1 STAFF REPORT
DATE: August 9, 2022
TO: Justin Hess, City Manager
FROM: Elizabeth Goldman, Library Services Director
SUBJECT: Review of the Public-Private Partnership (P3) Public Infrastructure Financing Model Being Considered for Potential Use in the Burbank Civic Center
RECOMMENDATION
Note and file.
BACKGROUND
The Burbank Central Library, built in 1963, has long been identified as a priority for replacement with a modern facility. As far back as 2002, the City considered a new Central Library to be an anchor for an updated Civic Center. The only component of that Civic Center plan to be completed was the Community Services Building (CSB) in 2008.
In 2020 and 2021, the City carried out an updated study, “A Vision for a New Burbank Central Library,” prompting City Council to give staff direction to pursue a viable way to finance the building.
Like many other cities, Burbank has struggled to identify funds to meet public infrastructure needs, resulting in a significant backlog of infrastructure projects that are estimated to cost hundreds of millions of dollars to complete . The City identified a local Transactions and Use Tax (TUT) as one method of bringing in additional funding. To that end, voters approved Measure P in 2020 to create a dedicated funding stream for infrastructure improvement and maintenance programs. Staff has been exploring models from other municipalities and has identified the public-private partnership (P3) model as another potential tool for use in moving forward complex, major projects.
BURBANK
PUBLIC
LIBRARY
2 An interdepartmental staff team is currently evaluating use of a P3 for the redevelopment of the Burbank Civic Center, a project that will include a replacement Central Library, replacement office space for the Administrative Services Building, new open space, parking, and affordable and market rate housing.
The purpose of this report is to introduce City Council to the concept and basic principles of the P3 model. The report presents the most likely version of a P3 to be suitable for Burbank’s project as a basis for Council’s later consideration of a Civic Center plan.
DISCUSSION
Introduction to P3s
Public-private partnerships take many different forms. This financing model has been applied to projects as diverse as toll roads, ferries and civic centers. As use of P3s has grown throughout the United States, they have become an important tool in the municipal toolbox to accomplish core goals such as stimulating economic development and building important community assets.
The use of the P3 model for new government buildings is relatively new in California but has multiple precedents , including the new Long Beach Civic Center, the Long Beach Courthouse, the Los Angeles County Vermont Corridor project, and the UC Merced 2020 P3 project. Other projects are in the feasibility or procurement stage, including the Potrero Bus Yard Modernization and Affordable Housing P3 in San Francisco. P3 projects usually involve significant public infrastructure of at least $100 million and can be much larger than that.
In the case of a project like the Burbank Civic Center, the specific type of P3 that is most relevant to understand – and is most prevalently used – is a model known as Design- Build-Finance-Operate-Maintain (DBFOM). This can be applied to a straight public infrastructure project; in Burbank’s case, the project under consideration is a “hybrid P3” involving both public infrastructure and housing. The housing in this model is privately owned and operated. The DBFOM takes the form of a contract between the public entity (Owner) that owns the public assets, including land – in this case the City of Burbank – and the developer and its partners (Developer).
This model brings the following potential benefits:
• Transfer of construction risk and long- term asset condition risk to a qualified development partner who invests at-risk equity and works to ensure the project goes smoothly in order to achieve the agreed return on investment. 3 • Optimization of costs across the asset lifecycle, from construction to preventative maintenance and replacement, and having committed funding in place to maintain the asset over a long period of time.
• Performance-based contracting that places the onus of the project success on the Developer while providing the Owner with predictability of payments and a means to rectify problems should they occur.
• Project financing that does not involve the Owner other than the Owner’s obligation to make agreed- upon payments once the project is built according to the P3 contract.
• In the case of a hybrid P3, leveraging of public investment to initiate significant private development, with revenue from the private development offsetting public infrastructure costs.
A DBFOM P3 generally involves the Owner and Developer entering into a contract of 25- 40 years, during which time the Developer is responsible for the design and construction, operations, and maintenance of the facility. During the operating period, the Owner makes regular payments (like a mortgage), not only paying off the project cost over time but also paying to ensure the building is kept in good condition. At the end of the contract, the Owner regains control of the facility and is responsible for continued maintenance or replacement going forward. “Operations” in the case of a P3, refers to facility management, not any service provided in the building such as library services.
