United States: Gov’t Issues: What Should Owners Know About Federal Tenants?

Last Updated: March 26 2012
Article by Suzanne D. Reifman

Originally published in Commercial Investment Real Estate, March/April 2012

You are an investor who has just snapped up a distressed property that includes a lease with the federal government. In the best scenario, you gain a desirable tenant with a long-term lease, and the U.S. General Services Administration wants to lease additional space in your building.

In a sadder tale, you review the lease and learn that the terms are not as favorable as they originally appeared. You also receive notice that the GSA will be vacating half of its space in the building — moving out the Securities and Exchange Commission and moving the Social Security Administration into the balance of the space.

The GSA represents more than 400 federal agencies and has more than 7,000 leases in properties throughout the U.S. In effect, it is the nation's largest tenant, but one with many faces: Not all federal agencies use space in the same manner. For example, while the SEC might be a quiet corporate office, an SSA office may have greater public contact. With more people wandering through the building, your security costs increase.

Because the federal government plays by its own leasing rules, this exchange of tenants and many other aspects of government leases can be a rude awakening to those who purchase foreclosed properties without realizing the complexity of leasing to government tenants. In a perfect world, GSA leases can provide "government-insured" stability to properties, but these days, who lives in a perfect world? These tips will help identify some of the issues that GSA leases present to property owners.

Lease Issues

A surprising number of buyers of foreclosed properties do not realize that the property includes a government lease. Property due diligence needs to specifically address whether there are government tenants and what agencies are involved.

Federal government tenants will not agree to use a building owner's lease document and will demand that the building owner use a standard government form, which contains literally hundreds of pages of unique government requirements. As a result, GSA leases require substantially different — and more robust — due diligence than leases with commercial entities.

In addition, some new owners fail to understand the financials of a GSA lease and end up with an investment that is significantly less advantageous than they thought. GSA leases also afford the government unique rights not found in most private-sector leases, so solicit assistance from a professional with GSA expertise.

Perhaps more significantly, government leases contain many onerous compliance requirements. Has the previous building owner provided the required supplies and services or have there been performance problems? These could result in the government performing the work (and charging you) or possibly terminating the lease for default, among other consequences.

This is most important in cases involving possible violations of the False Claims Act or certain other criminal laws and regulations. Government enforcement of FCA violations is at an all-time high. Moreover, the government has certain mandatory disclosure requirements for violations of the civil FCA and for other civil and criminal violations.

The GSA 's "subordination, nondisturbance and attornment" lease clause provides that, in the event of a foreclosure, a purchaser/transferee of the lease automatically acquires all of the obligations of the lessor under the lease. In other words, when the building owner agreed to the original lease with the government, it committed you to providing uninterrupted services to the government.

Novation Agreements

The GSA and many other federal agencies will issue a "supplemental lease agreement" in which the new owner certifies to various requirements. In addition, all government contracts, including leases, are subject to the Anti-Assignment Act, which prohibits the assignment of the contract to a third party without the government's consent. This means the government will not recognize the property transfer unless it enters into a "novation agreement," under which the new owner agrees to assume the responsibilities and liabilities of the former owner.

It may be tempting to simply avoid the issue, especially since many new owners intend to re-sell the building as soon as possible. However, once the government realizes there is a new owner, it usually will place all rent payments in escrow until a novation agreement with the new owner is finalized.

Once you have executed the SLA and the novation agreement, you are now a government contractor subject to the stringent requirements of the lease. As a result, you need to take all necessary steps to immunize yourself from liability. First, assuming you determined the overall compliance of the former building owner before this point, you will need to stay on top of lease administration activities to avoid your own compliance problems. In particular, make sure that any invoices for payment are accurate.

Federal government leases contain various socioeconomic clauses that require certain government landlords to subcontract a certain percentage of their supplies and services to small businesses and to "flow down" various government requirements to their subcontractors. This usually requires modifying standard subcontracts and possibly changing subcontractors if a vendor cannot or will not meet the government's flow down requirements.

There is no doubt that leasing to a government agency can be an extremely sound investment, particularly in times of economic uncertainty. Although these recommendations represent only the tip of the iceberg in terms of issues to consider when leasing space to a government tenant, they should increase the possibility of a happy ending over a horror story.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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