A discussion on public/private partnerships (PPPs or P3s) among experts from Australia, the United Kingdom, Canada, and the United States was convened in October during the ULI Fall Meeting in Boston. It was organized and co-moderated by Sandy Apgar, a ULI trustee and real estate counselor who implemented the U.S government’s P3 program for military housing; and Leslie Woo, a ULI global trustee and chief planning and development officer of Metrolinx in Toronto.
Participants included Rick Geddes, an economist, professor, and founding director of the Cornell Program in Infrastructure Policy; Jonathan Kennedy, a transport, utilities, and social infrastructure expert and former executive director of Infrastructure Partnerships Australia; Casey Nolan, senior managing director of Clark Realty Capital, developer of seven U.S. military housing P3s and 7 million square feet (650,000 sq m) of commercial and mixed-use space; and Peter Zuk, chief capital officer of Metrolinx and former project executive for Boston’s Central Artery Tunnel project (the Big Dig) and the London Underground.
Participants followed Chatham House rules, in which commentary is distilled from a transcript, but is not attributable to individuals. An analysis of that discussion follows.
The United States faces a well-documented public infrastructure crisis. The American Society of Civil Engineers has assigned a grade of D+ to current conditions and estimates the improvement cost at $2 trillion. But states and localities, which provide over 75 percent of the country’s infrastructure funding, face sizable budget shortfalls that limit their capabability to take remedial or preventive action. And without resolute action and innovative approaches, the crisis will only worsen.
Public/private partnerships have proved to be an effective, long-term, performance-based approach to procuring and recapitalizing public infrastructure, facilities, and services. In addition to their use for hard assets such as roads and rail, sewers, and water systems, P3s can be vehicles for soft, social infrastructure, such as regenerating deteriorating neighborhoods, addressing community needs, and overcoming structural constraints.
Though ULI has a long track record of member interest and experience in P3s, until recently neither a critical mass of real estate industry interest nor empirical guidance has existed for P3 public policy initiatives. However, investors, developers, and operators alike are looking for practical guidelines for successful P3 projects.
Successful P3s have been operating globally for decades. Australia, the United Kingdom, and Canada have taken the P3 approach much further than has the United States, through a wide array of policies, governance models, and real-time applications from the national to the local levels. The shared capital-market and consumer philosophies, basic business practices, and administrative arrangements in these countries make cross-border comparisons relevant and useful.
Public/private partnerships enlist the capabilities and capital of private enterprise for public purposes. Public refers to government agencies at the national, state/provincial, and local levels; private refers to businesses, including real estate developers and financiers, and increasingly foundations and nonprofit organizations. Partnership describes relationships across the sectors. P3s are often formed when a government entity lacks capital and capabilities that business can provide, and business lacks the legitimacy, political will, and skills that the government provides.
Legal P3s are cooperative arrangements between public agencies and private entities for facilitating and managing partnerships to provide assets and deliver services. But P3s are also a term of art derived from theory and practice, which varies among jurisdictions. Australia, the United Kingdom, and Canada offer a sophisticated P3 menu, from traditional contracting to the complete transfer of responsibility for planning, financing, design, construction, operations, and ownership of government facilities and services. Thirty-seven U.S. states have legislation enabling P3s and empowering cities and towns to launch them.
Business P3s center on relationships in which two or more entities own, manage, and/or operate a business to provide public assets and deliver community services, based on common goals and mutual respect. Canada has a long history of infrastructure P3s, spanning transcontinental road and rail systems to hospitals to regional water and local sanitation facilities. In the United States, the scope for P3s is widening to embrace startups and infrastructure funds but is challenged by keen competition and thin deals.
P3s as Problem Solvers
P3s can solve large, complex public problems that neither government nor business can solve alone. The public sector is mostly working to catch up with a public infrastructure deficit. Rapid urbanization has presented a growing need for public facilities such as hospitals, schools, housing, public transit, and water treatment plants, placing a fiscal burden on the public purse at a scale that exceeds short-term financial means.
The public- and private-sector roles often sit in opposition to each other, with government as the regulator and business as the entrepreneur. In P3s, the sectors are contractually—and philosophically—fused to leverage the strengths of each in originating, capitalizing, and delivering projects. Typically, the business partner assumes the main responsibilities and risks, including planning and design, financing, construction, and, ultimately, long-term operations and maintenance. The government partner legitimates the project and seeds the joint venture with land or capital, or both. The business partner obtains third-party capital and introduces best practices, process innovations, and operating efficiencies.
