The 2016-17 Budget: Review of UC’s Merced Campus Expansion Proposal

The 2016-17 Budget: Review of UC’s Merced Campus Expansion Proposal MAC TAYLOR • LEGISLATIVE ANALYST • FEBRUARY 10, 2016 Executive Summary The University of California (UC) Proposes Major Expansion of Merced Campus. UC is proposing to double the campus’s facility space by 2020. Under the plan, enrollment on the Merced campus would grow from 6,000 to 10,000 full-time equivalent students by 2020. UC proposes to deliver this project by entering into an agreement with a private partner to finance, design, construct, operate, and maintain the facilities. The total cost of the project is estimated to be $1.1 billion, with $527 million associated with the construction of state-eligible facilities. Legislature Has Until April 1 to Review Proposal. Under the state’s current capital outlay approval process for UC, the Department of Finance is to notify the Legislature by February 1 of any UC projects it has preliminarily approved. As of the release of this report, the department had not yet provided this notification for the UC project. The Legislature has until April 1 to express any concerns it might have with the project. Given the size, scope, and complexity of the Merced campus expansion, we recommend the Legislature schedule hearings in late February or early March to express its views of the proposal to the administration and UC. Four Key Issues for the Legislature to Consider. As the Legislature examines the proposal, it will face four key decisions: • What growth in UC resident enrollment is desired over the next few years? • How should additional resident students be accommodated? • If additional students are accommodated at UC Merced, what are appropriate growth objectives for the campus? • Should any expansion of the Merced campus be accomplished using design-bid-build, design-build, or a public-private partnership? For each of these four key decisions, we provide the Legislature with various factors to consider. 2016-17 BUDGET INTRODUCTION In November 2015, the Regents of the assist the Legislature in reviewing this proposal. University of California (UC) approved a proposal Below, we provide background on the Merced to enter into a public-private partnership to double campus and the state process for approving capital the physical size of the Merced campus. Under the outlay projects at UC, describe key aspects of the plan, enrollment on the Merced campus would proposed project, and raise four key issues for the grow from 6,000 to 10,000 full-time equivalent Legislature to consider. (FTE) students by 2020. This brief is intended to BACKGROUND Merced Campus Opened in 2005. The tenth all types of facilities at UC. Specifically, the state and newest UC campus, Merced (located in the has funded facilities that support UC’s core San Joaquin Valley) was built to accommodate UC academic activities of instruction and research enrollment growth. As with all other UC campuses, (“state-eligible” facilities). By contrast, UC funds Merced was envisioned and is being built as a housing, dining, and other nonacademic facilities research university. Since 2001, the state has issued using fee revenue associated with those facilities. over $350 million in bonds to develop the campus Prior to 2013-14, the state funded construction of site and construct facilities. The Legislature has state-eligible facilities by issuing general obligation maintained an ongoing interest in the campus’s and lease-revenue bonds and appropriated development. It took its most recent related action funding annually to service the associated debt. in the 2015-16 budget, earmarking up to $1 million Chapter 50 of 2013 (AB 94, Committee on Budget) for the campus to plan for the development of a revised this method by authorizing UC to pledge medical school. its state support appropriation to issue bonds for Merced Campus Has Been Steadily Growing. state-eligible facilities and associated campus Over the last ten years, UC Merced has received infrastructure. The state allows UC to pay the a steady increase in applicants, and every year associated debt service using its state support more admitted applicants enroll at the campus. appropriation. Given these changes, the state has Enrollment has grown from 865 FTE students not issued bonds for UC projects the past few years. in 2005-06 to more than 6,000 FTE students in State Recently Changed Legislative Review 2015-16. Over 93 percent of the students at Merced Process for UC Capital Outlay Proposals. In are undergraduates, with the remaining students order for UC to use the authority granted under enrolled in academic graduate programs. Merced Chapter 50, the Department of Finance must remains the smallest campus in the UC system, approve each proposed project. Chapter 50 with other UC campuses ranging from 17,000 to requires UC to submit project proposals to the 37,000 FTE students. department and the budget committees