What’s in the Box III: Feasibility of the Valiant Proposal (Part A)

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this question at length in March and the data about hotel room occupancy and ADR (average daily rate) may be slightly out of date.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.

Explore posts in the same categories: Business, civic finance

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