Real Deals

Real Deals: Wake schools' lease deal leaves bad taste

STAFF WRITERFebruary 9, 2012 

When a real estate deal doesn't turn out as planned, there are two things that you can be fairly certain will occur: Monday-morning quarterbacking and finger-pointing.

When the deal involves taxpayers - and is anointed "lease transaction of the year" by the Triangle Commercial Association of Realtors - the scrutiny increases by multiples.

Such is the case with the Wake County schools' 2010 decision to lease 173,741 square feet in the Crossroads Corporate Park in Cary.

To recap: The system hired the Raleigh firm Grubb & Ellis Thomas Linderman Graham to perform a strategic analysis to determine what would be the most cost-effective solution to its space needs.

In January 2010, Grubb & Ellis recommended that the system move its main administrative offices to a new location and sign a long-term lease. Grubb & Ellis then acted as the broker on a 20-year lease valued at $66 million, which netted the firm a sizable, though undisclosed, commission as well as the aforementioned accolade.

The deal raises two separate but related issues.

One is whether Grubb & Ellis had a conflict of interest in recommending a course of action that ultimately resulted in a significant financial gain for the firm.

The other is whether Grubb & Ellis' analysis was sound, particularly given that it now appears that the school system will be unable to sell its surplus properties for anywhere near the $12.2 million figure that was included in the firm's report.

(On Tuesday, the school board agreed to sell one building, at 2302 Noble Road, for $2.6 million, 26 percent below what Grubb & Ellis' analysis estimated it would fetch.)

The proceeds from the sales are to help cover the long-term lease and operating costs of the expanded Cary headquarters.

Grubb & Ellis CEO Rex Thomas says both his firm's, and the industry's, code of ethics prevent it from steering the school system in a direction that would result in a bigger commission. The company provides advice based on what it believes is best for its client, he says.

Agent's role questioned

Grubb & Ellis' dual role in the deal has raised eyebrows among some in the real estate community, but it is not uncommon. Having done the analysis, Grubb & Ellis was familiar with the school system's needs, and it's possible that the firm could also have reaped some benefit from recommending that the school system buy an existing building or construct a new headquarters.

It's also important to note that the school system structured this process. It sent out a request for proposals before it hired Grubb & Ellis. The contract called for Grubb & Ellis to both examine the school system's space needs and, if necessary, negotiate lease terms.

The fact that Grubb & Ellis has not disclosed its commission has - fairly or unfairly - added to questions about the deal. It likely came to more than a million dollars, as a typical commission is 4 percent of the value of the first 10 years of a lease.

Grubb & Ellis seems more open to criticism on its strategic analysis, particularly the values it placed on the school system's surplus property. Those estimates are based on sales of comparable properties, the firm said.

The estimates, which the school system's facilities department says it vetted, appear aggressive even if you factor in the decline in value that's occurred since Grubb & Ellis submitted its analysis in January 2010.

Take the school system's former headquarters on Wake Forest Road - the key asset in the deal. The 99,603-square-foot building has a number of things working against it. It's empty with no existing tenants. It was built in 1968, and any buyer would have to invest considerable money repositioning the property and then leasing it up.

Overvalued buildings

Grubb & Ellis estimated it would fetch $7.9 million, or about $80 per square foot. Although in recent years there have been relatively few comparable sales of buildings of similar age and size, a number have sold for less than that.

For example, two office buildings in Durham's Pinnacle Park - one 60,000 square feet and the other 80,000 square feet - each sold for less than $50 per square foot in December 2006. Both properties were built in 1989.

In May 2010, LED light maker Cree bought the smaller of the two buildings for $49 per square foot.

Grubb & Ellis, of course, is hardly the only firm to overestimate the value of real estate in recent years. But in this case those estimates were crucial.

In the firm's analysis of different scenarios for the school system, the lease option was portrayed as $5.7 million cheaper than constructing a new headquarters, and $4 million cheaper than purchasing an existing building.

Both those options would have left the school system owning an asset, though it is debatable whether voters and school board members would have been willing to allocate the upfront money necessary.

Now the school system is left trying to justify its decision. In perhaps the ultimate sign of wishful thinking, it has its former headquarters on the market for $9.8 million, or nearly $2 million more than what than Grubb & Ellis' estimated two years ago.

As so many people learned after the housing bubble burst, it's never a good idea to enter into a real estate deal that assumes the ability to sell certain assets at certain prices in the future.

The marketplace dictates price. Just ask the school system.

Staff writer Thomas Goldsmith contributed to this report.

Bracken: 919-829-4548

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