By Norman Dong, Joe Delogu, and Anita Molino

Once again, the United States of America is facing the ominous threat of breaching the Federal debt ceiling in the coming months. As lawmakers stake out their positions on this evolving policy battlefield, there has been much speculation about the potential impact of a breach on the Federal Government and the overall economy. Here, we will examine the implications of a debt ceiling breach for owners and investors in Federally-leased property – and the corresponding implications for values, rents, and capital costs. 

The debt ceiling is a cap on the total amount of money that the Federal Government is authorized to borrow to fulfill its financial obligations. Because the United States runs budget deficits — meaning it spends more than it brings in through taxes and other revenue — it must borrow huge sums of money to pay its bills. This includes money for rent payments on Government-leased real property.

As the Government faces the prospect of a debt ceiling breach, it is tempting to compare this financial crisis to the many previous standoffs about Government funding.  In the past, the Government has shut down when Congress failed to appropriate the annual funding, also known as budget authority, to sustain agency operations for the fiscal year. We have become familiar with many of the public images of prior Government shutdowns – IRS offices shuttered, the Washington Monument closed to visitors, etc. But in the case of GSA leasing, the Agency has always had sufficient budget authority carried over from the prior fiscal year – allowing it to make lease contract payments without disruption. As a result, the credit quality of Government-backed leased property has remained largely unaffected by prior shutdown drama.

A debt ceiling breach is a very different issue – with far greater consequences for the country and for owners and investors in Federal real estate. This is not about the authority to spend – the FY2023 Consolidated Appropriations Act already provides agencies with the ability to commit the Government though grants, contracts, salaries, and other financial obligations.  Raising the debt ceiling simply allows the Government to pay the bills it has already incurred.  For building owners who lease property to GSA and other Federal agencies, lease contracts would continue without disruption under a debt ceiling breach. But when the time comes for the Government to pay its rent, it may not have the cash to do so.

Failure to pay contract rent would be a breach of contract under the lease and a condition of default.  The byproduct of nonpayment of rent would clearly be harmful to any individual unpaid lessor, but the specter of unpaid Government obligations even generally within the financial system will have immediate effects on the entire system. For owners and investors in properties leased to the Federal Government, these immediate effects would include:

• Interest Rates Will Increase: If the Treasury Department is unable to make payments to lenders who hold federal debt — what is known as a default — the Government’s credit quality in the marketplace could diminish, thus causing risk-adjusted lending rates to increase, including loans to lessors of Government-occupied property. In addition, depending on the severity of any downgrade to the Government’s credit rating, lenders may be forced to “call” outstanding loans, based upon the tenant credit quality no longer meeting previously underwritten standards.
• Costs Will Increase:  Any increase in interest rates will ultimately translate into an increase in the rental rates the Government pays for the space it leases from the private sector. As leases come due for renewal or replacement, the higher cost of financing will ultimately be passed on to Federal agency tenants in the form of higher rents for the same product.
• Assets Will Lose Value:  A decrease in credit quality will cause not just an increase in borrowing costs but also an increase in capitalization rates associated with Government-occupied properties – both of which will cause asset values of Government-leased properties to decrease. Existing leases may also suffer an immediate loss of value as “mark-to-market” accounting rules for many investors will require them to reflect the diminished credit quality of their Government-leased property assets.

An actual breach of the debt ceiling is still considered an extremely remote possibility, and many are hoping that the Government will be able to avert a financial crisis. However, the fractious state of the United States Congress is still a concern, and current political brinksmanship may have unintended consequences. In 2011, the contention over the debt-limit resulted in the first-ever downgrade of the U.S. credit rating, even though a default was ultimately avoided. Despite the downgrade, significant capital continued to flow into U.S. Treasury securities, as they were still regarded as a safe and liquid asset class.

We may not be so fortunate this time around. There is already concern that some countries have turned away from the U.S. Dollar as the world currency and have turned to the Chinese Yuan. This latest impasse over the debt ceiling may have other consequences.  Another downgrade or suspension of the U.S. Government credit rating could possibly force investors in U.S. Treasury securities to sell based on internal investment guidelines that require minimum credit ratings on their holdings. If so, they could then be selling into a chaotic market causing major losses. Owners and investors of Government real estate might also feel the impact, as mortgage holders could similarly be forced to call the debt.

For now, Treasury is using “extraordinary measures” to manage its cashflow and stave off the day when the U.S. Government actually reaches its debt ceiling and no longer has the ability to borrow funds to pay its bills. As the debt-ceiling brinksmanship escalates with each passing day, many are hoping that cooler minds will prevail and lawmakers will agree to increase the debt ceiling as they have done 78 times since 1960. Despite the current drama, “the full faith and credit of the United States” today remains a secure and reliable return for owners and investors of Federal real estate. Hopefully, lawmakers will approve an increase to the debt ceiling in a timely manner so this will remain the case. 

• Norman Dong is a Managing Director at FD Stonewater and is the former Commissioner of Public Buildings at the General Services Administration.
• Joe Delogu is a Founding Partner of FD Stonewater and an established leader in the Federal Government real estate industry, with over 35 years of leasing, development, and investment management experience.
• Anita Molino is a Managing Partner at Bostonia Partners and has extensive capital markets experience focusing on real estate, energy, project finance, and the securitization markets.

For questions about this white paper, please contact:

Norman Dong

Managing Director, FD Stonewater

[email protected]