P3s offer the public sector an open and transparent business model that can take advantage of private-sector financing and expertise, thereby making larger, more complex programs affordable. In addition, well-constructed fiscal models and contractual arrangements allocate appropriate risk between the public and private sectors to create efficiencies that benefit both parties.
P3s are not to be confused with privatization, nor are they successful if the public sector loads all the risk onto the private sector. They result in a partnership in which both parties have shared values and a long-term vested interest in the success of the assets and the services delivered.
P3s can also facilitate innovation by being outcome driven, enabling new methods or systems that would be precluded by highly prescribed specifications. The need to be forward-thinking and integrate new technologies or new markets, and to innovate for extreme fluctuations in environemental conditions, can be given a heightened value through a P3. As a result, the public sector can take advantage of the entrepreneurial strengths of the private sector.
Unique Role of Real Estate
The real estate industry is uniquely qualified to engage in P3s with capital, entrepreneurship, management, and services, along with inspiration and innovation—the “secret sauce” that differentiates this model from all others.
Real estate in general and housing in particular have been shackled to a primitive business model that impedes innovation, starves new investment in better products, and separates essential services from the production process. Instead of one industry segment, there are three—builders, developers, and service providers—with a baker’s dozen of large but specialized market subsets.
P3s are upending that traditional model by streamlining the structures for planning and implementing major projects and simplifying the complex, costly chains for supplying and selling them. Over the past 20 years, some 25 original partners in the U.S. military housing program have been whittled to 14, with five of them representing 80 percent of the market. Australian global giant Lendlease acquired Actus, instantly launching its engagement in U.S. P3s and its platform to field even more. Forest City Realty Trust, which in late 2018 was acquired by Brookfield Asset Management, in 2016 sold its military P3 business to Texas-based Hunt, which is now firmly positioned as an industry leader.
P3s enable governments to leverage a small amount of public equity with a massive amount of new private capital investment in return for predictable, consistent cash flows to the private entities. If P3 projects outperform financially and can serve other needs within or beyond the original scope, the P3 could take on additional third-party debt to build more assets or provide more and better services. P3s could be even more transformational if they were allowed greater flexibility and risk sharing among projects in the master portfolio. In addition, operations and maintenance funding is locked in for the duration of the contract and cannot be dialed down to suit short-term political considerations.
Revenues generally flow from user rents, tolls, or service charges through a “waterfall.” For instance, in a traditional billion-dollar residential project leveraged with 70 percent debt: for every revenue dollar, about one-third is consumed by operating expenses, half by debt service, 8 percent by investors (net cash flow), and under 1 percent for reinvestment or reserves. Thus, in a rising rent environment, a substantial amount of the cash flow in a traditional development can be returned to investors, whereas in a P3, most of that cash flow is retained in the P3 reinvestment account.
Australia, the United Kingdom, and Canada use a formal multiaccount business case methodology to assess the performance of P3s. Ensuring that a project or program’s benefits are maintained through a project’s life cycle requires a rigor regarding the evaluation and metrics against which the builder/service provider can be assessed. A business case defines a proof of concept that demonstrates the feasibility of the defined scope of work. This is not to be confused with value engineering.
The discipline of the business case method ensures that the broad benefits of the investment—which range from strategic/public policy, economic, financial, and speed of deliverability—are maintained. A business case establishes outcomes, scope, and requirements, and is separate and distinct from the performance specification that goes to market.
As ULI advances its strategies to address the issues facing cities globally such as housing affordability, climate change, economic development, and infrastructure needs, it is clear that the complexity of these issues requires new relationships between the public and private sectors. Learning from each other, collaborating, and sharing best practices through networks continue to be core ULI strengths.
At the 2019 Spring Meeting in Nashville and in subsequent forums, product councils and district councils should consider how longstanding industry biases and regulatory and political barriers against the P3 model can be removed. The future of cities requires fiscal and financing models that can sustain investments in the public systems that allow land to be developed for its best use and thereby contribute to more complete communities.
At the 2019 World Economic Forum, Christine Lagarde, head of the International Monetary Fund, called for economies that are more resilient, inclusive, and collaborative. In this environment, alternative ways to address the public infrastructure deficit in the Americas are imperative. Our industry, its investors, and public policymakers, must pursue different strategies to build and operate complete, successful communities, and public/private partnerships are ideally framed to be a central part of the solution.