By Joe J. Wallace

Update: On Monday Mayor Winnecke announced a plan to start a downtown hotel by giving an out of town developer a gift of $37.5 Million with $20 Million of that amount as a direct supplement for the hotel itself. The article below is republished from 2010 as a reminder that planning and competence back in 2008 when the first of four rounds of half-baked announcements were made could have avoided the 5 years of false starts and embarrassments for the City of Evansville. In the end the subsidy of $20 Million was predicted to the penny by the article in the CCO years ago. Please recognize that at the time there was hope that the Ford Center would bring enough business downtown to attract a developer without a subsidy. Alas that did not happen and here we are in 2013 being asked to write a check for $20 Million as if it were 2008. In short valuations have not changed at all. The question of real interest is why the people of Evansville will not be 50% shareholders in this hotel as they are being asked to make an investment of 50% of the capital right up front.

Original Article: We all have encountered a time in life when there is something that we desire that just isn’t worth the cost associated with acquiring that object of our affection. It may be a toy for a child, an automotive accessory for a young man, that perfect pair of shoes, or an overpriced bauble of success for a captain of industry. The choice of whether to knowingly and deliberately overpay for what one desires in all of these cases has personal consequences but fortunately these consequences are only personal.

In decisions where taxpayer’s money is involved the consequences are distributed over the population at large, yet the decisions always seem to be made by the few or the one. Such a decision is facing the City of Evansville. The City-County Observer accurately predicted months ago that the Executive Inn would have to be torn down and that the financing for the project would not be secured.

Last week, The City of Evansville came face to face with what I will refer to as the Executive Inn Dilemma when Browning Investments of Indianapolis announced that they will be returning the Executive Inn to the City of Evansville on Monday August 17, 2010 at a meeting of the Evansville Redevelopment Commission. The reasons given were cost overruns due to some structural issues with the building and the fact that they have not been able to secure financing for the project after exhausting their options over many months.

Upon hearing this I did what I always do when curiosity gets the best of me and dug out some books from graduate school and did a little research on the internet. Given the conditions that David Dunn articulated to Dan Shaw of the Courier Press for a 250 room hotel, with rooms that rent for $120 per night, and an average occupancy of 60%, I used these initial conditions and assumed a 3% growth rate for the next 10 years. These assumptions lead to a value for the proposed hotel in the range of $18M to $22M with the variation coming from the efficiency range assumptions of the overall operation.
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Browning is on record from its 2008 announcement that a three star hotel of this size will cost around $35M to complete and that the recently disclosed problems will add several million dollars to the price tag. It is safe to conclude that undertaking this task will require a budget of at least $40M to complete.

A dilemma is a problem offering at least two solutions or possibilities, of which none is practically acceptable. One in this position has been traditionally described in America as being “between a rock and a hard place”. Here is the Executive Inn Dilemma:

• The Centre is Currently Losing Convention and Entertainment Revenue
• When the Arena is Built, Both will continue to Suffer Financially with no Convention Hotel
• Taxes from the Hotel are Committed to Pay off the Arena Bonds
• The Taxpayers were Promised a Three Star Hotel Financed Privately
• The Convention Hotel will Cost $40M+
• The Convention Hotel on Completion will have a Value of $20M +/- 10%

What Are We Going to Do???

First, given the value vs. cost proposition it is highly unlikely that there is going to be a white knight with deep pockets come to the rescue and take on a project that has a high probability of many years of losses and an instant $20M negative hit to the company balance sheet. For the same reason that a solid business like Browning could not find a way to make this happen, other for-profit entities will be quite bearish when deliberating on such an investment.

Secondly, If it is determined that Evansville must have a hotel right now, then the City of Evansville and Vanderburgh County, that owns the Centre are going to have to consider finding some way to arrange for financing for the Convention Hotel. This could come in the form of a bond issue to cover the construction with a leaseback agreement with an operator, a combination loan and grant to a developer, or a combination of other creative financing alternatives. The bottom line is that the City of Evansville probably can find a way to do this. The $40M question then becomes, is it prudent for the City of Evansville to pay $40M for something that has a value of $20M? As odd as it may seem, the answer is maybe. The aggregate economic benefit to the Arena, the Centre, and other Downtown tax generating businesses may just justify this.

The third option as pointed out so eloquently by Mizell Stewart in his Sunday editorial is to wait and see if the Arena delivers on the economic impacts that were so highly touted in the meetings that lead to the decision to build it. It is quite reasonable given the hyperbole surrounding the $128M Arena that it will have a $20M positive impact on the investment potential for a Convention Hotel. If that is the case, in a couple of years a private entity will eagerly embark upon this project.

I did a few more iterations on my valuation routine and here is what is needed to make a 250 room hotel achieve a value of $40M. The Convention Hotel will need to command between $250 and $300 per night and achieve an 80% – 90% occupancy rate. If the Arena can create commercial success that allows the rack rate to double and the occupancy to increase by 50% over the current assumptions, private investors will find this project attractive. That is no small requirement as Evansville has never been considered to be a market for $300 rooms.

Could the Executive Inn Dilemma have been avoided? No, but it could have been known before any shovel struck the ground for the Arena or any wrecking ball hit the Big E. The value calculations did not just appear. The value resulting from the assumptions that have been published has not changed in the last two years. There have been rumors of structural problems with the Executive Inn for many years. A test to have assessed that could have been done. It may have been done. The construction cost has also not changed dramatically. I must conclude that the Executive Inn Dilemma was unavoidable.

What is baffling though is why the analysis and the structural testing were not done three years ago when the planning process was begun. They could have been. If they had been, there may very well be a Convention Hotel under construction right now ready for a fall 2011 opening along with the Arena. A little more planning and testing could have avoided the anxieties of the last week along with any ire that the citizens of Evansville may feel if another bond issue is undertaken.

Evansville has created another classic paradox. Situations like this where the right hand does not know what the left hand is doing are known as Condorcet’s paradox or a paradox of voting. This is where a group of separately rational individuals or project managers may have preferences that are irrational in the aggregate.

Right now, the Big E has got to come down. The prospect of having this rotting reminder standing there looking like a scene from Will Smith’s “I am Legend” where he would capture zombies for medical research is just not an option. The people of Evansville and Vanderburgh County will have nearly $200M invested in the Centre and the new Arena. Both are showcase facilities and deserve to have something of class adjacent to them even if it is just a memorial garden or a park for the time being.

Notes for the Curious: I have included two websites below that are good tutorials on valuation methods and the equations used to reach valuations. For those who are curious and mathematically inclined valuation is a good skill to have as the same principles apply to parking garages, rental properties, and lease based capital equipment. Enjoy!!

http://www.hvs.com/Bookstore/HotelValuationTechniques.pdf
http://www.entrepreneur.com/tradejournals/article/120350582.html