‘Paying to Play’
in the Corporate Game
As Dallas-based Koll Development Company (KDC) came off 2002—its best year ever—its challenge was to continue its outstanding growth and profitability even as the market continued to slide.
Said CEO Steve W. Van Amburgh: “In the fourth quarter of last year, we had a lot of development underway, a total of 1.5 million square feet of projects, but our volume was dwindling. We had a meeting in Dallas with our new business development people from all our offices including Detroit, Dallas, northern and southern California and Colorado.”
A decision was made at the meeting to go out to the company’s 100 largest customers, including FedEx, EDS, Citigroup, Nokia, Del Monte, Nortel Networks, Ford Motor Company and AT&T Wireless to ask them the following questions:
- Did they see any growth at all?
- What would enable KDC to do business with them in the future?
- Did they have a need for expansion?
“What came out of this,” explained Van Amburgh, “was that any development between now and 2005 would be niche development. In fact, as we looked over our recent development work, we found that it was based on cost-saving measures: companies were spending money to save money. If a company had five or six facilities with 600,000 square feet of total space, it wanted to consolidate that space into one facility of 400,000 square feet.”
KDC discovered something else from its interviews as well, which prompted it to change its logo and recapitalize the firm to add acquisitions. “We were told by these big clients—and it was uniform among them—that if we wanted to develop, for example, that new call center for them in Arlington, Virginia, they would certainly keep us on their list and send us the proposal. However, if we wanted to enhance our opportunity to be the winner, we needed to buy the facility from them that they were vacating in Charlotte, North Carolina.
“They said they would sign a 15-year lease on the Virginia facility and a two-year lease on the North Carolina facility, which would end when the new lease began because they did not want any double-rent problems. In effect, they wanted us to pay to play.”
What if the old facility was a white elephant? How would Koll handle the risk? Said Van Amburgh: “We did two things. We made certain that we had the capital to move forward but we also created an internal mandate that we would never buy the old facility just to do the development deal. That is, we will not do a deal that leaves us with a white elephant after the tenant leaves where we cannot recoup our investment.”
KDC is very sensitive to what it will buy, but it likes the opportunistic upside of the acquisition piece of the transaction. For example, KDC has one project right now for a $10 billion company. It received an RFP for a 120,000-square-foot office requirement in which the company would be willing to sign a 10-year lease. It wanted KDC, however, to buy two regional office buildings to get them off the company’s books.
Van Amburgh said that in making this deal, Koll effectively became a one-stop shop to solve this company’s problems. It turns out that numerous other clients want to get non-core assets off the books as well. They do not want to own real estate anymore. Why the change? Van Amburgh said that Wall Street investors are interested in a company profitably producing its products or services, not in its real estate investment savvy.
This strategy seems to be a win-win for Koll and its clients: “If we walk into a meeting and represent ourselves as being only developers, then they are not going to think of us as solutions providers. If we go in with a foundation of development and the capacity to buy and manage the existing projects, we are effectively accommodating their needs. We are solutions providers.”
Time for a Change
in the Way Federal Govt.
Handles its Real Estate?
Do we sense an opportunity? With the U.S. government owning 3.2 billion square feet in nearly 525,000 buildings, some legislators are thinking that it’s time to trim the bloat. In fact, Rep. Tom Davis (R-Virginia), chairman of the House Committee on Government Reform is planning to introduce legislation that would free up some of the bureaucratic obstacles for agencies to dispose of excess properties, enabling them to enter into public/private partnerships with non-government entities to use the facilities; or to lease and sell the properties outright. The House Transportation Committee’s subcommittee on public buildings and economic development, headed by chairman Rep. John LaTourette (R-Ohio), is said to be working on similar legislation.
In a report released at a congressional hearing in June, the U.S. Government Accounting Office (GAO), said “over 30 agencies control hundreds of thousands of real property assets worldwide, including facilities and land. These assets are worth hundreds of billions of dollars. Unfortunately, much of this vast, valuable portfolio reflects an infrastructure based on the business model and technological environment of the 1950s.
