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City of Indianapolis Proposes Taking on Role of Banker by Financing a
$155 million Privately Developed, Mixed-use Project
to Include a Hotel; A Move Fraught with Risks

By Jeff Swiatek, The Indianapolis StarMcClatchy-Tribune Regional News

Oct. 05, 2010--A former mayor of Pittsburgh finds it "gutsy." A New York real estate attorney calls it "extremely unusual."

They're referring to Indianapolis Mayor Greg Ballard's proposal, revealed last week, to guarantee an $86 million loan to build a hotel, apartments and office and retail space near Eli Lilly and Co.'s headquarters on the south edge of Downtown.

In essence, the city would be taking on the role of banker by financing the privately developed, mixed-use project. Few cities are willing to go that far.

And, perhaps, for good reason.

The move is fraught with risk, putting taxpayers on the hook for the success -- or failure -- of a $155 million development at a time when there's an oversupply of hotel rooms and office and retail space and most lenders are avoiding new commercial real estate.

"It's a gutsy move by the city," said Tom Murphy, the former three-term Pittsburgh mayor, now a senior resident fellow for the Urban Land Institute in Washington. "But times are unusual, so it's hard to be critical of a city willing to take on that kind of risk."

Ballard's proposal would make the city the mortgage holder on the proposed 14-acre development, called North of South, and guarantee its construction loan with property tax revenues from Downtown tax-financing districts.

In past public-private projects in Indianapolis, such as Circle Centre mall and the JW Marriott hotel, the city became a minority equity investor or financial partner, but it has never backed the main loan with its taxing power on a private project of this size.

The project and the city's role in it still face numerous hurdles, including planning and zoning votes and approval by the City-County Council.

A rare opportunity

City officials see the city's role as loan guarantor in North of South as a rare chance to develop a project that would bring much value to the city and benefit its leading corporate citizen, Lilly, the city's largest private-sector employer.

"The risk of not doing it outweighs the risk of doing it," said the executive director of the Indianapolis Bond Bank, Deron Kintner. "It just made sense here. We don't intend it to be an everyday practice."

City officials say not doing the project would mean losing the estimated 2,000 construction jobs it would create over two years; an additional 200 permanent jobs; $5 million a year in tax revenue for the city, county and state; and the chance to build a 10-building complex on prime undeveloped land linking Lilly's headquarters with Downtown.

Charles Cagann, president of Mansur Real Estate Services, an Indianapolis developer, said "there's no doubt" that Lilly's presence in the project helped sway the city to back it.

The city has rejected other requests for similar city loan deals from other developers, said Cagann, whose company several years ago submitted a proposal to redevelop the former Market Square Arena site.

"We're encouraged the city is considering alternate financing mechanisms with the current situation in the market," he said, but "it puts a project with city backing in competition with everyone else. I don't understand how they (the city) go about selecting this one over other things proposed."

Lilly and its hand-picked developer for the 14-acre site, Buckingham Cos. of Indianapolis, didn't plan to get the city as their lender. It happened only after private lenders turned them down.

"We reached out to the banks," Kintner said. But "the banks weren't very eager (to provide financing), even with a city backstop. We didn't get a firm proposal (from a lender) and we saw how it was materializing and realized we were going to have to do it on our own."

The city also will kick in $9 million in tax money for infrastructure improvements, such as new sewers and sidewalks.

'There is no cheaper time'

How risky could the project be for the city?

At worst, said Kintner, the project wouldn't get built and the city would take over its mortgage and have to find a new developer. Or the project would be built but revenue would fail to cover bond payments.

In that case, Kintner said, the city would tap property tax revenues from the Downtown tax-increment financing (TIF) districts. They were set up years ago to subsidize new developments Downtown (such as Circle Centre), using their own newly generated property taxes together with other businesses' in the district to pay off some of their costs.

The Downtown TIF districts still have unclaimed money available to use as a loan guarantee, Kintner said. TIF money is segregated from the city's general fund and isn't available for such things as schools and police.

Kintner said the city would limit its risk by calling in the long-term bonds used to finance the project after just 10 years. The developer would then replace the bonds with private financing.

