For the last two decades, much of the public and media attention has been focused on the problems in K-12 education. Higher ed coverage was concerned largely with stories on school rankings or sports scandals.
For the last two decades, much of the public and media attention has been focused on the problems in K-12 education. Higher ed coverage was concerned largely with stories on school rankings or sports scandals.
It's a new day at Harvey Mudd. Known for its focus on engineering, science, and mathematics education, the 700-student liberal arts school-part of California's Claremont Colleges consortium-has done well in realizing its vision of attracting the brightest students.
Real estate is a modern American obsession. What the neighbors got for their house is a leading suburban backyard barbecue topic.
According to the National Association of Realtors, in 2005, 69 percent of American families owned their own house. In other words, a lot of people know a little about real estate. Although the average Dick and Jane know little about the commercial market, where institutions of higher ed would traditionally invest their funds, this area of real estate has also performed well. You might say the real estate conversation has filtered down to the fraternity-party level.
Administrators are talking about the wealth to be had in real estate, too. According to the National Association of College and University Business Officers' 2005 Endowment Study, the average university endowment posted 9 percent average returns for that fiscal year. The top-performing asset class for endowments over $1 billion in the period? Public real estate. This investment category returned an average of 36 percent for IHEs, on average.
The report lists public real estate as the second-best asset class, behind natural resources, for smaller endowments, which reported a 27 percent return on public real estate investments. By contrast, the largest endowments earned 9 percent in U.S. equity in the last fiscal year. Despite these stellar numbers, the overall allocation to real estate remains small, at 3 percent for all endowments-but that's up from just less than 2 percent in 1996. With a total of $299 billion tracked in the NACUBO database, that 3 percent represents a hefty $9.3 billion invested in real estate.
Alternative investing in general is becoming a bigger part of investment policy for more colleges and universities today. Real estate is just one of many asset classes that fall into that "alternative" category, which includes pretty much everything that is not stocks, bonds, or cash. (See "Alternative Investing 101," p. 66.)
As for real estate investment categories to consider, the commercial market is divided geographically, by industry segment (retail, office, warehouse, etc.) and by type of property:
Core real estate is high-quality property, usually centrally located office buildings with major corporate tenants, with most space occupied, generating stable income and a good rate of return.
Opportunistic real estate includes troubled buildings to be torn down or overhauled, or raw land that will be developed.
Value-added real estate involves buying buildings that are inexpensive but need some work, then working with a developer to upgrade them and lease them to new tenants.
In addition to endowment investing, many IHEs acquire real estate as an investment that supports the campus without pushing out its borders. Such properties may add off-campus housing options, promote community economic development, or act as an option for future campus expansion. These holdings generate revenue to offset other operating expenses, grow the endowment, and further the mission of the institution in interesting ways.
Institutional investors, like IHE endowment managers, distinguish between public and private real estate investments. Public investments are those made into funds registered with the U.S. Securities and Exchange Commission, usually in the form of real estate investment trusts (REITs). These pool investors' funds, invest in commercial real estate, and pass on the income.
Because they combine money from several investors, REITs can offer greater diversification than other types of real estate investments, a key advantage for smaller endowments that may not have the assets to diversify otherwise. The shares trade on the stock exchanges, so buying and selling them is much easier than buying properties outright.
National Association of Real Estate Investment Trusts (NAREIT) research has found that the majority of university endowments invest through real estate investment funds managed by outside managers or through real estate investment trusts. Of 108 IHEs reporting investments in real estate, seven have bought properties outright, 27 invested through REITs, and the remaining 74 used private real estate equity funds.
Abby McCarthy, senior director of industry information and statistics at NAREIT, makes the case for REITs in this way: "If you want an asset class that has good diversification benefits, that will generate good returns and reduce risk, then real estate and REITs are the way to go."
