by Joe Sullivan
It's very clear that a headquarters hotel is needed to keep Knoxville's new convention center from languishing. By all reports, many of the meeting planners who make convention bookings won't even consider Knoxville until a 400-room hotel is in the works that's both adjacent and complementary to the $162 million, state-of-the-art convention facility.
There's also little doubt that a new, amenity-laden hotel will do a lot more to spur convention activity than the renovation and enlargement of an existing hotel. The convention center's general manager, Bill Overfelt, has said that only a new, closely connected hotel will maximize the facility's potential and minimize operating losses that are expected to amount to $2.7 million in the current fiscal year.
Recent experience in many other cities also stands for the proposition that new convention hotels don't get built without substantial governmental assistance. So the question becomes how big a financial commitment to a new hotel should the city be prepared to make in order to optimize its huge convention center investment. At the same time, the city needs to weigh the impact of a new publicly backed hotel on downtown's four privately owned hotels, whose viability is also important to the city's economy.
In shaping his recommendations to proceed with a new hotel, the city's hotel consultant, Donald Hunter, presumed that the city assumption of the cost of the site and a garage would be sufficient to enable prospective developers to obtain private financing for the hotel itself. The cost of the desired site just across Henley Street from the convention hotel has been estimated at $4 million and the cost of a garage at $15 million. That adds up to a total city commitment on the order of $20 million, which might be pushed slightly higher by erection of an enclosed connector over Henley between the two facilities.
The city's Industrial Development Board has been charged with selecting a developer on a basis that would make the IDB itself the owner of the new hotel. The reason for putting a public entity in this position is to permit the hotel to be financed with tax-exempt bonds at much lower interest expense than on the taxable bonds a private hotel owner would have to issue. In its request for proposals from developers, however, the IDB stipulated that, "the city of Knoxville does not expect to pledge tax revenues or provide debt guarantees for the financing of this project." In other words, the bonds would be backed solely by the hotel's revenues.
In response to the RFP, the IDB last week heard presentations from three impressive development teams that envisioned exactly the kind of sparkling new, top-flight hotel the city covets. The cost of the hotels they proposed ranged from $60 million to $72 million and differed architecturally and in other ways. But the proposals all had one thing in common: They presumed that in order to obtain financing the city would have to guarantee a significant part of the debt incurred.
The amount of these annual debt-service guarantees ranged from $1.3 million to $2.2 million, depending ultimately on negotiations between the developers' investment bankers and prospective bond investors. All three proposals stressed that the city wouldn't be called upon to make any payments under its guarantee unless the hotel's operations fell far short of projections made by Hunter on which the developers have relied. In simplest form, Hunter's projections assume that the new hotel would achieve and sustain a 70 percent occupancy rate by its fourth year of operation at an average room rate of $115.
The developers also painted a rosy picture of returns to the city from its ownership of the hotel (through the IDB) based on these projections. One of them, Lawler Wood of Knoxville, foresaw the city realizing $30 million in "excess cash" from the hotel's operations over the 30-year life of the bonds financing it and ending up with full ownership of a hotel worth $90 million once the bonds are paid off. Another, Garfield Traub of Dallas, projected an even larger payoff to the city. As that firm's Ken Garfield put it, instead of letting a private owner reap the hotel's profits, "We say make it an investment for the citizens.... The city can use the surplus funds coming from it to reinvest in the hotel, retire the debt early or any other public purpose."
In addition to the three proposals for new hotels, the IDB also received two proposals to meet the stated need for a 400-room headquarters hotel through expansion of existing downtown hotels.
The Holiday Inn Select presented plans for a $20 million, 110-room addition to its present 293 rooms through acquisition and renovation of the state office building that adjoins it. But its presentation paled by comparison with those made by the high-powered teams representing each of the would-be new hotel developers. Not even the Holiday Inn's illustrious but controversial owner Franklin Haney showed up, and his son Frank Haney struggled with a number of questions posed by IDB board members. When asked about the availability of the state office building, he responded that he hadn't spoken to state officials about that in three years. Nor could he relate the $1.1 million in tax abatements that the Holiday Inn is seeking to requirements for financing the 110-room addition. And it was left less than clear whether the hotel would be upgraded to a Crowne Plaza, which connotes a more upscale identity desired for a headquarters hotel.