of the State Recently Granted UC Authority to Legislature by September 1 for the upcoming fiscal Finance Capital Projects With State Funds. year. The legislation requires the department to Historically, the state has funded some but not 2 Legislative Analyst’s Office www.lao.ca.gov 2016-17 BUDGET notify the budget committees by February 1 as to maintain and operate state-eligible facilities. which projects it intends to approve. The budget For the Merced project, Chapter 22 specifically committees then can express any concerns with the requires UC to use its own employees for routine projects. The department can grant final approval maintenance, meaning the partner only would of projects no sooner than April 1 for the upcoming perform maintenance on major building systems. fiscal year. UC must still undergo the same approval process State Recently Granted UC Authority described above. (Prior to Chapter 22, the state to Enter Into Public-Private Partnerships. already had authorized other agencies, including Chapter 22 of 2015 (SB 81, Committee on Budget the California Department of Transportation, and Fiscal Review) revised UC’s capital outlay the Administrative Office of the Courts, and the authority to allow UC to enter into contracts with High-Speed Rail Authority, to enter into public- private partners to finance, design, construct, private partnerships.) PROPOSAL Merced Expansion Proposal in Midst of New project would add 917,500 square feet of facility State Review Process. A major expansion of the space to the campus, of which 414,400 square Merced campus is UC’s only state-eligible capital feet would be state-eligible. Over 40 percent of outlay proposal for 2016-17. The UC Regents the state-eligible space would be for new research approved this proposal in November 2015. As of the laboratories and another 35 percent would be office release of this report, the Department of Finance space for faculty and academic administrators. Of had not yet notified the Legislature whether it the 17 percent of space dedicated for instruction, intended to preliminarily approve the Merced a majority would be for small classrooms (24 to project. The Legislature has until April 1, 2016 to 30 seats per room) and teaching laboratories. review the proposal and express any concerns it UC estimates the total cost of construction to be may have to the department. We provide further $1.1 billion, with $527 million attributable to state- detail on the proposed project below. eligible facilities. Purpose of Project Is to Expand Enrollment. UC Proposes to Deliver Project Using Public- The proposal aims to grow the Merced campus Private Partnership. UC asserts this partnership from 6,000 to 10,000 FTE students by 2020. UC will provide the following benefits: (1) faster asserts that the campus is currently operating at delivery of the project’s facilities, (2) construction physical capacity and projects that student demand and maintenance savings, (3) the transfer of for the campus will continue to grow as in past certain construction-related risks onto the private years. In addition, UC asserts that enrollment entity, and (4) increased budgetary certainty for growth at Merced will provide the campus a larger the maintenance of the facilities. We describe the base of tuition revenue and generate economies of proposed partnership below. scale, thereby reducing per-student instructional UC and Partner Each Would Finance a costs. Portion of Construction. Under the partnership, Project Would Double the Physical Size of the the partner would design and construct the Campus. As shown in Figure 1 (see next page), the facilities. UC would issue $400 million in bonds www.lao.ca.gov Legislative Analyst’s Office 3 2016-17 BUDGET UC’s Annual Figure 1 Ongoing Costs for Project Proposed New Space and Costs for UC Merced Project Would Initially Total (Dollars in Millions) $47 Million. UC would Assignable cover annual debt service Square Feet Cost on the bonds it issued State-Eligible Research labs and support 181,000 $300 for state-eligible facilities Faculty and administrative offices 144,600 121 ($21 million) and would Classrooms, teaching labs, and other instructional spacea 69,800 86 perform annual routine Otherb 19,000 20 Subtotals (414,400) ($527) maintenance on the new facilities ($7.3 million). Not State-Eligible Housing 380,500 $258 In addition, UC would Student recreation 122,600 163 make annual payments Parking — 95 to the partner for the Other — 100 Subtotals (503,100) ($616) partner’s financing Totals 917,500 $1,143 costs ($13 million) a Includes flexible space adjacent to research laboratories. UC indicates this space will be for faculty and and for the partner to student interaction. b Facilities for public safety, environmental safety, and workplace safety personnel. perform maintenance on major building for construction of the state-eligible facilities. The systems ($5.4 million). partner would finance the