Tapping Partnership Potential
When you have the need for speed or specialized expertise, consider an approach that adds private-sector players to your team.
By Sandra R. Sabo
“It’s a major facility, in the $50 million to $60 million range, and it was built on time,” says Maurice Scherrens, GMU’s chief financial officer and senior vice president. “Because of all the hoops to jump through at the state level, we would have missed a year on getting that housing if we hadn’t done the partnership.”
GMU isn’t alone in turning to the privatized student-housing model. In fact, according to estimates by George K. Baum & Co., an investment banking firm that underwrites such projects, more than 200 higher education institutions have added beds for nearly 114,000 students through nonrecourse arrangements since 1995, totaling approximately $5.2 billion in financing.
“The privatized model has been popular because it allows institutions to move expeditiously,” explains Lee White, executive vice president and manager of the company’s Higher Education Finance Group, based in Denver. “Typically, in the nonrecourse model, you can go from hiring a developer, negotiating a deal, and opening the doors within 18 months, where it might take you three or five years to do the same using internal bonding and construction procedures.”
Worth noting is that in this era of growing popularity for pursuing public-private initiatives, similar public-public partnerships are likewise emerging. For instance, more state universities and community colleges are collaborating with city or state municipalities or public agencies to accomplish projects beneficial to both. The point is this: Even when speed isn’t of the essence, partnering with the private sector or a public entity often enables an institution to undertake a project that would otherwise remain on the “wouldn’t it be nice” list.
Cuisine and Caffeine
Several years ago, the University of South Carolina (USC), Columbia, completed a deferred maintenance audit of all its foodservice facilities. The bottom line was that renovating and expanding the somewhat antiquated kitchen and dining facilities would require a major investment to increase functionality and to meet student expectations.
“The university had so many needs more critical to our mission that we couldn’t justify making those investments in dining over investing in academic and research facilities,” recalls Helen Zeigler, USC’s director of business. “The only way to get a major infusion of capital for renovation and expansion, without detracting from other building needs, was to let the private sector do it.”
In 2002, the university signed a 15-year foodservice contract with Sodexho, which included modernizing dining facilities. This past August, only a year after signing a 15-year agreement with Barnes & Noble College Booksellers, USC opened the doors to its new bookstore in which a Starbucks café resides.
Zeigler notes, “Given all of our other needs, the university couldn’t have come up with $1.5 million just to have gourmet coffee in the bookstore—but Barnes & Noble made that investment.” If the university terminates the contract early, it must pay the company for the unamortized investment.
Who Does It Better?
USC had previously outsourced its foodservice and bookstore functions, so entering into public-private partnerships to renovate and build facilities seemed like the next logical step. “You come to a point where you need to revisit your business model. Where does it make sense to have an external partner who can do something better?” asks Robert Fernandez, manager of university business in Canada for Johnson Controls, Inc., Milwaukee. “Once you realize that someone else can better manage a particular risk or control a specific cost, partnerships become a natural outcome.”
Public-private partnerships go beyond simple outsourcing. They encompass long-term, complex business relationships that are intended to transfer an institution’s risk of financing, building, owning, maintaining, and managing a facility to partners who engage in those activities as their core businesses. At the center is this goal: to free the institution from the full responsibility for a project so it can focus on its core mandate to educate students.
To be sure, such partnerships represent a trade-off between risk and equity for the parties involved. The more risk an institution is willing to assume, the more equity it may realize. If the developer takes on more of the risk, it usually reaps more of the immediate direct financial benefits. Seldom are these deals without any risk to the institution. Similarly, at least some of the many potential benefits will accrue to the institution.
Diane Hartley, vice president and managing director of Clark Education, Bethesda, Maryland, sees the trend toward these partnerships accelerating as educational institutions seek to establish and maintain their competitive edge in attracting students, faculty, research funding, and alumni dollars. Top-quality facilities are a big draw, but they often require skills not well-represented in administrative offices, such as specialized expertise in project design, delivery, and management.
