Perspectives on Real Estate Newsletter - Summer 2011 (PDF-3297kb)
Bringing Entrepreneurship to Public Projects: An Interview with Edgemoor Real Estate Services
The Federal Low-Income Housing Tax Credit Program: 25 Years of Public-Private Partnerships
Keeping the Government Accountable: Enforcing Contracts With “Non-Appropriated Fund Instrumentalities” Is Now Easier
Social Infrastructure Public-Private Partnerships-Helping Government Overcome Budget Constraints to Deliver Public Services
Perspectives on Real Estate Newsletter - Summer 2011
Federal, state, and local governments increasingly are using public-private partnerships (PPPs) to facilitate the construction of major infrastructure projects. Such PPP projects include toll roads, bridges, mass transit, ports and other large-scale projects. Across the United States, state and local governments are grappling with fiscal difficulties as a result of the combined effect of the economic downturn and longer-term structural budget pressures from rising pension and healthcare commitments. These fiscal difficulties are affecting the largest of state economies, as well as the smallest of municipalities’ budgets.
Amidst these difficulties, governments are trying to identify ways to fund their essential social infrastructure—schools, libraries, courthouses, public healthcare facilities, parks, roads, water and sewer systems—that enable their communities to thrive. This challenge is compounded by governments’ reduced expectations of resources being available and allocated to fund their social infrastructure on a sustainable basis, now and for the foreseeable future.
Governmental entities partnering with private enterprises in order to deliver public facilities and infrastructure is not a new phenomenon. However, until recently, U.S. governments have not embraced the use of long-term public-private partnerships as a means to finance, construct and operate social infrastructure projects, although PPPs are commonly used in other countries.
In the U.S., federal agencies, including the General Services Administration, the Department of Veterans Affairs and the Department of Defense, have experience in partnering with private enterprises to deliver facilities, such as government offices, court buildings, public healthcare facilities, prisons, military housing and other major projects, through a variety of procurement approaches and deal structures. State and local tiers of governments, including states, counties and cities, also have used similar procurement approaches for the delivery of their social infrastructure, such as schools, college campuses and public sports/recreational facilities.
Although broadly termed “public-private partnerships,” these experiences for the most part have not included the use of long-term public-private partnerships as commonly used in other countries, such as Canada, Europe and Australia. In these countries, the terms “P3” or “PPP” have a more narrowly defined meaning.
In this context, PPPs have the following fundamental characteristics:
- The use of long-term contracts for the delivery of services by a private partner that include design, construction, operations and maintenance, using project finance techniques.
- The retention of ownership and ultimate control of the asset by the public partner whereby it retains only those risks that it is best positioned to manage, such as land acquisition and force majeure events.
- The making of performance-linked payments by the public partner to the private partner in exchange for the services delivered by the private partner.
- The acceptance of the risks and opportunities associated with cost, schedule and level of service performance that are transferred to the private sector by the providers of the private capital used to finance these PPPs.
Properly structured and executed PPPs are a tool that state and local governments can use to finance, construct and operate their infrastructure projects. The benefits of these PPPs for the public sector include:
- A more cost-effective delivery, by transferring most construction cost and schedule risks to the private partner, who is best positioned to manage those risks and who can optimize design with life-cycle maintenance costs.
- Dedicated funding for the PPP project that is not subject to short-term, political decision-making or diversion of funding to other non-essential assets, which in turn results in:
- A higher level of service for the users during operations; and
- Adequate funding and management to prevent premature deterioration and cost overruns for replacement and refurbishment.
- An additional financing and procurement option that can be supplementary to traditional pay-as-you-go and municipal financing methods.
Project Spotlight: ARUP and the Long Beach Courthouse
ARUP has an extensive history of planning, designing and engineering complex PPP infrastructure and building projects and in structuring, analyzing and leading through procurement PPP deal structures for these projects. The firm’s project experience ranges from providing financial and technical advice to the local transportation agency delivering California’s Presidio Parkway PPP project to supporting the developer of a large PPP sports and entertainment complex in Singapore. A recent PPP project success story is the Long Beach Courthouse in the City of Long Beach, California, in which ARUP advised the equity and debt investors.
About the Project
Built in 1959, the existing Long Beach courthouse is a functionally deficient facility that suffers from overcrowding, failing internal systems, structural problems and obsolete security systems. The Long Beach courthouse is the busiest in the California judicial system and one of the busiest in the United States, averaging 109,000 visitors, 385 felony filings and 3,300 misdemeanor filings per month.
The new Long Beach courthouse building will be approximately 500,000 square feet, and it will house 31 courtrooms. The courts will occupy roughly three-fourths of the overall space, and the rest of the space will be used for offices of county justice agencies and for commercial office and retail space that is compatible with courthouse uses.
