Rent Or Own

April 1, 2006       Mark Hrywna      

What the stock market was to the 1990s, the real estate market is to the 2000s. Historically low interest rates have facilitated a spending spree and fueled a skyrocketing market. The market may have slowed some while the Federal Reserve has bumped rates up a bit, and might even do so again.

There are a number of factors to consider when a nonprofit must decide to own or lease, including the size, finances, and its short- and long-term space needs.

“It’s a complicated question for anybody,” said Clara Miller, president and CEO of the Nonprofit Finance Fund ( NFF), a financial advisory and lending service for nonprofits. “Some of it depends on what kind of organization you are to begin with.”

Cash on hand “is always good, but many nonprofits decide to buy because of opportunity,” Miller said. For instance, the city or someone donates a building or offers it at a bargain price.

Low interest rates aren’t necessarily a factor in whether a nonprofit will buy, but rather, what a nonprofit can achieve in the real estate market, according to Brian S. Waterman, executive vice president and principal at Newmark Knight Frank in New York City. He said it’s always a good time for nonprofits to buy property, considering the different government programs that provide low-interest financing for nonprofits.

Purchasing is “driven by the availability of product more than anything else,” Waterman said, and will be the driving factor whether a nonprofit will buy.

What compounds the issue for nonprofits, Waterman said, is the allocation of some funds or grants that do not allow for coverage of debt service but do allocate for rental payments.

The ability or desire of landlords to sell usually is driven based on the softness or tightness of the market, according to Waterman. “As the market gets tighter, availability to buy for a nonprofit gets less,” he said.

New York City and Washington, D.C., are home to perhaps the most nonprofit organizations in the country, with nearly half of the top 100 groups identifying their headquarters in the two cities. Atlanta, Chicago, Colorado Springs, Dallas, Los Angeles and Boston also dominate the NPT Top 100 Group.

There has been positive absorption in the Washington, D.C., market, which has about 11 percent availability, Waterman said, and added that Chicago could have a potential for buying opportunities, as total availability increased from about 18 percent last year to just more than 19 percent now. He also cited the central business district of the Dallas-Fort Worth market, where there’s a 22 percent vacancy rate that had been as much as 24 percent but dropped since the middle of last year to the first quarter of 2006.

As for Los Angeles, “that market is really all over the place,” Waterman said, with the typical vacancy rate between 14 and 17 percent.

 

Money in the bank

The New York Academy of Sciences (NYAS) is expected to move into its new digs on the 40th floor of 7 World Trade Center in the fall. The association sold its headquarters — a 20,000-square-foot mansion on East 63rd Street near Central Park — for $31.25 million last year, after having it appraised for $22 million.

The academy’s board of directors was looking to cash in on a red-hot real estate market when discussions of selling first started five years ago, said NYAS Vice President and Chief Financial Officer Thomas Kelly.

Who can blame a nonprofit for selling at these prices? The Hazelden Foundation sold its 31,000-square-foot Victorian on East 17th Street for $10.25 million last year — about three times what it paid 15 years ago — and is now leasing one-third of that size across town on 8th Avenue. The Edwin Gould Foundation hopes its Gramercy Park townhouse headquarters will fetch about $17 million.

According to Cushman & Wakefield, a real estate services company, 32 nonprofits sold properties in Manhattan totaling $582 million during 2004, the third year in a row that sales exceeded purchases. The same number acquired buildings last year for a total of $293 million.

“One of the reasons why we wanted to sell, we had 100 percent of our net worth tied up in a 100-year-old mansion,” Kelly said, recalling that he’d told the board, “I’d rather have $18 million in the bank than a mansion.”

By 2003, more activity in the academy’s programs and membership brought pressure to sell for other reasons: increased demand and a lack of capacity.

One of the advantages to renting, Kelly said, is creating a cash reserve that provides flexibility in tough economic times. “Most nonprofits don’t have reserves so this is an opportunity for us to have a cushion against possible bad years,” he said. “It gives us a better feeling of security, not living hand to mouth.”

Initially, the plan was to sell the property and buy a smaller building in a less expensive location while pocketing the proceeds for the future. That might work in other markets, but almost no property in Manhattan is for sale.

“When the idea of renting was introduced to the board, in the beginning it was an anathema,” Kelly said. “But 95 percent of businesses in Manhattan rent and somehow find that okay. You need to open your mind a little, look at the long-term economics.”

The few properties that are for sale in New York tend to be very vertical buildings, Kelly said. “You don’t want 65 or 80 people on seven floors.”

