Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Landlords Set Rent Wrong
Transcript
- Lucas: So the UK government owns a building at 102 Petty France in London — it's where the Ministry of Justice is headquartered. Prime real estate, walking distance from Parliament. And the rent the Ministry pays to the government itself? One pound per year. Luna: One pound? That's not a typo? That's less than the cost of a meal deal. Lucas: It's the official 'nominal rent' set by the UK's Government Property Agency. And it's not just that building. Hundreds of government tenancies across the UK operate on rents of £1, £10, sometimes £100 a year — sums that have nothing to do with the market value of the property. Luna: Okay, but surely there's some accounting reason for this? It's not like the government is trying to save money by paying itself peanuts — it's all taxpayers' money either way. Lucas: Exactly right — it's a wash in aggregate. But here's the thing: the way these internal rents are set creates real-world incentives. If an agency's rent is essentially zero, there's zero cost to holding onto space. So agencies accumulate and hoard offices, storage rooms, even whole floors they barely use. Luna: And the flip side — if the rent is set too high relative to the agency's budget, it can force them to cut services or crowd out other spending. Lucas: That's the other half. Let's look at the US system, because it's the mirror image. The General Services Administration — the GSA — manages federal real estate, and it charges other agencies what it calls 'market-based rent.' The idea was to create a discipline: agencies would only rent space they truly needed, because they'd pay commercial rates. Luna: Right, so if you're the Department of Education and GSA charges you $60 per square foot, you feel that in your budget. That's supposed to encourage efficiency. Lucas: In theory. In practice, the GSA's 'market rent' is set through a formula that includes operating costs, maintenance reserves, and depreciation — but it's not actually benchmarked against comparable private-sector leases. A 2019 report from the Government Accountability Office found that GSA's rental rates were often 10 to 20 percent higher than equivalent commercial space in the same city. Luna: So agencies are paying above-market rent to their own landlord, which eats into their program budgets. That's the opposite problem from the UK — they're being overcharged. Lucas: Precisely. The US Department of Agriculture, for example, was paying GSA about $65 per square foot for a building in Washington D.C. that, according to a commercial appraisal, should have been around $48. That extra $17 per square foot — about $2 million a year — came out of USDA's farm support and food safety budgets. Luna: So either way, the internal rent system distorts decisions. Either it's too low and encourages hoarding, or too high and drains operational funds. There's no real market pressure to get it right. Lucas: And the scale is enormous. The US federal government's real estate portfolio is valued at roughly $1.7 trillion. That includes 300,000 buildings. The rental payments between agencies — the 'rental of buildings' line item in the federal budget — amounts to about $6 billion a year. But that $6 billion is a pure internal transfer: it moves from one government account to another. It creates no net revenue for taxpayers. Luna: It's just reshuffling money within the government while potentially distorting agency behavior. That's a hidden cost. Lucas: And it's not just buildings. Governments also lease land. In many US states, the state land office charges other state agencies a nominal fee — say, $1 per acre per year — for land used for prisons, universities, or highway maintenance yards. That land could otherwise be generating revenue through timber leases, grazing permits, or even sold to private developers. Luna: So the opportunity cost is real. If a prison sits on land that could fetch $1,000 an acre in a timber lease, the state is effectively subsidizing that prison by $999 an acre every year — but nobody accounts for it. Lucas: That's exactly the concept that a pilot program in New Zealand is trying to fix. New Zealand's Treasury launched something called the 'Public Sector Landlord Index' last year. It's an attempt to price every piece of government-owned property at its 'opportunity cost' — that is, what the private sector would pay to use it. Luna: How does that work in practice? Do they actually charge agencies market rents, or is it more of a shadow pricing exercise? Lucas: It's a shadow price for now — a notional rental charge that appears on the agency's budget as an 'imputed cost' but doesn't result in a cash transfer. The idea is that it changes decision-making: if an agency sees that holding onto a downtown office costs them, say, $200,000 a year in imputed rent, they might decide to consolidate into cheaper space and free up the prime property for sale or lease. Luna: So it's a budgeting tool, not a revenue tool. It's trying to make the invisible cost visible. Lucas: Exactly. And early results are promising. The New Zealand Ministry of Social Development identified about 15 percent of its office portfolio as surplus after applying the imputed rent model. They're now in the process of subleasing that space to private tenants — at market rates — generating actual revenue for the government. Luna: Whereas before, they probably would have just sat on that space because it cost them nothing to keep it. Lucas: Right. And the US has taken a small step in a similar direction. In 2016, the Obama administration issued a memo requiring agencies to report the 'utilization rate' of their buildings — basically, how many square feet per employee they were using. But it had no teeth. A 2022 follow-up by the Government Accountability Office found that 40 percent of agencies still couldn't produce reliable utilization