Damien House and Leisl Harris

The Accommodation Business Case and the Role of the University

4th Annual Student Housing Forum

23 August 2013

Damien House & Leisl Harris

Introduction

Who is Social Infrastructure Solutions (SIS)?

PAST – full risk developers (FURTHER PAST…. architect, builder, financier, chartered accountant)

Some development projects include:

• Pharmacy Australia Centre of Excellence (PACE) University of Queensland Pharmacy School, Brisbane ($130m);

• Queensland University of Technology Health Faculty / Australian Red Cross Blood Service – Brisbane ($100m);

• Australian National University 2,500 student accommodation beds and ancillary facilities, ACT ($280m); and

• Twin Towns Services Club 260 key Short Stay Accommodation, Tweed Heads ($80m).

NOW – advisors to the university, government, semi-government , NFP and community sectors

Some advisory roles include:

• Mid West Development Commission – Geraldton Health Education &Training Accommodation Project Business Case

and Master Plan, WA;

• Goldfields – Esperance Development Commission – Tertiary Education Accommodation Business Case, WA;

• Private Developer, Student Accommodation Business Case, South East Queensland;

• Plus various Local and State Governments. – Redlands, Sunshine Coast, Victoria Government DEPI; and

• Community Sites – Stockland.

Introduction

How does an organisation whose core business is not accommodation formulate and assess such a Business Case?

Damien

• Navigating the Business Case? Known knowns and known unknowns but what about unknown

unknowns?

• Definition of feasible / viable. Is the definition really contestable and what does it mean?

• Risk allocation, risk mitigation and risk gates.

Leisl

• Options for University involvement and role in the development of accommodation.

• Contracting, financial close and delivery.

• Classic breakdown points.

Introduction

How does an organisation whose core business is not accommodation formulate and assess such a Business Case?

• In our experience - with difficulty, nervously, slowly and sometimes without a result (Decision!

Consensus!)

• Often our services to assist cannot be articulated and briefed with precision (telling)

• There are so many FUNDAMENTAL questions:

• How many beds?

• What mix of beds

• Budget and quality?

• Operations outsourcing?

• Timeframe?

• Whose money?

• What investment return?

• What price (rent)?

• On whose approval?

• Whose land?

• Amenity inclusions?

• Level of pastoral care?

• Delivery methodology?

• Under whose management and guidance?

• Private sector partnering?

• Uni underwriting - any/soft/hard?

• Ownership term (hold to prove up?)

• Profit maximisation?

Introduction Context - Business Case

• Brief (not only the physical but the BC Brief)

• Quantitative aims

• Qualitative aims

• Measures of success (qualitative)

• Demand study

• Financial model

• Risk analysis

• Sensitivity Analysis

• Approval pathways

• Cost Benefit Analysis (qualitative issues)

• SROI Analysis

• How wide is the study? Project or University

And remember – GIGO - Garbage In Garbage Out!

Navigating the Business Case

Known knowns and known unknowns but what about unknown unknowns?

“Need to be an expert in areas we didn’t know we had to be experts in” Edwina, Day 1

“We don’t know what we don’t know…how do they sleep at night?” Damian, Day 1

• Risk navigation - various tools (see later)

• Simplification - paradoxically making things simple is very hard sometimes

• Unknown unknowns is expert assistance required? – tens of millions at stake

• Unis are some of the most fixed asset rich institutions on the planet

• Unis have a great deal of expertise in facility procurement

• But this is a separate asset class and potential commercial business stream

• Importantly it need not be a commercial business YET

• But can be established and structured to be in the future IF NECESSARY



Feasibility context some examples…

Known knowns:

• Most of the pre-development expenses

• construction price and timing (market tested and mitigated by LDs)

• interest rate and margin (with hedging max 5-7 years)

• Warranties

• Operating costs (say 2/3s)

Known unknowns:

• Latent conditions (risk allocation)

• Demand (notwithstanding Demand Study)

• Price elasticity

• Operating costs (say 1/3)



• Our team started out on one of the first (happy to be challenged here) BOOT student

accommodation developments in the country

• We had an englobo land agreement with a G8 university

• We also had:

• three experienced ex-project financiers in the development team

• experienced developers in each state

• a willing financial institution with UK PFI experience

• a tier one contractor

• a very nascent professional operator now one of the largest in the country then run by a

husband and wife team

• We pretty much started from scratch



Frank admissions!

