After months of discussion surrounding Urbana’s Landmark Hotel renovations potential — a proposal of turning it into a Hilton Tapestry Collection line — the City of Urbana has deemed the project “not feasible”. Check out the press release:
Contacts:
Diane Marlin
Mayor, City of Urbana
217-384-2456
Brandon Boys
Economic Development Manager, City of Urbana
217-384-2439
For Immediate Release – June 26, 2017
Hotel Project Not Feasible
The City of Urbana has concluded that a proposal by developer Crimson Rock Capital to renovate the Urbana Landmark Hotel is not feasible.
Mayor Diane Marlin said the major issues were the large amount of money the city would have to borrow to finance the project, the low level of equity participation by the developer and overall taxpayer risk.
“A vibrant hotel would make a great addition to our downtown, but unfortunately after many months of discussion, we were unable to reach an agreement with this developer on the current proposal,” Marlin said.
The primary hurdle for the proposed $24.5 million project was the developer’s request for $9.5 million in city funds, which would have required the issuance of taxpayer-backed bonds. Total cost to the public would have approached $15 million over a 20-year period. Renovation costs were estimated to be $19.5 million, with the remainder going for the purchase of the now-closed hotel.
At the city’s request, SB Friedman Development Advisors of Chicago conducted a financial analysis of the project proposal and found the developer’s share in the risk to be too low.
“The developer’s planned level of equity participation is substantially below industry standards and would not normally be considered sufficient in the eyes of other capital sources,” the report said.
The developer’s proposed equity share of the completed project was calculated to be less than 2 percent, or approximately $400,000.
“The numbers just don’t work,” said Marlin. “The current proposal would have put the city’s general fund at risk at a time when we’re trying to address a structural deficit and other financial challenges.”
Marlin said the city would welcome other proposals for the site and has already had recent inquiries. “Everyone supports revitalizing this area but this particular proposal is not the best way to get there,” she said.
Crimson Rock Capital, doing business as Upsilon Lambda Heta, LLC, is based in Glen Rock, NJ. The firm was notified of the city’s decision last week.
Top photo by Justine Bursoni.
UPDATE: 11:30 a.m.
Below is a report by consultant SB Friedman Development Advisors of Chicago, who reviewed the proposed development agreement for the Urbana Landmark Hotel on the city’s behalf.
TO: Brandon Boys, City of Urbana
MEMORANDUM
FROM: Geoff Dickinson, SB Friedman Development Advisors
Direct: (312) 384-2404; Email: [email protected]DATE: June 19, 2017
RE: Review of Developer’s Request for Financial Assistance – Landmark Hotel Redevelopment Project
SB Friedman Development Advisors (SB Friedman) has been engaged by the City of Urbana (the “City”) to conduct a review of a request for financial assistance to make the redevelopment of the Landmark Hotel (the “Project”) feasible. The Project encompasses a renovation of the existing Landmark Hotel into a boutique, upscale hotel under the flag of Hilton Hotels’ Tapestry Collection. The Project, located at 210 South Race Street, will create 128 hotel keys along with a hotel bar and restaurant, and 4,200 square feet of meeting space.
Crimson Rock Capital, LLC (the “Developer”) has requested City assistance to close the Project’s projected financial gap. The Developer has indicated that costs associated with renovating the historic hotel and the Project’s achievable revenues drive the need for City financial assistance.
This memorandum includes a review of the following:
Project characteristics
Development budget
Proposed sources of financing
Pro forma assumptions and 10-year cash flow
Need for requested financial assistance
Developer Request for Assistance
The Developer indicated that a City grant of $9.5 million is required for the Project to be financially feasible. He requested that the City provide that grant when the Project receives its Certificate of Occupancy. He indicated that he will be able to temporarily bridge the Project’s capital needs during the construction period but will need to substantially reduce his level of equity in the Project’s permanent financing structure.
