How COVID-19 May Change Universities' Use Of P3s

By Yukiko Kojima and Josh Burke
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Law360 (December 2, 2020, 4:31 PM EST) --
Yukiko Kojima
Yukiko Kojima
Josh Burke
Josh Burke
In recent years, universities have used public-private partnerships, or P3s, to deliver various types of campus capital and maintenance projects, including projects for student housing, academic and recreational facilities, utility systems, and even overall campus expansions. Using P3s for campus improvements has allowed universities to build important projects, and leverage private industry expertise and capital.

Despite this growing trend, the COVID-19 pandemic may have an impact on universities' appetite for using P3 models for campus improvements in the near future. Two interrelated factors that could affect the attractiveness and feasibility of university P3s are potential revenue reductions and declines in demand for the facilities constructed.

Early data on fall enrollment for the 2020 school year indicates a significant decrease in overall undergraduate enrollment, which will likely result in revenue decreases for many universities. Significant decreases in the number of out-of-state and international students for public universities could especially hurt university budgets.

Furthermore, a Moody's Corp. report released this year predicted a slowdown in the student housing P3 sector, in part due to concerns about on-campus housing demand softening as COVID-19 forces many students to continue to learn off campus.

However, even in the face of such uncertainty, P3 project delivery can allow universities to leverage the flexibility afforded by P3 models to continue progress on campus projects amid these challenging times. One advantage of P3 project delivery is that it can allow owners to defer certain capital cost investments. With tighter budgets, universities may seek to engage the private sector to finance capital outlays — especially for larger capital projects that may not be sensitive to short-term enrollment declines.

For projects that may not generate significant revenue through operations — or for which revenue forecasts are less certain — universities can retain the revenue risk and use the availability payment P3 model to make contractually specified payments to the private partner through the operating period. In addition, the availability payment model incentivizes private partners to deliver quality projects, as the amount of the private partner's payments depends on the improvements performing to contractually specified standards.

An example of a project delivered using the availability payment P3 model is the University of California's $1.3 billion Merced campus expansion project, completed in June. The project roughly doubled the size of the campus, with the delivery of student housing, academic, research and recreational facilities, a central utility plant upgrade, and other infrastructure to support the expanded campus.

The developer received progress payments for a portion of the design and construction cost through the construction period, and receives availability payments for completed facilities through the 30-plus-year operating period. The facilities were delivered in three phases, to allow for early delivery of the most urgently needed facilities before overall completion in 2020.

While the project leveraged an availability payment structure to deliver a massive project that reshaped the university's campus, this structure can also be used to deliver single buildings and other more targeted projects. California State University, Fresno's, planned design, build, finance and maintain project for the replacement of its central utility plant in return for availability payments offers an example of a project with a more limited scale.

Several universities have leveraged their existing utility infrastructure by entering into P3 deals that provide for the private partner to make a large up-front payment to the university, and then operate, maintain and make capital improvements to the utility infrastructure facilities.

Given the current pressures on university budgets, these deals may be particularly attractive to universities desiring both an injection of cash and upgrades to utility facilities. Both Ohio State University and the University of Iowa have entered into agreements with private partners in which the private partner makes an up-front payment to the university of more than $1 billion, and receives fees to operate, maintain and make capital improvements to the university's existing utility system for 50 years.

These fees are comprised of an annual fixed fee — escalated after an initial period — plus an operating and maintenance fee, and a variable fee for capital improvements to the utility system. In early November, the University of Idaho's board approved a similar deal with a private partner that includes a $225 million up-front payment to the university.

While this particular deal structure will not be appropriate for every university or situation, these deals offer examples of how P3s can be structured to allow universities to monetize essential assets that are not central to a university's educational mission, while still upgrading the assets and ensuring that they will be operated in a manner that meets the university's long-term needs.

Even in light of potential challenges for student housing P3s, some universities have forged ahead with projects. The University of Washington and the University of Oregon both recently reached financial close for student housing P3s. While some universities have continued with their planned student housing P3s, it seems that COVID-19 will have a lasting impact on the structure of such deals going forward.

Universities have often structured student housing P3s as revenue-risk deals, with the private partner bearing all, or the vast majority, of the risk of reduced demand. The university shutdowns last spring fundamentally disrupted the basic assumption of revenue-risk student housing P3s — namely, that most university students would attend classes on campus. As reported by Moody's, in light of the changed circumstances, some universities have worked with student housing P3 partners to mitigate the partners' financial losses.

Though universities and their private partners could not have foreseen COVID-19 and its impacts, it seems likely that future student housing P3 agreements, and other campus revenue-risk P3 agreements, will address the potential for shutdowns and place limits on the risk of revenue losses that the private partner will bear. Such contract terms will obviously benefit private partners, by limiting the risk of their investments.

However, negotiating the terms to address catastrophic events up front will also benefit universities, by providing some clarity as to how those events will be handled, rather than the scrambled negotiations in which many universities have found themselves. Also, such terms will allow universities to better manage and understand their retained risk in revenue-risk P3s, as COVID-19 has revealed practical limits to the risks that universities will require their private partners to bear, regardless of contractual terms.

Furthermore, placing reasonable limits on private partners' risk exposure could also entice investors and developers to commit to P3 projects that the investors and developers may otherwise consider too risky.

Though the COVID-19 pandemic has disrupted how universities approach and plan for campus building and improvement projects for the foreseeable future, with the appropriate structure and risk allocation, P3s can allow universities to continue to tap private sector expertise and capital to progress campus improvements, despite short-term uncertainties over revenues and demand.

Yukiko Kojima is a partner and Josh Burke is an associate at Nossaman LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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