‘The lease that will go down in history’: Documents reveal details of ill-fated VCU Health development deal

vcuhealth3 1

A rendering of the office tower and complex that would have replaced the Public Safety Building. (BizSense file)

Editor’s note: This is the first installment in a series analyzing the failed VCU Health-anchored development in downtown Richmond.

Last week’s letter from Gov. Glenn Youngkin calling for changes to the governance of VCU Health, as well as to its relationship with Virginia Commonwealth University, is renewing scrutiny of the aborted downtown development that has cost the health system $80 million and counting in exit payments.

In the letter to General Assembly leadership, Youngkin states that the aborted redevelopment of the city’s old Public Safety Building site could end up costing VCU Health as much as $100 million and “should serve as a wake-up call to the significant flaws in the current governance of the University and (the health system), particularly related to the planning, approval, and implementation of sophisticated and costly capital projects.”

Youngkin notes that the lease that VCU Health agreed to as the master tenant for the $325 million project made it responsible for not only more than $600 million in rent over 25 years, but also any project cost overruns and real estate tax payments to the City of Richmond that continue to be made in the wake of the deal’s failure.

The letter states that outside financial advisors were not consulted during negotiations with the project’s financing group and developer, and that a detailed risk analysis “was only conducted immediately prior to closing.”

“This analysis reportedly outlined serious risks with the proposal and did not point favorably towards approval,” Youngkin said. “Yet despite the repeated warning signs, VCU Health pressed forward and approved the Project.”

A closer look at that analysis – obtained through Freedom of Information Act requests that Richmond BizSense made over the past three months – reveals a clearer picture of the risks that VCU Health was taking on with the project and red flags that were raised.

BizSense also requested and obtained over 1,000 pages of email correspondence, some partially redacted due to FOIA exemptions, between key administrators over the course of the project.

The documents show that it was health system administrators, including then-VCU Health CEO Art Kellermann, who were sounding the alarm about those risks in an 11th-hour attempt to get senior leadership to reconsider the project – what one administrator described in an email as “The lease that will go down in history.”

Complex deal

PublicSafetyBldg1

The 3-acre Public Safety Building property at 500 N. 10th St. (BizSense file photo)

Circulated in early June 2021 – just weeks before the deal was originally scheduled to close – the risk analysis was produced by Hunton Andrews Kurth, the downtown law firm that was VCU Health’s outside legal counsel.

Hunton’s analysis identifies several risks that VCU Health faced with the deal that was crafted in the wake of Navy Hill, the larger and unsuccessful development project that included a similar plan for the Public Safety Building site.

Known in Navy Hill as “D Block,” the 3-acre site at 500 N. 10th St. had long been desired by VCU and VCU Health for an expansion of the adjacent MCV campus. The plan was for a multi-building complex with a high-rise office tower to be used by VCU Health, as well as a reconnection of Clay Street through the site, hence its reference by administrators as “the Clay Street project.”

Because the site was city-owned, the deal that formed out of Navy Hill was based on the concept of VCU Health leasing the building as a master tenant from a private ownership entity, in order to keep the property tax-generating for the city. Typically, real estate owned by the health system or university is exempt from local taxes.

An executive summary of the project, produced for VCU Health officials and also circulated in June 2021, states that financial proposals that the developer solicited for the project showed “the best deal financially was available when VCU Health was a master tenant.” But the summary adds: “VCU Health expressed concern about being master tenant.”

VCU Health ultimately agreed, signing a letter of intent with developer Capital City Partners, the same team behind Navy Hill under a different name. CCP, led by developers Susan Eastridge and Michael Hallmark, brought to the table Chicago-based Oak Street Real Estate Capital as the project’s capital provider.

“The developer had brought several financial institutions to the table for consideration for the financing of the project but clearly had a front runner who was less dependent on market conditions for closing and therefore less risky from timing and pricing,” the executive summary states.

Oak Street, through an entity called Project 10th Street LLC, would effectively be the property owner and VCU Health’s landlord, but with the health system paying the real estate taxes to the city, in addition to the yearly payments on its 25-year lease. The lease called for rents to increase annually, from roughly $12.8 million the first year to nearly $32 million the final year, with the overall lease totaling more than $617 million.

The arrangement was a novel one for VCU Health, which at the time also was developing its nearby Children’s Hospital of Richmond and Adult Outpatient Pavilion, on land owned by either the health system or VCU.

The Adult Outpatient Pavilion did not include significant office space and was to be supported by the Clay Street building, which also would have housed nonprofits The Doorways and Ronald McDonald House Charities, bringing the latter closer to the children’s hospital it supports.

