The pluses and pitfalls to engaging in a public-private partnership.

Huth

By Greg Huth, Esq.
Published online 7-6-07

     The public-private partnership is a marriage in the truest sense of the word — there are pluses and pitfalls you need to know from the start in order to be successful.

     The phrase “public-private partnership” was coined several decades ago when many major U.S. cities were suffering from decline. Many of these cities were facing an over-abundance of underused property but didn’t have the resources, either financial or human, to bring the property to its highest and best use. Developers, on the other hand, had the money and the talent, but needed to be coaxed to the table. Thus, the public-private partnership was born.

     The public-private partnership continues to be a viable development structure due in part, for example, to the increased interest, in both the public and private sectors, in central-city living and the continuing interest in redeveloping environmentally challenged properties. That being said, the public-private partnership must be approached like a marriage — each party must know the strengths and weakness of the other and how they complement each other. This article will focus on the pluses and pitfalls a developer has to be aware of before walking down the aisle.

     Typically, the public side can bring some interesting financing resources to the partnership. Tax-increment-financing, tax incentives, bonding capacity (including tax-exempt bonds) and low-interest loans are only some of the incentives the public sector can utilize to support development and re-development. But there are a few potential pitfalls a developer must keep in mind when utilizing public sector support, including:

1.         There is no such thing as free money, only cheaper money.

2.         It takes time, and time is money.

3.         There are strings.

     Number 1 is self-explanatory. This overview will discuss a couple of the time issues to keep an eye on and then cover some of the strings. Then, we will discuss the pluses.

Who’s Time Is It, Anyway?

     Today, not much coaxing is needed to pique developers’ interest in public projects; and, in fact, when public bodies or non-profit institutions (the “public” member of the marriage) send out Requests for Proposals (“RFP’s”) or Requests for Qualifications (“RFQ’s”) for new development projects, the competition among developers (the “private” side of the marriage) is often fierce. Without any guaranty that their efforts will pay off, developers make significant upfront investments of time and money. They put together written proposals and plans that they hope will get them invited to the dance — an event where they get maybe an hour or two to put on a presentation in front of a selection committee in hopes that, just maybe, they will get chosen as the public side’s spouse.

     Oftentimes, the public side sends RFP’s or RFQ’s to 20 or more potential developers, all or most of whom scurry to complete their proposals or qualifications by a drop-dead date. Though most or all of the developers will submit proposals, typically, only a few are invited to give a personal presentation; and, in the end, only one developer is selected to walk down the aisle. The rest go home, write off their time and expense as a cost of doing business, then gear up all over again for the next RFP or RFQ that intrigues them.

Who’s Pulling the Strings

     Public financing tools — whether loans, grants or bonds — are driven by public policy. Public policy typically dictates outcomes beyond the bottom-line that you, the developer, are focused on. For example, an economic development bond will, in many cases, require that all workers be paid at the state’s prevailing wage rate and, in some states, the prevailing wage rate fluctuates monthly (as opposed to federal prevailing wage, which is fixed at the start of the project). In most cases this does not present a direct financial challenge, but it often requires record keeping that can add an indirect cost. Many federal, state and local programs require that the project meet certain goals for participation of minority-owned or disadvantaged businesses. Again, this may not have a direct financial impact but may require that additional documentation be maintained. And more local jurisdictions are now adding local-resident hiring and “living wage” requirements that can have both direct and indirect financial implications.

     Public financing tools will also often dictate how the funding can be used. Tax-exempt bonds, for example, while at a lower interest rate than conventional bonds, often require that bond proceeds be used for improvements that will be deemed public improvements. Most large-scale development and redevelopment projects today include infrastructure that can be considered public improvements. However, that often means that a private end user cannot get exclusive use of those improvements, or that the private end user cannot get any direct rights with respect to those improvements. For example, a parking garage that supports a new retail development may be eligible for tax-exempt financing if owned by the local government or port authority. The parking spaces in that garage, however, must be open to the public and, in most cases, cannot be subject to a reciprocal easement agreement in favor of the developer or any tenant within the retail development. Consequently, the developer is in the position of persuading tenants to come to that location even though the typical contractual assurances of the ability to use such parking spaces are not present, as the grant of any easements or other control rights to the developer would invalidate the tax exempt financing provided for those improvements.

     Another situation is when the government entity provides tax-exempt financing for street and sidewalk improvements in a mixed-use or lifestyle center. Here again, tenants are in a position of not having direct rights to use the very improvements that provide access to their respective premises. These structures can often lead to interesting discussions between — and some creative writing by — the public-entity’s attorney, developer’s counsel and tenant’s counsel, in order to create a structure that protects the developer and the tenant without granting direct easements or similar control rights that would invalidate the tax exempt financing.

     Public financing tools also, depending on the manner in which such funds are permitted to be disbursed, must be coordinated with the normal construction draw process. Often, the requirements for disbursement of the public funds will not be co-existent with the typical monthly draws employed by the developer and its construction lenders, and therefore developers either have to adjust the construction draw process or must provide alternative financing to cover any “gap” that may occur in that process.

Why Walk Down the Aisle

     Why? Well, of course, like any other business proposition, it is because the developer thinks it can be a good economic deal. But frequently, these public-private partnerships offer a little something extra.

     Public-private partnerships tend to develop around large-scale projects; you will get the chance to tackle a large site and create a project that makes a significant statement. It could be the opportunity to develop a project on choice inner-city land previously thought to be unavailable because it has been owned by a university for 100 years, and now the university has determined it wants to create a vibrant new mixed-use development to serve the university community. It could be a highly visible project, such as the development of a new convention center for the city, with related mixed uses. A successful project will draw a lot of attention, both locally and beyond the region, which in turn raises the profile of your firm.

    Because the public entity also has an interest in the success of the project, you can usually expect them to be fairly accommodating in the area of permitting. What you may lose in time working through the public financing you may make up in permitting for a large-scale project. Even zoning hearings can go smoothly when the political stars are aligned. And the reputation you develop working closely with the government staffers in the trenches will go a long way on your next project.

     Yes, there will be a financial return — it is just a bit further out than your typical project. The public lender is, in most cases, much more patient than the market (the local government is probably going to be a bit hesitant to foreclose on a project it put a lot of political horses behind), so there’s less of a risk if things are a little rocky at the start. Once the project stabilizes, you will have the satisfaction of knowing you’ve made some money and made a major contribution to the community.

Conclusion

     The benefits can seem a bit intangible at first but, again, like a marriage, the long term returns can be substantial. And the successful public-private partnership can have a significant positive impact on your firm. As noted, though, there are pitfalls that you need to keep an eye on. It’s important to pull together the right team as you embark on this marriage — lawyers, accounts, planners, etc. — that have experience with the public entity that can build on those relationships to make your project successful.

Greg Huth is a real estate attorney with the Cleveland-based law firm Kahn Kleinman, LPA. He can be reached at 216/696.3311.