The following chart and supporting materials are meant to summarize the main aspects of standard privatized housing – student housing built on campus land by a private developer that is subject to a ground lease. There are many other permutations between the traditional university delivery system and the standard privatized model, but hopefully these materials will provide information on the two ends of the spectrum in terms of risk, control, and return between the university and the private developer.

Median development cost per bed for privatized housing is $20,300. [Source: Education Real Estate Services survey; 1997]

Factors contributing to the cost difference are likely the residential grade of most privatized construction and the fact that most privatized projects are not subject to procurement guidelines (which typically increase the cost of construction).

Universities often do not account for indirect costs such as staff time and marketing, thereby understating the true cost of the project. All project-related costs are included in a developer’s budget.

Below is a comparison of two project proformas from two student housing projects. Although no two projects are the same, making a direct comparison difficult, both of these project budgets were developed in the same year, in the same state, and using a similar construction method (brick and wood frame, low-rise apartments). The proformas illustrate (1) the previous point concerning direct project costs and (2) those indirect project costs that are not fully accounted for in the university budget.

Development risk is a broad term for a variety of risks present in a development project. Major types of risk include design risk, construction risk (e.g. injury to workers or others, physical damage to project) and post-construction risk (e.g. discovery of design defects). Development risk also encompasses delivery risk, which is discussed in the next section. In privatized housing projects, the developer bears development risk and is required to carry the appropriate insurance coverage.

However, because the developer carries the risk, the developer also has significant control of the development process.

"..Lessee shall have sole control of the selection of construction professionals, construction design, means, and methods and the final decision regarding construction of the facilities." 

Although the developer has control, the university is not completely shut out of the process and usually retains the right to approve the plans and specifications before construction begins as well as the right to approve or disapprove subsequent major alterations.

In privatized housing projects, the developer typically bears the delivery risk (i.e., the risk that the project will be completed on budget and time). For student housing, this is a significant risk because once the fall semester deadline is missed, it will be impossible to reach full occupancy in the first year of operations.

Although atypical, the university can carry the delivery risk.

On-campus privatization deals utilize a ground lease through which the university leases campus land for the housing to a private developer. The developer builds, owns, and potentially manages the housing for a period of years. At the end of this period, ownership of the housing reverts to the university. The length of this period varies from 20 to 50 years; the average is 35 years.

Ground leases contain many components, such as occupancy guarantees and profit sharing. Ground leases differ from institution to institution based on the relative negotiating power and expertise between the university and the developer as well as the unique needs and priorities of the university. Ground leases also vary depending on whether the university is contracting with a local developer (which may lack student housing expertise, but may be more flexible) or with a national firm (which may have more housing experience, but may have a more standardized approach).

Ground rent is typically split into two portions: a fixed portion (base rent) and a portion based on a share of net revenues (annual percentage rent).

• Base rent is usually a nominal amount (e.g., $100 per year) paid either on an annual basis or as a lump sum at the inception of the lease.
• Annual percentage rent is typically 50% of the net revenues from the housing, with the other 50% going to the developer. Net revenue is the cash flow that remains after all project revenues and expenses have been taken into account.

• Deficits from any given year are not carried forward to subsequent years. Although this seems to place financial risk on the developer, the risk is limited. Annual budgets, determined in advance, typically include occupancy guarantees from the university, which protects the developer from revenue risk. On the expense side, the developer has ultimate control over the budget and expenses, making it reasonable that any remaining risk be borne by the developer.
• Although the 50/50 is fairly standard, there are exceptions.
• At one university, the percentage rent is based on gross revenues. The university’s share of gross revenues varies between 0% and 20% depending on the level of gross rents. If net revenues are insufficient to make the percentage rent payment, payment is deferred with interest accruing until the developer pays the deferred amounts to the university.
• At another university, the university does not receive a percentage rent, instead intends for the "contribution" of its land to result in lowered rents for the students.
• At yet another university, annual percentage rent to the university is only 25%, but if net revenues are equal to or greater than 110% of projections, the developer provides ten $2,000 scholarships.

• The use of the traditional approach to developing student housing allows the institution to take advantage of tax-exempt financing. Private developers cannot usually utilize tax-exempt financing for the project unless some type of nonprofit corporation is involved. As taxable financing is 200 basis points or more higher than tax-exempt financing, the developers’ annual debt service is higher than the university’s debt service.