Key Developer Pro Forma Assumptions
SB Friedman has reviewed the application materials submitted by the Developer, and has engaged the Developer in subsequent conversations to obtain additional and updated information to best understand the underlying financial assumptions regarding the Project. The Developer has provided the following documents for review:
Program description and development timeline
Narrative response to SB Friedman data request
Live pro forma including: budget (sources and uses), 10-year cash flow (income and expenses) and
return calculations
Preliminary construction cost estimates
Project Phasing
The Developer has indicated that the Project will take 24 months to complete, with hotel occupancy starting in 2019 (hotel year 1) and the Project reaching stabilization in hotel year 3 (2021).
Review of Developer Assumptions
PROJECT BUDGET
Table 1A below presents projected total development costs (TDC) included in the Developer’s preliminarypro forma.
Table 1A: Preliminary Development Budget
Developer-Submitted Budget
Development Costs
Original
Budget [1] $ per Key % of TDCAcquisition Costs
$5,171,200 $40,400 20.6%
Site Preparation Costs
$0 $0 0.0%
Hard Construction Costs
$10,801,361 $84,386 43.1%
FF&E Costs
$4,717,020 $36,852 18.8%
Soft Costs
$3,133,379 $24,480 12.5%
Financing Costs
$600,390 $4,691 2.4%
Developer Fees
$650,000 $5,078 2.6%
Reserves and Other Costs
$0 $0 0.0%
TOTAL DEVELOPMENT COSTS (TDC)
$25,073,349 $195,886 100.0%
[1] Costs reflect budget provided by Developer on March 27th, 2017 Source: Crimson Rock Capital, LLC
To evaluate the reasonableness of the preliminary Project budget, SB Friedman benchmarked certain development budget line items as a percentage of total costs and/or as cost per hotel key against SB Friedman’s project experience elsewhere and industry data including HVS. Key findings from our review of the Project budget are outlined below.
Site Acquisition. As of May 1st, 2017, the Developer had an option agreement to purchase the site from the current owner for $5.1 million. We have not been provided a recent appraisal for the site, nor comparable recent hotel property sales in the area. Thus, SB Friedman was unable to evaluate the reasonableness of the planned acquisition price.
Hard Construction Costs. Preliminary hard construction cost estimates for the Project were provided by a member of the development team and are based on the Developer’s experience with similar historic hotel redevelopment projects. The current budget includes a 15% contingency on construction costs. This is not uncommon for a project at this stage in the development process. As the Project advances, the Developer expects to gather additional information to reduce the level of uncertainty in the budget and thus the amount held as contingency in the hard cost budget.
Furniture, Fixtures and Equipment (FF&E). The budget includes FF&E costs of $36,900 per key. However, the Project’s total FF&E cost includes a 10% contingency, as well as back-of-the-house and kitchen buildout costs. When considering FF&E only for the guestroom and common area portions of the hotel, the Project’s costs are $27,100 per key (excluding the contingency) – very similar to industry data from the 2016 HVS cost estimating survey for new hotel construction, which suggests FF&E costs average $28,300 per key for full-service hotels.
Given the preliminary nature of the renovation project, the inclusion of a 10% FF&E contingency may be reasonable. As the Project moves forward, this contingency should be reduced and the actual FF&E cost figure will presumably be refined.
Soft Costs. The Project’s projected soft costs, financing costs, and developer fee all appear to be within current industry benchmarks for hotel development. The Project’s soft costs of 12.5% of TDC are within the 2016 HVS cost estimating survey range of 12-14% for full-service hotels. The Project’s financing fees at 2.4% of TDC is slightly below the 3-5% of TDC range seen on other hotel renovation projects on which SB Friedman has worked. The Project’s developer fee at 2.6% of TDC is within the 2-4% of TDC range of comparable projects on which SB Friedman has worked.
Based on our review, SB Friedman made one, minor, adjustment to the budget. It was a reduction in hard construction costs equal to the Developer’s anticipated amount of Enterprise Zone sales tax exemption. In parallel with this minor reduction in costs, sales tax exemption on materials was removed as a source of funds. As shown in Table 1B below, this did not result in substantial changes in the development budget.
