Podcast - Trending Topics in Federal Real Estate, Part 1: What Makes Government Leases Unique

Jeffrey Calk: Welcome to Holland & Knight's "Real Estate Law Unlocked" podcast series. This episode is "so you want to be a landlord to the federal government and basics you should know." This will be one of two episodes that we will be talking about and when we deal with doing business with the federal government, either as a tenant or as perhaps a seller. My name is Jeff Calk. I'm a partner in Holland & Knight's Real Estate Practice section in Nashville. It's my privilege to be joined by my law partner, Gordon Griffin. Gordon is officed in our Washington, D.C., office. So Gordon, welcome. Give us a brief introduction, and let's launch into what we'll be talking about today, in particular what you need to know when you're a landlord to the federal government or its agencies.

Gordon Griffin: Jeff, thank you very much for the introduction. For the folks listening at home, my name is Gordon Griffin, and I am a partner here in the D.C. office. I am also the chair of our federal real estate practice. At Holland & Knight, we have, [I'm] not trying to be overly modest here, I think we have hands down the broadest and most robust federal real estate practice in the country, but I'm really proud of our team and all that we do. But for the purposes of today's call and podcast, I'll note that my practice is on federal leasing. I work with landlords, developers, real estate investment trusts (REITs) and really anyone else who is involved with the buildout and leasing of commercial real estate to the government. Now, that's typically office space, but it can also be warehouse space, ware yard space, especially medical space when you're dealing with the Department of Veterans Affairs. And oftentimes it'll be office space with Sensitive Compartmented Information Facilities, or SCIFs, that can handle classified materials and information. As the single largest tenant and the lessee of commercial office space in the United States by orders of magnitude, the federal government really has the ability to influence local markets and to provide uniquely high-credit tenants whose rental streams are guaranteed by the full faith and credit of the United States. But as we're going to note today, those opportunities come with a number of strings attached, and landlords should really go into these opportunities with their eyes wide open. I've been practicing in this space for well over a decade now. I'm the co-author, along with one of my former colleagues, of the Federal Real Estate Leasing Guide by LexisNexis and currently on the board of the Federal Real Property Association, which is one of the trade associations that focus on federal real estate.

Jeffrey Calk: Very good. Thank you, Gordon. So Gordon, I'm a lot older than you. I've been practicing since 1991 and since '93 have been focused solely on healthcare real estate and real estate generally. And from time to time, I have been involved in a transaction where the client will buy a commercial office building – could be a medical building – and we are reviewing leases and we discover the Veterans Affairs (VA) or some other federal agency is a tenant, and our private clients will say, and I will say, "Oh no, how do we get out of that?" Just because you look at the lease form and it has all these provisions that are not normally in a market lease, and they're almost regulatory, almost promulgated language, and it just makes buyers and new landlords uncomfortable because they have to take the round hole and plunge it into a square hole, you know, whatever it is, and it's just a challenge. So, from your perspective, tell us about what we need to know, or give us some principles that we need to know as a landlord, as you do business with the federal government. And I will just say, my former firm, Waller Lansden, joined Holland & Knight in 2023. And whenever I came across issues involving the federal government as a tenant or whatever, we just kind of made do, you know? But I was awakened when we came to Holland & Knight that there are folks like yourself with extensive experience and understanding about how you deal with the federal government or what are the consequences of dealing with the federal government. And that's what I want to highlight today. But Gordon, give us some principles.

Gordon Griffin: Yeah, absolutely. And first, Jeff, I'll tell you, your reaction to federal real estates is, you're in good company. There are plenty of folks out there who see a building with federal tenants and they run in the other direction as fast as they can. And there are some reasons for that. There are some just really challenging and unique aspects to having the government as a tenant in your building. But there are a handful of principles that you can rely on that will help you at least stay close to a safe harbor when you've got the federal government in your building. The first one I'd tell everyone when they're getting into this for the first time, when they are considering buying a building that has a tenant or they're considering a competition for a new opportunity for the government, the first thing you've got to understand is you're not going to be using your own lease form. You're going to be stuck with the government's standard template form, which for most leases is going to be a GSA or General Services Administration form called the L100. The reason for that is statutory. In the background of all of government procurement, whether you're buying tanks or airplanes or paperclips, or getting a lease for office space, you are going to be stuck working under the rubric of the Competition in Contracting Act, or CICA. Now, that means that they have to do everything they can on the government side to ensure there's a fair competition. And for leasing, what that means is everyone is going to be competing with the same terms and conditions for a lease, the government terms and conditions, and the award decision's going to be made on price. That makes it as even a playing field as they can get to. So you're stuck with that L100 form more or less no matter what.