• Private developers also cannot typically avoid paying property taxes for the improvements to the land. Property taxes make up a significant portion of the typical apartment complex operating budget. According to figures from the Institute of Real Estate Management, median property taxes on conventional garden-style or low-rise apartments are in the range of $450-500 per year, per unit.
• Universities typically finance 100% of project costs, resulting in no equity contribution. Private developers typically contribute 25% equity into the project and finance 75%. The developer’s return on and of equity comes in three forms:
• Annual percentage rent payments
• A refinancing of debt
• Purchase of the property by the university or other permitted purchaser

Occupancy risk is the risk that the projected number of beds will not be filled, resulting in insufficient project revenues. Developers typically look to shift the occupancy risk to the university because it is difficult for the developer to obtain financing without an occupancy guarantee. Developers are usually, but not always, successful in requiring an occupancy guarantee.

Two types of guarantees are:

• A guarantee based on renting a sufficient number of units to break even. If a sufficient number of units are not rented, the university must pay rent on the required number of units. If the university makes such a rental payment, it is entitled to receive all of the net cash flow from the project until it has recouped its rental payment. Once the university has recouped its payment, the property manager receives all net cash flow until any subordinated management fees are recouped. The occupancy guarantee provision ceases if the project achieves a specified investment rating.
• A guarantee based on meeting a gross rental threshold set as a specific dollar amount in year one and adjusted annually based on changes in expenses. Each semester, the university assigns students according to a priority system until the threshold is met. If the threshold is not met with prioritized students, the university is required to assign non-prioritized students to the housing (although no student can be required to live in the housing if they prefer other accommodations).

The actual wording of occupancy guarantees is very important. For example, there should be a clear understanding of how the gross rental threshold is set and adjusted each year. Also, there are ways in which the occupancy guarantees can be worded to help the guarantee be less onerous to the university. In practice, occupancy guarantees typically are implemented through working arrangements between housing officers and the developers' on-site managers, allowing for some flexibility from the rigid requirements of the contract. The result is still to force the university to either shift students from its own housing into the privatized housing, more actively market the housing, allow different groups to occupy the housing (e.g., freshmen in housing intended for upper division students), or allow the housing to be opened up to non-university-related persons.

Although universities can gain the ability to manage privatized housing, in the standard privatized model, day-to-day operations of the housing are managed by the developer.

• Marketing: The developer markets the housing to students, usually with the campus's distribution of developer-supplied materials to students. The campus may refer students to the developer's housing by some agreed upon order of precedence (e.g., seniors ahead of others) but the campus is not forced to require that students live in the housing.
• Rent Collection: The developer collects the rent and the university often pledges to help collect debts from students by withholding grades or taking other enforcement measures, perhaps at the expense of the developer.
• Maintenance and Repairs: the developer handles maintenance and repairs, with the campus frequently having the right to inspect the property at specified intervals. The campus may require the developer to match or exceed the standard of maintenance and repair of university-owned housing. The developer may be required to set aside a predetermined reserve amount each year to cover future maintenance or renovation costs.

• Management Committee: In most cases, some sort of management committee or "team," formed with representatives of the developer and the campus, meets regularly to approve budget, hiring, and management issues. Typically the developer is accorded the final vote on financial issues and selection of the manager; the university is accorded the final vote on policies and procedures (other than those addressed in the budget).
• Rate Increases: The management committee controls rental rate increases through its approval of an annual budget. Campuses that require more control over the size or speed of rent increases may include increase limitations in the ground lease contract or state that the rent must be comparable to on- or off-campus rates.

• Personnel: A typical ground lease also includes a clause allowing the university to meet the developer's chosen manager before hiring. The contract may require the developer to consider hiring students; it may allow the university to force the developer to fire or replace any employee whose job performance is inadequate.

Developer operating budgets and university operating budgets often differ dramatically in terms of types and levels of costs. Recent bids developers submitted to a Florida university included operating budgets that ranged from $3.00 per gross square foot to $5.00 with a median of $4.00. By comparison, according to a survey conducted by MPC Associates Inc. in 1991 (and adjusted for inflation), operating costs for university-run housing typically range from $3.65 to $9.00 per gross square foot with a median of $6.56.

This cost differential is one of the financial benefits of privatization. As can be seen in the following chart, even with the payment of a management fee, housing is operated more cost-efficiently by a private developer.