WAYS OF MAKING THE PUBLIC-PRIVATE PARTNERSHIP WORK

Mayor William A. Johnson, Jr.
City of Rochester

Written Testimony for the Commission on Affordable Housing and
Health Facility Needs for Seniors in the 21st Century

Syracuse, New York
July 30, 2001

The City of Rochester has extensive experience in creating successful partnerships with citizens, other governments, not-for-profits, and the private sector -- from the neighborhood level to the global level.

Through a process called Neighbors Building Neighborhoods (NBN), Rochester residents partner with City government to establish budget priorities for housing, public safety, economic development, human services, land use, capital improvements, and Community Development Block Grants. NBN is a national model for citizen empowerment. Versions exist in cities as diverse as Houston, Des Moines, Miami, Syracuse, and Newark (www.rochesternbn.com).

At the regional level, Rochester's new comprehensive plan, Rochester 2010, establishes a framework for inter-governmental cooperation and partnerships (www.r2010.com).

In the area of affordable housing, the City of Rochester has partnered with not-for-profits and private developers to build nearly 400 new units and rehabilitate 1400 existing units since 1994.

Over the past four years, partnerships between the City and the private sector have resulted in the construction of five new full-service supermarkets and 100,000 square feet of additional new retail space in City neighborhoods, countering a national trend of disinvestment in inner city neighborhoods.

Other ongoing public-private partnerships include a $100 million renovation of the Port of Rochester, the development of nearly 600 market-rate center city residential units, and a very complex $150 million partnership involving investors in four countries to begin a fast ferry service across Lake Ontario between Rochester and Toronto.

Given its extensive involvement with private sector developers, the City of Rochester has created a comprehensive framework for dealing efficiently and cost-effectively with public/private partnerships. There is no "one-size-fits-all" prescription, yet, from our experience, there are general rules of wide application which transcend individual projects and can be tailored to specific circumstances. Rochester's framework offers a generic model for making public/private partnerships work.

This testimony will review very briefly Rochester's general model for creating successful public/private partnerships (pages 2-6), describe a specific Rochester program for increasing private sector participation in affordable housing and special needs housing that is readily transferable to other cities (pages 6-7), and offer recommendations to the Seniors Commission (page 8).

Within Rochester's City government, an interdepartmental Development Committee meets regularly to review and discuss all proposed and current real estate developments. The Committee is chaired by the Deputy Mayor and includes representatives from the Departments of Economic Development, Community Development, Environmental Services, Parks and Recreation, Finance, and Budget.

The Development Committee maintains proper project coordination, makes sure everyone understands where responsibilities lie, sets priorities in cases of conflict, and addresses design and funding issues. A primary responsibility of the Development Committee is to initiate and evaluate public/private partnerships according to established guidelines, a summary of which are set forth below:

The City's operant definition is fundamentally economic:

A public/private partnership is a business relationship where the public and private sectors share the risks, rewards, and responsibility for the success of a project.

As in all economic transactions, potential benefits (relative to alternative means of attaining the desired outcome) must be weighed against potential costs:

Potential Costs We Seek To Avoid:

1. Inordinate loss of control

2. Inadvertently taking on risks that City had not identified or fully understood

3. Choosing an inappropriate risk strategy

4. Sanctioning a situation that allows the private sector partner to misuse or abuse a position of privilege relative to other private bidders

5. Failing to identify fully the technical requirements for the project or service, resulting in costly changes to the agreement and/or inappropriate or inadequate project outcomes

Screening Process

Benefits can be achieved and costs avoided through proper project screening. The City of Rochester has developed six criteria for determining which projects are suitable candidates for public/private partnerships. Within each of the six criteria are identified specific questions to help determine whether or not a project meets the criteria.

Several of the questions are effectively show stoppers on their own, and a negative response is reason enough not to pursue a public/private partnership. Most of the questions, however, are not absolute prerequisites to a successful partnership, although they will help delimit its scope.

The list of questions is not intended to be comprehensive. Additional questions may be warranted. Often, during the initial screening of a project, it is not practical to fully answer a question. In such cases, a provisional positive response is assigned, and the question is revisited at a later date when more information is available.

Financial - Is it likely that a partnership between the City and private sector will be able to carry out the project under financial terms that are acceptable?

1. Does the City enjoy a pre-existing cost advantage?

2. Is the project, or can it be, financially viable to the private sector? (Requires a thorough business case analysis from the perspective of the private sector)

3. Is it possible to define an equitable and appropriate price-setting mechanism to reflect changes in a range of identifiable costs (such as inflation, cost of specific inputs, interest rates)?

Technical - Is it reasonable to expect that a technical solution to the project can be found through a public/private partnership?

