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Facilities Funding Thaws

Frozen capital markets had a chilling effect on new construction in 2009. But, some resources are still flowing, with developer-financed housing projects, bundled mixed-use facilities, and other creative deals on the rise.

By Roger Bruszewski, Sam Jung, and Jeffrey Turner

*Higher education leaders are still sorting out all the implications of the financial meltdown that led to the bankruptcy or consolidation of some of the country's most recognized financial firms. More than a year after these events, however, one thing is clear: The development and financing strategies for future campus projects have changed dramatically. For many colleges and universities, public-private partnerships (PPPs) were suitable development options because the traditional methods of financing projects (with state support, private donations, tuition increases, and so forth) were largely unavailable or tapped out. But key questions remain: Has the recent economic chaos made PPP ventures more or less attractive? And what other funding variations or options might be available?

Historical Perspective

With National Center for Education Statistic's data revealing enrollment growth of approximately 33 percent from 1993 to 2009, colleges and universities have relied more heavily on private industry to fill their needs for additional facilities. Nowhere is this more apparent than in the growth of privatized student housing, which has become a strong and growing industry across the country. Since starting with Allen & O'Hara's student-focused projects in the 1960s, the model transformed from the early 1990s to include privatized on-campus housing, executed most notably by the erstwhile Century Development Corp. (now known as Campus Living Villages).

The privatized market has matured with the effective launch of initial public offerings of American Campus Communities, Education Realty Trust, and GMH Communities Trust (the student housing division of which was sold to American Campus Communities). The combined valuation of American Campus Communities and Education Realty Trust is now approximately $2 billion. In addition, the private housing market continues to represent a significant force in the higher education market as indicated by George K. Baum & Co., which reported nearly $5 billion worth of nonrecourse bond transactions from 2000 to 2008. The success of the early projects and initial public offerings, along with large transaction values, legitimized the industry and provided financial credibility to the near-campus housing niche, thus increasing the ease of obtaining capital and lowering the financial barriers for many would-be competitors.

With institutions finding themselves in constrained financial positions, PPPs provided a very viable alternative. As Mark Schundler, senior director of investments at Campus Apartments, states, “As colleges and universities have seen endowments decline and state funding dry up, there's even more of an emphasis on preserving debt capacity. It is highly unusual for institutions to fund student housing projects by issuing general revenue bonds.” Over the years, these PPPs have evolved to meet the economic and development parameters of their institutional clients, offering a range of services and financial arrangements from traditional ground leases to joint-ownership transactions.

The PPP market has evolved over the past 15 years to offer 100 percent nonrecourse, stand-alone tax-exempt financings. For example, the University of Central Oklahoma, Edmond, developed one of the first investment-grade housing projects, setting a precedent for acquiring independent credit ratings for student housing-related PPPs. As more developers participated in these tax-exempt deals, the 501(c)(3) foundation model became the method of choice. This approach allows the developer to work through the university's existing foundation, a newly developed university-affiliated foundation, or a collaboration with an unaffiliated national foundation that partners with institutions.

While the foundation model has evolved to conform with the Internal Revenue Service's more stringent rulings, it continues to maintain its popularity because of its ability to maintain a low cost of capital while bringing in important private sector development expertise. Many of the Pennsylvania State System of Higher Education (PASSHE) schools have continued to utilize this approach.

Historically, colleges and universities benefited from PPPs in several important ways:

  • By using the private sector's efficient development and management methodologies to construct properties faster and less expensively than institutions were able to do themselves.
  • By bringing a desired asset on line without adding institutional overhead, such as additional full-time employees or increased operating expenses.
  • By treating the development as an off-credit, off-balance sheet transaction that preserved institutional borrowing capacity and balance sheet integrity.
Over the past several years, however, the off-credit, off-balance sheet transactions have come under considerable scrutiny from lenders, rating agencies, and accounting standards boards because of the direct or indirect ties between the project and institution. Over time developers and universities learned that a project can meet the qualifications to be off-balance sheet and still be included in an institution's debt profile. These initial on-campus project financings were completed without any developer equity and as 100 percent “project-based” debt. Typically, a not-for-profit entity owned the improvements (subject to a ground lease) and the developer was paid a fee to complete the project. The capital markets determined that because of the absence of equity, the high loan-to-value ratio, the project-based nature of the debt, and the lack of any meaningful developer commitment to the project, an institution was the only logical backstop in the event of trouble. “This 'moral obligation' resulted in potentially negative implications for an institution's debt capacity,” states Bill Bayless, president and chief executive officer at American Campus Communities. Hence, the move to developer-equity arrangements, which will be discussed in detail later in this article.

