Niche properties

Capitalize on Campus

University properties hold opportunities for redevelopment.

R undown campus properties often languish in colleges' real estate portfolios with their revenue potential unrealized. To capitalize on these opportunities, commercial real estate professionals can create joint ventures with educational institutions. The key is to identify the best prospects for redevelopment and structure proposals that meet the needs of colleges and universities.

Almost any property that lies within the environment of a large college or university has potential value because a student body always demands good housing. When developed in the right way, student-housing buildings become highly coveted places to live that benefit from word-of-mouth advertising and a waiting list of prospective tenants. Companies that capitalize on the redevelopment potential and are identified with good student housing have a ready audience for future buildings.

Determining Potential

Many factors work in favor of developers, brokers, and others who are interested in pursuing the student-housing property niche. First, many universities lack the resources to redevelop properties into a significant income source. Second, most universities face increasing enrollment numbers every year and a subsequent increased need for housing. Not only are college admissions more competitive than ever, it's also a challenge to obtain university housing. At some large universities, only freshman are guaranteed on-campus housing. This creates a huge demand for student housing on- and off-campus for older students.

Finally, colleges are wary of owning properties that have not been maintained properly by previous owners. Deteriorated college-owned buildings reflect poorly on a school's image, among both town residents and tuition-paying parents.

The following case study highlights the potential commercial real estate professionals can find when working with universities and colleges. The University of Pennsylvania owned Pine Arms, a 74-year-old mid-rise apartment building in University City in West Philadelphia, where the university's campus is located. Once an architectural gem and asset to the community, the building had suffered years of neglect. University of Pennsylvania purchased the property to protect it from further deterioration, knowing that this building could help fulfill the need for university housing in the future.

Campus Apartments of Philadelphia realized the opportunity and took the initiative. A student-housing pioneer, the company's private holdings now total more than 220 properties and include mid-rise buildings, brownstones, townhouses, and garden-style apartments. By partnering with the university rather than simply negotiating a long-term ground lease, Campus Apartments created more value for both partners.

The Joint Venture

A university-commissioned study indicated Pine Arms should be torn down and replaced immediately - an expensive proposition. Campus Apartments approached the university with a redevelopment plan that would cost 33 percent less than what the original study had proposed.

The company proposed a joint equity venture in which it would develop, manage, and assume all debt risk for Pine Arms. The university, as a limited partner, would share in the positive cash flow. In exchange, Campus Apartments would receive a percentage of the rental revenue of the redeveloped building.

Attracting a university to such a partnership requires a well-crafted joint venture proposal. Universities often lack the budget - and expertise - for redevelopment. Developers can provide a valuable service by taking the project off the school's hands - at minimal risk and cost.

Campus Apartments tailored a financing strategy that suited the school. Ideally, colleges or universities are looking for plans that do not take any dollars out of their budgets and do not require them to assume any liability. However, they also need to retain rights to properties in the event that they may one day need them for campus expansion.

In addition, as not-for-profit institutions, certain financial issues affect their balance sheets and credits. They need to be extremely cautious and they make decisions much more slowly than private-sector companies. That was the case with the University of Pennsylvania.

Structuring the Proposal

The Pine Arms proposal outlined a plan to transform the property into attractive, luxury apartments - and save the university money and liability at the same time. Campus Apartments found the most important component in structuring the joint venture was the understanding that the school wanted to maintain certain controls. University of Pennsylvania requested control over the sale, refinancing, and the property's change of use.

Campus Apartments took all the risks, including a construction completion guarantee, a personal guarantee of the construction loan, permits, construction pricing, and finally, rental and lease-up risk.

By assuming lease-up risk for Pine Arms, Campus Apartments removed the final hurdle from the university's perspective. Because of the company's experience and reputation in developing and managing real estate in University City, the school was very receptive to the partnership. However, the Pine Arms deal still took 18 months to negotiate and the project itself took 2.5 years.

The Financing Details

To finance the redevelopment, Campus Apartments obtained a two-year, interest-only construction loan based at a rate of prime plus zero, with the loan amount equaling 80 percent of the construction cost.

The permanent financing went smoothly. Once the project was completed, upon achieving a 90 percent occupancy rate for 90 days, Campus Apartments placed a 10-year loan with a 30-year amortization non-recourse with Fannie Mae, at a rate of 5.78 percent.

When structuring the financial details in the proposal, developers need to make it clear to the university exactly how cash will be obtained for the project. But they also should look at every angle to streamline costs to make the joint venture proposal more attractive financially.

Brokers and developers can investigate other ways to create financing, too. For example, older buildings may qualify for historic tax credits. However, joint ventures with not-for-profit partners, such as most universities and colleges, cannot sell historic tax credits. Therefore, creating different entities to accomplish their sale may work. For instance, a university can be structured as a limited partner, or the developer can transfer the stake in historic tax credits to for-profit university subsidiaries.

Façade easement is another type of tax credit that developers can utilize. Many nonprofit preservation organizations want to ensure that building exteriors are preserved. The rights to the easement can be sold to a nonprofit in exchange for the developer's assurance that any replacements or upgrades will be done in a historically accurate manner. In return, the developer and university receive the benefit of further tax deductions.

From Eyesores to Profit Centers

In the end, University of Pennsylvania gained a fully occupied luxury apartment building, and Campus Apartments had a new long-term revenue stream.

Working within the historic natureof the building, Campus Apartments preserved its original French doors and crown molding, leaden antique glass, and original hand-turned woodwork. In addition, the apartments now sport the latest technology including high-speed Internet, high-definition television, and voice over Internet provider telephony.

Renovations came in ahead of schedule and on budget, which delighted University of Pennsylvania officials. Even more important, the building preserved an important community landmark, improving the neighborhood.

The University of Pennsylvania was so happy with the Pine Arms redevelopment that it marked the beginning of a series of projects and partnerships. Campus Apartments also was awarded the management contract for 78 university-owned scattered-site properties. The success of these projects has been financially rewarding for Campus Apartments, resulting in additional student-housing projects with other universities and investors.

David J. Adelman

David J. Adelman is president and chief executive officer of Campus Apartments in Philadelphia. Contact him at (215) 382-1300 or [email protected]               While preserving architectural details, Pine Arms\' renovation included many technology features such as high-speed Internet access and high-definition television. Photos: Campus Apartments

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