Financing may be part of the partnership package, too, especially as public funding shrinks and more private donors restrict how their contributions may be used. “Having a private partner standing at the ready to fill the financing role is sometimes what an institution needs to get a project moving forward, even if it ultimately does most of its own financing,” observes Hartley.
Projects in need of such a jump-start are good candidates for a public-private partnership, especially if they have parallels in the private marketplace or have usage fees attached. In addition to dormitories and dining halls, think parking garages, research laboratories, sports facilities, mixed-use community developments, and hotel and conference centers.
Any type of program or activity that has an identifiable cash flow lends itself well to a public-private partnership, says Eric Gelb, chief executive officer of Gateway Financial Advisors, LLC, a real estate finance firm located in Armonk, New York. Gelb, for example, is working with one college that needs a new stadium but is not currently in the financial position to make such a large investment. The college plans to defray the construction costs by entering a partnership with one or more professional sports teams. In this case, the college would own the stadium and be one of its tenants; the other teams would pay rent to use the stadium and generate other revenues as well.
Sometimes, says Gelb, the educational institution or its foundation owns only the land on which a project is built. It leases the land to a private developer who, with the institution’s input, designs, constructs, and manages the building. At the end of the contract’s term, or after the developer has received an agreed-upon rate of return, full ownership of the building reverts to the institution. The number of years on the ground lease may extend up to 99 years, depending on the type of building and its anticipated rate of return.
“There is no ‘typical’ arrangement,” emphasizes Hartley. “The terms of these partnerships depend upon what makes sense for a particular institution. The goal is to optimize the allocation of risk to the most appropriate party.”
|Primed for Partnership|
The payoffs of partnering with the private sector can be alluring. Imagine, for instance, that your institution can meet a pressing infrastructure need in the short term without expending funds and still owning the facility in the long run. Before you rush headlong down the public-private partnership road, make sure you have the makings of a successful journey.
High-level commitment. You won’t get far without the support and advocacy of your president and senior leadership, believes John Porcari, vice president for administrative affairs for the University of Maryland. “You need a visionary president who understands why and how to build consensus with all the stakeholders.”
Good financial grades. If your institution is on solid ground with the rating agencies, lenders are more likely to assume it has the credit-worthiness to withstand the risks of partnering with the private sector. “At one time, we thought that the debt or liabilities associated with public-private partnerships would not be seen on the institution’s balance sheet—but, for the most part, the rating services consider that debt anyway,” says Maurice Scherrens, George Mason University’s chief financial officer and senior vice president. “Now, we spend more time developing a solid business plan for each project, one that shows ‘good debt,’ or 120 percent coverage of our debt service, and both short-term and long-term cash-flow adequacy and financial sustainability.”
Realistic expectations. Developers can often design and construct a building faster, cheaper, and more efficiently than an educational institution. With those benefits, however, come the compromises that characterize a true partnership.
“Once you have a partner, you are no longer solely your own boss,” says Eric Gelb, chief executive officer of Gateway Financial Advisors. “If an outside party has plunked down a couple million dollars, it expects to get its money back. Consequently, that party will ask for certain terms and conditions, such as reporting, operating, and accounting requirements.”
“Appreciate the different mind-set that the developer brings to a partnership,” adds Louis Kiang, vice president of Wexford Science & Technology. “Developers face financial penalties if they don’t meet their schedule or budget obligations, and they’re usually the ones with all the risks and rewards of a successful or failed project,” notes Kiang. That’s why developers are disciplined about asking pointed questions, making compromises, and meeting deadlines. For its role in being a good partner, an institution needs to not only understand but also accommodate this for-profit orientation.
The University of Maryland, College Park, showcases the wide range of projects possible through partnering agreements. Through what Vice President for Administrative Affairs John Porcari calls “fairly traditional partnerships,” UM negotiated long-term ground leases with a private firm that built beds for 2,500 students. The university also sold a parcel of land directly to a development firm, which took on 100 percent of the risk associated with designing, financing, constructing, and operating a 16-story high-rise with 900 beds.
