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Weekly UpdatesEditor's note: In February 2002, Government Finance Review published an article entitled "Tax-Exempt Hotel Financing: A Primer for Finance Officers. This article presents a different perspective on this issue.
In recent years, a number of cities have directly financed the development of hotels intended to serve local convention centers. Many other cities are now in various stages of planning and constructing such facilities, including Baltimore, Columbia (South Carolina), Dallas, Denver, Osceola County (Florida), Phoenix. Portland, Raleigh, San Antonio, Syracuse, and Washington, D.C. These public hotel developments have moved beyond the historic public-private partnership or subsidy arrangements to direct public ownership, most commonly through a nonprofit corporation. They have been promoted with the assumption that an adjacent headquarters hotel is a virtual necessity for attracting expanded convention activity.
Public convention hotels have now been open for some time in Sacramento, Myrtle Beach, St. Louis, and Overland Park, Kansas. The experiences of these cities to date offer some preliminary yet instructive lessons on the risks involved in public hotel development. The actual performance of these hotels, and that of the convention centers they were designed to boost, can also provide a more realistic basis for assessing the consultant feasibility and market studies typically supporting their tax-exempt bond issues.
THE LOGIC OF HEADQUARTERS HOTEL DEVELOPHENT
Convention centers have become an increasingly common and presumably economically attractive local public investment. The total exhibit space in U.S. exhibit venues has increased from 40.4 million square feet in 1990 to 60.9 million in 2003, with annual state and local construction spending on convention centers totaling about $2 billion. As cities have developed new exhibit space, the competition for events has grown increasingly sharp. Industry consultants now commonly argue that an adjacent, full-service hotel is a vital necessity for sustaining and enhancing the competitive position of a convention facility.
With private investors unwilling or unable to provide the necessary financing, even with public incentives, many communities have turned to tax-exempt bond financing through a corporate entity or city department. These bond offerings have often taken the form of triple-tiered debt, secured with some combination of the hotel's direct operating income and the local government's taxing authority. Public commitment has taken the form of a pledge of citywide occupancy tax revenues (Overland Park and Houston), direct city appropriation (Omaha and Myrtle Beach), and incremental tax revenues from the hotel itself (Houston and St. Louis). In some cases, revenues from an adjacent garage have been used to supplement the revenues of the hotel (Austin and Sacramento).
The central justification for public investment in a headquarters hotel is the potential economic stimulus from a substantially increased volume of out-of-town convention attendees. The incremental convention business from the hotel also provides a revenue foundation for the hotel itself. For example, the bond offering statement for the Myrtle Beach Radisson Hotel noted that the Myrtle Beach Convention Center had generated 161,645 hotel room nights of activity in 2000 and an estimated 168,000 for 2001, with a potential future maximum of approximately 250,000. The 80,000-plus additional room nights would provide an occupancy base for the hotel, such that the market consultant could project a 65 percent occupancy rate for fiscal 2004 at an average room rate of $125.83, generating net operating income of $6.06 million.
In Sacramento, a 1996 study concluded that the city had lost some 50,000 annual hotel room nights for lack of a convenient and sufficiently large first-class hotel. The study went on to predict that with a large hotel, the convention center's room night generation in fiscal 2005 would increase from 146,404 to 206,736. A 1999 consultant study predicted that the 500-room Sacramento Sheraton hotel would help boost group meeting activity by more than 100,000 annual room nights in 2004. According to projections, the hotel could expect a 70 percent occupancy rate in 2002 at an average room rate of $136.00, generating net operating income of more than $6.6 million.
The promise of the publicly financed headquarters hotel is twofold. First, the hotel represents a reasonable public investment offering the prospect of residual cash flows with relatively little downside risk because of the low cost of tax-exempt borrowing. Second, the new
hotel will boost attendance at the convention center and thus create an even greater public benefit in the form of economic impact and tax generation.
CONVENTION CENTER AND HOTEL PERFORMANCE RESULTS
Much of the public financing of headquarters hotels took place in 2000 and 2001, although new bond issues in Omaha and Denver occurred in 2002 and 2003. The economic downturn of 2001 and the terrorist attacks of September 11 have obviously had a marked impact on the travel and hospitality industries, driving down hotel occupancy over the last three years. Unprecedented as these events have been, they do provide an opportunity to assess a "worst case" environment for hotel and convention center performance. The current market environment also constitutes the base from which any new headquarters hotel project will have to develop.
