Local in Ann Arbor

A continuation of the series that began with analyzing the Roxbury report on the Valiant proposal.

In reading the Valiant proposal for the Library Lot, one is struck by the huge sums promised to the City and, they add, to the State.  The Appendix B for the proposal states that over 20 years, the project will bring an aggregate total of $113.7 million, with an NPV of $61.6 million.  The use of the NPV term indicates the notion of treating the project like a long-term business operation; it is a method of estimating cash flows and indicating a yield rate.  But, as Wikipedia states, “it does not provide an overall picture of the gain or loss of executing a certain project.”  I’m inclined to agree with Karl Marx in this context, who called it “fictitious capital“.  But that is a discussion well beyond the scope of this blog.  Let’s just look at the aggregate total and the gains attributed to the project.  After all, apart from the perceived need for a conference center, one reason that the City of Ann Arbor supposedly issued this RFP was to make money to support the dwindling city coffers.  One way to do that, apart from outright revenue from sale of property,  would be an increase in the tax base.  And it is indeed mostly taxes that the Valiant proposers use to justify their estimates of yield to the City.

6. Taxes

1. Payroll Tax

Appendix B lays out a number of the assumptions that Valiant’s figures are based on.  One is that they are assuming the creation of new jobs.  These include 260 construction jobs and 187 permanent jobs.  Much of the accrued value to the city and state are based on these.  Oddly, they acknowledge that these will not be highly paid jobs.  The average salary of conference center employees is estimated at $42,188 while the average hotel salary is $19,000.  There are also a few jobs associated with the residential condominiums, mostly maintenance, and those are also very low.  But the payroll taxes from these jobs are a major component of the dollar benefits cited for the project. They list both “direct” (presumably from employment of the project itself) and “indirect” (perhaps from other area business employment?).

Here is the 20-year summary of payroll tax benefits:

So of the total aggregate benefits that Valiant claims over 20 years ($113.7 million), $43,704 million are in the form of payroll taxes.   (The remaining amount is $70, 038 million from all other taxes.)

Skipping over whether their assumptions are valid (numbers of jobs, etc.), there remains the uncomfortable fact that payroll taxes are collected by the Federal government to support Social Security and Medicare.  They are completely irrelevant to City or even to Michigan finances.

2. Sales tax

The majority of that $70 million remaining is evidently as sales tax.  The calculation is not quite broken out, but the elements that are revealed are puzzling. The percentage shown for state sales tax is “5.16%” and then there is a column for city tax at “14% of state sales tax” – so it is calculated at 0.84%.  However, the Michigan sales tax is 6%.  There is a program that was set up to return some portion of that revenue to local units of government.  However, that revenue sharing has been steadily reduced since the new system was introduced in 1998.  The system is supposed to include a constitutional share (required to be paid) and a statutory share to municipalities, as explained in this white paper from the Michigan Municipal League. But the “statutory” share is subject to the whim of the Legislature and has been a favorite source of fixes for our state’s decade-long budget problems.   The formula is complicated, based both on population and and prior amounts received.  It is possible that Valiant’s reference to the city tax % of state tax is alluding to the shared tax formula.  But there are two important points about that (ok, three):

1. The sales tax collected in Ann Arbor will go into a statewide pool, thus will not benefit Ann Arbor directly; and

2. The portion of the state sales tax collections coming to Ann Arbor are likely to decline in any event; but also

3. Don’t forget that the City does not collect any sales tax directly, and is prohibited from doing so by state law.

And yet, given all that, it is clear that not only are a major portion of the “tax benefits” supposedly accruing to the city are sales taxes, but that they are primarily collected from the restaurants and retail businesses that are part of the development.   Those have not been described or even necessarily planned.

3. Accommodations Tax

The Accommodations tax is levied on hotels primarily to support the Convention and Visitor’s Bureau.  As explained in an article by the Ann Arbor Chronicle,  Washtenaw County collects the tax and passes it on to the Bureau.  The rate was increased from 2% of room rents to 5% in 2009, and the County renegotiated its contract with the CVB so that it receives a higher percentage (10%) of the tax as an administrative fee.

The Valiant proposal calls this a “use and occupancy tax” and calculates that about $5.4 million would be subject to the tax in the first year, or about $271,000 in tax collection.  Presumably this is multiplied over the 20-year period (which would be about $5.4 million total) to add to the total benefit calculation.

But this is again irrelevant to the City of Ann Arbor.  All this tax revenue goes to the county and the CVB.

4. Property Tax

So what is left?  Those of us who follow tax and budget issues in the City of Ann Arbor are continually bellyaching about the diminution of our tax base due to encroachment by the University of Michigan, the loss of assessed value because of the recession and housing bust, etc.  We are, of course, talking about property tax.  And one motivation, we are told, in encouraging development is to increase the property tax base.

Ann Arbor actually collects two kinds of property tax.  One is the tax on real property – those of us who own a house are very familiar with that one.  The other is the misnamed “personal property tax“, which is levied only on businesses and is actually a tax on the value of equipment used in the business, including furniture.  So a hotel would obviously have two big tax bills – one on the assessed value of the real property itself and one on the furniture and other equipment used in operation of the hotel and restaurant. But the proposal is mostly silent on the subject of property taxes. Property taxes are not included in the “benefits” summary and it appears clear that the developers do not expect to pay them.  Here are some likely explanations.

a. They are counting on leasing the ground rights. As we explained earlier,  the arrangement would be for a very complicated formula by which a Ground Rent would be calculated on the basis of a Net Operating Income, or NOI.  If the city retained ownership of the ground rights, property tax might not be payable.  (They are also separately selling part of the air rights for condominiums, which would be taxable.)  (Note that “personal property taxes” for a business would still be payable in leased property.)

