By Gregg Rockett and Jeff Sachs
Part One: Despite evoking controversy at many levels, the wheels are still firmly on the rails as it relates to public ownership of hotels
The legacy of public sector whole-ownership of convention hotels extends several decades but became more prevalent in connection with provisions of the 1997 U.S. tax code (Revenue Procedure 97-13). These revisions facilitated clarity on the safe harbor status of management agreements related to facility operations financed by tax-exempt bonds.
The first convention hotel to open following the revised provisions was Chicago’s Hyatt Regency McCormick Place, developed and owned by the Metropolitan Pier and Exhibition Authority (MPEA). Since then and through 2014, there have been some 30+ hotel developments undertaken and owned by the public sector – most as a complement to convention centers, but also in connection with gateway airports.
Public subsidies to attract different industries and promote economic development have been extended– whether it be to incentivize the establishment of technology industry, automotive manufacturing or relocation of a major employer, the practice is now common place and generally scrutinized.
When it comes to sponsoring and funding events to encourage commerce, government involvement extends back to the establishment in the 19th century of the international exhibition (or World’s Fair). The building of convention centers to facilitate large group meetings in cities began in earnest in the mid-20th century and the very foundation of which became an inherent subsidy as competition for large events led to discounting of convention space to protect market share.
Before long, maintaining a competitive advantage in promoting conventions necessitated access to adjacent hotel accommodation. However, the economic viability of large, urban full-service convention hotels began to erode due to three factors: the effects of 1980s tax-reform, the devaluation of assets following the Savings & Loan Crisis in the 1990s and the disruptive impact arising from affordable, select-service hotels. As private sector interest in funding large-scale convention hotels became challenged, the public sector increasingly became involved in helping to underwrite these facilities with incentive packages to “bridge the gap”. Additionally, increased construction costs and higher yield requirements of private investors extended that feasibility gap, which often leads the public sector to become the lender and/or owner of last resort if the convention hotel is to become a reality. In effect, convention center ownership has, in many cases, obliged the public sector to get into the hotel business.
As can be the case with any public sector involvement in private activities, there is a well-documented stigma associated with the motivations of the public sector to be directly involved in the ownership of convention hotels. Documentation – both academic and journalistic – of the public sector’s perceived ill-considered decision to become a hotel owner and the related pitfalls is extensive. Naturally, the literature skews toward the imprudence of these decisions and more often than not, highlights the negative and extreme examples.
The controversy ranges from an apparent lack of transparency in the undertaking of the project, to poorly resourced processes manipulated by biased stakeholders and lamentations over unrealized expected benefits of the initiative.
The recurring argument centers on whether the public sector should involve itself in a project that is generally the domain of the private sector. However, this argument ignores that public ownership has longtime been a socially acceptable means of spreading wealth, particularly when it emphasizes benefits to the underserved. For example, the development of public parks and performing arts centers that instill civic pride or enable development in underprivileged neighborhoods are deemed worthy initiatives, but the sentiment rarely extends to a public works project that can be considered a destination improvement initiative, particularly if it is perceived to represent unfair competition to the private sector.
An additional criticism focuses on whether the public sector is appropriately equipped to effectively undertake a project that is the domain of the private sector. The reality is that there are influential stakeholders in any initiative, whether public or private. Neither myopic processes nor imperfect execution of complex projects is the exclusive domain of the public sector. The fact is that in recent years, many processes associated with the undertaking of a publicly owned hotel has created collaborations between motivated and informed public officials and private sector talent that understands the industry.
Possibly the most strenuous condemnation is that these projects have over-inflated projections of the benefits that will accrue from the development of the hotel. There are valid examples of overly ambitious expectations that do not materialize for unforeseen reasons. But in the case of a complex undertaking such as a convention hotel project that has endured a decade or more of development planning, likely over more than one economic cycle, the underwriting is unlikely to be watertight. The prospect of variable outcomes that are the reality of business cycles should be part of the underwriting, not a de facto deterrent to moving forward with the project.
