Michigan’s biggest charter operator charges big rents: 14 schools pay $1M

June 22--National Heritage Academies is not just the state's largest charter school management company -- it's also the largest charter school landlord, and its schools pay NHA some jaw-dropping rents.

That money, critics contend, would be better spent in the classroom.

"For every dollar that we're pulling out of the classroom to put into a lease agreement that is exceptionally high, that's a dollar that's not going to a child's education," said Casandra Ulbrich, who as vice president of the state Board of Education has argued for Michigan to set a fair-market-value standard.

A Free Press review of records shows that two-thirds of NHA's 47 Michigan schools -- scattered across the state -- pay as much in rent to NHA as tenants in Detroit's Renaissance Center, with its expansive views of the Detroit River. And some schools pay nearly as much as tenants in even tonier locales -- downtown Birmingham, Grosse Pointe or Troy's Somerset Collection, featuring luxury retailers such as Gucci and Louis Vuitton.

But NHA's Nick Paradiso said Friday: "There are new schools in communities that wouldn't have existed were it not for NHA's investment, and at the end of the day it's about providing students with more public school opportunities, and that's what we're doing. It's private investment in a public good."

Leases can be expensive. Michigan does not require charter school leases to be at fair-market value, nor does it require them to be posted on school websites. Information is not readily available to parents and the public.

When questioned by the Free Press, even some board members at NHA schools did not know their school's rent payment.

John Austin, president of the state Board of Education, which sets education policy and advises lawmakers, said that underscores a fundamental flaw with Michigan's charter schools: Management companies, not the boards themselves, are a school's real decision-maker.

"The board isn't necessarily the driver, the owner and operator of the vision, the learning program and the finances of the school if they don't know what's going on," Austin said.

Paradiso, NHA vice president of partner services and government relations, said the company builds its schools at no cost or financial risk to "our partner boards. Our partner boards value this model because it eliminates the burden of raising capital to create and launch a school. No NHA partner board has ever ended its relationship with NHA."

Four schools in Detroit pay NHA more than $1 million in rent annually

For this report, the Free Press analyzed the files of the Michigan Department of Education and records from charter schools obtained under the Freedom of Information Act.

The documents show NHA:

-- Routinely charges schools rents that experts consider above fair-market value.

-- Charges 14 schools, four in Detroit, more than $1 million each per year.

-- Has collected more than $380 million in rent -- including almost $42 million in 2013-14 -- since the company opened its first school in 1995. NHA's schools pay separately for utilities, maintenance, insurance and taxes, pushing the costs of their buildings well above what many real estate and education experts consider acceptable.

-- Collected approximately $220 million in taxpayer dollars in 2013-14 from its 47 Michigan schools.

If NHA, with more than 32,000 students, were a traditional school district, it would be the state's second largest. Only Detroit Public Schools is bigger. NHA has more students than the school systems in Utica, Dearborn and Plymouth-Canton.

Paradiso said its schools are "good stewards of Michigan taxpayer dollars" and that local school boards, along with their legal counsel, negotiated the leases. Paradiso said the leases allow NHA to recover its investment, including debt, risk, construction costs and property acquisition.

Critics, however, say NHA boards may not be independent, especially if members were recruited by the company. And rents typically do not come down once NHA recoups its initial investment.

"At some point they've hit that threshold where they've paid themselves back. So you would expect those leases to start coming down. ... And we're really not seeing that," Ulbrich said. "If anything, they continue to go up. So I don't think that argument really holds water."

Ulbrich said taxpayers have "essentially built" NHA's real estate portfolio.

The leases are paid out of each school's per-pupil funding -- taxpayer dollars from the state. The money goes first to the school's authorizer, which keeps up to 3% for oversight. The rest goes to the school board, which decides how to spend the money. Many NHA boards hand almost the entire sum to for-profit management companies.

The company controls at least 95% of the money. The board gets 2% or $35,000, whichever is less, for discretionary spending. The arrangement is standard in NHA's management agreements with its schools.

NHA is unique among the state's six largest management companies in that every one of its schools leases its building from National Heritage.

A Free Press review of the 2012-13 audits of more than 50 charters managed by the five other large management companies, all for-profits, found most own their own buildings or lease from someone other than the management company. And they spend a lot less on rent.

Only seven of the non-NHA charters spent more than $500,000 a year in rent, including six that have schools in at least two buildings with separate leases in 2012-13. All but one of National Heritage's schools, by comparison, spent more than $500,000 on rent.

Only one non-NHA charter spent more than $1 million on rent -- and it has multiple leases and locations.

Are high rents necessary to recoup investment?

NHA spokesman John Truscott said its million-dollar schools "look like any other school" and have no "gold-encrusted faucets" but do have up-to-date equipment and technology. He also stood by the company's position that the leases are necessary for NHA to recoup its investment in the schools.

Are the rents fair? It depends on the expert, though many agree that they are not.

William Watch, president of First Commercial Realty & Development Co. in Southfield, said even $28 a square foot, the most expensive NHA lease, might be reasonable.

"If I had to build a brand-new school from scratch -- buy the land, do the site work, utility connections, furnish it -- $28 doesn't sound all that bad to me," said Watch, whose company owns, leases, develops and builds commercial and retail projects.

But other real estate experts told the Free Press that NHA leases appear excessive. They said schools should generally spend about $15 a square foot for new construction and $10 or less for an existing property.

Education experts and critics of NHA's business model fault school boards for not shopping around for a better deal -- instead just taking the NHA package.

Two-thirds of NHA's Michigan schools pay the company more than $15 a square foot.