b. No PILOT either. The original proposal called for a “PILOT” of $250,000 a year.  Though this is not spelled out, it apparently refers to a Payment In Lieu Of Taxes.  This is a common way to pay municipalities some portion of taxes lost because a non-profit enterprise is occupying real estate.  A number of universities have paid them to cities.  Significantly,  a PILOT was involved in a prior project by one of the Valiant partners,  Michael Bailkin,  who was behind a (failed) project, the New York Sports and Convention Center.  In a move similar to that project, Valiant’s proposal called for applying the PILOT to payment of the bonds to finance the conference center (they also mentioned applying “real estate taxes on the hotel/retail – average of $250,000 plus” to the bond repayments, perhaps the same thing.)   However, the revised proposal drops the PILOT.

c. What about the DDA? Since this project is in the DDA district, any property taxes collected would presumably go to the DDA instead of the City of Ann Arbor (because it would be all new construction and therefore subject to the Tax Increment Financing provision).  This could, of course, be corrected through negotiation.  But as a column in the Ann Arbor Chronicle discussed, there is perhaps a thinning of the membrane between the DDA TIF fund and parking fund, and the City has been withdrawing huge sums from the parking fund.  So possibly, even if the property taxes were collected, and even if they did end up with the DDA, the city might benefit from them.  But direct payment to the City’s general fund of any real estate taxes from the project – or even the personal property taxes –  is not a certainty, and is apparently not planned.

So in conclusion, the Valiant partners claim that their development will bring the City over $100 million in taxes over the next 20 years – but none of it is actually payable to the city.

Next – what about those condos?  And other things.

In this (ever-expanding) series, we have been examining all the pieces of the proposal by the Valiant partnership for a development on the Library Lot.  The series began by pointing out that the consultant, Roxbury Group, who were retained by the City of Ann Arbor (but paid by the DDA) to examine the feasibility of the Valiant proposal, failed to do that.  Recall that the original proposal by Valiant is on the city’s RFP page and a revised proposal was presented in a table contained in the Roxbury report (summarized in this post).

5. The Bonds

a. Then and Now

The major change between the original Valiant proposal and the revised proposal was the basis of financing the bonds that are to pay for the conference center.  The original proposal called for the city to issue “Full Faith and Credit” municipal bonds.  This puts the city at risk, should the development fail to produce enough revenue to make the bond payments.  In the revision, the developers assert that their own credit standing will be applied to EDC (Economic Development Corporation) bonds.

Here is the text from the original proposal.  Note the candid admission that the conference center will not be self-supporting. It is also clear that the developers consider the conference center to be at heart the city’s responsibility.

The primary proposition of the Developer is that this project will be built around the most important economic development facility for Ann Arbor, the Conference Center. Since Conference Centers rarely generate enough revenue to cover debt, since they are public purpose facilities, these facilities are usually built with public sector funding. It is clear that a Conference Center of this size and quality cannot be paid for from the hotel/retail component. At the same time, we do not want to have any costs imposed on the City for this Center. Our proposal therefore is to utilize a portion of the tax and other revenue streams that would be generated from the private portion of the project, to cover the costs of the Conference Center. That way the community obtains a most valuable asset, but without any out of pocket costs.

The specific proposal is to have the costs of the Conference Center paid for by proceeds of a Full Faith and Credit… bond, issued by the City or other appropriate issuer. The debt service on this bond would be covered from a number of income streams generated for the City by the private portion of the project.

Here is a summary of the bond financing from the original and revised proposals:

b. The Bond Alternatives

If the city had been persuaded to issue full-faith-and-credit bonds,  its treasury would have been open for the debt payments.  The text from the parking structure bond offer makes it clear:

The City shall be obligated to pay the principal of and interest on the bonds as a first budget obligation on its general funds, including the collection of any ad valorem taxes which the city is authorized to levy…

Notice that phrase, “first budget obligation”?  It means “no excuses”.

However, the revised offer calls for Economic Development Corporation bonds.    As the Roxbury report summarizes, “Valiant has offered to guarantee the amount of financing necessary so that any shortfall is covered by the developer, not the City.”  This made the offer much more attractive to members of the DDA, at least.  As quoted by the Ann Arbor Chronicle, “Leah Gunn added that she thought the most exciting line in The Roxbury Group’s report was that ‘Valiant was able to strengthen the development’s potential for revenue generation, eliminating the need for any publicly-guaranteed debt.’ ”

So what is an Economic Development Corporation bond and how does it work?  Municipal Economic Development Corporations are established under the authority of Michigan Act 338 of 1974. Actually, Washtenaw County has two, the Ann Arbor Economic Development Corporation (established in 1978), and the Washtenaw County Economic Development Corporation (established in 2001).

Here is what the preamble to the Ann Arbor EDC information packet says.  It is a sweet evocation of the Ann Arbor we came to love.

Projects approved by the EDC must, by consensus of its board of directors, be in the public interest; they must provide commercial services where a need for them exists; they must offer permanent employment opportunities to city residents; and/or they must be in keeping with the city’s character and the needs of its residents. Preference is given to enterprises which are non-disruptive of the environment and which add diversity to the jobs pool in the city. Demographic changes in Ann Arbor may, therefore, result in some alteration of these guidelines.

It is the intention of the EDC to retain and attract qualified applicants engaged in (1) research and development activity; (2) providing necessary services; and (3) light manufacturing and assembly. The EDC is not a lending agency; rather, it is an issuer of tax-exempt bonds, under Michigan Public Act 338 of 1974, as amended.

According to a 2009 update, the Ann Arbor EDC has issued bonds at over $125 million par value for many Ann Arbor endeavors, including Glacier Hills upgrades,  Weber’s Inn, the new YMCA, and Greenhills School.  Some of these were evidently a long time in the past, like the notation in the list for “Parke, Davis”.  The EDC makes money from fees associated with the loans and sometimes uses it in making grants.
The Washtenaw County EDC signed a memorandum of understanding for service delivery with the Washtenaw Development Council, which has subsequently become SPARK.  According to a story in the Ann Arbor Chronicle,  the WCEDC met earlier this year for only the second time since 2005.