remaining $127 million UC indicates that the contract it plans for the for these facilities. (UC and the partner also would partnership would allow it to reduce or withhold share responsibility for financing the facilities these payments if the facilities do not meet certain that are not state-eligible.) Under the contract, operational standards. For example, if a facility UC would pay the partner for the construction were to shut down and no longer be available for costs in three installments upon completion of use, UC could withhold funding from the partner. certain construction milestones. UC states that In 2055, UC would assume full responsibility for this payment schedule would provide an incentive the operation and maintenance of the facilities. for the partner to complete construction without (Annual ongoing costs for the facilities that are not delays. state eligible initially would total $58 million.) ISSUES FOR LEGISLATIVE CONSIDERATION Recommend Early Legislative Hearings. the proposal and convey any concerns to the Under the new capital outlay process established administration at that time. for UC under Chapter 50, the Legislature must send Proposal Raises Four Key Issues for the clear signals to the Governor by April 1 if it wishes Legislature. To help guide the Legislature in to influence UC projects on state-eligible facilities. its review of the proposal, we examine the key Given the size, scope, and complexity of the Merced decisions it faces. As shown in Figure 2, these proposal, we recommend the Legislature hold decisions are largely sequential, as the first hearings in late February or early March to discuss decisions will have implications for the remaining 4 Legislative Analyst’s Office www.lao.ca.gov 2016-17 BUDGET issues. The Legislature first will want to consider new facility space at Merced, it will want to set how much growth in UC resident enrollment some basic growth objectives for the campus. After it desires over the next few years. Once the settling on these growth objectives, the Legislature Legislature determines this number, it will want will want to select a capital outlay approach to to weigh its options for accommodating these deliver the new space. We describe these key students. If the Legislature decides that additional decision points in the remainder of the report. students are best accommodated by constructing Figure 2 Key Decisions Facing the Legislature What Growth in Resident Enrollment Is Desired Over the Next Few Years? How Should UC Accommodate Additional Resident Students? Free up space through Free up space for residents by Increase utilization Construct new facilities instructional efficiencies reducing nonresident enrollment of existing space If new facilities at UC Merced, then. . . What Should Be UC Merced’s Basic Growth Objectives? (cid:127) How many students? (cid:127) What time frame? (cid:127) What balance of instruction and research? After settling on growth objectives What Capital Outlay Approach Should UC Use to Expand Merced Campus? Design-Bid-Build Design-Build Public-Private Partnership www.lao.ca.gov Legislative Analyst’s Office 5 2016-17 BUDGET What Growth in Resident Enrollment student body) declining 6 percent by 2020. Is Desired Over the Next Few Years? Projections of public high school graduates fluctuate between small increases and decreases Master Plan Defines Which Students Are over the next several years, with a less than Eligible to Attend UC. The state has long sought 1 percent increase in graduates between 2015-16 to provide residents an opportunity to earn a and 2019-20. bachelor’s degree through its two public university Not All Eligible Students Admitted to systems, UC and the California State University Campus of Choice. The Master Plan established (CSU). Instructional costs, however, are higher systemwide eligibility criteria for admission, at the public universities relative to the state’s providing UC discretion to allocate enrollment community colleges, particularly at UC due to its among its campuses. Student demand varies emphasis on research. The 1960 Master Plan for greatly by campus, with Berkeley, Los Angeles, Higher Education in California established two and San Diego receiving the most applicants. pathways to the universities in order to preserve In order to accommodate all eligible applicants, access for students and reduce pressure on the UC traditionally redirects some eligible students state General Fund. Under the first pathway, the applying to high-demand campuses to other top 12.5 percent and 33 percent of public high campuses. Currently, eligible students not admitted school graduates are eligible to attend UC and to a campus of their choice are offered admission at CSU, respectively, as freshmen. Under the second Merced. pathway, students who are not eligible to attend the Legislature Increasingly Concerned About universities as freshmen can attend a community Resident Access to High-Demand Campuses. In college and transfer to UC or CSU after completing recent years, UC’s highest-demand campuses have two years of full-time study with a certain grade- become increasingly more selective for resident point average. These Master Plan goals historically students. For example, the Berkeley and Los have served as the state’s policy basis for enrollment Angeles campuses, respectively, admitted around decisions at each segment. 