by Jon Olmstead, Executive Managing Director, Non-Profit & Association Practice Group Co-Head
The new administration’s impact on Washington, DC region real estate has been evident over the past year, when industries began making changes in reaction to predictions of major legislative shifts. Several sectors, such as hospitality, telecommunications, and most notably defense, are seeing opportunities for growth due to expected increases in Department of Defense funding which would include greater contracting expenditures. The healthcare sector and related industries, however, are on guard due to the proposed repeal of the American Healthcare Act.
The wider nonprofit sector faces a host of unknowns – and because of the sector’s significance in the Washington, DC region, home to the most nonprofits per capita, the metro area could be particularly affected by the changes.
Federal spending has direct and indirect effects on nonprofits. By cutting funding to the areas in which nonprofits operate, the budget shapes demand for their services. Yet the federal government is also a vital source of direct revenue for many nonprofits through grants, contracts, or fees for goods and services. Budget cuts can increase demand for nonprofit services while cutting the resources that supply that demand. Cushman & Wakefield has seen an increase in activity from nonprofits, whose operations depend heavily on federal funding, seeking office solutions for the possibility of greatly diminished budgets. What fundamental changes can we expect nonprofits to make in lieu of the shift in federal policy?
Mergers & Acquisitions Increased merger and acquisition (M&A) activity in the nonprofit sector has been expected since the great recession. The loss of jobs combined with federal budget cuts implemented as part of the Budget Control Act of 2011 were expected to lead to a drop in both private donations and funding for nonprofits thereby causing organizations to band together for survival. But this has yet to materialize in any significant way. According to nonprofit database provider, GuideStar, merging these types of organizations is very complex with considerations for location, regulations, mission and management impeding any potential M&A. That said, the M&A landscape may begin to change. Cuts to funding combined with a lack of organic growth has many anticipating that 2018 will be the year of major mergers in several sectors including government contracting, legal, healthcare, commercial banking, as well as nonprofits. Then, there’s the new tax law.
Change in Funding Sources The Tax Cuts and Jobs Act of 2017 affects nonprofits by indirectly shaping the motivations of individual donors in a few key ways. First, the new law doubles the standard deduction, effectively discouraging the impetus of the incentive to give for most Americans who to write-off charitable donations though itemization. It could be argued that the loss of the charitable donations incentive may be offset by the tax cuts many Americans are expected to receive this year, freeing more income that Americans can give to nonprofits. However, the tax cuts will likely result in less money flowing into the government. When less money is collected by the government, there is less money available to allocate for programs and services that government-hired nonprofits provide.
Impact on Real Estate An increase in M&A activity in the nonprofit and association community could have serious implications for the office sector, as well as provide opportunities. While nonprofit merger activity has been mundane in the DC region we can make assumptions based on the M&A activity we have seen from other Washington, DC region industry sectors – for example, law firms. While law firms occupy higher quality office space than most nonprofits, they have gone through an uptick in M&A in recent years – a trend that will continue in 2018. When these mergers have occurred, as was the case for Blank Rome/Dickstein Shapiro, Squire Sanders/Patton Boggs, Dentons/McKenna Long and others, the amount of office space occupied by the combined firm is usually much smaller, resulting in a softening market and better leasing conditions for occupiers. We can assume these efficiencies of scale will be similar with potential nonprofit M&A.
The significant wave of new construction hitting the market through 2020 will also have a major impact on nonprofit real estate options. In order to make way for development in a land-constrained market like Washington, DC, old class B and C product must be demolished. Currently there are three options in DC’s Central Business District for office space that leases for less than $55.00/SF, with two of those options not available until 2019. Large, value-conscious organizations will likely need to look to the east and west to find suitable relocation options. Crystal City, a submarket with rents $15.00/SF – $20.00/SF cheaper than core DC Class-B office rents, has been a net beneficiary of several nonprofits. Examples include Worldwide ERC, American Institutes for Research (AIR), Grocery Manufacturers Association (GMA), the National Council on Aging (NCOA) and the International Foundation for Electoral Systems (IFES).
Ultimately, the looming changes in policy that affect the nonprofit sector will present specific challenges for the management and boards that make the important decisions. One key for nonprofits will be to adapt to the realities of their political support. Nonprofits should work toward increasing collaboration and partnerships with organizations with aligning missions. This way, the greater goal and mission will still be accomplished and this method insures nonprofits will continue to weather any future political changes.
Optimizing data collection and reporting is another important method nonprofits could adopt to maintain expenses without compromising the goals of their mission. Financial and operational uncertainty makes communication to key board members and donors crucial to the continued success of the organization.
And finally, it will be important for nonprofits to use the political atmosphere to their advantage. Donors, supporters and mission beneficiaries, in many cases, have not changed along with the residents in the White House. 2018 will be a true test for many nonprofits, and making the aforementioned changes will insure that many of these organizations will not only survive, but thrive as the year progresses.