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Public Sector |
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Private Sector |
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Definition
This PPP model involves the long term lease of existing, publicly-financed toll facilities to a private sector concessionaire for a prescribed concession period during which they have the right to collect tolls on the facility. In exchange, the private partner must operate and maintain the facility and in some cases make improvements to it. The private partner must also pay an upfront concession fee.
Long term leases are procured on a competitive basis, with awards going to the qualified bidder making the most attractive offer to the sponsoring agency. The most important criterion for the award of long term lease concessions generally is the amount of the concession fee. Other criteria may include the length of the concession period and the credit worthiness and professional qualifications of the bidders. |
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Recent Experience
As of autumn 2006, three major long term lease transactions have closed in the United States. This nascent trend began with the 99-year lease of the 7.8 mile Chicago Skyway for a fee of $1.8 billion in January 2005. This was followed by the 99-year lease of the financially troubled 8.8 mile Pocahontas Parkway in Richmond, Virginia for $548 million, and most recently in July 2006 by the 75-year lease of the 167 mile Indiana Toll Road for a fee of $3.85 billion. |
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Factors Affecting the Use of Long Term Leases
There are a number of factors that influence the use of long term leasing arrangements. For the public sector the most basic factors are the political and financial situation of individual states and local jurisdictions. When these two factors coincide, local leaders may make the decision to consider leasing arrangements. In cases where there is not a pressing financial need, local decision makers may explore the possibility of leasing toll road assets to ascertain whether the terms of a potential transaction would attractive enough to move forward with an actual transaction. For private investors, the primary motivation for pursing leasing opportunities is the potential to gain an adequate rate of return on their investment.
Moody’s Investors Service has identified several characteristics that may make certain toll facilities good candidates for long term lease arrangements. These include:
- Established toll roads that have political limits on toll raising ability
- Roads owned by governments that are short of capital to fund government programs
- Roads with a significant number of non-resident users, such as truckers or tourists, who may be less able to effectively protest against privatization
- Roads that are financially distressed but which may present a strategic business opportunity for concessionaires seeking to enter the U.S. market
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The Prominent Role of Overseas Investors in the U.S. Leasing Market
It is also notable that to date all private long term lease investors active in the U.S. market are overseas investors. The PPP markets in Europe and Australia in particular are more mature than those in the United States and experienced investors from both continents are actively seeking out new investment opportunities in the United States. This trend has been buoyed by the weakening of the U.S. dollar together with the perception that toll road investments in the U.S. are perceived as less risky than those in developing countries. It also reflects the fact that due to the strong tax incentives that compel the U.S. capital markets to prefer municipal debt the market for private activity debt is far greater outside the United States.
The prominent role that overseas investor are playing in the emerging U.S. market for toll road PPPs is generating interest in these types of investments amongst U.S. banks and investment funds. A number of U.S. financial institutions are now in the process of establishing infrastructure investment funds. The new authority provided by SAFETEA-LU to issue tax exempt private activity bonds for transportation projects should encourage U.S. investors to expand their activity in the domestic toll road market. |
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The Pros and Cons of Long Term Leases
While recent upfront payments for the Chicago Skyway and Indiana Toll Road are impressive, the jury remains out on the merits of long term leasing. Public and elected officials are contemplating potential long-term leases of toll roads and bridges in New York, New Jersey, Delaware, Pennsylvania and Illinois. The largest of these involves the New Jersey Turnpike, which has one of the highest revenue flows of any tolled facility in the United States. The potential lease of some of the nation’s most valuable toll road assets has generated a great deal of discussion, including hearings on the subject conducted by the U.S. House of Representatives Transportation Committee in May 2005 (links provided below).
A number of toll road owners have made the decision not to pursue leasing options. These include the Harris County Toll Road Authority, which spent over $1 million studying the feasibility of leasing its 82 mile toll road network in Houston. Although these studies indicated that a 75-year lease of these facilities could fetch a fee of as much as $7 billion, the Harris County commissioners unanimously rejected a possible lease in July 2006. Rather they preferred to maintain public control over their toll road network and use the revenues generated to help fund other transportation needs.