19 percent and 16 percent of California resident Available Data Suggest UC Currently Meeting freshman applicants in fall 2015, as compared to or Exceeding Master Plan Expectations. For about 25 percent for both campuses in fall 2007. At fall 2014, UC admitted 13 percent of public high the same time, these campuses have enrolled more school graduates as freshmen. An even larger nonresident undergraduate students, increasing share of public high school graduates is eligible for the nonresident share of their undergraduate freshman admission because not all eligible high enrollment from under 10 percent in fall 2007 school students choose to apply. (The state currently to about 25 percent in fall 2015. During 2015-16 is conducting a study to estimate the overall share budget hearings, members of the Legislature of students eligible for freshman admission. The expressed growing concerns regarding these trends. results of the study are due December 2016.) Legislature Recently Provided Funding for For transfer admission, UC reports it has been UC to Grow Enrollment. The 2015-16 budget admitting all eligible applicants in recent years. set an expectation that UC enroll 5,000 more Available Data Suggest Little Growth in Pool resident undergraduate students in 2016-17 than of Eligible Students in Near Term. Demographic in 2014-15. The 2015-16 budget made a $25 million projections show the 18 to 24 year-old population augmentation contingent upon meeting this (which comprises 93 percent of UC’s undergraduate 6 Legislative Analyst’s Office www.lao.ca.gov 2016-17 BUDGET enrollment expectation. UC plans to meet this accommodate additional students. In a recent expectation by growing enrollment at all of its report to the Legislature, UC indicated that it has campuses, including Berkeley, Los Angeles, and made some progress but is still in the early stages of San Diego. The state has not set any additional implementing these reforms. Before committing to enrollment expectations for UC beyond 2016-17. new facility construction, the Legislature may wish Master Plan Periodically Revisited. Over the to consider how these instructional efficiencies will last several decades, the Legislature has periodically expand access to UC and whether the university revisited the Master Plan’s provisions, doing so system could further its efforts in these areas. most recently in 2010. If the Legislature continues UC Not Maximizing Use of Existing Space. to have concerns regarding access to UC, it could Periodically, the state has made efforts to expand initiate a new Master Plan review. As part of this the use of UC facilities in the summer and fully review, the Legislature could consider expanding use UC facilities throughout the year. UC has UC’s freshman eligibility pool, enabling more been expanding summer enrollment since 2001. students to enroll in UC directly after graduating In summer 2015, UC enrolled 19 percent of the from high school. It also could consider setting number of FTE students it enrolled during its other resident enrollment targets for each UC campus, terms. As part of its May 2015 agreement with the potentially enabling more students to attend their Governor, UC plans to experiment with different first choice campus. Any changes such as these to pricing models at three campuses in summer the Master Plan would have significant implications 2016 to encourage more students to enroll during for UC systemwide enrollment, campus enrollment, that term. If UC were to expand these efforts, and state costs moving forward. it potentially could accommodate a significant number of students. For example, if UC were to How Should UC Accommodate double its summer enrollment to equal 40 percent Additional Resident Students? of its other terms, it could accommodate an UC Implementing Instructional Efficiencies additional 15,000 FTE students. to Free Up Space. The Legislature has multiple Decreasing Nonresident Enrollment Would options for expanding access to UC. One option is Free Up Space, but UC Would Lose Associated to encourage UC to achieve additional instructional Revenue. UC currently enrolls over 30,000 efficiencies. In a May 2015 agreement with the nonresident undergraduate students, over Governor, UC committed to implementing a 60 percent of whom are located at Berkeley, number of changes to its academic programs. Los Angeles, and San Diego. These nonresident The goal of these changes is to expand access for students occupy space that could be used by resident students