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Big Deals on Campus: Special-Purpose Entities

July 24, 2002

Big Deals on Campus: Special-Purpose Entities

By MICHAEL BRICK

TEMPE, Ariz., July 18 — Alison Flader lives on the campus of Arizona State University here in the Alpha Delta Pi house, part of an open complex of 12 buildings that a private developer erected last year. She prefers these quarters, with each sorority having its own building, to the dormitory floors that the sororities previously occupied.

"You get to know other girls, other houses," said Ms. Flader, who is pursuing a master's degree in elementary education. "It makes the whole Greek community stronger."

The developer of the 12 buildings, which are home to about 320 sorority members during the school year, was Century Development of Houston, which has built housing on 42 campuses in the last 13 years and is now working on similar projects at seven other colleges, including Louisiana State University.

But the university does not own the buildings. Nor do the sororities; nor does Century. The owner is a special- purpose financial entity created by the university for the single purpose of building housing by issuing $10.6 million in debt that does not appear on the university's balance sheet. The debt is to be repaid with revenue from operation of the houses.

Exactly who is ultimately responsible for that debt is, however, completely untested. It is a matter of dispute among bond rating agencies, the university and the special-purpose entity. All three parties agree that the test will come when Ms. Flader's future sorority sisters decide that they prefer other, perhaps newer, accommodations.

The principals of the special-purpose entity, called the Arizona Capital Facilities Financial Corporation, are two Tempe businessmen and a lawyer who serve as a board and agreed to act as a conduit among the university, the bondholders and the developer. The three receive an annual fee of less than $1,500 each for attending a yearly board meeting as well as any additional meetings that may be required.

Under the twin pressures of declining budgets and rising student populations, dozens of colleges around the country are making these deals, and a cottage industry of private developers is generating millions of dollars in one-time fees.

Special-purpose entities like this one differ from state agencies, like the Dormitory Authority of the State of New York, that are responsible for coordinating campus housing projects under the oversight of state legislatures. On individual campuses in states with separate dormitory authorities, however, including New York, fund-raising groups have employed techniques similar to that of the special-purpose entities elsewhere to build housing.

"Colleges didn't necessarily think about doing it until developers came up with the idea," said Mary Peloquin-Dodd, director of higher education research at Standard & Poor's, which rates Arizona State University's general obligation bonds but not the debt of the special-purpose entity, which obtained a rating from Moody's Investors Service.

"There's more risk in the long term than there is in the short term," Ms. Peloquin-Dodd said. "The risk to investors is that there aren't any real barriers to entry. Developers can draw tenants away with a newer facility next door."

Private developers have been coordinating the building of housing on university campuses for one-time fees for at least a decade. By the late 1990's, at least half a dozen companies specialized in offering these arrangements to universities, but now the schools themselves are seeking the deals out.

"Not wanting to use our bonding capacity was issue No. 1," said Ray T. Jensen, executive director of purchasing and business services for Arizona State University. Besides, he said, "we didn't have to come up with any cash."

Arizona State created the Arizona Capital Facilities Financial Corporation as a 63-20 corporation, an Internal Revenue Service designation allowing it to sell tax-exempt bonds. It then leased 3.74 acres of its land to the corporation for 37 years for a total of $1,000 plus the entity's net cash flow over that period.

The corporation issued the bonds and hired Century Development of Houston to build the complex for a fee of about 5 percent of the $10.6 million development cost, or about $530,000. When construction was complete, it hired Century Campus Housing Management, an affiliate of Century Development, to promote the housing, collect $410 a month in rent from each student, pay expenses and service the bonds. The management company returns any extra money, the net cash flow, to the university as rent on the ground lease.

"The concept has really caught fire," said Wayne Sramek, the president of Century Development, which currently manages 20,000 beds on 42 campuses. The sales pitch from developers to universities, he said, is that these arrangements allow the schools to perform off-balance-sheet transactions.

"A significant number of schools around the country are starting to do this," he said.

The Arizona sorority project, he said, was a particular challenge because it was the first involving group housing for student organizations.

"We had to sell the investment community and the rating agencies that this is not 'Animal House,' " he said.

Though the debt from deals like these does not appear on the universities' balance sheets, it increases their cost of capital if analysts become aware of them, said Greg Letran, senior managing director for higher education services at Trammel Crow, the real estate company based in Dallas, which has avoided the deals.

Ms. Peloquin-Dodd of Standard & Poor's says her researchers count the debt from these deals when evaluating universities' credit ratings if they become aware of the deals.

"Just because it's off balance sheet, it's not necessarily off credit," she said.

William Hicks, a lawyer with the firm of Snell & Wilmer who represents the special-purpose entity, said the bond rating agencies' assessment of risk against the university was based on their opinion that the university would bail out the development if its rents or occupancy fell.

"Legally, the university has no liability," Mr. Hicks said. "The ratings agencies have taken the view that, practically speaking, if things go south, the university will step in. That's in somebody's mind."

Because the developments are new, the risks are untested.

"The risks are operational shortfalls," Mr. Hicks said. "All that means is the amount that will be remitted to the university will be reduced, but only slightly."

"We're assuming kids will fill up that facility," he said, adding that the sororities have proved that assumption correct, at least for the first year of the ground lease.

Several administrators here said the arrangements with developers had provided a far speedier process than gaining legislative approval, acquiring permits and budgeting and then erecting the housing. The sorority project took less than a year from the bond sale to the time Ms. Flader moved in.

Arizona State University West, a small affiliated campus in Phoenix that recently began admitting freshmen and sophomores in addition to upperclassmen and graduate students, has entered a nearly identical deal with another developer to sell $10.5 million in bonds and build a $13.5 million student housing complex with 400 beds, a community center and a swimming pool.

To sell the bonds, it created West Campus Housing L.L.C., a special- purpose vehicle run by the same three Tempe men involved in the sorority project — John Benton, Ross Robb and Richard Neuheisel. They are working on studies to promote the bonds with the audit firm PricewaterhouseCoopers and the investment bank Legg Mason.

"The debt is never on the university's balance sheet," said Gebeyehu Ejigu, executive vice provost of A.S.U. West. "That's one of the attractions."

The Phoenix campus's limited liability corporation has hired Collegiate Development Services of Dallas to build the project once the bonds are sold. The developer, too, is pleased that its capital will not be at risk.

"We are fee developers," said Rafael A. Figueroa, president of the company. "Our fees are presented and negotiated upfront. That's it."


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