Imagine yourself embarking on a cruise. As you board the ship, you meet the captain. Shortly after, you meet the cruise director, who is in charge of your experience on the ship. The cruise director is the person you are interacting with regarding entertainment. The captain makes announcements and joins you at a formal dinner. The cruise director radiates charisma, while the captain exudes silent dignity. There’s a reason why both of these jobs exist, and you don’t assume the skill sets are interchangeable. It seems intuitive, but what does this have to do with the risk of higher education?
Public-Private Partnerships: Opportunities and Risks
Institutions are increasingly relying on Public-Private Partnerships (P3s) to build out their student housing portfolios. The private partner typically assumes responsibility for the upfront capital costs and long-term maintenance expenses. This financing model shifts millions of dollars in financial exposure away from the university’s balance sheet, but it does not come without risk. P3 agreements require university personnel with a solid understanding of financial modeling, contract law, operational oversight, and risk management. One risk that can be overlooked is ensuring that the right personnel are included in critical decision-making and financial reporting. Without this knowledge, your institution could be steered by cruise directors into a financial risk iceberg.
Why Use a P3?
A P3 is a rational outcome from a student housing make-or-buy analysis. Universities typically lack the in-house expertise to construct a large new student housing facility. Between permitting, following modern design requirements, and managing construction companies, it is a complex and time-consuming process. Furthermore, operational management and maintenance become the private partner’s responsibility. To achieve a successful P3 partnership, institutional leaders should consider the following insights.
The ideal spokesperson for P3 housing performance should have experience in both student and business affairs, understand contractual obligations regarding data reporting, and be familiar with the complexities of P3 payment arrangements. Given that P3 agreements span 50-85 years, selecting the right representative is not only a critical risk management tool but also essential for the long-term success of the partnership.
How do you communicate the overall performance of the building to your institutional leaders? A fiduciary or board member might innocently ask, “How is the building doing?” If your answer sounds like, “Doing great, we are at 97% occupancy,” you should dig deeper. That answer betrays a critical misunderstanding of the accounting and finance terms.
Prepaid rent starts as a liability for a landlord until it becomes an asset. The rent revenue only becomes an asset when the period covered has passed. Universities typically bill student housing costs in the summer for the fall semester or during the winter intermission for the spring semester. Just because you billed a lot of money doesn’t mean you’re actually going to walk away at the end of a semester or rental period with the same amount.
For example, students leave housing for many reasons. A good student support program can mitigate some of that attrition, but some students need to leave their housing assignment. In many cases, they may receive a full or partial refund of their rent. Hearing about 97% occupancy at the start of the fall semester sounds excellent, but it’s not the whole story. Any change in that figure can create financial risk for the institution; and you may find that at the end of the billing period, the building made substantially less money than expected.
The correct answer to the question “How is the building doing?” frames occupancy in terms of economic occupancy and should include some manner of estimation in the response. An accurate or honest answer is this: “Right now, the building is 97% occupied, but we expect it to be an average of 90% overall this semester.”
This answer differentiates the current physical occupancy from the expected overall economic occupancy. For example, in the fall semester, billing and assignments tend to finalize in the month of July. Students move in during August, and the first payment on performance for a P3 might not be due until three weeks into the semester.
Accurate initial payments are essential, given that the new facilities lack operational reserves. This understanding will avoid high upfront payments that require later reconciliation, which creates cash flow risks rather than benefits. If student affairs cannot verify occupancy within three weeks, fundamental operational risks exist that require immediate attention.
A P3 is an equity partnership. Each party has a role in the success. The developer fronts the capital and maintains the long-term plan for the facility, while the operator, which is typically a student affairs unit, manages the student housing business. The student experience is, of course, critical.
Ensuring the building plays a role in the persistence and retention of students is the foundation for why a university would seek student housing in the first place. However, if the building is not functioning according to its business design, the developer will lose money. Businesses cannot exist if they do not make money. The need for an optimal learning environment and the need to generate income must exist in an equal partnership for any P3 to be successful. This is the nature of business.
Why Is This Important?
As a fiduciary or a board member, imagine being confronted at the end of the first semester by an angry P3 developer who is claiming they only made an equivalent of 85% occupancy off of their brand-new building, especially when many of the agreements for these buildings hold well known occupancy requirements. These are the kind of discrepancies that can produce ugly headlines and costly long-term risks for the university.
The Risk of Failure
P3s over the years have not always been successful. For example, consider the failure of Cross Village1 at the University of Oklahoma (UO) or the Texas A&M Park West2 project, which saw occupancy fall far below expectations. At UO, the bonds that financed Cross Village were downgraded significantly, and lawsuit threats between OU and the Bondholder Trustees made headlines nationally. At Texas A&M, rents had to be reduced by 30%, resulting in a very negative outlook from Moody’s Investor Services and potentially damaging Texas A&M’s ability to seek capital for future projects. The risk is not only financial but also reputational.
BOTTOM LINE
Student housing projects are complex. The famous saying, “If you’ve ever done a P3 before, you’ve only done one P3,” is a common refrain at trade shows to highlight the complexity of these projects. The difference is that the institutions have choices, and they ultimately agree to the terms before a shovel enters the ground. Therefore, to avoid unnecessary risk, industry professionals who understand occupancy modeling, financial structures, and contractual obligations need to be consulted in negotiations and ongoing management. Fiduciaries and board members must ask substantive questions about the project and ensure that the appropriate professionals are included at the table. Not doing so could be disastrous.
https://nondoc.com/2021/05/26/ou-cross-village-settlementleaves-bondholders-feeling-swindled/
https://www.bloomberg.com/news/articles/2023-07-06/texas-luxury-dorm-financed-by-bonds-falls-deeper-into-distress?embedded-checkout=true