assess the extent to which GSA achieves market leasing rates. GAO also assessed how GSA’s cost estimates compare with the actual costs of leasing paid by federal tenants by analyzing documentation and estimating the actual costs for a non-generalizable selection of leases from each of GSA’s 11 regions. GAO also interviewed key GSA staff for all selected leases, interviewed officials from GSA headquarters about its leasing process, and interviewed officials from all 11 GSA regional offices, as well as two tenant agencies represented in the sample.

Agency Comments & GAO Contact

GAO provided a draft of its January 2016 report to GSA. In response, GSA agreed with GAO’s recommendation to seek to reduce tenant agencies’ interest costs, stating that it would evaluate its existing authorities to determine whether it is able to loan unobligated FBF balances to agencies to cover tenant improvement costs for new leases, which would otherwise have to be financed. GAO continues to track GSA’s actions related to this recommendation.

GAO provided a draft of this report section to GSA for review and comment. GSA did not provide comments on this report section.

For additional information about this area, contact Dave Wise at (202) 512-2834 or wised@gao.gov.

 

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