Table 1B: Preliminary & Adjusted Development Budget
Developer-Submitted Budget
SBF-Adjusted Total Budget
Development Costs
Original
Budget [1] $ per Key % of TDCSBF Adjusted SBF-Adjusted Budget – $ per
Budget Key
% of TDC – SBF-Adjusted Budget
Acquisition Costs
$5,171,200 $40,400 20.6%
$5,171,200 $40,400 20.9%
Site Preparation Costs
Hard Construction Costs [2]
$0 $0 0.0%
$0 $0 0.0%
$10,801,361 $84,386 43.1%
$10,418,161 $81,392 42.2%
FF&E Costs
$4,717,020 $36,852 18.8%
$4,717,020 $36,852 19.1%
Soft Costs
$3,133,379 $24,480 12.5%
$3,133,379 $24,480 12.7%
Financing Costs
$600,390 $4,691 2.4%
$600,390 $4,691 2.4%
Developer Fees
$650,000 $5,078 2.6%
$650,000 $5,078 2.6%
Reserves and Other Costs
$0 $0 0.0%
$0 $0 0.0%
TOTAL DEVELOPMENT COSTS (TDC)
$25,073,349 $195,886 100.0%
$24,690,149 $192,892 100.0%
[1] Costs reflect budget provided by Developer on March 27th, 2017
[2] SBF-adjusted budgets reflect hard costs reduction by amount of Enterprise Zone sales tax exemption Source: Crimson Rock Capital, LLC and SB FriedmanOverall, Project budget assumptions do not appear unreasonable based on the preliminary stage of development planning and available documentation of costs and industry benchmarks. However, as further due diligence is conducted and the redevelopment scope is further refined, we anticipate the level of constituency will be reduced.
PROPOSED FINANCING SOURCES
In addition to City financial assistance, the Project is anticipated to be financed with conventional debt, Federal historic tax credit equity, and cash equity from the Developer. Table 2 presents the preliminary financing sources included in the Project pro forma, with additional detail provided below.
Table 2: Preliminary Sources of Construction & Permanent Financing
Source: Crimson Rock Capital, LLC
• Conventional Debt. The Developer indicated that historic rehabilitation hotel projects in secondary or tertiary markets have challenges when trying to attract permanent and construction debt. The Developer has asserted that lenders have only been willing to provide debt financing at up to 50% loan-to-cost for both construction and permanent financing. SB Friedman has not independently verified the level of debt that the Project could attract. However, a figure on the order of a loan equal to 50% of total cost is consistent with debt levels we have observed for other complex redevelopment projects in smaller markets.
Source
Construction Capital Stack
Permanent Capital Stack
Permanent Capital Stack (w/ full City Assistance)
Conventional Debt
$12,500,000
$12,500,000 $12,500,000
Developer Equity
$12,190,149
$9,890,149 $390,149
Federal Historic Tax Credit Equity
$0
$2,300,000 $2,300,000
City Financial Assistance
$0
$0 $9,500,000
Total Sources
$24,690,149
$24,690,149 $24,690,149
Federal Historic Tax Credit Equity. The Developer has indicated that they will be seeking Federal historic tax credits for the entire Project. They have indicated that there is a question as to whether 100% of the project will be eligible. For the purposes of our review, we have assumed that the Developer will be able to secure and monetize these credits. The current Developer pro forma assumes that the entire Project is eligible. Assuming the Project can attract the level of credits as contemplated by the Developer, his calculations to estimate how much tax credit equity would be generated appear correct.
The current capital stack does not appear to assume that the Project will attract state of Illinois historic tax credits. It is our understanding that the state of Illinois program is scheduled to expire on January 1, 2018. This may be an additional source of funds to explore as the Project moves forward.