The two parties do not have an ongoing financial or legal arrangement, although the developer coordinates its marketing with the university. In turn, UM has linked its shuttle bus service to the privately owned residence hall and helped finance construction of a pedestrian bridge to campus.
About one mile from campus, adjacent to a subway station, the university designated 128 acres as the site for M Square, a new research park. After a public request for proposal (RFP) process, the university selected two developers and a leasing company as its partners in the joint venture.
|A Don’t-Miss Workshop|
Build the framework for your decision-making process as your campus meets increased demands for new and upgraded facilities. At NACUBO’s Public-Private Partnerships for Facilities workshop, April 11-13, 2007, in Atlanta, join fellow business officers, facilities directors, student affairs and student housing directors, and senior residence life administrators to learn how to structure the relationship between partners. Hear from campus leaders and finance experts as they present diverse models and strategies for building effective partnerships. Possible areas of discussion include athletic and recreation facilities, campus retail, conference centers, energy plants, faculty and student housing, parking structures, research labs, and student unions. The program also addresses sustainability.
To register, or for more information on this and other NACUBO professional development programs, visit www.nacubo.org or call 800.462.4916.
“We bring the land to the deal, and they bring the financial capability, track record, and management expertise,” says Porcari. “Part of this undertaking is financial necessity. Like most publicly funded institutions, our funding is relatively flat. But our research program, with $350 million in sponsored research, is the one leg of our financial stool that we can grow.”
M Square’s first project, a 128,000-square-foot building, already has two anchor tenants. One is the Center for the Advanced Study of Languages, a joint venture between the university and the federal government. The other is the National Oceanic and Atmospheric Administration’s center for weather and climate prediction. A second, 120,000-square-foot building under construction will house other entities primarily related to the earth sciences, providing a creative environment for students, faculty, and private researchers alike.
Each lot is set up as a separate partnership, with the university extending a 70-year ground lease to its corporate partners but not investing any other financial resources. The buildings revert to the university at the end of the term. “We selected 70 years because it offered a good balance between the economic life of the project and was finance-able by our partners,” explains Porcari. “Although we have no legal requirement to find tenants, we are actively involved in identifying prospects and putting together research partnerships that will help build our research program,” he continues. “Our partners have a legal requirement to build a certain amount of speculative space. If it doesn’t fill up, they have no further obligations.” By mutual agreement, the university and its partners can change or dissolve the joint venture.
UM has an even more complex partnership in the works for its main campus, which—with 52,000 students, faculty, and staff—qualifies as Maryland’s fifth largest “city.” But this city has no core area. “We’re attracting the best students and faculty from around the world, but we don’t have the amenities and the vibrant retail and entertainment environment that they deserve,” observes Porcari.
The university plans to address this deficit with its ambitious Town Center project. UM will retain ownership of the 38 acres it has earmarked for the project, then enter into long-term leases with developers to bring in a mix of retail, office, residential, entertainment, and perhaps public spaces. As Porcari notes, “The students won’t care who owns and manages a particular building. They will care what it is and how it improves their quality of life.”
Suggestions for Forging Ahead
If you think the private sector might help your institution rein in operational costs or take on certain risks associated with a new or renovated facility, sound out the market, say the experts. Call in a potential partner or two for a what-if session and to figure out whether your institution might be a good candidate for an ongoing partnership (see sidebar, “Primed for Partnership”).
“There are a lot of creative people in the private sector. Use that gray matter,” advises Marv Hounjet, business development director for public-private partnerships at Johnson Controls. Representatives of the company often sit down with a university’s senior administration and several stakeholders for a brainstorming session. Such freewheeling discussions help delineate the boundaries of a potential partnership, says Hounjet.
In these sessions, stakeholders may share their thoughts on which party is best suited to take on a particular risk associated with operating or owning a building. When the party best able to manage and control certain risks has the mandate to do so, a more cost-effective solution will typically result, adds Hounjet.