So with that in mind, principle number two: Be aware that there are going to be things in this lease that you are not accustomed to that really have nothing to do with the actual space that you're leasing. The government implements a lot of its policy decisions through contract terms. Again, not just leases, but also if you're buying airplanes or paperclips, that they put a lot their policy goals into the contract terms, and what that means is you see a lot of social/economic requirements. You see a lot of cybersecurity. More and more, you're seeing things like supply chain security. So when you're building out a space, there's going to be restrictions on which supply chains you can use. Can you take products that have an original manufacturer based in China? Well, if it's for telecom equipment or security cameras, probably not. So understanding what those requirements look like up front is really important. Understanding that most of those are statutory and you can't get out of them, is important as well. And I'll highlight one of those sort of unique issues you're going to deal with. The government more and more wants to know exactly who it's doing business with. So you're probably going to have to disclose, particularly if you're a high-security space, whether you've got foreign ownership or foreign financing associated with your building, or really anywhere in your ownership structure. So understanding those up front is important. The good news, again, just like with the L100 form, all these government terms and conditions are publicly available already. You already know what they're going to be asking for. They're published on GSA's website or, if you're dealing with another federal agency, they'll be on their website as well. And most of them are statutory. So you can look up the GSA form L100. You can look up at the general clauses, which is the GSA Form 3517B. And you can really understand just what you're getting yourself into. A lot of these requirements are implemented through a couple of regulations called the Federal Acquisition Regulation, the FAR, and the General Services Acquisition Regulation, the GSAR. So understanding what those FAR and GSAR requirements are and what those compliance obligations are up front will really allow you to better prepare yourself and more effectively price your leasing.

Moving on, number three: Be aware that there's some mechanical and logistical issues with getting the federal government to implement a lease, to sign a lease and to start paying rent. The single biggest hurdle – a bar to entry, if you will, for people trying to really just sign on the dotted line, get the lease executed, they've already decided they're going to do this, now they're just kind of dealing with the administrative mechanics of doing so – the single toughest thing people deal with is the government's online portal for registration called SAM.gov. It stands for System for Award Management. It is the definition of a clunky, confusing, difficult website. And unfortunately, it's also fraught with peril. If you make a misrepresentation or a foot fault on there and the government awards you a lease based on that representation, well, there's a risk of fraud there. So you've got to be careful. You have to understand what you're doing. I think the biggest takeaway for this really is understand that it's out there, that you have to get your entity up and running first, you have get yourself registered in SAM.gov, and it's going to take a couple of weeks and some real soul searching and head scratching as you go through the process. So understand that SAM.gov requirement, understand that it's going to take a while to get the lease signed and get rent flowing your direction. One more little bullet on that, the government does pay rent in arrears. So you're always going to be paid, there's something called the Anti-Deficiency Act out there that says they can't pay for something they haven't received. So they pay for the month prior on the first business day of the following month.

Principle number four: If you sell your property, or you purchase a property leased to the government, you can't assign a lease automatically. Typical commercial lease, there's a notice of assignment, assumption of leases. It's really just sort of paperwork drill and notice provided. And the tenant recognizes the new landlord and everyone goes about their business. Well, the federal government doesn't do things quite so simply. There's something called the Anti-Assignment Act out there that prohibits the assignment of government contracts. Like a lot of rules on the government side, great intentions behind this. It was tried to prevent fraud or people from acting as fronts and then assigning them to someone else. That's great. The reality is it creates a pretty big paperwork drill and headache for people trying to buy or sell. Now, the good news is these things are approved well over 99 percent of the time. The bad news is you have to understand when you sell or buy a building with a government tenant that it's going to be about a three-month process post-closing before you can actually get recognized as the landlord and before you have rent start coming directly to you. So, putting a consideration for that and that obligation to forward rent into the purchase agreement is really vital when you're dealing with government tenants.