“Many of the assets are no longer effectively aligned with, or responsive to agencies’ changing missions and are therefore no longer needed. Further, many assets are in an alarming state of deterioration; agencies estimate that restoration and repair needs are in the tens of billions of dollars. Compounding these problems are the lack of reliable government-wide data for strategic asset management, a heavy reliance on costly leasing instead of ownership to meet new space needs, and the cost and challenge of protecting these assets against potential terrorism.”
Desperately Seeking Incentives?
What Are You Bringing to the Table?
Once upon a time—maybe two years ago or so—states and localities were aggressively offering both retention incentives to hold companies and other packages to attract firms to the area. As state and local budgets have begun to hemorrhage, most are cutting back on their incentives to stanch the bloodletting.
Michael D. Bailkin, managing partner and chairman, and Susan Harte, managing director of Stadtmauer Bailkin, a New York City law firm that has been working in the area of incentives for the past 25 years, noted that it is a “mixed bag” across the country today.
“A few years ago, most states, except the Rocky Mountain area which was trying to stop development, were providing substantial incentives,” said Bailkin. “Typically, the incentives ranged from $2,000 to $5,000 per job. Every once in a while you would have an extraordinary deal like a Mercedes plant coming into South Carolina or a big financial services firm moving to New Jersey or Connecticut.”
Incentives Nationally
Susan Harte said that on a national scale, California, Missouri, Rhode Island and Virginia have cut back on their programs.
“It all depends on the philosophy of the state,” she said. “We just completed a project for a Fortune 60 company, which is selecting a site for a bio-pharmaceutical manufacturing facility. It is a half-billion dollar facility. We started looking at 26 states in which to locate the project. The incentives ranged from hundreds of millions of dollars to literally zero dollars. States like New Hampshire have the philosophy that they are so low cost with so little taxes that they do not need to offer other incentives.”
Harte said that other states have become very sophisticated with the incentives that they offer, noting that discretionary incentives present the greatest value. “The attitude among states should really be ‘what do we need to do to make this project happen here,’ rather than ‘how much is this going to cost us,’” she said.
Bailkin said that to get the best deal for its clients from states and localities, he needs to understand what the company is bringing to the table. What is its edge? “If you are going to get high-value incentives, you need to communicate why this company is different from others. You need to package the argument.
“If you are going to develop an office building at the King of Prussia, Pennsylvania Mall, you are not bringing anything different to the marketplace than any other developer in that area, so why should you be favored?” he said. “If, however, you are bringing in a biotechnology center with state-of-the-art facilities and state-of-the-art equipment that will be available to incubator-type companies that the state would have difficulty attracting without the facility, then that facility has special value.”
Developer Incentives
According to the lawyers, states are actively using developer incentives because they know that the developers have better resources available to attract tenants to a project he/she is building.
Bailkin offered an anecdote of why it is critically important for states and localities to offer developer incentives.Years ago in New York City, developer Sam Lefrak tried to develop the Sunnyside Yards, a sprawling rail yard complex in Long Island City, part of New York City. He was a visionary and needed subsidies because he was proposing nothing less than building a deck over the rail yards. He sought help from the city. It turned him down. New Jersey was of a different mindset and set up an enterprise zone to help him and others. Lefrak went across the Hudson River to New Jersey and helped create what has become The Gold Coast in New Jersey, which is now serious competition for New York City.
Non-Programmatic Discretionary Incentives: Ask and You Just Might Receive
Susan Harte, managing director of Stadtmauer Bailkin, a New York City law firm, said that when you log onto an Economic Development Agency's (EDA") website you will often find an extensive menu of incentive and financing programs. Typically, these consist of "as of right benefits," which are most often tax-credit based and eligibility is determined upon meeting set thresholds of job creation and/or investment amounts. However, often it is the discretionary benefits, the ones you don't see on the web page, that can actually yield the greatest value to a project.