Arizona State University, Tempe, partnered with American Campus Communities to complete Vista Del Sol, a 1,866-bed resort-style apartment community complete with fitness center. (Photo credit: American Campus Communities)

Arizona State University, Tempe, partnered with American Campus Communities to complete Vista Del Sol, a 1,866-bed resort-style apartment community complete with fitness center. (Photo credit: American Campus Communities)

Clearly, the way the PPP relationship is interpreted can have a dramatic influence on the project's and institution's debt capacities or credit ratings; however, in many cases an increase in debt load does not necessarily mean a negative credit impact. For schools where the shortage of on-campus housing is mission critical, the reverse may be the case. The PASSHE system is a perfect example. Despite hundreds of millions of dollars of additional issued debt for privatized housing, Moody's has upgraded the system's rating, stating a stable outlook based on modest enrollment and revenue growth. The new privatized housing at many of the PASSHE institutions has played a significant role in the overall demand equation, making these schools more popular among many of their cross-applicant institutions. 

On Thin Ice

Unlike the last major recession in the early 1980s, this economic downturn hit colleges and universities particularly hard. Not only are state contributions to higher education down significantly, but the overall economic turmoil caused many schools to experience double-digit declines in their endowments or the need to borrow money or convert liquid assets to cash in order to maintain operational stability. The economy also forced the cancellation or postponement of major capital projects, including the highly publicized $1 billion Allston Initiative at Harvard University, Cambridge, Massachusetts. Under its new financial realities, Harvard is considering scaling down or delaying development of the 589,000-square-foot science complex.

Evaluating the Viability of PPPs

When urgency to deliver a project is low and your institution has excellent operating and financing capabilities, it is wise to evaluate the overall vision of the asset to determine its proper delivery method. However, when urgency to deliver a project is high but your institution suffers from limited operational capabilities, you might consider the public-private partnership (PPP) approach.(See table, “Decision Quadrant for Considering PPPs.”)

In addition to more general considerations, you'll need to consider some specific issues when evaluating whether a PPP is right for your institution. Here are some points to consider:

Transfer of risk. The structure of your PPP deal can affect four types of risks associated with any development project: revenue risk, financing risk, capital cost risk, and operating cost risk. Identifying the obligations of all parties in terms of project delivery, financing, and operations can secure the net benefit that this approach provides your university.

Project control. The level of control your university wants over both the construction and management of a project is a major factor in the PPP decision. Obviously, as other partners are brought into the project, your college's or university's ability to control all factors will decrease. As partners become increasingly involved, pay special attention to several areas of possible conflict, including:

  • The amount of nonrevenue spaces included (for example, student program space).
  • The types of units to be built.
  • The types and quality of materials used.
  • Operating policies.
  • Maintenance and capital reserve requirements.
  • Rent levels.

Project timeline. The time required to plan and develop a project will likely be different under a PPP approach. Private entities can usually develop the project faster than institutions working with initiatives that require state funding and oversight. Working with a private industry partner can result in cost savings because of the following:

  • The state's contracting and procurement procedures often are cumbersome.
  • State design requirements and reviews may add significant time and costs to the project.

Construction quality. A primary drawback to private development is the institution's loss of a high level of control over the design and construction process. While developers can generally build at a lower cost than institutions, some, but not all, of the cost reduction has to do with residential versus institutional construction quality. On one hand, “stick-built” construction will not last as long as a steel or block building, and will most likely require more ongoing maintenance expenditures. On the other hand, when weighing material selection and construction quality for new facilities, particularly housing, be mindful that institutional quality construction often outlasts student preferences. In other cases, the project cost is simply cheaper, not due to the construction quality, but because of more flexibility given to the private entity, which can often remove many levels of bureaucratic review and other onerous campus or state requirements.

