Performance Guaranteed Facility Model Provides Outcomes-Based Construction Method

The Performance Guaranteed Facility (PGF) model is a relatively new type of public/private partnership that allows the occupants to own a building the moment construction begins, while private-sector partners commit to its design, construction, financing, and ongoing maintenance, including future rehabilitation. The model goes by different names, but the concept involves an interactive partnership designed to benefit all parties for the long term.

“The private sector enters into a relationship—with a private not-for-profit, a private university, a public facility, or a state-run facility—for typically 25 to 35 years,” explains Mike Marasco, CEO of Plenary Concessions, a Canadian-based independent long-term investor, developer, and operator of public infrastructure. “The only way the developers/financers get paid back is if the facility performs.”

The occupants (also known as sponsors) in the PGF model enjoy the benefits of owning without having to raise the capital themselves. Monthly payments are fixed for the term of the partnership. The private sector partners provide upkeep and guarantee that the facility will perform optimally for the duration of the partnership.

Advantages for the private sector partners include a longer return on their investment.

“The financial partners pay for the construction but get back their money plus a level of profit for other aspects under their control,” says Mark Whiteley, global science and technology practice leader and board director at Cannon Design, an integrated design, consulting, and engineering firm. “They are not worried about short-term payback like a typical developer; they’re focused on long-term, low-risk results.”

“Everybody’s bound together as a team, and success depends on true partnership where you use everyone’s strengths,” he says.

History and Tenets of PGFs

The flailing economy and global tightening of access to capital had a big impact on the development of PGFs, says Whiteley. In the early- to mid-90s, governments in the United Kingdom, Australia, and parts of Europe were unable to fund much-needed infrastructure, especially social infrastructure such as prisons, universities, and hospitals, so they had to find new ways to address those needs.

“We were looking at optimizing value for money, but another major aspect was making the building the most effective vehicle for the client’s programs,” says Marasco. “We need to ensure our client’s business is continuously successful, given the long-term nature of our relationship.”

Unlike a typical lease, PGF agreements contain a firm repayment price for the capital and lifecycle rehabilitation during the agreement period, with an inflationary index typically applied to the services portion (maintenance and other fluctuating costs).

“You know up front what your costs are going to be. There isn’t deferred maintenance, because we have to make sure the facility performs from day one and that it is maintained to a standard,” says Marasco.

The occupants don’t begin making payments until the facility is completed, and there is an abatement process if anything fails to function properly. That’s why PGFs are especially beneficial to occupants such as universities or hospitals where up-to-date, functioning research laboratories are a key component, says Marasco.

“Under a traditional real estate lease, you’re making a payment whether the building works for you or not. Under this deal, you are not paying for rooms you can’t use, and the fee is reassessed for the time you couldn’t use it,” he adds. “This is not intended to be penal; it is intended to incentivize quality, which it does.”

The PGF model encourages the private partners to include better equipment and materials in the initial construction, instead of having to operate within a certain budget—a process that often leads to cutting corners, adds Marasco.

Under the PGF model, the private partners even assume the risk for tenant upgrades, something a typical landlord would not do.

“Under the PGF model, the private partners take on everything. They are responsible for refreshing the tenant improvements. They maintain the street front and lobby to a standard the occupants specify for 30 years,” says Marasco.

“Under a traditional lease, if you want to change the use during the 30-year period, for example, you have to ask permission. Under a PGF, occupants own the rights from day one. If the private partners want to add a Starbucks to generate revenue, they have to ask permission, not the other way around. All of the conditions in the lifecycle of the facility are predefined and performance based. We get paid only if we hit those targets.”

“This approach gives users the agility to adjust their businesses and adapt to changing conditions now and in the future,” adds Whiteley.

Both Marasco and Whiteley emphasize that PGFs are not just a financing tool.

“Finance is the catalyst that causes the private partners to focus on the true cost of operation over a 30-year period. Finance is also the catalyst for the risk transfer and the innovation that occurs in these projects, but it is not a real estate transaction; there is no transfer of title,” notes Marasco.

“It’s not about accounting. The finance model assures those outcomes, because the financing is the way the private partners get paid back. When this model started 15 to 20 years ago in the United Kingdom, they were doing this to get transactions off book. Since Enron, it is next to impossible to get any of these long-term transactions off book.”

The PGF Model in Action

To illustrate the benefits of PGF, Marasco compares two projects located in the same region of Canada that were constructed at the same time: They used the same architect and construction company, one under the PGF model and the other under construction management, with vastly different results.

The Abbotsford Hospital and Cancer Centre is a 650,000-sf regional cancer facility with an estimated $450 million price tag. Utilizing PGF, the project came in on time and slightly under budget. The Vancouver Convention Centre, completed under a traditional construction management approach, came in six months late and 55 percent over the original $565 million budget.

But PGF principles do not work for all projects, says Marasco. Generally, the estimated cost of the project should be more than $100 million, and it should be new construction or a major addition/renovation. There is no real upper limit to the cost; PGF has been used on a project as expensive as $1.7 billion.

The Victorian Government Department of Primary Industry (DPI) and the La Trobe University in Melbourne, Australia (the Joint Venture), undertook a project using PGF principles to build a $188 million, 355,000-sf Biosciences Research Centre (BRC) Facility. The BRC includes as its core a PC2 and PC3 research facility, external glasshouse research, laboratory facilities, and built-in future laboratory expansion. The BRC’s purpose is to maintain the integrity of Victoria’s food supply, as well as disease control, so the facility’s research is predominately concerned with plants and animals.