She suggested probing for the following benefits:
Quasi-Discretionary
In between "as of right" programs, which are usually legislatively originated, and completely discretionary benefits, are "quasi discretionary" incentives. These are traditional tools such as cash grants, real and personal property tax abatements, training grants and sales tax exemptions; however, to whom and for what amount they are granted is solely at the discretion of the authoritative agency. With this discretion, EDAs can channel resources specifically to projects which align with their economic development objectives and goals.
Discretionary Incentives
Discretionary incentives are designed when programmatic and quasi-discretionary incentives are not enough or are unusable, or their delivery mechanisms do not work or function with transaction structures or project timelines. They are increasingly used as EDAs become more sophisticated in their approach of not only how to get a project to their location, but how to ensure the project is successful. This translates not only economic savings to a company, but a reduction of risk as well. Below are examples of ways EDAs have used their discretionary authority to create value to a company.
- Financing Structures. Almost every state will offer some type of low-cost loan or bond financing for qualifying projects. However, strong credit companies often have lower costs of capital than what is offered by an EDA, rendering little value for this benefit. Some states have become quite sophisticated in financing techniques that yield significant benefits to a company by either deferring or reducing costs. Often using a quasi-governmental entity, EDAs can purchase land or equipment and lease it back with a variety of beneficial terms such as reduced lease payments, deferred interest, and/or risk sharing lease termination provisions. The EDAs then fund these discounts with payroll tax revenues generated by the new jobs, special budget allocations or general revenue bonds.
- Infrastructure Improvements. Infrastructure improvements are a great tool for localities to use that often have little cash to contribute to a project or are prohibited or restricted from the State from granting real or property tax abatements. Localities, if you ask, can construct roads or exits, add lights, grade land, and extend fiber optic, power and sewer lines. Often these services can be delivered within the limits of an existing operating budget thereby adding value worth millions, without a bond issue or digging into the county coffers.
- Expedited Permitting. Another opportunity for a locality to contribute a significant benefit is to provide for pre-permitted sites or expedited permitting. In some instances the local authority will assign at its own costs, a full time project manager to liaise with all the permitting and regulatory agencies involved in a project. This has proved to be such a valuable tool, that in some cases it is offered as of right. For instance, in order to attract the semi conductor industry to New York, the State created shovel-ready sites located across the State and has facilitated the pre-permitting of industrial sites specifically for chip fabrication.
- Education and Training Programs. While most EDAs will provide resources for the recruiting and training of employees, some will actually create an entire curriculum at a community college, customize a BS program at the State University, or even endow a fellowship, according to the company's needs. In some instances, even the students of the employees of a new project are offered out of state tuition waivers or a free college education. As opposed to just offering per employee training grants, EDAs will provide at their cost, complete training services from pre-employment screening and recruiting to actually developing and executing an entire training program down to writing the training manuals.
- Resolution of Regulatory Issues. In cases of business retention or negotiating expansion of existing operations, an EDA's relationship and interaction with other agencies can be an extremely valuable tool. Some high variable operational costs are generated from unfavorable tax, legal, banking, environmental or other regulatory issues. If an EDA has the creative ability and political capital to initiate relief in these areas, the benefit yielded can be far greater than any incentive program. A few years ago a New York publishing company was considering relocation to New Jersey. While reduction of operating costs was the driver for this contemplated move, the company mentioned to the economic development officials that due to an interpretation of the State Department of Finance regarding certain tax treatment of one of the company's lines of business, it had to pay millions more in taxes annually than it would elsewhere outside the state. Empire State Development (the State EDA) was able to obtain a ruling from the tax commissioner that the provision would be changed to the benefit of the company. The tax ruling was of greater economic value to the company than the total proposed incentive package.
"These are just a few examples of how EDAs with discretionary authority can create value outside the box of the traditional programs and structure packages according to the subjective needs of a company," said Harte. "Incentives are most useful when they are considered as a tool to reduce cost and risks, create value, and induce a project to a location. Companies that understand this approach and EDAs with flexibility and broad discretion, will find that they can leverage several times over the total value of an incentive package while working within an existing framework of available traditional tools."
Understanding Corporate Real Estate:
By Ron Derven, co-editor of Development magazine