An institution's size may well determine what decision is made. "Larger endowments tend to approach the market differently than small endowments," says Michael K. McMenomy, global head of Investor Services at CB Richard Ellis Investors in Los Angeles, which invests in real estate for its own account and for pensions, endowments, trusts, and other large investors. Larger endowments tend to concentrate on specific niches, such as high-rise office buildings in a handful of central business districts, he explains. They typically want the investment management firm to invest in these projects alongside of them.
Smaller endowments, on the other hand, will usually invest in pools organized by a real estate investment company. These pools are limited partnerships that operate for a set time period, say five to seven years. "The fund manager has complete discretion relative to the investment management agreement and the strategy therein," McMenomy says.
Most endowment funds are investing through REITs or private equity funds because managers view real estate as simply an asset class with favorable risk, return, and income characteristics. But many IHEs own land outright. In some cases, it is property acquired through donation that generates enough income and other benefits that it remains in the portfolio. For other campuses, real estate is an investment that also helps in the execution of the institution's mission and values.
For real estate gifts, having donation policies can help ensure that it works out in the institution's favor. The Kansas University Endowment of the University of Kansas, for one, accepts gifts of real estate under two conditions. First, it must be given free and clear of debt. Second, it must undergo an environmental assessment; if problems are found, it must be cost-effective to remedy them.
Finally, says Jen Humphrey, who works in communications for KU Endowment, "We check with the university to see if they have a use for it. If they do, we'll lease it to them. If they don't, we'll sell it."
The endowment foundation also accepts donations of mineral rights without the property attached, and it holds such rights in five states. In total, its real estate had a market value of $158 million as of June 30, 2005, making up 16.5 percent of the endowment's $955 million in assets.
The Kansas endowment owns farmland in 54 Kansas counties as well as in Oklahoma and Nebraska. Most of this acreage was donated and is leased to operating farmers to generate steady income. Two full-time staffers handle property management with the assistance of two regional banks. Humphrey says that farmland's low management cost and low operating risk makes it a better investment for them than, say, student housing, where maintenance, rent collection, and liability factors cut into returns.
That doesn't mean the endowment won't buy properties in town. Humphrey says that on occasion, property near the Lawrence campus comes on the market. The university may want it for future expansion, but the administration is not ready to commit now. The endowment buys the land and operates the properties until the university makes its decision. This offers a way for the foundation to support the campus.
While the KU Endowment staff is happy to own land, University of Nebraska-Lincoln endowment managers aren't so eager.
NU's endowment receives about six or eight property donations a year, says Dorothy Endacott, director of Communications for the University of Nebraska Foundation, but almost all of those are liquidated. Less than 1 percent of the university's $1.3 billion endowment is invested in real estate, mostly through investment funds managed by outside money managers.
The land the foundation holds outright was given to it for academic use. One such property is a 145-acre arboretum northeast of Lincoln used as an outdoor classroom by students at the NU's School of Natural Resources. The other is a ranch in North Platte used for groundwater and surface water research.
A.T. Still University, which operates four colleges on two campuses (one in Missouri, another in Arizona), has real estate ventures on each designed to be both long-term investments and sources of relationships to enhance student learning and faculty research.
In Kirksville, Mo., the university has schools of osteopathic medicine and health-care management, while in Mesa, Ariz., it offers programs in dentistry and health sciences. In Kirksville, the goal was to promote osteopathic medicine's strengths in managing the needs of a healthy, aging population by giving students practical experience. Located in north-central Missouri, the town was in need of economic development programs that would attract and retain residents. A continuing-care retirement facility adjacent to campus would help students learn and meet the town's needs now while creating a long-term asset.
In 1999, the university acquired 100 acres of land there, through a purchase that added to a property donation for the project. Since "A.T. Still is in the business of education, not in the business of running continuing-care retirement communities," says Elsie Gaber, associate vice president for University Relations, the school partnered with a St. Louis-based developer to build a 50-unit retirement residence. That developer was joined by state and local officials to develop a community center on the site. The land under these buildings is leased from the university. The buildings themselves will revert to ATSU at the end of the multidecade lease.
