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Business Officer Magazine

Wise Buys

In the midst of a depressed real estate market, a series of smart deals by Calvin College created a new model to address space needs, avoid the burden of new construction, and generate nontraditional revenue.

By Henry DeVries and Samuel Wanner

*Calvin College has grown in significant ways in the 135 years since the liberal arts college first opened its doors as a seminary in 1876, with seven students. Currently 3,800 students are enrolled at the 352-acre campus situated in the heart of Grand Rapids, Michigan. Nearly a decade ago, as part of Calvin's long-term strategic planning, the institution's leadership articulated a desire to grow academic and research opportunities for faculty and students, including nurturing and supporting intellectual property development.

Calvin, like other institutions, was also keen to find new ways to generate nontraditional revenue streams. These goals, coupled with the need for additional office space and a desire to help more students live closer to campus, pushed college leaders to consider how to expand square footage without negative financial impact.

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In the early 2000s, in the midst of a $150 million capital campaign, we were beginning to face an impending space dilemma. Planned renovations to our fine arts center and athletics complex required us to relocate departments temporarily displaced by these improvements. We also faced the question of how to create more office and classroom space without constructing a new building.

We began considering options for moving some administration offices and Calvin's centers and institutes off campus to preserve the campus for classroom and other priority academic space. Simultaneously, the availability of a class-C office building adjacent to Calvin's campus provided an opportunity that allowed us to develop and test a new model for addressing the college's space deficit. The exploration of this approach would also lead us to consider alternatives for financing new building construction and facilities expansion other than the traditional way of tying projects to donor gifts endowed for facilities purposes.

Opportunity Knocking

The following sequence of real estate acquisitions depicts how Calvin's leadership took advantage of market opportunities to position the college for strong future growth while minimizing its financial burden.

Raybrook Building. Our intention in 2006, when we purchased this 10,000-square-foot class-C office building adjacent to the campus, was to maintain the building as a mixed-use property. Our plan was to continue to rent the majority of the space to external tenants, using the rental revenue to pay for the acquisition. We would set aside approximately 20 percent of the space to house some of Calvin's related academic centers and institutes, gradually increasing the share of Calvin's use of the space over time as it made financial sense to do so. However, in the year following the purchase of this property, two other opportunities emerged—a nearby apartment complex and a class-A commercial office building.

These new spaces allowed us to expedite our transition of the Raybrook Building to 100 percent internal use by the college. Since owning and operating a rental property is far different from owning and operating an academic building, our Raybrook purchase provided a working model for moving forward with these next acquisitions.

Glen Oaks East. In recent years, proposals have emerged from within our student life services division to expand Calvin's presence as a residential campus. When we learned that the owner of a nearby 144-unit apartment complex wanted to sell the property, we saw this as an opportunity to increase Calvin's housing supply.

The already developed property was highly attractive for two reasons. First, it could be brought online quickly to provide additional student housing. In this regard, the Glen Oaks complex would be especially beneficial if the college decided to implement a third-year residency requirement. Second, the college would not have been able to build new residence quarters for the cost of purchasing this existing space, approximately 1.5 miles from campus. All around, we saw this as a good strategic investment decision that provided flexibility to increase Calvin's residential capacity in the future. Currently, about 20 percent of the units are rented to Calvin students, maintaining a blend of families, young professionals, and students.

Weyhill Building. At the same time, another opportunity emerged to purchase a six-story class-A commercial office building within a five-minute walk of Calvin's campus. As we began to look down the road 10 to 20 years, we envisioned a day when the college would need to move administrative offices off campus in order to repurpose existing campus facilities for residential or academic space.

As with the apartment complex, our initial plan called for maintaining a majority of external tenants so that we could use the rental revenue stream to pay for the properties. These two acquisitions gave us confidence that we were addressing future space needs while providing the college the financial capacity to pay off the Raybrook Building and acquire some much-needed storage and office space.

Youngsma Building and storage properties. Another opportunity presented itself in the form of two general office buildings that became available across the street from Calvin's campus. Leveraging the rental revenue generated by the Weyhill and Glen Oaks East properties, we were able to purchase these two buildings and dedicate them completely to our needs for document storage and the relocation of departments temporarily disrupted by campus renovations.

We also relocated the development and human resources departments as part of our effort to free up additional academic office and classroom space. Purchasing these properties allowed us to maximize our tenant rental of the Weyhill Building rather than occupy only a portion of that space, as we had planned.

We also acquired a third building adjacent to the campus to store all the furniture, fixtures, and equipment displaced by the recent renovation and expansion of the fine arts center. Currently, with space freed up from concluding our renovations, we are ready to build out this overflow storage site. This structure was essentially a shell when we purchased it, and we are in conversation with interested tenants who would like to lease the space.

