Privatized Housing Moves On-Campus

During the past two years, developers of privatized housing have created a financial concept based on nonrecourse, tax-exempt, off-balance-sheet debt that many institutions will find difficult to resist.

"CFOs love it," says Michael Godwin, president of Ambling Companies, Inc., a Valdosta, Ga., developer of privatized university housing. "This kind of financing means a university can provide new on-campus housing that includes all the latest amenities and technological advances, but does not place any debt onto the university’s balance sheet. What’s more, the university can participate in any profits generated by the venture."

That’s having your cake and eating it too.

An Idea Whose Time Has Come

Privatized housing has been around for years. But it’s only been during the 1990s, as university enrollments rose and housing budgets declined, that developers began seeing opportunities to tailor off-campus developments to the needs of students.

Ambling, for instance, will soon complete phase two of an 878-bed off-campus student housing development near Middle Tennessee State University in Murfreesboro, Tenn. Situated about one-quarter mile from campus, the development offers furnished two- and four-bedroom units, a clubhouse with a fully furnished computer lab connected to the campus and the Internet, a game room, exercise room, swimming pool, picnic areas and other amenities.

"Traditionally, students at Middle Tennessee State have gone off campus to rent," Godwin says. "We’re providing them with an opportunity to get a lease on a bedroom basis, which they can’t get elsewhere in the private market."

Godwin estimates that as much as 60 percent of today’s student housing development follows this off-campus pattern, but believes the balance will change with the maturation of new financing concepts for privatized housing built on campus. Ambling is planning several on-campus projects and has begun construction of one development for the University of Maryland in Landover.

Century Development of Houston pioneered on-campus privatized housing in the early 1990s. According to a recent New York Times article, Century developments now serve 19 colleges in seven states and house more than 13,000 students.

Market observers describe Century’s original approach as a variation on traditional multifamily housing finance. The firm would lease the land for the apartment site from the school and finance the project through conventional equity and debt instruments. The university would receive the student housing it needed and a modest cash flow from the ground-lease. Century’s profits would come from development fees, property management fees and an operating cost margin.

Balancing the Pros and Cons

More recently, other developers such as Ambling and Capstone Development of Birmingham, Ala., began to investigate the on-campus market in response to inquiries from colleges. "We analyzed the way privatized on-campus developments were financed and found problems with conflicting goals as well as opportunities for new forms of financing," says Michael Mouron, Capstone’s president.

The conflicts include the fact that a developer will want to set rents as high as possible for the market, while a university wants rents to remain as low as possible to accommodate students.

Ambling and Capstone executives also note four financing strengths that universities might bring to an on-campus residence hall development that could help to hold rents down. First, universities generally own land that can be used at no immediate or capital cost. Second, universities, both private and public, can use tax-exempt debt to build structures on campus, a tool not available to private enterprise. Third, because a housing asset produces a revenue stream, it may be possible to finance 100 percent of such a project with debt and eliminate the need to attract a relatively expensive 20 percent to 30 percent equity investment. Fourth, as nonprofits, universities don’t pay property taxes.

Taken together, these strengths can reduce the cost of capital. Capstone’s Mouron estimates that the interest rate on a package taking advantage of these strengths might cut 175 or more basis points off of what conventional financing could offer.

Keying on these strengths, developers are finding ways to structure on-campus housing finance in a way that allows these benefits to accrue to a university and its students while enabling the private developer to earn a profit as well.

Doing this requires a not-for-profit owner, according to Ambling’s Godwin. The school would qualify as a not-for-profit owner, but school ownership would require showing debt on the school’s books. In many cases today, schools operate under mandates not to add debt to their books.

"In addition, ownership by a school that is part of a larger state university system might lead to other problems," adds Mouron. "If such a university owned a housing development, any surplus paid to the school might be sucked back into the system rather than remaining at the host institution."

On the other hand, a university foundation often keeps its financial statements separate from its university parent. Could it serve as the not-for-profit owner? Mouron says yes.

On the other hand, a university foundation won’t always be able to do this. "You have to be careful about who controls the foundation," Godwin says. "If employees of the university make up the foundation board, then a rating agency would likely draw a line and say that the university is in control, which would mean that the debt would have to go onto the balance sheet. For this method of financing to work, the school and the foundation must have an arm’s-length relationship. If you have five people on the foundation board, three couldn’t work for the university. If only two work for the university, then you could argue that the university doesn’t control it. In addition, it’s also important that housing be a part of the foundation’s charter."

