Approaches to Financing
A turnkey delivery approach allows for tailored financing solutions that meet the specific needs of the building owners and occupants. Financing structures can accommodate the needs of project owners/occupants, whether they seek off balance sheet treatment, bridge financing or long-term facility ownership. This article includes descriptions of the most common financing approaches that are used within a turnkey delivery approach.
Approach 1: Concession/PBI Transaction (Availability Payment)
Concession/ Performance Based Infrastructure (PBI) with an Availability Payment is often used when a new asset cannot generate revenues that are sufficient to cover the cost of delivering the asset as reflected in debt service payments and return on equity investment, or if the project is viewed as a significant long-term income generator and the public sector wants to capture future revenues. An Availability Payment is used to transfer the project risks of delivery, O&M and lifecycle costs to the private sector while leveraging the credit strength of the public agency to create efficient project financing. As long as the private sector fulfills its obligations and makes the facility available for its intended use as defined in the performance specifications for the project, the public sector is obligated to make the Availability Payment. Failure by the private sector to meet prescribed standards can result in reductions to the Availability Payment.
“Debt providers require the private sector to inject more equity for an At-Risk transaction than an Availability Payment transaction for greater cushion in case the projected revenue levels do not materialize.”— Zoe Markwick, Societe Generale
This structure generally allows for high loan-to-cost ratios in the 80% to 90% range and flexibility to use bank or bond financing. Concession terms typically last anywhere from 25 to 50 years, with the private sector responsible for life cycle costs, including maintenance and capital expenditures, such that at the end of the concession term they hand back to the public sector an asset in good working order.
Bank Debt Bank financing in the current market will typically have a term of 5 to 7 years covering construction and the initial years of operation. Depending on the size of the transaction, bank debt may require the participation of multiple banks, as any single financial institution currently limits its funding to no more than $75 million per transaction.
As many as seven banks have participated in recent Availability Payment financings, including the Long Beach Court Building and Presidio Parkway in California. Bank debt is typically most attractive to those sponsors/investors who, in the short term, plan to transfer their interest in the concession or believe they will be able to return their investment through a recapitalization of the project. Bank financing does carry refinancing risk and the possibility of higher or lower interest rates at the time of refinancing. While underlying rates can move, the risk premium (margin) charged by banks typically decreases once construction is complete and the project has completed a few years of operations.
Bonds Taxable bonds represent a long-term financing option for both Availability Payment and At-Risk transactions (See Approach 2). Terms on bonds can go as long as 35 years, depending on the term of the concession. Based on market conditions, bonds can represent a higher or lower cost of capital than bank debt, but serve to reduce refinancing risk. Bonds are most attractive to sponsors/investors who intend to maintain their interest in the concession for the long term. Bonds typically are non-callable for at least 10 years, so while interest rates are fixed for the term of the bonds, they provide less refinancing flexibility to take advantage of reductions in interest rates during the first 10 years.
Equity The level of equity investment in Availability Payment transactions is typically 10% to 15% of the total project capitalization. Investor equity targets receipt of an internal rate of return (IRR) of 10% to 12% over the investment period.
There are some variations in the financing options available for projects, such as toll roads and bridges, which have the private sector taking real risk on the revenue generation of the project as a means to pay back the project financing. Generally, these projects bring more significant risk to sponsorship and require a much higher level of equity investment when compared to Availability Payment deals. Equity investment of 30% to 50% of total project capitalization is required for At-Risk deals. The debt making up 50% to 70% of the capital structure is typically in the form of Bank Debt, Private Activity Bonds and TIFIA (a form of low cost subordinated Federal funds).
Approach 2: Concession/At-Risk Operations (Toll Road/Tunnel/Bridge)
Bank Debt Bank debt for revenue risk projects has similar characteristics to bank debt on Availability Payment transactions except that loan-to-cost ratios will be much lower, in the 50% to 60% range.
