It was early Sunday morning of Memorial Day weekend in 2021, but Dr. Art Kellermann couldn’t wait. The stakes were too high, and the clock was ticking.
The then-CEO of Virginia Commonwealth University Health emailed VCU president Michael Rao and other university leaders expressing concern about a pending development deal that would cost the health system hundreds of millions of dollars.
VCU Health had agreed in principle with the city of Richmond and a developer to replace the Public Safety Building at 500 N. 10th St. with a 17-story office tower for VCU Health employees. VCU Health would pay about $650 million over 25 years to occupy the space, and the deal was set to close in a few weeks.
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Kellermann strongly disliked the arrangement, saying the costs were high and the risks abundant. Others shared his concern. A vice president for the health system called the project “the lease that would go down in history.”
But university leaders dismissed his concern, characterizing his emails as annoyances. Ultimately, VCU leaders convinced Kellermann to stick with the deal, which was signed in July 2021.
A few months later, it became clear that the cost to build had skyrocketed, and there was no longer a market for large office buildings like this one. VCU backed out, agreeing to pay $73 million to exit.
A law firm later hired to investigate the failed development determined that VCU had prioritized its mission over finances. This account is based on 100 pages of emails gathered by the law firm and obtained by the Richmond Times-Dispatch in a Freedom of Information request.
The emails raise questions as to whether Rao should have become involved in the details of the deal earlier and why VCU Health did not have the necessary personnel to evaluate the terms of the agreement.
Members of VCU’s board of visitors disagree as to the degree of culpability Rao bears, two people familiar with the matter said. Dr. Marlon Levy, interim CEO of the health system, said in an interview Monday that the failed Clay Street deal was an anomaly and that VCU has successfully pulled off numerous real estate projects.
‘Deal is awful’
There were other players in the deal, including the city of Richmond, land developer Capital City Partners and a private equity real estate firm connected to Blue Owl Capital Inc. But VCU Health held all the risk.
The health system was on the hook for paying rent beginning in 2024 whether the building was ready or not. It had to pay repair costs, maintenance and $55 million in taxes — costs sometimes covered by the landlord. If the cost of construction exceeded the planned $316 million, VCU had to pay the rest, too.
The city had its own specifications — it wanted child care and parking commitments from VCU Health and space to house Ronald McDonald House Charities and The Doorways, which provide housing for families of patients. And because the building served as office space, it wouldn’t generate revenue for VCU Health.
“The Clay Street deal is awful,” Kellermann said to coworkers. “I fear, however, that it is unstoppable — for all the wrong reasons.”
Hired the year before, Kellermann was new to his role. Another administrator, Melinda Hancock, had negotiated the deal and was about to leave the health system. When she left, VCU Health lacked anyone with intimate knowledge of the agreement.
Shirley Gibson, an interim vice president at VCU Health, called the project “the lease that would go down in history.”
VCU Health agreed to what is called a triple net lease, in which the tenant is responsible for all property expenses, including taxes, insurance, maintenance, utilities and rent. In exchange, the tenant gets a lower rent payment. This deal made sense for VCU Health, several people said, because VCU Health was interested in occupying the building for long-term use.
Susan Eastridge, one of the leaders of Capital City Partners, did not respond to a request for comment Tuesday.
Risks to backing out
Administrators at VCU felt there were risks to backing out, too. Walking away would have disastrous effects on VCU’s planned athletics village, Matt Conrad, a vice president for VCU, wrote in a 2021 email. Leaving could damage the university’s relationship with the mayor’s office, city council and possibly state legislators, Karah Gunther, another VP, added in an email at the time.
Levy, the current interim CEO of the health system, said this week that he doesn’t believe the fallout has affected the athletics village, which VCU plans to build along Hermitage Road.
VCU had pursued the parcel housing the public safety building for 15 years, and city leaders were already celebrating its redevelopment, Conrad said. If the plan failed, VCU would be seen as the “bad guys,” and Mayor Levar Stoney’s team would box out the university from acquiring the land in the future.
“I see no second bites at this apple,” Conrad added.
That prediction doesn’t appear to have come true, either, as VCU still hopes to build a $415 million dental school on the plot.
Rao’s role
Rao wasn’t familiar with deal’s details until about a month before the agreement was set to close, and he wasn’t initially aware the deal was potentially one-sided and carried substantial risk.
As chair of the VCU Health board of directors, Rao is not involved in the day-to-day operation of the health system. That work belongs to the CEO. The board is responsible for VCU Health’s mission, vision and high-level goals, he said.
Rao wrote in an email Tuesday to The Times-Dispatch that he asked the right leaders to review the project, including university administrators, because the health system had several new faces in leadership during this period.
“I met and talked frequently with those involved in the project,” Rao wrote in the email. “Concerns were heard, and it was decided to move forward. Clearly, everyone is very disappointed about the outcome, despite the project’s best intentions.”
Members of VCU’s board of visitors have differing opinions concerning the degree of Rao’s culpability on the deal’s failure, two people familiar with the matter said. Some members of the board have come to Rao’s defense, saying that in 2021, business leaders could not have predicted that office buildings would remain empty for years to come.
After VCU Health had committed to spending $650 million to occupy the building for 25 years, it exited at a cost of $73 million, or about 11%. One person familiar with the series of events called the cost “not great but not shocking,” which characterizes how some board members feel.
VCU Health lacked a project manager
When it didn’t have the resources on staff to identify all the risks, VCU Health turned to a law firm. It sought guidance from Hunton Andrews Kurth, which identified numerous worries. The law firm agreed the bulk of the risk lay with VCU Health. The landlord, the firm tied to Blue Owl, had no obligations other than financing the project.
Conrad recommended VCU Health hire a full-time project manager, but that apparently never happened, and it’s unclear why. Kellermann declined to comment Tuesday.
After the deal broke down, Rao recommended an independent review of the situation, and the health system hired law firm Saul Ewing. The firm determined VCU Health did not have sufficient staff to evaluate the deal’s terms, and its board did not have the personnel needed to sufficiently scrutinize it. The VCU Health board of directors approved the agreement multiple times.
Saul Ewing wrote in a report that VCU Health prioritized its mission, vision and values over finances. The health system conducted insufficient due diligence, and called in third-party help too late.
The firm recommended more open and respectful discussions from VCU leaders, and it suggested VCU Health establish project management teams with a clear manager. It suggested health system leadership provide more information to the board when seeking approval in the future.
VCU is committed to following the recommendations, Rao said. The health system hasn’t hired a project manager yet, Levy said, but will do so when it begins its next project.
As part of the termination of the deal, VCU Health agreed to pay for the demolition of the still-standing Public Safety Building. The health system has not yet awarded a contract for the work, Levy said.
In July 2021, the university’s chief financial officer, Karol Kain Gray, offered her thoughts to Kellermann and others. She repeated points that there were no second chances, that VCU had sought the parcel for more than a decade and that the administration’s position had not changed.
Kellermann accepted her words and signed the deal.
“Thank goodness,” Conrad responded.
About six months later, VCU Health and Capital City Partners came to the realization that construction costs had risen and there was no market for that kind of office tower. The deal wouldn’t work.