Exploring

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Exploring: Identifying Diverse Revenue and Funding Sources Identifying Financial Tools Considering Alternative Delivery Models

Types of Funding and Revenue Sources

To generate revenue for infrastructure, agencies have traditionally looked to either taxes or user fees (for infrastructure services that people have been accustomed to paying for, like water, or wastewater).


Financial strategies increasingly involve expanding the revenue base to new options, including:

  • Redefining utility fees to include new types of infrastructure services (e. g., stormwater and transportation utility fees);
  • Diversifying revenue sources to both project-specific and broader sources (such as combining sales tax with user fees);
  • Examining revenue generation potential associated withinfrastructure projects; and
  • Tapping property and economic development value created by projects.


Revenue Sources: a Taxonomy

Grants

Grants

Federal Grants
Federal funding for infrastructure has been declining over the past few decades. Some infrastructure programs have been reduced or eliminated—for example, grants for wastewater treatment were converted into the State Revolving Fund (SRF) program for wastewater. Still, many cities receive substantial funds from the federal-aid highway program, transit capital grants from the Federal Transit Administration, and other funding for capital projects.

Even as funding has declined, many federal programs have increased the types of projects that are eligible for support and the kinds of grantees that can apply. Many agencies have expanded eligibility for grant funding to more innovative projects, including equitable and resilient approaches. Without increased funding, however, this increased eligibility just makes the competition for federal funding more intense. Eligibility doesn’t guarantee that a city could obtain grant funds, just indicates that a project could be eligible in theory. As grants become more competitive, federal agencies are requiring applicants to demonstrate that the project has a complete financial plan before they will award federal assistance.

The Catalog of Federal Domestic Assistance (CFDA) includes all forms of federal assistance that can be provided to governments and individuals. Agencies can scour CFDA for possible sources, but usually a more effective way of identifying potential grant funds is to monitor industry publications and maintain strong relationships with the federal agencies associated with each type of infrastructure that is being funded.

Federal funding comes with federal requirements, including minimum wage scales under Davis-Bacon, rules requiring major components to be American-made (so-called “Buy-America” requirements), applicability of the National Environmental Policy Act (NEPA), and federal restrictions on local hiring preference programs. Depending on the size of the project, the cost of complying with these restrictions may not be worth the federal funds.

State Grants
States are stepping in to fill the gaps in federal funding in different ways. In the past five years, more than 22 states have raised their gas taxes to pay for transportation infrastructure improvements (while the federal gas tax has not been increased since 1993). Most of these gas tax funds are being provided to infrastructure projects, some in the form of competitive grant programs, and some allocated to specific projects. The State of California dedicated much of its proceeds from a carbon-trading program to a competitive grant program for infrastructure projects.

Philanthropic Grants
Philanthropic capital can get behind projects that align with the social missions of organizations. The Friends of the High Line raised $44 million of the total $152 million cost for initial construction of the elevated park in New York City. The Atlanta Beltline received $41 million in philanthropic contributions in the initial stages, and the strategic plan anticipates up to $275 million in philanthropic support by 2030, when all the project elements are complete.

Philanthropic capital is generally contributed via a nonprofit that works in close partnership with the city, rather than directly to a city. This model avoids complex ethical issues that could arise if city employees solicited donations directly (often a prohibited activity). Conflicts of interest may have to be managed in any case, in terms of contributions from any sources that are depending on city action or permits.

Payments in Lieu of Taxes (PILOTS)
Payments in Lieu of Taxes (PILOTS) are voluntary contributions by otherwise tax-exempt entities to help defray municipal governments’ costs of providing services to them. A 2012 report by the Lincoln Land Institute found that at least $92 million in PILOTS had been received by at least 218 localities in 28 states since 2000. According to the report, more than 90 percent of PILOTs come from “eds and meds”—colleges/universities and hospitals, with the university sector contributing 2/3rds of payments and hospitals about one quarter.
PILOT payments are often negotiated with nonprofits in the context of expansion plans that might impose additional costs/service requirements on cities. For example, the city of Boston’s PILOT program would make contact with nonprofits whenever they acquired new properties and requested a real estate tax exemption.

Corporate Contributions
Companies are sometimes willing to contribute directly to infrastructure assets that create specific benefits for them. For example, Micron PC paid the entire cost of installing an interchange at its headquarters in Boise, ID. The athletic shoe company New Balance is paying up to $16 million to build a new transit station in its Boston-area headquarters. To accept these contributions, infrastructure agencies need to ensure that they do not compromise existing planning and environmental analysis processes, or conflict-of-interest policies.

Crowdfunding
Crowdfunding via sites such as ioby.com (in our backyards), Spacehive.com, or www.citizinvestor.com can also provide funding for infrastructure. Citizens can contribute directly to projects in their communities, and get a tax deduction in exchange for the donation. Crowdfunding is typically most appealing for projects on a smaller scale, and connected to a popular mission, such as parks or community gardens. According to Rodrigo Davies, who researched the issue while at Stanford University’s Center for Work, Technology and Organizations, the median amount raised from crowdfunding campaign for infrastructure projects was only $6,357.

  • Other people’s money is everyone’s favorite funding source.

Most grant sources for infrastructure cover only a small portion of the need. Yet grants can serve as the public equity in many projects, the early funding that enables the development of a financing strategy to attract more capital.

Although chances of receiving a grant may be slim, participating in a competitive grant or credit process can have a catalyzing effect that has value beyond the likelihood of success. In order to submit an application for most grants, state, regional, private, and other partners have to coordinate on a preliminary financial plan and bring it to the table. The prospect of external money—that can be obtained without going to the voters or reducing funding for other programs—can be motivation enough to lock in commitments that can otherwise be elusive or delayed. In this sense, applying for grants can be worthwhile even when it’s a long shot, because it brings project stakeholders to the table.

Direct Service and User Fees

Direct User Fees

Tolls
For highway projects, tolls are an obvious source of funding. Cities do not always have control over toll policy on facilities in their geographic area, but often state legislation will provide a degree of local control or input as to tolling policy.
Drivers generally expect the proceeds of tolls to be used on the facility or group of facilities on which they are charged, and sometimes resist their use for other projects. In some cases, policy makers have gained support for dedicating tolls to transit and other projects along the same corridor that may reduce congestion on the tolled facility. For example, tolls on the Bay Area’s Golden Gate Bridge fund bus and ferry operations that reduce bridge traffic.

The most popular forms of tolling in the last decade have been “managed lanes” where single-occupancy drivers can buy their way into a carpool lane that would otherwise be limited to vehicles with more than two or three occupants. Other projects offer “express lanes” dedicated solely to paying customers. These lanes offer a higher level of service, for which drivers are often willing to pay. Rates can vary depending on congestion and time of day. By spreading out use to less congested times of days, congestion pricing may reduce or eliminate the need for facility expansion. In fact, studies have shown that congestion relief benefits from facility expansion can be short-lived, while pricing strategies can continue to keep managed or express lanes free flowing.