The income is small right now, Gaber says, but the amount of income generated and the underlying value of the land will increase as more of the property is developed and the Kirksville economy grows. And, she says, "This added dimension of the senior campus is attracting applicants and students who want to be a part of it," enhancing the medical school's reputation in geriatric care.
ATSU expanded into Mesa in 1995 to help meet the demand for health-care professionals there. It operates the state's only dental school, the Arizona School of Dentistry and Oral Health, while the medical programs at the Arizona School of Health Sciences educate baseball trainers and geriatric physical therapists alike.
Next to campus is the Arizona Health & Technology Park, which ATSU launched in 2001. The land is owned by the school and leased to the Alter Group, a real estate development firm. The firm handles construction and management of buildings used for campus offices, medical practices, and health care services businesses.
"We're not in the business of health care. We're in the business of training health-care professionals," explains Craig Phelps, provost of the Arizona campus. Among the park's tenants is the National Academy of Sports Medicine.
The next phases of the project, scheduled for 2007, will solidify the connections between ATSU students and the community even further. The Valley of the Sun YMCA and an acute-care hospital operated by Vanguard Health Services will be added, creating internship opportunities for students and as well as possible employment for alumni. As for the income from the land lease, Phelps says, "We see it being used to fund new programs, but also see a certain percentage going back into the endowment."
Although campuses are getting value from real estate now, will this continue? Market observers think it will, noting that the commercial real estate market is very different from the residential one.
The residential market is much more exposed to interest rate changes than the commercial market, says McMenomy, because individuals buying houses often borrow 80 percent or more of the value, while commercial properties are typically purchased with little or no debt. "Residential is all about affordability, and interest rates affect affordability," he says, adding that "residential has an emotional underpinning."
Commercial real estate is very much driven by income generated from rent. Tenants may be visiting faculty members using off-campus apartments, corporations leasing entire floors of downtown office towers, or agribusiness concerns renting farmland for their growing operations.
"Corporate leases are typically for 15 years," says NAREIT's McCarthy, "so the revenue is locked in." In other words, returns on a commercial property fluctuate less from year to year than returns on residential properties might. Demand for these properties tends to be driven by overall economic health rather than interest rates and family size.
Each market sector has its own outlook. The National Association of Realtors, which analyzes both residential and commercial market trends, sees a strong market for warehouse space (based on trade with China), rental housing (because so many units have been lost to condominium conversion), and hospitality facilities (as cities pick up convention business lost from New Orleans). The organization is less enthused about retail rentals, given that large blocks of space are coming on the market from the recent Sears-Kmart merger.
"There are submarkets within the U.S., and property types within those submarkets, that have challenges," McMenomy says. At the same time, though, "there's more and more knowledge, objective and otherwise, with which to make a decision." He says that information on historical performance, risk, investment styles, and operating strategies can help endowment managers make good decisions about whether to invest in real estate. And for those who choose this alternative investment, doing that legwork will help in finding good investment managers to work with and making the best real estate deals.
Ann C. Logue is a freelance investment services writer based in Chicago. She can be reached at firstname.lastname@example.org.
When students moved into the new residence hall this January at Ursuline College, a small Catholic liberal arts school for women in suburban Cleveland, they had a most unusual hallmate.
To combat the growing number of health issues affecting college students today, colleges and universities have greatly expanded the range of health services they offer-tackling everything from fitness and stress management to alcoholism and smoking cessation.
University officials have undergone a crash course over the last few years in the need for more reliable sources of power. Life-threatening weather patterns, widespread blackouts, and terrorist threats have all weakened an already fragile power grid. And the lesson learned?
There are few givens in the world of facilities management outsourcing. Take the percentage of colleges that have taken the plunge, for one: Most providers estimate about 20 percent of this market has turned over control of some aspect of its operations-food service, bookstore, groundskeeping, building maintenance, janitorial, energy maintenance, or security-to an outside expert.
