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Provide Opportunities for Hotel Financing
By:
Thomas Hazinski In an increasingly competitive convention market, success in attracting new visitors depends on having hotels proximate to the convention center. Recognizing hotel proximity as an important competitive factor, many cities are pursuing development of quality, full-service hotels adjacent to their convention centers. Over the last five years, most of the headquarters hotel projects that have been completed or that are under construction have used some form of public sector incentives. Minus these incentives, headquarters hotel proposals tend to languish. In Boston, for example, Starwood has been unable to complete the conventional financing of a 1,200-room Sheraton Hotel, which is intended to serve as a headquarters hotel for the new Boston Convention & Exposition Center. Similarly, in the City of Overland Park, Kansas, a 512-room convention center hotel was originally planned to be financed conventionally and without public subsidy. Despite a strong local hotel market, the cost of borrowing and the requirements for substantial returns on equity precluded a conventional financing. But the tax-exempt bond market was available, and the City successfully financed the project by guaranteeing the repayment of debt on municipal bonds. Public sector incentives and funding support for a headquarters hotel can come from a variety of sources: contributions of land, infrastructure, and parking facilities; direct subsidy payments; and contingent pledges of financial support, to name just a few. In particular, tax-exempt bond financing can significantly change the financial calculus of a project’s feasibility. Tax-exempt bond financing and other forms of public support dramatically reduce interest rates and equity requirements. Over the last 18 months, several cities have used tax-exempt bonds to finance new convention center headquarters hotels. Recently financed properties include hotels in Austin, Texas; Overland Park, Kansas; and Myrtle Beach, South Carolina. A privately owned project currently under construction in an empowerment zone in St. Louis was also partially financed by tax-exempt bonds. For many proposals, tax-exempt bonds can provide the majority of the overall financing needs. The important credits and typical financing structures of tax-exempt deals are described in detail in “Tax-Exempt Hotel Financing: A Primer for Finance Officers” in the February 2002 issue of the Government Finance Review, in an article by Tom Hazinski and Mark Laubacher, respectively the Managing Director and a Senior Consultant with HVS Convention, Sports & Entertainment Facilities Consulting. Tax-exempt hotel deals are highly negotiated transactions whose successful completion requires a significant investment of time, focused attention, and experience. Several factors influence an investor’s decision to purchase the bonds for a hotel project, including:
Reviewing these factors will provide a better understanding of the public support needed to successfully finance headquarters hotel developments. The bond financing must be tailored to shield bond investors from various risks inherent in a single-project financing. Even projects with strong rationale and underlying economic forecasts must mitigate construction and operational risks before investors will commit capital at a reasonable interest rate. A variety of alternative structures can mitigate these risks. The essential difference among the financing alternatives is the allocation of risk and reward of the hotel operation. The risk of the hotel’s operating success should be allocated among the government, the hotel operator, and the bond investors. The allocation of risks should be proportionate to each party’s incentives and rewards. In the current economic environment, investors are unwilling to purchase hotel project bonds unless the public sponsor assumes a reasonable share of the risk. By shielding investors from risk, the public sponsor can lower its borrowing cost, which enhances cash flow and the prospects for long-term success. Conclusion Increasingly, local governments are stimulating convention center headquarters hotel development with public incentives, including public ownership of hotels financed with tax-exempt bonds. The financing of hotels using tax-exempt debt gives municipal governments significant advantages over the alternative of providing direct subsidies to privately developed hotels. Lower costs of funds dramatically increases project feasibility. If the hotel performs as expected, the municipality will reap the financial benefits of residual cash flows and eventually receive proceeds from the sale of the hotel. Many hotel operating companies are also keen on tax-exempt deals since they offer the potential for a fixed stream of management fees and an important presence in the local market with a well-positioned headquarters property. Hotel development companies can benefit from participation in municipally financed deals in the form of tax-exempt earnings on high-yield subordinated bonds and development management fees. A well-informed understanding of the means of allocating risk in a tax-exempt bond financing can help municipal owners, hotel operators and private developers to attract investors at reasonable costs and with a prudent amount of commitment to the project.
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Thomas A. Hazinski is the Managing Director of HVS Convention, Sports & Entertainment Facilities Consulting. Hazinski has 16 years of experience in the public policy arena, as a public official and as a consultant. He specializes in providing economic and financial research to public agencies involved in economic development initiatives. Prior to starting his division of HVS International, Hazinski has served as Senior Vice President of C.H. Johnson Consulting, Inc. Hazinski holds a Masters Degree in Public Policy from the Harris School of Public Policy at the University of Chicago, where he specialized in municipal finance.
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