While the deal came with significant financial obligations, it was appealing to VCU Health in part because it included an option for the health system to purchase the Clay Street property after its 25-year lease.

According to the executive summary, the deal originally would have allowed that purchase to be made at fair market value but was later negotiated to put the purchase price at 10 percent of the fair market value or $31 million, whichever was greater at the time the option was exercised.

VCU Health would have had to continue paying the real estate taxes in perpetuity if it took that option, according to the deed from the city’s $3.5 million sale of the property to the landlord LLC. But in terms of ownership, the property would be the health system’s.

‘Horribly one-sided’

Public Safety 2020 photo

The Public Safety Building as viewed along Ninth Street in 2020, with the under-construction VCU Health Adult Outpatient Pavilion rising behind it. (BizSense file)

The risk analysis was conducted by Hunton attorney Dan Campbell, who was among the attorneys who consulted on the multiparty agreement that memorialized the deal, along with Roth Jackson’s Mark Kronenthal and Jennifer Mullen for CCP, and David Rosenberg with Kirkland & Ellis in Chicago for the landlord LLC.

According to Campbell’s analysis, which lists nine areas of “material risks,” legal documentation prepared by CCP’s team “was horribly one-sided, and certainly not what any of us would have recommended as a starting point for a complex transaction such as this.”

Campbell states they negotiated some protections for the health system within the framework provided, but that “those protections are limited and the bulk of the transaction risk remains with VCUHS.”

The analysis notes the health system’s responsibility for project cost overruns, adding that the development was likely to go over budget based on forecasts that showed project contingencies would be depleted prior to completion. It also notes the real estate payments to the city over 25 years would add up to $55 million.

According to the analysis, the deal required that rent payments start on a fixed commencement date, regardless of whether the project was complete and ready for occupancy. “If there are any unexpected delays, VCUHS will have to begin paying rent but may not be able to occupy some or all of the space or collect rent from subtenants,” it states, referring to Doorways and Ronald McDonald House.

At the time of the analysis, letters of intent with the subtenants were still being negotiated, keeping the project’s final budget in flux.

As for the lease structure for VCU Health, the analysis states: “While VCUHS will technically be a tenant, for all intents and purposes, in addition to paying rent, it will be acting as an owner, with all of the related obligations to repair and maintain the Project after completion and rebuild in the event of a casualty.” It adds: “Other than financing the Project, Landlord has no obligations under the Lease.”

Of the landlord’s and developer’s financial stake in the project, the analysis states, “Developer and Landlord are making significant fees over the course of the Project without placing their respective profits at much risk.”

According to the executive summary that was circulated along with Hunton’s analysis, Oak Street, now a division of New York-based investment firm Blue Owl Capital, requested a reimbursement agreement several times due to the deal’s closing being delayed. VCU Health would have had to pay $2 million plus expenses to Oak Street, but it did not agree to the request, contending that the delays were due to other parties in the deal.

“There was also a request by the developer for a reimbursement resolution for its deposit of approximately $450k which we denied,” the summary states.

According to the project budget, CCP was to have been paid $11 million in developer fees and $5.5 million in project management fees over the course of the nearly four-year project. The project’s demise cost Eastridge and Hallmark the full contract for their work.

‘The political stakes are high’

PublicSafetyBldgWork1

A welding crew was active this summer on the site of the old Public Safety Building. City Hall is visible in the distance. (BizSense file photo)

The Hunton analysis followed weeks of emails from then-VCU Health CEO Art Kellermann and other health system administrators who said the project’s terms had become lopsided. They also questioned the need for a new 17-story building with 150,000 square feet of office space for the health system amid the pandemic’s impact on office work and on VCU Health both operationally and financially.

Kellermann had joined the health system as CEO in late 2020, after the Clay Street project had been announced. Seven months into his tenure, on May 30, 2021, he sent an email expressing his concerns about the project to VCU President Michael Rao, who also serves as president of VCU Health and chairs the health system authority’s Board of Directors.

“I am concerned that the agreement being pushed by the developers essentially puts us on the hook for most, if not all, of the project’s costs and risks,” Kellermann wrote.

“If this is true,” he added, “we need to be clear-eyed about how it fits in our overall priorities and other pressing and pending needs, and how we’ll pay for it, since it will generate relatively little revenue compared to its annual cost.” Later, he continues: “All of this makes it imperative that we understand precisely what the Clay Street project entails and our capacity to sustain it before we sign any agreement.”

