Building Prisons with Private Financing

Using private financing to build government-run prisons is surging in an era of tight budgets, with states such as North Carolina and Alabama turning to the investment markets when taxpayers balk at building new lockups. Justice architects and contractors are providing this alternative by teaming up with private financing agencies.

Known as lease-purchase or lease-back financing, the trend of using the hitherto commercial financing method for government projects was born in the business-friendly South.

“As the economy has become less robust, municipal owners have had more difficulty in raising capital from traditional means. It’s really a pent-up demand,” says Randy Brown, acquisition manager at Highland Municipal Finance, which is currently seeking to enter the corrections market with a design-build team.

“A state in budget crisis either does something like this or they continue to wait two or three years, or however long it takes for voters to finally pass a referendum,” says Brown. “In the meantime, they expose themselves to additional costs and potential lawsuits because their facilities are outdated.”

In the 2004 Leaseback Study, commissioned by United Trust Fund, researchers found that 42 percent of respondents indicated plans for building projects of any type in the next 24 months. Municipal officials were asked if they would consider using sale-leaseback financing for municipal project. More than one third said ‘yes.’ (Based on 100 responses).

Investors would own the facility until they are repaid. What are the risks? “The risk to governments is if they fall short of revenue collections,” says Mark Alles, project executive for Turner Construction. Working with The Garfield Group, Turner just completed its first lease-back project in the criminal justice field to build a new courthouse for the city of Atlanta.

In Atlanta’s case, investors are counting on revenue generated from court fines and forfeitures. “The city controls how many tickets they write and what they charge for a ticket, so they’re in control of their own destiny,” Alles says, who is quick to note that Turner is not interested in owning the facilities themselves.

With prisons and jails, investors look for a guaranteed revenue stream in the form of income from renting their inmate beds to other jurisdictions. Otherwise, the state legislature or county board must set up a period lease payment.

“It’s a simple inclusion in the budget because it’s a period lease payment instead of a large capital expenditure,” says Brown. “And they have the ability to buy it out at any time, so they’re not committed to that lease if they want to get out of it earlier.”

Lease-back transactions allow for 100 percent financing, including professional fees. It is not a debt and the county or state doesn’t pledge their full faith in credit, and the lease isn’t subject to constitutional debt limitations. “Even though it’s not an interest rate, it’s comparable to a competitive interest rate,” Brown explains.

Alabama is currently seeking to access $250 million to coordinate two upgrade projects for the state, which has been unable to generate public funding for much-needed prisons. Over a 20- or 30-year term, the state would make lease payments until they own the facilities outright.

State laws regarding the use of private financing for public projects vary widely. Laws in Alabama permit a financing/construction team to deal with the state directly, but many other Southern states often call on government entities to create semi-private, semi-public entities to broker the deal.

North Carolina has completed three prisons and is planning more under lease-back transactions guided by Centex Rooney. “We actually had an ownership entity in our group because we technically financed and built these facilities and owned them until we finished the construction and then the state purchased the facilities from us,” says Ted Adams, director of corrections for Centex Rooney.

North Carolina created the Infrastructure Finance Corp. to raise the funds to purchase the facilities, state lease payments are made to this state-created ownership entity.

Soon after North Carolina changed its laws to allow for lease-purchase prison projects, Virginia changed theirs. “We are doing the same thing for the state of Virginia now, the only difference is Virginia’s is design-build,” says Adams, who is working with Lehman Brothers in Virginia.

Texas has the longest track record for constructing county jails under lease-purchase arrangements. A major player there is Hale Mills Construction Ltd., which over the past 15 years has partnered with financing agents such as Corplan Corrections and Municipal Capital Markets Group (MCM), all based in the Lone Star State.

“I think you’ll find that more and more counties will take this direction and you’ll see that similar kind of growth across the country,” says Kendall Phinney, general partner at Hale Mills.

According to MCM Executive Vice President Michael Harling, whose firm has brokered more than 40 lease-purchase agreements to build correctional facilities, end-users need to understand that lease-backs still allow them to steer the project. “End-users can spec out what they want with a controllable cost,” he says.

“If somebody has the ability to pass a tax issue or a bond, I think they’d be foolish not to. That’s still the cheapest and the best way to go,” Harling advises. “But I think the momentum is gaining in terms of trying to find other sources than the taxpayers. It’s starting to snowball.”