Public-Private Partnerships: What You Need to Know About this Emerging Trend in Construction
What is a Public-Private Partnership?
Public-private partnerships (P3s) are contractual arrangements whereby resources, risks, and rewards are shared among partnering public entities (federal, state, or local government agency or authority) and private companies to deliver a service or facility for the use of the general public. Although there are many ways to describe P3s, forward-looking definitions of P3s focus more on the partnership and collaborative relationship between the public and private sectors, and less on the mechanics of how the agreements are structured.
How are P3s different from the traditional design-bid-build model?
Unlike the design-bid-build model traditionally used by public entities, P3s are typically based on the design-build model and can take a variety of forms, such as design-build (DB), design-build-maintain (DBM), and design-build-finance-operate-maintain (DBFOM). In the design-build model, the private sector partner designs and constructs the public project. The primary advantages to the public entity of the design-build model over the traditional design-bid-build approach are:
- shifting risk to the private sector partner for design and construction, resulting in a single point of responsibility;
- increasing the likelihood of cost reductions due to having construction professionals involved in the early stage of design; and
- increasing the likelihood of shortening the time period for project completion by integrating and overlapping design and construction, instead of the traditional sequential process.
However, in order to maximize the benefit of using an approach premised on one of the design-build models where the design risk is shifted to the private sector partner, the public entity must give up a significant amount of control over the design. This can create tension within a public entity that is used to controlling the design process and can create problems during the project if the scope of the public entity’s input into the design is not clearly articulated in the contract.
The latest DBFOM P3 trend involves agreements where the private sector partner is responsible to design, build, finance, operate, and maintain the public project. This model differs from the basic design-build model in two significant ways: (1) the private sector partner obtains financing to help pay for the project; and (2) the private sector partner agrees to operate and maintain the public project for an extended period of time, which could run from 15 to 50 years. Recent DBFOM P3s have 20 to 35-year durations.
By requiring the private sector partner to operate and maintain the project for an extended period of time, there is an incentive to design the project in a manner that takes into account the life-cycle costs and performance of the project, resulting in a focus on energy efficiency. This approach also addresses one of the government’s most difficult problems — the culture of deferred maintenance, as budgetary constraints make it difficult for public entities to budget sufficient resources for the necessary maintenance of aging public facilities and infrastructure. In these DBFOM P3s, the public entity pays the private sector partner over the maintenance period using “availability” payments based on the project achieving contractually-specified performance measures, such as a train station or courthouse being available or open to the public. The failure to achieve such requirements could result in the public entity withholding or deducting amounts from payments otherwise due.
How are P3s being used across the country?
While P3s are a hot topic in construction today, they have been around for a long time. P3s were first used to build, operate and maintain transportation infrastructure like interstate highways. P3s are still used that way today. Nevertheless, the economic downturn in recent years and the deteriorating condition of the nation’s infrastructure has resulted in increased interest in the use of P3s. For example:
- In Virginia, the I-495 high occupancy toll (HOT) lanes project was completed in 2012, which created 14 miles of four new toll lanes for the Capital Beltway outside Washington D.C. This project replaced more than $260 million in aging infrastructure, including more than 50 bridges and overpasses, and upgraded 12 key interchanges. The HOT lanes use dynamic toll pricing, which changes the toll based on traffic flow. It also provides toll-free access to HOVs, buses and motorcycles.
- Pennsylvania’s Rapid Bridge Replacement project aims to replace at least 500 structurally deficient bridges across the Commonwealth within the next five years. The project contemplates creating efficiencies through economies of scale, innovation, and optimal risk allocation that will allow PennDOT to deliver more bridges at a lower whole-life cost than a traditional design-bid-build procurement.
- In New York, the Goethals Bridge Replacement project is the first surface transportation P3 project in the Northeast U.S. that includes project finance and long-term maintenance. The Port Authority of New York & New Jersey expects to completely replace the existing four-lane, 85-year-old bridge with a new six-lane, cable-stayed toll bridge by 2018.
