Financing Long Term Debt
The early planning activities such as building assessments, needs assessments, and even master planning is often funded out of general revenues. Once a decision is made to go forward with a capital project it is necessary to secure more substantial funding to cover the design architect fees, the site acquisition costs, and construction costs.
Two of the most prevalent public funding options are general obligation bonds (GOB) and revenue bonds. The choice of which method to use may depend on the length of the project, the political viability of public funding that normally requires a referendum, and the expected life of the building.
General Obligation Bonds (GO bonds)
General obligation bonds are debt instruments issued by states and local governments to raise funds for public works, and are the most commonly used means of financing long-term public capital improvement projects. What makes general obligation bonds (or GO bonds for short) unique is that they are backed by the full faith and credit of the issuing municipality. General obligation bonds are still the preferred financing vehicle for most jurisdictions because of the advantages, but it may not be feasible to use general obligation bonds because of the disadvantages.
Advantages of General Obligation Bonds
- Requires voter approval.
- Relatively inexpensive and easy to sell (assuming a good bond rating).
- May mean courts have to compete with other needs such as schools and roads.
- Voter involvement can insulate public officials from later criticism.
- Least expensive means of borrowing because the general credit of the governmental entity is committed.
Disadvantages of General Obligation Bonds
- Requires voter approval.
- Tax and debt limitations that require forms of debt that are not subject to legal limitations.
- Tend to take a long time. Not a good option if there is a need to proceed quickly.
- Poor bond ratings make it preferable to use a public authority.
- Inability to obtain a priority rating in the capital improvement program of the government that finances court facilities.
- A desire to avoid restrictive laws in the construction of public buildings.
- Tax and debt limitations.
Revenue bonds are normally the second choice if issuing general obligation bonds is not feasible, but there are jurisdictions where issuing revenue bonds is the primary method of financing public buildings because the legal limitations on debt and taxation make it difficult or impossible to use general obligation bonds. More commonly, however, revenue bonds are a possible option rather than the sole practical choice. Revenue bond financing is available through a variety of public agencies: state building authorities, judicial building authorities, industrial development associations, and local building commissions.
Advantages of Revenue Bonds
- Greater certainty and speed, by avoidance of the lengthy and unpredictable political process surrounding general obligation bonds.
- Expertise provided by some of the more sophisticated building authorities.
- In some jurisdictions, latitude in applying the laws governing the construction of public buildings.
Disadvantages of Revenue Bonds
- May be slightly more expensive than GOBs.
- May result in raising rates or fees.
- Additional indebtedness may be constrained.
- Lack of voter involvement may be unpopular.
Private financing is becoming more popular as communities seek ways to leverage their tax revenues to greater advantage to finance long needed capital improvements. In general private financing works much like a home mortgage.
A private entity such as a commercial bank, real estate developer, or builder provides the funds to design and construct the facility and the local government body then buys back the facility through a lease purchase agreement that may last 30 years. The loans are paid back through possible revenue that may be generated by the property or through general tax revenue.
Certificates of Participation (COPs)
One private financing method is the use of Certificates of Participation (COPs) which can be used as an alternative to GOBs. The COP is based on sale of interests in lease revenue from a capital project; for instance, the revenue from a parking garage that is constructed as part of the project or a bridge for which tolls are levied. COPs are not viewed legally as "debt" because payment is tied to an annual appropriation by the government body.
Also widely used as an alternative to general obligation bonds are certificates of participation. This method of capital financing is based on sale of interests in lease revenues from a renovated or newly constructed facility and has frequently been used to finance court facilities.
Revenue bonds are available through a variety of public agencies such as a local industrial development authority.
- Circumvents the lengthy and unpredictable political process required with GOBs.
- May be some latitude in applying laws governing the construction of public buildings.
Public Private Partnerships (P3 Projects)/Design Build and Finance
Another form of private financing that is becoming popular is the use of Public Private Partnerships often referred to as P3 projects. This process involves the use of lease/purchase arrangements between a private builder/developer and a local government body. It allows private entities, to acquire, design, construct, improve, renovate, expand, equip, maintain or operate capital projects. The private partner provides cost or completion guarantees for which it is given an equity investment in the project. Inherent in this type of financing arrangement is the need for the local governing body to identify a dedicated revenue stream that will support the lease payments for the term of the agreement.
This method eases many of the front-end political problems of GOBs and other methods requiring public approval. The retirement of the debt shows up in the governing bodies operating budget in the form of rental or lease costs. It provides good cost controls because there is a single entity which is accountable and there is less likelihood of cost-related changes in the project, the project can be completed faster and there is less likelihood of delays, and it defers the need for public funds because the builder picks up a lot of the early costs.
Some of the states that have adopted legislation authorizing the use of P3 financing include Virginia, Florida, Texas, Utah, Maryland, Arizona, California, and Michigan.
Advantages of Privatized Financing
- The private entity, not the government entity, incurs the long term debt.
- Better cost controls because there is a single accountable entity and less likelihood of cost-related changes.
- The cost of the project to the government is spread over a longer period of time.
- Projects generally take less time to complete, thereby reducing costs.
- Defers the need for public funds because the builder picks up a lot of the early costs
- The loan does not affect the debt load of the governmental entity.
- The private enterprise carries the risks associated with the project, including cost overruns and delays.
- Ongoing maintenance of the facility can be a component of the agreement.
Disadvantages of Privatized Financing
- Does not provide public accountability.
- Not suitable for complex phased projects with a long construction schedule.
- Reduces the level of court (user) involvement.
- Best used for generic public buildings that are not court-specific. Project scope and cost may not be defined until late in the process giving the local governing body and court less control over design issues.
- A P3 project bypasses public approval and subjects the project, the funding body, and the governing entity to resistance from the voters/general public.
- Experience to date with P3 projects demonstrates that they receive a limited number of bidders; typically one to three bids. This reduced competition could be detrimental; in contrast, competition among a larger number of bidders generally reduces the overall cost and increases the quality of a project.
- Cost of borrowing is higher (partially offset by speed and reduction of front-end costs.) because a private entity pays higher interest rates than government entities to borrow money. A P3 project also includes a profit margin for the private entity.
- The financing for a P3 project typically extends out over a longer period of time than in a traditional building model, with the court leasing the facility over a period of up to thirty years.