while reducing the need for resident students. Nonresident students, however, significant state enrollment funding or new facility provide significant funding to UC because they pay space. Some of these changes, such as counting a supplemental tuition charge ($26,682 in 2016-17) more college preparatory work as college credit and that exceeds the per-student funding rate that reducing the required units for certain degrees, UC requests from the state for resident students could reduce the need for some students to take ($10,000). UC asserts that the $16,682 difference certain courses, thereby freeing up space for other helps fund instruction for resident students. If students. Other changes, such as expanding online the Legislature were to consider requiring UC to course offerings, could free up lecture space to decrease nonresident enrollment to admit more www.lao.ca.gov Legislative Analyst’s Office 7 2016-17 BUDGET resident students, it would need to consider how to consider is over what time frame it would UC would manage the associated loss of revenue. like to attain its enrollment target for Merced. Constructing New Academic Facilities Entails Traditionally, the state has expanded campuses on Significant Capital Expenditures. The state an incremental basis. The state took this approach traditionally has constructed new facility space to when it first developed the Merced campus between accommodate enrollment growth. Unlike the options 2000 and 2006. An incremental process offers the discussed above, this approach requires significant state and UC flexibility to adjust priorities in future capital expenditures. For example, the 2013-14 years. UC’s latest proposal, by contrast, bundles budget authorized $45.1 million to construct a single together many facilities under one project. This classroom and academic office building at the Merced approach reduces the number of times the state campus that contained six medium-size lecture would be able to review and asses the campus’s classrooms and one small seminar space. Moreover, growth priorities. If the Legislature concluded new facilities require ongoing funding to operate that facilities were needed in the near future, the and maintain and, in the past, UC has not kept up bundling approach could have the benefit, however, on regular maintenance of its buildings, leading the of potentially reducing the time required to university system to estimate it has over $1.2 billion construct all the new facilities. in deferred maintenance. Despite these issues, the Research Space Significantly Adds to Legislature still may wish to expand facility space at Construction and Operational Costs. Although one or more UC campuses. In deciding which campus UC cites enrollment growth as the key justification or campuses to expand, the Legislature likely would for expanding the Merced campus, over 40 percent want to consider various factors, including campuses’ of the proposed state-eligible space and over growth objectives, existing footprints, and relative 50 percent of the estimated state construction cost construction costs. is for new research facilities. Increasing research activities at Merced increases costs because (1) it What Should Be UC Merced’s increases the campus’s overall space needs and Basic Growth Objectives? (2) research space is the costliest type of space Not Necessarily One “Right” Number of to construct. UC also would incur ongoing Students for Campus. If the Legislature decides maintenance and staffing costs for the research to construct new facility space at Merced, it will space. UC asserts that research space is necessary have to decide how many students it would like the for the instruction of the campus’s students campus to serve. The Legislature could consider majoring in a science or engineering discipline. several factors when making this decision. It could The Legislature, however, could prioritize the consider economies of scale and per-student costs, construction of instructional space, including which UC cites as one reason to grow enrollment teaching laboratories, enabling the campus to to 10,000 FTE students. The Legislature also could continue accommodating more students and consider projected enrollment for the Merced reducing the cost of the project. campus and the effect of growth on the campus’s What Capital Outlay Approach Should surrounding communities. UC Use to Expand Merced Campus? UC Traditionally Has Proposed Campus Growth Incrementally Over Longer Time Frame. UC Considered Three Procurement Methods The next question the Legislature will want for Merced Project. UC proposes a public-private 8 Legislative Analyst’s Office www.lao.ca.gov 2016-17 BUDGET partnership to deliver the project. It also considered under a public-private partnership to outweigh the two other procurement methods. Under the first likelihood of increased financing costs. method, “design-bid-build,” UC would hire an Bid Threshold Does