Developer Equity. The Developer anticipates funding about half of the Project costs ($12.2 million), during the construction period, with equity. Upon Certificate of Occupancy, Federal historic tax credit equity and the City’s financial assistance would then “take out” the majority of the Developer’s equity. With the full assistance request, long-term Developer equity of $390,000 would represent 1.6% of TDC. Typically, financial partners/lenders prefer to see developer equity levels of 20% to 40% of TDC to help ensure that all parties have a substantial financial incentive in the long term success of the project. The Developer’s planned level of equity participation is substantially below industry standards and would not normally be considered sufficient in the eyes of other capital sources. The City may want to require a higher level of equity investment by the Developer. As shown in sections below, SB Friedman recommends a reduced level of City assistance.
As a whole, the Project has levels of capital from two sources that appear reasonable when compared to industry standards. These are 1) conventional debt and 2) Federal historic tax credit equity. However, upon inclusion of the requested $9.5 million in City assistance, the share of Developer equity in the Project appears relatively small compared to standard industry benchmarks and presents a potential concern for the City.
CASH FLOW ASSUMPTIONS
The City engaged Patek & Associates (“Patek”) to conduct a third-party review of the Developer’s revenue, operating expenses, and net cash flow. Patek concluded that “the projections appear to be reasonable for the as described and renovated Urbana Landmark Hotel as a Tapestry Collection by Hilton.” In addition, Patek indicated that “the [Average Daily Rate] [in the Developer’s pro forma] is slightly higher than the competitive set ADR in the STR report by about $9-$10 yet it appears to be a reasonable ADR for an Upscale hotel concept by Hilton.” Based on the Patek review, SB Friedman has accepted the Developer’s operating revenue and expense projections for the purpose of evaluating the Project’s financial performance.
However, SB Friedman has made one additional change to the Developer’s pro forma related to historic tax credit financing. It is our understanding that tax credit investors earn a 2% annual priority return for five years, along with a 5% priority put/return in the fifth year of the project. Collectively, these priority returns slightly decrease the Developer’s cash flow after debt service. This reduction in projected cash flow does not appear to substantially alter the Developer’s return calculations nor need for assistance.
Need for Financial Assistance
SB Friedman analyzed the Project’s financial performance under two scenarios:
Without Assistance. This scenario assumes the Project will not receive any City financial
assistance (but will still secure Federal historic tax credits and enterprise zone sales tax relief).
With Requested $9.5 million in City Assistance. This scenario assumes the City provides $9.5 million in financial assistance upon Project occupancy (in addition to the Developer securing Federal historic tax credits and enterprise zone benefits).
SB Friedman typically uses one or more of four return metrics to benchmark project returns, including:
Unleveraged Internal Rate of Return (IRR). This is the rate of return for a project, accounting for initial expenditures to construct the Project and ongoing cash inflows (annual net operating income [NOI] before debt service), as well as a hypothetical sale of the Project at the end of the analysis period.
Stabilized Yield on Cost. This metric is calculated by dividing NOI before debt service in the first year of stabilized operations by total project costs funded with private capital, and is an indicator of the annual overall return on private investment for the Project’s private capital.
Leveraged Internal Rate of Return. This is the annualized rate of return the Project’s equity investors would be projected to realize over their full investment period, including an assumed hypothetical sale of the Project at the end of the analysis period.
Stabilized Cash on Cash Return. This metric indicates the annual cash return to equity investors once the Project reaches stabilization, and is calculated by dividing net cash flow (after debt service) in a given year by the total initial equity investment.
SB Friedman evaluated the Project’s projected returns based primarily on leveraged returns and cash-on- cash return, as these are most sensitive to the Developer’s equity investment in the Project. Unleveraged IRR presents an overall picture of the feasibility of the Project, without considering financing sources.
• Returns and Incentive Calculation. SB Friedman calculated the Project’s terminal value based on Year 11 net operating income (NOI), the Developer’s assumed 9.5% terminal cap rate, and a 3.0% cost of sale to be subtracted from sale proceeds. This differs from the Developer’s assumptions which calculated the reversion value based on Year 10 NOI. (The Developer’s terminal cap rate assumption is at the upper end of current industry data from PwC, but we believe that likely appropriately reflects the risk of the Project and size of this market.)
