Financing structure provides savings for New York City agency consolidation
An innovation in the funding for large-scale tenant improvements, paid for by financing a portion of the rent, has enabled the Human Resources Administration (HRA) of New York City to save significant dollars and complete a complex transaction for a 400,000-square-foot facility in downtown Brooklyn. HRA is the primary Health and Human Services agency and delivery vehicle in New York.
The project, which included more than $100 million in construction work for renovations, demonstrates how municipalities, in the face of unprecedented budget stringency, can economically and efficiently complete large, complex transactions that might not otherwise get done without a large capital outlay to build out the office space. The time is past when government agencies could afford to leave money on the table that is available to fund their operations.
HRA was consolidating three locations into one and downsizing from approximately 600,000 square feet of office space to reduce budget spend. In searching for a new location, New York City identified a former manufacturing building being converted to office space. The nature of the renovations at the location, however, required significant construction work to create an appropriate office environment.
The deal was not able to close until Lance Capital, in a unique approach, arranged a non-recourse $44 million tenant improvements loan for the building owner, provided by CGA Capital Corp. The loan was backed not by the property or other forms of traditional equity, but by a portion of the rent payable by HRA under the lease. Bonds tied to the rental stream and loan were privately placed with institutional investors. Those bonds, which fully amortize over seven years, are unrated, but implicitly benefit from the double-A rating of New York City, resulting in a loan rate just over 4 percent, much less expensive than traditional real estate financing. The resulting savings were then passed on to HRA in a lower rental rate, and further, the rent is an allowable administrative expense for federal and state reimbursement purposes.
Tenants typically receive a tenant improvements contribution from the landlord to perform build-out and renovations, and the tenant provides capital for the balance – often 50 percent or more – from their own budget. In this case, HRA did not want to make a large up-front expenditure and preferred that GFI Development, the building owner, take the loan exposure for the full tenant improvements budget, perform the build-out and provide a turnkey solution. Most importantly for NYC and HRA, by funding the entire tenant improvements budget for the leased space through the landlord, what would otherwise have been capital improvements expenditures were converted to rent and thus administrative expense, allowable as an indirect cost for reimbursement under federal and state guidelines.
The leasing transaction structure was reviewed and approved by New York City’s Department of Citywide Administrative Services, Office of Management and Budget, and Corporation Counsel. All funding for the tenant improvements budget under the Lance Capital structure was deposited into escrow at the lease closing, to be controlled by the landlord during construction but under New York City’s oversight as tenant.
By having the landlord, GFI Development, assume all ownership, funding, and construction responsibility for the tenant improvements budget, New York City was able to avoid a tedious procurement RFP process and also to save the interest expense to be incurred if New York City had financed the build-out itself. While the additional cost of tenant improvements funding was extremely favorable compared to typical landlord financing options, the added and key benefit to the transaction was the fact that the rent assigned to secure and cover the tenant improvements funding is approximately 70 percent reimbursable to New York City via federal and state reimbursement programs. Standards for determining costs for Federal awards carried out through grants, cost reimbursement contracts, and other agreements with State and local governments are available in 2 CFR Part 225, “Cost Principles for State, Local, and Indian Tribal Governments (OMB Circular A-87)”.
The Lance Capital lease-based tenant improvements funding structure is widely applicable for all state and local governments, in terms of both a low-cost approach to amortizing build-out and renovation costs into rent, and even more importantly converting capital expenditures into reimbursable administrative expense. Lance Capital is currently focused on tenant improvements funding as an invaluable tool for state and local government nationwide, initially for Health and Human Services-related reimbursable activity, such as Medicaid, CHIP, WIC, TANF, etc., but also other opportunities for federal reimbursement relating to Sustainability, Education, Transportation, Homeland Security, etc.
Executive offices, OMB, administrative and real estate departments, etc., should all be focused on this opportunity: Avoid using budget for tenant improvements capital expenditures, but where possible “rentalize” into reimbursable administrative expense.
Richard Podos is the founder, CEO and President of Lance Capital LLC, a specialty corporate real estate and finance company.