Not Necessarily architecture and engineering firm for the project Guarantee Savings. In order to ensure that it does design and then award the construction contract not pay more under a public-private partnership, through a competitive bid. Under the second UC has established a bid threshold equal to its method, “design-build,” UC would contract with estimate of the cost to construct and maintain the one firm to both design and construct the project. proposed facilities under a design-build method. Under both methods, UC would finance the whole UC indicates it will not accept a bid that comes project and assume responsibility for operating in above this threshold. The effectiveness of this and maintaining the facilities once construction is cost threshold, however, depends on the accuracy completed. of UC’s design-build estimate. Procurement cost No Timing Advantage of Public-Private estimates are subject to significant uncertainty and Partnership Over Design-Build. UC indicates that can over- or underestimate the project’s true cost. both a design-build approach and a public-private If UC has overestimated the cost of design-build, partnership could deliver the project by 2020. In it may not realize any projected savings under a contrast, UC estimates a design-bid-build approach public-private partnership. would complete the project by 2024. Though its Public-Private Partnership Creates Risk of own analysis indicates no advantage in delivery Legal Disputes. Though UC asserts that a public- time over a design-build approach, UC identifies private partnership would transfer risks associated a faster time to delivery over a design-bid-build with the construction and operations of a facility approach as one of the strengths of a public-private onto the private partner, the partner most likely partnership. will factor these risks into its bid. As public- Savings From Public-Private Partnership private partnerships tend to entail complex legal Uncertain. UC asserts that a private partner could contracts, with each side attempting to minimize develop innovative construction and maintenance risk, disputes are common. For this project, future practices that would produce long-term savings disputes between UC and the partner over the relative to a design-bid-build or design-build terms of the contract could be numerous and procurement method. Although these savings serious. For instance, UC could experience costly are plausible, estimating costs associated with a disputes with the partner if the contract fails to public-private partnership are highly uncertain address an unforeseen issue or lacks clarity on a because the state has entered into only a few specific performance metric. Such disputes have partnerships and evidence from other states is occurred in other public-private partnership limited. In one regard, a public-private partnership projects in California and created increased costs almost certainly will cost more than the other for the state agencies involved in the disputes. procurement methods. Specifically, the partner Public-Private Partnership Could Improve will face higher interest rates than UC when Maintenance. Under the proposal, UC would issuing debt, thereby increasing financing costs be contractually obligated to provide ongoing for the project. In our view, UC has not been able payments to the partner to maintain the project’s to provide sufficient evidence that construction facilities. The contract also would require the and maintenance costs would be low enough partner to maintain a reserve account to ensure www.lao.ca.gov Legislative Analyst’s Office 9 2016-17 BUDGET that funding is available for scheduled facility prevent the campus from accumulating a large renewal. A stable budget for maintenance could deferred maintenance backlog. CONCLUSION As with most complex proposals, the As the time allotted to the Legislature for its review Legislature faces several major issues as it assesses is so short under the new capital outlay review the merits of UC’s proposal to expand the Merced process, we encourage the Legislature to begin campus. As conveyed throughout this report, each its review immediately. The views the Legislature of the issues raised is multifaceted, and the issues shares with the administration about the proposal tend not to lend themselves to quick and clear could have far-reaching implications for the state answers. Given this complexity, the Legislature and UC for years to come. likely will want to sift through each issue carefully. 10 Legislative Analyst’s Office www.lao.ca.gov 2016-17 BUDGET www.lao.ca.gov Legislative Analyst’s Office 11 2016-17 BUDGET LAO Publications This brief was prepared by Jason Constantouros, with assistance from Helen Kerstein, and reviewed by Paul Golaszewski. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This brief and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 12 Legislative Analyst’s Office www.lao.ca.gov