CGNA: Chapter 1 - Real Estate | Advanced, Part 2 of 3

CGNA: Chapter 1 - Real Estate | Advanced, Part 2 of 3

Article posted in Assets on 12 September 2017| comments
audience: National Publication, Bryan K. Clontz, CFP®, CLU, ChFC, CAP, AEP | last updated: 14 September 2017
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This article is an excerpt from Charitable Gifts of Noncash Assets, a comprehensive guide to illiquid giving by Bryan Clontz, ed. Ryan Raffin. Published by the American College of Financial Services for the Chartered Advisor in Philanthropy Program (CAP), with generous funding from Leon L. Levy. For a free digital copy, click here, and to order a bound copy from Amazon, click here.

Real Estate: Challenges and Solutions

What holds these donations back? Below are a number of perceived challenges in accepting real estate gifts, and emerging best practices for addressing and over-coming them.

  1. Real estate gifts are too time-consuming: Many charities commit a great deal of staff time and resources to exploring proposed real estate gifts, only to conclude after many months that they do not wish to accept the gift. This can be very off-putting to the donor prospect, and can reinforce the belief that real estate gifts just take too long.

    As a best practice, a charity should divide the real estate screening process into two stages, aiming for a balance between donor-friendliness and the very real need to gather extensive information. The first stage — designed to be minimally time-consuming for charity and donor, at least initially — aims at gathering enough essential information about the property and the prospect in order to render a relatively quick (one to two weeks) decision on whether to reject the gift out of hand or to begin intensive due diligence procedures. The donor can typically gather this data in one or two phone calls or personal visits, with a Real Estate Gift Data Sheet guiding the gift officer to collect essential information about the proposed gift.

    The charity should combine the basic information it collects with informal inquiries of local real estate brokers as to general market conditions for a property of the sort the donor proposes as a gift. That data is generally sufficient to render an initial Go/No Go decision, i.e., determining whether the proposed gift is worthy of further examination, or whether the donor should be told, before more of anyone’s time is wasted, that this gift does not hold promise. Such an approach helps a charity devote its scarce staff and consultant resources to only promising gifts, and does not lead on prospective donors.
     
  2. Tax and Legal Complexity: After the nonprofit’s representatives decide to seriously consider the real estate gift — generally stopping far short at this stage of actually committing to accept — then the more labor intensive (for donor prospect and charity) work of due diligence begins. At this time a detailed questionnaire will gather more extensive information about environmental issues, property operating costs, leases, etc. Even here, a gift officer should generally work with the prospect to complete the questionnaire and gather information, as opposed to mailing it and asking for its completion in two weeks. Donor friendliness at this stage can make all the difference in the world.

    Generally, most real estate gifts which nonprofits process are relatively straightforward. However, issues raised in the course of due diligence can be daunting: prearranged sales (Palmer/Blake/Ferguson cases);12 unrelated business income tax;13 concerns related to legal documents and agreements; self-dealing; private inurement; and excess benefit audits are among the potential obstacles. Generally, experienced internal staff along with both pro-bono and retained counsel can sufficiently navigate these issues.

    It is not uncommon for the donee organization to retain an attorney operating in the vicinity of the gift property to review existing deeds, mortgages (if any), and title work and to commission a title search. This same attorney may often handle the legal closing of the gift acceptance (recording of deeds, purchasing of title insurance, etc.) on the organization’s behalf, and to render similar services upon resale of the property.
     
  3. Environmental Concerns: Often most charities cite this as the primary reason they are uncomfortable with real estate, but this concern is typically overblown. Engaging an environmental appraiser to complete a Phase I environmental appraisal is usually a rather quick way to determine any issues.

    First, a representative of the charity should visit the land to conduct a site inspection.14 Touring the property with the donor can be helpful to learn about the history of the land and any potential issues. As an example for farms in particular, disposal of fertilizer on an area of land over a prolonged period of time can result in the potential for environmental remediation or clean up. Furthermore, run-off of fertilizer can result in contamination of flowing or standing bodies of water.

    The Phase I environmental assessment should identify anything at all problematic with regard to environmental hazards. The assessment thoroughly reviews public fire and safety records, interviews existing and previous owners, and conducts a physical inspection of the property. In order for the charity to be in control of this important investigation, and to assure that a qualified environmental engineer or the equivalent conducts a quality review, it is important for the nonprofit to arrange for and pay for this service. This is a critical step in protecting the organization from exposure to environmental liability. The fees for a Phase I assessment (typically in the range of $1,000 to $2,000 for most properties) are dollars well spent in the interest of completing a gift with minimal risk. If a Phase I assessment suggests the need for further explorations in a Phase II assessment, donor and charity may elect to share the payment responsibility. It may be appropriate in some instances for the charity to delay commissioning the Phase I while awaiting other elements of the due diligence.

    To ask the prospective donor to pay for a Phase I assessment can be quite off-putting, and does not make any more inherent sense than asking the donor prospect to pay for the organization’s title insurance. Both services — environmental assessment and title insurance—protect the donee organization’s balance sheet, and are thus appropriate financial obligations of the charity.

    In some instances, the charity might purchase environmental liability insurance. However, the expense of such policies has generally limited their use to large commercial transactions, rather than charitable trans- actions. Such policies generally are in effect for a maximum of ten years (sometimes with renewal options), with a large premium payable up front.
     
  4. Management and Holding Period Concerns: Internal management concerns are usually based on either risk or responsibility aversion. Frankly, too many development officers close gifts without involving the business office soon (or often) enough in the process. The business or finance department is usually responsible for organizational risk management, and if a gift goes bad, they can be blamed. The business office’s memories of bad experiences are much longer than those of most development officers.

