By Dr. James T. McGill – Retired Senior Vice President for Finance and Administration Johns Hopkins University and member of the Edu Alliance Advisory Council
“P3” (Public/Private Partnership) has become a commonly used acronym in U.S. higher education, as well as in other spheres, notably state and local government. Definition:
- “Public” is a non-profit institutional or governmental entity that engages a “private” for-profit entity to pay for a particular project.
- The “private” partner provides funding (and often expertise) to deliver (and often operate) the project used by the “public” entity to meet its purposes.
- In return for its capital, the “private” entity gets a revenue flow from the asset it has paid for.
A typical example of a higher education P3 project is a private partner paying for and operating a new, revenue-generating facility on the public partner’s property, such as a student residence hall.
The P3 term also can encompass outright purchase by a “private” entity of a physical asset of a “public” entity and subsequent operation of that asset with the cost and revenues emanating therefrom accruing to the “private” partner. The public seller reaps a one-time payment up front. Two recent higher education examples are selling the ownership, and turning over the subsequent operation, of i) campus parking and ii) heating, ventilation, and air conditioning facilities.
This blog focuses on the positives and negatives of the use of P3 arrangements in providing a new facility through a P3, exemplified by a residence hall transaction.
There are a plethora of economically challenged colleges and universities with relatively small operational staff, thereby having only limited financial and personnel resources to manage the delivery of a new building. An institution’s capacity to pay for new student residence hall, say, may be constrained in several dimensions: i) insufficient accumulated cash, ii) reluctance to use endowment resources, and/or iii) limited borrowing capability. Such an institution may consider turning to a private partner with investment capital. Typically, the private partner will have expertise and experience in delivering the facility, knowing efficient construction approaches, how to deal with local zoning and environmental regulations, and managing local permitting processes. Perhaps, too, a partner might be experienced in dealing with the interested publics – neighbors and political interests. Such firms may also be familiar with governmental subsidies available to support such projects; an example is a project located in an economic empowerment zone. Too, not atypically, such a partner is able to deliver a project more quickly than if managed by the institution.
All sounds positive – some else’s money, expertise in building, knowledge of local regulatory restrictions, and fast delivery of a right-priced facility. Are there any drawbacks? Several countervailing factors to consider:
First, the “cost of capital” must be considered. The private partner is paying for the project with its own money (or, often, with that of financial partners it brings to the transaction); thus, it expects a return of perhaps 8-12% annually, maybe more. That return is generated from the “profits” of the operation of the facility it financed. If the institution is capable of borrowing from i) its own endowment (at a long-term annual cost from foregone investment returns of, say, 6% to 8%) or ii) a bank or the public bond markets (at rates today of perhaps 4% to 5% annual interest costs), there is an incremental carrying cost, ceteris paribus, to the public partner in a P3 arrangement.
Also related to “cost of capital” with the use of the private partner’s money, the bond markets and rating agencies may count part of the project cost as if the public partner had actually borrowed the money, resulting in a decline in the institution’s net worth (“balance sheet degradation” in accounting talk). If a rating agency believes that the institution would be obligated to step in to “rescue” the project if the private partner fails to meet its obligations, its cost will be counted, at least in part, as a credit obligation of the public entity. Any such project located on the campus property is usually so considered, in part at least, as an obligation of the institution. But access to a private partner’s capital nonetheless may be very attractive.
Second, the private partner will manage the facility. While relieving the institution from those day-to-day responsibilities, the public partner must negotiate conditions that ensure proper treatment of occupants in, say, the new residence hall, as if they were in a campus-owned facility. Often, too, the institutional partner is expected to help ensure the profitability of a residence hall by guaranteeing a flow of students to keep its beds filled, maintaining that the cash flow to the private partner. Thus, the institution gives up certain operating autonomies that can be core to its mission. These arrangements have been negotiated satisfactorily at many higher education institutions.
Third, there is the matter of the quality vs. cost of a building to be delivered under a P3 arrangement. The institution needs to specify such requirements and the private partner needs to agree to adhere to an institutional review process to ensure standards will be met. Imposing quality requirements may have pricing implications: the more expensive the project to build, the less value it may have to the private partner. Related is agreement on the responsibility of the private partner to maintain physically the facility throughout the life of the deal. Examples include roof repairs, replacement of heating and related infrastructure, painting and repair of the interior, facade maintenance, etc. Also, it is important to have documented understandings about the “end of the deal” condition of the facility — tear–down condition or fully operational, for instance.
Fourth, P3 arrangements are long-term, perhaps running to 75 years or more. And so, such arrangements will restrict uses of the land on which a project sits well beyond anyone’s capability today to project future institutional needs.
In short, there are positives and negatives to P3 arrangements. A higher education institution considering such must thoughtfully balance them all to arrive at a best decision.
Dr. James T. McGill (Jim) is a life-long higher education finance and administration executive. He served as the chief business and finance officer at three universities spanning thirty years: Oregon’s academic health science university, Missouri’s four-campus land grant institution and the Johns Hopkins University. All involved considerable focus on the academic health sciences. He had responsibility for the full range of financial operations; facilities; land development; human resources, and various other administrative functions.
Since retiring from his last full-time position, he has had an active consulting business, serving as a temporary executive at three different institutions and advising on strategic and financial planning at others. He has supported several non-profit charitable enterprises through board membership and has also recruited and mentored higher education executives.
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