Unknown unknowns:

• Input tax credits!

• Now almost common knowledge but not when the GST was just introduced

• Ordinarily, the GST for construction costs CAN NOT be claimed back

• This is a complex area of law with some baffling case law precedents

• Most recently a successful challenge has been made but under specific circumstances

• Price point – always surprised how high!

• Rigorously test upside/aggressive assumptions

• Price elasticity (airport privatisation financial models explicitly modelled duty free spend)


Goods and Services Tax – Known Unknown!

Commencing working assumptions:

• input tax credits are NOT recovered for any and all capital costs

• input tax credits are NOT recovered for any and all operating costs

• GST is not charged on the accommodation rentals (and no remission to the ATO is required).

Assumes accommodation is “input taxed” - consistent with ATO guidance.

However, there is recent case law precedent that may “unlock” the input tax credit by treating the accommodation as “Commercial Residential”.

This particular area of indirect tax is a complex area of law with some very contentious and seemingly conflicting decisions in recent cases.


Price Point - Disincentives/barriers to private house rental:

• lack of single bed accommodation

• product not designed for purpose of shared accommodation (ie lacking locks and ensuites)

• finding partners to share with for multi bed accommodation

• financial commitment for multi bed (underwriting your partners!)

• refusal to rent to students

• language barriers

• term of student lease may not fit market

• general logistical difficulty for a young person (never done it)

• lawn and garden maintenance costs (if a house)

• travel - lack of proximity to campus

• safety

• lack of student community (if communal amenity is provided)

• lack of “house rules”

• predatory landlords

THESE ITEMS WILL BE VALUED BY STUDENTS IN LONG RUN

Definition of Feasible / Viable

Is the definition really contestable and what does it mean?

• Yes absolutely - it can mean different things to different people

• Last two accommodation BC had vastly different starting points and feasibility criteria

• One was for a commercial off campus facility incorporating both a refurb of existing and new

accommodation development in Brisbane. This needed to meet hurdle rates of return for the

transaction term and at specific points through the life of the transaction for equity and debt.

• Our last assignment was for an agency of the WA Government in a health education and training

precinct.

• The feasibility criterion for this project was operationally breakeven. No return ON or OF capital

required

• NFP providers. What are their criteria? Service mission but how is capital decision made?????

• Clearly, the starting point is critical to navigating a successful outcome

Definition of Feasible / Viable

Solutions Targeting

• Solve rent – Base Case assumptions but allowing rent to fluctuate to solve for a xx%pa equity IRR.

• Solve capex – Base Case but allowing construction costs to fluctuate to solve for a xx% pa equity IRR.

• Solve opex - Base Case assumptions but allowing opex costs to fluctuate to solve for a xx% pa equity IRR.

• Solve land price – ditto

• Solve break even – for rent, capex, opex (and operationally breakeven)

• Solve concession term

• Other critical criteria - Project IRR, Equity yield by year, DSCR, ICR, Gearing, Payback

• Sinking fund allowance of xx% of revenue treated as cash outflow

• Later explicitly model lifecycle costs

• General comment

• Risk free rates, risk premium, debt tenor, AUD, yield play – all augur well

• Qualitative – student experience, VFM, regional WA nurses community vs built environment)

The Future….

Hertfordshire University Accomodation – GBP 190m (AUD 300m+)

Debt funding via an index-linked unwrapped private bond placement with a maturity of 41 years, one of the longest maturities

to be raised for greenfield infrastructure projects.

