This is the second in a series of articles by Michael R. Baird, Managing Director, RBC Capital Markets (bio below). The series addresses current issues impacting the P3 Higher Education Industry. You can read the first article, about tax reform, here.
A primary goal of public-private partnerships (P3) is to transfer risk from a public entity to a private partner. P3s in the higher education industry can take many forms, but in their broadest application they allow colleges and universities to utilize the expertise of private partners to finance, construct, operate and maintain certain infrastructure. Many P3 higher education projects completed in recent years have successfully transferred the operating risk of a given project. For example, privatized student housing projects have shifted the risk that students won’t lease enough beds to allow the project to cash flow sufficiently, from colleges and universities to investors. If a project falls short on revenue, it is no longer the college or university that must find other revenues to offset the shortfall but investors who may potentially not receive their scheduled debt service payments.
As P3 higher education financings have become more commonplace, there can be a tendency to take any risk transfer in these projects for granted. However, it is crucial to understand that the risks associated with a P3 higher education investment are real and, although financing structures are put in place to mitigate these risks, they are not completely eliminated.
Since project financing is typically secured solely by the project, and not by any financial support from the college or university, it is important that the bond investors have confidence in the project’s ability to generate sufficient funds to pay its ongoing debt service and operating expenses. To develop such confidence, a key consideration is for investors to conduct a detailed diligence process to fully understand the market within which the project will be operated, the demand for the project, and its affordability. Additionally, they need to evaluate the demand and enrollment trends of the institution, as well as how it compares to its peers. This due diligence is best achieved by hiring an independent third party that has prominent recognition as an industry expert to conduct a thorough market study.
Every college or university, and every market in which it operates, has varying area demographics, student profiles and market dynamics. As such, each market study must be tailored to reflect these specifics. Some higher education institutions are located in vibrant cities with many options for students, while others are located in rural college towns where options may be more limited. Some colleges or universities have student populations willing to pay a premium for certain high-quality, high-amenity services, while others have students that place more value on overall affordability. In many cases, institutions have a student population that demands a complementary variety of these options.
The purpose of a market study is to examine the specific features of the market being considered, analyze all factors that could impact the operations of the proposed project, and draw a conclusion as to the feasibility that the project will be successful over the life of its financing. While no one can guarantee the success of a project, particularly over a 30- or 40-year period, an effective market study can give investors enough currently available information to make an educated investment decision.
Some key components of such an effective market study include:
- A description of the local area, including the location and history of the community, current development patterns, area population and demographics, the types of households within the community, and income levels in the area;
- A general overview of the college or university, including a brief history, its vision, mission and current institutional goals, a summary of its master plan with details of any planned facilities improvements, the location and description of its campuses, and the programs offered (undergraduate, graduate and doctoral programs, schools and colleges of study, accreditations);
- A description of the college or university’s enrollment, including enrollment trends and projections (full-time equivalent and headcount), applications, acceptances and matriculation data, and student demographics (geographic origin, age, classification, and areas of study);
- A summary of the college or university’s tuition and fees, including tuition for the various programs, student fees, discount rates, and financial aid profile;
- A comparison of the college or university to its primary competition, including student demographics, tuition, fees, and housing and dining costs;
- An detailed description of how the proposed project fits into the university community (for example, for a student housing project, a description of the university’s housing, including housing requirements, a description of the facilities, special programs, rental rates, capacity, occupancy trends, meal plans, and future housing plans would be included);
- A review of the off-campus market, including a comparison of facilities available to students, current rents and fees, demand and occupancy trends and additional planned development;
- A description of the proposed project, including the site and location, layout and amenities, proposed rents and fees, a comparative market price analysis (on and off campus), and demand trends for the project;
- An on-line student survey distributed to the entire student population to determine students’ current situations, future plans, opinion on existing facilities, preferences, budgets and interest in the proposed development;
- Student focus groups where several in-person meetings are held with a relatively small number of students from various student demographics in each meeting to gain qualitative information regarding preferences and student perception of the proposed development, refining and enhancing the results obtained from the student survey; and
- A conclusion summarizing the consultant’s opinion of the viability of the proposed project, including the level of demand currently in the market, the types of units preferred by the targeted student population, and the affordability of the rents for each unit type.
The P3 higher education industry has enjoyed a high level of success over the years, but it has not been without its share of troubled projects. In reviewing these projects, one common thread is a lack of understanding of the specific market conditions at the outset. This further emphasizes the importance of investing in a robust market study from an experienced and diligent market study consultant. The benefits of doing so far outweigh the potential costs, increasing the likelihood for a successful project that meets a need in the market and ultimately benefits the college or university and its students.
MICHAEL R. BAIRD is a Managing Director and the Co-Head of the Higher Education Finance Group in the Municipal Markets Division of RBC Capital Markets. He joined the firm in 2003, when he opened its Baltimore investment banking office and started its Privatized Higher Education practice. He specializes in structuring innovative solutions to meet the specific needs of the firm’s higher education clients and has extensive experience financing and refinancing various project-based funding programs, including all types of taxable and tax-exempt, fixed and variable rate structures. He has also developed an expertise in structuring project-specific programs through public-private partnerships and various other privatization models. Some of his clients have included the Texas A&M University System; Louisiana State University; the University of Oklahoma; the University of California, Irvine; Southern Oregon University; the City University of New York; Florida Atlantic University; Illinois State University; Northern Illinois University; the University System of Maryland; the Pennsylvania State System of Higher Education; the University of Colorado; the University of Louisville; Virginia State University; and Howard University.
Mr. Baird has approximately 30 years of investment banking experience, including over 25 years as a Public Finance Banker. He has participated in hundreds of taxable and tax-exempt financings, totaling over $15 billion in aggregate principal amount. Prior to joining RBC Capital Markets, Mr. Baird was a member of the Public Finance Groups of Legg Mason Wood Walker, William R. Hough & Co. and Alex. Brown & Sons. He has an MBA and a BBA in Finance from Loyola University Maryland. He is a Municipal Bond Principal and has his Series 7, 50, 53, and 63 registrations.
Note: The quotation in the article’s title, “The best vision is insight,” is from Malcolm Forbes.