Management & Operations

What Does the Future Hold for Rail Transit Public-Private Partnerships?

Posted on January 12, 2007 by Edward J. Fishman

For more than 10 years, transportation planners in the rapidly growing urban area surrounding the cities of Raleigh and Durham, N.C., have been working on the development of a regional rail system.

The system would provide passenger rail service from Duke University’s east campus, through downtown Durham, the technology center known as Research Triangle Park and the town of Cary, to various activity centers in downtown Raleigh. The Triangle Transit Authority rail project has completed many significant milestones, including completion of the environmental review process and the acquisition of necessary railroad right-of-way. However, the project recently removed itself from the FTA New Starts pipeline because of difficulty meeting heightened cost-effectiveness standards. Nonetheless, the rail project remains alive and active due to an innovative proposal to replace some portion of public funding with private capital investments in station development.

Triangle Transit is actively negotiating a master development agreement with Cherokee Investment Partners, a financial development and real estate developer. Under the arrangement, both Triangle Transit and Cherokee would contribute land and money into the transit-supportive development that is expected around the system’s 12 planned passenger rail stations. Triangle Transit would receive a portion of the future revenue stream from these joint development activities. This income would defray future operating or capital costs of the rail system, thereby reducing the need for public funding in the future.

Attracting private investment
Headlines in the transportation industry press and discussions among transportation policymakers have been dominated recently by the expanding use of such public-private partnerships (PPPs) in various sectors. Much of the activity has occurred in the highway sector, where toll revenue often can produce an income stream that is sufficient to attract private investment in roads, tunnels and bridges. Chicago and the state of Indiana both entered into long-term leases on portions of their highway infrastructure in return for upfront payments well in excess of $1 billion from private concessionaires.

There also have been a number of public-private partnerships in the freight railroad sector where the revenue generated through user fees, such as tolls, often can be large enough to reimburse state and local governments for funding necessary capital improvements.

The use of PPPs in the rail transit industry is also expanding at a rapid pace as transit agencies explore additional ways to stretch limited federal and state funding for new projects. New Jersey Transit’s Hudson-Bergen light rail transit system was developed and is being operated by a private consortium under an innovative design-build-operate-maintain (DBOM) arrangement. Many other transit systems, including the Metropolitan Transit System in San Diego, TriMet in Portland, Ore., and Dallas Area Rapid Transit (DART), have used their light rail systems to attract TOD (transit-oriented development) projects. These projects have attracted private capital investment and have produced significant public benefits.

There are a range of different relationships between a public transit agency and the private sector that could be referred to as PPPs. The most basic of these arrangements, which involves the contracting out of services by the public sponsor, is widely used today. The most interdependent arrangement, involving the direct investment of equity capital by the private sector into a public transit project, does not make economic sense in all circumstances and is unlikely to replace government funding as the primary source of financing rail transit projects. However, there are projects such as the Triangle Transit proposal where private participation from an equity standpoint through joint development may be feasible.

Defining PPP
The term “public-private partnership” can be used loosely to define a spectrum of different collaborations between the public sector and the private sector. A U.S. Department of Transportation (DOT) report to Congress in 2004 defined a public-private partnership as “a contractual agreement formed between public- and private-sector partners, which allows more private-sector participation than is traditional” under standard procurement methods. This broad definition can be simplified into three project structures: outsourcing services, innovative contracting and innovative financing.

The broad DOT definition would include the contracting out of traditional public transit functions to private contractors. Herzog’s operation of the South Florida Regional Transportation Authority commuter rail service and the consortium that operates the Massachusetts Bay Transportation Authority commuter rail service in Boston are two of the more prominent examples of the outsourcing model.

Innovative contracting
The DOT definition of a public-private partnership encompasses design-build, DBOM and other innovative project delivery techniques that have become popular ways to save time and money on construction projects by shifting more responsibility and risk to the private sector. These methods are beginning to replace the traditional “design-bid-build” method of contracting by public transit agencies.

New Jersey Transit entered into a DBOM contract with 21st Century Rail Corp., a consortium of contractors led by the Washington Group, to develop the Hudson-Bergen light rail system. The Hudson-Bergen project, with a total expected cost of at least $2.2 billion, is one of the largest public works projects ever undertaken in New Jersey. The initial phase of the light rail system, completed in 2000, connects Bayonne, Jersey City and other areas of Hudson and Bergen counties with the Hudson River waterfront and crossings to Manhattan.

The DBOM contract required 21st Century Rail to: (1) deliver a fleet of vehicles; (2) design and construct the light rail system and supporting facilities; and (3) operate and maintain the system for a period of 15 years. This innovative project delivery method resulted in significant project timetable savings (up to eight years by some estimates) and has been successful from an operations and maintenance standpoint because of the incentives placed on the private consortium through the contractual arrangement. Many other rail transit projects (including the Hiawatha LRT project in Minnesota) were recently developed under design-build and DBOM models instead of the traditional design-bid-build approach.