The city plans to cover the expected $7 million yearly bond payments with projected profits from the project, plus about $2 million in property taxes it would generate. Buckingham also would be required to set aside $7 million to cover a year's worth of bond payments, Kintner said.

Murphy, the ex-mayor from Pittsburgh, said there's no doubt "you're putting the city at risk."

"I would not, as mayor, have done it (the loan guarantee)," he said.

Michael W. Newbold, president of the Central Indiana region for Huntington Bank, said he thinks the 600,000-square-foot project could pay off if its office and retail space and 320 high-end apartments can be filled fairly quickly after opening.

"I have high hopes that it will be successful. Clearly I think the city made a decision . . . to look toward the future and create a rallying point for redevelopment" on the south edge of Downtown, he said.

Newbold said his bank has made "virtually no" loans to commercial retail or office projects in Central Indiana this year.

Tadd M. Miller, principal of Milhaus Development of Indianapolis, which proposes a similar project with apartments and retail and office space in the empty Bank One Operations Center east of the City-County Building, said the city's AAA bond rating from the nation's three main credit-rating agencies allows it to qualify for extra-low interest rates on bonds.

"We're one of the only triple A bond-rated cities in the country. There is no cheaper time . . . to take advantage of it. You're competing against a lot of cities that are bankrupt."

"I'm just disappointed we are not doing more deals like this," Miller said. "We are watching Carmel kick our butt doing things we should be doing." Carmel is building a $167 million performing arts center backed by a city bond and loans.

Edward Mermelstein, a national commentator on real estate issues who is managing partner at the New York real estate law firm of Rheem Bell & Mermelstein, said Indianapolis' proposal to guarantee a major commercial development "is extremely unusual."

"It's not anything we've seen anywhere else," he said.

All facets raise questions

City and project officials say they designed the project to minimize risk, by spreading revenue among the hotel, apartments, office and retail space, and even public parking garages.

But each of those uses faces weak demand in the current market, except for apartments, which enjoy 90 percent-plus occupancies Downtown.

The 152-room Dolce brand hotel in the project would join a hotel market suffering from a surplus of rooms. The average Downtown room occupancy, which stood at 63.4 percent in 2007, slipped to 59.9 percent last year, according to Smith Travel Research.

The president of Montvale, N.J.-based Dolce Hotels and Resorts, Steven Rudnitsky, said he's optimistic the proposed six-story Indianapolis Dolce will thrive when it opens.

The hotel should enjoy the advantage of receiving substantial corporate bookings from Lilly, he said.

Moreover, Rudnitsky said, hotel bookings are on the rise. "We have every reason to believe . . . occupancies will be well back into the 70 percent range as we run into 2011."

Adding another hotel to the Downtown market "makes hoteliers more nervous" because room demand is so weak, said Phil Ray, general manager of the Marriott Indianapolis Downtown. But he said "it's a good thing" that the city sees hotels as worthy of city support.

Retail space for lease is overbuilt as well, and the North of South project would contain 30,000 to 40,000 square feet of retail space, equivalent to a medium-sized strip center.

The retail space shouldn't be too difficult to fill, considering there is little competing retail space for rent around the Lilly corporate campus, said Steve Delaney, a broker for Sitehawk Retail Real Estate Group in Indianapolis.

Buckingham's senior development executive, Scott Travis, said it will lease the retail space to service businesses, such as a dry cleaners, hair salon or car rental office.

He said he's confident retailers can be lured to the site, given the presence of nearby campuses of Lilly, Farm Bureau Insurance and Anthem Blue Cross-Blue Shield's operations center, which together employ more than 10,000 employees.

The project also contains office space, which at 10,000 square feet will be the smallest commercial use in the project.

It might be the least likely to produce profits, since the plan is to lease the offices to startup companies, including life-science companies working with drug maker Lilly.

It's unclear whether the business incubator office space will be subsidized by Lilly.

Kintner said Lilly has pledged to invest almost $15 million in cash in the project, using money it's due from a city-assisted property-tax-financed project done at its Kentucky Avenue campus in the 1990s.


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