A New Way to Finance

Tax and Legal Implications

Evaluating any new business opportunity involving acquisition of an asset or business requires addressing a number of tax and legal considerations.

Entity selection. When acquiring a business or asset, you must first determine what type of entity (for example, limited liability company, corporation, and so forth) would best serve your institution. Key considerations include:

  • The liability protection afforded by the type of entity.
  • The governance and management structure of the entity and how it relates to the parent and/or affiliate entities.
  • The tax treatment of different entities.
  • The tax reporting of various entities.

While limited liability companies (LLCs) have many advantages with regard to their flexibility, in some instances a corporate model may make more sense. This may be particularly true within the context of a complex parent organization, but is dependent on the taxability and tax-reporting structure of the overall enterprise.

Tax-exempt status and unrelated business income tax (UBIT). Both of these issues are complex, especially in the context of acquisition of, investment in, or some level of operational involvement by a tax-exempt organization where the assets and/or business complement the tax-exempt organization's core activities. UBIT is defined generally to be income that is:

  • Derived from a trade or business.
  • Received from business regularly carried on.
  • Unrelated to the organization's exempt purpose.

The tax consequences of these activities largely hinge on a detailed analysis of the business in question when compared to an entity's exempt purpose. In the event UBIT is generated, tax is due on those activities. When considering a new activity for an exempt organization, getting it right at the outset is critical; the risk of having UBIT determined on a retroactive basis could result in unanticipated tax liabilities.

In addition to triggering a requirement to pay tax, UBIT—if deemed “excessive” relative to an exempt enterprise's other sources of support—could be deemed to change the overall character of the exempt organization. In a worst-case scenario, it could jeopardize the institution's tax-exempt status.

Given the stakes, organizations considering activities that could give rise to these issues must work hard to coordinate their internal business resources with their external tax, accounting, and legal resources. This will help ensure that the entire team gets it right with regard to establishing acquisition and operation parameters of the assets/activity in question and will ensure that such activities are maintained consistently over time.

At Calvin, new building construction and facility expansion and renovation have long been based exclusively on donor gifts. Further, Calvin raises funds from donors to endow new building maintenance and operations. Neither current operating funds nor the tuition structure are used to pay for these costs.

We knew we were facing an impending space shortfall, yet all the brick-and-mortar dollars of our capital campaign were already identified and allocated to academic needs. We needed a new approach to addressing pressing needs for additional office space. Our purchase of the Weyhill and Glen Oaks properties provided an opportunity to obtain the additional space the college needed now and in the future by leveraging the tenant revenue generated to help pay for these other acquisitions.

Finding these new types of real estate solutions for our college space issues also required exploring new models for funding their acquisition. This included making decisions about setting up the right business structure and financing options for our ventures.

Choosing the LLC option. After a thorough vetting of financing options with our tax and legal counsel, we moved forward to acquire these two properties through LLCs (limited liability companies). This structure was appealing for a variety of reasons.

  • It answered our primary objective of keeping these transactions at arm's length from the college, for liability purposes. For instance, if a fire were to break out in one of the apartment units, we wanted to ensure that this would not negatively affect the college.
  • Ancillary reasons for choosing an LLC included the facts that (1) the governance by a board of managers resonates well with the general governance model of the college, and (2) since the prior owners of each property had already established an LLC, there were some transactional tax benefits in acquiring the LLC versus the real property.
  • Initial property taxes were minimal. Unlike Calvin's tax-exempt status as an educational institution, the LLCs do pay property taxes based on their use of each building. In the case of the Weyhill Building, the LLC pays 100 percent of the property taxes since Calvin does not occupy any portion of the building. In the case of Glen Oaks East, the LLC also pays 100 percent of the property taxes even though approximately 20 percent of the apartment units are occupied by Calvin students. At some point, if 30 percent or more of the apartment units are consistently rented to Calvin students, we may petition the state for a reappraisal of the property to reduce the portion of property taxes payable—allowable under Michigan's tax code.

Using taxable bonds. As we explored our financing options for the two LLCs, we weren't able to use a tax-exempt bond, since these properties generate revenue not directly related to tuition revenue. Instead, we financed both buildings with taxable bonds. This bond issue is, however, divided into two series, allowing one series to be converted to a tax-exempt structure if the associated properties are used 100 percent by the college at some point in the future.

It is critical to note that such real estate deals can be risky and complicated, and they raise a number of implications beyond property and income tax concerns (see sidebar, “Tax and Legal Implications”). Such endeavors are not for the faint of heart, nor for the impatient, since ample time is required to vet each deal with institution leaders and stakeholders.