Here are seven other suggestions offered by parties on both sides of these partnerships.
1. Know what you want. “Do a lot of work up front to define your needs. You don’t want to risk having the private sector have a different idea of what you need,” cautions USC’s Helen Zeigler. For instance, is your main objective to save money now or 20 years down the line? Have you reached your debt capacity but still have a pressing need for a specific facility? Does speed trump all other objectives? Be sure institutional stakeholders at all levels have the same understanding before initiating an RFP and reviewing the responses.
Whatever your objectives, keep them front and center. Officials at UM made a conscious decision to place a lower priority on financial return when evaluating developers’ proposals for its research park. “We decided to emphasize growing our research program, which helps fulfill our mission. The financial return is long term; there is nothing in the short term for us,” says John Porcari.
Once you’ve selected a partner, clearly communicate those objectives along with any key institutional concerns, emphasizes Hartley. “Sometimes, during the negotiating stage, people don’t feel they should be totally honest about how they view downside risks, but you have to engage in those discussions. You have to understand your partner’s weakest moments to be able to mitigate those risks and play to strengths,” says Hartley.
2. Call on colleagues and other experts. At GMU, Scherrens is currently contemplating public-private partnerships to develop faculty and staff housing, a hotel and conference center, and a university-based retirement center. He’s not an expert on any of those areas, but he will find others who are.
“Have a willingness to spend the time, effort, and resources on areas that previously you didn’t think of,” says Scherrens, who often augments the advice of university lawyers with outside counsel. “You create a whole new circle of colleagues to talk to, including developers who don’t have a vested interest in your project but know the business.”
Before getting too far into the contractual process, Zeigler contacts up to a dozen business officers at other institutions to ask for sample contracts and to pick their brains about various companies. She usually adapts one of the sample contracts to better address USC’s particular needs and objectives.
Perhaps because of a previous experience with a private-sector firm that went bankrupt, Zeigler asks the university’s bond counsel to conduct a thorough analysis of a potential partner’s financial stability. Plus, she does extensive reference checking to verify a company’s credentials, find out its track record for meeting performance measurements, and determine how it resolves problems.
“You need to know who these people are who will be coming onto your campus and interacting with your important customers,” notes Zeigler. “Although you know it’s a private company, it becomes the university to most of the campus and the rest of the world. Your identities become intertwined.”
|Considering Private Partners?|
|What public-private or public-public endeavor is your institution entertaining? E-mail firstname.lastname@example.org to share details.|
3. Check for compatibility. While meeting with representatives from the private sector and checking their references, make sure you’re comfortable with the personalities involved. After all, you may be working with these same people for years to come. Also get a feel for the firm’s overall culture and values.
“Look for a company [with the] style and policies [that] mesh with the culture of your campus,” says White. If, for example, you have privatized student housing, determine to what extent the company will adopt your institution’s procedures.
“Will the same rules—such as [for] alcohol—apply in the privatized dorm as in university-owned housing?” posits White. “What about rents? How aggressively will the project owner raise rents and handle collections? And what will the private manager do to ensure students are integrated in the larger residence life in the university?”
4. Develop extensive documentation. For approval from GMU’s governing board, Scherrens prepares an interim agreement for each proposed partnership. This is followed by a comprehensive agreement that spells out every detail of the deal, such as,who does what, by when, how, and for how much. On countless occasions, Scherrens says, he has gone back to a private partner to clarify or change contract language.
Even the best of friends may disagree at times, and the parties in a public-private partnership are no different. Be sure your agreement spells out how you’ll deal with friction within the partnership.
“Stuff happens,” says Gelb. “In addition to laying out your goals and project parameters, describe the framework by which you’ll solve problems. Make sure you have a good mechanism in place to sort out disputes and figure out resolutions.”
You’ll also need a termination clause. Be prepared to pay for a company’s unamortized investment if you end your partnership.
