By Michael A. Stein and J. Kevin Lawler - Miami, Fall 1995
Public sector support for hospitality development has been episodic and erratic in the United States and elsewhere in the world as economic development policies have shifted. When government has commonly stepped in, support has focused on the development of key hotel properties deemed essential to stimulate business travel and tourism, and create new jobs. Formal public/private alliances in these cases have often opened the door to lower-cost financing of hotel development, as well as a host of other incentives to stimulate private investment.
Public entities have at their disposal a wide array of programs and financial vehicles that can assist in making a hotel project feasible and thus contribute to an area’s overall economic well-being. The potential to access lower-cost financing, tap redevelopment incentives, structure favorable land lease terms, secure site improvements and other alternatives should not be overlooked by hotel developers when development projects have a clear link to public interests.
Convention Centers Expanding
Public financing of private hotel investment is not new in the United States. The Small Business Administration (SBA), for example, has financed the development of smaller hotels since the mid 1950s. In the past four years, loans provided by the SBA for hotels were approximately three percent of total SBA loans, and the average size was $560,000.
Most commonly, however, public financing and other incentives to promote hospitality investment in the United States have arisen at the local level in development of convention headquarters hotels, which are essential to the success of these large meeting and trade show facilities. Conventions are big business in the United States with more than 800,000 national meetings held annually, much of that market dominated by corporate bookings. Collectively, these conventions attracted some 55 million attendees in 1993.
The more than 500 public and private convention and meeting centers in the United States, in fact, typically form a linchpin in the economic development strategies of local and regional governments. Convention center development and expansion have been components of local economic development strategies since the mid-1980s and continue to rise. Three new centers opened in the last 18 months at locations in Charlotte, North Carolina; Mobile, Alabama; and outside Washington, D.C. And a 1994 Tradeshow Week survey indicated that more than 60 percent of U.S. convention centers were considering expansion -- versus only 31 percent in 1993. Planned expansions of exhibition space in convention centers are expected to generate 58.8 million square feet as of 1994, climbing to 64 million by 1999.
The interdependent economics of convention centers and the hotels that serve them create opportunities for public/private partnerships of benefit to government entities and private investors. The evolution of public/private partnerships to support development of convention headquarters hotels, as a result, offer an excellent foundation for examining how public sector financing and other incentives can support private hotel investment.
Most cities require a convention headquarters hotel to market their convention center successfully. Yet many mid- to upper-tier cities often lack sufficient hotel inventory that can be specifically committed to this purpose. Conversely, room nights generated from a convention center are often insufficient to exclusively support a convention headquarters hotel serving the meetings and trade shows so important to local economies. Further complicating the problem, convention headquarters hotels often incur higher than typical development costs due to the amount and quality of public areas required. The result -- a need for public/private partnerships to support the economic feasibility of a convention headquarters hotel. This hotel, in turn, will support the public investment made in a convention center, as well as generating other local economic benefits.
These public/private partnerships have therefore become increasingly critical as convention center facilities have proliferated in the United States. They also evidence the range of options available to the public sector to support private hotel development. While these types of incentives most often may be used to support convention hotels, they may also be important tools for other types of hotel projects in which there is a strong relationship between public interests and private investment.
Convention Hotel Economics
Nearly 65 percent of U.S. convention centers are owned by cities, counties, states or other types of government authorities. Major convention cities, such as New York or Las Vegas, generally have had sufficient hotel supply in appropriate locations to support the needs generated by meeting and trade show participants. For many other municipalities, however, new hotel development can be critical to competing for the middle- to upper-tier convention market. Convention facilities in these cities may be located in areas peripheral to hotel concentrations. In addition, existing hotel operators are often reluctant to commit the room inventory required to serve convention delegates -- typically offered in package deals at lower room rates -- while simultaneously reducing rooms available to serve guests that make up their core business.
The basic economics in hotel development and operations pose additional challenges. Convention-oriented hotels are typically 10 to 20 percent more expensive to develop than a comparable size, group-oriented hotel. At the same time, room rates for a convention hotel’s core market segment may run 20 to 30 percent below comparable business hotels due to discount package deals negotiated for delegates as part of convention attendance.
To remain successful, a convention center must attract annual national bookings in the range of 25 to 30 events that have a minimum of 2,500 participants each. These bookings, however, on average support occupancies of only 30 to 35 percent in terms of total room nights. As a result of these factors, convention center hotel properties must either achieve higher average occupancies, develop other sources of business or realize higher room rates attributable to non-convention guests to succeed.
