What’s the Cheapest Way to Keep Getting You There? Alternative Project Delivery in the 50 States and a Financial Analysis of Alternative Project Delivery Systems on Road Projects July 2012 Monthly Conference Call for Div. 4 ABA Construction Forum on the Construction Industry Kyle Ostergard, Esq. Alston + Bird LLP

2 Kamran Ghavamifar & Ali Touran, Alternative Project Delivery Systems: Applications and Legal Limits in Transportation Projects, 134 J. of Professional Issues in Engineering Education and Practice 106 (2008). The paper is a snapshot of the legal codes for the 50 states regarding alternative project delivery (APD) systems in transportation projects as of December 2006.

3 What Does Project Delivery System/Method Mean? Term referring to all the contractual relations, roles and responsibilities of the entities involved in a project. AGC defines as “the comprehensive process of assigning the contractual responsibilities for designing and constructing a project. A delivery method identifies the primary parties taking contractual responsibility for the performance of the work.”

4 Design-Bid-Build On the one hand, under the Brooks Act (Public Law ) passed in 1972 and state Little Brooks Acts, the selection of the designer should be quality-based. On the other hand, the lowest, responsible responsive bidder performs the construction. These two principles led agencies to adopt the Design-Bid-Build (DBB) delivery system, which dominated transportation projects until 1996.

5 Design-Build In 1996 the Federal Acquisition Reform Act was passed authorizing the use of Design-Build (DB) on federal projects. The Transportation Equity Act for the 21 st Century allowed state DoT’s to award DB contracts if the state’s code authorized it. The owner chooses a single entity following completion of conceptual design or preliminary engineering when performance requirements established.

6 Design-Build The design-builder assumes almost all responsibility for the detail design and construction and delivers the final product, which should fulfill the performance requirements. DB is actually the oldest delivery method in the construction industry – many large cathedrals in Europe built by master builders, the rough equivalent to DB contractors. Up to the 19 th Century, almost all project in US delivered with form of DB.

7 Design-Build States fully authorized DoT’s to use DB: 17. States that required extra approval from outside DoT: 2. States had pilot programs or limited number or cost over period of time: 18. DoT’s that had no authority to use DB: 13.

8 Construction Management-at-Risk CM-at-Risk (CMR) sometimes referred to as Construction Manager/General Contractor (CM/GC). Contractor engaged early during the project design phase to help owner manage duties and increase the feasibility and constructability of the design. Expected to provide realistic cost estimate early in project life cycle.

9 Construction Management-at-Risk States normally reserve the right to bid construction if CMR price is not competitive. Difference between CMR and CM-Agency (CMA) is that CMR is obligated to deliver project with GMP and CMA is the owner’s agent and adviser and, so long as CMA performs duties, not responsible for time or cost overruns. CM for fee.

10 Construction Management-at-Risk States that authorized CMR: 14. States that required extra approval from outside DoT: 2. States with limitations per fiscal year: 3. States did not allow DoT or any agencies to use CMR: 31.

11 Public-Private-Partnership P3 also referred to as Public-Private-Initiative or Comprehensive Development Agreement A non-traditional arrangement between the department and one or more private or public entities that provides for:

12 Public-Private-Partnership 1.“Acceptance of private contribution to a transportation system project or service in exchange for public benefit concerning that project or service; 2.Sharing of resources and the means of providing transportation system project or services; or 3.Cooperation in researching, developing, and implementing transportation system projects or services.” –(State Code of Georgia)

13 Public-Private-Partnership 2007 U.S. Secretary of Transportation authorized to use three capital projects as pilot program with results to be studied. Similar to DB in technical aspects, but the financial aspects has caused apprehension

14 Public-Private-Partnership States that have accepted P3: 24. –Of those 24 states, 4 had some limitations. State DoT’s fully authorized to use P3: 19. One (1) state authorized but required outside approval. States that had pilot programs: 4. States where not authorized: 26.

15 APD is the Future The process of passing legislation for APD slow at times, but the trend is toward authorization. From , an increase from 30 to 37 states permitting DB. The trend serves as reminder to stakeholders that DBB will become less prevalent.