So number five, tenants' right to terminate. There's good news and bad news story to this one. One of the most enticing things about having a government tenant is those leases are backed by the full faith and credit of the United States government and they can't get out of the lease, at least if it's with GSA, during the firm term. GSA has a special statutory authority that allows it to go up to 20 years in lease term. And when you're in that firm term of a GSA lease, they can't get out of it except for default or casualty, meaning the building is unusable due to a fire or flood, or it's a landlord defaults on their obligations. Those are the only two outs for the federal government during the firm term. If, however, there is some issue with performance, for example, and we see this, unfortunately, more and more in the current distressed market, a building will be purchased without a full understanding of just what those operating costs look like, particularly if it's sort of a specialized space like a VA medical space. Operating costs far exceed the budgeted amounts because inflation has been pretty substantial in 2022, 2023. So if the lease was signed in 2017, 2018, 2019, the lease could be underwater, at least from an operating revenue perspective, pretty easily in a lot of these cases. So if the performance starts to lag, if janitorial services aren't being provided, if there's a problem with mechanical/electrical/plumbing that isn't remedied, the government can terminate your lease. And here's a real kicker. When they terminate their lease, if they find a follow-on lease, someone else to replace you, and it's more expensive than your option, you're on the hook for the difference. So they have some real levers to pull and some real leverage on landlords to perform in these government leases.

Finally, number six, and this has been a really tricky one lately because the government has let go so many people and a lot of the administrative backlog has grown on the government side. The sixth principle is be aware that you cannot evict the federal government. I could put a period dot there, stomp on the ground, put an exclamation point behind it. If they stay past their lease expiration, they're going to keep paying rent at the rate they were the last month before the lease expired, but you can't kick them out. There is a legal issue of sovereign immunity that has been litigated in the courts, that has been definitively decided time and time again. Basically, you can't get rid of the federal government. And if they decide to stay, they're going to stay. So it's best to work with them to try to find out what they're going to be doing a couple of years before their lease expires. Find out if there's a succeeding lease opportunity. If not, do everything you can to help them move so you can reposition the asset. I will stop right there – I have given you six principles – and turn it back over to Jeff for any more questions.

Jeffrey Calk: Yeah, great job Gordon, very helpful. Let's go back and explore some of the principles. We talked about the federal government's requirement that you use their form. In the course of let's call negotiating that lease, if I'm the landlord, who am I going to be negotiating with or discussing the lease with? Will it be a government lawyer? Will it be the contracts administrator for GSA? Who will I be talking to?

Gordon Griffin: That's a great question and actually a really important point, Jeff. The only person out there with statutory authority to bind the government and contract and to obligate funds, so really the only person who can really negotiate and really commit to any sort of lease term exception or deviation from the standard terms, is an individual who has the title contracting officer. So that's the individual that can actually sign the dotted line and then accept any sort of changes to their template form if you're negotiating terms of the lease. And again, as we discussed, you're stuck with their forms. You're kind of negotiating around the edges. You might be able to get a little bit here and there. It's not going to be substantive, huge sweeping changes to their lease form. So if you want to make these changes, the person who has to buy off on it at the end of the day is the contracting officer. And if you try to get a competitively awarded lease, every exception you take to a lease term, you know, sort of puts a little bit of a ding on your proposal, right? It makes it a little tougher for them to award it to you, even if you have the lowest price. So, understanding the risk of taking those exceptions and understanding the only person that can actually obligate the government is that one individual. You may have an attorney involved, it may actually help to sort of talk through what's legally permissible, but at the end of the day, the person who signs the dotted line is that contracting officer.