P3 Principles
For a public entity to reap the full benefits of a P3, three core tenets must be met:
• The whole lifecycle of the asset is considered and planned from the beginning. • Risk is transferred to the party best fit to manage that risk. • The contract is performance-based.
Lifecycle
The first tenet of a successful P3 is consideration and planning for the entire lifecycle of an asset, in this case public buildings. The most common reason public assets are replaced is because they reach the end of their useful life. Sometimes this is accelerated by code changes that render the asset too expensive to retrofit, but regular deferred maintenance is often the culprit. Over time, municipalities make a series of incremental decisions that cumulatively result in a significant backlog of the type of work needed to keep facilities in good repair. Deferring maintenance makes assets deteriorate faster, necessitating further increases in maintenance budgets. The building condition can also have a significant impact on a municipality’s ability to provide services. 4 The DBFOM P3 model prevents asset deterioration by incorporating long- term performance of the asset into the contract. The Developer not only constructs the building or other asset but agrees to maintain it to a certain standard – including lifecycle replacement of major systems. Failing to maintain the facility condition results in payment deductions to the Developer, providing an incentive to keep up with maintenance. The Owner, meanwhile, has budgeted for and agreed to make payments to the Developer for this maintenance, preventing the kind of deferred decisions that have resulted in many civic facilities being in subpar condition.
Both parties contractually agree to routine and preventative maintenance plans , which are budgeted into the cost of the project. Approximately every 3- 5 years, a facility condition assessment is conducted by a third party, resulting in updates to the maintenance plan. At the end of the contract, when the Owner takes back management of the building, the Owner can be confident that it is in good condition and that no major investments should be immediately necessary.
Transferring Risk
The second tenet of a successful P3 is the risk remaining in the hands of the party best fit to manage that risk.
Public entities typically allocate resources on a pay-go basis, first paying for design, then contracting, financing and paying for capital works, then budgeting and paying annually for operations and maintenance. This is how Burbank has historically constructed its public buildings, a delivery method known as Design- Bid-Build (DBB). While a common model, the pay -go system silos the elements at various stages, often leading to delays between each step and adding risk that is entirely held by the Owner.
It may be possible to pass some of the risk during the design and construction period on to a private partner though alternatives to DBB such as Construction Manager at Risk (CMAR) or Design-Build (DB), but the P3 DBFOM model results in the least risk for the Owner over the lifecycle of the building from design through years of operation.
P3s are used to manage the risks of major projects, especially the risk of capital delivery (design and construction) and long- term asset preservation (maintenance and lifecycle replacement). This is in part achieved through involving the Developer, design- build contractor (DB Contractor) and facility maintenance service provider (FM Service Provider) in the process from an early stage. In a P3, the Develop er will typically create a consortium in the form of a limited liability corporation that includes the DB Contractor, who will design and build the project, as well as the FM Service Provider, who will operate and maintain the building over the course of the contract. 5 The DB Contractor is itself a group led by a general contractor and including architects, engineers, and other specialty designers. On behalf of the consortium, the DB Contractor agrees to deliver the capital project on time and on budget. The DB Contractor takes most risks associated with design and construction and bids accordingly. These risks may not include those best managed by the Owner, such as unforeseen ground conditions or regulatory certifications, for example, requirements of the California Environmental Quality Act (CEQA).
The FM Service Provider is typically a company experienced with performing operations and maintenance (O&M) including routine and preventative maintenance of facilities and grounds, custodial, security, parking management and/or other services required to meet the performance requirements of the P3 contract. The specifics of what this provider will handle and what might be retained by the Owner’s staff or subcontractors is negotiated as part of the contract, impacting costs. However, costs of maintenance will be incurred whether the Owner is handling them directly or the P3 Developer is handling them on the Owner’s behalf. A P3 Developer would not generally accept a contract wherein they were being held accountab le for contractually obligated work being provided by public employees.
