A GOODW IN PROCTER PUBL ICAT ION FOR THE RE AL ESTATE INDUSTRY

SPRING/2009 SOURCE

n Special District Knowledge Gap

n REITs, FIRPTA, and Infrastructure Financing

n Financing Solar Energy

n Impediments to Privatization

The

Issue

SOURCEA Goodwin Procter PublicationFor The Real Estate Industry

Editor-in-ChiefRobert M. Haight, Jr.

EditorsLewis G. FeldmanEdward C. HagerottJohn T. HaggertyChristopher B. PriceAndrew C. SucoffJohn M. FergusonDouglas A. Praw

ProductionSarah E. MooreBridget C. HuffstutlerNathan G. LeonardMatthew FetterMatthew D. Trotter

DesignThe Castle Press www.goodwinprocter.com

Copyright© 2009 by Goodwin Procter LLP. All rights reserved. Reproduction, in whole or part, without permission is prohibited.This publication may be considered advertisingunder the ethical rules of certain jurisdictionsand should not be considered legal advice.

SPRING /2009

I n the game of MoNoPoLy®, real estate wealth is tempered by payments for infrastructure — the Electric Company, the Water Works, four railroads, school taxes, and street repair assessments.

While a lot has changed since the game was created in 1935, those same facilities continue to be essential to communities throughout the United States. But, those facilities are only a small portion of the infrastructure improvements needed.

If the game were created today, and reflected additional facilities from the broader definition of infrastructure, we might find our token landing on spaces for International Airports, Interstate Highways, Cargo Ports, National Parks, Mass Transit, Cable and Digital Television, Hydroelectric Dams, Toll Bridges, The Information Superhighway, and The National Power Grid. We may draw a Community Chest card and pay a fee for Superfund Cleanup, open Space and Parks, Landscape Maintenance, Police and Fire Services, Library Taxes, and Solar and Wind Assessments. And, were we to land on Parking, it would not be free.

The United States has a vast and impressive infrastructure, but it is aging and, in some cases, outdated. The projected cost of the upkeep and the upgrade is staggering. How will these costs be financed, by whom, and in what priority? That is the issue.

Traditional financing methods — taxes, assessments, charges, and fees imposed by governmental entities or special districts — are not going to be sufficient. The private sector is going to have to be a player, and it will have to be creative. It will not be easy.

The four articles in this issue of REsource highlight some of the challenges facing infrastructure finance. The first article discusses the difficulties of financing infrastructure through special districts in the midst of the current real estate market upheaval for a new class of landowners — lenders, opportunity funds, private equity investors, and

pensions. Financing solar technology in the green era is the focus of our second article. The third article expounds on the benefits and the burdens of classifying infrastructure as real estate from a

tax perspective. Finally, the limitations on financing infrastructure improvements through privatization are explored in our last article.

Each article makes clear this fact: notwithstanding the challenges, infrastructure opportunities exist. Whether the United States will over­come these challenges and meet the infrastructure demands…well, that’s another issue.

— Robert M. Haight, Jr. Editor-in-ChiefMONOPOLY® & ©2009 Hasbro, Inc.

Used with permission.

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by Lewis G. Feldman and Robert M. Haight, Jr.

The Special District Knowledge Gap

In the history of infrastructure finan cing, special districts have a long and impressive resume. Across the United States, special districts — such as Nevada’s limited

improvement districts, California’s Mello­Roos Community Facilities Districts, and Texas’ Municipal Utility Districts — provide financing for public infrastructure improvements in lieu of private funding outlays.

Developers, equity participants, debt providers, and regulators must increas ingly contend with the impact

of special district liens on secured assets as they restructure troubled assets, recapitalize real property ventures, acquire distressed real estate, protect debt or equity positions, or obtain project ownership through foreclosure or deeds­in­lieu of foreclosure. Whether capital market participants decide to buy, sell, or hold, the details of the special district that were once considered relatively immaterial often become the linchpin to successful asset resolution. Those lenders and investors that

understand in detail the substance of and interplay among special district financing

vehicles, municipal bonds, and real estate finance can convert that knowledge into

asset optimization and profit.

