Public/Private Partnerships in Greek Housing; Does the Reward Justify the Risk?

Sean Callan, Manley Burke, sean.callan@manleyburke.com

The University of South Carolina, Bowling Green State University, the University of Alabama, Texas Christian University, High Point University, Clemson University, William & Mary – all of these institutions are either beginning or in the midst of ambitious development projects centered on Greek housing.  Importantly, this is not an exhaustive list; the goal of development or redevelopment of Greek housing is a national issue impacting campuses across the country.  As a national issue, the Greek community should be evaluating its response to these development goals, formulating a strategy of its own to deal with what appears to be a development rush.

There is no question that we should all encourage the development of safe, secure and habitable student housing.  Also without question, life safety concerns are paramount.  But this concern is not unique to the Greek community.  Colleges and universities face their own issues in providing safe, secure and habitable student housing.  Couple the decline in the student housing stock with a poor economy, dwindling government support, lack of campus space and the risk inherent to development, and there is little to no institutional desire or capability to address the student housing issue.

The lack of desire or ability to develop new student housing has caused many institutions to seek to partner with private developers to meet burgeoning student housing needs.  These kinds of public/private ventures take on a multitude of forms with the private developer taking greater or lesser roles in each project as dictated by the circumstances.  However, the one common theme, and indeed the key to a successful public/private partnership, is the proper allocation of risk and reward between the partners.  Fundamental to this allocation is the idea that if the developer contributes private equity to the project, then the developer owns the project.  While the public partner may retain fee ownership of the land underlying the project, and lease the land on a long term basis (i.e., 50-100 years) to the developer, the developer always owns the project and improvements.

Host institutions are now moving beyond public/private partnerships for student housing in general.  Many of the colleges and universities that are developing Greek housing or Greek villages have proposed to partner with the Greek organizations themselves.  Institutions seek Greek organization private partners for the same reasons they have entered into public/private partnerships generally, most important to alleviate financial constraints.  However, unlike transactions negotiated on the open market, the deals being offered to Greek organizations are often characterized by a warped allocation of risk and reward.

The risk/reward distortion in Greek organization developments can be deceptively hidden.  In some cases, optimistic pro-formas mask the risk of relying on student occupancy for cash flow.  In other cases, lengthy contracts written in dense legalese camouflage potential dangers.  Of course, in some cases, a Greek organization may make a determination that on a particular campus and at a particular time that it will accept a skewed risk/reward scheme.  Such a decision could be made when first chartering a chapter on a campus, for instance, or perhaps in conjunction with an aggressive push to become or remain competitive on a given campus.

The purpose of this article is not to evaluate the relative merits of any particular decision to engage in a public/private partnership.  Rather, this article merely seeks to identify some ways that the relative risks and rewards inuring to the parties in a public/private partnership can be distorted.  In particular, we are concerned with legal risks that must be fully understood when evaluating such a project.

To demonstrate some of the legal risks involved, consider the following hypothetical scenario based upon terms and conditions found in several institutional forms.  Please note that the terms described below are merely representative of the offerings we have seen, and it is unlikely that any particular proposed transaction would look exactly like this hypothetical composite.  However, these hypothetical terms are representative of many of the transactions we have reviewed.

Hypothetical Development Situation

A host institution has determined to upgrade its housing stock, including Greek housing on campus.  The institution has created a deal structure in which the Greek organization is 100% responsible for the cost of construction, which cost may be met using a combination of debt and equity.  The institution is willing to use its resources to facilitate the issuance of debt, but there is no doubt that the Greek organization itself, not the host institution, is responsible for the debt.  On this particular campus, the average cost of constructing a Greek house is approximately $7 million.

So, as may be seen at the outset, this is an expensive proposition.  However, expensive is not necessarily bad, provided that the risk/reward allocation is proper.  In the proposed documents drafted by this particular institution, the allocation of risk and reward is out of balance.  Here are some of the issues:

Short Term Lease

In this particular example the host institution proposes a short term (i.e., 5 year) lease.  While the lease contains options to renew, the options must be mutually agreed.  Because there is no right to an extension, the Greek organization could find itself without a lease after 5 years unless the institution agrees to extend.

Financially, it makes no sense for the institution to extend the lease.  As set forth below, the institution now owns the improvements and project.  The bottom line is that having spent millions of dollars to build a chapter house, only the initial 5 year term is assured.  After expiration of that initial 5 year term, the Greek organization is relying upon the goodwill of the institution to continue its occupancy of the chapter house.

No Ownership of Improvements

The lease document in this hypothetical case unequivocally provides that the improvements and project belong wholly and solely to the host institution.  There is no ambiguity on this point.  So, having invested many millions of dollars, the Greek organization owns nothing but a right to occupy the house for five years (subject to the default provisions described below).

Default and Default Remedies

Default and default remedies are a critical consideration.  Upon default, most leases provide that the host institution may take back the chapter house, with or without terminating the lease.  In this way, the default clause is simply another way for an institutional landlord to shorten the term of the lease and take the chapter house back.  Some events of default are appropriate and acceptable, such as a failure to comply with the lease, provided there is a cure period and the default remains uncured.  However, in this particular example, events of default include the following:

1) Revocation or suspension of the chapter’s charter by the national organization;

2) Loss of recognition as a student organization by the host institution;

3) Non-disciplinary disbanding of the chapter (e.g., failure to maintain membership);

4) Failure of the chapter to comply with applicable laws or the rules and regulations of the host institution.

So, in any of these events, all of which occur with some regularity, the Greek organization would effectively forfeit its $7 million investment.

We have seen other problems with the institutional form documents as well, but these are simply some highlights meant to demonstrate how tenuous this investment can be.  In this hypothetical example, the private partner – the Greek organization – is completely at risk for its entire investment.  However, there is no corresponding reward; there is no ownership of the project, but only a short term lease that can be terminated for the slightest of infractions resulting in a complete loss to the Greek organization.

The transaction outlined above would never be consummated in the commercial market.  Not only would commercial developers balk at these terms, but no lender would finance such a transaction.  This kind of asymmetric allocation of the risk and reward generated by a public/private partnership is unique to the Greek community.

When presented, these kinds of transactions have appeal.  They appear on the surface to be a relatively easy way to provide members with new, state-of-the-art housing, with an institutional partner that can facilitate financing.  But the devil is in the details.  In this hypothetical example, the Greek organization has taken all of the financial risk, while the reward (i.e., ownership) flows directly to the host institution.  We strongly suggest that before entering into these transactions, the Greek organization private partner fully understands the risk/reward allocation.  It may be that in some circumstances, a Greek organization may determine that this kind of transaction is beneficial and acceptable.  But understanding the relative benefits and burdens of the contractual arrangement is critical to making that determination.

The Greek community as a whole may wish to consider whether some sort of unified approach is necessary.  As stated above, an individual organization may find this transaction to be in its own best interest on a particular campus.  That kind of decision may then prompt other organizations to follow suit to remain competitive leading to a cascade of bad deals for many organizations.  Some common themes that all groups might try to negotiate would include long-term leases with unilateral renewal clauses, true ownership of the project and improvements for which the Greek organization pays, and ensuring that the default provisions are carefully crafted to protect the private partner’s investment.  If these fundamental issues can be hammered out with the institutions early in the development process, the entire Greek community may well be better positioned to realize a reward commensurate with the investment risk it is taking.