Establishing a new tolling program involves a lot of administrative expenses, from buying the toll technology to creating the back-office operations and customer service that will collect tolls. If tolling already exists in the area, this expense is lowered. In addition, there is considerable uncertainty surrounding the revenue forecasts for “greenfield,” or newly constructed toll facilities, and usually toll revenues take several years to ramp up before they achieve their full potential. A number of P3 projects have faced financial failure because of optimism bias in their initial toll projections. As a result, financing new build toll facilities solely with tolls as a pledged revenue source can be difficult.

Transit Fares
Transit fares have historically not covered the full operating cost of delivering transit service. The average so-called “farebox recovery” rate for transit rail systems in the U.S. is less than 29%. Thus, transit fares are not solely relied upon as a primary source for new capital projects, except in rare situations where service can be delivered cheaply and the market will support fares greater than the operating cost.

Parking Fees
Many cities control a valuable commercial asset in the form of on-street parking and city-owned parking facilities. Some cities, including San Francisco, actively manage on-street parking, changing rates according to demand. Demand-based parking fees can involve administrative costs, but can help cities accomplish multiple goals: ensuring that spaces are available in high traffic areas, so that shoppers aren’t discouraged from coming downtown, steering commuters to longer-term options and other modes, and generating revenue.

Traditional Utility Fees (Drinking Water, Wastewater, Electric)
Traditional utility fees are generally set to recover the capital and operating costs of delivering utility service. If a project can be defined as part of a utility’s mission, then it might be possible to incorporate it into its rate base, and achieve capital funding. For example, some green stormwater infrastructure might be alternatives to more expensive wastewater capital projects, and could be recouped through wastewater utility rates. The ability to coordinate for projects on the city’s portfolio depends on the relationship between the city and the utility.

Stormwater Utility Fees
Many communities have established stormwater utility fees to recoup the cost of storm sewers and other solutions to reduce runoff and control flooding. Stormwater utilities usually attempt to charge fees that are proportionate to a parcel’s demand on the stormwater system. Larger properties with the highest percentage of impervious pavement are likely to impose the greatest cost on the system. These fees can be used to support financing for stormwater-related infrastructure, including green stormwater infrastructure.

Transportation Utility Fees
Like stormwater utility fees, transportation utility fees (TUFs) attempt to allocate the cost of using a system based on the demand imposed by a property on the system. A TUF allocates cost of street improvements according to an estimate of the trips generated from each type of property Loveland, Colorado, Grants Pass Oregon, and Provo, UT have all established transportation utility fees at some point. Most of the cities that establish these programs have generated between a couple hundred thousand dollars to a few million in annual revenue. The fees have been challenged in courts because in some states, a charge must be “voluntary” in order to qualify as a fee. Otherwise, it is considered a tax, which general requires enabling legislation from the state government and/or a voter referendum to impose.

Impact Fees/Proffers
Another method for raising funding for infrastructure is to impose impact fees on new development. Many cities use these fees to mitigate the cost of providing wastewater, water, stormwater, and transportation services to new developments. These fees are usually attached to initial construction of new houses, and can range from a few thousand dollars to $50,000 or more per parcel. While they can generate significant revenue, they place an additional burden on developers and may make it even more difficult to keep housing affordable. They also tend to be less predictable than utility fees, since they are generally charged on a one-time basis as houses are constructed. A city could get millions in impact fees in a high development year, and little or none in a subsequent year. Thus, this source can provide upfront funding, but is not generally securitized. Another alternative to impact fees is “proffers”—requiring a developer to provide in-kind infrastructure in lieu of impact fees for new developments.

  • Some projects come to the table with obvious sources of revenue—wastewater and water utility fees, transit fares, tolls or stormwater fees.

Most of the obvious sources charge users in proportion to their use of a facility or service. In some cases, governments can expand the potential use of service fees by defining infrastructure services that the public had not previously realized they were being provided, or by including resilience projects in the eligible costs for utility rates. For example, several cities have created transportation utility districts to pay for the cost of maintaining streets and other parts of the local transportation network (see additional information on transportation utility fees, on page 87).

Enterprise Revenues

Enterprise Revenues

Advertising/Sponsorship
Some agencies generate revenue through advertising on city-owned facilities, including buses, transit stations and trains, benches, and other locations. Usually revenues from these activities aren’t predictable or large enough to serve as a source of funding for capital projects, but can sometimes support elements such as lighting, or maintenance activities, such as cleaning. Some cities have policies that restrict advertising on city-owned assets, to avoid over-commercialization of civic facilities. In some cases, instead of direct advertising, cities permit sponsorship in exchange for dollars or in-kind contributions, such as the San Francisco Municipal Transportation Agency’s arrangement with Clear Channel Outdoors. Under this arrangement, Clear Channel installs and maintains bus shelters in exchange for the right to advertise.

Naming Rights
Some cities have been able to benefit from selling naming rights for transit stations and other major facilities. In 2015 the University of California, San Diego entered into a $30 million, 30-year deal with the Metropolitan Transit System for naming rights for the stations on the Mid-Coast Trolley Line. As with advertising, some oppose the idea of having civic facilities “branded” with private names. It is also difficult for both public and private sector to estimate the value of these rights. When Boston’s MBTA system tried to do the same thing in 2014, it didn’t get any bidders at the prices it named.

Recreational or Food Concessions
Cities may be able to generate revenue from minor recreational, or food concessions associated with civic facilities. For example, cities may create a food court or food truck gathering near a public park, or create an ice rink. Unless they have a proven track record of operation, concessions that are ancillary to a project generally don’t produce enough of a reliable surplus to borrow against. Even when predictable, the level of funding is usually only enough to support operations and maintenance funds. (In contrast, a project that creates substantial leasable land or joint development opportunities might be able to use lease or tax proceeds to finance part of the infrastructure development).

Branded Merchandise
Some agencies or associated projects can benefit from branded merchandise. The New York MTA generates $500,000 each year from MTA-branded T-shirts and other licensed products. The Friends of the High Line generate $1 million per year from the sale of High Line-branded merchandise.

  • Enterprise revenues are revenues associated with commercial businesses linked with or occurring on the premises of an infrastructure facility.

They are usually not predictable enough to borrow against, but can provide up-front funding for project development and/or ongoing resources for O&M activities. Cities may be able to increase the amount of potential revenue from an infrastructure and economic development initiative project by considering revenue-generating potential in the project design. Local business owners can provide input on retail potential at transit stations and near park areas; community residents can indicate what kinds of fee-based recreational amenities might be desired in new urban parks.

Value Capture/Project-Specific Options

Value Capture Options

Tax Increment Financing (TIF)
Tax increment financing is a method of capturing the expected future value of an infrastructure project development. The “tax increment” dedicates a portion of property tax that represents the increased value created by an infrastructure project. The property value is usually “frozen” at the level prior to creation of the district. Then some or all of the tax on the additional value in subsequent years is allocated to the project.

TIF districts are popular tools in some cases because they tap a new, not existing source of revenue, and may be perceived as competing less with existing priorities. TIFs are speculative and sometimes difficult to finance because many factors other than the infrastructure project may affect land value. If a TIF district is created immediately prior to a downturn in the business cycle, there may be no incremental net revenue available. The City of Austin uses its TIF as a grant to increase the supply of affordable housing: developers can put the TIF on their properties back into building more affordable units. In some cases, a city can ensure that the value of land subject to a TIF will increase by “upzoning” it to a higher use. For example, if development is restricted to a certain height, and the city increases it, the land will automatically be worth more because more units are feasible.