The Special District Knowledge Gap

Commercial banks, savings and loans, land banks, opportunity funds, private equity investors, pensions, and other real estate capital providers have generally approved of the special district encumbrances because

they traditionally have enhanced the value of the capital­ or debt­provider’s security with additional infrastructure capital and facilities, notwithstanding that the special district lien is superior to the lien of the lenders’ security. Moreover, tax­exempt bonds bearing lower interest rates and non­recourse,

affect creditors’ decisions to sell or hold a special district encumbered asset.

Investors and lenders holding special district encumbered assets through foreclosure or negotiated transfer must pay annual real property taxes and assessment levies on such assets. Without keeping tax payments current, penalties result, and an accelerated foreclosure process ensues. Depending on the amount of outstanding bonded debt secured by special taxes or assessments, this carrying cost can be economically significant.

Strategic AlternativesAlternatives available to debt and equity participants

depend on the circumstances involved. Relevant inquiries include, among others: whether bonds have yet been issued; whether the project development is currently vacant land, a partially completed community, or a fully built­out development; whether residents live in the special district; whether the issuing agency will cooperate; whether bond moneys remain on account; whether capitalized interest is available for payment of debt service; and whether developer defaults have occurred.

off­balance sheet status add an additional piece of debt in the capital stack that limits the requirement for additional private debt or equity. Consequently, capital and debt providers rarely participate in special district formation and, in fact, often rely upon the development operators to avail themselves of special district funds to satisfy capital requirements for a project. This decoupling of money source and development concern has resulted in a huge knowledge gap on the part of secured creditors about special district financing that encumbers their real property collateral.

Now that property values have declined and capital markets have tightened, the impact of special district financings on real property valuations is rarely understood by debt and equity providers. on the other hand, those with knowledge of special districts and workout techniques can apply that knowledge to enhance asset valuations and to confidently purchase or sell debt at prices resulting in extremely high returns.

Understanding Special District Encumbrances

The first step in understanding what to do when faced with a special district encumbrance on an asset is to analyze the tax rates and methods of apportionment of the special district levy. The amount of the special district levies are fixed at the time of district formation when an appraisal is conducted, and the special district tax is sized to ensure that the overall tax rate for real property in the special district meets or falls below the established municipal bond market threshold – usually 2% of forecasted home values in the case of a residential community. If the burden of the special district levy exceeds that 2% level, it may hinder the residual value of the property because a higher­than­market tax burden thwarts product absorption. A number of more recently formed special districts sought to mitigate this risk by imposing a mandatory prepayment on a lot­by­lot basis as a condition to a developer’s receipt of a certificate of occupancy when reduced property values cause the overall tax burden to exceed the 2% cap. But, while elegant in theory, the buy­down results in a cash call at a time when cash flow is scarce, resulting in less money for debt service and a lower residual value. These issues also

“[There is] a huge knowledge gap on the part of secured creditors about special district financing... .”

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The presence of unexpended bond proceeds can also be preserved for use by subsequent purchasers or joint ventures, thus providing a lender or investor a means of obtaining a higher market value for the project. The right to use these funds, however, does not necessarily follow ownership of the property, so subsequent purchasers of partially completed projects must quickly arrange for the continued effectiveness of acquisition agreements and other operative finance documents previously executed. In some instances, cure rights must be exercised or bankruptcy court approval obtained to access bond proceeds.

