The government shutdown's impact on REITs with federal contracts

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The U.S. government's ongoing shutdown will likely have a minimal impact on real estate investment trusts with long-term federal contracts in the near term, though the risks could grow if the impasse lasts longer.

"Government shutdowns do not usually result in a lease default to a REIT such as COPT (NYSE:CDP) or (NYSE:DEA)," said Eric Croak, president at Croak Capital. "This is due to the multi-year term of the leases and the appropriation by Congress instead of an agency’s operating cash flow." Other federal-contract REITs include CoreCivic (NYSE:CXW) and GEO Group (NYSE:GEO).

The General Services Administration -- the government's property manager and purchasing agent -- still has carryover funds to make lease payments in the absence of appropriations, according to a directive, but that cushion doesn't last forever. And the GSA cannot start new leases or projects without new appropriations.

Looking further out, Croak explained that the U.S. Treasury’s "payment queues move slowly, and many non-critical agencies begin to delay non-essential rent payments" when the shutdown last more than 1-2 months. That delay "does not result in loss of revenue, but it impacts liquidity (cash-on-hand ratios) which is closely watched by the REIT’s lenders and rating agencies."

A COPT Defense (NYSE:CDP) spokesperson said that federal "shutdowns have a minimal impact on our business, and we still collect rent. A government shutdown can delay the timing of an award to a defense contractor, which can impact the timing of new leasing activity. However, those delays are typically less than one month."

Legislation passed in 1982 -- the Prompt Payment Act -- required federal agencies to pay their bills on time, including rent and contract awards, the spokesperson told Seeking Alpha in an emailed statement. "Our Defense/IT tenants, along with the Department of Defense and Intelligence agencies, are essential functions which do not shut down, with occupancy virtually unaffected."

Meanwhile, these specialized landlords have significantly underperformed the broader stock market this year, with all the aforementioned ones dropping double-digits year-to-date. The S&P 500, by contrast, advanced 13% over the same period.

Federal shutdowns are rarely prolonged enough to dent operating cash flow for most REITs, Croak said, but market sentiment tends to turn long before the numbers do. "The more astute investors use these events to stress test liquidity and see how long they can weather the storm," he added.

Office Properties Income (OTC:OPITS) and Geo Group (NYSE:GEO) did not immediately respond to Seeking Alpha's request for comment.

Prediction market Kalshi sees an exceptionally prolonged shutdown this time around, lasting 35.5 days. It's been 14 days so far.