Are any institutions farming out the whole ball of wax? According to a 2002 survey of attendees conducted during several National Association of College and University Business Officers meetings, a mere 2 percent had done so.
From Kristy Elmore's office as the director for Higher Education Solutions at Johnson Controls in Milwaukee, those numbers are definitely climbing. "In just three years with the higher education market, the conversation has gone from 'Don't say the O word' to 'We need help,'" she reports.
Yet the field report from Rick Justis, an area sales manager for Johnson Controls, is that mass scale outsourcing isn't nearing tidal-wave proportions-it's more like the tide itself. "It's really not very common," he says. "For a while outsourcing was a good thing, and for a while outsourcing was a bad thing. Now, it's situational, and the university's attitude depends on local politics, local labor pool, and so on."
The concept, of course, is solid. "As a risk manager, if it reduces your potential liabilities, it's a good strategy," says Michael Christensen, assistant vice president of Risk Management Services at California State University, Sacramento. Yet he can't identify a single outsourcing project on the IHE level.
The atmosphere is a bit chummier in Waco, Texas, where Baylor University's Don Bagby, director of Facilities Management has finally, after 12 years, shed his oddity status at Association of Higher Education Facilities Officers conventions. "We had a tough time attending activities because colleagues wanted to spend [an extraordinary amount of] time with us finding out how we outsourced and our reasons," he says. "At that time a lot of people said it would never work at their university. Now I hear they've outsourced that work."
According to a 2002 study by FMLink, an online publication for facilities and building managers, 72 percent of the nation's businesses in general outsourced custodial and housekeeping, 65 percent farmed out design and architecture, 63 percent hired others to do landscape maintenance, 51 percent said good-bye to in-house security, 50 percent contracted for preventive maintenance, and 45 percent of utilities maintenance was handled by outsiders. Of those polled, 36 percent said they were likely to add still more functions to their outsourcing lists.
Meanwhile, the folks at Philadelphia-based Aramark worked with 350 registered attendees last year when it held a web seminar on the topic, with a 67 percent increase in web traffic immediately after that event. Overall, the site has received 2 million hits since it launched last year. Such data means officials there estimate the number of IHEs now looking into comprehensive outsourcing is growing at perhaps 1 percent a year. In this large market segment, even a single-digit jump represents serious profit dollars for vendors.
Still, Elmore isn't spinning when she claims that comprehensive outsourcing as a strategy for campuses is not stagnating, but simply resting before the next crest.
The facts: Energy costs are escalating, a large percentage of college employees are nearing retirement, and deferred maintenance
issues have reached critical status (the average age of buildings on American campuses is 30 years), just as new construction hits a record pace over the next decade. It's no surprise that Thomas Galvin, vice president of marketing at energy management provider SourceOne in Boston, now sees first-timers knocking at his door instead of the other way around.
But SourceOne hasn't necessarily found a slam-dunk angle with its market niche. On campus outsourcing priority lists, "I'd say energy hasn't been at the top," Galvin admits. "In parts of the country where we see very stable, low-cost sources of electricity, there isn't the same sense of urgency as in Massachusetts, Connecticut, New York, and Texas, where there is real volatility in pricing."
So in the end, vendors and administrators agree on only one statement about facilities management outsourcing: "We are seeing, quite dramatically, an increase on the part of institutions to think about their facility needs and to consider outsourcing more often and much more seriously than before," notes Frank Mendicino, president of Aramark Education-Facility Services.
As a verb, outsourcing has outlived its headline news status. UNICCO, based in Arlington, Va., has served more than half its IHE customers in operations areas for more than 15 years. Randy Ledbetter, vice president of Business Development, says the facilities services firm retains more than 95 percent of its business-so longevity is piling up.
