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Why Churches Should Use Caution When Collaborating with Developers

Key questions—and steps—to avoid legal battles and other painful situations.

Editor’s Note. This article is part of the Advantage Membership. Learn more on how to become an Advantage Member or upgrade your membership.

Many churches today are asset rich but cash constrained. Selling or developing church property has become an interesting and helpful process to create more cash flow for some churches, but it’s important to be aware of the many details—and potential pitfalls—involved with these transactions.

Sales have increased

As of August 2019, more than 6,800 religious buildings had sold in the preceding five years and more than 1,400 were for sale in the U.S., according to the commercial real estate database CoStar. The increase in property sales during this period was attributed to two factors: declining church membership and the rising costs related to the maintenance of aging and declining facilities. The pressure to sell or develop has apparently only increased for some churches.

“Two and a half years ago, we decided that upkeep of [our] building and the age factor of it was way too much for a congregation of about a hundred people to keep up with long term,” pastor David Lodwig of River Valley Church in Missoula, Montana, told Missoulacurrent.com. In December of 2019, River Valley Church sold its property and is working on a securing a new one.

There are some churches that are okay with selling their property outright and seeking a new place to worship. They view such a transaction as an opportunity to downsize and have more manageable property expenses.

Other churches will only sell a portion of the space and retain the rest. A church can structure a deal with a developer that includes the developer paying for them to rent space elsewhere while that portion of their property is under construction.

There are pros and cons to either approach, depending on the church and what its infrastructure is capable of handling. This is an important note. A church has to think through what it is capable of maintaining on its own, or once the project is completed and new responsibilities emerge with the new space.

The remainder of this article will focus on the development-based approach, since it is a less common—but increasingly popular—trend among churches.

Trends in developing property

While selling prime real estate is one option for addressing cash shortfalls, many turn to property developers and collaborative projects. Second Canaan Baptist in the New York City borough of Manhattan chose to replace its former worship facility with a new church building and residential condominiums available for purchase that include finishes like walnut vanities. The church’s pastor told The New York Times that “if you don’t undertake projects like this, chances are the ministry will fold, because the continuing costs of maintaining an old building will sink you.”

The prospect of a church working with a developer or an investment company—or even the city—can seem like an ideal solution to counter aging facilities and cash-strapped congregations. However, negative consequences can result if proper steps are not taken.

Two troubling examples

In August of 2019, St. Luke’s Baptist Church in Harlem asked the state’s highest court to intervene in a deal with a developer that the church said “left it at the precipice of shuttering its doors for good,” according to a Crain’s New York Business article. The church sued the developer and its president, accusing them of using their real estate expertise to “take advantage of a church whose unsuspecting nature and charitable parishioners left it vulnerable to the defendants’ predatory practices.”

The church entered into an agreement with the developer in 2014 expecting a new sanctuary as part of the developer’s construction of a residential building on the church’s property. The terms of the deal included a provision that if the new church was not completed by 2017, the developer would give the church $21,000 a month for each month beyond the deadline.

By August of 2019, the developer was two years past the deadline—and the developer refused to make the monthly payments. The church also asserted in its complaint that the developer had colluded with the church’s attorney at the time to enter a deal that was not to the church’s benefit. This lawyer had previously worked with the developer on another church deal and ultimately pleaded guilty to stealing $600,000 from that other church .

More recently, as reported by the New York Daily News, Gospel Mission Baptist Church, also in Harlem, entered into a deal with a developer whereby the development company would own 80 percent of the building and the church would own the remaining 20 percent. There would be no expense to members, the church would receive a new sanctuary, and the developer would build and sell condos located above the church’s space.

In the agreement between the parties, the church was listed as a commercial entity and not a religious organization, so it was required to pay condominium fees as a unit of the condo. This important requirement in the contract was missed by the church, and it was stuck with ongoing maintenance fees that accrued and exceeded $270,000.

Additionally, the building was sold in a foreclosure proceeding unbeknownst to the church. The church was evicted, despite waging a legal battle for a year, and on January 19, 2020, it held its last service at the location.

Thankfully, Gospel Mission was able to join with another congregation to continue its ministry operations at another location. However, the church expected to lose 70 percent of its members due to the distance of the relocation.

Such unfortunate outcomes could most likely have been avoided with advanced planning and preparation, the assembly of the right team, and the proper structuring of the development agreement. Here’s how these steps can help churches avoid the types of unfortunate outcomes other congregations have experienced.