The bond has been rated A- by S&P. The high rating reflects the fact that despite demand risk to which the SPV is exposed, the

University is guaranteeing occupancy during construction. The University has also taken credit risk on students, meaning that it

will pay if they do not, which provided a significant enhancement in terms of revenue risk.

Gearing is 75:25, which also contributed to the high rating.

Project details

The project is for the DBFO of student accommodation totalling 3,000 bedrooms and associated spaces. Construction involves

the development of over 2,500 new bedrooms.

Derwent Living’s provision of asset management and facilities management services for the new and existing units will be

worth more than GBP 200m over the lifetime of the contract. Derwent Living will also refurbish the existing 500 bedrooms over

the next three years.

The scheme will be delivered in three phases with the first phase scheduled to be completed in September 2014.

Issue amount: GBP 143.5m

Maturity: 31 July 2054

Issue price: 100

Coupon: 2.057%

Spread: 235bps versus UK 2035 Inflation linked

Frequency: Semi-Annual

Rating: S&P A-

Understanding Risk

Risk allocation, risk mitigation and risk gates.

• Risk allocation at a broad level is a function of the delivery and operations model

• Accommodation need not be delivered under a BOOT model

• Our team helped deliver under BOOT and under direct ownership with a third party operator

• Much of the completion risk is contained within the building contract and usually for circa 80%+ of

cost

• Our team has developed several template style RAMMs for different style developments (example)

• We also developed a detailed risk capital gate model that ensures appropriate risk taking and

expenditure commitment during the critical early phase investigations and through project life

(example)

The Role of the University What options are available for the University’s involvement and role in the

development of accommodation? Consider

Student Accommodation – Core University Business or to Support Core University Business?

“The Universities do not necessarily recognise the benefit and value that accommodation brings to the students” Laura, Day 1

Just another University asset? Is accommodation the same as an academic / faculty building?

“Whose responsibility is it to provide student accommodation – Property and Facilities, Student Services, Others?” Day 1

Discussion

What is the best use of limited University capital?

Round 5 of NRAS closed 6th August – Secondary market?

“We have to more with less, in a more efficient way” Edwina, Day 1

Resources – expertise and capacity

Specialist user requirements – design and operations - capital versus operations – lifecycle costs

Certainty of outcomes – short (delivery) and long term (operations)

Brand – preservation, enhancement and value

How does the University ‘stay safe’ throughout the process - from project inception to operations?

The Role of the University

What options are available for the University’s involvement and role in the

development of accommodation?

Role Responsibility

‘ON CAMPUS’ Design (fit for intended purpose)

Funding (Debt & Equity)

Construction (Delivery)

Occupancy Operator Maintenance and Capex

Comments / Other

Developer & Operator D&C or construct only?

Full responsibility in all areas (Monash BVN example)

Developer Only Operator may or may not take occupancy risk if not the developer. Example: Third party operator takes existing facility.

Equity Investor Only Financial returns through term and asset reversion at the end of the term (BOOT example).

Partner (with Private Sector)

May or may not be required to underwrite minimum occupancy level and may benefit from increased occupancy level. Branding is important to operations. Design guidelines versus operator requirements.

Land Owner Only (Contribution via Ground Lease)

Certain level of control over design (maybe design guidelines), development or operational outcomes. Brand protection is important. Asset may revert to University at end of life under Ground Lease.

Brand Contribution Brand recognition to students (marketing tool) and ease of booking when choosing accommodation is critical and therefore assists occupancy levels.


Contracting, Financial Close and Delivery – let’s start building….??

Need

Use

Market

Site

Investment

Strategic

Stakeholder Needs

Schematic / Concept Design

Planning Parameters

Assumptions • Development

Costs • Revenue • Operations • Funding – debt

and equity

‘Solve for’

Sensitivities

Market testing / Demand Study

Support Feasibility Assumptions

Commercial Positions / Options and Recommendation

Delivery Options and Recommendation

Certainty

Planning

Design Risk – fit for purpose?