Meltdown modifies funding choices. At press time, the capital markets were performing better than in early 2009 but are still under significant stress. Wider credit spreads, fewer institutional lenders, tighter lending requirements, and fewer bond insurers have created major obstacles for would-be borrowers. During the height of the crisis, the spreads between investment-grade, high-quality credit and lower, more speculative credit widened considerably, resulting in higher borrowing costs for most non-AAA-rated entities. Projects that had once seemed financially feasible were suddenly unaffordable. Says Michael Baird, director of RBC Capital Markets Housing Finance Group, “For many of the current projects to work financially, interest rates need to stay below the 6 percent mark; and, unfortunately, they are not quite there yet.” Because of this increased cost of capital, many 2009 PPP projects delayed construction or reverted back to institutional-led financing. For instance, East Stroudsburg University, East Stroudsburg, Pennsylvania, delayed construction on its student housing project to work through the financial turmoil. Other schools such as Oregon State University, Corvallis, cancelled developer-led request-for-proposal projects in favor of doing the projects themselves.

Stimulus provides some solid ground. The American Recovery and Reinvestment Act of 2009 (Stimulus Act) is part of the reason why some institutions are reverting back to traditional institutional borrowing. This act has made it more attractive for universities or their affiliates to issue debt directly. While many of the programs are set to expire in 2010, some institutions have taken advantage of Build America Bonds and bank-qualified loans. Build America Bonds are taxable government bonds that offer federal subsidies (tax credits) equal to 35 percent of total coupon value with no borrowing limit. The bank-qualified loans provide lower interest rates with no underwriting fees, no offering documents, and reduced cost of insurance. The tax benefit from bank-qualified loans goes to the issuing bank, with the maximum loan amount being $30 million.

While other development projects were being stalled, the University of West Florida, Pensacola, along with its foundation, was one of the first higher education institutions to obtain stimulus funding options for its new student housing project. The institution was able to obtain a 20-year bank-qualified loan at just over a 5 percent interest rate for its 250-bed project, currently under construction and set to open in fall 2010. The timeline was critical because the school experienced an 8 percent increase in its fall 2009 enrollment—and it was able to take advantage of a very attractive construction market.

Bonds on hold. One key player in the growth of the student housing PPP industry was the bond insurer, who insured investors against default by the bond issuers. The credit crisis has thinned out this market considerably, and only one highly-rated provider remains in Assured Guaranty Ltd.

While this exodus may be only temporary, the long-term impact on accessing capital for student housing projects through alternative financing options is not known at this time. The consolidation of the insurance industry and fall of the financial market have made it challenging to obtain credit and, in particular, letters of credit needed to close the development deals. Schundler states, “It is much more difficult to get bond financing; bond investors are looking for university guarantees and involvement. The rating agencies, however, are keeping a close eye on this, and university involvement can adversely affect a project's impact on university debt capacity. The greater the university involvement, the less the project is considered an 'arm's length' transaction by the rating agencies.” Clearly, yesterday's 100 percent debt-financed, nonrecourse deals are much more difficult to execute in today's environment.

Typical of community colleges wanting to enrich the student experience by improving auxiliary facilities, Finger Lakes Community College, New York, developed on-campus student housing in partnership with the United Group of Companies. (Photo credit: United Group)

Typical of community colleges wanting to enrich the student experience by improving auxiliary facilities, Finger Lakes Community College, New York, developed on-campus student housing in partnership with the United Group of Companies. (Photo credit: United Group)

PPPs Begin to Break Through

To continue to move projects forward as well as to attempt to reduce the risk of affecting the institutional partner's balance sheet, several developers are now offering their own equity to meet the funding gap. This private equity model can range from a partial financial contribution to full funding of the project. According to a recent report, Moody's “Global U.S. Public Finance—Impact of Student Loan Market Turmoil on U.S. Higher Education” (June 2008), “We have begun to see newer, revised models for student housing projects that involve a private partner using some form of its own equity. ... We believe that the unique circumstances of each university, project, and financial arrangement warrant individual review in determining the associated credit impact.”