When Opportunity Meets PreparednessWhether a lender seeking to maximize recovery

on a loan, a bond trader seeking to buy low and sell high, a developer seeking to restructure a distressed development, a private equity fund seeking to profit from an opportunity purchase, or a regulator charged with

appropriately valuing a real property asset, the impact of special district financing in today’s real estate environment must be understood. Through careful analysis based upon strategic advice from experienced public finance and real estate professionals, financial stakeholders can navigate with clarity and optimize the opportunities presented. n

Successful strategies for managing the impact of special districts under various scenarios include:

• Loweringthetaxorassessmentimpositionsandattendant annual debt service

• Financingofauthorizedimprovementsdirectlyfromannual assessments or tax levies rather than through bond proceeds

• Cancellingthespecialdistrictlien

• Partiallyorfullyprepayingthespecialdistrictlien

• Creatingtaxzonestomatchreviseddevelopmentproducts and absorptions

• Issuingrefinancingbonds,includingadjustablerate,credit­enhanced, or privately­placed securities

In each case, the goal is to efficiently optimize the marketability of the asset and lower carrying costs. Local government agencies, weary from delinquencies, foreclosures, and defaulted bonds, will often work with

debt and equity providers to restructure special districts in a mutually favorable manner.

Preserving ProceedsThe opportunity for a successful financial outcome is

often enhanced when bonds have not yet been issued against special district levies. Customization of debt parameters and lien burdens are much easier to structure. Where debt is outstanding, however, special districts still offer ample opportunity. When property is taken back from a developer, there may be construction fund moneys, maintenance hold­backs, unclaimed deposits, and investment earnings available for financing additional infrastructure improvements or as a source of repayment for improvements already constructed.

Lewis G. Feldman is Chair of the Los Angeles office and head of Goodwin Procter’s National Public/Private Development Finance Practice. He can be reached at (310) 788-5188 or lfeldman@goodwinprocter.com.

Robert M. Haight, Jr. is a partner in the Los Angeles office of Goodwin Procter, and can be reached at (310) 788-5150 or rhaight@goodwinprocter.com.

“…those with knowledge of special districts and workout techniques can apply that knowledge to enhance asset valuations… .”

As the world’s economy suffers through what feels like a long, cold, lonely winter, landowners

are turning to solar power to generate revenue and offset costs. Technology and financing mechanisms make solar projects particularly attractive when other planned projects have stalled. Solar projects can (i) be installed at improved properties and on vacant land, (ii) utilize tax credits to offset infrastructure installation costs, and (iii) make real estate developments more marketable and sustainable. Landown­ers need to understand certain basic principles to properly evaluate which properties realistically can take advan­tage of these benefits.

Land of OpportunitySolar panels can be installed in areas

of existing developments that can support the heavy panels or on vacant land. owners of existing developments of all asset classes, from shopping center

developers to residential developers, are implementing solar panels primarily on rooftops and in unused parking areas with great success — as little as one acre of rooftop space can generate enough energy to reduce the overall load of a large office building by 10% to 15%. At the Class A MGM Tower in Los Angeles, for example, a solar photovoltaic system recently installed on unused portions of its adjacent parking structure is projected to offset more than 12% of the building’s annual energy use.

There currently is no shortage of vacant land owned by master­planned community landowners and residential builders. Much of this land is in the “sunbelt,” extending from California to Texas, where concentration of solar radiation is highest. Ten acres of vacant land can house approximately 7,400 tilting photovoltaic panels, which can power 750 to 1,000 average­sized homes. Unlike many other generation sources, solar panels can

be installed on portions of a planned development without abandoning the originally contemplated residential or commercial development. In addi tion to the revenue created by a solar project, landowners might have a more attractive development that can be touted as “sustainable” or reducing its residents’ carbon footprint.

Initial ConsiderationsVacant space is not the only require­

ment for solar projects. A site’s viability depends on its size, proximity to large users and interconnection facilities, and various other factors. For landowners with little energy experience, there is no substitute for an energy consultant with solar industry expertise to conduct a feasibility study. Nonetheless, answer­ing the following threshold questions can provide preliminary indications of which solar projects may be suitable for landowners and their sites:

“...one acre of rooftop space can...reduce the overall load of a large office building by

10% to 15%.”

by Elliot D. Hinds and Douglas A. Praw

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REsource Spring 2009

Elliot D. Hinds is a partner in the Los Angeles office of Goodwin Procter, and can be reached at (310) 788-5145 or ehinds@goodwinprocter.com.

