by Scott M. Helfrich
While there has been significant discussion about the development of public-private partnerships for student housing on college and university campuses, almost nothing has been written on the dissolution of these P3s. Certainly, this rarely happens, and there are agreements and assorted safety measures put into place to ensure financial success. It is also understandable that neither institutions nor associated student housing firms want to broadcast case studies of partnerships gone wrong or projects that have experienced significant challenges. Still, there have been and will be times when these agreements will come to a less-than-positive end. For that reason alone – not to mention the increased financial pressures under which campus housing departments and private developers now find themselves working – it is of paramount importance that all partners enter P3 relationships with clarity, transparency, and unified goals.
At its core, a P3 is a partnership between a public and a private entity with a mutual interest in an infrastructural asset. In the case of student housing, the asset is owned by a private for-profit or non-profit entity, and there is an agreement with a host institution regarding revenue-sharing, operations, and maintenance. A university-affiliated entity, such as a university foundation with a non-profit 501(c)3 status, can serve as the private partner while the university serves as the public partner. In other cases, there may be a private housing development firm that partners with the university. In many cases, there are more than two entities involved, which can include the university, the project owner (or multiple owners), and a private management company. This management company may sometimes be referred to as the operator.
The financial arrangements and associated partnerships that constitute a P3 can be extremely complicated and cumbersome, involving various financial intermediaries that provide oversight to better ensure the success of a student housing community. Furthermore, the dynamics of each P3 project are unique, which ultimately can lead to various challenges related to leadership dynamics, decisions about expenditures, and the complex relationships between the host institution and project owners’ representatives. It is also important to understand that there is a difference between the dissolution of a P3 and the substitution of one management company for another at a student housing project. A management company does not necessarily have any stake in the ownership of the housing community that it oversees and will essentially have a formal agreement with the owner to operate the facility in exchange for a management fee based on a mutually agreed upon amount, which oftentimes is a percentage of the annual net revenue earned. Like any relationship, there can be conflict and potentially a subsequent mutual agreement between the university and the management company to part ways. However, this does not mean that the P3 no longer exists. Ultimately, the owning entity may change out a management company or decide to manage the student housing community itself, but the structure of the P3 will remain intact with the host institution.
It may seem odd, counterproductive, or at least glass-half-empty thinking that new business partners will spend valuable time exploring the mechanics of how to end a relationship before it even begins. Yet this is exactly what occurs in the case of a public-private partnership where settling on a dissolution agreement is done well before the first shovel of dirt is moved on a construction project. In a rough sense, it is like having a prenuptial agreement for a marriage. Legally binding agreements will be drafted and agreed to by all the constituents involved. Various financial goals and metrics are defined, and associated contingencies and required remedies go into effect should those financial goals not be met. This is important because one aspect that can be easily overlooked by the general campus community is that a P3 project is a fungible investment for the owners – not simply the provision of a place for students to live. Private equity partners or bond investors can pledge tens or hundreds of millions of dollars for the development, construction, and maintenance of a student housing community. Naturally those partners expect a sound return on that investment and have expectations for its ultimate financial success.
Typical financial metrics, also known as covenants, that need to be met for a P3 to be successful can include an occupancy requirement as well as a debt service coverage ratio (DSCR), which is essentially an annual calculation that illustrates whether you have enough funds to cover the payments for the money you borrowed. When millions of dollars are used to construct new student housing, the lender needs reassurance that the project is financially healthy enough to make the required payments on the debt (i.e., debt-service) as well as to operate and maintain the facility over the course of the agreement. They expect a project to have more financial success than simply earning enough money to cover the debt payments. They want to see that a project is operating prudently so that there is enough money remaining over and above the annual debt payment amounts. A student housing project that is essentially living paycheck-to-paycheck, or not even up to that level, is a significant financial risk, which lending institutions and equity partners attempt to avoid. Having sufficient cash flow permits them to make the principal and interest payments, pay for operational costs (such as personnel, facilities maintenance, and other expenses), and set aside funds for capital projects such as building and property improvements – and still have some money remaining.
The dynamics of each P3 project are unique, which ultimately can lead to various challenges related to leadership dynamics, decisions about expenditures, and the complex relationships between the host institution and project owners’ representatives.
One way to better ensure this is through an occupancy requirement that is based on the number of revenue-generating beds that need to be filled. For example, a 1,000-bed suite community may need to have a 95% occupancy requirement, which means that 950 beds must be filled. Additional requirements can come into play, including first-fill and no-compete clauses. These mean, for example, that the host institution agrees to fill that P3 student community first before filling the beds of its own housing stock. Furthermore, the university agrees not to compete with that project by building additional beds unless a formal market study illustrates that there is a clear need for more beds at that particular institution.
The P3 agreements will also define default scenarios and the remedies that can occur should the student housing community be unable to meet its financial obligations to the private equity partner or bond investors. This can differ depending on the type of deal under which it was formed. One example includes the inability to meet the debt service coverage ratio over the course of multiple years. In dire circumstances, a project may not only be unable to fully make its debt service payments, but may not even be able to cover budgeted operational expenses. If that occurs, the property owners are typically required to hire a financial consultant to scrutinize what may be occurring, which can include problems caused by simple mismanagement, a saturated housing market, or even decreasing enrollment numbers at a host institution. This may prompt the decision to replace the management company with another one that is more capable of solving the problems.
