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What makes a government real estate transaction succeed? The most important element is a strong team of real estate experts who understand the business aspects of the transaction, the nuances of government procurement, and the concerns of private landlords and federal tenants. To manage these various factors, the federal government in recent years has turned to the private real estate community. Outside real estate advisers (including my law firm, Kilpatrick Stockton) have helped to bring the private sector’s time frames, sense of urgency, innovation, responsiveness, and accountability to the government’s processes. RULES OF THE DEAL Federal real estate procurements are not completely different from private real estate transactions, of course. For example, any real estate deal needs to take into consideration issues of size, location, term, program needs, occupancy date, and cost. At the same time, there are elements particular to the real estate needs of the federal government. At each step of the way, private-sector advisers can bring useful expertise to bear. The typical General Services Administration solicitation has requirements covering safety (including fire and seismic), security, environmental protection, labor, small business subcontracting, insurance, and other financial controls. In fact, the GSA currently lists 26 public laws and seven executive orders governing its real estate acquisitions. Offers must be analyzed in light of these federal mandates. In addition, the federal government imposes budgetary and obligation rules and limitations. A special challenge is the analysis of what are called “scoring” issues based on Office of Management and Budget rules. Scoring rules determine whether a real estate transaction is a capital expenditure or an operating expenditure � a distinction that has significant financial effects. A capital lease, for example, would require the GSA to budget the entire cost of a multiyear lease in the first year of the lease, even though actual outlays would be spread throughout the lease term. An operating lease would allow the rental payments to be budgeted throughout the lease term. A lease must have the following six criteria to become an operating lease: Ownership of the asset remains with the lessor; the lease doesn’t contain a bargain-price purchase option; the lease term does not exceed 75 percent of the estimated economic life of the asset; the present value of lease payments does not exceed 90 percent of the fair market value of the asset; the asset is a general purpose asset and is not built to unique government specifications; and there is a private sector market for the property upon lease expiration. If it violates any one of the six rules above, it becomes a capital lease. In negotiating a government lease, care must be taken to ensure that the risk of ownership remains with the owner. The government cannot provide financing or guarantees. If the GSA were forced to score, or account for, the unobligated portion of all leases in effect in the Washington, D.C., metropolitan area, the price tag would exceed $16 billion. As it is, the GSA’s annual rent bill in the region is about $1.37 billion. Another complication in government leasing is the involvement of multiple stakeholders. Besides the GSA and the tenant agency itself, other executive branch officials and the congressional authorizing and appropriating committees that oversee the GSA and the tenant agency have a significant say. The wisdom of relocating agency headquarters will certainly be discussed in congressional committees and can even arise during floor debate in the Senate and House. Votes on agency budgets may be held up by members of Congress seeking to delay or prevent a particular procurement. If an agency can’t convince Congress to continue to allocate funds for a planned relocation, already rented space could sit unused. Once a real estate procurement takes place, private-sector experts in the area of post-award services can come into the picture. They can complete the documentation necessary to support the award, handle changes during the move, and organize and implement the approach to lease administration, which might include future tenant improvements. They can also work on matters of taxation, prompt payment, and operations. PRIVATE BROKERS In order to fulfill the government’s need for leased space, the GSA has turned to broker services from the private sector. Based on an idea first proposed in 1988, the GSA awarded eight contracts for real estate broker services nationwide in 1997. Later, the government awarded other regional contracts. By 2004, more than 32 contracts were in place for regional broker services. Now the GSA is in the process of converting the regional broker contract concept into four national broker contracts to provide a uniform level of service to federal agencies. Without any increase in the GSA’s existing lease inventory of about 166 million square feet, each of the four brokers could find itself managing approximately 100 real estate transactions annually, involving 3 million square feet of space. Together with the commercial real estate firm of Studley Inc., Kilpatrick Stockton is poised to begin work for the GSA as one of those four national brokers. Neil Levy, partner and head of the real estate practice group in the D.C. office of Kilpatrick Stockton, calls the field of federal real estate “one of the most challenging transactional arenas these days.” “You only have to look at the national brokerage contract and some of the other projects under consideration in the federal leasing environment to know that we are looking at a new world,” says Levy. LONG-TERM RELATIONSHIP While the national broker designation is a new development, the Kilpatrick-Studley team has been advising the GSA for some years. In 1997, the GSA hired the two firms to prepare a congressionally requested report on the relocation of the Department of Transportation’s headquarters. After the GSA delivered that report to Congress, the House and Senate committees authorized a 20-year operating lease at up to $55 million per year for a new DOT headquarters. The GSA then hired the team to represent the government in the lease procurement. The resulting procurement, an $850 million lease for 1.35 million square feet of office space, was the largest single broker-tenant transaction ever in the District. The lease was signed in 2001, and the project is scheduled to be finished in 2006. It also was the first Cabinet department headquarters procurement in 35 years. The key to its success was convincing the private marketplace that the procurement would actually take place. Previous attempts to relocate the DOT had failed, so when the procurement was first announced, many landlords were skeptical about the government’s ability to deliver. David Lipson, executive managing director of Studley, points to one simplification of the process as key to the deal’s success: Instead of the government’s typical approach of requiring a complete design of the building before the lease would be awarded, developers were allowed to propose a budget for the project without submitting a building design. The winning bidder then designed the new DOT construction. NEW HOME FOR CENSUS Kilpatrick also had a hand in another giant GSA project. Recently, the GSA sought to buy new space for the U.S. Census Bureau. This project called for federal construction on federally owned land. Richard Barnett, Kilpatrick’s director of government relations, notes that the prospectus � essentially the financial information developed by the GSA � can be the key to whether the construction project succeeds. Only when all of the relevant government entities agree on the prospectus, he says, “can the steps in the process fall into place.” When the GSA initially went forward with a proposal that authorized only 750,000 square feet of space for a new building, Census felt the plan was insufficient and would take too long. The bureau, working with a team of private real estate professionals, including Kilpatrick, procurement experts, and advisers, quickly put together an alternative plan. Six weeks later, Congress gave the go-ahead. That meant the original stakeholders had to be persuaded to support the revised plan, including the OMB, the administrator of the GSA, and the commissioner of the GSA’s Public Buildings Service. The revised plan, which the GSA agreed was less costly and would save two years in delivery of the needed space, calls for new construction of 1.5 million square feet of office and related space, plus parking for 3,100 cars in two structural garages. Total price for the project, currently under construction at the Suitland Federal Center in Maryland, is estimated at $330 million, including design, management, and construction. In the current environment of budget constraints, downsizing, and outsourcing, the federal government will need to continue to explore innovative and multidisciplinary approaches to real estate transactions. Together with private advisers and new authority, the government has already begun exploring the use of public-private partnerships and alternative forms of leasing as new ways to finance federal space requirements. “GSA and the federal government are more accepting of the private sector as a valued contributor of expertise and skills in real estate procurement,” says Levy. “We expect significant growth in this area in the years to come.” Kathy B. Cowley is a senior associate in the D.C. office of Kilpatrick Stockton, focusing on government contracts. Previously, she was with the Department of the Navy’s Office of General Counsel. She can be reached at [email protected].

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