Innovative financing
The third PPP category involves innovative approaches to financing public transit projects. The private financing of infrastructure projects is more of a challenge in the rail transit sector because of the unlikelihood that revenues generated by the operation will be able to cover debt-service obligations. Most rail transit capital projects, and subsequent operations and maintenance, are subsidized heavily by local, state and federal funds. However, in certain circumstances, it is possible to use a specific transaction structure to attract private investment in rail transit projects.

One such structure involves “availability payments” that compensate the private participants for minimizing the need for government subsidies. These payments can be structured to increase with the quality of their performance. The performance can be measured against standard benchmarks, such as on-time arrivals, the availability of service or the reduction in operating and maintenance costs.

This category of innovative financing also covers rail transit projects that are financed through joint-development arrangements. Several transit agencies have engaged in successful joint-development programs at particular locations on their systems, including DART’s Mockingbird Station and TriMet’s Pearl District. These projects take advantage of the value of appreciating land or air rights adjacent to passenger rail stations, which are very attractive to residential and retail developers. These developers may fund part of the cost of providing rail service to that station in exchange for exclusive development rights. Triangle Transit’s proposal is particularly innovative because it would allow the agency to participate directly in the stream of revenue from transit-supportive development.

The Las Vegas Monorail’s 4-mile system that runs along Las Vegas Boulevard and serves eight major resort properties and the Las Vegas Convention Center is another example of a PPP using innovative financing.

The Las Vegas Monorail Co., a nonprofit public benefit corporation, was created to develop the monorail through tax-exempt revenue bonds. The project was the first urban-grade fixed-guideway system in the U.S. to be constructed with only private financing. The Las Vegas situation, however, is unique because during the planning phase it was determined that farebox and advertising revenue from operations were expected to meet or exceed the operating costs.

Potential benefits of PPPs
The primary potential benefits of innovative contracting methods include accelerated and more cost-effective implementation of high-priority projects and the use of the private sector’s specialized expertise and technology. Many of these benefits are created by establishing a single point of responsibility and shifting certain project risks to the private sector, which may be in a better position to manage budget and timetable concerns if their overall return is dependent on performance.

The primary potential benefits of innovative financing techniques include the promotion of private equity participation in the project. The use of PPPs potentially facilitates the development of projects, such as the Triangle Transit regional rail project, that may not otherwise have been built due to financial constraints.

Why are PPPs important?
PPPs are increasing in importance in the rail sector for two principal reasons. First, there is increasingly fierce competition for a limited pool of government funding for transportation projects. Second, there is increasing demand for the development of new transit alternatives and the maintenance and revitalization of mature transit networks.

Thus, with greater needs and less available funds, public transportation agencies are thinking more and more about ways to encourage the private sector to participate in their infrastructure and development projects. This dialogue is being reflected in Washington, D.C., where Congress has directed the FTA to develop a Public-Private-Partnership Pilot Program (referred to as “Penta P”) designed to explore benefits of using PPPs for rail transit and other fixed-guideway capital projects.

The FTA solicited public comments on the program earlier this year and is expected to issue final criteria early this year. Several transit agencies, including Triangle Transit, submitted initial expressions of interest to participate in the pilot program.

Other project proposals include California’s Bay Area Rapid Transit (BART), which has expressed an interest in the Penta P Program in connection with its “E-BART” extension project to eastern Contra Costa County. This 23-mile extension project, using diesel multiple unit (DMU) technology instead of BART’s traditional heavy rail service, would involve both DBOM contracting and transit-oriented development.

The Virginia Department of Rail and Transportation, in connection with a private consortium led by Bechtel and the Washington Group, is sponsoring an extension of the Washington, D.C., Metro system from the East Falls Church station to Dulles Airport in northern Virginia.

The Triangle Transit regional rail project, the E-BART extension, the D.C. Metro extension to Dulles Airport and several other projects have expressed preliminary interest in obtaining one of the three slots available in the Penta P Program.

Looking to the future
Although we are likely to see an increase in the use of PPPs in the rail transit sector, this project structure does not work for every situation and is unlikely to replace public funding as the primary source of financing for rail transit projects. There are various challenges associated with the further implementation of PPPs in the transit sector, including certain restrictive state laws that may prevent innovative contracting and financing methods from being used in particular states.

In addition, it will be difficult to attract direct private equity investment in rail transit infrastructure projects unless a business case can be made. The continued use of design-build and DBOM project delivery structures and the participation of private investors in rail transit projects through joint development are the most likely forms of PPPs that will occur in the rail transit sector in the near term.

Edward J. Fishman is a partner in the Transportation Group of the Kirkpatrick & Lockhart Nicholson Graham LLP law firm in Washington, D.C.

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