Leveraging Public-Private Partnerships for Real Estate Development: Beyond Bridges and Roads

Presenting a live 90-minute webinar with interactive Q&A Leveraging Public-Private Partnerships for Real Estate Development: Beyond Bridges and Roads Identifying New Project Opportunities, Structuring Deals, Navigating the Procurement Process and Financing THURSDAY, AUGUST 14, 2014 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Steve T. Park, Attorney, Ballard Spahr, Philadelphia D. Hara Sherman, Attorney, Goulston & Storrs, New York Linda E. Carlisle, Partner, Miller & Chevalier, Washington, D.C. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

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Leveraging Public-Private Partnerships for Real Estate Development: Beyond Bridges and Roads Steve T. Park, Esq. Ballard Spahr LLP parks@ballardspahr.com 215.864.8533

Introduction to P3s Public-private partnerships (P3s) are an innovative method of funding, delivering and procurement for infrastructure projects. P3s are used for a variety of infrastructure asset types. A contractual agreement between a public agency and a private entity to achieve all, one or a combination of the following: Monetize an existing infrastructure asset. Design, construct, finance, and/or operate and maintain an infrastructure project. Transfer risks such as revenue, operations, environmental, labor, construction to the entity best able to retain and manage them. 6

Reasons for Greenfield P3s Design-Build Savings reduced construction costs Operations and Maintenance Savings reduced O&M costs Private Sector Financing longer-term debt and wide array of financing tools; access to private capital Accelerates project delivery Asset is still owned by public agency, which retains tight control on toll rate setting, O&M standards etc. Long-Term Risk Allocation and Transfers Long-Term lease provides tax benefits to private partner that can flow through as savings to public agency. 8

Key Considerations for Greenfield Projects Transit/Rail Projects Slower Project Delivery Fare Box Revenue Risk Additional Financing Sources (FTA New Starts, FRA RRIF) Social Infrastructure Projects Lack of Revenue Stream Different Class of Project Sponsors Smaller Projects 9

Key Considerations for Greenfield Projects Availability Payments Long-term agreement with fixed periodic payments to private party for DBOM/DBFOM of certain facilities and/or services Availability payments are typically not paid until construction is complete and the project is made available to the public agency Private parties do not bear revenue risks and have greater certainty as to return on investment. 10

Types of Non-Road P3 Projects Greenfield Projects Transit/Rail Projects (Denver Union Station, Eagle P3 FasTracks, Purple Line, Edmonton Light Rail) Social Infrastructure (Long Beach Courthouse, Alberta Schools, UC Merced, Indianapolis Justice Complex) Brownfield Projects Utility (Allentown Water/Sewer, Philadelphia Gas Works) Parking (Ohio State University, Harrisburg) 11

Reasons for Brownfield P3s Operations and Maintenance Savings reduced O&M costs Asset is still owned by public agency, which retains tight control on toll rate setting, O&M standards etc. Long-Term Risk Allocation and Transfers Fiscal reasons - budget tension, underfunded pensions Policy reasons 12

Key Considerations for Brownfield Projects Additional public scrutiny Clear and careful procurement Legislative approvals Lessons learned from other jurisdictions 13

Major Risk Allocation Issues Procurement Issues: best value analysis vs. lowest cost Delay Events Compensation Events Force Majeure Events Defaults and Remedies Termination 14

Construction Related Issues O&M of asset during construction Control of design/construction Early works Delay events Acquisition of Project ROW, utility relocation Permits and approvals Substantial completion/segment completion Liquidated damages 15

O&M Related Issues Ongoing Capital Expenditures Procedures relating to maintenance Public Entity's right to oversee work Access and inspection rights Noncompliance points Handback 16

Industry Sectors Infrastructure Underutilized Government Real Property (including urban renewal sites) Housing (military, affordable, student, etc) Renewable Energy Social Services Social Impact Bonds Goulston & Storrs 2014. All rights reserved. 18

Underutilized Government Property - Local Real estate structures in local government deals (including urban renewal sites): Fee Transfer; Ground Lease; Sale Leaseback; Commercial Condominium Enforcement mechanisms: Deed reverter; deed restriction; escrow; guaranty; monetary penalty; operating protocol Goulston & Storrs 2014. All rights reserved. 19

