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Sequestration Looms for Washington Office Market

02/28/2013 | By Carisa Chappell

Sequestration Looms for Washington Office Market

The looming sequestration in the federal government has the potential to challenge the office sector, especially in the Washington region, but some anticipate that the effects may only be felt in the short term.

Beginning March 1, federal agencies are slated to cut spending by $85 billion total over the next seven months. This is part of a scheduled series of across-the-board cuts to government agencies that would total $1.2 trillion in the course of the next 10 years.

 “Implementation of sequestration cuts would likely have a deleterious impact on office tenant confidence in the short run, particularly in the defense-sensitive Northern Virginia market,” said Michael Knott, managing director with Green Street Advisors.

Knott called the ongoing budget debate in Washington “Kryptonite” to the confidence of tenants in the area around the District of Columbia that might be considering making long-term lease commitments.

“However, in the long run, the D.C. region will likely continue to benefit from the U.S. government’s ever-greater control of the economy’s purse strings and spending an eye-opening share of our nation’s output,” he said.

If the sequestration were to go into effect, it would not last for a prolonged period, but instead just “enough time to force serious and responsible budget-cutting decisions to be made, according to Roger Waesche, president and CEO of Corporate Office Properties Trust (NYSE: COPT).

“Under this scenario, leasing would become more challenging, but our franchise will still be intact,” he said.

COPT is among a handful of REITs that have the government as their top tenant. The company has 63 government leases and receives 24.2 percent of its revenue from the federal government. Waesche said his confidence stems from COPT’s efforts to shed its non-strategic properties that weighed down past results.

“The portfolio we now have is both lean and well-aligned with demand drivers that support missions that the nation cannot afford to cut, or at least not cut materially,” he said. “We feel strongly about or competitive position, regardless of the outcome.”

Aside from the impact on demand for space, John Guinee, managing director with Stifel Nicolaus, said he anticipates rent decreases in the Washington area office sector resulting from the budget cuts.

“After the expected sequestration cuts and realization that there is no pent-up demand, we think the landlords will shift to action, competing aggressively on price and concessions for the first time in recent memory,” he said.

Guinee added that he thinks rate cuts will be especially evident in the suburban office submarkets. He noted that in 2012 there was very little office leasing activity as tenants primarily focused on short-term renewals and downsizing.