As these roles relate to risk, the key is that each consortium member—the Developer, the DB Contractor and the FM Service Provider —participates in the design- development process, ensuring that design decisions consider not only initial costs and design objectives but also long-term cost, maintenance, and performance objectives. In this way, the whole lifecycle of the asset is evaluated and priced before the Owner signs the contract. Agreements the DB Contractor and FM Service Provider enter into as part of the consortium allow the Developer to track total project costs and optimize the entire lifecycle cost of the asset while meeting the Owner’s performance goals.
Performance-Based Contracting
The third tenet of a successful P3 is a well-written performance-based contract that spells out the rights and responsibilities of the Developer and Owner, including remedies and penalties for the Developer’s failure to perform.
The Developer has primary responsibility for solving issues during the construction and operating periods. During construction, if the Developer is unable to maintain the schedule, its lender must step in to cure the reason for the delay, and if that is not successful, ultimately the Owner can come in, at which point the Developer loses its rights to receiving its initial equity investment and any future returns on that equity.
6 Once the facility is built, the Developer is entitled to monthly or semi -annual payments from the Owner that cover O&M costs, capital debt service, and equity remuneration (in that order, known as a “waterfall”). These payments are subject to a key performance indicator (KPI) standard detailed in the P3 contract that is used to measure performance during the operating period and to estimate any performance deductions. The payments have been negotiated, giving the Owner certainty as to their maximum obligations over the contract period. This leaves the risk in the hands of the Developer.
The Owner can elect to retain some operations or maintenance responsibilities. P3s can accommodate this as long as the services being kept by the Owner are not critical to meeting the contractual performance requirements made by the consortium of the Developer, DB Contractor and FM Service Provider.
Financial Considerations
Along with the risk mitigation provided by the actions described above, the Owner of an asset receives benefits through the type of financing used in a DBFOM. Specifically, the Developer is generally responsible for securing the debt financing with lenders for the project, not the Owner. This benefits the Owner in a few ways.
First, the risk for the Owner is lower because the financing arrangement is between the Developer and the lenders. The Developer can only obtain debt financing if lenders have a favorable view of the P3 contract terms, including but not limited to the form and amount of at-risk equity committed and the DB Contractor’s security and other guarantees, as well as the Developer’s experience delivering P3s. The only role the Owner plays in t he financing is to provide the underlying credit through its contractual obligation to pay the Developer if everything is built according to the negotiated P3 contract.
Second, the maximum amount of each payment over the course of the contract is known up front, providing the Owner with predictability and stability for budgeting and forecasting. Any deficiencies in the Developer’s performance will be deducted from the Owner’s payments to the Developer. Cost overruns, schedule delays, insufficient O&M funds, unexpected maintenance and repairs, and overall Consortium performance are the responsibility of the Developer. The Owner has one party to deal with for all aspects of the Project over the term of the agreement.
Third, the Owner’s obligation to pay the Developer over the course of the contract is not considered debt. Rather, it would be listed on the Owner’s financial statements as a long- term payment obligation. This means the Owner does not take on the same potential impact to its credit rating as it would issuing debt. This preserves the Owner’s debt capacity for other projects as needed.
7 In some instances, the Owner may wish to finance the Project using public financing such as revenue bonds, certificates of participation, 63-20 bonds, and other tax-exempt bonds.
This should be done when the difference between the interest rates for taxable project financing (private) and tax -exempt financing (public) is large enough that it is not worth the added risk transfer of a DBFOM.
When this occurs, certain critical risks are not transferred to the Developer. For example, were the Owner to issue bonds, the Owner would ultimately be responsible for construction cost overruns should it not be able to recover the funds from the DB Contractor. If the project is not completed, the Owner (who is the borrower) still must start paying debt service. Also, for most types of public financing the Owner’s obligation to pay the debt service cannot be subject to performance deductions during the operating period – only abatement can be used in the case that the facility is not occupiable.
Legal Considerations
California Government Code section 5956 authorizes local governments to utilize private sector investment capital for carrying out “fee- producing infrastructure fac ilities.” There are no California state laws authorizing P3s that do not produce revenue. When projects are not fee- producing, P3s can be used by municipalities, but each situation must be carefully analyzed by legal experts.
