The founders of George Washington University could not have anticipated that, almost two centuries later, the institution’s prime location in D.C.’s Foggy Bottom neighborhood would be a developer’s dream—and a golden opportunity for the university.
Their major venture, a mixed-use retail, residential and office development called Square 54 and completed in 2011, has close to 1 million square feet and is located on the site of GW’s former hospital.
The income from Square 54 paid for 90 percent of a 500,000-square-foot, state-of-the-art research facility on campus that opened in March 2015, without the university having to dip into operational funds.
While that is certainly an all-star real estate success story, revenue alone doesn’t drive every real estate initiative. Higher ed institutions involved in development, typically off-campus, also consider the economic revitalization of a blighted surrounding neighborhood and initiatives that support the core mission.
Serving programmatic needs—think student housing, retail options for faculty and students, parking and hotels for guests—is another motivation for building real estate assets.
In the even-bigger picture, investing in real estate is a way to have some control over the future.
“A university is an institution that will be there 100 years from now,” says Herman Bulls, international director and vice chairman for the Americas at JLL, a Chicago-based consultancy and professional services firm specializing in real estate. “They have to take a very long-term perspective as to how they would control and influence their surrounding areas.”
In other words, the key to reaping the rewards and mitigating the risks of real estate assets lies in the planning.
Maintaining ‘ground control’
Besides Square 54, located at 2200 Pennsylvania Avenue, George Washington is also developing a 250,000-square-foot office building at 2112 Pennsylvania Avenue NW, having entered into a ground lease with Skanska USA. The university owns two office buildings on Pennsylvania Avenue and two local hotels as well.
“We use all of our commercial real estate to improve the area, to build a sense of community and to bring income into the university for our programs,” says Lou Katz, the university’s executive vice president as well as its treasurer.
Smaller in scale is Argonaut Village, a new 13,000-plus square foot restaurant development that serves as the entry to east side of University of West Florida’s campus. It was developed in collaboration with Chartwells, the university’s food service company. The institution also purchased an adjacent golf course and has plans to lease that to a private-sector operator.
Georgia Institute of Technology went the revitalization route. Officials are transforming a deteriorated retail/industrial area in midtown Atlanta into Technology Square, with plans for a mixed-use complex called the High Performance Computing Center. Overall, Technology Square will constitute 3 million square feet of space. Georgia Tech is also holding other parcels for potential development.
Georgia Tech’s goals were to create a vital and dynamic environment to make the campus an attractive place to work, learn and play, says Steven Swant, executive vice president for administration and finance.
Administrators at Carnegie Mellon University in Pittsburgh—where there is limited space to expand near campus—are working on the Gateway Project, a complex intended to be a hub for innovation and attracting top talent. “We are creating a platform where industry can be located closer to campus,” says Amir Rahnamay-Azar, vice president and CFO.
Over the past 20 years, University of Pennsylvania officials have purchased land and buildings on the outskirts of campus. These include the site of a former U.S. Post Office that has been redeveloped into green space, housing and offices. University officials also converted DuPont Marshall lands into a warehouse and lab space, and turned a former aerospace manufacturing plant into apartments for students. And a plumbing warehouse has been transformed into a radio station and a performing arts venue.
“Our main concern is maintaining long-term ground control so that we ultimately have an influence over the type of amenities in terms of quality of design and in terms of tenant mix,” says Craig Caranoli, executive vice president. “If you’re urban, you need to be active in real estate largely to facilitate future growth for future administrations.”
Rewards beyond revenues
For the most part, colleges and universities do not enter the real estate market seeking big profits, at least not in the short term. In fact, real estate often does not represent a significant chunk of income even for those large institutions that are knee-deep in property development.
“The driving decision here is not to make money but meet some programmatic need to promote the mission,” says Bulls at JLL. “When you’re planning for these projects, seldom do you plan for them to be big moneymakers.”
Georgia Institute of Technology officials typically refer to its real estate ventures as “revenue neutral.”
