Making Sense of Recent U.S. Parking-Lease Transactions
By Michael Benouaich
Many municipalities and local transportation agencies across the U.S. face continuing financial challenges, including operating budget shortfalls and underfunded pension programs, and are looking for innovative solutions to reduce spending and increase revenue.
Publicly owned parking garages, surface lots and on-street parking, with rates often well below market, are increasingly seen as underutilized assets that can be leveraged to help bridge the funding gap.
Since the start of 2009, more than a dozen cities and transport authorities nationwide have announced their intention to solicit long-term lease agreements for their parking facilities. Such agreements generally grant the rights to a private partner to operate and maintain parking assets and collect associated revenues for a specified period of time in exchange for an up-front cash payment.
Several transactions reached successful financial close, but not without facing public criticism. However, a few deals collapsed after the completion of a competitive selection process and an apparent agreement on lease terms. In recent transactions, when public and private partners have reached an agreement, asset values have varied widely, resulting in prices ranging from $32,200 per parking space to $5,500 per space.
While this flurry of activity demonstrates a strong interest from public and private stakeholders alike, the wide range of outcomes can be difficult to interpret, leaving public sponsors to ponder whether or not to engage in such a venture and under what conditions.
Overview of recent transactions
On the heels of the high-profile, 99-year concession for the Chicago Skyway toll bridge that generated an up-front payment of $1.83 billion, in December 2006 the City of Chicago let a 99-year concession for its off-street parking, leasing to Morgan Stanley 9,178 garage spaces for $563 million ($61,000 per space) and a commitment from the private partner to invest $500 million over the life of the concession.
In February 2009, the city closed a second concession with JP Morgan and LAZ Parking, generating $1.16 billion for the 75-year lease of 36,000 on-street parking meter spaces ($32,200 per space) and a commitment to invest approximately $30 million to implement a cashless payment system by 2011.
These two transactions spurred nationwide interest, encouraging cities and public transport agencies to take a closer look at their parking assets and their potential for monetization.
In early 2010, Pittsburgh and New Haven, CT, reached tentative agreements with concessionaires. Pittsburgh negotiated with JP Morgan and LAZ Parking a $452 million, 50-year lease for 18,000 spaces ($25,100 per space). New Haven negotiated a $50 million lease of 2,750 spaces with Gates Group Capital Partners for 25 years ($18,200 per space).
However, the Pittsburgh agreement was ultimately rejected in October 2010 by the City Council, mainly over concerns about price increases and the length of the agreement. Similarly, in New Haven, the agreement was tabled by its Board of Aldermen in September 2010.
In November 2010, in Indianapolis, the City Council approved an agreement with Xerox Co.’s Affiliated Computer Services (ACS), by a 15-14 vote, to lease approximately 3,650 spaces for 50 years for an up-front payment of $20 million ($5,500 per space) and a commitment by ACS to upgrade the meter system.
Hartford, CT, and Las Vegas have also issued Requests for Proposals (RFPs), and three other U.S. cities have made announcements but do not appear to be ready to move forward at this time.
In October 2010, New Jersey Transit issued a Request for Qualifications (RFQ); the RFQ, which was scheduled in March, was delayed due to the complexity of the due diligence process for public and private parties alike. Most recently, in February 2011, the Los Angeles City Council unanimously voted to end the city’s (otherwise promising) pursuit of a proposal to lease nine public garages.
In all cases, private interest for these transactions has been tremendous: In Chicago, 10 teams submitted qualifying statements for the on-street meter lease; and 11 teams responded to the RFP in Pittsburgh, six in Hartford, seven in Indianapolis, and 19 initially in LA.
Taking a closer look
While the capital market environment has been quite volatile over the past 24 months, the wide discrepancy in prices seen between the Chicago on-street parking meter transaction and the more recent Indianapolis transaction (see sidebar) reflects not just the swings of the market, but also in great part the wide range of policy decisions made by the public sponsors.
To understand the nature and impact of these decisions, one needs to take a closer look at the underlying economics of such transactions.
The value of a long-term lease agreement is basically derived by discounting future forecast earnings, i.e., calculating the present value of the forecast annual revenue, minus the assumed operating costs and capital expenditures. Thus, the primary value drivers are growth rates in earnings resulting from price, demand and operating cost assumptions; the discount rate chosen by the bidder, driven by its own cost of capital; concession length; and capital investment requirements.