Douglas A. Praw is an associate in the Los Angeles office of Goodwin Procter, and can be reached at (310) 788-5117 or dpraw@goodwinprocter.com.

Is the landowner willing to commit to the installation of solar technology on a long-term basis? Solar developers and utility companies need the technology in place for a number of years (at least 10 years) to create a meaningful asset.

What is the electric load profile of the property (if any)? Are there heavy power users adjacent to the site that can buy the power directly from the developer?

What are the other site characteristics? Is the site unshaded and sturdy? Full access to south­ or southwest­facing sunlight is preferred. For rooftop projects, if the roof needs to be reinforced to support the panels and is due to be replaced within five years, it may be practical to combine the solar and roofing projects.

Is the site near an interconnection point? This is critical for utility scale projects as interconnection is extremely expensive to build and is fraught with regulatory challenges and delays.

What tax credits and incentives are available? These vary based upon the project’s size and the state and muni­cipality.

Tax IncentivesThere is a panoply of federal, state, and

municipal incentive programs that pro­vide grants, tax credits, and other sources of financing or revenue for solar and other renewable energy projects. Most notably, the recent bailout package (Emergency Economic Stabilization Act of 2008) and the stimulus package (American Recovery and Reinvestment Act of 2009) include more than $42 billion in grants and energy­related investments that directly or indirectly benefit solar projects, plus they include specific solar technol­ogy tax credits. These grants include a program that will enable taxpayers to redeem solar investment tax credits that exceed their tax liability; eliminate

the tax penalties for subsidized energy financing; and provide billions for “smart grid” efficiency and renewable energy research. The Business Solar Investment Tax Credit set forth in Internal Revenue Code Section 48 was extended through December 31, 2016. This tax credit allows for an offset of regular and alter­native minimum tax in an amount equal to 30% of the cost of solar equipment. owners of solar energy systems also can take advantage of a 5.5­year equipment depreciation schedule. The tax credits can either be used directly by the land­owner/project owner or bundled and sold to tax credit investors.

Transaction StructuresSolar power developments generally

use one of four structures:

Sole Ownership. For projects that are one megawatt or less and will sat­isfy existing on­site or adjacent load, direct ownership by the landowner is a realistic possibility. Several commercial installers can construct such projects, it is easier to satisfy existing load require­ments than to develop projects for off­site end users, and both conventional debt and municipally issued tax­exempt bonds can be used for financing. Recent changes to California law authorize cit­ies and counties to enter into contracts with owners of improved property to bond for the installation of permanent improvements for renewable energy and energy efficiency.

Sale-Leaseback. A sale­leaseback is a financing that uses a lease as the security instrument rather than a mort­gage, and the landowner first conveys the project to the financier, who then leases it back to the landowner. The tax implications of this structure need to be examined carefully, particularly the use of tax credits. This type of transac­tion can also be structured as a land­

banking opportunity, whereby the solar developer acquires the property from the real estate developer pursuant to an option contract.

Third-Party Leases. Under this structure, the landowner leases the project to a third­party who builds, owns, and operates the facility. This structure is extremely common be­cause the landowner’s involvement in the project’s development is minimal. The rent typically increases as the proj­ect meets development milestones such as obtaining key permits, ground­breaking, commercial operation, and specified dates.

Joint Venture. In a joint venture, the landowner and a third­party build, own, and operate the facility jointly. This structure is attractive where the landowner wants “a piece of the equity,” is willing to take development risk, and has found a compatible and experi­enced solar power developer. Tax credit or tax equity financings typically are structured as a form of joint venture.

Sustainable DevelopmentThe push to sustainability is not

a new concept. Implementing so­lar technology can lead to a win­win situation for landowners, furthering corporate environmental objectives such as reducing carbon dioxide emis­sions and other air pollutants, and increasing revenue and profitability. n

by John M. Ferguson and Mandee R. Silverman

The Bottom Linein Infrastructure Investing:

“REITs can be an effective tool to bridge the infrastructure gap...

