If you build it they will come – helping cities build convention center hotels with the new Build America Bonds - Investment Law Blog

We are just now beginning to see how cities will want to use the new federal stimulus bill to create jobs and build new infrastructure. In the past few weeks, we at JMBM have received several calls from cities seeking to build convention center hotels. Convention center hotels can revitalize downtown areas and generate more revenues for both local businesses and local government services by attracting visitors to the community and providing a place for local events. However, financing for convention center hotels has been difficult to obtain. Will the new Build America Bonds provide the source of financing that will allow cities around the country to build their own convention center hotels? We think it will.

For at least the last twelve years, most convention center hotels have required public incentives and funding support. Several cities have used tax-exempt bond financing to attract investors to their projects, with good results.

We think the American Recovery and Reinvestment Act of 2009 signed by President Obama on February 17, 2009 will provide a new and welcome addition to the sources of financing that may be available to cities seeking to develop their own convention center hotels. Among other things, this Act has created a new type of bond called Build America Bonds that will allow cities to finance hotels at a lower cost than they could achieve with traditional tax-exempt bonds.

What Are Build America Bonds?

Will the new Build America Bonds provide the source of financing that will allow cities around the country to build their own convention center hotels? We think it will.
Build America Bonds were created to provide special incentives to cities and investors to build publicly owned facilities, including hotels. These bonds can only be used by government entities, and the facilities must meet the same operating requirements that apply to tax-exempt bonds. In addition, Build America Bonds can only be issued in 2009 and 2010. So, for cities that have been thinking about building a convention center hotel for a long time, this may be a good opportunity to make it happen.

How Do Build America Bonds Work?

There are two different kinds of Build America Bonds, and they each work differently. One type is called Credit Build America Bonds (or “Credit BABs”) and the other type is called Subsidy Build America Bonds (or “Subsidy BABs”).

The Credit BABs work like this: The city issues governmental purpose bonds that satisfy all the IRS requirements for tax-exempt bonds for a hotel project, and makes an election to treat the bonds as Credit BABs. When the city makes that election, the buyers of the bonds receive a federal tax credit equal to 35% of the interest they receive on the bonds. The interest and tax credits received by the buyers are taxable, but even with that tax the buyers will likely receive a higher after-tax yield on these bonds than they would with either tax-exempt bonds or taxable bonds. Since the buyers will receive a higher yield, the city can offer a lower interest rate than it would normally have to offer to attract buyers. The end result should be a win for the city and a win for the buyers of the bonds.

The Subsidy BABs work like this: The city issues governmental purpose bonds that satisfy all the IRS requirements for tax-exempt bonds for a hotel project, and makes an election to treat the bonds as Subsidy BABs. When the city makes that election, the city will receive a cash payment from the U.S. Treasury equal to 35% of the interest payable on the bonds. The interest received by the buyers of the bonds is taxable, and the buyers do not receive any credit. The city will have to pay an interest rate on the bonds that will be comparable to other taxable bonds, but the benefit is that the city can use the subsidy that it receives from the U.S. Treasury for any purpose, which can be related to the hotel development, but doesn’t have to be. The city can decide what it needs the money for most, and can use the money in the way that it decides.
This is of course a simple explanation, but we think that for any city that has ever considered building a convention center hotel, it is worth spending some time to decide if these new Build America Bonds will make it worthwhile to pursue the project.

What Else Does a City Need to Know About Developing a Convention Center Hotel?

Build America Bonds were created to provide special incentives to cities and investors to build publicly owned facilities, including hotels. These bonds can only be used by government entities, and the facilities must meet the same operating requirements that apply to tax-exempt bonds. In addition, Build America Bonds can only be issued in 2009 and 2010.

There are three main phases to developing a convention center hotel: financing; designing and building; operating. The city needs to work on all three of these phases in parallel with an experienced team of hotel experts.

Financing a hotel begins with a feasibility study to determine how big a hotel should be built, and the amount of revenues that might be generated if the hotel is built. When the feasibility study is complete, the city should talk to an experienced bond underwriter, preferably one who has worked on other convention center hotel projects. At this stage, the city can decide with the underwriter what type of bonds will work for the project, and what other financing terms will be required to get the bonds rated and ready for sale.

For any city that has ever considered building a convention center hotel, it is worth spending some time to decide if these new Build America Bonds will make it worthwhile to pursue the project.
Designing and building a hotel is a project that is best done through a competitive bidding process. The city should distribute a request for proposal to build the hotel project using the feasibility study to establish the size and type of hotel to be built. The city will want a guaranteed maximum or fixed price contract that specifies a completion date, with penalties for failure complete construction by the completion date.

The city will also want to conduct a request for proposal for hotel operators, working with lawyers and consultants who understand both the special IRS requirements for operating a hotel that is financed with Build America Bonds and the market terms for hotel operating agreements. The qualified hotel operating agreement is usually for a 15 year term, so the city needs to make sure that it negotiates the best possible terms with its hotel operator.

Catherine DeBono Holmes is the chair of JMBM’s Investment Capital Law Group, and has practiced law at JMBM for over 30 years. She specializes in EB-5 immigrant investment offerings and hotel and real estate transactions made by Chinese investors in the U.S. Within the Investment Capital Law Group, Cathy focuses on business formations for entrepreneurs, private securities offerings, structuring and offering of private investment funds, and business and regulatory matters for investment bankers, investment advisers, securities broker-dealers and real estate/mortgage brokers. Contact Cathy at CHolmes@jmbm.com or 310.201.3553.