If all remediation options are exhausted, the P3 may be terminated, a process variously referred to as a dissolution, breakup, separation, or wind up. In some circumstances, depending upon how the deal was financed, the university can purchase and manage the project itself. This can happen if there is a university-affiliated organization, such as a university foundation, that essentially sells the student housing project to the university and ceases the land lease arrangement. The university may purchase the asset using its own capital reserve funds or may rely on other funding sources, such as tax-exempt bonds issued by a state-related agency. In the case of an agreement with an external development and management firm that owns the project, the firm will require being made whole for the equity invested along with any expected financial returns projected through the term of the agreement. Those amounts will be negotiable. However, this will require a large outlay of cash on the part of the institution.
A potential P3 dissolution causes further ramifications for whatever management company is operating and maintaining that student housing community. A change in ownership can also quickly prompt a change in management, which will certainly affect the multiple employees responsible for that community. There is never a guarantee that a new management company will maintain the same employees as the previous company. Obviously, this can create job losses for those individuals who worked at that housing community.
Like any relationship, there can be conflict and potentially a subsequent mutual agreement between the university and the management company to part ways. However, this does not mean that the P3 no longer exists.
Furthermore, a university that acquires funding from an external source to purchase the asset will generally be required to have a qualified entity to take over the management responsibilities. A rubric of various qualifications must be met for this to happen. This can include a track record of successfully managing student housing communities with a minimum number of years in operation and a certain level of beds or communities currently or previously managed in their portfolio. This ensures that a university does not hire a less reliable company or attempt to operate and maintain it itself without previously having student housing management experience. Those requirements will typically be met for institutions that already manage student housing outside of the asset being purchased. In some cases, the university was already managing and maintaining the facility, but now ownership simply reverts to them, thereby eliminating the private partner.
In a much more immediate example, given the troubling COVID-19 situation that has been imposed on higher education and more specifically on the student housing industry, we could see more P3 dissolutions over the course of the next five years. If institutions with P3 housing are not able to fully open for all or part of the academic year, they will quickly find themselves in default scenarios. In anticipation of that, rating agencies have already downgraded rating for various P3 projects across the United States. Higher education institutions will need to cover the debt service for the project potentially through their own reserve dollars if the project itself does not have enough of its own reserve to see itself through the year. This has already occurred in multiple situations in which colleges and universities provided refunds to students for requiring early move-outs.
Again, each P3 project is unique, as are the various agreements under which they are formed, so any potential dissolution parameters will vary. Far more frequent, however, are those P3 projects that never get out of the gate. This can occur for multiple reasons, such as the inability to secure adequate financing, a pro forma that would make student rental rates too high for that campus market, or irreconcilable differences between the developer and the university – or it could be that the university or developer has simply changed their minds. Developers, investors, associated contractors such as architectural firms and general contractors, and colleges and universities alike have become much more cautious going into a P3 project because of the costs associated with exploring such an arrangement. Add into the mix that P3 agreements are intended to be long-term arrangements, negotiated to last for 30 to 90 years or more, so it is vital to understand that there can be a number of difficulties as both parties attempt to unknot those ties that bind.
Public-Private Post Pandemic
After campuses followed the directives from governmental and educational agencies to virtually empty their campus housing communities, it followed that most also had to refund portions of student fees, including housing and dining charges. This poses a myriad of systemic implications for student housing public-private partnerships given the complexity of the business relationships that exist with this type of arrangement. While universities with wholly-owned housing portfolios will certainly suffer the effects of refunding millions into tens of millions of dollars for housing fees, universities with these types of arrangements, on the other hand, will face unique financial and operational challenges.Because of the various entities involved in a student housing public-private partnership, the management and effects will not simply be confined to a campus. Between ownership entities, operating firms, investors, underwriters, and various campus departments, there will plenty of shared distress to go around. In some cases, the host university has picked up the bill for refunds given to students mandated to vacate while in other cases the project itself may dip into their own reserves to cover this.S&P Global and Moody's Investors Service have already negatively downgraded the outlook for multiple privatized student housing projects given the precarious situation that colleges and universities will face with the challenges of paying debt service. The uncertainty with how the 2020-21 academic year will play out adds to the situation. If institutions decide to go to fully remote, it will quickly put these P3 campus projects in financial risk. Financial stress will still occur even if there are plans to open, but with decreased occupancy to conform to social distancing standards. Given the partnership dynamics that exist, any direct or subordinate personnel expenses will be affected negatively resulting in the potential for position layoffs. Additionally, any net revenues contributed to the university will essentially be eliminated should debt covenants not be met. This will have ripple effects throughout the institution as those funds are utilized for operational expenses, discretionary projects, and even student scholarships that feed a recruitment and retention strategy.One advantage of these privatized halls, though, is that they generally provide the apartment-style housing that, in most cases, is better suited to accommodate the types of conditions to help slow the spread of COVID-19. Apartments with single bedrooms, bathrooms, and full kitchens can easily house two to four students each unlike large residence hall buildings that can house dozens to hundreds of students on a single floor. Universities that have P3 arrangements with affiliates with apartments are better positioned to permit students to remain with a certain level of social distancing that can not necessarily be accommodated elsewhere. Additionally, institutions that successfully navigate occupancy management decisions and responsibly balance business operations within the Centers for Disease Control guidelines, certainly will weather the storm quicker.Given the ability for the higher education industry overall to bounce back from the pandemic financial crisis, analysts are relatively confident that student housing will return to normal in regards to a cash flow, construction, and credit standpoint. P3 projects are typically positioned to maintain reserves that can help to alleviate short-term financial distress. Also, given that the universities will typically step in to help with a short-term emergency, the outlook is more encouraging. Seeing the hope for a vaccine on the horizon, the stress on P3 communities likely is only temporary and should not extend over the course of multiple years.
Scott M. Helfrich, D.Ed., is the director of housing and residential programs at Millersville University in Pennsylvania. He is also the owner of Helfrich Advisory Services, LLC.