Is It Real Estate?I nfrastructure projects are no lon­

ger exclusively the domain of the govern ment, and momentum is

building for private capital investment in U. S. infrastructure projects. Unlike government, however, private investors will evaluate infrastructure investment by the same metric as all other invest­ments: after-tax cash returns. Ultimately, this metric alone will determine wheth­er private capital will be invested. The key to the tax analysis is whether infra­structure constitutes “real estate” or “real property” for various sections of the U.S. Internal Revenue Code (IRC).

For those considering investing in the burgeoning U.S. market (many of whom are either established infrastructure investors with experience in the more well­developed private infrastructure markets of Australia and Western Europe or investors from within the United States with backgrounds in real estate, private equity, or fixed income), it is criti­cal to understand that characterization of investment assets under current law and Internal Revenue Service (IRS) inter­pretations as real property can be both a benefit and a burden. on the one hand, if infrastructure assets are character­ized as real estate, investors may enjoy the substantial tax benefit of real estate investment trusts (REITs). on the other,

such a characterization may subject non­U.S. investors to the burden of the Foreign Investment in Real Prop­erty Tax Act (FIRPTA).

REITS (Real Estate Giveth . . .)REITs are tax­advantaged vehicles

that have successfully attracted wide sources of capital to real estate. Subject to compliance with a number of asset and income requirements designed to ensure an almost exclusive focus on ownership and operation of real estate, REITs have the benefit of being treated as corporations under the IRC without the corresponding burden of paying entity­level U.S. federal income taxes to the extent they dividend out their net income. REITs have made investing in institutional­quality real estate in a diversified manner avail­able to the public, and may also be used to “block” certain U.S. tax­exempt

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institutional investors from receiving “unrelated business taxable income” from the operation or leveraging of real estate.

To use REITs to invest in infrastructure, the infrastructure assets must be characterized as real estate under the IRC. As the REIT market has developed over time, the IRS has concluded that certain infrastructure assets — from railroad tracks to broadcasting and cell phone towers — may constitute real property, thereby constituting good REIT assets. Good REIT income will also be created if the revenue streams from such assets are allocated and structured properly — often a challenging task involving an analysis of both the assets held and the income derived from those assets.

The IRS recently concluded that both an electricity transmission and distribu­tion system and the rental payments from the lease of such a system were “REIT­able.” The IRS distinguished the transmission and distribution aspects of the system from the generation of the electricity. Similar to railroad tracks, the transmission and distribution assets are passive conduits of a commodity created elsewhere. The IRS concluded that the underlying asset is real estate that is producing rental income and not operating income from a trade or business. This rationale appears to apply equally to the transmission and dis­tribution of water, oil, gas, and new sources of clean energy.

When applied to infrastructure, the distinction between rental income and operating income is reminiscent of the early days of structuring operating leases to facilitate REIT investments in hotels. To avoid characterization as ordinary income from an operating business, the real estate was leased by the REIT to a

taxable REIT subsidiary so as to separate the revenue stream and value of the real estate from the revenues derived from the operation of the hotel and its other revenue generating enterprises. Thus, in evaluating infrastructure assets, if the IRS finds that they constitute “good” real property but generate “bad” REIT income, arrangements similar to those employed in the hotel context show great promise for allowing certain private infrastructure investors to realize returns in a tax­efficient manner.

FIRPTA (Real Estate Taketh Away . . .)Unfortunately, characterizing infra­

structure assets as real property may be detrimental to non­U.S. investors subject to substantial federal withholding tax under the FIRPTA rules. Under these rules, withholding tax applies to distributions to non­U.S. investors on proceeds from the sale of “U.S. real property interests” (USRPIs) and from the sale of interests in or liquidation of a “U.S. real property holding corporation,” which is an entity with greater than 50% of its value attributable to USRPIs.

The FIRPTA withholding tax analysis hinges upon whether an asset, or a majority in value of the assets of a company, constitutes a USRPI under the IRC. In the case of single companies with multiple assets, only some of which may be real estate, classification is critical to analyzing and structuring the transaction.