These bodies can issue tax-exempt bonds (municipal bonds) that are not full-faith-and-credit; the city or county is not encumbered by them.  The bonds are restricted to use for projects, obviously, that have economic development potential, and there is the intent that it should be a benefit to the community, as expressed by the AAEDC’s preamble.  The bonds are not a loan from the municipality; independent financing has to be identified before bonds are issued.  The point is simply that by making the bonds tax-exempt, borrowers can expect a lower cost of financing (i.e., interest), since tax impacts are important to some investors.

c. Where does the money come from?

Recently there was a flurry of activity for EDC bonds across the state because of the 2009 Recovery Act.  As the press release about recovery zone bonds issued by SPARK explains, “Recovery Zone Facility Bonds” were available for private borrowers. The Chronicle story says that the entire county was designated a Recovery Zone by the county Board of Commissioners in 2009, and that the county was allocated just over $33 million for such bonds.  (This was evidently the “renovation zone” money that was mentioned fleetingly in the Valiant proposal.)  Both the Ann Arbor EDC and Washtenaw County EDC would have been able to issue bonds based on this money.  But as Stephen Lange Ranzini recently confirmed in an email, none of these dollars were ultimately loaned out.  He says, “Yes, despite a lot of effort to advertise the program and many meetings with interested parties, no one applied. The program ends 12/31/2010.”  (Note that renewal of the Recovery Act was one of the actions that the US Congress failed to do in this session.)  Ranzini, who is the President and CEO of  University Bank in Ann Arbor, is the outgoing President of the Ann Arbor EDC (but remains on its board) and is also a board member of the WCEDC.

Generally, in the absence of such exterior funding (as the Recovery Act money), the money to finance the EDC bonds must come from a bank, via a mortgage or simply a loan. Ranzini confirmed that in such a case an applicant would have to present an irrevocable letter of credit from a bank in order to be considered for bond issuance.

d. What happens if the debt payments are not made?

If a bank is to loan money to the Valiant partnership with bonds as the repayment mechanism, there must be a clear plan for how bond payments will be made.  The picture is more complicated since the idea is to finance a public facility (the conference center).  Here is what Ranzini said about this:

“Private individuals would need to secure credit from a bank (which would issue the letter of credit backing the bonds). The bank would of course use the public facility and other assets (such as corporate and personal guarantees of the sponsors) to secure their loan. These guarantees might be unsecured or secured but that is up to the bank’s credit committee to decide how much risk the bank is willing to take.”

So in other words, either the Valiant partnership would have to be able to persuade a bank to issue a letter of credit (and remember that an irrevocable letter of credit is absolutely binding) based on their own personal credibility and assets, or – as seems possible – the conference center itself might be required to assume some responsibility if the promised revenue does not materialize.

But look at where that revenue is to come from, according to the assurances of the developers: ground rent (which we indicated in the previous post is very shakily premised on some optimistic projections), sales returns from very expensive condominiums (which have not sold well if at all in Ann Arbor lately), and property taxes from those same condominiums.

If you were a bank, would you sign that letter of credit?  If the city of Ann Arbor assumes the responsibility for financing the conference center, you might yet.

This is the continuation of a discussion of the Valiant partnership’s proposal for a development on the Library Lot. Part A was a consideration of the hotel and the conference center.  In Part B we discussed the issue of parking (availability and cost).  Now we consider another critical financial issue, namely the payment to the city for the land (the Ground Rent) and its effect on other factors in the package.

4. The Ground Rent

a. Calculation of NOI: As we explained in Part A, the Net Operating Income (NOI) for the hotel is based on wildly optimistic assumptions.  As might be supposed, the NOI is calculated by subtracting expenses from revenue.  So for example, in Year 2 (2014) the Total Revenue is $13,753,971, from which expenses and administrative costs are deducted to obtain a Gross Profit of $3,702,862.  After subtraction of management fees, insurance and taxes, we finally arrive at a NOI of $2,627,869, which is about 19% of the gross revenue.  Obviously, if the revenue is below what is projected (as we predict), and assuming that the expenses and fees would remain nearly the same, the NOI could approach zero rapidly.

b. Calculation of Ground Rent :The Ground Rent is the amount that would theoretically be paid to the city for a 75-year lease of the land, or alternatively as an outright purchase of the land.  It is based on the NOI, as plugged into a very complicated formula.  Here’s what the Cost Proposal says:

The (Ground Rent) will be based on the Residual Value of the Land. Residual Value is determined by taking the net operating income in the (3rd) stabilized year, and capitalizing that on a 8% cap rate, and attributing 10% of that finished Project Value to land. Given the NOI of $3,487,837, the Residual Land Value is projected at $4,359,796. …On a Ground Rent basis, developer’s offer is 8% of the Residual Value, or $348,784 per year. This Ground Rent will be increased by 10% every 10 years.

Note that if NOI in that third year (which was based on a hotel revenue of over $15 million) is below the (very optimistically) projected amount, the Ground Rent is also cut.  If the NOI (revenue minus expenses) approaches zero, so might the Ground Rent.  It is not clear from the proposal whether they would feel contractually obligated to pay the Ground Rent if future years’ NOI is less than projected.

UPDATED: Here is an effort to illustrate how vulnerable the NOI is to overly optimistic assumptions about hotel occupancy and ADR (average daily rate).  The figures in the first two rows are directly from the Valiant pro forma.

In the third row, an attempt has been made to estimate the effects of a more likely scenario, with an ADR 50% higher than the current citywide average and an occupancy of 55%. Since the proposers forecast an occupancy of 55% in their first year, presumably the “distributed” expenses (due to room occupancy) would be about the same. We used a figure for revenue that was proportional to the RevPAR ratios of the 3rd year and the estimate case. The undistributed and fixed expenses from the 3rd year were used.  (Gross Profit is the difference between the revenue and distributed plus undistributed [for example, administration and marketing] expenses; the NOI is the amount left after subtraction of the fixed expenses like management fees.}

Note that under this scenario the operation is at a deficit and there is no Net Operating Income.