Special Districts (Business Improvement Districts)
Special districts can also be established in the geographic areas that are expected to benefit from a project. Districts can levy taxes or fees that can be per-parcel, or based on property value, anticipated benefit, proximity to the infrastructure project, or by other means.

Special districts can be perceived as more equitable than other funding options because those who benefit most from the economic development in a growing region wind up paying for the costs of the infrastructure. They can also be created as independent or nonprofit entities that may have more flexibility than traditional municipal agencies in hiring and contracting. Yet in some cases, residents may perceive them as “double taxation” since they are already paying all of the other taxes that other local residents pay for infrastructure services. Special districts also add another layer of administration that can lead to inefficiency/diseconomies of scale compared to having an existing entity levy taxes.

If poorly structured, special districts can also have unintended consequences, discouraging the economic development they were supposed to support. In the late 1980s a number of counties in the state of Texas used special districts in rapidly developing areas. The districts were structured such that if a landowner were unable to pay its special assessment, the unpaid assessment was added to the obligations of all of the other payers. When the recession hit in the early 1990s, many landowners in each district declared bankruptcy, and then their debt was added to the ones who were still afloat, causing them to go bankrupt as well. Subsequent special districts have been structured to avoid this “death spiral” by adding other collateral and reserves in case of unexpected reductions in property values.

Density Bonuses/Transferable Development Rights (TDRs)
Density bonuses and transferable development rights are another method of using property value to fund infrastructure development. A density bonus can be awarded to a developer in exchange for a cash or in-kind contribution to an infrastructure project. The bonus would allow denser development than would otherwise be zoned. Transferable development rights are a similar mechanism in which a developer buys up the development rights from one site (which will be protected from further development, via easement, in perpetuity) and is able to use them to develop a different site more intensely. TDRs usually used to protect rural or environmentally land from development, but could also protect affordable housing by prohibiting further development or change in use.

  • By examining co-benefits of projects as well, agencies can widen the pool of potential revenue sources to include those with a nexus to beneficiaries of the project, not just users.

Being adjacent to a transit station increases the value of real estate, for example. Studies conducted on behalf of San Francisco’s Bay Area Regional Transportation Agency (BART) by Strategic Economics, Inc., found that a condominium within a half -mile of a BART station is worth 15 percent more than a condominium located more than five miles from BART, all other things being equal. A single family home located within a half mile of BART is worth 11 percent more than a similar property more than five miles away. If green stormwater infrastructure and other improvements create greater land value, land and business owners may be willing to contribute funding, either in a special taxing district or via tax increment financing, which relies on the anticipated increase in value due to a project.


Revenue Sources and their Nexus to Projects

Linking projects to additional benefits may also open access to other sources of funds. If a project has documented public health benefits, for example, it may become eligible for health-related grants. Projects that reduce greenhouse gas emissions may become eligible for targeted funding related to those goals.

Selected General Taxes

General Taxes

Property and Property Transfer Taxes
Property taxes are a highly competitive source that already funds a high percentage of local government activities, including serving as the primary source for schools in most areas. One common way for infrastructure to tap this source is via property transfer taxes, which serve as a proxy for the pace of development. Rapidly growing areas experience more rapid turnover of properties, leading to higher transfer tax receipts.

Sales Tax
Sales taxes are increasingly popular sources for transportation and other infrastructure. The policy argument for devoting sales tax to infrastructure, particularly transportation infrastructure, is that even if individuals don’t use the transportation facilities that they fund, they buy the goods that are transported to stores by using the transportation system. Sales taxes are also a proxy for capturing the value of economic development that may be associated with infrastructure. Yet sales taxes are considered regressive, since lower-income individuals wind up paying a higher share of their overall income in sales taxes than higher-income individuals.

Transportation Related-Taxes (Gas Tax, Vehicle Registration Fees, Parking Tax, Bicycle Tax)
Transportation-related taxes are often used for transportation infrastructure. Historically gas taxes have served as a proxy for direct user fees like tolls (since the amount that a person drives has some relationship to how much gas is used). With the advent of late-model fuel-efficient cars, gas taxes have become increasingly inequitable as a source of revenue, since the lowest-income individuals tend to have less fuel-efficient vehicles. Vehicle registration fees feature similar equity concerns, although rebates and discounts can be easier to accomplish than on a gas tax.

Tourist Taxes (Rental Car Tax, Hotel Tax)
Tourist taxes are often popular ways to build infrastructure because voters don’t pay. Hotels and other tourist businesses can be convinced to support their use for infrastructure if they perceive a link between the infrastructure and tourist activity. Yet in many jurisdictions, these taxes have already been increased for projects directly related to tourism, such as funding convention centers, and there may be little opportunity for further increases for infrastructure.

  • In general, the more narrowly targeted a revenue source is, the more administratively complex it is to collect and manage it (and the more volatile it can be).

Broad sources such as property and sales taxes already have a collection process in place and can raise large amounts for a comparatively small rate increase. However, these well-established sources are much in demand, and often already at high levels.

Linking Revenue Sources to Project Benefits

  • Part of building a resilient financial strategy is diversifying the revenue and funding base that a project depends on.

In general, sources that have a closer nexus to the project will be more politically acceptable (because the link between the project and the revenue source will be widely understood by voters and policy makers). The table on the next page presents some examples of how to link revenue sources to projects.

Linking project benefits to revenue sources
Examples: linking project benefits to revenue sources

Yet the base for project-related revenue sources will tend to be limited by the scope and scale of the project and the affected areas. The impact of more targeted revenue sources will also fall on a smaller base of payers.

Charging those that benefit most from a project may be perceived as equitable, but it may not reflect benefits that extend beyond a project’s area. For example, the BART Silicon Valley project, which is helping link San Jose, Oakland, and San Francisco via transit, will benefit all of Santa Clara County, even in communities that have no stations. Thus, a countywide sales tax is one of several local sources being used to fund it. An infrastructure reuse project may occur only in one economically distressed area of a city, but the property value increase, economic development, and increase in incomes that happens to area residents will benefit the city as a whole. Requiring all of a project to be paid for by revenue sources that are tied to residents and businesses in the distressed area may also make it more difficult for the project to succeed, as it may disincentivize development in that area.

Creating a “Basket” of Revenue and Funding Options for Analysis

  • Many major projects investigate dozens of potential sources in order to come up with a robust mix of funding and financing sources.

It is tempting to cross less feasible items off of the list at the earliest stage, and not even expend the time or resources to analyze them. Creating a comprehensive list, and documenting the reasons why an option may not be feasible can help convince stakeholders who may be wedded to ideas that sound good, but are not workable in practice. For example, many people believe that advertising and sponsorship revenue should be used to help support transit capital projects. While these can be viable, and are much more palatable to the public than taxes or fees that they might be called upon to pay, in most markets they don’t add up to more than a small share of total capital costs.

Another reason to create a comprehensive list is to build resilience into the financial strategy; options have the potential to become obsolete or less robust. Infrastructure financing is an open book test: agencies are allowed and encouraged to adopt ideas from other cities, and one of the best sources for ideas is cities that have recently financed similar projects. Unfortunately, there is not a single repository for financing plans for municipal capital projects, and many cities are too busy delivering projects to document them. Many states have guidebooks that describe the basic financing options available to cities under state law. Some federal resources to draw on include publications from the EPA’s Environmental Financial Advisory Board and Environmental Finance Centers and the US Department of Transportation’s Build America Bureau.



