Capital Markets Tax-Exempt Bond Financing
To lease or to purchase property? A difficult dilemma for the nonprofit organization facing acquisition financing challenges. Many nonprofits prefer not to expend so much of their operating budget on leasing costs. However, they frequently do not have the cash resources available to execute an acquisition. Capital markets tax-exempt bonds may help you achieve 100% financing for your project.
Strategies for Cash-Strapped Nonprofits
For acquisition financing, a lender typically requires a significant amount of equity and a strong operating history, as well as other requirements that a nonprofit may find too challenging to overcome. This is a predicament frequently faced by charter schools, social service agencies, and many mission-oriented organizations seeking to consolidate, relocate, or expand.
Nonprofit Tax-exempt Status
501(c)(3) status allows for multiple advantages beyond exemption from paying real estate taxes. For organizations that prefer to be owners but lack substantial liquid resources, acquisition through long-term tax-exempt bond financing can offer tremendous advantages over leasing alternatives.
Advantages of Tax-Exempt Bonds
Tax-exempt bond financing through the capital markets involves long-term (up to 35 years), unrated private debt placement. Typically, 100% of the financing is offered and with no requirement for equity. This solution is advantageous for transactions exceeding $10M.
The Case for Tax-exempt Financing
Tax-exempt financing offers lower interest rates, making annual debt service costs very competitive when compared with existing or projected leasing costs. Significantly, this type of financing also enables the borrower to build substantial equity. Even during economic downturns, some investors in the bond markets look for unrated paper and offer attractive financing structure and rates.
Financing Analysis: Lease vs. Purchase
What follows is a fictional example (for illustrative purposes) of a nonprofit organization evaluating a 70,000 sf, $55M commercial condominium acquisition and renovation project. Our “client” is weighing the pros/cons of leasing space versus purchasing the equivalent property.
After many years of leasing office space, the nonprofit is faced with a significant rent escalation.
Projected leasing costs are $3.5M, or approximately $50/psf, with 2% annual escalations. Faced with such high, escalating costs, they have elected instead to acquire a $45M commercial condominium, which will require an addition $10M for renovations. The total project cost is $55M, or 70,000 sf at $785/psf.
Loan Structure
The project is structured to be financed with a long-term, unrated, $60M tax-exempt bond with an average interest rate of 4.75% on a 32-year amortization schedule, following three years of interest-only payments.
Debt Service Costs
Following the interest-only payment period, the nonprofit will experience annual debt service costs starting at approximately $3,125,000, plus common charges and other facility operating costs that total approximately $770,000, or $11/psf. This property purchase scenario results in an average annual occupancy cost of $3,900,000, or about $56/psf.
How Acquisition Financing Costs Progress Over Time
During the initial years of tax-exempt bond financing—as demonstrated by the previous example narrative—occupancy costs exceed those under the leasing option. However, the debt service on the bonds is fixed for 35 years, and, in contrast, the leasing costs escalate with each passing year.
Eventually, leasing costs exceed the bond debt service.
Although average occupancy costs under both alternatives are roughly equivalent over the 35-year term, the results are not equivalent. Acquisition results in a large asset on the balance sheet, one that is estimated to total between $85M-$100M after 35 years. Furthermore, 501(c)(3) status, as previously noted, means that the nonprofit will pay no property taxes. This is a win for the organization, free and clear.