A more easily read version of the table is available here.

c. Subordination of the Ground Rent to the First Mortgage: But even if the NOI is sufficient to pay the Ground Rent, another complication is that the developers would have financed the hotel with a first mortgage of approximately $28 million.  They state very explicitly that the Ground Rent must be subordinated to the mortgage: in other words, if the profit from the hotel is not sufficient to make both the rent and the mortgage payments (estimated at $2,483,010 per year), the Ground Rent will not be paid.  (Even by their estimates, Year Two falls short, since there is only $144,859 left over after paying the mortgage.)  Yet, in the updated proposal, the Ground Rent amount is increased to $775,000 (no explanation about the increase).

d. Use of the Ground Rent to Pay for the Bonds: But in the reconsidered proposal presented as a table in the Roxbury Group report,  the city would not actually receive the Ground Rent as cash.  Instead, it would be used to pay for the bond (confusingly noted as an EDC bond and a TIF bond in two different places) and to put money into reserve.

Presumably, if the NOI was not adequate to pay the Ground Rent, the bonds have a risk of going into default.

Note that in the original proposal, there was an alternative payment scheme to the city for full purchase of the land, but that has evidently been dropped, since the Ground Rent is now obligated to the bonds.

Yes, it seems that this series must go into another segment. Coming next: the bonds.

UPDATE: A recent article on AnnArbor.com quotes Charles Skelton, a nationally recognized hotel analyst, as saying that hotel occupancy in the Ann Arbor area was 60% in 2010, and room rates (ADR) fell from $96 to $94.

This is a continuation from the previous post, Part A.  We are discussing the factors that bear on the feasibility of the Valiant proposal both in terms of business sense and of benefits to the city.

3. The parking question

The subject is a hotel and conference center (plus some other development) to rest on top of the underground parking structure that the DDA is building on South Fifth Avenue (the location we call the Library Lot).  The question of who will be using that structure for parking has been bandied about quite a lot. As reported by the Ann Arbor Chronicle, public comment on February 17, 2009 (when council authorized the parking structure) indicated a hope on the part of downtown merchants that this would provide lots of customer parking.  CM Leigh Greden even said “If you vote against this garage…you’re voting against our locally, independently-owned businesses.”  Then-DDA board chair Roger Hewitt, who also owns a business on State Street, cited the fact that the Maynard Structure is almost 100% full at times, and also the pent-up demand for parking permits (presumably for people working in the downtown). As Sabra Briere commented in a message to constituents shortly after the vote, “The underground parking structure…will add nearly 530 new parking spaces (altogether 677 spaces will be built)…The new parking will be a mix of hourly parking and permit parking. The permit parking will move from other structures, such as Maynard – thus opening up more hourly parking near State Street. Both merchants and shoppers will benefit.”

There was an additional push for the new structure to promote the location of businesses downtown. Newcombe Clarke, speaking at the February 17 meeting while representing the Chamber of Commerce and the Main Street Association, cited the loss of businesses who are locating elsewhere than downtown because of the lack of (permit) parking. An article in Concentrate at the time said  that “The Library Lot underground structure is expected to facilitate the future growth of Google’s AdWords headquarters (one block away), the planned redevelopment of the library and old YMCA site and perhaps the construction of more office and residential buildings nearby.” And of course, the Ann Arbor District Library  itself will need some parking for library visitors.

The exact number of spaces in the new structure is not clear yet.  Originally the plans called for 777 spaces, but 100 were whittled off by an amendment introduced by CM Carsten Hohnke, removing the portion proposed under 5th Street all the way to William. The recent story on AnnArbor.com claims 717 spaces on the basis of contractor’s ongoing counts, but the official DDA site says there will be 600 spaces.  According to an email from Susan Pollay (Dec. 17, 2010), the exact number has not yet been fixed because some issues such as location of the parking office, etc. are still being worked out, but it is likely to be in the “middle 600s”.  Let’s say 650 for the sake of argument.

Valiant clearly expects that some of them will be assigned to the project.  As they state in the original proposal (page 8), “Further, it is estimated that average daily underground parking demand would be created by the various activities of the Town Plaza as follows: (1) Hotel – 75 spaces; (2) Conference Center – 35-50; (3) Residences – 25 (permanent for an annual fee); (4) Banquets/social events – 20. Total 155 spaces (not including Restaurant and Bar). About half of these cars would occupy spaces for full days, the balance for 3 – 6 hours per day.”

Visitors to the Conference Center could just take their chances with the hourly parking spots, and any condominium owners could just contract separately with the DDA for permits.  (Any effort to set aside spaces for this purpose as a contractual entitlement should be resisted, especially not at the rate of two spaces per condo!)  But the hotel and banquet facility probably does need permanent assignment of spaces.  (Are 75 spaces for 150 rooms really enough?)  And Valiant has figured in parking as both an expense item and a revenue item.  For example, for Year 2, there is a line item for Parking Expense for $152,319 but a line for Parking Revenue at $169,243.  Clearly, they are expecting to reserve some spaces from the DDA and then have hotel users pay an upcharge.  Also, the attractiveness of the hotel as an investment (for private financing) probably depends on secure parking access.

There are three problems with this scenario.

1. Loss of use for the public, including local businesses.

As already indicated, customers and employees of local businesses and the AADL, will expect to use the structure, especially if permit holders are transferred from Maynard.

2. Loss of the city’s Federal subsidy.

As explained in a cautionary letter from the Great Lakes Environmental Law Center, the Build America Bonds (Recovery Act) that the city used to finance the structure are for public facilities.  If more than 10% of the facility is used by a private entity, the city could lose the subsidy that these bonds represent.