Due Diligence Done

We attribute the success of these acquisitions to widespread information-sharing and discussion and a planning approach designed to identify potential problems early in the game.

External expertise. In addition to consulting with Calvin's tax counsel and general counsel, we hired external accounting expertise to help review what these properties would represent in terms of debt service and debt load to ensure that the purchases made sense financially.

Internal governance. In the process of developing each proposal, we vetted property acquisitions through key internal governance processes. The board's administration and finance committee was instrumental in assessing financial risk for the college. Our president kept cabinet members and the board of trustees' executive committee advised with regard to any emerging details. By engaging the faculty senate and other relevant campus committees as we developed each initiative, we made an effort to include stakeholders in conversations early and often.

This included close communication with student-development staff in relation to the Glen Oaks apartment complex. In this way, we addressed all possible questions and identified in detail the financial connections between the college and the various properties so that all stakeholders shared an understanding of the relationships and funding mechanisms.

Quality evaluation. Part of our baseline due diligence included “kicking the tires” to ensure these properties offered good value and low risk for the college. For instance, we drew on the expertise within Calvin's physical plant to help evaluate each property, bringing campus facilities staff along to tour properties under consideration. These staff experts provided invaluable assessment of structural and foundation issues, HVAC and electrical systems, and checks for mold and mildew or asbestos-related problems to identify potential trouble spots.

The questions driving us now have to do with what space the college may need in the future and how we can use our current properties in the most profitable way.

Mission test. In each instance, we underwent a vigorous “mission fit” assessment to determine whether and how each property would help fulfill Calvin's mission. If a property missed a critical test, we would not move forward. The ones that eventually surfaced were so well scrutinized by various committees that only the ones with a valid business proposition would rise to the level of being presented to the board.

Mission and Talent Match

It is important to make clear that Calvin College is not in the real estate business; we are in the business of educating students. All efforts focused on these various real estate acquisitions have been viewed with proximity, practicality, and mission in mind. We moved forward with caution, starting small and learning from our experience, since acquisition of revenue-producing rental property represents something most would not immediately connect with institution mission. In addition, these practices fall into a business arena outside traditional higher education administration, at least for smaller institutions like Calvin College.

Worth noting is that for every purchase we have initiated, we have received numerous proposals from the community that we've declined. During all parts of the vetting process—from the ground-level investigation of the properties to our president talking to the board's executive committee—we have determined many instances where the property ultimately did not mesh with Calvin's mission or long-term need. Some, for example, were not close enough to the campus, and others were not high-quality structures.

Another takeaway is the importance of paying attention to operational requirements. As we considered early on the various risks involved in such deals, it became clear to us that one of the biggest potential risks to an institution is that of business failure.

While there may be a future purpose for a particular building that suggests it makes sense to purchase it—and while market conditions may seem ideal for property financing—unless you are able to manage it well in the interim, your acquisition could wind up a colossal failure. A key question to ask: Is the right talent available to manage this property successfully? Especially in the tenant-rental arena, a poorly managed property will translate into declines in occupancy and subsequent reductions in potential revenue.

Calvin has enjoyed favorable market conditions for property acquisition and a positive labor environment for hiring the kind of talent that is not always available to higher education when greater competition for expertise exists. In part because of the depressed employment market, we have been able to hire individuals within the real estate, banking, and property management fields as we built our team.

Bottom line: Engaging successfully in these kinds of transactions requires having access to individuals who understand the complex world of financing and bond markets, the fine art of negotiating real estate transactions, and the details of complicated contracts.

Niche Fit

Today, all traditional colleges and universities face pressures to explore new revenue-generating initiatives in support of the nonprofit missions of their institutions. While some are entering the world of online learning or executive education, Calvin's foray into the real estate arena has been serendipitous and has meshed with the college's future ambitions for academic excellence.

One of the great values of exploring this process for Calvin has been learning to navigate a new funding mechanism that not only furthers the college's mission but fits within our priority goal of not dipping into operational funding or precious tuition dollars to expand our reach.

The questions driving us now have to do with what space the college may need in the future and how we can use our current properties in the most profitable way. At a future point, the college may need some of the space that we currently lease. In the meantime, it is valuable to identify a new source of revenue that allows us to expand our research and scholarship mission without placing additional burden on tuition or endowment dollars.

We believe that Calvin is proving that, with the right set of variables, even small institutions can make big and positive strides by successfully expanding their academic footprints, fulfilling research and scholarship opportunities, and generating nontraditional revenue streams to bolster an institution's bottom line.

HENRY DEVRIES is vice president for administration, finance, and information services, and SAMUEL WANNER is director of financial services, Calvin College, Grand Rapids, Michigan.