- The Port of Miami Tunnel project (DBFOM) will use advanced tunneling technology to provide new access to Miami’s port and ease congestion in the region by May 2014.
Modern trends are applying P3s beyond traditional infrastructure projects to hospitals, schools, community centers, and courthouses across the country. These social infrastructure projects are a growing source of P3s. Here are some examples of other public entities making use of P3 contracts:
- Since the mid-1990s, P3s have enabled Virginia to build new county and state prisons at a 15 to 20 percent savings, while creating jobs for contractors in the region.
- The Long Beach, California project is the country’s first social infrastructure/non-transportation project in the U.S. using a DBFOM delivery method and availability payments as the revenue stream. This project finished ahead-of-schedule and under budget in the fall of 2013.
- In July 2013, Florida House Bill 85 was signed into law, authorizing counties, municipalities, school boards, regional entities, and state subdivisions to utilize P3s to develop transportation, water, housing, and municipal infrastructure.
- A rural North Carolina county effectively used a P3 to build a middle school to support the influx of military families to the area due to the Defense Base Closure and Realignment. The county used a sale/leaseback arrangement to pay the private developer over the term of the lease period. The private developer obtained a variety of tax credits, which enabled the development of a LEED platinum design for the school. The school opened in the fall of 2013 and is equipped to generate more energy than it uses.
What are some of the challenges associated with P3s?
Shrinking public funding is being met with increasing populations and growing needs for transportation, education, health care, and other infrastructure. These dynamics suggest that the role of the private sector will continue to expand in public projects in the United States. While there has been increasing publicity involving P3s and the opportunities they present to address infrastructure and other public needs, enthusiasm must be tempered by challenges that remain:
- P3 legislation differs from state to state. At least 32 states have some form of enabling legislation, authorizing some use of public-private partnerships. In some cases, the legislation must be amended to provide further flexibility for public entities to address their needs.
- For P3s to become reality, political support is critical. Further education of public officials and the local population on P3s is essential to obtain approval and support.
- There are significant transaction costs, which create challenges for, and potentially prevent, the use of P3s on all but the largest projects. For example, the absence of standard form agreements for P3s results in higher transaction costs for negotiating the various contracts. The Federal Highway Administration has proposed model P3 contract language to guide states in drafting transportation contracts. One possible solution for overcoming the significant transaction costs is for the public entity to “bundle” a number of similar projects together as one P3.
- P3s require a guaranteed revenue stream. The performance periods of P3s tend to be 20, 30, or more years. In order to pay the private sector partner for projects over this duration of time, there must be a dedicated revenue source. Typical sources include tolls, lease payments, and availability payments.
- While P3s offer significant opportunity, private sector contractors and developers face a steep learning curve to become familiar with the various models and each state’s unique enabling laws. Moreover, this model shifts to the contractor risks related to financing, design, and construction and potentially the operation and maintenance of the public asset. Some contractors may not be willing and/or able to absorb these risks.
What should you take away from this article?
As with any new and unique public-private collaboration, challenges remain and participants should keep a close eye on the laws and regulations applicable in each state and for each project. Nevertheless, P3s could create a win-win situation for all involved. In tight economic times, P3s can enable public entities to take advantage of private sector financing to help bring needed public projects to fruition. Moreover, the combined resources of the public and private sectors can result in a shorter construction schedule and other cost savings for the public entity. For contractors and developers, this recent trend in construction opens an exciting, new market offering both short-term, as well as long-term, financial returns. For communities, these partnerships could mean that once deferred, desperately needed public projects will have a better chance of getting off the ground. Additionally, because private entities may be obligated to operate and maintain what they build, the result is likely to be higher quality design and construction, including green and energy-efficient public facilities.
When federal or local governments and private sector developers exchange expertise and share investment burdens, communities can benefit from the resulting broader network of resources and sharing of best practices and industry knowledge, all while stimulating economic activity and creatively meeting public needs.