By Richard Podos, Lance Capital LLC
Government agencies need space to house their offices and accommodate all their people and operations. Making such space available involves financing, even when the space is leased.
In some cases, these agencies may already own buildings that will accommodate all staff and operations. But if not, it may be necessary to lease space from the private sector. This can be costly, into the hundreds of thousands or even millions of dollars.
One of the main factors contributing to these costs is the need for “tenant improvements” as government bodies must pay these costs when they move into a commercial space. The name is a misnomer. It is not a series of improvements being done at the whim of the tenant. It is necessary construction projects to make the space habitable and meet the minimum needs for its intended use.
Now, there is a special form of financing based on “rentalizing” tenant improvement costs. This process can be valuable to agencies as a help to the state or locality’s bottom line.
State and local governments today seek ways to reduce their real estate costs and footprint, such as consolidating multiple office locations into fewer buildings and less square footage. When an agency does that, there is often a hefty expense to reconfigure the office space.
In the commercial real estate office market, when a tenant leases 100,000 square feet, for example, the landlord will provide some tenant improvement funding. In general, however, that landlord contribution is not nearly enough to build out the space.
Problem one is that while consolidating is a good idea, using budget dollars for tenant improvements is difficult in and of itself. There is a lot of competition over alternative ways to use the limited funding available.
Problem two is construction. Given a choice, most state and local governments would rather have the landlord handle construction because the private-sector operator can be more efficient in getting it done, in both total cost and timing.
The solution to these problems is a special new loan to landlords that rentalizes the amount of tenant improvements to cover an entire project budget. The state or local government doesn’t have to use its own budget dollars and the landlord takes care of construction activity.
A case history illustrating such a transaction comes from New York City, where the Department of Health and Human Services consolidated from six locations in Brooklyn to one and reduced the square footage from 600,000 to 400,000 – for a huge saving. The city elected to occupy more than half a 650,000 sq. ft. building formerly used for manufacturing and warehousing at 470 Vanderbilt Avenue in the borough.
The savings were so compelling here that the city decided to replicate the transaction in another borough. This second case history, also involving the New York Department of Health and Human Services, consolidated the agency’s office space in the Bronx from three locations to one at the Bank Note Building in the Hunts Point section, where the city has taken 200,000 square feet and achieved similar space and cost savings.
Health and Human Services will occupy three floors in the BankNote, once the location of American Bank Note Company printing presses that printed currency, postage stamps, war bonds, and stock certificates for nearly 76 years. Built in 1909, the BankNote has now been made into an office and retail complex and a hub for creative companies, non-profits, community organizations and schools.
To make both the Brooklyn and Bronx transactions possible, separate loans of $45 million and $17.9 million, respectively, funded the tenant improvement budgets. Each loan was made to the landlord who paid for the entire tenant improvement cost. To pay back each loan, the city is paying additional strips of rent associated with the tenant improvements at each location.
There’s another benefit: the city has converted to rent what would have been a direct capital expenditure. Rent is an administrative expense, and approximately 70 percent of the rent for health and human service agencies is reimbursable by the federal government.
In the case of New York, the city and its citizens come out ahead because their costs are lower. The city uses its own occupancy as an economic revitalization tool.
The buildings it is moving city services into are in neighborhoods — Fort Greene in Brooklyn and Hunts Point in the Bronx – that have been economically challenged for a long time. By moving to the new locations, the city is bringing thousands of jobs into these neighborhoods as well as agency clients who will come to the facilities.