Convention hotels can often attract alternative sources of revenue, including sponsoring convention and meeting trade separate from a convention center. Sources of business may include smaller group business, commercial activity, and wholesale and tour operator business. Nevertheless, the hotel is in most cases fundamentally dependent on the convention center for its core business. To entice new development, local government entities must often work jointly with hotel developers to overcome the obstacles that tend to make these hotels more costly to develop and less profitable to operate.
These issues raise critical questions. What tools can government bring to bear to attract private hotel investment by improving their economics? How can a hotel developer work with local governments to close the economics gap and make development feasible?
Initiatives prior to the 1986 Tax Reform Act pointed the way to creative forms of public/private partnerships serving the interests of convention centers and their headquarters hotels. The City of Miami, for example, provided an array of incentives to attract hotel development in support of the James I. Knight Center. The city acquired land, provided a 45-year lease with attractive terms and furnished off-site improvements, as well as site utilities. The hotel additionally was awarded the food & beverage concession for the convention center, and real estate property taxes were abated during construction.
The incentives provided by the City of Toledo at Seagate Center is another case in point. A $7.4 million Urban Development Action Grant was loaned to the developer through the Convention Bureau at attractive rates and terms. Tax increment financing was used to support public improvements, while real estate taxes were abated. In addition, the hotel was supplied with convention center-owned parking at prevailing market rates.
More recent public/private partnership successes include the Westin Hotel venture in Providence, Rhode Island, which involved a $290 million bond issue, that covered the convention center, hotel and parking. A Sheraton Hotel at the Jefferson Center in Birmingham, Alabama, involved a $148 million low-interest bond offering, guaranteed by JCA and supported by city and county occupational taxes.
Not all public/private partnerships come together, despite concerted efforts on the part of both private developers and public entities. In Tampa, studies indicated a strong need for a convention hotel to support the city’s new convention center. A city commission approved a proposed 900-room Marriott hotel, estimated to cost more than $140 million or more, and to be owned by a private ‘not for profit’ corporation. Public financing for the hotel, however, was rejected by the Tampa City Council last year. A special task force spent six months analyzing two options and is presently formulating recommendations.
The dilemma faced in Los Angeles also is a case in point. A major expansion of the Los Angeles Convention Center was completed late last year, increasing total meeting space to more than 600,000 square feet. Historically, however, the center has hosted only about 20 conventions annually, and competition from other Western cities -- including San Francisco, San Diego, Anaheim, Long Beach, Seattle, Portland and Las Vegas -- has become more intense. The Los Angeles
Convention and Visitors Bureau has contended that a convention hotel within walking distance is required to make the city more competitive for attracting large conventions. Yet the downtown Los Angeles hotel market has been weak since the onset of the recession early in this decade, a condition which has been further exacerbated by the Los Angeles riots in 1992 and the Northridge earthquake last year. Downtown’s primary convention hotels, all located within seven blocks of the convention center, collectively posted occupancies in the mid-50 percent range last year (up more than six occupancy points from one of the worst years in recorded history) with projected occupancies edging toward 60 percent this year. Thus far, it has been concluded that a major new convention hotel is not economically feasible, even with generous public incentives.
Public and Private Contributions
These initiatives demonstrate the range of strategies available to the private sector to attract private hotel investment -- as well as the pitfalls that can create obstacles. At their best, these partnerships make it possible to reduce hotel development costs, set the stage for more profitable hotel operations, and allow a government jurisdiction to safeguard public investment and achieve local economic development goals.
Generally, public contributions that can drive development of a hotel may include land at favorable lease terms, off-street parking facilities, construction/use rights of public space and marketing support. Hotel developers may also be granted the convention center’s food and beverage service concession. This ancillary revenue can be an important step to offset the lower room rates often associated with delegate business. Among the contributions made by the hotel developer are equity funding, the track record of team members, a superior product development plan, and strong management and marketing.
In addition, the public and private entities must have controls in place to ensure that relationship objectives are maintained. A convention headquarters hotel, for example, must commit room nights to the convention center, even at the cost of displacing higher rated business. Conversely, the convention center must book events, which generate room nights, perhaps foregoing higher revenue-generating consumer shows that tend to be oriented to a local audience.
A range of successful private/public techniques are available to further these partnerships:
Land values in urban or resort environments are generally very high with these costs typically representing a significant component of hotel development. Government participation is often essential, either by writing down the market value of a property or purchasing a property to lease to a hotel owner on a long-term basis at an economic cost.
