Heads Of Brookfield, USAA Real Estate On Federal Budget, GSA's Future, Opportunities

The looming possibility of federal budget cuts has some DC landlords on edge, but one real estate head who runs a government building fund with $2B of General Services Administration leases sees federal consolidation as an opportunity.

USAA real estate CEO Len O'Donnell, speaking at Georgetown University's McDonough School of Business Thursday evening, said the focus of USAA's government building fund is to own Class-A buildings that attract consolidated federal agencies. The property arm of USAA has $17B worth of assets in its portfolio.

"Generally speaking, the tenants that occupy our buildings represent a significant reduction in overall space for that agency," O'Donnell said. "We think we're a facilitator of some of the consolidation that you might want to see in Washington."

As one of the 10 largest government landlords, with the Environmental Protection Agency HQ and National Science Foundation HQ project in its portfolio, O'Donnell said USAA has been closely watching the discussions about government spending cuts.  To offset an increase in defense spending, President Donald Trump proposed to cut $54B from other federal agencies, even eliminating some entirely, which could lead to a reduction in the government's real estate footprint.

But many expect Congress, which has to pass a spending bill by next Friday to avoid a government shutdown, will make significant changes to Trump's plan. Congress could also pass a continuing resolution to avoid a shutdown and keep the government funded at its current levels. 

O'Donnell, who spent 26 years living and working in the DC market, said there are still ways to make money by owning federally leased buildings during a period of shrinking government. 

"You can focus on the fact that 65% of the space the government occupies in DC fails to meet its own standards for tenant occupancy," O'Donnell said. "I think there is opportunity in this space even if there are attempts to cut small amounts out of the budget."

As O'Donnell closely watches the budget negotiations, another panelist at Georgetown's event is keeping tabs on tax reform proposals coming out of Congress. Real Estate Roundtable CEO Jeff DeBoer represents the top 150 U.S. real estate firms and said the tax reform negotiations are a critical issue for commercial real estate.

"For this industry, we've got a lot at stake," DeBoer said. "There are a lot of opportunities and a lot of risk. Everybody should be paying very close attention to what's happening here."

DeBoer cited the treatment of 1031 exchanges and a potential new category for taxation of partnership income as areas to watch, but he focused primarily on the immediate expensing of investments and the elimination of the interest deduction tax as proposals that could affect the industry. He stressed how dramatic of a change this would be to the way people think about taxing real estate.

"I've been doing this for 35-plus years and if I would have gone to Capitol Hill even three or five years ago and said 'hey let's expense buildings,' in other words take all the costs and write it off in the year we make the investment, people would have laughed me off the hill... That's what the proposal is up there now to expense all investment."

As for the impact the new rules would have, DeBoer said it would be a largely even trade-off for investments in new buildings, but owners of existing assets should be more concerned. 

"We have $17 trillion of commercial real estate in the United States," DeBoer said. "It is capitalized by debt and equity that were put in place under a set of rules that Congress told them to do... Now along comes a new set of rules and it might be OK for new deals, but what about that $17 trillion of invested capital in real estate."

Brookfield Property Group chairman Ric Clark, the event's keynote speaker, said the firm is bullish on the U.S. economy but is concerned about potential negative effects of tax reform.

"One of the things we're worried about is 'will tax legislation be implemented and what will the impact be?'" Clark said. "In the 1980s they tried this and it was a disaster for the economy for a period of time. Unintended consequences of the tax plan are something we're keeping an eye on."

Clark also identified new sectors Brookfield is investing in where he sees opportunity for growth. He said the firm recently got into the student housing business, and he is also very bullish on self-storage, which he called one of the top-performing sectors in all of real estate. Owning storage bins where people toss their junior high school trophies and do not touch them for years, Clark said, gives an investor a stable cash flow with few capital expenditures. 

Another sector Brookfield has entered that requires small investment but can generate big returns is manufactured housing.

"What you're doing is bringing pads to people who buy mobile homes," Clark said. "We found out through our research in this sector that, although tenants sign one-year leases the average stay is 20 years, and it's very little capital to invest."