COVID-19 had a devastating impact on the commercial real estate market in 2020. And, even with things reopening in 2021, the effects will likely be felt over the next few years. This puts nonprofits that own their own real estate and/or are landlords in a tricky position. To help us sort through these issues, we turned to nonprofit real estate expert, Eliza Solender, president of Solender/Hall, to share her insights from a recent piece in D Magazine about the business of nonprofits becoming landlords.
The COVID pandemic has harmed income for most nonprofit organizations. In addition, like the for-profit business community, many nonprofits had a substantial percentage of their employees working virtually. This reality has caused many nonprofits that own their real estate to evaluate their space needs, especially the space they are not using.
With the squeeze on revenue, obtaining rental income on unused space becomes very tantalizing. However, the danger is that the staff’s and board’s lack of expertise in commercial real estate could cause the organization to have unexpected costs, less than anticipated income, and unexpected headaches.
Here are some tips that I find helpful for nonprofits to mitigate their risk of becoming a landlord.
Losing The “Good Guy” Status
No matter the good intentions, once a nonprofit decides to become a landlord, it runs the chance of moving to “the dark side” in its relationship with its tenants, especially if the tenants are other nonprofits.
The organization must understand that circumstances occur in any tenant situation where the landlord must say “no” or be firm in enforcing the lease’s terms. This situation can be difficult if the nonprofit landlord is not using commercial real estate experts to assist them.
Bring in Experts at the Outset
Retaining a commercial real estate broker and attorney are critically important. These professionals can serve as a buffer between the tenant and the landlord, allowing the landlord to play less of an enforcer role in negotiating the lease and administering it after the lease is executed. The broker assists the landlord in determining the rental rate, marketing the space, and negotiating the lease terms. The attorney will prepare the lease document and assist in negotiating the lease.
An architect/designer should be retained to create base space plans, review any code and compliance issues, and create preliminary space plans for potential tenants. A contractor may need to be retained to initially construct demising walls, upgrade restrooms, add fire exits, and other necessary enhancements to make the space ready for potential tenants and modify the space the landlord retains for its own operations.
Determine Potential Tenants
Most nonprofit landlords prefer to lease only to other nonprofits. They should create a profile of the “ideal” tenant, especially if the landlord and tenant(s) occupy the same building. The nonprofit landlord may want tenants that are potential or current nonprofit collaborators on services. It may also seek tenants that are aligned with the landlord’s mission.
If the landlord decides it can lease to for-profit tenants, it should determine which businesses are compatible with its operations or mission and which ones are not. The broker needs to know the landlord’s preferences before marketing the property.
Nonprofit Tenants Expect Below Market Rental Rates
Unless the nonprofit landlord plans to target for-profit businesses as potential tenants, most nonprofit tenants expect below-market rental rates. They anticipate that the landlord’s operating costs for the building are less than a commercial landlord, and the savings should be passed on to them. This may or may not be true. A lot depends on whether the nonprofit landlord must pay property taxes on the space leased to the tenant.
The landlord needs to contact the county appraisal district for a possible answer. However, the lease should state that the tenant is responsible for paying any property taxes during its lease term. The nonprofit sales tax exemption on utilities and construction costs do provide some savings, and the nonprofit landlord must determine how it wants to utilize those saving in the lease.
Other Reasons for Below Market Rental Rates
One key point of negotiation with any potential tenant is to shift most of the construction costs to the tenant. This shift can help in significantly reducing the upfront costs to the landlord. However, the tenant will expect a reduction in the rental rate since it uses its own funds to renovate the space.
Two other considerations that could impact the rental rate are building amenities and management services provided to the tenants. Many moderately priced commercial properties offer conference rooms, covered parking, exercise facilities, and on-site food service. In addition, they have professional management teams that can quickly assist tenants with building issues. If the nonprofit landlord has few building amenities and plans to manage the property itself, it should consider a below-market rental rate.
It Takes Money to Make Money
The nonprofit landlord should utilize professionals to create a budget for the costs and potential income from leasing the space. At a minimum, costs include architectural/design, construction, brokerage commissions, and legal fees. After reviewing those costs, the landlord must determine if it has the upfront funds to lease the space. It is not unusual for it to take 12 to 24 months before the landlord starts to see a return on its money after covering all the initial costs. The nonprofit landlord must determine if this is the best investment of its funds.
Property Management and Administration
The landlord should have someone with facilities management experience to handle tenant and building issues. In addition, lease administration is important, especially if there are multiple tenants with varying lease provisions. Systems must be created checking rent payments, tenant annual insurance requirements, and other lease provisions that the tenant and landlord must follow. If the landlord lacks this expertise, hiring a professional management firm is an excellent option over expecting a busy nonprofit executive director to shoulder this responsibility.
Tenant May Default
One major risk for a landlord is the tenant failing to pay the rent. This situation discourages commercial landlords, but it can be devastating for a cash-strapped nonprofit that could barely afford the upfront costs and is counting on the rental income to fund its operations. Nevertheless, this potential situation must be factored into this real estate decision.
Can be a Successful Venture
Many nonprofit landlords in our community have successfully leased space to other nonprofits. Some of our recent leases have been with Catholic Charities leasing to Family Gateway and Girls Embracing Mothers and South Dallas Fair Park Inner City Development Corporation to Prism Health North Texas. We just completed a lease for VolunteerNow to Cityscape Schools in their building located on Live Oak. A bonus: These nonprofit landlords are willing to share their experiences with other nonprofit organizations.
After weighing all the risks, I have found that when a nonprofit organization becomes a landlord and approaches the leasing process and the ongoing property management in a businesslike manner, it increases the likelihood that it can generate a new source of income. Just approach the process with thought, a lot of caution, and expert guidance.
We couldn’t agree more with Eliza – being a landlord is a business, and you must treat it that way. Done correctly, it can be a great social enterprise – linking your mission with unrestricted revenue. We would love to hear from you about your real estate experience – both positive and challenging.