Current trends suggest an expansive view by the IRS as to what constitutes an interest in real property for these purposes. In october 2008, the IRS issued a request for comments regarding the status of certain permits, licenses, and other rights granted by a governmental entity

that are related to the lease, ownership, or use of toll roads, toll bridges, and other physical infrastructure, sending shivers through the cross­border real estate industry by suggesting that such rights may properly be characterized as USRPIs. Accordingly, allocating value among multiple components of a transaction can be of great consequence. For example, is more than half the value in an electric company attributable to the generation of electricity (an operating business) or the transmission of electricity (a real estate asset)?

While these results can sometimes be mitigated through structuring, classifying infrastructure assets as USRPIs is not a positive development for attracting non­U.S. capital.

The Bottom LineREITs can be an effective tool to bridge

the infrastructure gap, but only if the IRS characterizes the infrastructure assets as real estate. But even if so characterized, FIRPTA presents a formidable challenge to attracting non­U.S. capital. Determining whether real estate is the right label for certain infrastructure assets and revenue streams is the key to successfully marrying capital with infrastructure investment opportunity, and is likely to play a large role in privately capitalizing U.S. infrastructure. n

John M. Ferguson is a partner in the New York office of Goodwin Procter, and can be reached at (212) 813-8827 or jferguson@goodwinprocter.com.

Mandee R. Silverman is an associate in the New York office of Goodwin Procter, and can be reached at (212) 813-8868 or msilverman@goodwinprocter.com.

...if the IRS characterizes the infrastructure assets as real estate.”

by Tuan A. Pham and Valerie J. Washburn

Mind The Capital Gap:

Impediments to the Privatization of

Infrastructure

I t doesn’t take a Hollywood executive to know that America’s infrastructure is in need of an “extreme makeover.” Built predomi nantly during the middle of

the last century, U.S. infrastructure has been pushed to and, in some cases, beyond its limits. The American Recovery and Reinvestment Act of 2009 acknow ledged this reality by earmarking over $100 billion of government funds for infrastructure­related spending — a level unseen since the days of FDR. While stimulus funds may provide some relief, a great deal more capital is needed. The American Society of Civil Engineers recently estimated that approximately $2.2 trillion dollars is needed to fund infrastructure over the next five years. Who will bridge the capital gap?

As traditional funding sources, such as increased taxes and public bond financing, have become increasingly difficult to access, private investment has moved to the forefront. Available equity capital for infrastructure from both U.S. and international institu tions has skyrocketed from $10 billion in 2004 to $180 billion in 2008. Many observers believe that, despite broader economic uncertainty, inves tors will continue to flock to the steady

yields and inflationary hedge offered by infra­structure investment. Previous successful projects such as the Chicago Skyway and Indiana Toll Road transactions also provide impetus for privatization. Heightened private interest, however, depends on

private investors’ ability to weigh the associated risks against the potential returns. In the infrastructure arena, the pitfalls and hurdles of privatization can be significant.

The Obstacle CourseTwo of the largest and most visible proposed privatiza­

tions – the Pennsylvania Turnpike and Chicago’s Midway Airport – vividly illustrate the obstacles confronting pri­vate investment in infrastructure. The Penn Turnpike transaction proposed a 75­year lease of a 537­mile state­owned highway to a private consortium composed of Citi Infrastructure Investors (“CII”), Abertis Infrastructure, and Criteria CaixaCorp. The Midway deal involved a 99­year lease of Midway Airport, a five­runway hub that handles 300 flights daily, to a joint venture comprised of CII, yVR Airport Services, and John Hancock Life Insurance Company.

Despite the promise of these two projects, neither has closed. The Penn Turnpike privatization collapsed in october 2008. The Midway privatization is now slated to be complete in the first half of 2009, but it has already been delayed once and several hurdles remain. Its failure

“The future demand for infrastructure capital will outstrip the supply available from public sources.”

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could deal a major blow to the privatization model. The scuttling of the Penn Turnpike deal and the delays in the Midway deal can be attributed to several factors, which are instructive for private investors evaluating infrastructure opportunities.

