Financing a P3 Using Privately Issued Tax-Exempt Bonds: An Introduction to the New American Approach

By John Finke, President, Public Facilities Group. Bio below.

 

The UW Medicine South Lake Union (pictured above) is a $500 Million Multi-Phased Biomedical Research Campus development project that used privately issued tax exempt debt and The New American Approach which is among the most frequently employed Public-Private Partnership (P3) models in the United States. The New American Approach is well suited to both social and traditional infrastructure and is effective in financing projects with a development cost greater than $20 million. The model can be employed to meet all services requested by public agencies, including Design Build Finance Operate and Maintain (DBFOM) delivery models. It effectively combines low cost, privately issued tax-exempt debt, progressive design-build delivery and the option to privately contract operations and maintenance to optimize lifecycle costing. Together, these features provide a cost effective, flexible and efficient alternative for delivering infrastructure projects that meet or exceed the exacting quality expectations of lifecycle conscience public clients while lowering project costs and expediting project delivery.

What is the New American Approach? 

The New American Approach uses tax-exempt lease revenue bonds, frequently called 63-20 bonds, named after the 20th IRS revenue ruling in 1963. This revenue ruling gives a private not-for-profit organization the ability to issue tax-exempt bonds (the interest on which is not subject to federal, and in most cases, local income tax) to finance an exempt facility. The most important feature in 63-20 financing is the requirement that the governmental entity receive at no cost, unencumbered fee title to the financed facility when the debt is retired. In addition, the governmental entity has the right to repay the debt at any time, thereby receiving unencumbered fee title to the financed facility earlier than the anticipated bond maturity. These important safeguards enable 63-20 transactions to avoid the unwind difficulties that some jurisdictions have experienced in other forms of P3 delivery.

If you would like a more in-depth description of the New American Approach. Our website contains an eight-step guide and an animation describing the process.

Why is the New American Approach Effective?

The New American Approach pairs an experienced not-for-profit owner with a selected development team and the governmental user in the design and costing of a desired public project. Once the project is designed and priced to the user’s satisfaction, the not-for-profit issues the bonds and hires the development team to build the project. The development team, being involved in the design and costing of the project, is required to deliver it at or below the established price. Cost savings are shared between the development team and the public client, giving the development team an incentive to seek cost savings that benefit both the public agency and themselves.

As the obligated party on the debt, the not-for-profit owner is responsible for repaying the bonds. Rent is fixed equal to the debt service on the bonds plus the actual long term operating and maintenance costs required to oversee and maintain the facility. Since the lease does not obligate the governmental entity to pay rent until it has “beneficial use” of the facility as designed, the contracts are written to require the development team to complete the facility within a specified timeframe and at a not-to-exceed price. Because the governmental entity is not a party to the construction contracts it is protected from construction risk and cost overruns.

For the owner to sell bonds to build the facility, it must complete three key steps:

  1. Engage a strong design-build team willing to provide a Guaranteed Maximum Price (GMP) with a date specific completion guarantee;
  2. Obtain approval of all entitlements; and
  3. Negotiate a ground lease (if applicable) and facility lease agreement effective upon substantial completion.

Because the private not-for-profit owner can borrow only sufficient funds to build the facility, and do so without recourse to the governmental entity, there is no means for the design-build team to exceed the limits of the Guaranteed Maximum Price.

Why a Developer-Led Progressive Design-Build Delivery Approach?

In typical publicly led development it is customary for contractors to price in a premium when bidding. Their bid typically includes the costs associated with a public learning curve and the expectation of time delays from a more protracted public decision-making process. By employing an independent and experienced not-for-profit owner with a Developer-Led Design-Build Team, a frequent problem associated with Publicly-Led projects can be avoided, and a lower bid can be negotiated.

The New American Approach’s Developer-Led Progressive Design-Build Delivery brings all key project disciplines together with the public client into the design and pre-construction process. This early engagement fosters collaboration as well as effective and efficient decision-making, optimizes design, and creates the greatest project value. Once the project is designed and priced the delivery become the responsibility of the Development Team and the public agency is shielded from cost overruns and time delays. This approach has resulted in projects that are on average 15% to 20% less costly to build and are delivered 30% to 40% faster with equal or higher quality when compared to traditional design-bid-build projects.

The structure not only delivers the most cost-effective approach to construction, operation, and maintenance of public facilities, it is beneficial in insulating the public entity from cost overrun risk. After a decision is made to use this means to finance and build a facility, the public entity and the non-profit owner sign a lease, which is the only contract between the two. Without contractual privity between the public entity and the design-build team, the public entity is not an obligated party for cost overruns, should they occur. In contractual disputes, the design-build team has no recourse to the governmental tenant.

Operations and Maintenance

Once the project is complete, the New American Approach allows for a series of short-term operations and maintenance (O&M) contracts. These contracts are between the not-for-profit owner and the O&M provider and are designed around the public entity’s needs. By using shorter term contracts, the process can introduce competitive bidding and more advantageous pricing into the facility’s Operations and Maintenance needs. By making O&M a requirement of the lease between the not-for-profit owner and the governmental user, it assures that the facility is managed to optimize its lifecycle cost for the governmental user. This is the most effective approach to lifecycle costing and is universally used by private owners in addressing their own operation and maintenance needs. The New American Approach also allows for the flexibility of the governmental entity self-performing O&M functions if it chooses.

For more information, Public Facilities Group hosts a free webinar series that covers Tax-exempt bonds and their use in Public-Private Partnerships.

 

 

 

JOHN FINKE is President of Public Facilities Group. He has more than 35 years’ experience in local government, nonprofit management, private sector development, and financing public private partnerships. John pioneered the American Model Approach and has used that model to finance and develop more than 1,600,000 square feet of government and university offices, 750,000 square feet of medical offices, 400,000 square feet of research laboratories, 2,500 spaces of structured parking facilities for public institutions and 1,100 units of student housing (See Portfolio). These award-winning projects total more than $2 Billion in direct development costs.