San Francisco Seawall Finance Working Group List of 48 Revenue and Finance Options

These agencies focus their resources on the types of projects they support (environmental and transportation infrastructure) but are important resources for cities seeking innovation in all infrastructure modes. The High Line Network, a peer network for urban infrastructure reuse projects, is an example of the power of peer exchange. (See brief case study on following on page).

Once a list of options has been identified, the next step is to gather enough information about each option to determine if it could be applicable.

Legal Authority

  • Does the city have the necessary legal authority to implement the options?

Legal authority for most finance and delivery options at the city level initially derives from state legislation. Cities need to determine whether their jurisdictions have the authority to enact an option (or if it can be obtained?). Given the lifespan of major infrastructure projects, it can be worth including an option in a financing strategy, even if it is not currently available. When conditions change, policymakers may be willing to alter current law or policy in order to accomplish a project. For example, a financing strategy may identify a P3 as potentially beneficial before a city has authority to enter into it.

In some cases, an option may be technically legal, but present too great a risk of lawsuits if undertaken. For example, the Santa Clara Valley Transportation Authority (VTA) was seeking options to finance the BART to San Jose and considered using its legal authority to create a benefit assessment district (BAD) near stations, to generate dedicated taxes from landowners, whose property values were likely to increase markedly. The statute establishing BADs requires agencies to charge landowners based on the specific benefit accrued to their property. This standard was so exacting that the districts attracted expensive and protracted legal challenges. Rather than pursue that option, the VTA examined other methods of capturing value from landowners who benefited from the project.

Revenue Potential

  • Does the option have the potential to raise sufficient revenue or create sufficient financial capacity to make it worth exploring (especially compared to its administrative cost and difficulty)?

At the earliest stages, it is unnecessary (and costly, and perhaps impossible) to try to develop precise estimates of revenue potential. A ballpark range ($10–$50 million; under $2 million) is usually sufficient for analysis.

Part of evaluating the potential for grant funding sources is evaluating the likelihood of a city actually receiving the assistance. Being eligible for funding under a federal, state, or philanthropic program is like having a lottery ticket; it doesn’t guarantee that a city will get the funding; it just gives it the right to enter the competition for it. The best way to get a real-world prediction of a city’s chances at receiving assistance is usually to talk to internal and external experts with experience in the grant application and award process and/or the legislative process.

For example, the first five rounds of the USDOT’s discretionary Transportation Investments Generating Economic Recovery (TIGER) grants were overwhelmingly oversubscribed, receiving more than 5,200 applications requesting $136 billion in funding for $2.6 billion in available grants. This means the USDOT could award less than 2% of the requested funds.

Revenue Stability/Predictability

  • Will the revenue stream identified be predictable enough to borrow against or rely on for funding?

For example, while federal and state grants are popular ways to fund programs, since they don’t call on either users or taxpayers, often they are not predictable enough streams of revenue to borrow against. Similarly, some types of tax revenue (such as special taxes on IPOs) fluctuate substantially, making it hard to pledge them for regular debt service. When the public sector is designing a new revenue option, it can take steps to make it more predictable. For example, stormwater fees can be structured to have a fixed component and a variable component that fluctuates with the level of runoff from each property.

revenue tools
The table above presents an hypothetical, high-level comparison of some of the revenue tools explored by the City Accelerator participants, based on the criteria above. Additional information about each revenue tool is included in Appendix A.

Administrative Ease & Cost

  • How difficult will an option be to implement, both in cost and staff time?

Some revenue options may have great benefits and offer financing capacity, but they require substantial investment of staff time and higher transaction costs. Adding on to existing taxes or fees is generally cheaper and easier than developing a new tax or fee and the accompanying administrative infrastructure.

Political Feasibility

  • Will the option be politically palatable?

An option can be legal, administratively easy, and raise sufficient revenue, but be so unpalatable that it can sink a project (and the careers of elected officials who support it).

California Governor Gray Davis was recalled, partially due to supporting increased vehicle registration fees. Other projects have faced difficulties implementing unpopular tolling and tax programs.

Racial and Economic Equity

  • How will the chosen option affect the community (at implementation, and in the future)?

Some taxes and user fees may have a disproportionate effect on low-income individuals. Targeted rebates and discounts can sometimes mitigate these impacts. For example, tax-increment financing or property value-based special assessments could have income-based exemptions, discounts, and payment deferral options. Fees and taxes can also be structured to target beneficiaries (who generally have assets) rather than users (who may not).

Positive Incentive Effects

  • Will the selected option incentivize consumer and market behavior that an agency desires? Will it discourage future investments or encourage consumer/market behavior that it does not want?

For example, increasing vehicle registration fees might provide a good source of funding for transportation infrastructure projects, but increasing the fixed costs associated with vehicle ownership gives people an incentive to drive rather than take transit. In some cases, an option can be structured to align incentives with agency goals. Stormwater programs can offer fee rebates if landowners construct their own green stormwater infrastructure. This can incentivize homeowners and developers to install the type of green infrastructure communities want to have.

Resilience/Sustainability

  • How resilient will the options be to climate, technology, and other shifts?

Will the source of revenue be affected by sea level rise? Will it be more susceptible to certain business cycles/downturns? Will it become obsolete as technologies shift? For example, the gas tax has historically been used as the primary funding source for transportation capital projects. Yet as fuel efficiency increases and electric cars take a larger share of the market, the gas tax generates less revenue.

Financial tools have different benefits, which may be valued differently by cities depending on their situation. Some cities may seek to increase financial capacity, while others may be more interested in tools that lower interest or facilitate use of new revenue sources.

Potential Benefits of Financial Tools

Reduced Interest Cost (Compared to Traditional Municipal Finance)

  • By reducing interest costs, some financing tools can produce actual cash savings, which can be turned into revenues used to support additional project funding or O&M expenses.

Especially on large projects, achieving even a hundredth of a percentage decrease in interest rate can lead to hundreds of thousands or even millions in savings to a local government. For example, a loan from a State Revolving Fund for wastewater infrastructure (which was created with federal grants) often comes at a much lower interest rate than would be available to municipalities on the market. Instead of reducing costs directly, some innovative financing and procurement tools reduce the risk that a government’s credit rating will be downgraded due to a default or the perceived risk of a default. An agency with a higher credit rating is able to borrow at lower rates, and is able to access capital markets more easily, so avoiding the risk of downgrade is critical.

Appeal to Wider Pool of Investors

  • Some innovative tools are designed to increase the pool of investors interested in lending to the project.

For example, green and sustainability bonds are designed to appeal to socially-motivated investors; crowdfunding bonds such as neighborly or Denver’s mini-bonds program appeal to local residents. The appeal may make a bond issuance sell more rapidly, but does not always translate into interest cost savings, at least in the short term. Still, by widening the pool of investors who have an interest in the project, it can increase the long-term resale value of the bonds.

Increased Financial Capacity

  • Some financial tools can simply increase public sector capacity to finance projects.