Nor are IHE administrators strangers to the success stories. That's why Tom Oates, who left Roger Williams University (R.I.) in 2003 to take over as vice president of Administration and Finance, treasurer, and CFO of the University of Bridgeport (Conn.), didn't mess much with the status quo there. Instead, he built on it-switching vendors in charge of buildings and grounds and janitorial but leaving the dining provider in place. Then he found a fourth company to handle security and a fifth firm to handle the mailroom. Still another group of gurus has taken over information technology.
In just three years, his policy helped turn a deficit into a $2.5 million surplus on the operational bottom line. Still, he says, he's ridden this train to the end of the outsourcing track, and he's not especially motivated to consolidate the current farmed-out functions. "You may have more than one service under your umbrella, but-to me, anyway-you have to be better in one area than the other," Oates explains.
He has a friend in Margaret Plympton, vice president for Finance and Administration at Lehigh University (Pa.). She didn't complain about the grounds and custodial contracts she inherited upon joining Lehigh five years ago. Both were with local firms with good reputations that would make competing with them in the hiring arena a tough proposition. "We've never seen that it's particularly preferable to have only one provider of both of these services, so that hasn't been a change worth making," she says.
Yet, when the university embarked on a major upgrade to its energy management systems, it made sense at the start to outsource the highly technical maintenance needs that accompanied it. "Over time, however, our facility staff had to develop expertise in those new systems, so when it came time to renegotiate that contract, it was not as financially advantageous and not as necessary," Plympton reports. So long, HVAC vendor-the boilers are back in house.
Baylor's Bagby oversees vendors that handle maintenance, groundskeeping, food service, cleaning, even elevators. Most of them came on board one at a time. That timetable is one reason he dismisses the notion this was a stressful change. "There really weren't very many fears. As long as we have the right people in place on the Baylor side to manage that, everything's fine," he says.
But vendors shouldn't expect much from a sales call on Herbert C. Peterson, vice president of Business and Finance at the University of Richmond (Va.). He did outsource food services years ago, and then tried the strategy again with information services over nearly a five-year period in the mid-1990s. "That was not a happy arrangement," he says bluntly. "It's a culture clash between two entities. It hampers flexibility. Everything has to be negotiated and renegotiated as opposed to making a decision and moving on."
Of course, many public IHEs have an economic incentive to put up with the hassles of outsourcing. For example, often they'll use money saved from outsourcing for capital improvements on campus, Peterson says. As a private institution, Richmond "can borrow money for things like renovations less expensively." Having more avenues for borrowing money makes outsourcing less important from a financial standpoint.
Such a variety of experiences signals one truth for Johnson Control's Elmore: Today's IHEs are making informed, deliberate decisions rather than being sold a program. Mendicino has seen the same shift. "Administrators are looking at facilities differently, with a greater sense of urgency to use them to the greatest advantage," he says. "The context for outsourcing and the discussion about outsourcing are different as a result."
Many of Rick Justis's contacts cite the classic reasons for outsourcing: Facilities management simply isn't a college's core business-or the task is complicated, changing often, and officials can't leverage their internal economies of scale to keep up. When the technologies needed for skills like floor cleaning, for instance, don't require certification or special tools, they keep it in-house.
In the next breath, he reverses himself. "There is another line of thought that says to do complicated stuff in-house because it gives staff more of a challenge. These campuses outsource the routine, basic stuff," he reports. "And that's what's so confounding with universities. You see just as many thinking one way as another. Then the administration changes and the new person decides to use exactly the opposite logic."
-Kristy Elmore, Johnson Controls.
In other words, there's no discernable pattern as to how IHEs handle outsourcing. Nor can vendors pinpoint whether it makes more sense for public or private institutions, large or small campuses-although some experts do admit the heavy union representation at larger schools can nix a lot of outsourcing possibilities. Perhaps most shocking of all, the players can't determine if this strategy is a savings, and whether they care either way.
From Christensen's seat, if outsourcing doesn't make sense from a financial liability standpoint and then also comes at a cost, why bother? Financial benefit weighs in as the largest factor among the IHE folks Elmore rubs shoulders with as well.