Plans for a $16 million, 100-room addition to the 317-room downtown Hilton were presented by a team consisting of Atlanta-based Portman Properties and the Hilton's Seattle-based owner. The addition was billed as phase one of a two-phase project in which a 300-room new hotel would subsequently be built as part of a mixed-use development on the site preferred by the city for a new hotel. But the timing and financing requirements for phase two were left vague. To finance phase one, a $10 million city contribution would be needed, but the presentation was also vague about what form this public contribution to a privately owned hotel might take. "We didn't want to come here and say write us a $10 million check. That's why we presented a number of options," said a Portman representative, A.J. Robinson.
One thing the Portman representatives were very clear on, though, is that a new 400-room hotel is more than the Knoxville market can support at present. "A new 400 room hotel would set in motion a vicious cycle vis a vis other downtown hotels," said Robinson. His colleague, Andy Dyer, cited a recently completed study by a hotel consulting firm, HVS, projecting that occupancy rates in these hotels would drop from 65 percent this year to barely over 50 percent in the three years following completion of the new one. The study, which was sponsored by all four existing downtown hotels (the Hilton, the Holiday Inn, the Marriott and the Radisson), concludes that at these projected occupancy levels at least one of them will fail.
The study is diametrically opposed to the assessment of the city's hotel consultant. In his feasibility study, Hunter concludes that, "The experience of other cities shows that a rising tide does indeed lift all boats—existing hotels are immediate beneficiaries of new business generated by new convention centers and their new headquarters hotels."
On Sept. 2, the IDB is scheduled to make its selection from among the five proposals. The IDB's chairman, Alex Fischer, says its role is "to weigh the proposal that we best think will help leverage the public investment in the convention center to the best advantage of the city of Knoxville." While Fischer won't say so, it's a safe bet the IDB is going to pick one of the three developers proposing to build a new hotel.
That selection, however, is only the beginning of what's expected to be a lengthy process of negotiating all of the terms of a complex hotel deal. Assuming the IDB and the developer reach agreement, the deal would then be subject to approval by the mayor and City Council. Because of the expected length of the negotiating process, that means the new mayor and the Council with four newly elected members who will take office in December.
Given the scope of the commitment on the city's part and all of the controversy that surrounds it, the mayor and Council are going to need a much better framework for decision-making than now exists. Among the issues that need to be evaluated are: (1) the validity of Hunter's revenue assumptions on which developers based their proposals; (2) the risks and rewards of city ownership of a new hotel whose debt is partially guaranteed by taxpayers; (3) whether such a guarantee is truly needed in order to obtain hotel financing; and (4) the disparity between the effect on existing downtown hotels claimed by their consultant and those foreseen by Hunter.
Such assessments need to be made at arm's length by a third party devoid of any vested interest in the outcome. One firm with strong credentials for this role is PKF, a leading hotel consultant that has done studies for the city in the past. PKF's credibility is enhanced by the fact that it concluded in a 1999 study that an additional downtown hotel wasn't feasible at that time, which wasn't what convention center boosters wanted to hear. But that PKF study went on to say that sufficient demand to justify a new hotel could occur by 2005.
City Council can contribute to the decision-making process by commissioning a new feasibility study at this time—a study that would focus on the development proposal selected by the IDB and be completed by the time the IDB makes its final recommendations to the city. At the same time, Council should be prepared to further the process by funding other assessments that are needed. These include soil borings and engineering and environmental analysis of the proposed new hotel site as well as a determination that it can be acquired by the city at a reasonable price.
For my own part, I hope that the IDB's negotiations and the city's own assessment lead to a conclusion that supports public investment in a new hotel. Knoxville has a big stake in the success of its new convention center in terms of economic benefits to the community as a whole. Investing in a top-flight new hotel seems much better calculated to realize those benefits than subsidizing the expansion of older hotels that are less well built or less well located.
August 21, 2003 * Vol. 13, No. 34
© 2003 Metro Pulse
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