Public financing often has policy or statutory limits that may not accommodate new projects. Public agencies also often have more conservative debt ratios that make municipal bonds raise less funding than private financing for the same amount of future revenue. These “coverage ratios,” indicate how much anticipated revenue the city will have compared to projected annual debt service. Many public agencies require minimum coverage ratios of above 2.0x annual debt service—understanding the consequences of any kind of default to debt ratings and future interest costs. Private financing, particularly for special purpose entities, is typically done with lower coverage ratios, because debt policies do not have to consider long-term ratings impacts.

Enabled Utilization of New Revenue Sources via Patient, Flexible Capital

  • Traditional capital markets are by definition impatient capital; their payback goal is usually under 10 years, even for impact investors.

For most communities, public works projects may not see a payoff for a decade or more, but lenders often can’t wait. Though a project may be very likely to pay off in 20 years, it may be unable to weather business cycles or attract financing patient enough to wait for revenues to accrue. In some cases, incorporating certain features into a project (such as green stormwater infrastructure features like rain gardens, transit-oriented development, or community art) may build long-term value, but capital markets can be reluctant to take a risk on a new revenue source. Patient capital can enable a revenue source to be “securitized” or borrowed against, when it would otherwise be too unpredictable or risky.

Facilitation of Alternative Delivery Models

  • Some innovative finance tools can facilitate alternative delivery models.


For example, federal credit assistance is provided to private and public entities on the same basis. This facilitates use of low-cost federal credit for public-private partnerships, since many other municipal finance tools are not available to private partners, or are taxable, and thus higher-cost. Other vehicles, such as outcome-based bonds, can facilitate transferring the risk of testing innovative approaches to private investors, as in the case of the DC Green Bond.

Basic Borrowing Options

Most municipal governments have access to three kinds of financing options: bonds, loans, and private equity investment. The private equity investment can come either via special federal programs such as the New Markets Tax Credit, or under alternative project delivery structures, such as a public-private partnership (P3) or a nonprofit-public partnership (NPP). Not all municipal governments have access to all kinds of project delivery options; state legislative action may be required in order to enable certain arrangements.

Municipal Bonds

Bonds

General Obligation Bonds
For General Obligation (G.O.) bonds the issuing government pledges its “full faith and credit.” If revenues are not sufficient to pay debt service, governments commit to raise taxes in order to meet their obligations. Because they are more secure, these types of bonds command the lowest interest rates. However, they also tend to be the most restricted by state and local law, because of the degree of commitment. Most municipalities have legal and/or policy limits on the amount of G.O. bonds they will issue, and many require voter approval.

Revenue Bonds
For revenue bonds, cities pledge to repay investors with a specific revenue source, such as electric utility fees or a dedicated gas tax. Since the pledge is not as comprehensive as a G.O. bond, the interest rates can be higher, but the restrictions on issuance and voter approval requirements are also less stringent.

Private Activity Bonds
Private Activity Bonds are a form of tax-exempt bond that is not subject to all of typical restrictions on private activity associated tax-exempt bonds. IRS rules restrict the length and type of management contracts that can be entered into on a facility financed by tax-exempt bonds, as well as other kinds of private activity. A limited amount of Private Activity Bonds not subject to these restrictions can be issued by each state. While they are not limited by the private activity bond rules, they are subject to the many other requirements associated with tax-exempt bonds. The U.S. Department of Transportation is also authorized to choose certain projects that will be able to make use of up to $4 billion in remaining PAB authority. PABs are valued tools in alternative delivery projects for infrastructure, because they allow the lower cost of tax-exempt financing in conjunction with the benefits of private involvement.

63-20 Bonds
The IRS allows certain nonprofit organizations to issue tax-exempt bonds on behalf of a public agency, if applicable restrictions are followed. These bonds are often used to enable some kinds of Nonprofit Public Partnerships (NPPs) as described in the project delivery section on page 66. In particular, they may allow governments to benefit from integrated delivery options, without running afoul of private activity restrictions on tax-exempt bonding.

501(c)(3) Bonds
Nonprofit charitable organizations are also allowed to issue tax-exempt bonds for public purpose projects. These can also be used in conjunction with an NPP; however, 501(c)(3) bonds have similar restrictions to governmental bonds in terms of limitations on private activity. They also are generally limited to maximum issuance amounts of $150 million, a cap that is not applicable to 63-20 bonds.

Green Bonds, “Social Bonds” and Sustainability Bonds
Green bonds are similar in financial structure to standard municipal bonds, but issuers pledge to use the proceeds of the bonds towards projects that will improve environmental quality or advance environmental goals. While exact data is difficult to confirm, issuers may get a slight “green premium” because there is greater demand among investors for bonds funding programs with positive environmental impacts. The Climate Bonds Initiative, an international nonprofit formed to promote the issuance of these types of bonds, estimated in 2016 that the U.S. had issued $9.7B in labeled green bonds, and $30.3 million in “climate-aligned bonds” that will advance environmental goals.

Many of the initial green bonds were self-labeled as such, and investors desiring to buy bonds that aligned with climate goals sought greater accountability. Various organizations offer certification, using different principles and requirements. In 2016, the San Francisco Public Utilities Commission issued the first water bond certified by the Climate Bonds Initiative as a Water Climate Bond. The ICMA also has principles for social bonds (defined as bonds that finance projects that meet social goals) and sustainability bonds (whose proceeds can be used to fund projects with either green or social goals).

Obtaining the certification as a green, social, or sustainability bond and fulfilling the transparency and management requirements involves some cost to cities—perhaps $10,000 or $50,000 per issuance, at minimum. In exchange, cities and states issuing these bonds may have an easier time marketing their bond issuances to a wider pool that includes socially motivated investors. A lower interest rate from a “green premium” may offset certification costs.

Outcome-Based Bonds
In the infrastructure context, outcome-based can be used to repay investors if infrastructure achieves a desired social goal, such as runoff or emissions reduction. The DC Water Green bond, which will help fund green stormwater infrastructure, is the first example of applying this kind of approach to an infrastructure solution (see full case study on page 56).

Crowdfunding Investments/Minibonds
The City of Denver undertook a successful “minibond” program to permit smaller scale investments by Colorado residents in its Better Denver program. The bonds were offered at amounts as low as $500, and allowed investors to earn returns several times what was being offered on savings CDs, while investing in projects that would benefit the community. Other cities are using new online platforms such as Neighborly or Infrashares to package and sell bonds to smaller scale investors.

Resilience Bonds: A Proposed Concept
Catastrophe bonds are financial instruments designed to provide payouts that limit economic disruptions in the event of a triggering event (e.g., a catastrophic flood). After the severe disruption wrought by Hurricane Sandy, the New York Metropolitan Transportation Agency issued two rounds of catastrophe bonds that will pay the agency a set amount upon certain “triggers” or catastrophic conditions. The bonds act as a form of insurance, for which the agency pays an annual premium to investors.

Resilience bonds are a new proposed subset of catastrophe bond , developed by Refocus Partners, in which payments can be reduced by linking the bonds to projects that reduce the likelihood and/or severity of the triggering event. For example, if a coastal community invested in seawall improvements and other activities that would make flooding less likely, the premium on a catastrophe could be reduced proportionately. The premium reductions could be used to finance the project that will lead to the risk reduction. To date, no resilience bonds have been issued, but the concept is under active discussion in several communities.