Similarly, the Metropolitan Washington Airport Authority (MWAA), which owns the Dulles Toll Road, recently ended attempts to lease that facility under the Commonwealth’s Public-Private Transportation Act (PPTA). Rather than seeing toll revenues leave the corridor, MWAA submitted a counter proposal to the Governor of Virginia to assume the operation of the toll road outright. MWAA plans to increase toll rates along the lines that the private sector bidders had proposed, but to invest all the proceeds in rail and roadway improvements in the corridor.
Although transactions such as the lease of he Indiana Toll Road have generated enormous sums of money that are used to fund transportation improvements that otherwise could not be built for years, it will only be possible to judge the ultimate success of lease transactions long after the lease proceeds are spent. The question for policy makers is to study whether ceding control of toll road income and assets for extremely long periods of time is in the public’s best interest.
The answers to several basic questions remain to be seen seventy or ninety years from now: Did the private sector partners derive reasonable profits or were they excessive? Were the transactions associated with legal battles? Were local residents overburdened by toll increases? Were there alternative ways that the public sector could have extracted comparable revenues from their toll road assets?
In some cases long term leases will bring real and important benefits. In others lease fees could under value strategic assets that no longer bring needed income into the public coffers. These issues will be studied carefully as this new partnership option is considered by toll road operators. The debate over the merits of potential lease transactions will benefit the transportation sector in the United States. |
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Potential Benefits of Long Term Leases
The potential benefits of long term lease transactions include:
- Depoliticization of toll setting process by transferring toll setting responsibility to the private sector
- Ability of leases to increase toll revenues generated by existing facilities
- Ability to generate extremely large up-front lease payments that can be used to fund badly needed transportation improvements
- Ability to reduce on going public sector operating, maintenance and capital improvement costs
- Potential to capture private sector operational and maintenance efficiencies
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Public Policy Issues Associated with Long Term Leases
There are also a number of policy issues associated with long term leases which need to be assessed carefully to ensure a beneficial outcome. One of the most important is the potential undervaluation of an asset to be leased. As was witnessed with the Chicago Skyway procurement where the value of the winning proposal was 2.6 times greater than that of the next highest bid, competition can help prevent undervaluation. Toll road owners considering leasing options should also seek the advice of financial advisors who can identify fair market values of lease transactions based on the anticipated revenue streams.
Other policy issues can be addressed in the legal terms and conditions underpinning lease transactions to ensure a fair outcome and protect the public. Such issues may include:
- Loss of public control over toll rates
- Loss of public sector revenue streams
- Potentially burdensome toll increases
- Inequitable return on private sector equity
- Channeling toll proceeds away from transportation purposes
For example, the terms and conditions can preserve some public control over toll rates. Similarly, caps can be place on the private sector’s rate of return. As with the Indiana Toll Road transaction, other regulations can be enacted to ensure that the lease proceeds are used to support transportation improvements in prescribed areas. Governments also provide oversight of the private sector partner’s performance as well as include capital reinvestment, availability, safety, and customer services requirements in their lease agreements. Public agencies executing long term lease agreements can protect the public interest when they using these types tools effectively. |
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Resource Documents
Understanding Contemporary Public Private Highway Transactions: The Future of Infrastructure Finance?
May 24, 2006 Testimony to the U.S. House of Representatives Transportation Committee Subcommittee on Highways, Transit & Pipelines:
This hearing was intended to provide Members of the Committee with information regarding contemporary public private highway transactions. Recent high profiles lease agreements for highway toll facilities in Indiana, Virginia, and Chicago have brought these issues to the forefront of the debate on the future of infrastructure financing. This hearing explained why state and local governments may find private involvement in highway financing attractive. It also focused on how a particular method – namely, long-term lease of existing non-federal toll facilities to private operators – is structured.
Indiana Toll Road for Sale
Webpage presenting a series of articles from January 2006 on the sale of the Indiana Toll Road organized by The Times, South Bend Tribune and Fort Wayne Journal Gazette.
Public Works Financing
Read this special issue of Public Works Financing which contains articles from other 2006 issues on various leasing topics.
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Projects
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Links
See the links in the case studies, as well as the resources listed above.
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