The Project returns with and without assistance are compared to industry benchmarks, as available, in Tables 3 and 4. SB Friedman estimates that the Project, without TIF assistance, generates an unleveraged IRR of 4.6%, which is below typical return thresholds for hotel development. Typically, a project of this type would achieve an unleveraged IRR on the upper end of an industry benchmark that ranges from 7% to 13%. Therefore, it appears unlikely the Project would move forward without City assistance. With the full requested $9.5 million in City assistance, the Project would achieve an unleveraged IRR of 12.9%, which is at the top end of benchmark returns.
However, with full City assistance, the Developer’s small equity contribution results in outsized returns to the Developer, well above what would be considered typical. With full City assistance, the Developer’s stabilized cash-on-cash return is 113%. This level of return would mean that the Developer is earning annual cash after debt payments equal to more than the equity the Developer has invested in the Project. In addition, a leveraged IRR of 86% is well above industry standards. A leveraged IRR below 30% should still provide sufficient returns to attract additional equity without making the Project financially infeasible.
Table 3: Projected Developer Returns
Returns Metric
No Assistance
Full Requested Assistance – $9.5M
Industry Benchmark [3]
Stabilized Debt Coverage Ratio
1.50
1.50
1.54 avg.
Stabilized Cash-on-Cash Return [1]
4.44%
112.67%
TBD
Leveraged IRR
2.20%
86.35%
20-30%
Stabilized Yield on Cost [2]
6.49%
11.26%
9.0-10.5%
Unleveraged IRR
4.58%
12.86%
9-13%
Source: Crimson Rock Capital and SB Friedman
[1] Annual cash return after debt service to Developer’s cash equity
[2] NOI on total project costs (less public assistance: Historic Tax Credits/TIF grant)
[3] Benchmarks based on PWC, HVS, and Realty Rates national industry benchmarks and SB Friedman project history, and use the upper end of standard ranges to account for the higher risk of this project and this smaller market.Based on our review of the Developer’s returns, it appears that, without assistance, the Project’s returns are below benchmark and thus, the Project is likely not feasible. However, if the City were to provide the full level of assistance requested by the Developer, the Project’s leveraged returns would be substantially in excess of benchmarks.
Potentially Appropriate Level of Assistance and Other Considerations
In an attempt to bring the Developer’s leveraged returns in line with benchmarks, SB Friedman analyzed a scenario under which the City provides $8 million in assistance rather than $9.5 million. See Table 4 below for a proposed alternative capital structure and resulting returns:
Table 4: Projected Developer Returns and Equity Contribution with Adjusted Level of Assistance
Returns Metric
No Assistance
Full Requested Assistance – $9.5M
Adjusted Level of Assistance – $8M
Industry Benchmark [3]
Stabilized Debt Coverage Ratio
1.50
1.50
1.50
1.54 avg
Stabilized Cash-on-Cash Return [1]
4.44%
112.67%
23.26%
TBD
Leveraged IRR
2.20%
86.35%
28.57%
20-30%
Stabilized Yield on Cost [2]
6.49%
11.26%
10.09%
9.0-10.5%
Unleveraged IRR
4.58%
12.86%
11.08%
9-13%
Developer’s Permanent Cash Equity Contribution
$9,890,149
$390,149
$1,890,149
N/A
Developer’s Equity as Percentage of TDC
40.1%
1.6%
7.7%
20-40%
Source: Crimson Rock Capital and SB Friedman
[1] Annual cash return after debt service to Developer’s cash equity
[2] NOI on total project costs (less public assistance: Historic Tax Credits/TIF grant)
[3] Benchmarks based on PWC, HVS, and Realty Rates national industry benchmarks and SB Friedman project history, and use the upper end of standard ranges to account for the higher risk of this project and this smaller market.If the City assistance is reduced by $1.5 million and the Developer’s cash equity contribution is subsequently increased by the same amount, the Project will achieve an equity return consistent with benchmarks. Note however, that the overall level of Developer equity invested in the Project under this scenario (now almost $2 million) is still substantially less than 20%, which is often considered a minimum in our experience. Without sufficient Developer equity, the following issues become material concerns for the City:
1) A Relatively Low Level of Developer Equity Creates Downside Risk for the City. Even with reduced City assistance, the Developer’s equity would be less than 8% of TDC. If the Project underperforms, normally the Developer’s equity would be the first capital source to see its value diminished. With a comparatively small amount of Developer equity in the Project, any downside risk will fairly quickly move from being a Developer concern to being a concern for the City.
