VOL. 130 | NO. 221 | Thursday, November 12, 2015
View From the Hill
Tennessee’s Landlords Find Hidden Costs of Privatization
By Sam Stockard
Murfreesboro businessman Tom Hyde felt the sting of Tennessee’s privatization practices two years ago when a representative of Jones Lang Lasalle notified him he would have to pay the company a commission as part of his next lease agreement.
“It came as a surprise here, because it was a continuation of a 10-year contract,” says Hyde, who leased office space to the Tennessee Department of Financial Institutions at his property, Hyde Park, on Middle Tennessee Boulevard.
At first, he says, JLL, which landed a contract as the state’s leasing broker, told him the commission was mandatory.
A few phone calls later, the company decided it wasn’t mandatory, Hyde says. But he had signed the contract already because he didn’t feel he had any choice, agreeing to pay 4 percent, which later fell to 2 percent.
Hyde says state representatives who raised questions about the commissions, which weren’t paid previously when he leased straight to the state, may have had some effect on JLL’s altered stance. He also wonders whether the state monitors the contracts the private company handles.
The 20 to 25 state employees who were based at Hyde Park moved out about two weeks ago. The state has an option to terminate when state-owned space becomes available, which happened in this instance.
The location was one of about 340 leases statewide totaling tens of millions of dollars and approximately 3.5 million square feet the Department of General Services handles through landlords.
As of October in Davidson County alone, it has contracts worth a combined $10.5 million, according to a General Services report. The largest are:
• $2.65 million for the Department of General Services through IPC Metro Center
• $2.17 million for the Bureau of TennCare with Aurora Properties on Great Circle Road
• $1.23 million for the Department of Health through Heritage Place Partners at French Landing
According to the state website, “The mission of the State of Tennessee Real Estate Asset Management Lease Management is to provide customers with exceptional tenant representation, make prudent real estate decisions on behalf of the taxpayers of Tennessee and present a fair, transparent and competitive opportunity for taxpayers to do business with the state.”
But as state officials debate the merits of privatization, primarily facilities management and whether to expand into state universities and other areas, some legislators are raising questions about the leasing program and whether it saves money or, instead, puts dollars into the pockets of Chicago-based JLL.
State Rep. Mike Sparks says he requested a meeting with the Department of General Services when he found out JLL was charging commissions to the state’s landlords.
“To me, if they’ve never procured a sale, how do they get paid a real estate commission? They never initiated that sale. The state of Tennessee already had that contract in place,” says Sparks, a Smyrna Republican.
“Ultimately, when something like that happens, [for] the taxpayers, instead of cost savings, it ended up increasing costs. That’s something I don’t think has ever been factored in when they looked at this contract.”
Landlords can’t absorb the cost of the commission, so they’re likely to tack the commission’s percentage onto their bid, passing it on to the tenant, which is the state’s taxpayers, Sparks says.
Initially, Sparks adds, he was “a little confused” about the arrangement, thinking JLL was doing pretty well by procuring leases on commercial real estate.
“But they didn’t do any due diligence. There’s nothing they’ve done,” he points out. “They inherited this, and it’s a pretty good deal for Jones Lang Lasalle.”
Tennessee’s contract with JLL to evaluate certain state buildings came under criticism when amendments such as the leasing provision expanded it to $10.75 million from $1 million. A second contract for facilities management, which will pay JLL $3.1 million over five years, is drawing some opposition as well as the governor studies further outsourcing.
State Rep. Craig Fitzhugh, who chairs the House Democratic Caucus, says he believes outsourcing of state parks, college campuses and other facilities will come under bipartisan scrutiny when the General Assembly convenes in January.
“We’ve started this, but it hasn’t turned out as anticipated, and the administration says they’re just in the preliminary stages of expanding it,” Fitzhugh says. “But … when the governor went to make a presentation with other state officials to the bond rating people (in New York), he made a very declarative statement that said, ‘This is what we’re gonna do.’
“So there’s, at the very least, some mixed messages coming out of the administration that the governor himself said it looks like they’re beyond the contemplating stage and they’re moving forward.”
Fitzhugh further notes a landlord leasing property to the state in his West Tennessee district ran into a situation similar to Hyde’s when JLL told him he would have to pay a commission.
“They said, ‘Oh, just add it to your bid,’” Fitzhugh says, which means the state and taxpayers are paying an extra 4 percent.
Fitzhugh recalls discussion about the leasing commissions, but says the administration explained those would be less expensive than going through the typical state process.
Tennessee’s contract with JLL did not go through legislators on the Fiscal Review Committee but was vetted instead by the State Building Commission. It’s made up of Gov. Haslam, Lt. Gov. Ron Ramsey, House Speaker Beth Harwell and constitutional officers.
Sen. Bill Ketron, who co-chairs the Fiscal Review Committee, said it has “no knowledge of what communications were made between the state and landlords prior to the awarding of the contract.”
He points out Mark Cate, the governor’s former chief of staff, discussed the JLL leasing contract before Fiscal Review in July 2013 and explained the commissions the company is authorized to negotiate with landlords are based on an amendment within it.
“Therefore, there was public knowledge of lease commissions in this meeting,” Ketron says.
In that meeting, Cate told the committee JLL will act similarly to a real estate agent who represents someone buying a house, thus receiving a commission from the seller, calling it an “industry standard.”
“What they bring to bear,” Cate says in video record of the meeting, “it’s hard to even explain here, the data they have, the experience they have ultimately brokering our leases is going to save the state millions and millions of dollars because of their experience, that we just quite frankly don’t have in-house, and if we tried to build up a leasing staff like they have and the data they’re able to bring to bear to get the best market rates (it) would be cost-prohibitive.”
He further points out commissions will be negotiated by the building owner and JLL, but says there is no requirement. Still, he adds, the industry standard is 4 percent on a new lease and 2 percent for a renegotiated lease.
Fast-forward two years, and Department of General Services spokesman Dave Roberson says commissions for real estate leases are standard in the industry.
In the case regarding Hyde Park, JLL procured a lease in June 2013, making the company eligible to earn a commission, he says.
“JLL and the landlord would have negotiated what the commission is,” he says. He did not know why the company would say at first the commission was mandatory and then say it wasn’t, as Hyde contends.
At any given time, JLL has 20 to 30 leases in various stages of completion, according to Roberson, which is a small portion of the state’s leasing program. Whether JLL handles a lease depends on the volume of work involved, the complexity of the contract and the type of the property, Roberson says.
The governor’s office referred questions on potential lease savings to Roberson.
Commissions are capped at 4 percent, and that’s the only way JLL can make money on its state leasing contract, he says.
But here’s the sticking point: Even though Cate told the Fiscal Review Committee the state would save “millions and millions,” Roberson says there’s no way to determine savings.
“If we have a broker negotiate a lease for us, we don’t know what price we would have gotten if we negotiated that lease ourselves. So there’s no way to know what the difference is,” he says.
Considering the undertaking the governor’s office is making to study outsourcing or privatization, the state needs to come up with something a little more solid.
People certainly want to save money, but when the savings can’t be calculated after privatization, a red flag should be raised quickly, because even though some officials call these commissions an “industry standard,” others may look at them as a shakedown.
Sam Stockard can be reached at email@example.com.