After many industries saw productivity remain stable with employees working from home, organizations across the country are evaluating their office real estate needs. The U.S. government, the largest office tenant in the United States, is no different, and having the largest checkbook in the world affords it the ability to dictate how business is done.
However, when that checkbook is funded by taxpayer dollars, that power is used to promote mission-driven efficiency, transparency and stewardship. Decisions made by the U.S. government can ripple through the macro-economy, particularly to the real estate market. In this case, the General Services Administration’s recent award of a flexible coworking services IDIQ (indefinite delivery, indefinite quantity) contract has piqued the interest of players in the government contracting and commercial real estate ecosystems.
Is this a signal that the federal government may be changing the way it does business? We think so.
As of July, the GSA reported the federal government held over 7,800 real estate leases totaling over 181 million square feet of rentable space dispersed across the country, with approximately 30% in Washington, D.C., Maryland and Virginia. The first flexible coworking space contract was awarded at the end of August to WeWork, Deskpass, Liquidspace, Expansive and The Yard, suggesting the federal government is ready to reduce its real estate footprint and promote flexible, remote work.
This mirrors sentiment of many private organizations re-evaluating their office needs. With the pandemic still an issue, many are looking for short-term solutions, like coworking space, before making a more permanent decision.
A more flexible customer?
Government contractors are particularly interested in the working patterns and preferences of their large, power-wielding customer. During Parsons Corporation’s quarterly earnings call on Aug. 10, its chief executive, Carey Smith, put some caveats on the company’s hybrid work program. She said the company is letting employees chose whether they work remotely, in the office or in a hybrid arrangement “provided that their customer agrees with that.”
Quick pivots to telework during the pandemic were addressed via modifications to existing contracts, keeping the government operational and critical work on task. Additionally, it is premature to examine new contract vehicle terms and conditions to glean new trends in how the federal government expects business to be conducted logistically.
Therefore, the award of the first flexible coworking services contract is a major signal that government contractors will be serving a more dispersed, flexible customer in the future. This is great news for contractors who are battling for talent in a tight labor market and looking for continued return on their recent IT remote work investments.
Roger Krone, chief executive of Leidos, a government contractor, highlighted the importance of flexible work during Bernstein’s Strategic Decisions Conference in June. “We’re going to have more hoteling space. We’re going to have more telecommuting or teleworking employees that will allow us, we think, to hold onto the workforce to attract the millennials and the Gen (Zers) who are coming out, and it will allow us to reduce our real estate footprint.”
But what about the secret stuff?
Will the federal government ever go fully remote? No, not even close. After all, the largest line item of the federal budget is for the Department of Defense, handling troves of classified information.
What does this mean for the government, then?
Classified work in the DOD and intelligence community will continue in-person at so-called sensitive compartmented information facilities. However, we expect to see further tailoring of what information truly needs to be deemed classified, as well as expansion of teleworking capabilities for DOD employees who don’t touch the most sensitive information.
In January, Navy Vice Adm. Nancy A. Norton, director of the Defense Information Systems Agency, underscored the value and feasibility of telework, noting that the DOD hasn’t just survived through the pandemic but thrived. She believes the department has “learned how to work with our workforce and trust our workforce in ways that we never did before.” She was adamant this evolution will continue across the DOD.
What does this mean for commercial real estate?
Office landlords will be on high alert following the government’s recent contract with coworking operators, especially those in the Washington, D.C. area. Despite an economy helped by the federal government, the office market in the nation’s capital has been tumultuous as best. Recent CoStar data reflects vacancy rates at 15%, the highest in 20 years.
Everything is not doom and gloom, though. Longer lease terms in office space have allowed for a buffer to some of the impact of the pandemic. The construction pipeline is at its lowest in decades and many developments are build-to-suit or have significant preleasing.
Similar to national trends, new trophy buildings continue to be of interest to tenants to replace older space. The rent for these high-end properties are going for much more than their 3-star peers. The premium rents for 4- and 5-star office space over 3-star office space has grown nearly 25% since 2013, according to CoStar data. Comparatively, the market rent difference between 3-star and 1- and 2-star office space has compressed in that period. Owners of lower-quality buildings will need to find opportunities to redevelop or risk losing tenants.
Middle market takeaway
For landlords with office properties in and around Washington, D.C., it will be important to present a product that will attract tenants beyond just its physical location. Having a coworking space in the building or providing top-end amenities are becoming table stakes to remain viable in the area.
Government contractors working in unclassified environments should reassess their real estate strategy for when leases come due. The first step is understanding the requirements and preferences of each government agency customer. The next time you connect with your contracting officer, be sure to discuss short- and long-term return-to-office strategies so that you can determine yours.