1. Is the project free of any technical constraints that are beyond the control of a private partner?

2. Can the City develop appropriate technical specifications for the project?

3. Can appropriate quality assurance and quality control mechanisms be established to ensure a private sector partner will meet technical specifications and legal agreements?

Operational - Are there operational hurdles that prevent a public/private partnership?

1. Is the project free of any operational constraints that are beyond the control of a private partner?

2. Can the City develop appropriate operating and maintenance standards for the project?

3. Can the private partner be held accountable for operating and maintaining an asset/program appropriately?

Acceptability - Is there acceptance of the involvement of the private sector?

1. Are elected officials willing to accept a public/private partnership?

2. Is the general public willing to accept the involvement of the private sector?

3. Are other stakeholders willing to accept the involvement of the private sector?

4. Is City staff willing to accept the involvement of the private sector?

Implementation - Are there implementation barriers that prevent a public/private partnership?

1. Is it possible to generate meaningful competition through a public/private partnership?

2. Is the project free of jurisdictional or liability issues that prevent the City from creating a partnership?

3. Can an internal (City) project champion be found?

4. Can the project champion access the resources necessary to administer a public/private partnership?

5. 5. Can a plan be developed to successfully transfer ongoing operations from City staff to a private partner?

Timing - Are there time constraints that would pre-empt consideration of a public/private partnership?

1. 1. Are the timelines adequate to develop technical specifications?

2. 2. Are the timelines adequate to develop operational specifications?

3. 3. Are the timelines adequate to develop involvement of the private sector through extensive consultation with stakeholders?

Internal Management Changes

In order to facilitate successful public/private partnerships, the City of Rochester improved its internal management and quality assurance processes:

1. Established an interdepartmental Development Committee

2. Established "universal" objectives for public/private partnerships (i.e., separate and distinct from any particular project) to reflect the policies and priorities of City government:

• Enhance City's capacity to develop integrated solutions
• Facilitate creative/innovative approaches to deliver public projects
• Reduce the cost to implement a project
• Reduce the time to implement a project
• Transfer risks to private partner
• Attract larger, potentially more sophisticated, bidders to a project
• Access skills, experience, and technology

3. Adopted common policies and procedures to guide and support public/private partnerships across all City departments

4. Improved project prequalification

5. Clarified roles and defined responsibilities of inter-departmental project teams within City government

6. Improved project planning

7. Improved process planning

8. Improved process for due diligence review of public/private partnerships

What Makes It Work

We have found that there are two fundamental requirements for successful public/private partnerships:

1. There is a substantive transfer of risk to the private sector

A. It provides an incentive for the private sector to manage and mitigate that risk.

B. If the right risks are transferred with the appropriate incentives and conditions, then the overall risk of a project is diminished, resulting in lower risk and lower costs for both the private and public sectors.

Experience tells us: (1) the less a financing transaction depends on direct or implied commitments by the City with respect to future annual appropriations, the more likely a true transfer of risk has taken place; (2) the more scope that exists for a private sector partner to generate third-party income, or benefit from windfall gains, the more likely this transaction represents a true transfer of risk and reward; (3) the more risks that are retained by the City or the more the City participates in potential future windfall gains, the less likely the City has achieved the goal of transferring a significant amount of risk.

2. Bidders are encouraged to develop creative approaches and solutions that meet the project requirements and produce the specific outcomes identified by the City.

In working toward achieving a substantive transfer of risk, the City's role as a public/private partner is to set out the objective and expected outputs in broad terms. In other words, we should not focus on how the private sector should provide the service, but rather on what service it should provide. It is then up to the bidder to develop solutions that provide for the most efficient risk management possible and pass at least part of the resultant benefits on to the City.

Rochester Affordable Housing Partnerships

1. Rochester Housing Development Fund Corporation

In 1999, the U.S. Department of Housing and Urban Development agreed to sell its inventory of foreclosed homes in the City of Rochester to City Hall. Rochester became the first city in the nation responsible for managing, marketing, and reselling HUD foreclosures. Traditionally, HUD houses were slow getting to the market, not maintained while awaiting sale, and sold primarily to investors to be turned into rental property rather than owner-occupants. The agreement gives the City of Rochester immediate control over the destiny of about 500-600 vacants a year.

Rochester faced a situation where it had to rapidly increase its capacity to provide homeownership opportunities. In response, the City created the not-for-profit Rochester Housing Development Fund Corporation. The Corporation is currently capitalized at $9 million:

*(The GRHP is a public/private partnership created in 1991 to finance affordable housing opportunities. It consists of the City of Rochester, Monroe County, and members of the real estate, banking, and health care communities.)

The $9 million represent a first-stage investment in financing and redeveloping single-family foreclosures for owner-occupants.

