In spite of current financial conditions universities are increasingly turning to public private partnerships(PPPs) as the preferred means of funding, building and operating student accommodation projects.
Understanding the PPP contractual structure
A PPP is a whole of life services contract where the University makes a fee for service payment for the delivery of certain infrastructure and related services over the long term. PPPs typically impose on the private sector parties who build, finance build and maintain the infrastructure, responsibility for its condition and performance on a whole of life basis. In other words a PPP model fully integrates the responsibility for up-front design and construction costs, with ongoing service delivery, operational, maintenance and refurbishment elements for the life of the contract.
This responsibility carries with it the risk of events that undermine the assumptions on which delivery (and payment) is based, except where the University expressly accepts or shares in those risks.
There are many differences between PPPs and traditional procurement models. PPPs replace traditional procurement contracts with long term contracts, upfront milestone payments with ongoing performance based payments, and input specifications with output based specifications.
The Project Agreement is the key contract between the university and the private sector party. It sets out all the key obligations relating to design/construction/commissioning and operation of the asset. It also ensures the university has a single point of responsibility as it is up to the private sector partner to manage its own contractual relationships with any sub-contractors who are providing construction or facilities management services.
Why PPPs work for student accommodation
The PPP model, as applied to university student accommodation, tends to work well. PPPs typically allow a university to place key risks, which it is generally not well placed to manage, with the private sector and off its balance sheet.
PPPs also transfer the risks and responsibilities associated with the operation and maintenance of student housing to a private entity, so the university can focus its own resources on the provision of its core educational services. Utilising private sector expertise and innovation is more likely to result in a solution which optimises the value of existing facilities and land.
Typically, throughout the operating term, the private sector will retain rental payments while bearing the operating risk of occupancy levels. The rent receivables will be used to service and repay its debt financing, with any profit providing a return on equity to its equity investors. In some projects, the university may have guaranteed minimum occupancy levels, and in doing so, re-allocated this risk.
Some key features of the PPP model
Some PPP's such as toll roads place demand risk on the private sector. Others, including most accommodation projects require the department or agency to take demand risk and the contractor is paid a fee for making the accommodation and services available.
Student housing is a hybrid with many of the characteristics of an accommodation project except that the contractor generally accepts a user pays return. For this reason the contractor must put in place arrangements to protect its revenue it will look very carefully at arrangements which cap rent increases, or whether any competing facilities can be constructed and the promotion of the facility to students including via the university website.
PPPs are about purchasing services at agreed quality, quantity and timeframe. Purchasing services (rather than the asset directly) gives the purchaser greater strategic flexibility and focuses attention on the quality of the services being delivered. The involvement of established service providers and the application of their expertise in student accommodation projects results in the delivery of innovative services which are customised to students needs, and optimises the value of existing facilities and land to the university.
Payment for Services
Under the PPP approach, services that are not provided on time or are not of agreed quantity or quality, earn reduced service payments. This is consistent with a fundamental premise of PPPs being that the private party bears the risk of asset performance and the public sector party only pays for the services it receives.
Hand back of assets
The university will generally want to retain long-term ownership of the accommodation facilities, particularly those located on campus. Under a private finance scheme, the accommodation facilities are usually transferred back to the university, in a pre-agreed hand back condition, at the expiration of the specified period. The pre-agreed hand back condition will be such that the facility is capable of continued operation for an agreed further term without significant further short-term capital investment by the university. The transfer of the facilities to the university will usually be at no cost.
Maintenance of asset
The private sector will be responsible for the provision of all maintenance and operational services necessary for the efficient running and upkeep of the facility to the university's requirements over the specified period. Under this model, all obligations and responsibilities in relation to the maintenance of the accommodation facility, including funding and management, are transferred to the private sector.
In many projects the parcel of services which the private sector provides will include those which impact directly on its ability to maintain revenue. In this regard both the private sector and the university have a common interest in ensuring that student residents are well cared for and enjoy their residential experience. The university will be keen to use the availability of quality accommodation at a reasonable price to entice students.
Using a PPP procurement method, a university will have less direct control or active management of housing facilities as it would if using another model. Significant lead time is required for the university to define its requirements more precisely and determine which risks it will retain and which are to be transferred to the private sector. Before opting for the PPP model, which is not suitable for all university accommodation projects, a robust analysis should be undertaken in light of the university's specific circumstances.
Cost and availability of funds
Any infrastructure project utilising private sector finance must consider the effect of tightening financial markets on the availability and cost of funds. The recent downturn in global credit markets has significantly impacted privately financed infrastructure projects because (in addition to large increases in the cost of capital):
- a major source of project funding (ie. debt capital markets) has dried up
- capital available from the banks has been rationed
- mezzanine debt has become prohibitively expensive and subject to severe capital restrictions.
Bank funding for PPP/infrastructure projects with a capital value of less than $200 million is still available, though less freely, because many banks can hold that level of debt without syndication but obtaining underwritten finance for projects over $200 million is currently problematic.
What remains important is that the project is robustly structured without unnecessary complications. It is essential for potential borrowers to approach financiers early in the project development phase and work collaboratively to gain credit approval in these conservative times.
Accordingly, universities seeking to develop student accommodation in the near future will need to allow for a longer period, and greater effort, to obtain finance and factor in higher costs of capital than pre-credit crunch.
How we can help
Minter Ellison is acknowledged as a leading property development adviser in the university sector. We have the breadth and experience to deliver the full range of services needed to assist with complex multi-use development projects and have done so for a number of universities and private sector developers. For further information on our practice in this area please contact the authors of this article.
Minter Ellison recently held a breakfast briefing on student accommodation projects in the University sector. Some of the issues discussed in that briefing are set out in this article.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.