MIAMI—Interest in public-private partnerships related to real estate continues to grow. Alexander I. Tachmes, a partner in the Miami office of Shutts & Bowen, where he is chair of the land use and government relations practice group and a member of the real estate practice group, has been receiving numerous inquiries from clients about P3s.GlobeSt.com recently caught up with him to learn more about trends in this area.
Why are public-private partnerships so popular right now?
For some time, public-private partnerships have been an attractive vehicle for local governments seeking to develop capital improvements but lacking the money to do so. Due to the current economic downturn in the US as a result of the coronavirus, the attractiveness of P3s to local governments should increase as funds available for municipal capital improvements go down sharply. Similar to investors who pursue the acquisition of distressed assets during an economic downturn, developers can position themselves during this economic crisis to intensify their attempts to engage in P3s with local governments that have significant capital improvement needs.
In Florida, P3s have been used by local governments for many years as an advantageous mechanism to develop new capital projects. For example, in 1997, the City of Miami Beach and its community redevelopment agency entered into a large P3 transaction with Loews Hotels for the development on public land of an 800-room convention center hotel under a 100-year ground lease. Over the years, many more P3s have been attempted and consummated all across the State of Florida. Although the city codes and charters of many municipal governments have provisions that govern P3s, the popularity of P3s received a boost in 2013 when the Florida Legislature adopted Florida Statute Section 255.065, which expressly authorizes local governments to enter into P3 transactions and sets forth basic parameters for such deals.
One of the most common reasons for a city to enter into a P3 is a lack of funding to undertake necessary capital improvements. As indicated above, lack of public funding to construct needed capital improvements has likely intensified due to the current pandemic. Assume, for example, that a city needs to construct a new city hall and police station complex. The existing city hall and police station may be old, structurally unsound and in need of a multi-million dollar refurbishment (or replacement). The existing city hall and police station may not provide adequate space to meet current needs, may not be equipped with the latest technology and may not be environmentally friendly. Although the above factors clearly justify the need for the city to construct a new city hall and police complex, it is possible that the city does not have the funds to build it and is unwilling to raise taxes on its residents for that purpose. In such a situation, a P3 can be an excellent way for a municipality to obtain brand new facilities without spending any city funds. As part of a P3 transaction, a city can solicit bids for a developer to construct a new city hall and police station in exchange for providing the developer lucrative property rights on other city-owned land.
What are some advantages of P3s?
There are multiple advantages to entering into a P3 transaction with a local government. First, in most P3s, a city transfers possession of its land through a ground lease rather than a purchase of city property. The ground lease format allows the developer to obtain site control with dramatically less up-front costs than in a purchase. In fact, if the property in question is located in a community redevelopment area, the CRA is allowed to ground lease the property to a developer at below fair market value. For example, assume a city and a developer enter into a ground lease transaction for the construction of an affordable housing project on city land. The ground lease can provide for a graduated rent structure where the rent is very low in the first few years while the apartment project is going through its stabilization period.
Second, if the subject property is owned by a CRA, the CRA will often subsidize the construction of the project. Depending on the funds available to the CRA, including its bonding capacity, a CRA could subsidize a potential project with millions of dollars in public funds. The subsidy obviously brings down the costs for the developer and increases the developer’s potential rate of return on its investment.
Third, the locations of properties offered by local governments for development are often in advantageous, centrally located areas of a city.
Fourth, because the property in question is owned by the city or the CRA, a developer under a ground lease often benefits from much more favorable and flexible zoning parameters than if the developer was developing a project on private land. For example, it is common for local governments to give themselves the right to waive zoning and other development regulations on projects built on government-owned land.
What are the potential risks of P3s?
Although there are multiple risks for a developer who desires to enter into a P3 deal (as there is in any real estate transaction), one of the most significant and unique risks of a P3 is the political aspect of the pre-development phase. Even if the project appears on paper to be an excellent project for the city, the transaction will fail if there is insufficient support by the city council or other governing body. A lack of political support can be based on many variables. For example, a developer may have had multiple productive meetings with the mayor or commissioners of a city before submitting its P3 proposal. Then, six (6) months later after submission of its proposal and the expenditure of tens of thousands of dollars, the developer may learn that its project has been terminated by the city commission due to major public opposition to the project at the first public hearing.
Another major risk is the competitive bid process. Regardless of whether a developer is responding to an RFP or the developer proceeds with its own unsolicited P3 proposal, other bidders may submit competing proposals in response to the RFP or during the required notice period following the city’s receipt of an unsolicited proposal. The city can select another proposer or even reject all proposals and choose not to move forward.
Even though there are material pre-development risks in trying to consummate a P3 deal, a developer seeking to do such a transaction must still spend substantial amounts of money and time in preparing the detailed P3 proposal and hopefully getting selected by the city. Local governments usually require P3 proposals to contain a detailed description of the proposed project, including architectural plans, financial budgets for construction and operations, traffic studies, evidence of financing capability, full information on the development team and its consultants and other factors. Moreover, a city usually requires that a substantial application fee and deposit (sometimes $50,000) be submitted together with the proposal to cover the city’s costs in reviewing the application and performing due diligence and possibly hiring outside consultants for those tasks. All the above expenses (and others) are incurred before the city decides whether to proceed with the P3 deal.
What steps can a developer take to mitigate its risks in the pre-development phase of a P3 transaction?
Although there are multiple pre-development risks in submitting a proposal, a developer can take key steps to mitigate that risk. As indicated above, the uncertainty of the political process is a major risk. Before expending time and money on submitting a proposal, a developer should meet individually with each commissioner and the city manager to ensure there is political support for the project. At the same time, the developer should interact with community groups to assess support. If the potential project does not have political support, a developer can walk away without risking funds or much time.
An analysis of the zoning code, city code and charter should be performed before preparing a P3 proposal. In some cases, even if a P3 proposal is selected by a city commission, the proposed project may trigger amendments to the zoning code or comprehensive plan, which entail multiple steps and public hearings. In fact, some transfers of land by a city require the approval of the electorate in a city-wide referendum. A developer should carefully assess the legal requirements under the zoning code and other laws before proceeding.
If a developer proceeds with an unsolicited proposal rather than responding to an RFP, the former route can reduce the risk of losing to competing bidders. Even though legal notices are required to be published inviting other bids when an unsolicited proposal is received, other bidders may not be aware of the published notices or, even if they are aware, they may not have adequate time to submit a competing proposal. The window of time to submit competing proposals can be as little as twenty-one (21) days under the Florida Statutes.
If a developer who submits a proposal is selected by the city as the top or only bidder, there are still numerous steps required before a binding ground lease, development agreement and other documents are negotiated, documented, voted on at public hearings and hopefully approved. To mitigate the financial risk of spending substantial transaction expenses between selection of the proposal and execution of binding agreements, a developer can try to negotiate a “break-up fee” where the city would agree to reimburse the developer for all or a portion of its transaction expenses if the negotiations are later terminated due to no fault of the developer. Similarly, a developer can request that the city agree in writing to give exclusive negotiating rights to the selected developer for a period of time. An exclusive negotiating phase can mitigate the risk of the city negotiating with other developers, who may be following the status of negotiations through updates at commission meetings and who may be providing allegedly better offers.