In response, Matt Conrad, vice president for government and external relations for VCU and VCU Health who was included on Kellermann’s email to Rao, stressed that the project had the support of Richmond City Council and the health system board, and that pulling out of the project could jeopardize coordination of the planned VCU Athletics Village with the city’s 67-acre Diamond District project.

“You are correct that the political stakes are high here,” Conrad told Kellermann, describing the Clay Street project as “perhaps the biggest economic development accomplishment of this mayor,” referring to Richmond Mayor Levar Stoney.

“Walking away would have disastrous effects on important deals with the city like development of the 60 acres in conjunction with our athletics facility,” said Conrad, who had been involved in project negotiations with the city. “…That said, if you truly believe there is lopsided, unmitigated risk that could hinder delivery of VCUHS’ mission, that needs to take priority and should be evaluated and discussed.”

Conrad added that outside counsel had been engaged on the deal, and asked Kellermann: “Have they not raised flags being that we are to close on this deal in a matter of days?”

The back-and-forth between administrators would continue over the weeks leading up to the deal’s consummation, culminating with a last-ditch effort by Kellermann days before he would end up doing what he was advocating against: signing off on the project.

vcuhealth3 1

A rendering of the office tower and complex that would have replaced the Public Safety Building. (BizSense file)

Editor’s note: This is the first installment in a series analyzing the failed VCU Health-anchored development in downtown Richmond.

Last week’s letter from Gov. Glenn Youngkin calling for changes to the governance of VCU Health, as well as to its relationship with Virginia Commonwealth University, is renewing scrutiny of the aborted downtown development that has cost the health system $80 million and counting in exit payments.

In the letter to General Assembly leadership, Youngkin states that the aborted redevelopment of the city’s old Public Safety Building site could end up costing VCU Health as much as $100 million and “should serve as a wake-up call to the significant flaws in the current governance of the University and (the health system), particularly related to the planning, approval, and implementation of sophisticated and costly capital projects.”

Youngkin notes that the lease that VCU Health agreed to as the master tenant for the $325 million project made it responsible for not only more than $600 million in rent over 25 years, but also any project cost overruns and real estate tax payments to the City of Richmond that continue to be made in the wake of the deal’s failure.

The letter states that outside financial advisors were not consulted during negotiations with the project’s financing group and developer, and that a detailed risk analysis “was only conducted immediately prior to closing.”

“This analysis reportedly outlined serious risks with the proposal and did not point favorably towards approval,” Youngkin said. “Yet despite the repeated warning signs, VCU Health pressed forward and approved the Project.”

A closer look at that analysis – obtained through Freedom of Information Act requests that Richmond BizSense made over the past three months – reveals a clearer picture of the risks that VCU Health was taking on with the project and red flags that were raised.

BizSense also requested and obtained over 1,000 pages of email correspondence, some partially redacted due to FOIA exemptions, between key administrators over the course of the project.

The documents show that it was health system administrators, including then-VCU Health CEO Art Kellermann, who were sounding the alarm about those risks in an 11th-hour attempt to get senior leadership to reconsider the project – what one administrator described in an email as “The lease that will go down in history.”

Complex deal

PublicSafetyBldg1

The 3-acre Public Safety Building property at 500 N. 10th St. (BizSense file photo)

Circulated in early June 2021 – just weeks before the deal was originally scheduled to close – the risk analysis was produced by Hunton Andrews Kurth, the downtown law firm that was VCU Health’s outside legal counsel.

Hunton’s analysis identifies several risks that VCU Health faced with the deal that was crafted in the wake of Navy Hill, the larger and unsuccessful development project that included a similar plan for the Public Safety Building site.

Known in Navy Hill as “D Block,” the 3-acre site at 500 N. 10th St. had long been desired by VCU and VCU Health for an expansion of the adjacent MCV campus. The plan was for a multi-building complex with a high-rise office tower to be used by VCU Health, as well as a reconnection of Clay Street through the site, hence its reference by administrators as “the Clay Street project.”

Because the site was city-owned, the deal that formed out of Navy Hill was based on the concept of VCU Health leasing the building as a master tenant from a private ownership entity, in order to keep the property tax-generating for the city. Typically, real estate owned by the health system or university is exempt from local taxes.

An executive summary of the project, produced for VCU Health officials and also circulated in June 2021, states that financial proposals that the developer solicited for the project showed “the best deal financially was available when VCU Health was a master tenant.” But the summary adds: “VCU Health expressed concern about being master tenant.”

VCU Health ultimately agreed, signing a letter of intent with developer Capital City Partners, the same team behind Navy Hill under a different name. CCP, led by developers Susan Eastridge and Michael Hallmark, brought to the table Chicago-based Oak Street Real Estate Capital as the project’s capital provider.