16 Financial Analysis of APD Road Projects Pertti Lahdenperä & Tiina Koppinen, Financial analysis of road project delivery systems, 14 J. of Financial Management of Property and Construction 61 (2009). Which PDS should the owner (client) select? –The various decision making and expert systems that have been developed are usually qualitative systems that consider various features of a project.

17 Financial Analysis of APD Road Projects –Those systems do not, however, indicate actual cost performance of the PDS’s. –Further, they focus more on the investment phase excluding so-called life cycle forms of contract. –Studies often focus solely on two PDS’s or variations and/or performance of a certain PDS’s. Precludes formulating a general view on cost efficiency of a number of PDS’s.

18 Financial Analysis of APD Road Projects In light of these deficiencies, the goal of the paper is to examine the cost performance of different road PDS’s by defining their indicative, relative cost performances. The authors used their earlier study from –That study did not include the private-financed option and financing issues were excluded. –The cost to the user community was also ignored.

19 Financial Analysis of APD Road Projects The paper seeks to address the deficiencies of the earlier study and focus on the significance of various financial parameters by means of sensitivity analyses.

20 The Project Delivery Systems Analyzed CM-at fee (CMA); CM-at risk (CMR) excluded Design-Bid-Build Design-Build Design-Build-Operate (DBO) –Owner arranges financing and pays for the investment in due time as w/ CM, DBB, and DB. Design-Build-Finance-Operate (DBFO) –Service provider or special purpose vehicle (SPV) arranges for financing.

21 The Analysis Discounted Cash Flow (DCF) method used to obtain PDSs’ present costs (PC’s). Two complementary analyses: 1.Cost to the owner 2.Cost to society Finland selected as the application environment for financial estimates and accounting constraints.

22 The Analysis Taxes excluded All work assumed to be out-sourced.

23 Financial Estimates/Assumptions Risk-free rate: 4% Industry margin (increased borrowing for private sector above risk-free government bonds rate):.5% Cost escalation/inflation: 2% Social opportunity costs: 4% risk-free rate Share of equity: 10% of project financing

24 Financial Estimates Return on equity: 4% risk premium or beta under CAPM –8% (Risk-free + beta) required rate of return on equity Consulting Fees in DBFO (legal/financial):.5% of debt raised (which here equals investment costs)

25 Other Estimates 30 year total study period –Close to the stated economic life cycle of roads. Early commissioning advantage: €1 million monthly cost of delayed commissioning

26 Conclusions The results of the financial analysis indicate “clearly” that DBO is the most efficient in terms of owner’s costs. The private finance of DBFO increases its costs close to those of DB, but not to the levels of the two most operationally inefficient -- DBB and CM.

27 Conclusions In sum, disregarding the financing component, the fewer the contracts the client enters into to purchase an entire road management package, the more cost efficient the project becomes. Consideration of early commissioning advantage improves the standing of CM the most, but it is likely to match DB and DBO only where speed of construction is critical.

28 Conclusions Sensitivity analysis –Changes in estimates do not usually affect the ranking order of DBB, CM, DB, and DBO since any alteration affects them much the same. –The lines representing CM and DBB are not completely parallel when variations occur in cost escalation and social opportunity costs due to differences in speed of construction.

29 Conclusions –Probably not surprising, but DBFO is affected differently by most variations in estimates. –Increases in senior debt to industry, share of equity, required return on equity, and concession period all diminish DBFO’s competitiveness. Social opportunity costs, which is related to the valuation of risk in public-financed PDS’s seems critical.

30 Conclusions Change is not always as dramatic in reality –Interest rates dealt with as independent factors are derivative from market rate and thus change in parallel.

31 Conclusions (1) DBO, (2) DB, (3) CM and (4) DBB DBFO’s competitive position is not absolutely clear but seems to be in the middle category with DB on the basis of the owner’s PC of a 30 year contract. –Consideration of the early commissioning advantage makes CM (fastest commissioning) nearly equal or sometimes better than DBFO, which increases its superiority over DBB.