Summary of Commercial Lease in Today's Market Roundtable (AUREO 2010)

(September 13, 2010)
Summary of Discussion and Practice Pointers
(28 attendees) Moderator: Gregory Ewig, Minnesota State Colleges and Universities

Disclaimer: This summary is based on the moderator's notes taken during the session, and relies on his spotty memory at times. Errors in campus attributions, facts, and such are the moderator's own. If the error is particularly bad – tell him to correct it – or just write a comment or add in on Linked in.


Renegotiation of Lease for a System Office
The conversation started about a lease restructuring at the Minnesota State Colleges and Universities in St Paul, Minnesota. About ½ way through a 10 year lease of Class A office space, Minnesota State needed to restructure the lease as a means of controlling their operating budget. Major deal points:

Original term – Aug. 1, 2005 – July 31, 2015
New Term – extends to July 31, 2022 (adds 7 years)
Original sq. ft. = approximately 103,000
New deal: ability to reduce footprint to 89,000 sq. ft. (14,000 sq. ft (1 floor)) by 12/31/11
Landlord waives prorata termination fee
Landlord provides $10 psf toward reconfiguration of space (approx $890,000)

Lessons learned:
- Sometimes it's a win when you can give back the space at no penalty.
- It's possible to reopen lease discussions more than 2 years in advance (especially when you're willing to add term)
- Time can become an enemy in lease negotiations (both too much and too little time)

Strategic Planning for Lease Portfolio
Several attendees reported that they did strategic planning in their lease portfolio (including targeting leases for early renegotiation, leveraging 1 year options to renew to apply pressure (uncertainty over continuation) on landlords to negotiate)

Leasing with the Federal Government
Depending on the agency within the federal branch, the General Services Agency (GSA) will be involved on behalf of an agency leasing space. In some cases, the Dept of Commerce will be the lease entity for certain agencies, such as the National Oceanic and Atmospheric Administration (NOAA).

University of Virginia
The University of Virginia described a renegotiation with the Army for a JAG training center on campus. The lease issues revolved around the default provisions, damages, and annual increases in rent. Ultimately, the university was able to whittle back the default provisions, limited damages to money back on the lease, and were able to obtain annual increases.

Practice points:
- University leveraged the feds desire to remain in the location to their advantage to get onerous “standard” federal lease terms modified
- Started with a shorter term lease
- Added 1 year right to terminate for health, life, safety concerns

University of Colorado

The University of Colorado had an experience with NOAA (National Oceanic and Atmospheric Administration ) where they were able to obtain a $7 psf amount attributable toward deferred maintenance.

Other Practice Pointers when dealing with the feds

- Look to the federal register – you can find valuable information (prospectus/budgets for amount the agency is able to spend on the lease)
- Feds rely on appraised lease values; one way is to counter with appraisal of own or prove out what the market is based on your own leases
- Feds want a full gross lease, which is difficult to provide. Many campuses have had success with obtaining pass through of operating costs; splits with base rent and operating expenses); and semi annual reconciliations to obtain some fairness in allocating risk of increased operating costs.
- Feds have fairly onerous requirements regarding leasing in buildings that are located in flood plains (they won't) and reporting obligations of environmental hazards (example was given regarding asbestos abatement)

Retail Leasing and Miscellaneous Topics

The University of Vermont discussed their experience with ATMs on campus and the ability to leverage current rents from ATMs out of a bank that had a special relationship with the university (“sponsor”) role.

University of California and University of Redlands attendees remarked about groups like Studley and Newmark that have leveraged information on loan refinancings to cultivate tenants from those buildings, and approaching such landlords collectively to renegotiate leases.

University of Mary and Washington operating as a landlord has been approached by a few tenants about renegotiating their retail leases. The university has rebuffed calls to renegotiate, but has been willing to increase Tenant Improvements.

UMW was willing to loan money to a proven sports bar concept to make a lease work on campus. ($200,000 for 5 years @ 6%).

The University of California (ed note: I don't recall which one) remarked about their use of a termination provision upon lack of appropriation. Historically, they have never invoked the use of the provision – until recently.

Overall Lessons:
- It's a tenants market.
- Those campuses / systems with termination for non-appropriation language in their leases might end up invoking the clauses if the budget situation continues to worsen.