Miami Beach's experience is instructive. The city in 1992 expanded its existing convention center located near City Hall, a location remote from Miami Beach’s highly developed existing hotels. No new major hotels have been developed in 27 years. Studies commissioned by the city addressed several pivotal issues. It was determined that none of the existing hotels -- clustered primarily at some distance along the coastline-- would or could continuously sell room nights to major national conventions that desire to book the city’s convention center. Additionally, major hotel developers would be unlikely to develop a new hotel away from the beach area without significant incentives. Arthur Andersen was asked to advise the city on incentive parameters required to entice developers and financial institutions in the development and financing of the 800-room hotel. Among the most important of the incentives was site control.
Arthur Andersen advisors concluded that the city’s purchase of the site adjacent or proximate to the convention center was essential. It was further determined that the hotel site should have ocean-front exposure. After analysis of three potential locations, the city purchased an ocean-front site at a cost of $24 million. The site is five blocks from the city’s convention center.
In the past five years, new full-service hotels have been extremely difficult to finance. Convention hotels, furthermore, are generally regarded as being of even higher risk -- a result of the uncertainty related to occupancies and above-average development costs. As a result, public financing can be the key element in making a convention center hotel feasible.
Again, a number of options are available to the public sector. While tax- exempt public bond issues are subject to 'private purpose' limitations, there are techniques which can blend in public funding to privately owned and operated hotel ventures. These include financing and leasing back the 'public' areas of a hotel ( or a parking, etc.) facility. Public revenues from hotel taxes or real property taxes may be designated for the facility through non-tax exempt issues. In addition, cities, counties and other government entities may offer certain operating guarantees, such as payment of debt service, for a specified period of time. Miami Beach, for example, agreed to issue $52 million in bonds as its share of land and construction of the $158 million convention hotel. The hotel developer -- St. Moritz, a joint venture of Forest City and the Loews Corporation -- will contribute $15 million in equity, with the balance financed with conventional debt.
In some cases cities have made equity investments in convention hotels. The municipality may become the junior equity partner in the hotel with 'first-in' risk capital, and 'last-out' return. In a broad policy sense, the city's rate of return is potentially greatly enhanced by an improved local economy, higher visitation and associated tax revenues.
Bond financing, and public ownership of the asset, for example, is a cornerstone of the financing structure for a new convention center hotel at McCormick Place, the final phase of its exposition center. The Metropolitan Pier and Exposition Authority, which controls McCormick Place, announced in March of this year that it plans to raise $110 million through a bond issue for the development of a new hotel adjacent to the center. The Authority will own the hotel, which is to have a minimum of 400 rooms and likely more. A third party will be selected to operate the property.
Other Public Incentives
Local governments also have incentive options that will have significant impact on the economies of building a convention headquarters hotel. These include incorporating public spaces and amenities, such as joint parking or meeting facilities to reduce the overall cost of the convention hotel. Municipalities may also provide property tax abatements, as well as redevelopment zone benefits such as expedited permitting and access to other public funding sources.
Structuring the Deal
From a development and operational standpoint, there are a number of challenges facing hotel companies as they consider convention headquarters hotels. In addition, many deals have failed because a city has insufficient resources to close a transaction, or lacks an understanding of the resources it can bring to bear in support of these developments. What is fundamentally at stake is shifting a portion of the risk from the developer to public entities, since the public jurisdiction stands to benefit economically if the hotel is a success.
More than a standard Request for Proposal (RFP) to attract a quality developer is often needed. The public sector must understand what types of incentives it has available to drive a project -- and the best way to frame the RFP process. And it will clearly require specialized expertise to ensure that financial incentive structures make the most of available opportunities and that the expectations are realistic.
In setting parameters for competitive bidding on these projects, municipalities or other public jurisdictions need to be specific about certain factors, such as the hotel size, design, quality of facilities and amenities, and management. But rather than defining the competition in a rigid envelope, it is more important to ensure that respondents customize a proposal that meets the city's criteria and defined needs, and includes financial structures crafted to match the public resources available. Clearly defined procedures for evaluation of proposals are also crucial.
Hotel development can generate a significant stream of economic benefits for a community including support for a tourism industry, job creation and an expanded tax base. Public incentives to support private hotel investment, as a result, can become a decisive component required to assure that public economic development goals are achieved.
Michael A. Stein is a partner in Arthur Andersen's Hospitality Consulting and Real Estate Advisory Services practice. J. Kevin Lawler is a partner in the firm 's Real Estate Advisory Services practice. Both are based in the Miami office.
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