    Development officers should also consider that property management work often means increased responsibilities in the “other duties as assigned” category for the business office. For example, it is critically important to know who is responsible for changing the property insurance, managing the landscaping, paying the water bill, renewing leases, paying the property tax, etc. Many business officers feel ill-equipped to perform these functions because of their lack of real estate knowledge, or a lack of staff time.
     
  5. Market and Liquidity Concerns: Most charities want to sell the property as soon as possible for the highest price possible. Hence, independent assessment of the marketability and value of the property is a critical component of due diligence. The donee organization should, at the very least, seek its own opinion of value and marketability from a qualified local broker or other real estate professional. This need not be a full-blown and fully documented (and expensive) real estate appraisal, since this is ultimately the responsibility of the donor. The charity can often obtain an opinion of value, and an informal report of how the subject property is positioned in relation to current market trends, for $500 to $1,000. This is an important and worthwhile expenditure, as the charity needs to make its own estimate of likely sales price and likely holding period prior to the time of sale. These are critical pieces of information leading to the ultimate decision as to whether to accept the gift property and, if so, subject to what terms and conditions.
     
  6. Charity’s Internal Process: While environmental concerns receive most of the attention, the reality is that the charity’s internal acceptance process, if one even exists, is by far the biggest culprit in keeping a charity from receiving real estate gifts.

    The NCPG/PPP Survey provides solid evidence that the most successful real estate gift programs have in place clear policies and procedures regarding the acceptance of real estate gifts. The purpose of such policies and procedures is generally to establish what sorts of real estate assets and what sorts of real estate gift structures the institution will and will not accept. Further, they should clarify exactly who does what—gift planning office, treasurer’s office, general counsel, outside counsel, real estate office — in moving a potential gift through the process.

    In addition to policies and procedures, many charities have created gift acceptance committees for any unusual gifts. Unfortunately, the charity usually populates these committees with knowledgeable, successful professionals who always seem to be on vacation whenever a new gift opportunity arises. Most charities find it very difficult to get a quorum within three to four weeks, and by that time donor relations can become strained. Further, many charities will have someone from both the development and the finance/business offices doing some of the internal due diligence to prepare the report for the gift acceptance committee. Having a single point person for this due diligence helps ease confusion about who is responsible for stewarding the gift.
     
  7. Benefit-Cost Analysis: Even with the best legal counsel, the most comprehensive internal process and the cleanest gift possible, the charity should still decline some gifts. The best example of this would be a very small parcel of property or a time-share. At some point, nearly every charity will accept one time-share (which is nothing more than a fractional ownership interest in real property). And then after putting in 100-plus hours on what was supposed to be an easy donation, the net proceeds check of $841.39 will eventually arrive. A quick approach to screening is the Pi rule: multiply how much internal work you think it will take and how long you think the property will be on the market and multiply by Pi, or 3.14.

    A policy on gift minimums applying to various real estate gift structures is an important part of the Go/No Go analysis. One increasingly popular approach is to establish a gift minimum using an estimated net present value basis. This method projects the likely amount in current dollars, net of all estimated costs in assessing and closing the gift, and net of projected payments (life income payments or bargain purchase amount). This approach allows for one yardstick against which to measure outright gifts, life income gifts, retained life estates, bargain sales and the like. It allows for the complexity of a gift—as it projects in likely staff, legal, consulting and due diligence costs—to be accounted for when estimating the true value to the institution of the prospective gift. Such real estate gift minimums tend to run from $50,000 to $250,000.
     
  8. How do we actually get to a gift closing on a complicated real estate gift? Once the charity has completed its due diligence investigations, assessed the benefits and risks, and gathered other necessary information, officials at the nonprofit organization can make an informed decision on whether to accept the proposed gift. It is generally helpful to communicate this decision in a gift acceptance letter or memorandum of understanding.

    This letter or memorandum should detail any outstanding information or documents, describe the alternative gift structure that the parties may have agreed to, and outline the terms, conditions, and responsibilities of the various parties and their attorneys. Often, the charity will ask the donor to countersign this letter as acknowledgment of his/her understanding of the terms upon which the gift may proceed, and in order to manage the donor’s expectations as to timetable and financial results of the gift. Sometimes, in more formal versions of such a document, the charity will include environmental indemnification language for the donor’s review and signoff. This letter can also serve as a “roadmap” detailing how the various parties — donor’s attorney, real estate broker, various staff and consultants at the nonprofit, nonprofit’s local counsel — will coordinate with one another to get to the successful closing of the gift.
     
  9. But no one ever calls us to suggest they give us a piece of real estate: No amount of internal procedures, thorough due diligence process and capacity to manage legal and tax complexity will be of any use if no one is inquiring about real estate gifts. Though a charity may get some “cold” calls proposing real estate gifts, the institutions that report high level of such inquiries—and a high level of resulting gifts—are the ones that effectively communicate their interest in real estate. When discussing any major or planned gift with constituents, friends, or prospects, the charity should list real estate as a funding option. Any donor materials should also include the willingness to discuss real estate gifts in various forms. Donor research should include information about real estate holdings, so that the charity can initiate conversations with prospects who own multiple pieces of real estate and otherwise have the ingredients that make up a promising real estate gift prospect.
  • 12. For an excellent overview of prearranged sale issues, see “How Far is Too Far? The Prearranged Sale and the Palm- er/Blake Conundrum” by Emanuel Kallina, II and Philip Temple - Planned Giving Design Center http://www.pgdc. com/pgdc/article/1999/07/how-far-too-far.
  • 13. The treatise on UBTI is The Tax Law of Unrelated Business for Nonprofits by Bruce Hopkins, John Wiley & Sons (2005).
  • 14. Thanks to Phil Purcell for the comments in this paragraph.

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