Brokerage commissions on land leases

There was some discussion about whether and how much a broker should be paid on a land lease (especially when the broker “brings the deal to the University”). The common thread seemed to be that commissions are negotiable, and not mandatory.

The discussion also touched on some of the highlights of using a tenant's rep broker.

Practice pointers:
- Tenant rep brokers typically know which landlords are in trouble
- Some use a rotational basis so that no one firm or broker monopolizes tenant reprentation
- Colorado has used tenant representation very effectively for over a decade

Thoughts about the AUREO Conference - San Francisco

Despite the slump in the economy, it sounds like the Association of University Real Estate Officials (AUREO) annual conference in San Francisco this September will be well attended. At the conference, I'll be moderating a roundtable about "Commercial Lease Considerations in Today's Market."

I expect it will be an engaging discussion. Although my roundtable description leaned toward the more ominous trends, such as commercial foreclosures and restructuring leases, the news is never as bad (or as good!) as the reports make it out to be. My prediction for the roundtable is that most real estate markets surrounding universities will have remained stable or increased in rents slightly, despite the doom and gloom of their local markets.

My theory is based on three primary ideas: stalled commercial development, a temporary uptick in enrollment, and reduced appetite by legislatures to take on more debt for construction. Specifically, the nationwide markets for new commercial product has continued to stagnate. It's very unlikely any new product will be built soon, so new commercial square footage will continue to be limited. Secondarily, it seems that the recession has caused an uptick in enrollment among many colleges and universities that may translate into a temporary need for new program space. Except for some programs with long-term funding streams, capital for the construction of owned space will be limited, leaving commercial leasing the most feasible option. A further trend that bears watching is how legislatures deal with political trends against taking on more debt, even though extraordinarily low bond rates make it a perfect time to finance for capital projects. New debt service on bonds may be a bridge too far, so the trend line will continue with universities contrained from new bonds or borrowing, despite the extremely attractive cost of capital and lowered cost of construction.

We'll see if my roundtable predictions come true...

Mixed Use Developments

Below are a number of mixed-use developments on or nearby campuses throughout the U.S. and in Canada. The list is by no means exhaustive, but provide a cross section of sampling of recent developments. Thanks goes to Fred Pierce of Pierce Education Properties, Paul Senhert at the University of Pennsylvania and others for providing these examples.

Financing for these and most other projects have dried up considerably yet, as you can see, there are some fairly substantial projects in the pipeline that were able to weather the financial storm.

Arizona

Arizona State University, Tempe, AZ – The Threshold Project

California
University Gateway, University of Southern California. University Gateway is an 8-story, 623,000 square foot mixed-use project currently under construction for delivery in fall 2010. The project includes 421 units (1,642 beds) of student housing built over 81,500 square feet of ground level retail space (including 30,000 sf master leased to USC), privately financed on a 95-year ground lease from USC. This project is a development of LA-based Urban Partners LLC.

Iowa
Iowa State University, Ames, IA – Campustown Business District

Maryland

University of Maryland, College Park, MD – East Campus Redevelopment Initiative

Michigan

Michigan State University, East Lansing, MI – East Village

Minnesota

St. Cloud State University, St. Cloud MN - 5th Avenue Live

North Carolina

University of North Carolina, Chapel Hill, NC – Granville Towers Site

Ohio

South Campus Gateway, Ohio State University. South Campus Gateway at Ohio State University is a 7.4 acre, $160 million, seven-building, mixed-use entertainment complex located on the southern edge of the OSU campus. The 500,000 square foot project’s five-story structures contain restaurants and nightspots, an eight-screen arts cinema, a 50,000 square foot Barnes & Noble campus bookstore, a 14,000 square foot natural foods grocery store, several locally and nationally owned boutique shops, 184 market-rate student apartment units, 88,000 square feet of university office space and a 1,200 square foot parking garage (completed by Campus Partners for Community Urban Development, a nonprofit organization closely affiliated with Ohio State University).

University of Toledo, Toledo, OH – Dorr Street Gateway Redevelopment Project

Pennsylvania

University of Pennsylvania

Radian Apartments
http://www.domuspa.com
The Hub on Chestnut

All three are done on long-term participating ground lease with the University and a private developer.