“… there is a legal risk that the bonds used to construct the parking structure and other infrastructure at the site will violate the private activity test, risking millions of dollars in federal subsidy for the City, if the parking structure spaces are contracted to or if special parking entitlements are provided to a private facility. Further, given statements made by the Downtown Development Authority regarding the significant portion of bond proceeds being used for site infrastructure to benefit a future developer including the private development’s share of costs for Library Lane, the service alley, the 12” water main, site work, and building structural support (which appears to solely benefit the private building), even a limited allocation of parking spaces for a private hotel could put the city at risk of losing millions of dollars in federal subsidies.”

If the number of spaces is about 650, clearly 10% (65) does not meet Valiant’s hopeful expectations.  Yet clearly this is still an important part of the deal.  The draft “letter of intent” by Roxbury states

“The DDA shall reserve not fewer than ____ parking spaces in the Deck in support of the Project.  The precise location of such spaces, consideration for such spaces and the means of access to the elevators and stairwells serving the Project shall be agreed upon between the parties as part of the Development Agreement.”

Meaning – even the fees paid for use of the parking are a matter of negotiation and subject to a future contract. But costs of permit parking are currently decided by the DDA and the City Council on a year-to-year basis.

3. Loss of revenue and cost to the system.

This was a very costly parking project.  Just the face value cost of the bonds cost $49,420,000, though the cost with interest is much higher according to the settlement statement.  The total cost to the city of building the structure is $80,766,324.99, even after the Federal subsidy of nearly $17 million. The payment due next year is $1,787,539.81 and in 2012 we will begin paying the principal as well as interest.  The payment due in 2012 is $2,442,539.81 and by the end of the bond life the yearly payment is $3,491,537.50.  (There were also a million or so in upfront costs paid by the DDA and the city.)

We were assured when the bonds were sold that their costs would be covered by parking fees.  “No taxpayer dollars were harmed in making this bond sale.”  (OK, I made up that quote, but not its meaning.)  If not just income from the structure, then the entire parking system would pay for it.   This was an important selling point, since, as we explained at length earlier, the city has issued full-faith-and credit bonds and could be stuck with general fund payments for any part of the debt repayments that parking fees don’t cover.

It was understood at the time the project was approved that a raise in parking fees would be necessary.  Here’s what was reported by the Chronicle from that February 2009 meeting:

Q: Would the DDA be able to build the underground parking garage and make bond payments if they didn’t raise parking fees?

Crawford didn’t mince words: “No.”

And indeed, parking fees have gone up already, and we are not done yet. As was reviewed recently by the Ann Arbor Chronicle,  the DDA is experiencing huge stress in its parking fund.  Because the city has been draining $2 million a year from the DDA parking fund to plug the holes in its general fund, the parking fund is currently operating at a deficit.  The Chronicle asks some very good pointed questions about this state of affairs, which seems to have the DDA leaning on its TIF fund to remain solvent.

Clearly, it is not a benefit to the city to have Valiant remove some of the parking spaces from their dynamic management by the DDA.  Yet we are caught in a Chinese finger puzzle here.  Without the parking spaces, the hotel and conference center are not likely to be successful.  But the cost of supplying them is dreadfully great. (In Year 2 for the hotel, the 650 spaces are costing $4,780 per each just for that one year, and Valiant’s 75 spaces would cost $358,534, but they have only budgeted $152,319.)

That’s if we don’t lose the Federal subsidy, which is worth nearly $1 million just in that year.

Yes, this post must continue for yet another segment.  Watch for Part C in the near future.  And there will be a recap and “balance sheet” in the last post.

As we noted in the previous post, there are many questions to be answered about whether the Valiant proposal is feasible – that is, whether it makes sense either as a business proposition or as a project that will benefit the city.

Today’s serving is just a start.  Part B will follow in short order.

1. The Hotel Business

At core, this is about building a hotel.  Much of the success of the project over the long term hinges on its 150 rooms and the income stream that they present.

Checking the figures

We reviewed this question at length in March and the data about hotel room occupancy and ADR (average daily rate) may be slightly out of date.  These data are very closely held and difficult to obtain.  However, based on what was known then,  area hotel occupancy has been in the 50-60% range and the ADR has been roughly $100.  The Roxbury report asserts that “the Ann Arbor area continues to have the highest hotel occupancy rates in Michigan” and the table (Attachment A) comparing Ann Arbor to other college towns states that city-wide hotel occupancy is 65%, but does not say for what years.

The Washtenaw County Accommodation Ordinance tax is an approximate measure of room rental income.  The county treasurer, Catherine McClary, recently issued a report showing these tax collections over the last ten years.  Beginning in 2007, the returns became negative, and 2009 was a very bad year, with a drop of almost 12% in collected taxes.  Two month’s worth of data are missing for 2010, but it appears that this year has been essentially the same as 2007, still flat in comparable revenues.  (Figures have been adjusted to allow for the recent increase in the percentage of tax collected from each room rent.)

A metric commonly used to measure hotel room revenue is RevPAR (revenue per available room).  It is loosely calculated by multiplying occupancy times ADR.  Valiant uses this metric to estimate their revenue from their 150 hotel rooms.

So, for example, in Year 2 (2014), they assume 72.5% occupancy and ADR of $193.46, for a RevPAR of $140.25. With 150 hotel rooms, total room revenue for that year is estimated at $7,165,283. (The calculation is somewhat confused by the inclusion of suites with different occupancy and rate profiles.)  There is additional income from food service, suites, and parking. After expenses, the Net Operating Income (NOI) in Year 2 is estimated to be $2,627,869.  This just exceeds the payments due on the mortgage ($2,483,010) by $144,859.

But if occupancy were instead 65% and ADR was $120 (a 20% increase from the area average), RevPAR would be only $78.  This would mean a drop of total room revenue by over half, and other revenue (food service, etc.)  would also decrease, perhaps proportionately.  This would compromise the ability of the hotel to make even the mortgage payments.