Inevitably, the scrutiny begins with an assessment of the most expected benefit of the development of the convention hotel – incrementally more convention business. Anything less than this outcome will invite a presumption of flawed underwriting. Unfortunately, it can be an easy target as public officials invite this criticism by over emphasizing this prospect as the overarching goal, when there are other considerations that the critics don’t appreciate or understand, and the stakeholders should be emphasizing.
For one, the absence of the convention hotel can lead a convention group to choose another destination that offers a convention center and adjoining headquarters hotel. The ensuing admonishment that this represents “throwing good money after bad” does not appreciate that a changing market can require investment just to maintain a competitive position. And while this evokes anecdotal references to an unending “arms race” that is the convention business, resisting or ignoring destructive market forces is not a viable management strategy.
The convention market has also evolved in such a way that not all groups desire to hold an event in a convention center or exhibit hall. The headquarters convention hotel typically caters to a large component of in-house business that can easily represent more than half of the overall convention and group business accommodated in these hotels. It is also not unusual for parallel events to occur during a city-wide convention event that purposely seeks out the adjacent hotel facility to leverage the activity of the convention for one reason or another. Arguably this should be considered incremental business that a simple head count of the convention center business will ignore.
Groundhog Day or a New Enlightenment
While adverse media coverage of public sector sponsorship of headquarters hotels to support a convention center is extensive, a review of academic journal publications on the subject is not as widespread, but is almost overwhelmingly negative. It’s reasonable to expect that this well-documented opposition over more than twenty years would discourage public ownership of hotels, but the tendency to pursue the option as a method of last resort persists.
For example, in order to solidify its candidacy to host the Republican National Convention in 2016, Cuyahoga County and the City of Cleveland partnered to undertake the development and ownership of a 600-room Hilton convention hotel. Public officials and local stakeholders that included the Convention and Visitors Bureau (CVB) and a coalition of downtown businesses wanted this headquarters hotel to complement the new Huntington Convention Center and the Global Center for Health Innovation. These projects were spawned from the continued efforts to revitalize downtown Cleveland as a means to reverse decades of declining population and stubbornly high poverty rates.
Similarly, the City of Des Moines and Polk County created an urban renewal plan centered on the under-developed areas surrounding the Iowa Events Center (IEC). The lynchpin was a headquarters convention hotel, which would activate the southern quadrant of the IEC and link this events district with the core of the downtown business district. After attempts to solicit interest from the private sector without success, the public stakeholders undertook development through a unique P3 initiative that resulted in Polk County owning a 330-room Hilton convention hotel through a quasi-private entity.
A third example is the City of Chicago, through the Chicago Department of Aviation (CDA), determining that it was in the public interest to convert a decades-long leasehold interest in the Hilton O’Hare Airport into a management agreement at the 2017 year-end termination of the lease contract. The CDA’s airport modernization plan envisions the creation of a premier gateway airport facility, which the City determined would include the existing Hilton and a new luxury hotel at Terminal 5. Retaining full-ownership of the hotel and the related full cash flow (as opposed to a percentage rent) was considered fundamental to a repositioning plan for the airport’s amenities.
Other public entities that have recently decided to become hotel owners include San Francisco International Airport, which will open a 351-room Grand Hyatt this year, and the Georgia World Congress Center, which is in the advanced design phase for a headquarters convention hotel to be operated by Hilton. The Chicago MPEA opened a 1,205-room Marriott Marquis in 2017, the second convention hotel to be owned by the authority. The City of Columbus, pleased with its initial investment in the 532-room Hilton convention hotel opened in 2012, has approved the investment in an expansion of the hotel to 1,000 rooms.
However, the opposition and controversy does not wane as more public authorities get in the business of hotel ownership. Does each new project represent a perpetuation of public folly or the evolution to enlightenment? The second part of this article will address important factors in support of the public authorities that choose to own convention hotels.