Political Opposition. Privatizing infrastructure is politi­cally sensitive. Political opposition often derives from suspicion of turning over public goods to profit­making entities. In this respect, local government budgetary shortfalls are a double­edged sword: even as they prompt governments to pursue privatization, they fuel arguments of opponents who wonder why governments do not simply find a way to reap for themselves the returns expected by private investors. one Illinois politician has compared infrastructure priva ­tization to “selling the furniture to pay the mortgage.”

The immediate precipitating factor behind the Penn Turnpike deal’s collapse was the Pennsylvania Legislature’s failure to grant necessary legislative authorizations. The deal met heavy opposition from Pennsylvania legislators and the Pennsylvania Turnpike Commission. After extend­ing its bid twice to accommodate the legislature, the investor consortium allowed its bid to expire on october 1, 2008. Likewise, in Chicago, the Midway privatization recently met opposition from candidates for a newly­ vacant congressional seat.

Credit Conditions. Infrastructure investments are not immune from the factors, such as the credit crunch, wreaking havoc on other deals throughout the economy. For example, with the Penn Turnpike deal structured as 50% equity and 50% bank debt, it is widely speculated that the uncertain credit markets were the most important factor in the investors’ decision to let their bid expire. The Midway transaction, which was originally expected to close by the end of 2008, was put on hold after the investor consortium announced in January 2009 that it was seeking additional equity capital, a move that may have been prompted by the need to replace expensive or unavailable debt.

Valuation Difficulties. Infrastructure is a relatively new asset class for private investors, and valuing these assets is still more of an art than a science. To illustrate, the Commonwealth of Pennsylvania’s financial advisers and the media estimated the value of the assets would range from $20 billion to upwards of $30 billion, but the winning bid for the Penn Turnpike was only $12.8 billion. For the Midway project, pre­bidding estimates ranged from $1.5 to $3 billion. The winning bid, at $2.52 billion, was within this range, but the range itself was sizable. The novelty of

valuing infrastructure assets partially explains the wide fluctuations. Dramatic swings in cost of capital and economic forecasts over the past several years are also factors. What is clear is that wide disparities in valuation, coupled with the lengthy time frames involved in getting privatization deals completed, can derail deals.

Regulatory Approvals. Various regulatory require­ments also create obstacles for private investors underwriting and completing these deals. A failure to obtain one of the many required approvals can derail a project in which substantial investment has already been made. Additionally, approval delays afford equity and debt investors opportunities to revalue, renegotiate, and

reconsider transactions — a dangerous prospect in the current investment environ­

ment. Finally, concessions required to obtain these approvals can affect (generally for the worse) the under­writing of the project.

The Midway transaction, for instance, required the approval not just of Chicago city authorities but also of certain neighboring cities. The privatization is being done pursuant to a national program spearheaded by the Federal Aviation Administration, which must approve the financial terms of the deal. Under the program’s terms, 65% of airline tenants also need to approve the transaction. To gain the approval of Southwest Airlines, the investor consortium agreed to freeze carrier charges at 2008 levels for its first six years of operation, followed by limiting fee increases to the rate of inflation for the next 19 years.

Mind the GapThe future demand for infrastructure capital will outstrip

the supply available from public sources. Who will fill this capital gap? While it is undeniable that infrastructure is a highly attractive asset class, that the political momentum is moving toward more infrastructure deals, and that there are successful precedents, investors are well advised to recognize the risks and hurdles presented. Capital alone will not be sufficient to address these obstacles. Success is achievable only with a thorough understanding of both generic and asset­specific obstacles to private infrastructure transactions in today’s environment.

“Who will bridge the capital gap?”

Tuan A. Pham is a partner in the San Francisco office of Goodwin Procter, and can be reached at (415) 733-6062 or tpham@goodwinprocter.com.

Valerie J. Washburn is an associate in the San Francisco office of Goodwin Procter, and can be reached at (415) 733-6089 or vwashburn@goodwinprocter.com.

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