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Providence Financial












MONTHLY NEWSLETTER:  MAY 2009 ISSUE

NEW FACILITY LANDMINES
BY BRENT VAN ALFEN
PROVIDENCE FINANCIAL CO., LLC



In previous newsletters we have mentioned a relatively recent development in charter school facilities finance that is a huge benefit to many schools. Briefly, it involves working with a real estate developer who will acquire the land and build the facility of your choice using his own financing. He then leases the facility to the school until the school can finance its own purchase of the facility even if the school is in its first year of operation. This service is available to new start-up schools as well as schools that want to dramatically increase their enrollment from one year to the next.

Many developers are more interested in keeping the school in a long-term lease rather than selling the facility to the school; but I have seldom, if ever, seen a situation where a long-term lease benefited the school when compared to their owning the facility.

If you are considering a lease/purchase scenario similar to the one I described above, I would offer the following suggestions and cautions.

Rental rate escalators are usually built into a lease to protect the landlord against increased costs over long periods of time or to increase his profit. In either case, as real estate values rise with time, the landlord can legitimately claim that the rent should increase. I have personally never seen, however, a clause that allows for the rental rate to decrease during the occasional deflationary periods in the economy similar to what we are now experiencing. Charter schools should be very careful about how the rate escalator language is written. I have spoken with several developers over the years who have stated flatly that they expected rate escalators that are pegged to the CPI or another commercial index that they are used to seeing in the commercial markets. The trouble with that reasoning is that charter school reimbursement rates do not necessarily follow along with the inflation rate. In one discussion with a developer that I recall, I had to tell the developer that he would put the charter school tenant out of business within five to seven years using the lease escalator he proposed. The escalator should in some way follow the increase in reimbursement rates in your state.

The purchase option in a lease is another potential land mine for a charter school. First, it should give the school ample time to arrange financing for a purchase--given the ambiguities of the market. On the other hand, a developer is often under pressure from his construction lender to sell the property or put it into a long-term mortgage financing as soon as possible. Once the property goes into a long-term real estate financing, early payment penalties will apply and be passed on to the school by the developer if the school then wants to purchase the property. Developers can arrange a bridge loan that lasts for two to three years so the school can have a comfortable amount of time to arrange their financing to buy the facility, as long as both parties are working together to accomplish the same goal. The second issue to be aware of in a purchase option is the price and terms at which the purchase should take place. Well “duhh”, you are likely thinking; but you would not believe how many purchase options in leases I have seen that are full of ambiguities. These, unfortunately, have often been intentionally written for the benefit of the seller. A specific price should be included or a specific manner of determining the price should be in writing such as an MAI appraisal or something that both parties agree to. Third, you should budget the amount of money you can comfortably spend on a facility well before you sign any documents with a developer. Overbuilding is a serious mistake that happens all too often. Know the borrowing ability of your school when it occupies the new facility. We can help you here if you need it…just call or email.

A final suggestion is to make sure that there is no language in the documents that will allow any “wiggle room” for the developer or contractor to pass along cost overruns to the school. The developer has a profit margin and a contingency amount built into his price. The developer is also being paid to assume the risk of unexpected cost overruns. Charter schools therefore should not assume this risk. I have seen a school effectively guarantee a developer’s profit margin by accepting the responsibility for any unexpected cost overruns…dumb!

The above is just a few of the things a school must be aware of and careful about when they are entering into a lease or lease-purchase transaction. As stewards of taxpayer dollars you must be very careful. We at Providence have been through this many times, so maybe we can help. If so, give us a call

For information contact Rick Van Alfen, Providence Financial Co., LLC
Phone: 801-556-2290 Email: brent@providencefinancialco.com