Unlocking the Value of College Real Estate

While the pandemic has created significant financial challenges for many higher education institutions, the campus itself may be the solution, Grace Winters and Elizabeth Levin write.

July 27, 2020
 
 
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The campus has not vanished. Grassy quads, historic dorms and state-of-the-art laboratories all sit dark and quiet, emptied of students, but the higher education institution itself remains, as do the rent, mortgages and basic operating costs. While colleges and universities explore ways to absorb the new costs of building a virtual campus, the expense of operating the physical one has not significantly diminished, even though the housing and dining revenues it previously generated have disappeared.

Administrators are asked to be diviners: If enrollment or on-campus residency drops, should we dip into the endowment to fund a few weeks -- or a semester or a year -- of virtual education? Should we maintain the campus in hopes of a return to normalcy in the future? Can we afford to operate if classrooms and residences can only be used at half capacity?

The campus itself may be a solution. The physical campus is the heart of the institution, but it is also real property, with real value. Administrators may be able to turn to creative real estate ownership structures, common in the commercial real estate world, to create an infusion of cash for the institution without selling a cherished piece of the campus to an unknown developer to turn into an office park.

The first step you can take to create cash flow from institutional real estate assets is to catalog and review your institution’s full real estate portfolio. College and university portfolios are often made up of a patchwork of types of real property -- contiguous parcels forming the core of a campus as well as leases on nearby property or smaller parcels in other locations (sometimes completely off the radar of those making the most difficult financial decisions for the institution). A California client of our law firm recently realized it owned a small vacant farm in Arizona -- a family property that a generous donor had willed to the institution years ago. Administrators can work with a lawyer or a title company to determine if the institution owns pieces of property that may have been overlooked previously.

Once you catalog your institution’s assets, the next step is to evaluate and prioritize those assets based on value -- monetary, strategic and sentimental. A property may be worth hundreds of millions, but if it is the building on the school’s crest, it may not be worth selling at any price. In contrast, a piece of property may be of minimal importance to the character of the institution but significantly attractive to potential developers or third-party users.

You can identify preliminary cost savings by assessing all the leases where the institution is a tenant to determine whether the lease could, by its terms, be terminated or the rent reduced. Some leases explicitly contain provisions that would give a break on rent when the tenant cannot operate. Even if a lease does not contain those provisions, creative arguments might be made that the tenant is entitled to deferral or relief of rent obligations under applicable law. Landlords may even be eager to allow a tenant to terminate or to sublease, especially in markets where rents have risen in the past few years or there is significant nonpayment of rents generally. After reviewing a lease with a lawyer, savvy institutions will reach out to landlords to negotiate creative solutions.

While eliminating or reducing rent obligations on an institution’s books can offer some relief, the way to generate actual income or liquidity from real estate is to dispose of some interest in it. That does not necessarily require a sale. Real property can generate cash from rents, from a mortgage or from a joint venture, all of which allow an institution to maintain some degree of control over the way that property is used or redeveloped. You can structure these arrangements flexibly to allow your institution to take back some use of the property when campuses are full again.

Leasing property to a third party allows the institution to maintain the most control. While seat counts are reduced in the coming semester or semesters, a college or university could offer short-term leases to office tenants or other educational institutions. Many office tenants will likely be searching for additional short-term square footage as employees come back to work but cannot safely work in the same close quarters as before. Working with a broker to market short-term leases could reveal surprising opportunities and allow for the option to take back control of the space once the pandemic danger lessens.

Institutions looking for more substantial cash flow from disposition (but preserving ownership in the long run) may consider a long-term ground lease instead. Ground leasing land gives a developer a right to own the building constructed upon it, but the ground lessor can often maintain consent rights over the method and the aesthetics of any new construction, limit the way the building is used, and have the right to consent to any sale.

Alternatively, a sale-leaseback would allow the reverse of the ground lease structure: your college or university can continue to occupy the property while monetizing the value of ownership. In a sale-leaseback, the institution sells the property to a third party, resulting in a cash payment to the institution. The institution then leases the property back from the new owner -- and may even have the option to buy back the property if the new owner ever decides to sell. That can provide a quick infusion of cash with little to no change in the day-to-day use and operation of the property.

Finally, you may want to explore partnerships with developers who are looking to develop student housing or mixed-use projects on university property. Through various formulations of underlying ownership, a partnership between your college or university and the developer would allow your institution to benefit from the developer’s construction and operational expertise while maintaining some level of ownership and control over the property. Many private companies, such as student housing developers, hospital systems and residential developers, are looking to partner with educational institutions to bolster the credibility of their brand and to find shared efficiencies.

The most effective real estate management strategy is likely a combination of all of the above. Shedding rental obligations will free up some operating budget. Short-term leases will provide cash in hand and flexibility for the future. Sales of noncore parcels will provide liquidity and relief of operating expenses. Sale-leasebacks, ground leases and joint ventures will provide cash in the short term and the comfort of additional income in the future, while maintaining institutional control over the look, feel and use of the campus property. All of these options afford liquidity without jeopardizing the longevity of the institution.

In such ways, a financially challenged college or university can minimize the threat of reaching into an endowment to cover expenses. By looking instead to the campus under your feet, your institution can effectively obtain an infusion of cash without relinquishing its identity and physical presence in the process.

Bio

Grace Winters is a real estate partner in the Orange County office of the law firm Manatt, Phelps & Phillips LLP, and Elizabeth Levin is a real estate associate in the Los Angeles office of the firm.

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