The new facility was developed to accommodate five divisions of the DPI and La Trobe University. One of the BRC’s primary objectives was to facilitate collaboration between the various research groups, as these were being merged into an entirely new entity.

To facilitate the project, the Victorian government provided an annual service payment underwriting and the partnership agreement for a 25-year operating term. Plenary, Marasco’s company, put together a consortium that included the builder, designer, facility manager, and financiers.

Contracted services include: general management, building infrastructure management, energy and utilities management, help desk services, administrative functions, and minor renovations. Reviewable services include: waste management, general cleaning (not laboratory cleaning or fumigation), security, pest control, and grounds and gardens maintenance.

“Reviewable services are benchmarked every five years, so the private partners take full lifecycle risk on the facility and maintenance for a 25-year firm price quote,” says Marasco.

The project was delivered on time and opened in July 2012. The project included change orders but was delivered within the initial budget. Joint Venture’s value for money outcome was about $20 million below the market, says Marasco.

Cannon Design, Whiteley’s firm, was involved in a quasi-PGF project to construct the Gates Vascular Institute at the State University of New York (SUNY) Buffalo Niagara Medical campus. The project brought together two Cannon Design clients: Kaleida Health, a private, not-for-profit healthcare body, had to consolidate its heart and vascular operations into one hospital; and at the same time the University at Buffalo (UB) was given state funding for a new clinical translational research center.

The projects were combined, not just to save money, but also to realize translational synergies between the research and healthcare partners and to act as a catalyst for local economic regeneration. With Kaleida serving as the developer/operator in the partnership, UB’s bond money was placed in a private, not-for-profit entity created by state legislation. This allowed UB to access the funding more quickly and freed it from the usual state procurement requirements, which allowed the project to be fast-tracked.

Typically PGF projects achieve around 20 percent savings over the cost of a traditional procurement route.

“With this project, we saved time and money by bringing together the client entities and the two contractors, and by using accelerated design and construction,” says Whiteley. “The building was completed two years ahead of schedule, and the UB/Kaleida partnership will save taxpayers $21 million through reduced construction costs and operational efficiencies.”

“We also created a dynamic program that focused on a new, innovative business model for the CTRC,” adds Whiteley. “By incorporating a biosciences business incubator, clinical trials unit, bio-repository, and bioengineering unit alongside traditional basic science facilities, we have given the CTRC the ability to realize new income streams.”

According to studies by UB, this will produce an additional annual economic impact of about $68 million.

“Using integrated methodologies, we create opportunities to strengthen and transform the academic medical enterprise. By synchronizing business model design with procurement route design and building design, and then following through into construction and operation, we can help reposition academic medical centers for a strong, long-term future,” says Whiteley.

Different Ways of Achieving PGF

There is no set way to achieve public/private partnerships with PGF goals, or to secure the financing mechanisms that facilitate its use. Because of varying requirements in each state, a one-size-fits-all PGF model would not work in the United States, note Whiteley and Marasco.

“If clients (occupants) want to be part of the investment consortium, they certainly can be. They can raise some of the money, or be put into a pot with a mixture of debt and equity where they have an increased level of financial control and are able to reap rewards down the line,” says Whiteley.

“Institutions with endowments can use that money up front,” says Marasco. “It’s best not to pay until the facility is ready to occupy, but then they can make what’s called a ‘substantial completion payment’ toward the principal. A substantial portion of debt should remain as an incentive for facility managers to meet their performance obligations.

“Most institutions can’t pay cash for a facility; they have to borrow anyway. This is simply a better method to deliver the facility. In Canada, the Alberta government can write checks for anything, but chooses to use public/private partnerships because they deliver a stronger value-for-money proposition. Even if you take the cost of financing into account, the value PGF models generate and the risks you transfer exceed the benefits of traditional financing.”

A strong reliance on traditional financing in the United States is one of the reasons PGF models have only recently begun to gain interest here, say Whiteley and Marasco. Since the U.S. market has been slow to recover from a recession, people are starting to look at concepts like PGF.

“People see that traditional structures are not working anymore. We’ve noticed increasing interest in PGF over the last six months,” says Whiteley.

“Americans favor tax-exempt debt over traditional bonds because the interest is tax free or taxed at a reduced rate. But the premium people pay for traditional financing versus tax-exempt debt is offset in the PGF model by the optimization of whole-of-life costs,” adds Marasco.

“With the gap narrowing substantially between tax-exempt markets and the infrastructure markets, it becomes even more attractive, and the value proposition is stronger.”

In Conclusion

The major benefits of this type of public/private partnership include performance-guaranteed infrastructure done more quickly and cost-effectively, and more in tune with the owner’s business, conclude Whiteley and Marasco.

“The PGF route offers a wider range of long-term benefits over and above traditional procurement and delivery methods. It provides opportunities to strengthen and reposition the owner’s business, improve operational effectiveness, and realize economic benefits to the wider community,” says Whiteley.

By Taitia Shelow

This report was based on a presentation Whiteley and Marasco gave at Tradeline’s 2012 Academic Medical and Health Science Centers conference.