But the Valiant projections include much more optimistic assumptions over the following years. Assumptions for occupancy and ADR continue to increase through the 10 years that they forecast, with RevPAR exceeding $200 in Year 10.  The projections call for steadily increasing NOI, up to $4,402,010 by Year 10.  This increase is based on a steady increase in the room rate and 79% occupancy in the later years, with no justification for these estimates.

In addition to the mortgage payments, this NOI from the hotel must support payment of the “ground rent” to the city, which in turn is supposed to pay for the bond.  Recall that the bonds are subordinated to the first mortgage, meaning that they won’t be paid if the revenue does not exceed the amount needed to pay the first mortgage.  So a shortfall in the hotel income affects the financial viability of the entire package.

The viability of the entire financing scheme rests on hotel profits that are higher than can be justified.

2. The operation and finances of the conference center

We began this journey because of a desire to have a conference center downtown.  The Valiant developers would like to deliver one.  But they aren’t interested in paying for it.  They seem to think they are meeting an expressed need on the part of the city and they list the ownership of the conference center as one of the benefits that the city would gain from their proposal.

Although it is not so stated, it appears that the purpose of the bond is to pay for the conference center’s construction.  In the new proposal, both the area of the conference center and the bond intended to pay for it are reduced.  There is silence about the taxes to be collected on the conference center, probably because it is supposed to be operated by a non-profit, 501 (c)(3) body.  This nonprofit, as explained in our post on the “Secret Plan”, an earlier version of the Valiant proposal, would be composed of our – stakeholders!

The conference center would be owned by a not-for-profit 501(C)(3) organization, with a board composed of “those institutions or public sector entities that would be most involved in or benefited by the center”.  This NFP would then contract with the developer to develop, manage, market and book the conference center (the last two possibly in conjunction with the Ann Arbor CVB).

The idea of the developers being involved in any way with the operation of the conference center has been dropped, at least for the time being.  But note that the entire responsibility for the operating expenses and the successful operation of the conference center has now been transferred to a group composed of various public entities, with the city at the lead.  This is curious, given that the success of the conference center and of the hotel business are surely linked.

It is not impossible but certainly beyond the scope of this blog to estimate what the cost and risks associated with operating a conference center would be. Here are just a few thoughts.

Day-to-day administration: There would have to be a full-time administrator with some support staff.  As a stand-alone organization, it would need accounting, payroll, legal, and maintenance contractors or staff.

Marketing and coordination of conference groups:  To make a successful center, a serious marketing program to groups putting on conferences would be necessary.  Coordination with use of meeting rooms for local uses (like the AADL) and with hotel reservations and meal service would be necessary. (Would the conference center administrator make access to other hotels easy?  Conferences often book rooms for visitors in more than one hotel.) And of course there is the issue of how to work around football and other major event days.

Pricing and fee structure policies: A fee structure would need to be set up if it is to be accessible to local groups but also competitive in bidding for conference use.

Technology support: Decisions would need to be made for how much expensive technology would be installed for conferencing purposes, including computer projection systems, video and audio recording capability, and in-house Internet and computer accessibility.

Of course some of the “stakeholders” could help out.  But if Ann Arbor, DDA, or Ann Arbor District Library staff are diverted to fill some of the gaps, that could result in a loss of service.  The Ann Arbor CVB could handle parts of it, but might need additional staff, placing a demand on their share of the tax revenues that support them.  We can be sure that UM would contribute only an advisory member to the nonprofit – they have resolutely kept at arm’s length from this proposal and know a tar-baby when they see one.

So who will put forward the upfront money to furnish and staff the conference center?  How will operating expenses be covered in its early years, before a smoothly running calendar is in place?  (Most conferences book a year or more in advance.)  Who is responsible for setting up the nonprofit and who will appoint its board?  What will be the source of its own operating budget?   None of these questions are addressed in the Valiant proposal, though it does state that the city will own the conference center.  Thus it appears that the city will bear the full responsibility and cost for these operations, at least in the short term.This is especially a concern because articles continue to be published with negative news about publicly supported convention centers, with most operating at a loss and failing to bring the positive results expected. (Once again, see also our post on the economics of conference centers.)

Because this treatise has become so long, the remaining issues will be discussed in the next post.

Here are some things to consider in the meantime:

1. Just what are those EDC bonds and what risk do they present to the city?

2. What importance does the other part of the development – the condominiums and office space – have to the success of the project? Do they make business sense?

3. What about the parking?

UPDATE: A recent article on AnnArbor.com discusses the current state of the hotel business.   It quotes Charles Skelton, a nationally recognized hotel analyst, as saying that hotel occupancy in the Ann Arbor area was 60% in 2010 and room rates fell from $96 to $94.  Note the effect that this would have on the hotel revenue estimates discussed above.

As we recently reviewed, the Roxbury Group was hired by the City of Ann Arbor to examine the proposals submitted in response to RFP 743, for the surface of the Library Lot .  The report, rather than being the examination of financial feasibility that had been promised, instead reads much like a sales proposal from a real estate broker.  After repeating a number of boosterish comments based on interviews with “stakeholders” to establish the need for a conference center,  the report compares the Valiant and Acquest proposals and legitimately concludes that Valiant offers to develop a conference center, while Acquest only suggests that the city should build one on an adjacent lot (the “old Y lot”).   (Note that the original RFP did not specifically call for a conference center, but this has now become the deciding factor.)  The consultant then recommends that Valiant should be chosen by the city, and not only presents a revised proposal from Valiant, but drafts a letter of intent for the city to enact.

The changes in Valiant’s proposal are mostly stated in a table (Attachment B).  In order to understand them fully, it is necessary to refer back to Valiant’s original cost proposal.

Elements of the new proposal

The original proposal had three elements:

1. Residential condominiums (12 units) with sales prices ranging between $750,000 to $1, 250,000. These would be sold to the public.

2. Hotel/retail portion. This would be owned and operated by Valiant or a business partner. (Keith Coe, one of the partners, is a principal in Valley Forge Hotel Management.)