The Long Beach courthouse project represents the first project in California, and possibly in the U.S., for which a local court system will use a long-term, project financed PPP delivery arrangement. This arrangement leverages the private sector’s access to financing, technological expertise, management efficiency and a financially incentivized business approach to provide a high-quality facility that will serve the needs of the Superior Court of Los Angeles County and enhance the public’s access to the justice system.
Key Aspects of the Transaction
This project, which reached financial close in December 2010, is the first social infrastructure PPP project in California to employ the traditional means of PPP procurement as described above and frequently used in other countries.
For this PPP project, the basic deal structure is as follows:
A consortium of private partners, referred to as the “private-sector consortium,” will design, build and then maintain the facility for 35 years. To finance the initial development costs, design and construction, the private sector consortium at financial close put in place a project-financing package consisting of long-term equity (10%) and debt (90%), with a total investment of just under $500 million. In exchange for these services, the private-sector consortium will be paid an annual service fee by California’s Administrative Office of the Courts (AOC), which owns the land and the building, with such payments starting only upon completion of construction to the AOC’s satisfaction. The service fee was contractually fixed at the time of financial close and has a mortgage-like payment profile over the 35-year operations period, plus an inflation indexation. At the end of that 35-year period, the private-sector consortium will hand back the facility to the AOC in good physical condition, as specified in the PPP long-term contract.
The service fee payments are linked to specific availability and performance milestones, which involve specified response times and potential payment deductions if requirements are not met. The most important milestone is the availability of fully functioning courtrooms for their intended use each day of the year. There also are a range of other maintenance and operational performance indicators, such as measurable targets for energy efficiency, which, if not met, may trigger deductions in the service fee payments.
This arrangement gives the private sector a great incentive to complete the construction of the project on time and on budget, so that the service fee payments start as scheduled, and then to operate and maintain the project in good condition to avoid potential deductions in payment.
The Long Beach PPP Team
This private-sector consortium is led by Meridiam Infrastructure (Meridiam), a New York-based firm that has built a business focused on investment in public–private infrastructure projects and has a team of professionals from across the world with extensive experience in PPP investment, engineering, industrial strategy, asset management and financial sector services. Meridiam also is the equity investor in the deal.
The private-sector consortium in turn is contracting for the design and construction of the courthouse with a team led by Edgemoor Real Estate Services, an affiliate of Clark Construction Group, LLC, and for the facilities maintenance with a team led by Johnson Controls.
A syndicate of six banks with extensive project finance experience provided the debt package to complete the financing.
A PPP procurement contains private sector risks within the project finance structure, with the only source of repayment being the project cash-flow that is contingent upon delivery of a properly constructed and maintained facility. The security is the 35-year PPP contract, there being no ownership interest in the land or the building. Therefore, both the equity and debt investors have an overriding need to identify risks up front, and then to manage, mitigate or transfer them.
As such, PPP procurement requires experienced investors and advisors that are familiar with the contractual requirements, the project’s technical and commercial fundamentals and the financial structure used to address these issues.
Furthermore, the current challenging economic environment has amplified the need to conduct a rigorous analysis of the financial and delivery risks associated with any PPP project. To fill this critical role in the LB courthouse project, Meridiam appointed ARUP as the Lender’s Technical Advisor (LTA).
ARUP’s role as LTA was to identify and evaluate project risks, their allocation, and mitigation strategies from a technical and commercial perspective.
A First for California, but Not the Last
“This is a first in the state of California for a project of this magnitude,” said Long Beach Mayor Bob Foster in an announcement published by the city. “Long Beach has found a unique and creative way to maximize our local dollars and enter into a public-private partnership that will result in a new courthouse for our city.”
With a PPP procurement for this large and complex project, California’s AOC is achieving a series of important benefits that can provide a model for other state and local agencies around the country, including:
- Earlier completion—the AOC estimates that the project will be completed 30 months earlier than a traditional segregated procurement.
- Lower cost—as a direct benefit of earlier completion, the construction bid was more than 15% below AOC’s estimates.
- Integrated procurement—ensures that the design and maintenance proposals are optimized with each other, therefore reducing life-cycle costs.
- Fully funded maintenance—because all payments to the consortium are the AOC’s contractual obligation and they are directly linked to potential performance deductions, occupants and visitors to the courthouse will enjoy a well-maintained and high-quality building for the next 35 years.
Although the LB courthouse project is California’s first PPP social infrastructure project, the state’s needs for ongoing investment and more cost-effective delivery of its essential social infrastructure nearly assures that this will not be California’s last. Indeed, the project’s success is a new template for governments throughout the state and possibly the country into using PPPs for social infrastructure.
Pillsbury and ARUP have worked as co-advisors for infrastructure clients on legal, engineering and business aspects of their complex projects. Ignacio Barandiaran is a Principal with ARUP, an international and independent firm of project finance advisors, transaction specialists, planners, and engineers offering a broad range of professional services. He is based in San Francisco and can be reached at 415.946.0202 or email@example.com.
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