Memorandum

City of Lawrence

City Manager’s Office

TO:	David L. Corliss, City Manager
CC:	Diane Stoddard, Assistant City Manager Casey Toomay, Assistant City Manager
FROM:	Britt Crum-Cano, Economic Development Coordinator
DATE:	February 17, 2015
RE:	Response to additional questions by Mr. Stuart Boley

Through an email dated February 17, Mr. Boley asked the City Commission to consider providing the public a more complete understanding of the actual investment returns from the project before approving incentives.

Mr. Boley’s questions appear to be related to the applicant’s comparison of project return rates to S&P and Treasury bill performance at the February 10, 2015 City Commission meeting.  At the meeting, the applicant displayed a handout that showed average annual return rates (on project investment) and cumulative profit over time as well as return rates for other investment vehicles. After obtaining a copy of the handout, and as a matter of course, staff performed additional analysis to check the accuracy of information presented on the handout.  Average annual returns on total project investment matched the applicant’s data.

The below is a response to questions expressed by Mr. Boley in his email.

In his email, Mr. Boley expressed concerns if staff analysis realistically reflects what the cash flow will be given efficiencies of combining the expansion project with the existing hotel.  Applicant provided data for two scenarios: the project operating alone (no efficiencies) as well as it operating with maximum efficiencies.  As per the applicant, non-controllable costs were given in both cases based on cost per occupied room.  Non-controllable costs are not subject to efficiencies as these are costs by the room (e.g. linens, light bulbs, cleaning products, etc.).  Controllable costs (e.g. salaries for front desk staff, sales staff, HR expenses, etc.) can be subject to efficiencies and were allocated, based on percentage, between the existing and expansion portion of the hotel.   Staff ran analysis under three cash flow scenarios: no efficiencies, efficiencies, and an average of the two.  As there likely will be some level of efficiencies gained by running a larger operation, Staff felt the average of the no efficiencies and efficiencies scenarios was a fair way to represent cash flow.  Additional cash flow scenarios for varying levels of efficiency could be examined, with additional efficiency assumptions and data to be provided by the applicant.

A second concern by Mr. Boley was the exclusion of property valuation on project return rates as compared to other investment vehicles. An IRR (internal rate of return) could have captured the appreciated value of the property, but since this expansion is part of a larger building and business, staff felt it was not appropriate to look at the IRR in isolation of the entire building/business (Technical Report, page 23).  In addition, an accurate IRR would require outside expertise in valuing a specialized property type such as a boutique hotel. 

Valuation information for the existing hotel as compared to projected valuation information on the finished hotel (incorporates existing + expanded portions) would be needed to extrapolate an IRR for just the expansion portion. Staff inquired about the cost and time frame for this type of analysis from Integra Realty Resources out of Kansas City.  Integra specializes in the valuation of hotels as well as other specialized property types.  The company estimates a four week time frame for analysis and the price range is estimated at $6500-$7500 (not including any additional analysis requests).

Mr. Boley also had questions regarding if the project would be financed and if returns were based on the total cost of investment or the actual cash investment.   The return on investment provided was a return based on project cost not a cash-on-cash return (return on equity).  Applicant has indicated the ownership group will likely pursue a loan for the project.  However, at this time, the loan has not been decided.  The analysis did incorporate an interest only expense based as loan assumptions provided by the applicant.  (The addition of principal payments would have the effect of lowering cash flow and was not used. Again, an IRR would consider principal reductions.) For reference, returns on equity (cash-on-cash) are shown on the attached for both the efficiencies and no efficiencies scenarios with and without the 15Y, 95% NRA.