The price paid for such lease agreements is also, closely related to the profitability of the asset measured by its Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) and is often expressed as a multiple of EBITDA. A simple EBITDA multiple, however useful as a proxy for valuing an operating entity that has reached a steady state, cannot capture the complexity of transactions with fast-changing operating costs structures, rates and growth profile.
The public sponsor can exert control, through the concession agreement, on price increases, share of revenue allocated to the private partner, concession length, and to some degree, the desired level of capital investment to replace or upgrade current systems. The private partner generally bears the risk for parking utilization, while operating efficiencies can be expected from a competent operator in combination with investment in technology, such as a new multi-space, cashless meter system. Last, the cost of capital is a direct reflection of the bidder’s sources of funds (including debt and equity capital) and its return requirements (see sidebar).
Long-term leasing of parking assets presents a very attractive value proposition for public and private stakeholders. From the private sector perspective, such contracts offer fairly stable, inflation-adjusted cash flows with upside potential resulting from technology upgrade and operating efficiencies. On the downside, the private operator takes the primary risk for future utilization over a very long period of time.
While the number of bidders on recent solicitations reflect these attractive characteristics, investors are wary of half-hearted attempts resulting in failed deals after having completed all the steps of the competitive process. Such failures are costly, for private participants as well as for public sponsors.
From a public sponsor’s perspective, leasing parking assets provides an opportunity to divest from what many consider a non-core function of city government and results in an immediate up-front payment and, in some cases, a continued stream of revenue (see sidebar, Indianapolis).
Some also see an advantage in passing the responsibility for rate increases to the private sector as political realities frequently make it difficult for cities to generate consistent rate growth to manage demand, or even just catch up with inflation.
The primary drawbacks are a potential loss of control over parking policy decisions (although such concerns can be addressed within the concession contract); loss of existing labor force and potential union disputes; and potential public opposition over rate increases. Although the use of proceeds is at the discretion of the public sponsor, the decision to use long-term assets to cover short-term budget deficits can expose a sponsor to strong public criticism.
Looking back at the transactions over the past 24 months seems to show an evolution from pure monetization deals toward more conscientious tradeoffs between higher transaction value and broader public policy objectives:
• A first generation of lease agreements, such as in Chicago (see sidebar), focusing on monetization with very long terms and aggressive rate increase clauses;
• A second wave of transactions trying to replicate the initial (financial) success of Chicago, but which were ultimately met with opposition by city councils, such as in Pittsburgh and New Haven; and
• What may be regarded as a new generation of concession agreements for parking facilities, as illustrated by Indianapolis (see sidebar), showing a more complex structure, more moderate rate increases, revenue-sharing clauses, and options providing flexibility for decision-making on urban planning over the long term.
As cities and transportation agencies consider their options for the long-term operation and maintenance of parking facilities, setting up a framework for addressing such tradeoffs should be a first priority. Questions such as — What level of control to retain on rate setting and fines? Should revenue be shared and how? Should restrictions on competition be included? Does the sponsor want to modernize its parking system? How can the sponsor retain some flexibility in deciding parking supply, location, and hours of operation? — should all be addressed up-front and agreed upon among decision-makers.
Once such a framework for the concession agreement has been accepted internally, the public sponsor needs to do its own due diligence; assess the current and potential future performance of its system; develop a structure for the lease agreement; and build a strong business case upon which a city council or board of directors can make an informed decision and vote before initiating the bidding process.
Approval of the negotiated lease agreement should then be only a formality if the final terms of the lease reflect the policy principles and value proposition developed in the business case agreed upon at the onset.
Michael Benouaich, a Service Area Manager at PB Strategic Consulting, a division of Parsons Brinckerhoff, can be contacted at firstname.lastname@example.org. Combining experience in engineering and finance, he works closely with public and private clients evaluating infrastructure investments, performing due diligence, and structuring complex Public-Private-Partnership (P3) transactions.
A version of this article was first published in December 2010 in EFR (Economic Forecasting Review), a publication of Parsons Brinckerhoff, a wholly owned subsidiary of Balfour Beatty.
Chicago and Indianapolis
The following two transactions in Chicago and Indianapolis, which closed 12 months apart, illustrate the relative importance of the value-drivers for parking lease transactions.