Construction Risk?

Budget Management

Programme / Time Management

Commercial / Funding Structure

Design Development

Planning Approval

Negotiation and Execution of Contracts

Financial Close / Construction Commencement

Development / Project Management

Handover

Operations

Opportunity Identification

Concept Creation

Feasibility

Business Case Validation

Choose Delivery Option

Implementation (Predevelopment and

Delivery)

Iterative process


Role evolution and adaptability…

Accommodation Projects 1&2

UNIVERSITY ROLE: Equity Investor Only

• Two other equity participants (Financier and Developer) – aligned objectives – University kept safe

• Developer undertook design and delivery risk as well as development management role –

University kept safe

• Third party operator – University kept safe with no occupancy, maintenance or capex risk

Projects 3 &4

UNIVERSITY ROLE: Developer

• Market changed (market failure)

• The ‘template’ had been tested

• Confidence in implementation

• University undertook development with development manager and operator


Contracting, Financial Close and Delivery – some examples…

Builder

PACE Project (Developer SPV)

The University of Queensland

(Landowner and Tenant)

Completion G’tee /

Performance Bond

Development Manager

Bond Proceeds

PACE Finance

(Debt Financier)

1. Facility Agreement (Loan)

2. Development Agreement

(including Ground (Head) and Tenancy

(Sub) Leases

3. Development Management

Agreement

4. D&C

Contract

Additional PACE Project (Developer) Documentation

• Principal’s Project Requirements (PPR)

• Ground Lease / Head Lease • Superintendent Deed • Completion Guarantee • Deed of Assignment of Rents

and Termination Value • Deed of Assignment of Ground

and Sublease • Deed of consent to assignment • Multi-party Deed • UQ Superintendent Deed • Precinct Agreement

In addition to the above, some 30 finance documents were also required for the bond components

University of Queensland, Pharmacy Australia Centre of Excellence (PACE)


Contracting, Financial Close and Delivery – some examples…

Various Lease Terms

Terms

3rd party COMMERCIAL AND

RETAIL TENANTS

DEVELOPER RISK

QUT

as LANDOWNER

ING HEALTHCARE as END OWNER

ground lease conditions controlled how the developer

can use the land and sets rules for future (re)development.

ground lease payments in return for using the QUT land.

ARCBS as pre-committed TENANT – 7900sqm

80 year lease term

Upfront NPV lease payment

DEVELOPER

Development, delivery and financial risk minimised to a level acceptable to QUT & ARCBS

The Development Agreement ensured that QUT and ARCBS were

shielded from risk and it clearly detailed the developer’s

development and delivery obligations.

Developer takes development risk and provides equity as necessary

QUT as pre-committed TENANT – 8300sqm

25 year lease term

Monthly lease payments Developer negotiates and enters into agreements with:

• D&C contractor • Development consultants

• Sales agreement with building owner • Financier (ING Bank) • Agreements to Lease (under Development Agreement) • Others as necessary

Lease Payments

Queensland University of Technology and Australian Red Cross Blood Service, Combined Facility

What could possibly go wrong?

Classic Breakdown Points

Translation of the ‘need or idea’ into ‘reality’…

Making the project ‘viable’ – under what definition?

Risk allocation and acceptance

Decision making – who is responsible?

University approvals process (particularly if third party delivery)

Delivery options consideration and comfort level – University through to third party provider

The Principal’s Project Requirements (Design Brief or the ‘glue’) – prescription or performance?

Demand Study Outcomes

Market appetite or even market failure (if third party involvement)

Too many false starts – market becomes wary

Questions?

Damien House and Leisl Harris

Education

unknown unknowns

core business

s known unknowns

development of accommodation

student accommodation

risk developers

university involvement

g8 university