  • Most municipal governments use the municipal bond market, which is a tax-advantaged way for state and local governments to borrow for public purpose projects.

Federal law permits the interest earned on these bonds to be exempt from federal taxes, and most states also exempt the interest from any state income tax. Thus, investors are willing to accept a lower interest rate on these bonds, because they do not have to pay taxes on the income.

Municipal bonds feature low interest rates, compared to commercial loans, and longer borrowing terms (up to 30 years in some cases). However, most jurisdictions have policy and statutory limits on bond issuance, because they do not want to obligate future stakeholders to high levels of debt. They also can be less flexible than other options, incur higher transaction costs and involve significant legal obligations in terms of disclosure to investors and following IRS rules related to the tax exemption on the bonds.

Loans

Loans

Federal Infrastructure Credit Programs (Transportation Infrastructure Finance and Innovation Act (TIFIA), Railroad Rehabilitation and Improvement Act (RRIF), Water Infrastructure Finance and Innovation Act (WIFIA).

The federal government has created several competitive credit assistance programs to provide long-term, flexible financing for public purpose infrastructure. These programs are cost-effective from a federal budget perspective, because the cost to the federal government is “scored” at the expected loss. The program essentially allows the federal government to pass on its low cost of borrowing to public and private borrowers constructing eligible transportation or water/wastewater projects.

All of these programs feature the following flexibilities.

• Fixed, low interest rates that are linked to the federal government’s own cost of borrowing. Unlike private market loans, federal infrastructure credit program interest rates don’t vary with the project risk—the rate is solely based on Treasury instruments of a similar maturity. For the RRIF program only, the borrower has to pay the “subsidy cost” (the amount charged to offset the potential loss to the government if the loan is not repaid).

• Long-term financing, with no prepayment penalty, or carrying costs other than credit monitoring fees.

• Flexible repayment schedules. Repayments don’t need to start until five years after “substantial completion” of the project, and can be aligned with income (so if the project produces less revenue than anticipated, repayments can be temporarily reduced. If it produces more, then the loan can be paid off early.

• Borrowers can be public or private entities. As long as the project is eligible under the program, a private entity constructing an eligible project can receive the assistance (as long as State and local agencies support the project and include in their transportation plans).

State Revolving Loan Funds (SRF)
Each state in the U.S. operates “state revolving funds” that provides low-cost financing for eligible drinking and wastewater infrastructure projects. Wastewater SRFs have been expanding eligibility to include green stormwater infrastructure in addition to more traditional wastewater and drinking water capital projects.

SRF rates vary, but they are always at or below market rates. SRF loan terms and underwriting policies are set by each state. The funds “revolve” because loan repayments are put back into the SRF, and made available for other lending.

State Infrastructure Banks (SIBs)
State Infrastructure Banks (SIBs) were initially created by federal legislation in 1998 that provided states with seed funding for a revolving loan fund for eligible transportation projects. 33 states have established SIBs and provided some form of assistance. States can establish their own lending policies, within federal parameters. Maximum loan terms are 30 years after substantial completion, and interest rates must be at or below market. Generally, SIBs can support projects that would be eligible for federal transportation funding under Titles 23 or 49 of the U.S. Code. The level of funding in each bank varies considerably, depending on whether the state chose to add to the federal seed funding, and how active its lending portfolio has been. SIBs have helped local governments advance projects by providing low-cost, long-term financial assistance.

Impact Investment Loans
“Impact investors” are investors who seek social as well as financial returns on their investments. Impact funds can be managed by for-profit and nonprofit firms, and may be focused on particular social goals, such as environmental protection, economic justice, or corrections reform. Loan amounts, interest rates, terms, and underwriting policies are established by each fund. For example, the Local Initiatives Support Corporation (LISC) supports investments in creative placemaking, by providing loans for renovation and reuse of urban land for parks and other amenities. The assistance can also be structured in alternative forms, such as bonds or equity investment, and may also be supplemented with grants.

  • Municipalities can also access loans from commercial banks or from state and federal programs or philanthropic sources.

Usually government loans offer subsidized interest rates for certain kinds of public purpose projects. Commercial loans tend to carry higher interest rates than tax-exempt bonds, but may be more flexible, since the government only has to negotiate with a single lender.

Private Financing via Public-Private Partnerships (P3s) or Nonprofit-Public Partnerships (NPPs)

  • Certain alternative delivery models involve the private sector taking on responsibility for financing infrastructure projects.

Private entities might finance construction of a new facility as part of a long-term Design-Build-Finance-Operate-Maintain (DBFOM) concession. Another possible model is a Nonprofit-Public Partnership (NPP) using a 63-20 bond issuance for financing. These models are discussed further in the alternative delivery section that follows.

Equity Investment Tools

New Markets Tax Credits
New Markets Tax Credits (NMTCs) are a financial tool designed to encourage private equity investment in economically distressed communities. From 2015–2016, $7 billion in NMTCs were allocated via a nationwide competitive process to Community Development Entities (CDEs) that provide loans, investments, and financial counseling in low-income areas. A wide variety of investments made by CDEs are eligible, from broadband in Alaska to conversion of a former tobacco factory into a mixed-use development.

The NMTC legislation defines a low-income area as a metropolitan area where the poverty rate is greater than 20 percent, and/or an area where incomes do not exceed 80 percent of the metropolitan area median income. NMTC investors receive tax credits for up to 39 percent of their total Qualified Equity Investment (QEI) in a CDE. The tax credit is taken gradually, with 5 percent over the first 3 years, and 6 percent each in the final four years. The investment must be held for at least 7 years or all tax credits are recaptured with interest. The tax credit is a low-cost way for CDEs to finance economic development projects, which may include some infrastructure aspects.

Private Equity Investment Via Employment Based Fifth Category Visas (EB-5)
The Employment Based Fifth Category (EB-5) program, also known as the Immigrant Investor program, is another financial tool that can assist some communities in delivering infrastructure. EB-5 was established in 1990 and is named for the fifth category of
U.S. immigrant visa.

Under the EB-5 program, immigrants can receive a U.S. visa by making an equity investment of $1 million ($500,000 in a rural or low-income area) and creating at least 10 jobs. The investor receives a temporary visa, which can be converted into a permanent visa if the jobs are created within two years of the investment.

Typically, EB-5 financing features very competitive rates, often half the interest rate that municipal bonds would be for similar projects, making it an attractive alternative for cities. Investors can either make their investments directly in a commercial enterprise, or through certified “regional centers” that identify projects and assemble capital on their behalf.

The Port Authority of New York and New Jersey and the Metropolitan Transportation Authority worked through the New York City Regional Center to use EB-5 financing to redevelop a bus station and hub on the George Washington Bridge, and to construct, operate, and maintain the subway system’s wireless network. The Seattle Waterfront Project is also being financed with EB-5 financing via the New World Regional Center. The project will create plazas, promenades, and a series of parks along the 26-block footprint of the Alaskan Way viaduct. The viaduct is being turned into a tunnel for seismic reasons.