“None of these initiatives targets generating revenue, but ‘targets’ our mission of academic research and economic development,” says Swant. “They need to be economically feasible and viable, but they were never designed to spin off revenue, though maybe they will at some point in the future.”
Many universities, such as Carnegie Mellon, look at real estate development not as an end in itself, but as a strategic tool to help pursue their overall mission of education and research.
“While this could be a revenue-generating asset, we are not pursuing this project for the rent revenue stream,” says Sarah Bush, associate vice president for real estate. Rather, she notes, it’s part of the academic research mission to support the innovation corridor and to help “enhance the university’s brand and improve the campus experience. We view the benefits of the project to be much more than the rental revenue.”
Carnegie Mellon would not consider purchasing land and developing it into a shopping center or hotels, for example, Rahnamay-Azar adds.
Steve Cunningham, vice president for finance and administration at the University of West Florida, says that Argonaut Village is not a revenue generator. Instead he labels the project a “break-even, cost-recovery type of approach.” The university isn’t required to borrow the money or pay the debt service on the capital investment side, with the risk being taken on by the private sector partner.
As George Washington officials know because of Square 54, the financial impact of a real estate project can indeed be great. Still, unless there is a direct strategic purpose, officials are not currently considering expanding the university’s real estate holdings. “We are not speculating in real estate; we’ve done very well, but we are not looking to put our balance sheet at risk,” says Katz. “What we are trying to do is build value so we can put more into our academic programs.”
The University of Pennsylvania also has struck financial success. “I think that the strategies we’ve employed have been financially advantageous to us based on the good deals we’ve negotiated,” says Caranoli, referring in part to fixed ground rents and favorable interest rates.
But where there is revenue, taxes nip at the heels—and unrelated business income taxes can be an issue. As most higher ed officials know, tax-exempt organizations may be subject to pay income tax when they regularly engage in a business or activity that is not substantially related to their purpose.
“Normally the ground lease type of model is one that does not have the same exposure to unrelated business income as would be the case if the university had an operating lease,” says Cunningham.
On properties in which it’s a passive investor, George Washington also does not pay unrelated business income taxes, but it does pay taxes on commercial developments like any other investor would. Katz says that every institution will have to determine which decision is the best regarding structuring real estate deals from a tax standpoint.
Sharing the risks
Just as buying land and building offices and retail shops can be profitable, there is always the other side to the proverbial coin. “If you build it and they don’t come, you have an albatross,” says Bulls.
Universities are better suited to weather the risks of economic downturns, says Carnegie Mellon’s Bush. “However, in a worst-case scenario where the market falls and all industries are significantly adversely affected, there is the risk that space sits vacant, rents fall below break-even, and the project fails,” she says.
Many large, urban institutions have taken on real estate projects with a public partner to offset the risk.
George Washington entered into a ground lease for Square 54 with its private sector partner, Boston Development. The land reverts back to the university in 60 years. “The reason we do those kinds of investments is that it takes all the balance sheet risk off the university,” says Katz.
University of West Florida also has a ground lease for Argonaut Village. Cunningham calls such public/private partnerships “a good way of bringing development capital into universities where other resources, state resources or resources from other income, like tuition, are very scarce and often not available to build many of these new facilities.”
Real estate for all?
Investing in real estate is not a strategy that works for every university. Factors such as land availability and proximity to campus, the need for growth, income potential, risk and support for a school’s core mission all play a role in the decision-making process.
Nonetheless, diversifying revenue with real estate is a valid consideration that may become imperative in the future. “We as business officers ought to be thoughtful and somewhat proactive in striking deals on behalf of universities that meet the mission but are economically smart,” says Rahnamay-Azar at Carnegie Mellon. “Real estate, given its share of possible impact, has become an area where people pay more attention.”
In today’s financial climate, real estate considerations extend well beyond the property lines of campus.
“The current operating environment, and I think the future operating environment, will require universities to be far more creative in terms of their development and improvement of campus facilities,” adds Cunningham.
Hilary Daninhirsch, a former practicing attorney, is a Pittsburgh-based writer.