3. Conference center (built within the shell of the hotel/retail portion).  This would be operated by a nonprofit corporation that would be established by the city and other entities for that purpose.

The revised proposal is an effort to reduce the cost and make the offer more financially attractive to the city by ostensibly removing the city’s financial liability.  They accomplish this in part by reducing the perceived benefits that the city would receive. Here is a summary of the changes in the elements of the proposal.

Note that the size of the conference center has been reduced. It is not explained what effect that would have on the size of conference that the center could host, or what it would mean to a floor plan.

The public space that was provided in response to the RFP has also been reduced by removing a rooftop garden.

Financial aspects

The financial aspects of the original proposal are convoluted and many of them were not updated in the report by Roxbury.  Here is a summary of the financial proposal and changes.  It does not address the business plan and pro forma that were in the original proposal.

Note that the total development cost in the project budget (p. 37 of the original proposal) is $54,043,044.76. (Editor’s note: yes, I know it is silly to carry it out to “cents” but I didn’t write the proposal.) That figure includes a $500,000 Development Fee and a $1,000,000 line for “Commissions” (no “cents” in either of these). Both of those fees presumably go to the developers.  But the mortgage and bond together for the original proposal only added up to $36.1 million.  It is not explained where the remainder of the balance is to come from, though there are some hopeful comments about sharing in various government incentives.

So how feasible is this offer?  There are several angles to look at.  Does the project itself make business sense?  Are there some lurking assumptions that are not being addressed?  Does the new proposal succeed in relieving the city of liability?  Does the city (government) budget actually make any financial gains from it?  Does the city (as a municipal body) benefit in general? What are the likely risks and benefits?

Those will have to wait for the next post.

I. What’s not in the Roxbury report

As we recently reviewed,  the long process of deciding about a conference center on the Library Lot has taken the next step with a report from a consultant, the Roxbury Group.  We will examine the details of those recommendations in a future post.

First, let’s discuss what is not in the report – but should be.

The report was prepared in response to RFP 758, issued by the city on January 5, 2010.   That RFP was for a consultant to help the RFP advisory committee evaluate the financial capabilities of the proposers (as explained in the committee meeting) and the DDA pledged the money ($50,000) to pay for the work.  There were 11 tasks named for the consultant to perform.  Here are the significant ones:

• Determine if the projects submitted to the City are economically viable and make financial sense in the Ann Arbor marketplace
• Help the City determine which project will provide the maximum financial return to the City
• Assist the City in working with each developer to improve their proposals and provide the City with competitive options that optimize desired features
• Help the City determine which project will provide the greatest community benefits
• Provide information on the impact of similarly scaled projects in similarly sized communities
• Assist the City as needed in negotiations with the selected project team

And indeed, in the proposal in response to the RFP,  they promised to (again, a selected list):

• Determine if the projects submitted by the respondents are viable, financially as well as from a marketplace perspective.
• Evaluate the strength of the prospective development firms – helping to determine whether the firms are financially sound and performing the necessary due diligence to confirm their ability to execute and track record of success.
• Support  the City, to the extent needed, in negotiations with the selected development team.
• Assist the City in determining which project will provide the greatest community benefits.
• Assist the City in crafting and executing a robust community involvement process to ensure residents are informed, have the opportunity for meaningful input and feel positive about the result.
• Advise the City on the strengths and weaknesses of each project, and provide analysis of which project will likely maximize the financial benefit to the City.

Note that the top item in each list is to determine whether the project is financially viable from a marketplace standpoint. But here is what the actual report says:

“It should be noted that this report does not include and is not intended to serve as a feasibility study for the concepts included in the two proposals. Accordingly, for purposes of this report, it is generally assumed that the overall concepts included in the uses for the Library Lot contained in each proposal are valid and supportable from a market and demand standpoint.”

And yet, early on, all parties seemed to agree that a market demand study was needed.  Indeed, in a letter dated January 28, 2010, the Valiant partners stated that they had hired a firm to do one:

“in response to the Evaluation Committee inquiry, we have hired a nationally known firm to do a ‘Demand Analysis’  for us, which we will share when completed.”

Acquest, in a letter sent to the advisory committee after the Valiant letter was publicized,  emphasized that feasibility studies were needed.

“we quickly acknowledge that the potential for a conference center on the YMCA site would most certainly require an independent feasibility study and equally important an economic impact study measuring the economic benefit to the City and the County as well as other downtown commercial establishments and other stakeholders…The scale of the project and specific functional and programmatic components will clearly need to respond to an independent market analysis…Valiant has apparently made a unilateral decision to commission a study by HVS Consultants to evaluate the demand. We assume they are referring to hotel as well as convention center demand.  In our opinion this should be a function under the direct control of the City and/or the DDA as the report loses its independence when the consultant’s client is one of the proposers.”

(See our previous post discussing the two letters.)

So – as we consider the new Valiant proposal as presented by Roxbury, the first thing to remember is that it does not contain a market study or the financial analysis that was discussed by the advisory committee.   But as has been said yet again in a recent article from AmericanCity.org, and as we summarized earlier,  conference center-hotels often do not pay for themselves.  We must hope that Valiant’s proposal will be studied with extreme care, and with the assumption that if things can go wrong, they will.  And can we please see what Valiant’s own consultants had to say about their project’s financial feasibility?

The roll-out of the Roxbury report began with the DDA board meeting (December 1, 2010).  According to a story published by AnnArbor.com, DDA officials touted the report as saying that the Valiant conference center proposal “made sense”.   Here is a quote from that story of former DDA board chair John Splitt:

“Splitt said the Roxbury Group has concluded a need exists for a downtown conference center, and the Valiant proposal is the better of the two proposals being considered.”

Note the drift in the objectives of this discussion.  While the original RFP was clearly drawn up in order to justify the conference center, its terms were sufficiently broad that two open space proposals could legitimately be made in answer to it.  Subsequently, the RFP advisory committee did have a coherent discussion of the four development proposals (after summarily dismissing the open space proposals) in which they chose two proposals (Acquest and Valiant) for further consideration.  Now the point appears to be choosing between those two proposals without consideration of whether either meets the city’s needs or the desires of its residents for its future course.