For example, after legal analysis, the City of Long Beach decided to pursue State legislation clarifying that it had the right to pursue a P3 as a charter city. This legislation (SB562), once passed, gave Long Beach the flexibility to structure the P3 in negotiations with its development partner in a manner best fit for the City. City attorneys in other charter cities have determined that the S tate constitution already gives them the right to enter most types of P3 contracts. It is important that municipalities seek good P3 legal counsel to advise on the method of P3 authorization and the structuring and negotiation of a P3 contract.
Beyond P3 authorization, two other notable areas of law impacting hybrid P3 projects in California are the Surplus Land Act (SLA) and possessory interest tax (PIT).
Recently passed amendments to the Surplus Land Act require California municipalities to undertake a specific process when making a publicly owned site available for private development. The purpose of the amendments is to promote the development of affordable housing on public sites. However, municipalities retain the ability to use public land to achieve other goals, such as creating a revenue stre am to help pay for public facilities in a hybrid P3. The municipality must still undertake the pr escribed process but can include requirements related to the larger project goals in the notice to developers.
8 For example, the Los Angeles County Department of Public Social Services (DPSS) used a P3 to construct a new building, requesting that the private developer construct said building at no cost to the County in exchange for any excess development rights . The County’s Notice of Availability stated that t he sites were available contingent on the delivery of the DPSS building. T he State Department of Housing and Community Development (HCD) found the County in compliance, despite the responding Developer proposing limited housing development.
Possessory interest tax (PIT) can be levied when there is private revenue generation on public land or in public facilities that are typically not subject to property tax. In California, County Assessor’s Offices have the power to collect PIT and publish assessment policies.
A municipality that pursues a P3 must ensure that it and the Developer have a plan to defend against PIT for the public facilities, as this additional cost can hurt the viability of the public elements of the project. In a hybrid P3, property tax wo uld be levied on the private development as with any private development.
P3 Implementation
Given all the considerations above, implementation of a P3 – especially a hybrid P3 including both private development and public infrastructure – is a lengthy pr ocess.
Burbank is currently in the initial phase of defining the project and determining feasibility.
The general steps are (with general timeframes noted):
1. Define the project and determine feasibility (6-12 months) a. Define project goals, objectives, components, and requirements b. Identify site(s) and determine a conceptual design
c. Engage the community and stakeholders
d. Develop capital, operating and lifecycle replacement costs e. Determine affordability
Land use entitlements and environmental review (or compl iance) are required before procurement commences.
2. Procure development services from the private sector (12-15 months) a. Conduct a market sounding to ensure market conditions and the project scope are right to attract qualified bidders
b. Conduct outreach to the community and stakeholders about the process c. Pre-qualify a list of potential development partners through a Request for Qualifications (RFQ), followed by a full Request for Proposals (RFP) process for the pre-qualified shortlist
d. Select a preferred Consortium team
9 3. Exclusive negotiations (9-12 months)
a. Develop the design
b. Engage the community and stakeholders in the design and overall process c. Estimate costs, eventually locking in Developer’s fixed price d. Conduct financial modeling of intended deal
e. Draft and negotiate the P3 contract
4. Contracting, financing and construction (length depends on complexity of project) a. Commercial close (execution of the P3 contract by Owner) b. Financial close (financing is secured by Developer)
c. Construction
d. Substantial completion and start of operations
e. Final acceptance
5. Operations period
6. Handback period. In the last 2- 3 years before the assets are handed back to the owner, the Developer will make final lifecycle replacements.
At several stages throughout the process, the governing body of the municipality participates in decision making, notably at points where appropriation commitments are necessary, such as the selection of the preferred partner and commercial close.
FISCAL IMPACT
None.
CONCLUSION
The P3 model has the potential to provide many benefits to a municipality looking to develop public infrastructure in a fiscally responsible manner, as is being contemplated by the City of Burbank. These benefits include the transfer of risks for a major project; optimization of project costs over the asset life, not just initial costs; long- term ass et preservation; predictable costs spread over time without issuing debt; and spurring private development that offsets public costs (in this case by building housing that accomplishes other important policy goals).
A review of the proposed plan for applying this model to the Burbank Civic Center will be brought to Council this fall, tentatively scheduled for September 13, 2022.
ATTACHMENTS
None.