If the promised jobs are not created, the investor can be permanently denied their visa. Some financing agreements will refund the EB-5 contribution if this happens, but it is a not a program requirement. The program has been criticized as inequitable for allowing some immigrants, typically the wealthiest in their countries, to “buy their way in,” to U.S. residency, while lower-income individuals have no such pathway to residency. The U.S. Government Accounting Office also reported concerns about invested funds potentially being obtained illegally, and laundered through the EB-5 program. Despite these criticisms, the program has been extended multiple times, and currently is set to expire in December 2017.


The table above presents some illustrative benefits of the financial tools explored by the cohort. Definitions and additional information about each tool are included in Appendix B.

In the past three decades, multiple initiatives have touted public-private partnerships (P3s) as the answer to infrastructure funding problems. While they can provide many benefits, generally P3s and other innovative delivery models aren’t a solution for funding gaps. P3s don’t usually generate revenue: they require it to work. Agencies may be motivated to explore P3s to attract private investment, but alternative delivery models are more likely to deliver value through performance-based accountability and innovation.

While P3s and other alternative delivery models vary considerably in structure, all of them involve the transfer of greater risk to the private sector than under a typical infrastructure finance project. The chart on page 65 shows some of the available project delivery models, ranging from the least amount of risk transfer (and private return) to the greatest. Selected alternative project delivery models are included in Appendix B to this report. Additional options are also included in the report on P3 Project Structuring Guidelines for Local Governments commissioned by the DC cohort as part of the City Accelerator work (available on the Stanford Global Projects Center website).

Threshold Factors for Considering Alternative Delivery

Some of the decision factors for alternative delivery are binary—
go or no go—decisions, rather than quantitatively determined.

Legal Authority

  • Before considering alternative delivery models, cities need to ensure that they have the legal authority to enter into an alternative delivery model.

It’s usually not worth going too far down the path of a potential procurement without having either legal authority or the reasonable expectation of obtaining it from the legislature or city council.

Minimum Size

  • Alternative delivery usually involves higher transaction costs—both in funds and in staff time—compared to conventional projects of a similar size.

Each city’s threshold may be different depending on availability of staff time and funds, and anticipated costs, but a typical minimum threshold is $50 million or above. This minimum may be achieved by bundling a number of similar projects.

Policy Appetite

  • If political leadership is unwilling to support greater private involvement for a particular type of project, it’s not likely to be worth pursuing.

Alternative delivery projects need a champion who understands the potential benefit(s) and is willing to go through the necessary analyses and approval processes to do it.

Risk-Based Factors for Considering Alternative Project Delivery

Alternative delivery models can often involve private financing and the contribution of private equity into infrastructure projects. Yet like all kinds of debt, private financing requires repayment, and is often more expensive (from an interest rate perspective) than public financing that might be available to a city. Cities may become interested in P3s due to the financing potential; but the performance and risk transfer aspects are really what make them potentially beneficial.
Before considering alternative delivery, cities may wish to consider the following questions:

  • Does the project feature technological risk that the private sector is better able to manage? Usually, projects with technologies that run on less than a 5-year cycle (e.g., IT, telecommunications, social media) are better handled by the private sector.
  • Does the project feature design aspects or construction aspects that the private sector is better able to manage (e.g., if the public sector lacks experience with building tunnels, bridges, or certain types of GI)?
  • Does the project feature O&M of new types of infrastructure that the private sector has greater knowledge of, or experience with (for example, GI).
  • Does the project include aspects that might create overall life cycle cost savings if a private partner were able to invest more up front in the facility? For example, is there a way to use more expensive materials or a design that is likely to reduce future O&M cost?

Traditional Procurement Model: Design-Bid-Build (DBB)

Most public works projects in the United States are constructed on a “design-bid-build” basis, where the public sector circulates a design for an infrastructure project, and seeks the lowest bidder to construct it. For example, suppose a city wished to construct a new city-owned parking garage.

Under the traditional process, the public sector would design (or engage a consultant to design) the garage, and then seek bids from construction firms to build it. The public sector would select the lowest bidder. The firm would then construct the project, and be paid as it was completed, generally with the proceeds from public financing, such as a municipal bond issuance. The project would be turned over to the public sector after completion, and the public sector would maintain and operate it.

Potential Advantages of Design-Bid-Build (DBB)

  • Doing a DBB in a low-bid procurement makes it easy to compare alternative bids.

This helps to prevent corruption, compared to more subjective evaluation processes, and can reduce costs by incentivizing bidders to reduce their bids. Traditional procurement also generally involves lower transaction costs (especially when the agency has already invested in developing its procurement systems and processes) and can be faster than undertaking a P3 or other innovative model.

Limitations of DBB

  • Under the DBB model, the lowest bid is not usually the final price.

Public agencies can be required to pay significantly more via “change orders” to the scope which are frequently initiated by the private contractor for expenses that are not considered their responsibility under the contract, such as design flaws or delays due to legal or permitting timeframes. Often courts are asked to decide whether these change orders claims are legitimate, or merely a strategy by companies that lower their bids in order to win the work, but seek additional compensation via change orders. Whether legitimate or not, change orders result in great uncertainty as to the final price of a project that can make it difficult to create a financial strategy. Having price certainty—even at a higher initial price—is one key advantage sought by cities pursuing alternative delivery models.

In a DBB project post-construction, obtaining compensation for any discovered defects or design flaws would require legal action against the constructing firm. Yet legal action to recover damages can be difficult when the public sector has already paid for the project, and when the constructing firm is often structured as a single-project consortium that ceases to exist after construction.

The private sector also has no incentive to minimize operations and maintenance cost, since this will be the responsibility of the public sector. It also has no incentive to use more expensive and durable materials, since replacement and rehabilitation will not be its responsibility either. Cities can (and often do) attempt to mandate use of certain materials, but it may be difficult for them to determine when the cost of such materials will pay off in the long run. Also under the traditional system, no long-term “warranty” is available for long-term projects. The warranty on a bridge that is constructed under a low-bid system is probably shorter than most of the cars that drive over it.

Public-Private Partnership Model (DBFOM) Availability Payment Concession

Under a P3 model, the public sector might offer a concession under which a private partner would design, build, finance, operate, and maintain (DBFOM) a new parking garage for a 35-year period.

Concessions that involve construction of a new facility are called “greenfield concessions, Under this model, cost overruns and delays would be the responsibility of the private firm. The private sector has incentives to choose a design that will be cheaper to maintain and operate. It also has incentives to use longer-lasting materials, since its involvement in the project will be longer. The long-term arrangement serves as an implied warranty, since the concession contract usually penalizes any kind of performance failure over the term.

Potential Advantages of a DBFOM P3

  • P3s may be able to deliver cost savings—and not necessarily by paying lower wages than government agencies.

In some cases, cost savings can be achieved because a P3 partner enjoys economies of scale. A global parking operator is more familiar with the purchase and operation of parking technology, and may be able to obtain a better price than an agency that might operate a smaller group of facilities. Cost savings can also be achieved because the private partner can apply best practices and efficiencies earned from operating multiple projects.