PPPs continue to offer and expand their menu of services, ranging from split operations, shared revenues, and development of campus facilities that are flexible to the institutional client's needs. These deals are no longer synonymous with just student housing, but include other revenue-generating facilities such as parking garages, research parks, retirement communities, sports facilities, campus-edge developments, retail stores, renewable energy projects, and recreation centers. Other projects have included the local municipality, which can add land or tax relief into the mix, making it a true public-public-private partnership.

In addition, PPPs may be used as a monetization strategy that provides institutions with substantial cash infusions, improved balance sheet performance, or a needed campus asset. A few recent examples demonstrate funding relationships available right before and immediately after the economic crisis. They include the following:

  • New York's Rochester Institute of Technology mixed-use community. Because of the institute's distance from downtown, its leadership worked with Wilmorite, a Rochester real estate development and management company, to develop a dynamic college-town community on campus called “Park Point at RIT.” The $85 million project was completed in 2008 on a 67-acre site on the north edge of campus. The land was purchased from RIT for $2.4 million; the school maintains a preset buyback option after 40 years. RIT holds a right of first refusal clause should Wilmorite choose to sell the project prior to the 40-year term.

    After entering into this agreement with RIT, Wilmorite developed 925 beds and approximately 60,000 square feet of retail. RIT's only commitment to the project is the 40,000 square feet of space it leases from Wilmorite for Barnes & Noble's operation. Park Point includes New York State's first Barnes & Noble Academic Superstore, along with a bank, salon and spa, fitness center, cellular phone store, music bistro, clothing store, sports bar, and multiple restaurants. The project opened at 100 percent occupancy and is maintaining that level into its second year of operation.

    Because of Rochester Institute of Technology’s distance from downtown, its leadership worked with developer Wilmorite to develop Park Point at RIT, an $85 million college-town community on campus. (Photo credit: Wilmorite)

    Because of Rochester Institute of Technology's distance from downtown, its leadership worked with developer Wilmorite to develop Park Point at RIT, an $85 million college-town community on campus. (Photo credit: Wilmorite)
  • Marshall University student facilities. In conjunction with Mustard Seed Housing and Capstone Companies, Marshall University, Huntington, West Virginia, expanded its wellness and housing facilities available to students. The development consists of a 784-bed residence hall and a 123,000-square-foot wellness center. Both projects were financed through a single financing inclusive of $90 million of nonrecourse tax-exempt bonds. The project financing was structured to preserve Marshall University's remaining debt capacity for other upcoming capital projects. Two separate third-party management firms, Capstone On-Campus Management along with Centers LLC, oversee the operations of the housing community and wellness center, respectively.
  • Arizona State University (ASU) housing and mixed-use projects. Faced with the pressure of exponential enrollment growth, Arizona State University worked with the city of Phoenix to create a new downtown Phoenix campus. As part of the campus development, Capstone began construction in 2007 on a two-phased, mixed-use student housing development. Completed in early 2009, the project houses approximately 1,300 students as well as ground-floor retail and open public spaces in the heart of the downtown campus.

    The project relied heavily on the collaboration among partners. Capstone initially purchased private property and contributed it to the city of Phoenix, which combined all of the parcels into a single developable lot and leased the property to ASU. The university subsequently subleased the development parcel to the developer, which worked with a local nonprofit, Community Finance Corp., to develop the two housing towers. The development was an integral part of the city's redevelopment plan and provides the downtown with a previously absent 24-hour population and a vibrant mixed-used and sustainable development.

