Public-private partnerships are here to stay, certainly for revenue generating facilities like student housing, but also beyond as some of the larger transactions (University of Kansas and UC Merced) have demonstrated over the last couple of years. While outsourcing appears to be an efficient way to deliver facilities, many institutions struggle with challenges that often surface after a project’s completion. One way to avoid disappointments is to evaluate each project early in the process with an emphasis on risk transfer opportunities. Construction projects can be very complicated and carry many potential risks. However, most of the risks will fall into three broad categories:
- Project delivery
- Long-term asset ownership
While the financial risks are extremely important, too often they are analyzed in isolation from other aspects of a transaction. For many institutions, balance sheet utilization and credit rating drive the key project decisions. In most cases, it is difficult to argue with hard facts – weak balance sheets or concerns about credit rating will trump other issues. With respect to the balance sheet, the totality of all key decisions related to the project have to allow the host institution to keep the project at a safe arm’s length. This will require careful planning as any meaningful ties to the project may make it difficult to keep the asset off the institutional balance sheet. Selecting the appropriate transaction structure will also be important. In addition, each transaction will always have an impact on the institution’s credit. Again, good planning and positioning of the new asset will help to assure that the impact is neutral or in many cases, even positive.
Housing projects have to be delivered on time and on budget. It is, however, critical to remember that in order to meet these conditions, many difficult decisions have to be made efficiently. From the early programming stages in which the long-term viability of the product is established, through the selection of building systems and finishes, difficult choices will be made. Ideally, a broad consensus is established around these choices by people with diverse expertise on the client side.
The third component of risk evaluation is the long-term ownership of the asset. Many institutions struggle with this element as they view themselves as the ultimate owners of the building and try to retain control of many operational aspects. This should come as no surprise to the private sector as universities and colleges generally try to avoid anything that may compromise their reputation. A damaged reputation may cause significant strategic problems related to, for example, recruitment and retention of students, therefore undermining the very purpose of the institutions’ existence.
Evaluation of the project risks and transfer opportunities is key to longevity of any P3 transition. Here are a few ideas on how to conduct the process. First of all, right people have to be at the table on the institution’s side. While the P3 projects are often driven by the CFO, it is critical to engage residential life and facilities design and operations as well. There has to be a comprehensive consensus around all key project decisions.
Secondly, due diligence is very important. Many aspects of a transaction can be modeled early, before key decisions are made. Conversations with auditors and financial advisors will shed light on the balance sheet and credit rating issues. Furthermore, institutions should be crystal clear in defining their priorities as they relate to ground lease, program, construction quality and operations.
The expectations have to be realistic – asking the private sector to solve an unsolvable problem will not work. Again, early modeling can define relationships among key project variables and inform internal prioritization. In addition, institutions should maintain consistency in communicating their priorities to the market. From the early stages of procurement through the final steps of agreement negotiations, consistency will help select the right transaction in an efficient manner.
Thirdly, in addition to looking for a transaction, institutions should look for a private-sector partner. Reviewing qualifications and checking references, or perhaps even engaging developers in market sounding is very important and relatively inexpensive. The partner has to be a right “cultural” fit for the institution. With a growing number of private sector entities entering the world of on-campus P3’s, getting to know the key players on the project team, the developer and investor in particular, will become even more important.
To summarize, there will always exists a conflict between a profit-driven private-sector entity and a mission-driven public institution concerned about its long-term reputational risk. The art of putting together a successful public-private partnership is all about the management of that conflict. From the institutional perspective, this process should start with establishing realistic priorities by key stakeholders, communicating those priorities to the market and selecting the right partner. The private sector should focus on a comprehensive understanding of those priorities and pursuing projects in which goals can be achieved given the market conditions and investor expectations.
Greg Wachalski is a founder and principal of Wachalski Advisory, a consulting practice which focuses on real estate strategies for higher education clients. He is a recognized expert in building types including student housing, faculty/staff housing, retail, recreation, student unions and other components of campus infrastructure. For more information visit www.wachalski.com or email Greg at [email protected]