Private Activity Bonds (PABs) PABs are a form of tax-exempt municipal bond available for both At-Risk and Availability Payment transactions in which a local government entity raises money for a private company. The municipality issuing the bond must be able to prove that a public benefit derives from the private activity bond in order to qualify for tax-exempt status. Private activity bonds generally are not guaranteed by the revenue of the municipality and they are used for projects such as housing, water and sewer, airports, road and rail. PABs, like other bond debt, have a long tenure but have limitations on repayment. The loan-to-cost ratio for PABs on revenue risk projects is similar to Bank Debt and is in the 50% to 60% range. PABs have been employed on many recent notable turnkey transactions, including I-95 Express, Capital Beltway Express Lanes, Midtown Tunnel, LBJ Freeway, North Tarrant Expressway, which were all At-Risk transactions, and the Denver FasTracks Eagle project, which was an Availability Payment transaction.
“When short term bank financing is used, the private sector assumes the risk of whether the debt will be able to be refinanced.”— Zoe Markwick, Societe Generale
Equity At-Risk Concessions, unlike Availability Payment transactions which have credit worthy governmental counterparties obligated to pay, rely solely on outside, third-party sources of revenues such as tolls or user fees to repay the cost of and return on investment. Due to the greater risk of revenue generation from these sources, At-Risk Concessions require equity to fund a higher proportion of the capital structure. Equity is typically provided by the sponsor entity with some participation from contractors and other investors. Equity IRR requirements for full revenue risk projects are in the range of 15% to 20%.
Approach 3: Built-to-Suite Operating Lease
The build-to-suit operating lease structure is common to standard commercial real estate with a major distinction from a concession being that at the end of the lease term, ownership of the asset remains with the private sector. The public sector either needs to renew its lease or vacate the facility. Financing options on build-to-suit operating lease transactions are quite flexible with the main drivers impacting the loan-to-cost ratio and interest rates being the credit quality of the public agency tenant and the financial strength and experience of the private sponsor.
The U.S. Department of Transportation used a build-to-suit lease structure for their 1.5 million square foot Washington, DC Headquarters, built in 2008.Bank/Institutional Debt
Bank/Institutional debt is available to finance the construction and early operations of new development under build-to-suit operating lease scenarios. This is the traditional method of finance for commercial real estate development. Whether construction financing or construction/mini-perm financing, banks, insurance companies and other lenders will provide financing for the construction period and up to 5 years of operations. The amount of debt that will be provided is dependent upon the credit quality of the public tenant and the financing strength of the borrower. If the borrower is willing to guarantee (recourse) a portion of the loan amount, they can typically borrow more than is available on a non-recourse basis. Generally, loan-to-cost ratios for build-to-suit operating leases are in the 50% to 70% range with equity IRR requirements in the range of 7% to 15%, depending on the credit quality of the public tenant.
Credit Tenant Lease (CTL) Bond Financing CTL financing is taxable bond financing which is typically structured in a private placement transaction to institutional lenders such as insurance companies or pension funds who like the
Equity Equity investment can vary significantly in the build-to-suit operating lease market depending on the specific terms of the lease, the debt financing options available and the philosophy of the developer/sponsor. Equity investment can be as high as 100% cash (for certain pension fund investors) to no equity under CTL financing structures. Equity IRR requirements are dependent on the capital structure and credit quality of the public tenant, with a minimum IRR requirement in an
Approach 4: Capital Lease for Vertical Social Infrastructure
Capital lease financing is a method which is used to finance a number of Non-Federal public facility-types including schools, healthcare facilities, jails, municipal centers and stadiums. Capital lease financing can be utilized with a turnkey delivery approach to provide risk transference to the private sector for the delivery and operation of the project. Capital lease financing is typically in the form of either tax-exempt Lease Revenue Bonds or Certificates of Participation that are subject to annual appropriation. The term of these tax-exempt bonds are generally anywhere from 15 to 30 years depending on the asset type and the appetite of the government entity. Capital leases generally do not require a referendum for approval and can be entered into by State and local governments without voter approval.
There are numerous ways to finance infrastructure projects that employ a turnkey delivery approach. This financial flexibility makes turnkey delivery available to any project where there is value in the risk transference. If desired by the public, financing risk can also be transferred to the private sector, placing all the risk of delivering, operating and maintaining new infrastructure with the private sector.