After putting $25M into Conrad, city finally will conduct audit

September 3, 2007

The city plans to hire an outside auditor in the next few months to review the books of the Conrad Indianapolis and determine how its investment is performing.

It's a routine process, Mayor Bart Peterson said. But it's one hotel-industry experts say is overdue. The city ponied up $25 million toward the $100 million Conrad project, yet has received no formal reports on performance since the hotel opened 18 months ago.

The city owns the equivalent of an 8-percent equity stake in the swanky hotel at the corner of Washington and Illinois streets. Yet the agreement does not require regular reports--a standard method of monitoring taxpayer investments in hotels.

"I'm firmly of the opinion that hospitality needs government subsidy, but I'm also of the belief that the public deserves to know how its public funds are being invested and how successful those investments are," said Bob Swerdling, managing director of Los Angeles-based investment bank Piper Jaffray, which works on publicly financed hotel deals across the United States.

Of the $25 million public investment in the Conrad, $3.75 million was added at the last minute as part of a so-called participation agreement that provides the equity stake.

City officials say they believe the 23-story project is performing fine, based on anecdotal reports they've received from the hotel's controlling owners, Circle Block Partners, a group led by the founders of Kite Realty Group Trust.

But the deal puts the onus on the city to seek performance and revenue data. For several months, IBJ has been asking city officials about the arrangement, which hospitality consultants say is unusual.

Peterson said the reviews by an independent accounting firm will ensure the city's interests are protected. He said the reviews will produce tracking documents, but he could not say whether the city would consider them public records.

The city wanted to give the hotel a 15- to 18-month period to "stabilize" before conducting the review, as hotel investors typically don't expect much of a return during the first few years. The process will be similar to audits of other properties in which the city has a stake, including a handful of downtown parking garages.

Agreement's origin

It's not unusual for local governments to fill funding gaps for hotel projects, either through tax abatements or direct cash infusions, in the interest of attracting visitors and creating jobs.

But hybrid models such as the Conrad arrangement are rare. Originally, the deal called for only a direct subsidy. But the developers came back after negotiations had ended and said they needed more equity to build the project, Peterson said.

"We told them, 'We've already cut the deal,'" Peterson said. "We didn't want to give them all the equity. It would be an investment instead."

The city's portion of funding for the Conrad comes from revenue from two parking garages, the Circle Block garage next door to the hotel and the World Wonders garage at Circle Centre, said Barbara Lawrence, executive director of the Indianapolis Public Improvement Bond Bank.

The agreement provides for a participation right, which is a step below an outright equity interest. The participation right entitles the city to a share of profits on financing, condemnation or distributions, said Tom McGowan, one of the hotel owners and the chief operating officer for Kite.

"I give credit to the city in coming up with a creative way they could participate in the long-term upside of the asset," McGowan said. "I believe it to be a prudent model for the city to utilize."

The contract gives the city the right to review the hotel's books, as opposed to receiving regular reports, in part to prevent the release of specific information that could put the hotel at a competitive disadvantage, McGowan said.

Enough information?

Preventing the broadcast of hotel performance is a legitimate concern, but there are plenty of line items, including total revenue, that could be shared without fear, said Rob S. Hunden, president of Chicago-based hotel consultant Hunden Strategic Partners.

Regular reports, for example, are required of the owners of Circle Centre mall. The annual updates include occupancy rates and sales-per-square-foot statistics. The city pitched in $187 million for Circle Centre.

"You would expect they would follow an example like that, where there would be some sort of reporting," said Hunden, whose experience includes a stint at the Indianapolis Bond Bank, where he worked on the development of downtown's 615-room Marriott hotel. "It makes me think they were not well-advised when they set up the agreement. If I were a citizen of Indianapolis, I think I would be a little concerned."

Lawrence, of the Bond Bank, is not concerned. She said the city is comfortable with the information it has received on the Conrad.

"The Bond Bank has taken the approach that it's a new product in the city and it needs to be established, given the opportunity to go through the full marketing cycle and becoming an established name and presence," Lawrence said. "We talk on a regular basis; we share information about the market and about what's going on at the property."

She said verbal updates haven't contained anything alarming, just early stumbles typical of hotel properties. IBJ reported in December that the 241-room hotel was on pace to finish 2006 with average occupancy of about 50 percent, well below the downtown average of 65 percent. The Conrad also was plagued early on by an underperforming restaurant, du Soleil, that has since been replaced by Capital Grille. The hotel's performance has improved since then, city officials say.

Neither the city nor the hotel owners would share specific performance data with IBJ. A city attorney, responding to a May public records request, said the city has no documents tracking the hotel's performance or the city's stake in the hotel.

One of a kind

For now, the Conrad deal is one of a kind.

The city would consider a similar arrangement again if it is a good deal for taxpayers, Peterson said. He said the city hopes to take an "upside stake" in a new JW Marriott convention hotel, which will get $48.5 million from the creation of another tax increment finance district. But he said that deal likely will not involve a direct stake like with Conrad.

Swerdling, the Piper Jaffray consultant, said the Conrad deal is great on one hand, because the city demanded a return for its investment. But the city didn't follow up with a reporting mechanism.

"No equity investor I'm aware of would not require regular reporting or the ability to get reports when it wants to," he said.

Mark Eble, a hotel consultant and regional vice president for Philadelphia-based PKF Consulting Corp., said it isn't fair to compare the Conrad stake with other types of investments, say mutual funds, since the city is looking for more than tangible results: It's trying to attract visitors who might have overlooked Indianapolis in the past.

"The city didn't do it because they thought they would make a million bucks," Eble said. "They did it because they thought they could improve the profile of the city."

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