by  J. Paul DeMyer, E.S.P. Investment Advisor and E.S.P. Brain Trustee

 

In the old days, not so long ago, government entities used powers of eminent domain, and general obligation bonds, to finance the development of public facilities and infrastructure.  Projects such as airports, ship harbors, highways and bridges, utility systems, convention/civic centers, arenas/stadiums, public parking facilities, and selected public housing projects were traditionally completed by private developers under fee-based contracts with public agencies. 

 

Today all this is changing because of  federal budget constraints and other curbs on government spending.  Municipalities are having difficulty funding existing services, much less paying for capital improvements.  But the public sector should not be written off.  Programs such as Federal Enterprise Zones and Empowerment Zones provide incentives for private investment in inner city areas that are a major catalyst for large scale development or redevelopment.  (Editor’s Note: Check out the E.S.P. Think Piece in this issue on the controversy over the use of public money for private profit.  You can’t please all of the people any of the time.)

 

By some estimates, the 83,000-plus state and local governments in the U.S. own land and buildings worth approximately $1.5 trillion.  If they sold one third to one half of such assets, they could eliminate their entire debt.  Of course, these governments are not about to dispose of their real estate on such a massive scale. 

 

However, state and municipal governments can and do realize important benefits from their properties when these holdings are used to attract private equity investment in commercial development projects.   Such private investment is now essential for economic growth. 

 

In today’s public-private partnerships, a wide variety of public agencies (many more than the typical redevelopment agency - including port authorities, prison systems, school districts, public assembly/convention services, military installations and housing agencies) are using creative, new, and sometimes complex methods to structure, finance, and engineer entertainment retail development and redevelopment deals.

 

In these partnerships, the agency typically sponsors the project and provides some type of funding, as well as the necessary entitlements.  The developer is expected to provide the required equity, as well as some portion of debt, and to manage the pre-development and construction process.  A third-party investor may also participate. 

 

In return for their capital, the developers and investors receive a share of the project’s return.  Both the public agency and the private partners may be able to securitize their portion of the project’s cash flow to assist the financing process.  There may be additional off-balance sheet financing to provide further leverage. 

 

Ownership of the project can range from 100 percent public to 100 percent private--and anywhere in between.  It’s a question of using investment, development and operational incentives and balancing risk, responsibility, economic return, and level of control. 

 

But it is not only the public agencies that initiate the development activity and realize the benefits.  In my new neighborhood in Washington D.C., parents of students in the 70-year-old Oyster public elementary school designed an innovative plan to finance the renovation and expansion of the school with funds from the proposed development of a 212-unit apartment project on the property.   A combination of land lease payments (part of a Payment in Lieu of Taxes or PILOT program) and property tax revenues paid directly to the school district was used.   Normally these revenues would have gone to the general municipal fund. The private developers were able to calculate an 18 percent internal rate of return. Under this plan, the school district would receive a $9 million surplus beyond the amount required to retire the revenue bonds.  This surplus would come from a combination of land lease payments and profit participation. 

 

Where does entertainment fit in?  Only a few years ago, one of the biggest public-private partnerships ever structured occurred in New York City.  A combined group of state, city and several different private developers agreed that entertainment and commercial activity was complimentary.  They decided that entertainment provided the opportunity for an extended business day (if not a 24-hour business environment).  They created a unique Business Improvement District in lower Manhattan that resulted in today’s Times Square revitalization.  This BID was supported by a self-imposed tax on the property owners and, among other things, provided transient occupancy taxes (TOT) on hotel accommodations and a ticket tax on entertainment charges.  The tax revenues are used to pay for supplemental services (e.g., sanitation) which would no longer be provided by the city. 

 

Benefits of
Public/Private Partnerships
to the Public Sector:

 

• lInduces private development atstrategic locations

• lMaximizes governmental investment, development and operational incentives

• lMaximizes use of funds in a special assessment district

• lCreates employment opportunities

• Reduces traditional risks of real estate ownership, construction and operations

• lReduces dependence on bond referendums and traditional tax-exempt bond financing

• Creates new income streams

• Reduces operating costs

• lUses less public capital in developing  facilities/infrastructure

• Improves performance of under-used assets