5. Designate one point person. While you will need a dedicated team of stakeholders to champion any partnership internally, taking the team approach to project management is sure to cause confusion. Ask Louis Kiang, vice president of Wexford Science & Technology, LLC, Hanover, Maryland. His firm specializes in developing research facilities and wet laboratories for universities and health-care systems.
“Management by committee never works,” Kiang says bluntly. “When issues come up—and they always do—a committee usually debates the issue almost to the point of paralysis before considering making a decision. So you need a strong, overriding personality to say, ‘We will find a way around this problem.’ ”
In Kiang’s experience, this forceful, determined advocate is often a senior administrator—a dean, chancellor, chief financial officer, or even the president. For day-to-day project oversight, however, he recommends designating one staff member as the developer’s primary contact. “This person should have an understanding of the transaction and its goals. Someone who can anticipate the bureaucracy of the institution—and be able to work around it—is especially invaluable,” notes Kiang.
For instance, GMU added one full-time staff member to work on public-private capital partnerships. She reports to the vice president of facilities and serves as the private sector’s main point of contact. Similarly, UM has a full-time real estate director.
Thanks to the Public Private Education Facilities and Infrastructure Act (PPEA), educational institutions in Virginia have greater latitude in pursuing partnerships with the private sector. George Mason University developed this graphic to clarify the decision-making points for its board: approval of concept, partners, interim agreement, and final agreement.
6. Formalize your participation. Zeigler looks for ways USC can keep long-term partnerships from going stale or growing complacent. As an example: “We have a provision in our foodservice contract that we will always be the company’s number-one customer reference. That stipulation keeps the pressure on our partner to always perform at a level that meets our expectations,” says Ziegler.
In all its partnership contracts, USC retains the right to approve a company’s primary contact with the university. If the bookstore manager leaves, for instance, the institution must participate in the interview and approval process for the new hire. Private-sector partners must also consult with the university when their on-campus representatives receive their annual performance evaluations.
7. Remain agile and open-minded. A change in the marketplace, a financial development, or a state government’s stubbornness might signal the need to rethink your approach. Or perhaps a new business opportunity will appear. The need for flexibility should be expected, say business officers.
“No plan survives the first contact with reality,” believes Porcari. “You can refer to your campus master plan, think through your needs, and articulate your objectives—but it’s inevitable that your plans will evolve.”
When Johnson Controls conducted an investment-grade audit of USC’s energy systems and facilities, Zeigler certainly didn’t foresee financing a large-scale construction project. Yet, in addition to entering into an energy performance contract with Johnson Controls, the university formed a partnership to build an $18 million biomass facility. The new plant, scheduled for completion in spring 2007, will convert wood chips into a gas that will power portions of the 205-year-old institution.
|For information on debt financing and management, go to www.nacubo.org/x349.xml. You'll find an S&P report on partnerships for student housing along with George K. Baum & Company's comprehensive list of nonrecourse-financed, privatized, student-housing projects.|
As Zeigler suggests, “Had Johnson Controls not done the research and brought the project proposal to us, the university probably would not have pursued the biomass project on its own. Yet, it will end up saving us money on energy expenditures because it’s cheaper to manufacture this gas than to buy natural gas.”
Although USC handled all the financing, it contracted with Johnson Controls to build and monitor the biomass facility. With a hint of relief in her voice, Zeigler reports: “We off-loaded our role, staff time, and worries and concerns to the private sector, which doesn’t have the learning curve we would have.”
And, say business officers, therein lies the true value of a public-private partnership—the time, money, and expertise that a partner can bring to the table.
Despite all the paperwork, negotiations, and inevitable, yet friendly, friction, Porcari believes public-private partnerships remain well worth the effort because they enable an institution to transform its physical and financial environment. “At the University of Maryland, we’re celebrating our 150th anniversary,” notes Porcari. “Public-private partnerships are one way we can ensure the university will be celebrating its 300th anniversary.”
SANDRA R. SABO, Mendota Heights, Minnesota, covers higher education business issues for Business Officer
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