Canada

The University of British Columbia (UBC) just finished a 40,000 sf project which has retail and common space on the ground floor and 3 floors of 81 students units above. This building is called MBA House and it houses student enrolled in the MBA program at the Robert H. Lee Graduate School at the Sauder School of Business.

UBC also completed another mixed use project which has a grocery store on the main floor and market rental apartments above. These units are open to the public but we still get students renting them. UBC Properties Trust developed the project and retains ownership with all profits going to the UBC Endowment Fund.

Do colleges closer to the capital get more money?

I was persuing some blogs when I ran across the article from a few months ago on Inside Higher Ed "Location, Location, Location" about studies that attempt to explain patterns in which some institutions end up doing better in funding from their state than others (or less worse than others), factoring in their missions. The article generalizes that location plays a fairly significant role in what institutions receive more funding. It also notes that states that tend to have more Democrats and professionalized legislatures tend to spend more on higher education.

Selected Auditors Evaluation of State Land Ownership

Recently the Minnesota Legislative Auditor has been asked to evaluate state ownership of land, which includes public colleges and universities. The outline of their scope is listed here. It's not clear whether the audit will include the University of Minnesota system, which is separately organized from the state. Incidentally, the U of M land holdings are about 4 times the size of the state universities and colleges, so it would seem logical that they would be swept in. That doesn't include trust lands or other lands that are for the benefit of the university, but are not titled to the U of M.

This seems to be the first state-wide audit of land ownership in Minnesota.

Nationwide, there have been several broad programmatic audits that included higher education real estate. For example, California undertook a state-wide audit in 2001, which included the University of California system and California State Universities. The report is shown here.

Oregon audited what they termed "off campus" properties, which seemed to be properties that were not located or contiguous from main campus facilities.

A recent New York audit of SUNY Upstate Medical University spent $409,000 leasing office space in downtown Syracuse that sat empty for nearly four years. The audit lays out some interesting leasing details about several SUNY campuses.

With the economic downturn, universities and colleges - like most public entities - will be the subject of intense scrutiny. Like corporate entities, the majority of their assets (and liabilities) are in personnel and land and buildings. Personnel costs have historically been easier to track and quantify or otherwise measure, and these costs are being addressed at many institutions with salary freezes, layoff and furloughs.

By contrast, very few higher education institutions have invested in measuring the performance of their real property assets, nor have they given much thought to "portfolio" management. The first rule in this area is that you need to know what you own before you can manage it, and that seems to be the fundamental question being answered in Minnesota. However, it will be interesting to watch after the results are reported. There is certainly growing political will to take more activist approaches to limiting college tuition increases at public colleges and universities, and perhaps land surplusing is a short term answer.

Credentialing Public Sector Real Estate Professionals

There are a subset of people working for colleges and universities throughout the U.S. and Canada who serve in a role similar to corporate real estate officers in the private sector. Borrowing from the CoreNet Global folks who have credentialing programs for "Master of Corporate Real Estate" and "Senior Leaders in Real Estate", I got to thinking: why shouldn't university and college real estate managers and directors have a credentialing program too?

What it would provide to the industry:
- Technical proficiency
- Best practices
- Leveraging technology
- Emerging trends in higher education
- Aligning real estate with institutional goals

Sure, we need to be technically proficient real estate practitioners, but we also need to understand our business, which is not just profit/loss and what the balance sheet shows in any given quarter. Higher Education Real Estate Professionals are impacted by an even broader array of federal and state laws, institutional policies and practices, and often have the authority of eminent domain. We're expected to do a lot with little, and to do it with the assistance of private sector help requires substantial investments of time and drafting RFPs.

We're a smart lot. People in our industry come from all over, including the private sector - we're attorneys or former commercial brokers.

We work for institutions of higher education. Why can't we find the discipline to be taught how to do our job better?

College Towns as an Investment

College real estate has been in the news recently with many articles about the what good investments can be had in college towns. One such example is the national real estate investor in a story July 2007. Forbes covered their own Top 20 list.

Even in an economic downturn, colleges and universities provide a stable, yet vibrant, investment.