HUD sells its single-family vacants to the City for 50% of assessed market value. The discount is passed on to the homebuyer. The City sells about one-third of the homes directly to owner-occupants. The City sells the rest to the Rochester Housing Development Fund Corporation. The Corporation works with about 20 private and not-for-profit developers to renovate and market these properties.

A second-stage will require additional capitalization to address rental properties (2-4 units) from HUD foreclosures. For this upcoming second-stage, the City of Rochester has used $1.5 million of its funds to leverage $1 million in Federal Treasury Funds and $0.4 million in state dollars. The Rochester Housing Development Fund Corporation will use these public monies to leverage an as-yet-undetermined amount of private funds to capitalize rental opportunities.

Eleven other cities have since gained control of local HUD foreclosures through HUD's Asset Control Area Partnerships program. In most of these other instances, the HUD arrangement is not with the municipality, but with not-for-profit sponsors. The other cities are reluctant to assume the risk that control of the HUD inventory entails. The Rochester Housing Development Fund Corporation could serve as a model for those cities as they explore ways to convert their HUD inventories into affordable housing. The Corporation allows the City of Rochester to transfer much of its risk while maintaining adequate control. And, of course, it leverages private dollars and creates affordable housing opportunities in a way that maintains neighborhood housing values.

2. Senior Housing

The Rochester Housing Development Fund Corporation could also be used to create affordable senior housing, an avenue we are exploring in Rochester.

In Rochester, there are vacancies in affordable senior housing projects operated by the Rochester Housing Authority. When analyzed, the type of structure is an issue. Most affordable senior units are in high-rises. Seniors seem not to like that environment any longer. They flock to garden-style units. In Rochester, we are exploring the conversion of 4-family HUD-foreclosed units into senior units.

The conversion of the former St. Bernard's Seminary to 149 affordable senior housing units is typical of how the City of Rochester does business. When the Catholic Diocese of Rochester decided to move the seminary to a local divinity school campus, the City partnered with Home Properties, one of the country's largest Real Estate Investment Trusts, and Unity Health Services, a national operator of hospitals and health care facilities, to redevelop the historic structure.

Essentially, the City functioned as a gap financier. It used City and state funds to leverage private investment by Home Properties. Home Properties, in turn, utilized low-income housing tax credits to attract corporate investment. Unity Health provided support services to allow seniors to live independently. The project's investment ratio of 20% public funds and 80% private capitalization is representative of the risk Rochester is willing to assume.

Higher risk projects are typically funded through such vehicles as the regional Community Lending Corporation, which is capitalized by private lenders, and which owes its existence to the Community Reinvestment Act.

For more information on housing development in Rochester, contact Tom Argust, Commissioner of Community Development, 716-428-6550.

The common thread through the present testimony about creating affordable housing opportunities is that government cooperation triggers the "critical mass" to get projects going.

Our experience indicates that private sector interest in investing in affordable housing is limited as return on investment can be more readily achieved through the construction of upper end housing. The prospects for public/private partnerships are limited in the face of these economics. Not-for-profits are willing partners with government, but social agencies require adequate public support to make these partnerships work.

The simple reality is that affordable housing -- and affordable special needs housing in particular -- need a high level of both capital and ongoing deep subsidy support. This support can only be provided by public entities.

Our experience also indicates that a comprehensive policy framework for public/private partnerships is a key to success. Failure to establish a clear policy framework that a private partner will be required to comply with introduces a level of uncertainty or risk that is beyond the control of potential bidders. Strong potential bidders may elect not to pursue the opportunity, and the overall benefits of the project to the municipality may be reduced.

Therefore, we recommend:

• Increase federal tax incentive programs (including tax credits to generate capital funding) to stimulate private sector interest in affordable housing.

• Increase Section 202 funds for senior housing by profit or not-for-profit developers.

• Expand methods for the nonprofit sector to tap into private capital with legislated changes such as expansion of the Community Reinvestment Act.

• Provide research, information, and guidance to local communities for dealing efficiently and cost-effectively with public/private partnerships that advance the public interest and yet can be easily understood by potential private sector partners without unduly constraining their creative energies.

• Expand HUD's Mixed Finance Program to make it easier for public housing authorities to work with profit and not-for-profit developers. The Mixed Finance Program allows profit and not-for-profit developers to own and manage public housing. A very successful model of this program in action is Rochester's Susan B. Anthony Square development.

• Emphasize, support, and incentivize affordable housing initiatives as part of long-term and strategic regional plans. Cities should not bear a disproportionate share of a metro area's affordable housing.

• Establish targets for the number and type of affordable housings needed in each region, with each community in the region responsible for a determined number of units, and track and incentivize the attainment of these targets.

• Incentivize the dedication of land for affordable housing.