Further, it is not typical for a City to have over four-times as much equity in a deal as a Developer. In our experience, the ratio of City equity to Developer equity would be, at most, 1:1.
2) A Relatively Low Level of Developer Equity May Induce Risky Developer Behavior. A developer with a relatively low level of equity investment in a project is more likely to attempt a highly risky project since he/she has very little capital at risk. Thus, the City should not consider the 7.7% equity on the part of the Developer (under this proposed $8 million alternative level of assistance) sufficient to help guard against undue risk taking.
This concern is heightened because the City, as the Project is currently contemplated, counts on the long term performance of the Project to pay off its equity investment. To the extent that the Project operates below pro forma, it will generate a lesser amount of taxes. This outcome could require that the City raise its tax levy to help pay off the loan required to make the $8 million contribution to the Project.
In conclusion, the proposed relatively low level of Developer equity exposes the City to material financial risks and may also induce the Developer to undertake a Project with more risk than he would if his equity levels were higher.
Conclusions and Recommendations
SB Friedman’s and Patek’s analyses of the information provided by the Developer indicate that the major inputs and conclusions regarding the feasibility of the Project without City assistance are reasonable.
The results of our review indicate that $8 million in City assistance appears to be necessary for the Project to close its financing gap while achieving viable investment returns for the Developer. This reduced level of City assistance would require an increase in the Developer’s equity. To the extent that negotiation between the City and Developer results in City assistance of more than $8 million, the Developer’s returns are expected to be above industry standards for a project of this sort.
Note that, even with the reduced level of City assistance to $8 million the Developer’s equity in the Project (8% of TDC) would still fall short of a typical transaction. Finally, the Developer’s equity would also be less than one-quarter of the City’s equity investment. This structure could lead to the City taking on too much financial risk in general as well as relative to the risk taken by the Developer. Ultimately, this Project appears to have a structural gap between the need for public support and the appropriate level of public support for a Project of this type.
Appendix A
LIMITATIONS OF OUR ENGAGEMENT
Our report is based on estimates, assumptions and other information developed from research of the market, knowledge of the industry, and meetings/teleconferences with the City of Urbana and the Developer during which we obtained certain information. The sources of information and bases of the estimates and assumptions are stated in the report. Some assumptions inevitably will not materialize, and unanticipated events and circumstances may occur; therefore, actual results achieved during the period covered by our analysis will necessarily vary from those described in our report, and the variations may be material.
The terms of this engagement are such that we have no obligation to revise analyses or the report to reflect events or conditions that occur subsequent to the date of the report. These events or conditions include, without limitation, economic growth trends, governmental actions, changes in TIF statute, additional competitive developments, interest rates, and other market factors. However, we will be available to discuss the necessity for revision in view of changes in the economic or market factors affecting the proposed project.
Our report is intended solely for your information, for purposes of reviewing a request for financial assistance, and is not a recommendation to issue bonds or other securities. The report should not be relied upon by any other person, firm or corporation, or for any other purposes. Neither the report nor its contents, nor any reference to our Firm, may be included or quoted in any offering circular or registration statement, appraisal, sales brochure, prospectus, loan, or other agreement or document intended for use in obtaining funds from individual investors without our prior written consent.
We acknowledge that upon submission to the City, the report may become a public document within the meaning of the Freedom of Information Act. Nothing in these limitations is intended to block the disclosure of the documents under such Act.