Advanced planning and preparation

Before pursuing a development deal, church leaders should consider the following six questions:

  • What are the church’s goals—and what is the quantitative value of its property? What is the church looking to gain from a development deal? What can it realistically obtain through such a deal? There are factors that will determine the type of deal that can be made. Location, the size of the property, and zoning restrictions are key components for understanding which goals are realistic and what type of value the property offers.
  • What documents are required and who needs to be involved? The church must have in its possession all of its governing documents, including the articles of incorporation, the bylaws, the property deed, and any other documents required under the specific denomination and/or governing body of the church. The formal process of approving a sales transaction—whether by the church membership or the church’s board or governing body—also must be identified. These details will be required for the deal to go through. All parties and documents necessary to the transaction need to be identified and duly prepared well before a deal is signed and ready to close.
  • Who owns the church property? There must be clarity as to the ownership status of the church property. Does the church fully own the property and therefore have full authority to sell it—or portions of it—for development purposes? Remember to follow any requirements established by the overarching denomination regarding the sale of property by an individual church.
  • What are the tax ramifications? The church must determine any tax-related implications triggered by the specifics of the arrangement. Generally, these deals do not jeopardize the tax-exempt status of the church. However, if the deal provides the church with new space that is a rental property or a community space used to generate unrelated business income, then tax considerations apply. The church must consult a qualified tax attorney to evaluate the opportunity and all of its implications.
  • What are the insurance considerations? The church must weigh the types of risk management concerns that a potential development agreement raises. Is special insurance coverage now necessary? Will the church insurer even sign off on something like this? How much additional cost in insurance premiums will the church face?
  • What restrictions, if any, does the church face with respect to a lender? If the property is paid off, this isn’t a concern. But if the church currently borrows money, or needs to borrow money for the development project, it needs to verify how the deal affects current obligations and triggers new ones.
Assemble the right team

It is imperative that the church put together a proper team to deal with the property development opportunity. The ideal team, which can involve staff members who fulfill these functions or volunteers with backgrounds in these subjects, should consist of:

  • the pastor;
  • a lawyer, preferably with real estate, church law, and/or general business experience;
  • a tax attorney;
  • a person with a construction and/or real estate background; and
  • a person with financial acumen, such as a CPA or financial officer.

It bears mention that in line with the church’s 501(c)(3) status and IRS requirements, no member of this team should have a financial/pecuniary gain in this transaction.

The pastor is a critical part of articulating the vision of the church for the project. This is important in making sure that the goals of the church remain the focal point.

The attorney ensures that the deal is carefully vetted and that it reflects the terms that the church has postulated.

The team member with construction and/or real estate experience is invaluable and can be given the role of the owner’s representative. This person will interact with the developer throughout the process and manage the day-to-day details of the project for the church.

The finance person should possess the ability to craft a financial deal offering the most benefits to the church. This person has to consider the current financial state of the church, any current or potential obligations to a lender, and the church’s ability to sustain any long-term obligations derived from the development project. There are likely lending and/or banking considerations that need to be addressed, including conversations with, and approvals from, a current or prospective lender. The finance person will be instrumental in this process.

A properly structured agreement

There are many considerations to go over before the final agreement is made. For instance, does the deal require giving up a portion of ownership in the property? Does it require the church to front certain costs or absorb new ongoing costs? Does it require the church to share a percentage of revenues forever? Questions like these must be answered before a church enters into a development opportunity.

The deal also has to be one that the church is comfortable with many years down the line. Despite any financials pressures, a church should not enter into a deal solely focused on the immediacy of the projected financial windfall. They must be forward thinking. While the deal has to be contemplated from many vantage points, the church must be mainly concerned with how the deal does or doesn’t track with its mission and core values.

The church can also place conditions on the developer to protect its interests. Such conditions may include a timeline that the developer must meet, with built-in financial penalties for missing any established deadlines and benchmarks. The church can also insist on maintaining the structural and historical integrity of the property, especially where there is some significance for the church.

Proceed with caution

Property development projects have enabled some churches to achieve a financial turnaround when they otherwise might have closed their doors. Unfortunately, development projects have also caused financial ruin for other churches. The difference lies in the advanced planning and preparation, the team assembled, and the structure of the deal. These factors, when properly utilized and executed, can breathe both life and financial health into a struggling church.

Gisele Kalonzo-Douglas is an attorney, risk manager, strategic planning consultant, and crisis management professional with over ten years of experience.

This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations." Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.

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Posted:
  • September 2, 2020

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