Sacramento. The City of Sacramento completed a $92.8 million bond sale in April 1999 for the new 500-room Sacramento Grand Sheraton. The bonds are backed by net operating income from both the hotel and an adjacent garage. The Sheraton opened in April 2001 with the promise that it would significantly boost the city's presence in the segment of the national convention market requiring 1,000 or more hotel rooms on peak nights. To promote the convention center in this market segment, the Sacramento Convention and Visitors Bureau provides free meeting rooms to organizers of such events. One initial consultant study estimated that the addition of a hotel would boost convention center business by some 60,000 annual room nights. The study accompanying the bond offering estimated that the Sheraton overall would generate some 125,500 annual room nights, including about 68,500 from the group market.
Prior to the opening of the Sheraton, the Sacramento Convention Center reported confirmed bookings of 86,980 room nights for fiscal 2000 and 82,609 for fiscal 2001. After the hotel opened, bookings rose to 103,584 for fiscal 2002 and 99,686 for fiscal 2003. The combined impact of the reduced space costs and the new Sheraton is somewhere between 15,000 and 20,000 annual room nights. While this growth in convention activity in the current environment is notable, the incremental impact is far less than the 60,000-plus room nights projected.
The Sheraton has consistently performed below the levels forecast by the consultant. The hotel had a 2003 occupancy rate of 73.6 percent at an average daily rate of $119.82 (compared to projections of 72 percent and $140.00), which resulted in net operating income (before debt service) of $6.3 million--$986,000 less than projected. The Sheraton only succeeded to the extent that it did by virtue of a relatively robust local hotel market and by focusing on leisure travelers and adding low-rate airline contract business with United and Mexicana. The hotel's impact on the city's convention center business has been much lower than projected.
Finally, the Sheraton's opening had an adverse impact on room rates at the other downtown hotels. The Hyatt Regency, for example, saw its average daily rate drop from $145 in 2001 to $126.50 in 2002 and $127.11 in 2003. The other four competitive downtown hotels also dropped their rates. The Sheraton gained business only at the expense of the other downtown hotels.
Myrtle Beach, The 404-room Myrtle Beach Radisson was developed with $64.3 million in revenue bonds issued by the South Carolina Jobs-Economic Development Authority. The $40.8 million senior bonds were backed solely by hotel revenues, while the $23.5 million junior lien revenue bonds carried both bond insurance and a city annual appropriation pledge. The City of Myrtle Beach committed to the hotel in part based on a 1996 consultant assessment that the absence of an adjacent hotel hindered the marketing of the convention center, and that an adjacent hotel would boost performance.
The bond offering noted that the "maximum potential hotel room nights that could be generated annually by the existing center" amounted to 250,000, much higher than the 161,645 generated in 2000. A subsequent study in February 2001 contended that the addition of the hotel provided "an exceptional opportunity to capture highly coveted (and profitable) conventions that bring in a block of 300-plus room nights of business on peak event days." The study concluded that additional hotel demand would amount to more than 120,000 annual room nights by 2003, providing a 65 percent occupancy rate for the new Radisson at an average room rate of $125.83 and generating net income of $6.06 million.
The new Radisson opened in January 2003. Within a few months, it became obvious that the Radisson was failing to meet the occupancy and revenue projections of the 2001 consultant study. By November, hotel management was forecasting occupancy of 46.6 percent (rather than 65 percent) and an operating loss of $1.2 million for the fiscal year that ended in March 2004. The actual fiscal 2004 operating loss (before debt service) came to $1.75 million.
Faced with the need to meet debt service requirements, the city defaulted on the bonds in April 2004, paying off bondholders at a 2 percent premium. Myrtle Beach then sold a new $45.5 million issue backed by a pledge of both the city's hotel, meals, and admissions tax and a backup of general revenues. The hotel has also sharply lowered its room rates and shifted its marketing strategy in an attempt to appeal to leisure travelers and in-house groups.
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