In the case of the Chicago on-street parking meter transaction, the very high up-front payment received by the city, reflected in the approximate 60 times price-to-EBITDA ratio, can be explained for the most part by the very aggressive earnings growth assumptions and a very long concession period.
Under the terms of the agreement, the city retained the rights for rate setting, enforcement and fine collection. The agreement, however, incorporates a city ordinance that fixes rate increases for the next five years equivalent to a five-fold increase in the average hourly rate from approximately $0.44 to $2.30 (i.e., a 39% compounded annual growth rate, or CAGR). Subsequent rate increases are capped to the Consumer Price Index (CPI) and subject to city approval.
The city did its own valuation of the parking assets prior to initiating the bidding process. Based on the city’s cash flow projections, and using a reasonable discount rate around 10% to 14% (appropriate for a transaction financed 100% with equity such as this one), the price is reflective of revenue growth assumptions directly aligned with the agreement, at around 33% CAGR for the first five years and 3% thereafter, while costs can be assumed to increase at 3% annually.
Using the same baseline and lowering the revenue growth assumption to a more moderate 10% per annum for the first five years would yield a price of $240 million, a price-to-EBITDA ratio of 12 times and a price per space of $6,600, closer to what was observed in Indianapolis.
The value of the concession is highly sensitive to the choice of discount rate. One could argue that an appropriate discount rate should reflect the long-term, optimal capital structure for the concession, in which case a lower discount rate around 6% to 10% would be appropriate. To achieve the same value with a 6% discount rate would still require assuming a revenue growth around 20% CAGR for the first five years.
The impact of the concession length on value is not as straight forward, as it depends on the amount of leverage – the higher the leverage, the lower the discount rate, and the more sensitive the concession value is to the concession length. Shortening the concession term from 75 years to 30 years decreases the value by less than 10% with a 12% discount rate, while the value of the concession drops by 35% with a 6% discount rate (reflective of higher future leverage).
The City of Chicago’s stated goals for the on-street parking meter transaction were to maximize the present value to the city, promote new technology and improve level of service. Viewed through that lens, the transaction can probably be considered a success.
However, the transition toward private operations was problematic and an overall source of discontent for residents, due to a significant initial price increase and the fact that existing coin-operated meters could not handle the increased quantity of coins, leading to inoperable meters and users receiving more tickets.
The city also was criticized for its short-term vision on the use of the proceeds, more than half of which were used to fund budget deficits, instead of investments benefiting the city in the long-term as initially planned.
The City of Indianapolis made very different policy decisions, leading to a much lower price-to-EBITDA ratio of seven times and a price per space around $5,500 for a 50-year concession.
First, the Indianapolis agreement sets forth a schedule of rate increases that is much more modest than what is allowed in Chicago. Hourly prices are to increase from $0.75 to $1.00 or $1.50 in 2012, depending on location. After two years, the rates increase with the CPI.
This is in sharp contrast with the five-fold increase in five years allowed in Chicago. Aligning the Indianapolis revenue projections to match such rate increases and assuming a 12% discount rate would yield a concession value approaching $50 million, corresponding approximately to a price-to-EBITDA of 16 times and a price per space of $13,600.
Second, the Indianapolis lease agreement includes a revenue sharing clause very favorable to the city, which receives 30% of the first $7 million in revenue each year (indexed on CPI), plus 60% of revenue over that amount. Without sharing revenue, the value of the lease could be estimated at around $40 million, corresponding approximately to a price-to-EBITDA of 13 times and a price per space of $11,000.
Compounding a five-fold rate increase in the first five years with no revenue sharing would yield an estimated concession value close to $100 million, corresponding approximately to price-to-EBITDA of 33 times and a price per space of $27,800.
The final terms of the agreements were settled only after several months of negotiations during which the city increased its revenue share and added a termination for convenience clause to the contract. The initial price offered was $35 million and landed at $20 million after negotiations. The city reportedly intends to invest the proceeds to make street improvements.
These choices reflect the emphasis of the City of Indianapolis towards moderate rate increases, the desire to keep a long-term revenue stream from parking operations without having to manage the assets, and retain flexibility in decision-making over long-term. The tradeoff is a lower up-front payment received.
Article Abstract from May, 2011