“The developer had brought several financial institutions to the table for consideration for the financing of the project but clearly had a front runner who was less dependent on market conditions for closing and therefore less risky from timing and pricing,” the executive summary states.

Oak Street, through an entity called Project 10th Street LLC, would effectively be the property owner and VCU Health’s landlord, but with the health system paying the real estate taxes to the city, in addition to the yearly payments on its 25-year lease. The lease called for rents to increase annually, from roughly $12.8 million the first year to nearly $32 million the final year, with the overall lease totaling more than $617 million.

The arrangement was a novel one for VCU Health, which at the time also was developing its nearby Children’s Hospital of Richmond and Adult Outpatient Pavilion, on land owned by either the health system or VCU.

The Adult Outpatient Pavilion did not include significant office space and was to be supported by the Clay Street building, which also would have housed nonprofits The Doorways and Ronald McDonald House Charities, bringing the latter closer to the children’s hospital it supports.

While the deal came with significant financial obligations, it was appealing to VCU Health in part because it included an option for the health system to purchase the Clay Street property after its 25-year lease.

According to the executive summary, the deal originally would have allowed that purchase to be made at fair market value but was later negotiated to put the purchase price at 10 percent of the fair market value or $31 million, whichever was greater at the time the option was exercised.

VCU Health would have had to continue paying the real estate taxes in perpetuity if it took that option, according to the deed from the city’s $3.5 million sale of the property to the landlord LLC. But in terms of ownership, the property would be the health system’s.

‘Horribly one-sided’

Public Safety 2020 photo

The Public Safety Building as viewed along Ninth Street in 2020, with the under-construction VCU Health Adult Outpatient Pavilion rising behind it. (BizSense file)

The risk analysis was conducted by Hunton attorney Dan Campbell, who was among the attorneys who consulted on the multiparty agreement that memorialized the deal, along with Roth Jackson’s Mark Kronenthal and Jennifer Mullen for CCP, and David Rosenberg with Kirkland & Ellis in Chicago for the landlord LLC.

According to Campbell’s analysis, which lists nine areas of “material risks,” legal documentation prepared by CCP’s team “was horribly one-sided, and certainly not what any of us would have recommended as a starting point for a complex transaction such as this.”

Campbell states they negotiated some protections for the health system within the framework provided, but that “those protections are limited and the bulk of the transaction risk remains with VCUHS.”

The analysis notes the health system’s responsibility for project cost overruns, adding that the development was likely to go over budget based on forecasts that showed project contingencies would be depleted prior to completion. It also notes the real estate payments to the city over 25 years would add up to $55 million.

According to the analysis, the deal required that rent payments start on a fixed commencement date, regardless of whether the project was complete and ready for occupancy. “If there are any unexpected delays, VCUHS will have to begin paying rent but may not be able to occupy some or all of the space or collect rent from subtenants,” it states, referring to Doorways and Ronald McDonald House.

At the time of the analysis, letters of intent with the subtenants were still being negotiated, keeping the project’s final budget in flux.

As for the lease structure for VCU Health, the analysis states: “While VCUHS will technically be a tenant, for all intents and purposes, in addition to paying rent, it will be acting as an owner, with all of the related obligations to repair and maintain the Project after completion and rebuild in the event of a casualty.” It adds: “Other than financing the Project, Landlord has no obligations under the Lease.”

Of the landlord’s and developer’s financial stake in the project, the analysis states, “Developer and Landlord are making significant fees over the course of the Project without placing their respective profits at much risk.”

According to the executive summary that was circulated along with Hunton’s analysis, Oak Street, now a division of New York-based investment firm Blue Owl Capital, requested a reimbursement agreement several times due to the deal’s closing being delayed. VCU Health would have had to pay $2 million plus expenses to Oak Street, but it did not agree to the request, contending that the delays were due to other parties in the deal.

“There was also a request by the developer for a reimbursement resolution for its deposit of approximately $450k which we denied,” the summary states.

According to the project budget, CCP was to have been paid $11 million in developer fees and $5.5 million in project management fees over the course of the nearly four-year project. The project’s demise cost Eastridge and Hallmark the full contract for their work.

‘The political stakes are high’

PublicSafetyBldgWork1

A welding crew was active this summer on the site of the old Public Safety Building. City Hall is visible in the distance. (BizSense file photo)

The Hunton analysis followed weeks of emails from then-VCU Health CEO Art Kellermann and other health system administrators who said the project’s terms had become lopsided. They also questioned the need for a new 17-story building with 150,000 square feet of office space for the health system amid the pandemic’s impact on office work and on VCU Health both operationally and financially.

