Hotel Development Issues for Municipalities Evaluating Hotel Projects

Hotel Development Issues For Municipalities Evaluating Hotel Projects

Hotel Development Issues For MunicipalitiesEvaluating Hotel Projects

• Despite limited capital market activity for existing assets with current cash flow, construction financing is quite “tight” if not non-existent in certain markets.

• When and if available, Loan-to-Cost ratios for construction loans are in the 65%+ range.

• Requirements for equity of 30%+ will continue to create significant pressures on yield; particularly on larger projects.

Trends In Debt & Equity …

• Treat the development opportunity like a potential “transaction” and not a report writing “consulting” engagement.

• Determine the most marketable, optimum capital structure that:

• Highest certainty of execution;

• Requires the least, if any, subsidy;

• Provides the greatest control;

• Greatest certainty of completion.

In Savannah, In Order To Move Forward, Success Demands…

• Determine the development model that ”makes sense”.

• Determine the players that have experience under the “optimum” capital structure and development model.

• Negotiate the contribution of qualified participants for a “team”.

• Determine timeline and activities to get to a closing table.

• Develop “awareness” campaign for internal and external constituencies.

In Order To Move Forward, Success Demands…

In Order To Move Forward, Success Demands…

Retain a Transaction Advisor who knows how to work, on behalf of and as an integral member of the Project Team, with the parties in interest to a potential transaction:

Authority ArchitectUnderwriter Convention & Visitors BureauCity Bond CounselRating Agencies Hotel ManagerDisclosure Counsel Underwriters’ CounselCounsel to the Authority Counsel to the CityHospitality Consultant Engineering FirmMarket Consultant Program ManagerTrustee Surety Bond Provider

Issues In the Sponsorship of

Hotel Development

Headquarter Hotel Market Fundamentals

• Room Revenue Per Available Room (“RevPAR”) generated by new downtown, convention-oriented hotels continues to not support the rate of return required by private equity investors.

• Construction costs increases for double loaded, vertical urban development are equal to or in excess of RevPAR gains.

• Some form of incentive/subsidy/grant/conveyance is required to make the vast majority of deals work.

If Credit Support is Provided To Private Hotel Developers, How Are Objectives Determined?

• How do you define how much, which types of support, to what projects? What is reasonable?

• How do you define a “successful” investment? Occupancy? Developer Profit? What is the metric used?

• How does an investment impact the City’s ability to contribute to other municipally sponsored deals?

• Investor-developer goal in securing “incentives/subsidies” is to close a financing “gap”. What is this financing “gap”?

• The “gap” is: (Equity Yield Developer Requires) minus (Equity Yield Project Can Support).

Credit and/or Direct Support is Needed to Make TheTraditional Private Development Model Work

Example: Investors require a 22% return on investment. Hotel Pro forma forecasts yield of only 15%. The “gap” is the dollar amount represented by the difference between 22% and 15%.

• Contribution of land.

• Infrastructure development.

• Hotel occupancy tax abatements.

• Parking facilities.

• Contribution of hotel meeting/public space.

• Direct subsidy payments (cash and/or loans).

• On-site sales, property and other tax abatements.

Closing the “Gap”When development costs exceed levels that can be supported by a investment return, municipalities have traditionally provided substantial subsidies. These have typically included:

What are the

Advantages & Disadvantages

in a Traditional Public/Private Deal?

Advantages:

• Beyond zoning, entitlement, permitting, inspection processes, little if any interaction necessary.

• Requested “subsidy”, if properly limited, defines extent of financial participation.

• Development, if constructed/operated as planned, satisfies certain economic development objectives.

Traditional Public/Private Deals…

Disadvantages

• In addition to tax abatements and other concessions, subsidy requests often must take the form of direct payments.

• Rarely can future “subsidy” requests, if truly needed, be limited. This creates the potential for unanticipated, increased financial commitment or project shutdown.

• No sponsoring entity control over the business model: service quality, facility maintenance, potential physical/functional obsolescence.

Traditional Public/Private Deals…

Disadvantages

• No control over use of “room block” for events with room nights requirements.

• No control of public space for community goals.

• No control or benefit over income distribution.

• No control over sale of the asset.

Traditional Public/Private Deals…

A Perspective on Financing

for Public Benefit Corporations and

Not-For-Profit Corporations

AdvantagesLow cost of capital. Probably 10+ percentage points below blended debt/equity cost of private development. This allows:

• greater cash flow for some defined building program;

• expanded spatial programming;

• higher quality level.

What Can Public Benefit and Not-For-Profit Corporations do?

Advantages• No “up-front” cash contributions.

• Recovery of project/transaction related costs through bond proceeds.

• Funding of Debt Service, Reserves, Operating Reserves, Pre-Opening Budgets, Operating Cash.

• 100% funding of all hard and soft development costs.

What Can Public Benefit and Not-For-Profit Corporations Do?

Advantages

• “Pro Forma” performance would result in no call on any requested/required guarantees.

• Cash flows can be structured in such a way that any guarantees, if necessary, can often be delayed for up to 5 years.

• Required Public/Private “subsidies” can be utilized to directly benefit the issuing entity and not private developers.

What Can Public Benefit and Not-For-Profit Corporations Do?

Advantages

• Use of income distributions for any lawful purpose whatsoever.

• Ability to sell the asset, when appropriate, to pay off bonds.

• Ability to eliminate guarantee obligations at the time of sale.

• Control.

What Can Public Benefit and Not-For-Profit Corporations Do?

Disadvantages

• Investors, mono-line insurers and credit rating agencies likely to demand some type of guarantee on annual debt service.

• In the event of substantive, long term market deterioration, annual debt service guarantee remains as long as the asset is owned by issuing entity.

• Should a Guarantor choose to default, insurers pay debt service obligation. However, impact of such an action should be considered.

What Can Public Benefit and Not-For-Profit Corporations Do?

Sacramento, CA Houston, TX Omaha, NESt. Louis, MO Denver, CO San Antonio, TXLombard, IL Erie, PA Vancouver, WASan Diego, CA Baltimore, MD Myrtle Beach, SCOverland Park, KS Trenton, NJ Bay City, MI

How Are Other Cities Moving Forward?

New York, NY Washington, D.C. Indianapolis, IN Broward County, FL Denver, CO Tucson, AZAnaheim, CA Savannah, GA West Palm Beach, FL

What is the Market Telling Us About How a Convention Center Hotel Can Get Done?

Examples of Cities That Have UtilizedProject Revenue Bonds

City Rooms Par (000,000’s) YearBaltimore 756 $301.0 2006Phoenix 1,000 $350.1 2005Erie County 203 $ 45.4 2005Denver 1,100 $354.8 2003Vancouver 226 $ 67.6 2003Omaha 450 $108.9 2002Bay City 202 $ 15.5 2002Austin 800 $265.1 2001St. Louis 1,200 $ 98.0 2001Myrtle Beach 404 $ 64.3 2000

Questions and Answers Questions and Answers