How It Works

While Ambling and Capstone have been working out their concepts for privatized housing finance, the state of Georgia embarked on a similar undertaking. In 1997, the state funded a study of student housing financing options. The Board of Regents, which oversees the state’s 34-school university system, the state Attorney General and Southern Polytechnic State University, conducted the study.

"The goal was to find a financing concept that could provide apartment-style housing for students through a financial structure that allowed no recourse against the state and so wouldn’t affect the state’s bond rating or borrowing limits," says John Hosey, vice president for business and finance at Southern Polytechnic. "Nonrecourse, off-balance-sheet debt was a critical issue for us."

The study led to a Request For Proposal (RFP) to construct and manage a student housing complex on the Southern Polytechnic campus. Forty firms responded to the RFP. Only three produced a workable concept for nonrecourse, off-balance sheet funding. Capstone won the project.

The developer searched for a 501 (c) (3) not-for-profit foundation that would serve as the project’s owner. The company originally approached the Southern Polytechnic Foundation. But that group’s charter involves raising money for scholarships and providing other forms of support for the university. Nothing in the charter relates to housing.

Capstone turned to the Atlanta-based Piedmont Foundation, whose charter includes low-cost housing. Piedmont agreed to participate in the project by taking ownership and serving as the conduit for tax-exempt bond financing. The issue sold out in 24 hours and raised $8.5 million.

Construction began in March of 1998. The project, completed in August of that year, consists of six units with 288 beds, evenly divided between four-bedroom and two-bedroom apartments.

While Capstone managed the financing complexities, the construction and the property management services, university officials paid close attention to the ground lease, which defines the contractual and financial relationships of the project.

Under the pro-forma contained in the ground lease, Capstone received a developer’s fee for the project. Rents flow through Capstone’s property management office, which pays operating costs for the project and provides a specified margin of profit for the property management services. In addition, a monthly contribution flows into a maintenance and repair reserve fund, also managed by Capstone.

The university and Piedmont, the foundation-owner of the property, will split the remainder of the revenue, with 10 percent going to Piedmont and 90 percent going to the university as a ground-lease payment.

Lessons Learned

Hosey cautions that the structure of such a deal must treat the foundation-owner as more than a conduit for funding. "The foundation has management responsibilities," he says. "Cutting the foundation out of management could endanger its tax-exempt liability. It must be an active participant. For example, in our original draft of the ground-lease, Piedmont would have received a flat $10,000 fee every year for 30 years. Of course, the future value of a flat fee is minuscule, and our attorneys told us that such an arrangement would give rise to questions by the IRS as to whether the foundation was simply a straw-man. So we changed that part of the ground lease to the percentage split. In addition, the foundation has authority over Capstone as the property manager."

A university must also be careful about income derived from a housing project or risk questions about unrelated business income tax (UBIT). "We avoided this problem by limiting the market to certain students," Hosey says. "We didn’t want this to be a housing project for anyone who wanted low-cost housing. So we limit availability first to our students, second to students within the University System of Georgia, and third to any student registered in an accredited university."

Hosey goes on to say that the existing ground lease fails to account for several issues that can prove troublesome. First, security issues were not covered. "Security should have been a part of the pro-forma," Hosey says. "Because we left it out, we have to pay for security by discounting the income to the university.

"Another thing we learned is that we need language in the ground lease on how to arbitrate disagreements between students and the management company. We did mention involving the vice president for student affairs in dispute resolution, but as a practical matter that isn’t working. We need to have a formal process that students can follow to air grievances."

While structuring many complex issues and relationships in the ground lease represents a continuing challenge of this form of privatized on-campus housing, Hosey praises the financial performance of the project. "I think that our pro-forma income for this year will be double the original projections," he says. "Some of the cost centers won’t be as high as we projected, especially in the area of maintenance. In addition, our revenue is high. The pro-forma listed break-even as 68 percent occupancy and income goals based on 85 percent occupancy. But the units are 100 percent full, and there is a waiting list. So I’ve been pleased."

Michael Fickes is a Baltimore-based freelance writer with experience in higher education issues.

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