Jeffrey Calk: Very good. We talked about how it can be a slow process to get in the federal government's accounts payables department. And I guess I'm just trying to think about timing. If I buy a building and it has the postal service or it has a VA as a tenant, and post-closing, I then begin trying to get filling out the quote paperwork that needs to be filled out to become the new landlord receiving payments, how long would you expect that to take?

Gordon Griffin: Oh, well, I will tell you this: Do not wait until closing at all. The second the purchase agreement is signed, typically you're going to take possession with a Special Purpose Entity (SPE), right? The second that SPE is actually formed and existing in whatever jurisdiction you're in, start the registration process in SAM.gov. Start going through that process. Because that process is without a doubt the longest lead turn item in the whole novation process. So you've signed a purchase agreement, the seller has got a federal tenant in the building, you start working through your SAM.gov during that sort of, that review period. Ideally, your SAM.gov is up and running at closing. If that's the case, if your SAM.gov is up and running at closing, that novation, if you've got someone who understands the process working on your side, you can do it in three or four weeks sometimes, if you've got someone in the government who's being responsive. If you have not started your SAM.gov, it's going to be more like three months.

Jeffrey Calk: Very good. I guess really my last question is more in terms of what the ability the government has to terminate a lease. You talked about for non-performance by the landlord, they have some rights to terminate. What I've seen typically in government documents, particularly federal, there's this provision that it's all subject to money being approved by Congress or I forget what the term is, but funds have to be, what's the right word?

Gordon Griffin: Subject to annual appropriations.

Jeffrey Calk: Appropriated. Your funds have to be appropriated. And you're like, well, that's not very comforting. You only have to pay us an honorary release if someone else cuts the check for you. What does that really mean? And is that just window dressing to say, hey, worst things that can happen, we could shut down this agency. What does that as a practical matter really mean?

Gordon Griffin: Well, I can tell you, before the current administration, as a practical matter, it meant almost nothing. Things have changed. And we have some very high-profile cases out there in the public domain, people are aware of, where leases that were subject to annual appropriations have been terminated because the federal government elected to shave down those agencies to the maximum extent allowable by law. I'm going to take a step back to answer your question briefly, though. The reason that General Services Administration figures so prominently in federal leasing is because they have a unique statutory authority. I mentioned earlier the Anti-Deficiency Act. That is the reason that most government agencies can't actually obligate past the current fiscal year. So every multi-year lease is subject to annual appropriations. You see a lot with Army Corps of Engineers leases. You see it with some VA leases. There's that language in there that says, we're going to commit to a 10-, 15-, even 20-year term. But it's really a one-year term with 19 option years, subject to annual appropriations. GSA does not have to do that. GSA can actually commit to an up to 20-year firm term. So that makes the GSA leases significantly more palatable, particularly to lenders who are looking at this. Now, as a practical matter, I think it's important to understand this. There are those agencies that, with their own leasing authority, like the Army Corps of Engineers, and a couple of others out there, that are subject to annual appropriations. It's a case-by-case basis, but as a general proposition, if they do commit the funding to build out a space for themselves – for example, the Army Corps of Engineers, they got very specialized spaces in a lot of these locations because they have very unique missions. They're monitoring the waterways, they're monitoring dams, they're monitoring infrastructure. They're doing very unique missions, so they spend a lot of money building out their space. And that money gets paid back at a lump sum right after construction for the most part. So if they commit to that sort of upfront expense and use of their money, while there's no contractual obligation to keep them in your space, they're going nowhere. And they're going nowhere for a long time, probably longer than the 20 years that's mentioned in their lease. If you're dealing with other agencies besides GSA, it's a case-by-case [basis]. But if they're spending a lot of money upfront, you've got some security in knowing they're probably going to want to stick around for a pretty long time.

Jeffrey Calk: Very good. Well, I think we're out of time, Gordon. Thank you for sharing these principles with us. And we look forward to, and we hope our listeners will join us for, episode two of this, where we're going to focus on buying and selling with respect to federal properties. Thank you all for listening.

Gordon Griffin: Thank you so much, folks. Take care.