By: Dee Brown – Published 3/12/2021 by Forbes.com
The December 2020 stimulus bill forgave more than $1.3 billion in federal debt for Historically Black Colleges and Universities. The debt had many HBCUs saddled for decades with more than 40 of these institutions carrying federal debt on their books for facility and infrastructure improvements. As part of the Capital Finance Debt Relief Act, Grambling State University reported that it will see $87 million forgiven. According to their website, approximately $80 million of the debt was for student housing. The Arkansas Times reported that Philander Smith College in Little Rock, AR, will receive $22 million in debt relief, while HBCU Sports stated that Florida A&M University will receive $111 million in forgiveness.
These are just a couple of examples of HBCUs that are breathing a sigh of relief after battling with a year-long pandemic that has caused a decline in enrollment and revenues. While the debt relief comes at a much-needed time, many HBCUs are still crippled by significant infrastructure and student housing needs. Many of the facilities built with the debt that is being forgiven are in serious need of repair and replacement. So that begs the question: How can HBCUs as landowners repair and expand their student housing inventory without becoming saddled in debt once again?
Public-Private Partnerships (P3’s) offer HBCUs a unique opportunity to execute substantial student housing renovations and new construction projects without incurring debt or taking a detrimental financial risk. The devil, however, is always in the details. Many privatized student housing developers ask for occupancy guarantees along with other financial considerations that expose colleges and universities to financial risk. A well-structured P3 that is financed in the capital markets can receive an investment-grade credit rating and not require the college or university to make any occupancy guarantees or take on any risk. This type of financial model would be hard to accomplish anywhere other than in the capital markets with an experienced development and finance team. This model also requires a non-profit ownership group and a national conduit issuer to be part of the transaction structure.
Putting The Model To Work
The conduit issuer issues bonds for the transaction. The non-profit project owner borrows the bond proceeds from the conduit issuer which are placed in a project account. The developer then constructs the project. Most private developers are very well capitalized to cover the upfront predevelopment costs. Therefore, the college or university typically should not have to spend any money on upfront costs. The financing is non-recourse and bonds can be sold into the market as either rated or unrated. As part of the transaction, the non-profit enters into a ground lease for the project site with the college or university; or the developer acquires a project site. The non-profit agrees to share the net operating income (NOI) with the college or university in exchange for a letter of support often referred to as an affiliation letter. The split of the NOI is negotiated with the non-profit at the beginning of the transaction. The split can be as high as 100% of NOI. At the end of the financing, the non-profit donates the project to the college or university.
Rated Or Unrated?
In order for the project to receive an investment-grade credit rating without guarantees, the transaction must be structured and submitted to a rating agency for review and a rating. The credit rating agencies look at a variety of factors when assessing a privatized student housing project. There are both quantitative and qualitative metrics to be analyzed by the agency. Land that is owned by the college or university and ground leased by the developer for the student housing project isn’t at risk. If a default occurs, the bond trustee becomes the new lessee and must fulfill the obligations under the ground lease agreement.
When underwriting a privatized student housing project without any guarantees from the developer, college or university, the credit rating agency scores elements that are most essential to their credit decision. The financial position of the property is a key element that accounts for 65% of the credit score. The financial position includes debt coverage ratio, liquidity and reserves, as well as diversity and sources of revenue. Adequate liquidity allows a project to encounter a temporary interruption in revenue without causing a disruption in payment. The debt coverage ratio is also a critical metric that is analyzed during the underwriting process. The debt coverage ratio measures the project’s ability to service current and future debt obligations.
The sources and diversity of income are also critical to the underwriting metric. The diversity and sources of student housing revenues impact the dependability of revenues over time. Projects that rely on volatile ancillary revenues to meet the debt service obligation are viewed as a weaker credit quality than projects that rely heavily on housing rental income.
The project’s market position will also be heavily scrutinized as it is a key driver of project revenues. Demand drivers and project size are the most critical elements of a market position that the rating agencies will review. Student housing projects where the tenants are required to use the units will be viewed as a stronger credit. Larger projects which demonstrate significant demand will also be viewed as having stronger credit than smaller projects. Rental rates that are below market rate are viewed more favorably by the rating agencies than rates at or above the market.
These are just some of the factors that must be considered when deciding if the bonds should be rated or unrated. The selection of an experienced development and finance team that understands the tax-exempt bond market, as well as qualified 501(c)3 bonds, will help HBCUs navigate a public-private partnership. With the many variables to be chosen in each partnership, it’s important to remember that an experienced team will seek to structure a student housing project that maximizes the elimination of risk and the creation of financial rewards for your property-holding college or university.