    As part of the 40-year ground lease–sublease, the project will pay the city an annual payment from surplus cash flow until the project ground lease runs out and all land and improvements revert to ASU. While other development in downtown has stalled because of current economic conditions in the greater Phoenix area and beyond, the downtown campus and this housing project have served the redevelopment plans of Phoenix well and continue to be an attractive draw for ASU students and a benefit to the overall downtown environment. 
  • Private equity housing and mixed-use projects at Arizona State University, Tempe. Within one year of completing another project on ASU's campus—Vista Del Sol, a 1,866-bed resort-style apartment community—American Campus Communities opened its doors to the university's Barrett Honors College last fall. The brand-new community consists of 1,721 beds, a dining facility, cafe, fitness center, business center, game room, amphitheater, outdoor activity courts, faculty and staff offices, and classrooms. Both projects were funded by the company's American Campus Equity program.

    The equity program is based on the equity investment and ownership of on-campus housing via traditional long-term ground leases, by which the university can modernize its housing offerings while minimizing the impact to its debt capacity. A combination of company equity and debt generally results in 25 to 50 percent of the total project cost being financed with company equity. Such an arrangement has the following benefits: (1) ACC's direct ownership of the project and large equity position positively influence the way the rating agencies view the transaction from a credit perspective; (2) the company is fully vested in the project's long-term success; (3) up-front fees are waived, with financial return earned through long-term cash flows and ownership benefits; and (4) the developer's ability to fund significant predevelopment expenses creates efficiencies that lead to expedited timeline and project delivery.
  • Green initiatives at Montclair State University, Upper Montclair, New Jersey. The state of New Jersey recently passed new legislation to allow public-private partnerships to form on New Jersey campuses. The first project is slated for Montclair State University's energy plant and infrastructure replacement that provides significant savings in energy costs and aligns the university with New Jersey's green initiatives. The project is estimated to cost $64 million. Separate from the green initiatives are housing, dining, parking, and academic facilities also in the pipeline for PPPs that may be completed in advance of the green projects.
  • Bucknell University, Lewisburg, Pennsylvania, retail consolidation. The university sought to relocate its campus bookstore to a downtown location to expand operations and strengthen the fragile local retail market. Ultimately, the university reduced the projected $9.5 million development cost by more than 80 percent through use of public economic development subsidies, including grants, low-interest loans, new market tax credits, and historical tax credits. The privately developed bookstore is currently under construction and is expected to open next fall.
  • Community colleges. With enrollments at these institutions up by more than 20 percent since 2007, many community colleges are feeling the increased demand on their facilities. Additionally, many community colleges want to enrich the student experience on campus by improving auxiliary facilities. According to the American Association of Community Colleges, more than 300 community colleges (25 percent) are offering student housing.

New residence halls, recreation centers, and student unions also are often desired, but difficult to finance given state rules, limited state or district funding, and institutional borrowing capacity. PPPs can provide a viable option. For example, Niagara County and Finger Lakes community colleges in New York have recently developed on-campus student housing in partnership with the United Group of Companies, which also manages the property through its United Realty Management Corp. Both apartment communities offer the same amenity—rich, student-focused housing found in traditional four-year institutions.

Adapting to the Times

Due to the changes in the financial market, funding options that worked only a few years ago are simply not possible in today's environment. But, the freeze in some funding areas has created new, unique development structures that allow for freer flow of dollars that make such projects attractive and beneficial to institutions.

Despite these changes, it is clear that institutions will continue to rely on the private sector to meet some of their important capital project needs. While private partners have also been affected by the downturn in the economy, they remain committed to working with institutions that must move their mission-critical projects forward both effectively and efficiently. The ingenuity of the private sector will continue to help colleges grow and adapt to changes in the higher education marketplace for years to come.

“While the economic situation since the fall of 2008 has seriously hindered the planning for many mission-critical projects,” says David Surgala, vice president for finance and administration at Bucknell University, “ultimately developing the right plan with the right private and government partners gave us the much-needed flexibility and menu of funding options to complete key initiatives.”

ROGER BRUSZEWSKI is vice president of finance, Millersville University, Millersville, Pennsylvania; SAM JUNG is project analyst and JEFFREY TURNER is senior vice president, Brailsford & Dunlavey, Washington, D.C.