P3s are also generally able to deliver greater certainty with respect to schedule and cost overruns, compared to traditional projects. While traditional contracts can be structured to mandate payment of “liquidated damages” (financial penalties) for late delivery, contractors are often able to blame the public design for schedule delays. Under P3 arrangements, the private sector usually doesn’t receive performance payments until a project is complete, and it cannot receive project-related revenues such as parking fees until a project opens. These incentives mean that P3s generally are constructed on time. Transferring the risk for cost overruns to the P3s also prevents cost overruns from the public perspective.

Potential Limitations of a DBFOM P3

  • P3s involve higher investments of staff time, consultant resources, and transaction costs.

They also generally involve financing at a higher cost. This “risk premium” is supposed to be offset by transfer of some of the project’s risks to the private sector. If a project is not well scoped, or an agreement is not well written, risk transfer may not be successful, and the public sector may still pay a premium while being on the hook for additional cost. It can be difficult for public agencies to develop performance-based standards instead of the traditional materials-based standards. For example, instead of requiring that a contractor construct a specific type of stormwater solution, a performance-based standard would mandate that the solution handle a certain amount of runoff. The choice of solution (and the risk of any innovations) would be left up to the private partner.



Examples of Potential Risk Transfer in a DBFOM P3

Long-Term Brownfield DBFOM P3s

  • Some existing city-owned facilities could be operated at a net profit, such as airports, seaports, toll bridges or tunnels, or electric utilities.

Private partners typically lease these projects in a form of DBFOM P3 for terms from 50 to 99 years in exchange for an upfront payment.

This is typically termed a “brownfield concession” rather than a greenfield concession because it involves a lease of an existing facility with a proven revenue stream. (This is not to be confused with the term “brownfield” as used in land development to refer to potentially contaminated sites). The leases generally include consumer protections (such as limits on rate increases) and performance requirements for public facilities. In exchange, the private partner is permitted to keep the revenues from the enterprise.

Potential Advantages to Brownfield DBFOM P3s

  • Brownfield P3s allow cities to take advantage of their revenue-producing assets to support the ones that are operated at a loss.

The City of Chicago was able to use proceeds from its long-term P3 for the Chicago Skyway to pay down city debt, which in turn resulted in a rating upgrade that reduced the cost of borrowing for every other infrastructure asset. In some cases, the private sector may be able to achieve cost savings in management, compared to the public sector.

Potential Limitations to Brownfield DBFOM P3s

  • The companies that bought the long-term concession for the Chicago Skyway and the Indiana Toll Road lost money on their investments (though the public sector did not).

Chicago’s 75-year lease of its parking facilities to a private consortium has been widely criticized, because it resulted in increased parking rates, and because the contract obligated it to compensate the consortium for removals of parking meters. This means every time the city wants to expand a bike lane or do bus rapid transit, it has to compensate the private partner for the loss of any parking meters that results. The public sector can lose considerable flexibility when it enters into long-term contractual arrangements.

Nonprofit Public Partnerships (NPPs) and the Nationald Development Council’s American Model

  • The term “public-private partnership” is used for many types of relationships between public agencies and the private sector, both for-profit and nonprofit.

It can be used for everything from one-time philanthropic donations to a new library’s capital campaign to a 99-year toll concession with a for-profit global infrastructure developer. In this guide, we introduce the term “Nonprofit-Public Partnership” because the partnerships entered into by public-purpose nonprofit organizations and agencies are materially different from the “P3s” conducted with the private sector.

Nonprofits often play key roles in infrastructure without being directly involved in capital project delivery. For example, every infrastructure reuse project in the High Line Network’s portfolio features a nonprofit partner whose role has been integral to the development of the project. The Friends of the Highline helped found the High Line, and now help fund and maintain the park. Nonprofits face fewer restrictions than government agencies on soliciting and accepting philanthropic capital contributions, and may be better able to quickly hire staff and engage in partnerships with the private sector.

The National Development Council is a national community and economic development organization dedicated to community revitalization. NDC’s innovative model involves partnering with local governments to deliver projects.

NDC works with local governments to create a special purpose nonprofit entity that manages the project. The NDC American Model uses two financing tools available to nonprofits—tax-exempt bonds under IRS Revenue Ruling 63-20, or through Section 501(c)(3) bonds. 63-20 bonds may be issued if the circumstances meet the following tests:

  • A local government endorses the financing;
  • The facility will be occupied by a governmental or tax-exempt entity.
  • The facility reverts to the ownership of the local government upon retirement of the debt.

Cities may become interested in P3s due to the financing potential; but the performance and risk transfer aspects are really what make them potentially beneficial.

The government transfers ownership to the nonprofit during the term of the project, and leases it back from the nonprofit. Lease payments pay for the debt service and/or payments to the developer. The special purpose nonprofit hires a development team (architect and developer), using an integrated delivery model. The development team can receive incentive payments for successful completion of schedule and budget performance targets. Post-construction, the nonprofit contracts with a firm for maintenance and operations, and establishes a dedicated reserve for repair and replacement.

If conditions are favorable, the local government can refinance the project and ownership will revert to it. Usually NDC’s contracts also include an option allowing the government to buy NDC out for $1 (the government retains the obligation to retire the bonds, however).

Potential Advantages of the NDC American Model

  • NDC’s model offers technical assistance along with financing.

NDC staff has conducted multiple procurements, and is familiar with how to structure and monitor integrated delivery contracts. This can be particularly important for smaller cities or cities without experience with integrated delivery, or in designing incentives for performance-based contracts.

NDC’s 63-20 bonding enables the delivery of large projects without large up-front payments, or bond issuances that count against statutory debt limits. Communities may be able to finance facilities without seeking voter approval (although any long-term obligations will count towards rating agency ratios). The model offers transfer of integrated delivery risk to the nonprofit, and ultimately, to development team (if successful).

Under the traditional system, no long-term “warranty” is available for long-term projects. The warranty on a bridge that is constructed under a low-bid system is probably shorter than the warranty on most of the cars that drive over it.

Potential Limitations to the NDC Model

  • While the 63-20 bond does not count against statutory debt ceilings, rating agencies consider lease payments an obligation of the local government.

If revenues are insufficient to pay debt service, the local government will likely have to step in to pay off the bonds. NDC’s model doesn’t include the motivation of having private equity, or “skin in the game” for the long term. This does not provide direct incentives to NDC or the developers it hires to make life cycle capital investments to reduce future O&M costs, for example). It is important to note that other 63-20 transactions are spearheaded by for-profit firms. They may create a special-purpose nonprofit in order to qualify for 63-20 financing, but a special purpose nonprofit, specifically created by the private sector for a project, would not have NDC’s long-term community development mission and experience with managing private developers on behalf of the public sector.

Other Resources on Alternative Project Delivery

There are numerous other examples of possible alternative delivery models in addition to the above. Appendix C includes an additional selected subset of alternative project delivery options that might be potentially used by cities. As part of its cohort work, the DC team also commissioned a report on alternative agreement structures for municipal P3s; P3 Project Structuring Guidelines for Local Governments: The District of Columbia P3 Project Delivery: A Case Example, by Julie Kim (Senior Fellow, Stanford Global Projects Center, and Urban Infrastructure Finance Fellow, New Cities Foundation, and Mike Bennon, (Managing Director and Director of P3 Financial Literacy in the Public Sector (P3 FLIPS) Initiative, Stanford Global Projects Center (GPC).