 

Tread carefully

The NFF has been in Manhattan for 25 years, in which time there have been two major cycles in the real estate market, Miller said. During the last one, she said, a lot of nonprofits trying to get a handle on real estate costs “learned about the real estate business the wrong way.”

Nonprofits bought more than they needed, thinking they could lease space to other nonprofits. Unfortunately, Miller said, they bought at the top of the market and it collapsed, driving down the cost of rentals. Some ended up issuing bonds, going into debt or even folding. “That was not a pretty story.”

Nonprofits sometimes find themselves headquartered in areas that have gentrified over the years, with their constituencies migrating to other neighborhoods, Miller said, citing Washington, D.C.’s toney Georgetown as an example. To maximize their mission, groups capitalize by selling their real estate. But there are other stories that do not have happy endings, when nonprofits sell property to move elsewhere, she said.

Acquiring real estate can be “a huge opportunity to grow their balance sheet, create earned income potentially” for nonprofits, Miller said. Organizations can become enamored with finally having room they’ve wanted for a theater, afterschool program or conference and meeting space.

“I think what happens in the excitement, the expense side of the proposition is forgotten,” Miller said. An acquisition can spawn new positions that require different skills, including real estate or conference center management, that sometimes get assigned to current staff who already have their own duties. These enterprises can pull management’s attention away from the original mission of a nonprofit, she said, and now they’re managing the real estate business because of the high component of fixed costs.

The National Urban League (NUL) had owned a building in Midtown Manhattan’s West Side until about 10 years ago, according to Ricky Clemons, vice president of communications. When NUL’s tenant, the United Negro College Fund (UNCF), moved its headquarters to suburban Washington, D.C., a decision was made to sell the building and place the proceeds into an endowment.

UNCF’s decision to move near to the nation’s capital was key to NUL making the move to 120 Wall St., he said, adding that NUL was able to secure a good nonprofit rate at the 33-story skyscraper. Erected in 1931, the 600,000-square-foot building is occupied almost entirely by nonprofit organizations.

Though NUL is still locked into a lease for a few more years, Clemons said the plan at some point is to look at purchasing a building again. “That’s always the plan.”

The Juvenile Diabetes Research Foundation International (JDRFI) has been at 120 Wall St. for 20 years and has no plans on moving. “I think that we have such a good deal here because building management has traditionally served nonprofit organizations,” said Peter Cleary, national director for media relations at JDRFI. “The nature and culture of the building lent itself to be a very good home for us.”

Lower Manhattan has always been a more affordable area of New York City, even before the Sept. 11, 2001 terrorist attacks, Cleary said. JDRFI has about 150 employees and two floors at 120 Wall St., with plans for some more space on another floor. “The building seems to meet our short- and longer-term size needs.”

Though the organization is not currently looking to buy property, if a favorable opportunity presented itself, given its diverse board of directors, Cleary said it would examine it.

Ask the important questions

According to Kelly of NYAS, the question that nonprofits must ask when determining whether to own or lease is, “What’s the long-term cost of occupancy going to be?” The academy and its leasing agent spent a lot of time creating a model that incorporates the costs, services and revenues involved. “Around the country, those models will tell you the answers,” Kelly said. Specific to Manhattan, if you must own, he said, you have to settle, but with rentals, there’s a lot more on the market.

Now is a good time for nonprofits because the downtown market has not been discovered yet, Kelly said. When he factors in assorted subsidies and incentives, Kelly said the net cost of the stated $48 per square foot rent at 7 WTC turns out to be “an amazing value.”

The $700-million, 52-story building is expected to open in April and by June Kelly hopes construction will begin on the academy’s new 40th floor headquarters currently in the design and detail phase. The new facilities will give its 74 employees better working conditions, as well as more conference and banquet capabilities. Kelly doesn’t foresee any substantial interruption in programming as the summer is a slow time of year, and the academy is not planning major events until after November, leaving time for any potential construction delays, as well as a chance to break in the new facilities. “The timing has worked out fortuitously for us,” he said.

Another thing for nonprofits to consider is the wild card of what direction the real estate market will go. Even based on historical perspectives, real estate values “have a funny way of being down at the point you’re wanting to sell.”

He also cautioned that it’s not safe to assume too much capital growth in the value of real estate but that depends on the philosophy of a board. “It’s not growth until you sell the building,” he said. “Oftentimes it’s the hard times that force you to sell buildings.”

The most important thing in deciding to buy or lease real estate, NFF’s Miller said, is for the organization to think about its vision. “Real estate is a specific business that’s not the organization’s mission. Sometimes it works well if you’ve got plenty of management support and can afford to actually capitalize another business alongside its regular business.” NPT