Kellermann had joined the health system as CEO in late 2020, after the Clay Street project had been announced. Seven months into his tenure, on May 30, 2021, he sent an email expressing his concerns about the project to VCU President Michael Rao, who also serves as president of VCU Health and chairs the health system authority’s Board of Directors.

“I am concerned that the agreement being pushed by the developers essentially puts us on the hook for most, if not all, of the project’s costs and risks,” Kellermann wrote.

“If this is true,” he added, “we need to be clear-eyed about how it fits in our overall priorities and other pressing and pending needs, and how we’ll pay for it, since it will generate relatively little revenue compared to its annual cost.” Later, he continues: “All of this makes it imperative that we understand precisely what the Clay Street project entails and our capacity to sustain it before we sign any agreement.”

In response, Matt Conrad, vice president for government and external relations for VCU and VCU Health who was included on Kellermann’s email to Rao, stressed that the project had the support of Richmond City Council and the health system board, and that pulling out of the project could jeopardize coordination of the planned VCU Athletics Village with the city’s 67-acre Diamond District project.

“You are correct that the political stakes are high here,” Conrad told Kellermann, describing the Clay Street project as “perhaps the biggest economic development accomplishment of this mayor,” referring to Richmond Mayor Levar Stoney.

“Walking away would have disastrous effects on important deals with the city like development of the 60 acres in conjunction with our athletics facility,” said Conrad, who had been involved in project negotiations with the city. “…That said, if you truly believe there is lopsided, unmitigated risk that could hinder delivery of VCUHS’ mission, that needs to take priority and should be evaluated and discussed.”

Conrad added that outside counsel had been engaged on the deal, and asked Kellermann: “Have they not raised flags being that we are to close on this deal in a matter of days?”

The back-and-forth between administrators would continue over the weeks leading up to the deal’s consummation, culminating with a last-ditch effort by Kellermann days before he would end up doing what he was advocating against: signing off on the project.

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Bruce Milam
Bruce Milam
9 months ago

Keep digging Mr. Spires. You may eventually find where the money leads.

Jeff Stein
Jeff Stein
9 months ago
Reply to  Bruce Milam

Huh? It leads straight to Blue Owl Capital as it states in the article. Henrico County is the next victim ahead of the line.

David Humphrey
David Humphrey
9 months ago
Reply to  Jeff Stein

Interesting that Blue Owl is in two articles this morning. I wonder if the principals have some connection to the Richmond area.

Michael Morgan-Dodson
Michael Morgan-Dodson
9 months ago
Reply to  David Humphrey

I would also like to know the principles of 10th Street LLC as they are the ones Oak Street created and the checks are going to them. I am sure they are a lot of the same persons as Oak ownership but could it any have in the Delaware LLC with connections to people/parties in VCU or City government? I think it smell enough for the US Attorney to look into it on the basis of municipal corruption possibilities.

SA Chaplin
SA Chaplin
9 months ago

Excellent article. And yet another reason to limit state involvement the health care business.

Justin Ranson
Justin Ranson
9 months ago
Reply to  SA Chaplin

State-supported Teaching hospitals are a fundamental pillar of the US Healthcare system. Remove them, and doctor education plummets, and the existing doctor and nursing shortages will hit unsustainable levels.

kay christensen
kay christensen
9 months ago

When will someone be fired for this mess?

Frank Wood
Frank Wood
9 months ago

Kellermann was (he was asked to resign) and he was a scapegoat for Rao who should have been fired.

William H Ferguson
William H Ferguson
9 months ago

Just reminds me of Governor McDonald’s Rt. 460 deal. Hundreds of millions of dollars out the window with not one shovel being turned.

Liz Smith
Liz Smith
9 months ago

*McDonnell

Frank Wood
Frank Wood
9 months ago

Dr. Art Kellermann, CEO of Virginia Commonwealth University Health System, resigned late Thursday under pressure from university leadership.” Nov 2022

Rao should have been fired instead of Kellermann.

The deal terms by CCP, Susan Eastridge and Michael Hallmark, were so egregiously lopsided that they NEVER should have been signed-off on.

I certainly hope Henrico has better overview on Eastridge and Hallmark regarding Greencity because if it’s structured the same way Henrico has all the downside and Eastridge and Hallmark the upside with limited exposure!

Bob Fergusson
Bob Fergusson
9 months ago

Check the Mayor’s pockets