Underutilized Government Property - Federal Authority to Leverage Department of Defense Real Estate Assets. Congress gave Enhanced Use Lease (EUL) authority to DoD, NASA and the Department of Veterans Affairs. This allows the government to grant long term leases of underutilized, non-excess property to private parties in exchange for cash and/or in kind consideration equal to the fair market value of the leasehold interest. In-Kind Services. EULs may be granted in exchange for development of improvements and/or the provision of services (e.g., construction of renewable energy facilities and provision of power to the military base, with a right to sell surplus energy to electric utilities). Developer Initiated Project. Unlike the Military Housing Privatization Initiative, where DoD initiates the project, EUL transactions can originate with the Developer, who brings the idea to DoD, the VA or NASA. Goulston & Storrs 2014. All rights reserved. 20

Military Housing - Structure Ground Lease and Conveyance: Government conveys fee title to the housing and leases underlying land to public-private venture (PPV) for 50 years. Lease to Service Members/Housing Allowance: PPV leases the Private housing to service members, who have a first right to rent the units and whose rent is equal to their basic allowance for housing (BAH). Securitization of Rent Stream: PPV pledges the stream of income generated by the rents to raise millions in private debt. Project Management: PPV develops, constructs, renovates and manages military housing for 50 years. Fee ownership of improvements reverts to government at the end of ground lease term. Goulston & Storrs 2014. All rights reserved. 21

Military Housing - Structure The PPV issues taxable revenue bonds at closing. Bonds are secured by the PPV s leasehold interest in the land, fee interest in the improvements and the cash flow generated by the project. Underwriter is the initial purchaser of the bonds and resells the bonds to additional investors under a 144a private placement. Cash generated by the bonds is used to construct new housing and renovate existing housing. Term of Bonds is 40 45 years. Bonds are rated and may be credit enhanced. Goulston & Storrs 2014. All rights reserved. 22

Military Housing Fees Developer Affiliate Fees/Cash Flow Managing Member of PPV Residual Cash Flow and Share of Construction Savings Development Manager Development Fee Design/Builder Design/Build Fee and Share of Construction Savings Property Manager Property Management Fee Asset Manager Asset Management Fee Goulston & Storrs 2014. All rights reserved. 23

Renewable Energy - Structure City agrees to purchase all power from a solar facility on the roof of a school. Private solar provider finances, constructs, owns and operates facility. Solar provider uses federal and state tax credits, takes depreciation and sells renewable energy credits. City obtains electricity at a rate lower than utility power. Excess power is net metered and put into the grid. City gets credit at retail rates, further reducing its power costs. Goulston & Storrs 2014. All rights reserved. 24

Renewable Energy Federal Property DoD Goal of 25 x 25 -- Congress established a goal for DoD to procure from renewable energy sources "not less than 25 percent of the total quantity of electric energy it consumes with its facilities and in its activities during fiscal year 2025 and each fiscal year thereafter." Renewable energy includes "energy generated from solar, wind, biomass, landfill gas, ocean (including tidal, wave, current, and thermal), geothermal, municipal solid waste, or new hydroelectric generation capacity achieved from increased efficiency or additions of new capacity at an existing hydroelectric project. Military Housing Privatization Initiative Rooftops MHPI Developers are interested in solar generation on rooftops to help DoD meet its 25 x 25 Goal. DoD has privatized thousands of housing units on which Developers have installed solar and thermal facilities across the country (Southwest, Hawaii, Mid-Atlantic regions). Goulston & Storrs 2014. All rights reserved. 25

Social Impact Financing New approach for funding social services First projects in Great Britain, several others underway in U.S. Private lenders fund expansion of social services by non-profit Government guarantees the repayment of loans, plus success fees, if social service provider achieves results that save government money - investors are repaid based on government savings How will this model be applied to real estate development? Goulston & Storrs 2014. All rights reserved. 26

