6.4 Capital Facilities Privatization

6.4.1 Background

During the latter part of the 1990s, though the practice had earlier origins, many public postsecondary institutions began to develop facilities through public/private partnerships. Although most institutions use private financing to support the development of residential facilities, the practice has extended to academic and other support facilities. This trend can be attributed to three factors.

• First, state support for facilities has declined significantly in recent years. The most recent national recession caused many states to pull back funding support for public postsecondary education and especially capital facilities development.
• Second, the recent explosion in student enrollment across the country has left many institutions unable to meet the demand for housing and academic space in the near term.
• Finally, students today expect more amenities in their living and studying environment, including state-of-the-art technology and greater privacy. Residence halls, many of which were constructed during the expansion years of the 1960s and 1970s, simply do not meet today’s student expectations. Since a residential life experience has been shown to have a positive impact on academic success, many institutions are eager to provide a quality living environment for students.

Under a typical privatized housing project, an institution will first determine the need for the project through a market analysis, which looks at project viability based, among other things, on student demand, comparisons with local housing rents, and projected occupancy. The institution’s foundation, and other affiliated 501(c)3 nonprofit corporations, often a limited liability corporation (LLC) set up specifically for this purpose, or a nonaffiliated entity will assume responsibility for owning, developing, and managing the development project. The nonprofit corporation will establish an agreement with a governmental or public entity (e.g., a local development authority) to issue tax-exempt bonds to finance the project on its behalf. The nonprofit corporation also will contract with a developer to design and build the project, an investment banker to develop a finance plan and underwrite project bonds, and a third party to oversee ongoing operational management of the project. If the project is constructed on the college or university’s property rather than adjacent land, the nonprofit corporation will obtain a ground lease from the institution for the duration of debt service payments. In these circumstances, ownership is usually transferred to the institution at the conclusion of the debt service period, which normally ranges between 20 and 40 years.

There may be several variations of this approach, reflecting the different roles that institutions have chosen to assume in relation to the project. For example, the institution may serve as project manager for the foundation or nonprofit corporation. The institution also may agree to a student rental referral policy with the nonprofit corporation, participate in a cost-sharing agreement based on net project cash flow, play a role in determining project scope, or review agreements with the developer. Increasingly, to exert a greater level of control over projects, some institutions choose to “lease back” facilities through rental agreements with the foundation or nonprofit corporation, which changes both the nature of the relationship between the two entities and the institution’s liability. The institution’s level of involvement has implications for the financing costs of these arrangements because of its impact on risk and liability as viewed by credit rating agencies and bond underwriters.

There are many benefits to privatization. First, housing projects developed under traditional state methods are subject to extensive rules affecting capital construction and procurement. These requirements can extend project completion time and increase project cost. Privatized housing projects can be completed more rapidly due to the developer’s ability to expedite contracts and financing agreements. In addition, institutions that lack the expertise in the construction, operation, and management of housing can call upon experts who have this knowledge and experience, which can lead to improvement in housing services, just as outsourcing other campus services can enhance service and reduce cost. Finally, depending upon the particular circumstances and financing structure adopted by the institution, these transactions can help preserve the debt capacity and credit rating of the institution or state.

There are disadvantages too. As with other outsourced services, the institution may feel a loss of control over the financing or operation of the project. Additionally, despite the fact that these projects are financed with tax-exempt bonds, interest rates will tend to be much higher than what might have been obtained using state general obligation bonds.

Top