October 24, 2013
Interviewed by: Privcap
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Capitalizing on the Public-Private Partnership

Public-private partnerships have created some of the most iconic real estate landmarks in the US, and the world. But for Columbia University’s Professor Lynne Sagalyn private capital more than just patience in executing on PPP deals.

Public-private partnerships have created some of the most iconic real estate landmarks in the US, and the world. But for Columbia University’s Professor Lynne Sagalyn private capital more than just patience in executing on PPP deals.

Capitalizing on the Public/Private Partnership

With Professor Lynne Sagalyn of Columbia University Graduate School of Business

 

What makes a successful public/private partnership?

 

Lynne Sagalyn, Columbia University Graduate School of Business:

In my assessment, what defines a public/private project is when both sectors are putting capital at risk.  The public sector has the land and has the embedded value of that land, which it may choose to sell at market rates or not, but then seek benefit package to make up that difference, whether it be public parks or land set aside for schools or any number of other agenda items.

 

Because the public and private sectors have different bottom lines, often they work out mutually agreeable transactions because they’re each seeking something different.  In the big picture, their objectives are very much aligned.  And that’s true with Hudson Yards, where it’s debatable whether the land’s price is market.  When private developers acquire land from the public sector in a public/private project like Hudson Yards, it’s not a land sale price.  It’s the acquisition of a development opportunity, which carries with it rights and obligations that make a whole package of transaction value.

 

These projects are very large, and they often acquire not just one source of private equity, but multiple layers.  If they’re phase projects, such as Hudson Yards, not every private-equity player in Phase 1 wants to be in Phase 2 or 3.  It’s a long-distance kind of run for both public and private sectors.

 

Does private capital need to underwrite additional risks beyond realestate development? 

 

Sagalyn: Absolutely, because if you take the conventional public/private project with a certain amount of political risk, it depends whether approvals are in place.  Clearly, if there are no approvals in place, the GP has a different kind of underwriting.

 

You have to underwrite time—these projects take a very long time.  If they go through more than one political administration, either at the city level or gubernatorial level, that can often cause delays because not every administration picks up where the other left off.  Some don’t even want to pursue a project.  The private capital has to be very patient.  Large-scale public/private projects are not for the faint of heart or for immediate profit.  They are long-term value creation transactions.

 

Considering the risks, why do public/private partnerships?

 

Sagalyn: There’s nothing like them.  That’s a question for private and public-sector developers.  Why do we live in cities?  Why do we choose certain environments over others?

 

The private sector does not or cannot do certain things, because it doesn’t offer a financial reward commensurate with the risk.  I could name lots of projects:  Time Warner Center, 42nd Street, and Times Square wouldn’t be here with public/private projects. Battery Park City and Atlantic Yards wouldn’t be around.  These environments are special—they are created out of a special joint venture relationship between public and private sectors.

 

Often, private developers do them because they’ve done everything else and they want a pinnacle project.  They want to leave a legacy.  I have seen this over and over, where private developers have done a huge amount of projects, they have tremendous portfolios and many millions of dollars in the bank, but there’s something very special about building a fabric of a city.  Ask any developer—they will say they are very proud of that pinnacle project more than some of the others.

 

Where’s the opportunity for public/private partnerships, or P3s, as many people call them?

 

Sagalyn: I don’t care for the term “public/private partnership” because “partnership” suggests it’s an equal sharing, and it never is a 50/50 balance.  Each sides gives in portion to their resources, and some resources are quantifiable, some aren’t.

 

The real opportunity for the private-equity investors is on the infrastructure side, less so on the economic-development side.  The U.S. has an amount of deficit investment on infrastructure. State and local governments are obviously fiscally pressed.  The rest of the world—in particular, Australia, the U.K., and Canada—have shown that you can finance and build significant amounts of infrastructure through P3-type agreements.  They’re complex, they must be carefully structured, and the contracts require a tremendous amount of sophisticated skill.  But, infrastructure doesn’t last forever, so the potential for private equity to fill this gap is quite large and is already beginning to funnel some money into that area.

 

Are public/private partnerships just for the 24/7 gateway cities?  What about the “Detroits” of the world?

 

Sagalyn: Let’s put Detroit aside for a moment.  Public/private approach to economic development to city building has been going on in all sizes of cities for the past, since the ‘80s; hundreds of little cities.  That was pioneered by the federal Urban Development Action Grant Program: it taught cities how to negotiate with private developers to build hotels and large-scale projects for that size city.  This is not just confined to the gateway cities.  Not at all.

 

Cities like Detroit have been attracting private capital into the downtown area.  Some well-known media articles have been written on the acquisition by a couple of developers and investors in property in Detroit.  Detroit is a different situation—it’s a city where demand has collapsed, people have fled.  You must rebuild the economic structure of the city and a single public/private project is not going to do it.  You have to have faith that there’s a competent political administration.

 

One thing private equity always looks for in these kinds of project investments is leadership: leadership from the mayor, or the governor, or the City Council that there’s support for this kind of project.  When Detroit gets its act together and has fiscal stability, maybe there will be a turn of events.

 

Clearly, Newark has had a turn of events: in recent years, there has been great faith in Cory Booker and his mayoral administration to provide a stable and direct leadership, which is essential.  Private equity has to look to that.  Without that, it’s a great risk.

 

Can public/private partnerships be measured on a performance basis?

 

Sagalyn: There are lots of success stories, but it seems much sexier to write about problems.  Unfortunately, there isn’t much performance evidence on the success.  You know it’s a success when you see people coming and it’s fully tenanted and the shops are very dynamic—you can tell it’s successful in that way.  But, interestingly, there are very few studies of the performance of these projects.

 

I did one on Faneuil Hall Marketplace years ago, and there haven’t been many done about the success.  If they’re a failure, nobody wants to spend time doing a study, except academics—we do things like that.  If they’re a success, who’s asking for a study?  It’s evident.

 

 

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