Social Impact Financing MA Example - Roca Decrease in Days of Incarceration Incarceration-Based Success Payments Gross Savings for Commonwealth 75.0% $ 26.5 million $ 49.4 million 65.0% $ 26.5 million $ 41.5 million 55.0% $ 25.7 million $ 33.4 million 45.0% $ 24.9 million $ 25.5 million 35.0% $ 18.3 million $ 18.3 million 25.0% $ 10.7 million $ 11.3 million 15.0% $ 3.5 million $ 4.4 million 5.2% $ 0.7 million $ 1.0 million 5.0% $ 0 $ 0.9 million Goulston & Storrs 2014. All rights reserved. 27

LESSONS How does the public ensure promises are kept? How does the private party constrain its commitments? 1. Compete! 2. Allocate risk. 3. Prioritize commitments from both sides. 4. Clarity on control. 5. Select the most suitable real estate structure. 6. Negotiate appropriate enforcement mechanisms. Goulston & Storrs 2014. All rights reserved. 28

Tax Considerations in Financing Public-Private Partnerships Linda E. Carlisle Miller & Chevalier Chartered lcarlisle@milchev.com Strafford Publications Webinar August 14, 2014

I. Background A. Competitive bidding. B. State and/or municipal authority involvement. C. Examples include toll, roads, wharves, parking facilities, and airports. 31

II. Why Public-Private Deals? A. Government 1. Monetize value of existing infrastructure assets or have new infrastructure assets partially or completely paid for by private sector. 2. Eliminate maintenance and development costs for duration of agreement. 3. Possible future revenue sharing. B. Private Sector 1. Investment diversification. 2. Capitalize on expertise in operation. 3. Potential for long-term, predictable cash flows. 32

III. Types of Equity Investors A. Operators and developers in infrastructure businesses. B. Infrastructure funds. C. Private equity funds. D. Pension funds. 33

IV. Broad Classes of Projects A. Brownfield projects 1. Existing infrastructure asset. 2. PPP assumes maintenance and operation of asset. 3. Generally, a concession and lease agreement is entered into between government and entity owned by private investors (the Concessionaire ). 34

IV. Broad Classes of Projects 4. Typical investment structure U.S. Shareholders Non-U.S. Shareholders U.S. Corp. U.S. Corp. Holding Company U.S. LLC treated as a partnership. State or Local Gov t Concession and Lease Agreement Concessionaire U.S. LLC treated as a disregarded entity. 35

IV. Broad Classes of Projects 5. Rights generally granted by a state or local government under a Concession and Lease Agreement include: a) the lease of real property and real property improvements that constitute a public infrastructure asset (the Facility ) for a term of years that exceeds the estimated remaining economic life of the improvements; b) the conveyance, transfer, or assignment of: i. any personal property that the state or local government owns and uses in the operation of the Facility; and ii. contracts to which the state or local government is a party that relate to the operation of the Facility; and c) the right to operate the Facility and collect fees for the use of the Facility. 36

IV. Broad Classes of Projects 6. The Concessionaire s obligations under the Concession and Lease Agreement generally include: a) make an upfront payment to the state or local government; b) make additional payments to the state or local government during the term of the agreement if specified windfall revenues or refinancing gains are realized by the Concessionaire; c) pay all costs of operating, maintaining, and repairing the Facility, and return the Facility to the state or local government at the end of the agreement in the condition specified in the concession and lease agreement; and d) bear all operational and financial risks relating to the Facility, including risks of casualty losses, during the term of the agreement. 37

IV. Broad Classes of Projects 7. Typical Financing a) The Concessionaire will typically fund the upfront payment with equity capital and debt from third-party lenders; b) Additional capital improvements to the Facility also may be eligible for tax-exempt private activity bond ( PAB ) financing from the state or local government; c) Additional capital improvements to highway projects also may be eligible for federal loans or federal loan guarantees under the Transportation Infrastructure Finance and Innovation Act ( TIFIA ) program. 38

IV. Broad Classes of Projects B. Greenfield projects 1. Developer has the right and obligation to develop and construct new infrastructure assets. 2. Upon completion, developer has the right to operate assets and collect fees for a term of years. 3. Generally, a Development and Lease Agreement is entered into between government and entity owned by private investors. 39