Ask John Anderson, vice president for Finance and Administration at Wake Forest University (N.C.), about their outsourced dining facilities, then get out a calculator and follow along: "Now we have a real food plan-before we just had a food service. That goes to the bottom line. It also means when we think about renovating other facilities we have a cash flow to think about. Not many endeavors that took a year of work and planning have paid off quite so well for us."
But although clients certainly bring up the cash angles with Mendicino, he claims it doesn't drive the conversation. Instead, chimes in Cathy Schlosberg, vice president of Marketing at Aramark-Education Facility Services, they are more interested in finding out how a hired gun can help leverage physical assets against pressures like increasing enrollment and competition for students.
Oates' experiences fall into that camp. He likes his budget boost at University of Bridgeport, but he really values getting top-notch advice for his investment. "I am not an expert in bookstores, I don't know all the policies relative to returns," he says. "We're getting a very good product for the price."
Plympton's initial number-crunching indicates outsourcing is the more expensive option. After all, a for-profit firm has to pay taxes (an area universities can duck) and show a profit for shareholders (again, foreign concepts to educational institutions).
"You might wonder why a university wouldn't say, 'Let's sell the entire campus and lease back the space,'" says Justis. "They don't even look into that because the numbers are shocking. The cost to rent total office space versus what it costs universities and colleges to own and operate their own campuses is outrageously lopsided."
But administrators forget the cost of finding, hiring, training, and keeping employees-numbers Plympton takes into account. To date, outsourcing in two areas has landed on the cost-effective side of the column. However, she admits, she can't currently quote a cost savings number for Lehigh University, so it's conceivable the situation has changed since the last contract negotiation.
"If somebody comes in looking at outsourcing as a way to obtain significant cost savings, I'd really question that," Bagby says. "Between 60 and 70 percent of costs related to facilities management is labor. You'd have to cut that significantly to see any difference." Ledbetter backs him on this issue: Bringing UNICCO in for a wages/benefits budget slash is a short-term approach, he explains.
Savings like Oates enjoys stem more from good management techniques, vendors say. For instance, best practices prevent repairs. They use their buying power as the representative of several campuses to drive down supply prices. They standardize inventory and implement more efficient procedures using higher-grade equipment. "We change the way [IHEs] do business," Ledbetter stresses.
SourceOne CEO Brian Casey routinely sees a shortfall in administrators' abilities to identify innovative products and stay on top of the energy marketplace's roller coaster. That alone has driven about 12 universities to outsource some aspect of their energy management. Future survival rather than immediate cash flow spurs them. It's also the death knell for any partnership that doesn't require both sides to put up a vested interest.
"One of the things we've seen in this market that was taken up pretty aggressively during the heyday of demand side are management initiatives funded by utilities as the shared savings model," Casey says. "It may work and give the appearance of avoided cost to the school, but it might not be as advantageous as it could be."
Such wildly fluctuating variables to every outsourcing question leave vendors more likely to admit their services aren't a foregone conclusion. To continue playing in this space, they must deliver improved service, greater competence, better asset protection, more optimization of resources, and efficiencies. It actually puts them in the same boat with the administrators they want to partner with.
No matter what decision is made on outsourcing, says Mendicino, facilities organization must be a strategic conversation.
Folks like Elmore are willing to bet the chips still fall on their side of the table. "Outsourcing will be a continuing trend. That doesn't mean IHEs will end up doing a full-on outsourcing of their facilities, but I think it will make sense for a lot of institutions to do some," she sums up. "At least everyone is more openly talking about it."
Ted Long, president of Elizabethtown College, a school of 1,600 students in central Pennsylvania, has seen many students go from economic struggle to success thanks to higher education.
Joseph Aoun is leaving his post as dean of the University of Southern California's College of Letters, Arts and Sciences to be president of Northeastern University.