But did the consultant’s report actually establish a need for a downtown conference center?  No, it presented no data to back up that conclusion.  What the consultant did do was to have a number of conferences with people representing institutions with an interest in a downtown conference center.  We call those “stakeholders”.

As we emphasized in our previous post, the dominant theme heard from those supporting a conference center on the Library Lot has been “consulting with stakeholders”.  But noticeably missing from the list of “stakeholders” have been any members of the public or those representing anything but big institutional interests.

Here are the interests interviewed by the Roxbury Group (in the order named in the report):

• Ann Arbor District Library
• Ann Arbor Area Convention & Visitors’ Bureau (AACVB)
• SPARK
• University of Michigan
• Ann Arbor/Ypsilanti Chamber of Commerce

That’s it!  No environmental, community, or art groups.  Not a transportation representative or the AATA. Not someone with authority in urban planning (though UM’s Jim Kosteva is trained as a planner, that is not the hat he wears.) Not even any downtown merchant group.

Note the primacy of the AADL in these discussions.  As we previously reported, the Library’s Executive Director, Josie Parker, and to some extent, its board, have been strong proponents of a conference center adjacent to the downtown library.

The report summarizes a number of benefits to the AADL of having a conference center on the Library Lot.  Here is an important one: “The development of this project will create new demand, urgency, and a platform for improving and upgrading the existing Library.” but “…the development of a conference center adjacent to the Library would permit…an optimal size and configuration for their own meeting facilities, thereby avoiding unnecessary or redundant public expenditures.”

This confirmed a portent from a slightly indiscreet preview floated last March by Larry Whitworth, the outgoing President of Washtenaw Community College.  In a report on the Ann Arbor Chronicle, Whitworth said, “…WCC is considering partnering with the Ann Arbor District Library. The library board and administration are considering moving ahead with rebuilding their current downtown facilities. ..I thought to myself, if we were thinking about the future, working with the library makes all kinds of sense,” …[AADL director Josie Parker] thinks that joining forces makes it a much more doable project. We’ve got all the meeting rooms. We’ve got the conference center. We’ve got parking. The bus depot is coming in.”

So – it is evident that the AADL has been planning for many months to add the conference center to its expansion plans and to shift costs for expansion from its own budget to the city’s.

It is difficult to know exactly what the AACVB’s motivation would be.  The consultant’s report cites a number of miscellaneous findings from a report to the AACVB, few of which seem to be directly relevant (see p. 8 of the report).  Further, the plaintive letter from the Hotel and Motel Association, which says that a new hotel would “threaten the viability of our properties, which are already struggling” would be expected to dampen enthusiasm from the CVB, which supposedly exists to find business for this industry.  But perhaps a recent report by the Washtenaw County Treasurer, Catherine McClary, may shed some light. The report, prepared for the commission that oversees the Washtenaw County accommodation tax, shows a drastic drop in occupancy (as measured by tax collection) over the last year.  As the Ann Arbor Chronicle has explained,  the accommodation tax was increased by the county Board of Commissioners from 2% of room revenues to 5% in early 2009, with the county taking a nice chunk of the increase.  This caused a stress on some bed-and-breakfast places, a few of which are in arrears.  But the spreadsheet, with rates adjusted to the former 2% level for comparison purposes, shows a substantial drop (over 11%) in 2009 (numbers for 2010 look a little better).  This means decreased occupancy for the hoteliers – and a decreased tax revenue for the CVB.  Would a new downtown hotel increase income for the CVB (though subtracting from the existing hoteliers’ income)?  That would depend on many variables, but it could be a factor in the CVB’s apparent support of the idea.

While there are relatively few comments in the report that can be directly attributed to SPARK and the Ann Arbor/Ypsilanti Chamber of Commerce, it is clear that many of the affirmative statements in the report are based in an unfocused belief that a conference center would simply bring in more business.   As the report states, “A first-rate hotel conference center in downtown would serve as a meaningful business attraction and retention tool.”  It goes on to say, “Ann Arbor is increasingly seen as an entrepreneurial, innovation-based community. The ability to host business and technology conferences downtown would allow Ann Arbor to showcase its appeal as an attractive headquarters locations for such companies.”  What this seems to say is that the business community would appreciate some nice places to host their guests.  (Note: these statements stand alone, without any further documentation.)

Now, the UM.    The report makes a number of statements relating to the UM, but it is my personal belief that there were no commitments made by UM related to this project.  The two people interviewed were Jim Kosteva, the UM community relations spokesman, and the head of conference services, Bill Villisides.  Although I don’t have a copy of one, Kosteva has repeatedly stated in private emails to various individuals that the UM could make no commitments to use a new facility.  The UM has an extensive network of conference facilities itself.  Further, there was recently a failure of a UM-affiliated center, the Michigan Technology Center.  As reported by AnnArbor.com, some very fancy conference facilities at MTC, including videoconferencing, failed to gain enough business to pay the bills.  An appendix to the Roxbury report states that the UM has 91,667 square feet of meeting space on campus (this was the greatest in 8 comparable campuses, where the average was 38,605)(see attachment A).  The comments in the Roxbury report seem to be more related to logistics than a perceived need: “…there is no centralized function at the University responsible for marketing and managing available conference space, or establishing fixed pricing and service offerings. Rather, individual colleges and departments each establish their own availability and rules,”  Those pesky professors!

A recent article in a new publication, The Ann, did an effective job of asking whether the changes in Ann Arbor are really serving the populace.  The question is, have we agreed (as a community) on whether a conference center on the Library Lot really serves our collective vision of where Ann Arbor should be aiming for the future?  These few “stakeholders” haven’t asked us.  Do the residents of Ann Arbor hold any cards?  Do we have a stake?