V. Principal Federal Income Tax Issues Relating to Brownfield Projects A. Lease versus sale treatment for real property improvements acquired by the Concessionaire. 1. Factors that have been considered by the courts and IRS in determining whether an agreement, which in form is a lease, is in substance a sales contract include: a) whether legal title passes; b) how the parties treat the transaction; c) whether an equity interest was acquired in the property; d) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments; e) whether the right of possession is vested in the purchaser; f) which party pays the property taxes; g) which party bears the risk of loss or damage to the property; and h) which party receives the profits from the operation and sale of the property. 2. Key is whether agreement conveys possession and control for remaining useful life of the property. 41

V. Principal Federal Income Tax Issues Relating to Brownfield Projects B. Characterization of the assets acquired by the Concessionaire. 1. A lease of the land on which the public infrastructure asset is located. 2. Ownership of the real property improvements located on the land. 3. Ownership of any tangible personal property conveyed to the Concessionaire. 4. Assignment of rights and obligations under contracts assigned to the Concessionaire. 5. Ownership of any intangible assets conveyed to the Concessionaire, including intangible assets associated with the trade or business assets such as government licenses, customer lists, know-how, goodwill, or going concern value. 42

V. Principal Federal Income Tax Issues Relating to Brownfield Projects C. Allocation of any upfront payment (and other consideration) among the assets acquired by the Concessionaire because the assets acquired under a concession and lease agreement constitute a trade or business, the consideration paid by the Concessionaire for such assets must be allocated under section 1060 of the Internal Revenue Code among such assets under the so-called residual method. D. Tax treatment of amounts allocated to the assets acquired by the Concessionaire. 1. Leasehold interest in land. 2. Depreciable tangible property. 3. Amortizable intangible assets. 43

V. Principal Federal Income Tax Issues Relating to Brownfield Projects E. Taxation of non-u.s. investors. 1. Non-U.S. corporations that are members or partners of a Holding Company also would be subject to the U.S. 30-percent branch profits tax under section 884 on the corporation s dividend equivalent amount for each taxable year, which may be eliminated or reduced under an applicable income tax treaty. 2. Non-U.S. corporations that are members or partners of a Holding Company also may be subject to the U.S. 30-percent tax on excess interest under section 884(f)(1)(B), which may be reduced or eliminated under an applicable income tax treaty. 3. Dividends paid by U.S. corporations to non-u.s. shareholders are subject to the 30-percent U.S. withholding tax on dividends, which may be eliminated or reduced under an applicable income tax treaty. 4. Under section 897, non-u.s. shareholders of a U.S. corporation are subject to U.S. federal income tax on gain from the sale or disposition of stock in such U.S. corporation (or distributions from such U.S. corporation that are treated as amounts paid in exchange for stock of the U.S. corporation) if such U.S. corporation is a USRPHC. 44

V. Principal Federal Income Tax Issues Relating to Brownfield Projects E. Taxation of non-u.s. investors (cont d). 5. A 10% U.S. withholding tax applies to amounts realized by non-u.s. persons from the disposition of stock in a USRPHC. 6. A U.S. corporation is a USRPHC if 50 percent or more of the fair market value of its assets is attributable to USRPIs (including the corporation s share of assets held through partnerships and disregarded entities). 7. USRPIs include interests in land and real property improvements such as structures, buildings, roads, bridges, and parking lots. 8. Leasehold interests are interests in land, but a government right or franchise that does not convey with a possessory interest in real property should not be treated as an interest in land. 9. In an advanced notice of proposed rulemaking published on October 31, 2008, the IRS and Treasury announced they are considering issuing proposed regulations that would treat certain licenses, permits, franchises, and other similar rights granted by a governmental unit with respect to toll roads, toll bridges and other public infrastructure assets as interests in land. 45

VI. Principal Federal Income Tax Issues Relating to Greenfield Projects A. Whether the Developer s costs of construction is treated as rent, consideration for a share of project revenues, or a tenant s depreciable costs of leasehold improvements. B. Whether any public funds paid for construction are treated as income to the Developer or as costs for leasehold improvements owned by the state or local government. C. What depreciation system applies to the Developer s capitalized costs. 46

VII.Conclusions 1. Privatization of public infrastructure assets provides needed capital to state and local governments with no extraordinary tax benefits for the private investors. 2. The U.S. federal income tax treatment of infrastructure privatization transactions mirrors the tax treatment of other investments in U.S. businesses, but there are questions as to how some of the standard rules apply. 47