data. Luna: So without a price signal, they have no incentive to collect the data, and without data, they can't set a price. It's a chicken and egg problem. Lucas: Which brings us back to the core issue: internal rents are an accounting construct, but they have real consequences. And the problem is that they're often set by bureaucrats with conflicting goals — the property agency wants to maximize its 'revenue', while the tenant agency wants to minimize its costs. The result is a negotiation that has nothing to do with market efficiency. Luna: And the taxpayer is left footing the bill either way — either through wasted space or through higher costs for public services. Lucas: If walking through the economy with us has made something click — maybe the way internal rents distort agency budgets, or the hidden cost of government real estate — a couple of dollars a month is genuinely what keeps these shows going. You can find us at buy me a coffee dot com slash fexingo. Luna: It's the kind of thing that makes a real difference — keeps the episodes ad-free and independent. And we appreciate it more than we can say. Lucas: So back to that New Zealand pilot — one of the interesting side effects is that it's also changing how agencies think about maintenance. If you're paying imputed rent that includes a charge for depreciation, you start to care about whether you're maintaining the asset. Luna: Because otherwise you're paying for a building that's losing value, and that shows up on your books. Lucas: Right. The US federal government has a deferred maintenance backlog of about $200 billion on its buildings. That's partly because there's no link between the rent an agency pays and the condition of the building. The GSA is responsible for maintenance, but the agency paying rent doesn't see that cost directly — it's baked into the rental rate. So there's no incentive for either side to prioritize upkeep. Luna: Whereas in New Zealand's model, the imputed rent includes a separate line item for capital charge — essentially a depreciation cost. That makes the agency feel the economic cost of letting a building deteriorate. Lucas: Exactly. And that kind of transparency is rare. Most governments treat their real estate as a sunk cost — they already own it, so using it is 'free.' But that's bad economics. The opportunity cost of using a building for one purpose is that you can't use it for another, or sell it and invest the proceeds. Luna: It's the same logic as a family that owns their house outright. They don't have a mortgage payment, but they could rent it out and earn income. Living in it has an opportunity cost. Lucas: Exactly. And governments rarely account for that. A 2023 study by the Institute for Government found that UK central government departments occupy about 10 million square meters of office space — but only about 60 percent of it is actually used on any given day. That's four million square meters of empty space that could be sold or leased, generating billions in revenue. Luna: And instead, it's just sitting there, costing money in utilities, security, and cleaning. Lucas: Right. So the question is: why don't governments fix this? Partly it's political — selling a government building can be seen as a loss of national assets, even if it's underused. Partly it's bureaucratic — no single agency wants to give up space because they might need it in the future, and there's no cost to holding it. Luna: And partly it's just inertia. The systems have been in place for decades, and changing them requires legislative or executive action that no one prioritizes. Lucas: But there are signs of movement. Canada's Treasury Board Secretariat is piloting a 'rental charge' for federal buildings that will be phased in over five years, starting in 2025. And Australia's Department of Finance now requires agencies to report the 'economic rent' of their properties as part of the budget process. Luna: So there's a trend toward transparency, even if it's slow. The question is whether the US and UK will follow. Lucas: The UK's Government Property Agency is actually reviewing its nominal rent policy. They've indicated they may move to a 'fair value' rent by 2028 — but it's a politically sensitive issue, because increasing rents for the Ministry of Justice or the Department for Work and Pensions would reduce their operating budgets. No department wants that. Luna: So it becomes a zero-sum game between agencies. The property agency gains, but the tenant agency loses. And the Treasury might end up having to compensate the losers, which defeats the purpose. Lucas: Unless they pair the rent reform with a budget adjustment — give the tenant agency more money to cover the higher rent, but then claw back the savings from property sales or efficiency gains. That's the theory behind New Zealand's approach: not a cash transfer, but a notional charge that changes behavior without changing budgets. Luna: It's clever, but it requires a level of accounting sophistication that many governments lack. Lucas: And a level of political will. But the potential savings are enormous. If the US could reduce its federal office space by just 10 percent — from the current 300 million square feet to 270 million — and sell or lease the excess, it could generate an estimated $15 to $20 billion in one-time proceeds and save $2 billion a year in operating costs. Luna: That's real money that could go to reducing the deficit or funding other priorities. Lucas: So the next time you pass a government building that looks half-empty, ask yourself: what rent is the agency paying? If it's £1 a year, there's a good chance they're not thinking about efficiency. And that's a cost everyone bears. Luna: It's a perfect example of how the way we account for things shapes the way we behave. Lucas: And how a simple change in accounting — from nominal rents to opportunity cost — could unlock billions in value without spending a dime.