"Those schools are being taken advantage of," said Steve Morris, anadjunct professor of real estate finance at the University of Michigan Ross School of Business and a managing principal at Axis Advisors, a Farmington Hills company that advises office and industrial tenants on how to reduce real estate costs.

During the 2013-14 school year, NHA charged 15 schools $12 to $15 a square foot; 17 schools paid $15 to $20; and 15 paid $20 to $28. In addition to rent, NHA schools are responsible for utilities, maintenance, taxes and insurance. Those costs could add another $8-$10, experts say, pushing the high-end facility costs to nearly $40 a square foot.

Office tenants in the Renaissance Center pay $22 a square foot and are not responsible for property taxes, maintenance and utilities other than electricity, Morris said.

Morris said schools should spend $6 to $10 a square foot for an older, existing building and $15 at most for new construction. He said net rents of $20 to $30 a square foot are "very much on the high side."

Sam Munaco, president of the Michigan office of Advocate Commercial Real Estate Advisors, agreed.

"I'm surprised to hear charter schools are paying that much -- it's considerably above market," said Munaco, whose Chicago-based company represents commercial tenants.

Robin Boyle, chairman of Urban Studies and Planning at Wayne State University, said that "anything north of $15 is outrageous, bearing in mind what you can lease property for in distressed markets all over southeast Michigan."

Four NHA schools that pay more than $20 a square foot are in Detroit.

John Mogk, a law professor at Wayne State who specializes in urban law and policy, said few buildings in Detroit can command that kind of money. Property values in most city neighborhoods have been declining since the first charter schools opened two decades ago.

In a statement, Paradiso said leases reflect a variety of factors, including construction costs and start-up capital.

"NHA assumes all risks associated with the specialized nature of a school building, the cost of raising capital in private markets, and the possibility of termination by the school's board or authorizer," Paradiso said. He said rent increases only when there are improvements to the building.

Buy or rent? Schools need to do their homework on long-term costs

If NHA's schools had bought their buildings, some experts say, they could have reduced their long-term costs and invested the savings in the classroom.

Eighteen NHA schoolshave spent more than $10 million each in rent since opening, including South Arbor Charter Academy in York Township. It has paid NHA $13 million in rent since 1999, more than any other NHA school.

NHA says it typically spends to $9 million to open a new school in Michigan. Watch said rents don't come down because landlords are responsible for maintaining, repairing or replacing things like a building's roof, parking lots and heating and cooling systems -- all capital outlays.

But other experts say the NHA school boards have an obligation to spend tax dollars prudently.

Bruce Baker, a professor in the Rutgers University graduate school of education in New Brunswick, N.J., said the boards need to do the same kind of cost-benefit analysis as consumers weighing whether to buy or lease a vehicle or a home. Which is more cost effective, in the long run: own or rent?

"If the board is supposed to be appointed as stewards of the tax dollars, then damn right they should do it. If the authorizer is responsible for determining whether or not the board is acting as responsible stewards, then the authorizer is equally responsible. There's just a breakdown at every layer of the system," said Baker, who specializes in school finance.

The problem, he said, is that NHA has no incentive to push for a cost-benefit analysis.

Mogk said the NHA lease payments are so alarming that the authorizers should "do a careful audit on the costs ... so that the funding available for students to be educated is not being diverted to pay lease costs."

Building expenses raise questions at other charters, too

While NHA leases stand out, other charters also devote significant portions of their budgets to building expenses, whether it's rent or a mortgage payment, janitorial services, landscaping or security.

Central Michigan University, the state's largest authorizer with 64 charters, analyzed spending by 56 of them during the 2012-13 school year and found they devote a wide range of their budgets to building costs, from a low of 7% to a high of 29% at Old Redford Academy in Detroit and Countryside Academy in Benton Harbor.

Of the charters examined by CMU, half spent 20% or more on occupancy costs. CMU, however, sets no best-practice benchmarks because it says its role is not to run the schools but to inform board members as they make spending decisions.

But Patrick Sweeney, a partner at Croskey, Lanni & Co., a Rochester CPA firm that works with more than 40 Michigan charter schools, said schools should limit spending on facilities costs to no more than 20%.

"Once you start pushing that 20% number, you have to evaluate where you're at, ask yourself some tough questions -- why you're here, is there a better place to put your funding and your resources," Sweeney said.

Many school authorizers say leases are not their business

CMU is not alone in its hands-off approach -- many charter school authorizers say they leave lease arrangements to charter school boards:

-- "The school board for each institution has the sole authority to decide how resources will be used," said Cindy Paavola of Northern Michigan University, which has authorized three NHA schools.

-- Leases are "really a function of the board -- the board contracts with NHA, and our contract is with the board," said Tim Wood, who oversees charters at Grand Valley State University. Grand Valley has authorized 20 NHA schools, more than any other authorizer in Michigan.

-- "It's a decision that's made by the board of directors, to go with this management company," said Nick Oshelski who runs the charter office at Lake Superior State University. He said he was not aware that Regent Park Scholars in Detroit paid $1 million in rent to NHA, or just under $22 a square foot, and that Ridge Park Charter Academy in Grand Rapids paid $1 million in rent to NHA, or just over $20 a square foot. Lake Superior authorized both.

But Greg Richmond, president and CEO of the National Association of Charter School Authorizers, said authorizers have a responsibility to monitor leases because "these are significant dollar values that are being exchanged."

Michigan law requires charter schools to sell property, if purchased with state aid funds, for fair-market rates. But there's nothing that says a charter school has to buy or lease property at fair-market rates. State schools Superintendent Mike Flanagan said the Legislature should change the rules.

"To me, the No. 1 issue is fair-market value," Flanagan said.

Contact Jennifer Dixon: 313-223-4410 or [email protected]

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