Failed TIF projects in the St. Louis region have been abundant over the past few decades and include projects such as the St. Louis Mills Mall, Renaissance Hotel, dozens of luxury loft projects and the St. Louis Centre. This summer the City of Maryland Heights (the “City”) issued over $55 million in bonds and contributed over $5.8 million in cash to fund a best in class ice sports complex (the “Complex”).
The lazy way in which this transaction was structured, the reliance on unpredictable revenue streams and the poor vetting of private operating partners could potentially make the Complex the worst publicly funded development in the region’s history. This post will take a deep dive into the three most glaring mistakes made during this project and discuss alternative methods local governments can use to prevent these issues in the future.
The Importance of Accurate Revenue Projections
The debt service coverage ratio (“DSCR”) is among the most common metrics used to gauge the quality of non-rated municipal revenue bonds. The ratio is determined by dividing total profits available for debt service by total annual debt service and provides a simple way to determine how short actual profit can fall vs. projected profit without creating a cash flow shortage.
The DSCR in Figure 1 of 1.06 indicates that actual profits can fall short of projections by as much as 6% before the Complex will not be able to make principal and interest payments to its lenders. This is substantially lower than the industry average DSCR of 1.25 making the margin for error very thin. Financial projections are only as valuable as their accuracy and a review of the feasibility study performed by HVS Convention & Sports Entertainment Consulting shows the Complex will be reliant on extremely unpredictable revenue sources which will likely vary significantly from projections.
In order to assuage lenders that the Complex would have the ability to repay them thee City agreed to pay $175,000 a year for “public usage costs” and to annually appropriate up to $625,000 from general fund revenues to fund any cash shortfalls resulting from project revenue falling short of estimates. In addition to the $5.25 million in public usage fees that could have been used to fund other City projects this risky and unusual commitment of general fund revenues to fund shortfalls exposes the City to as much as $18.5 million in additional contributions over the next 30 years.
The feasibility study reveals that almost half of the projected revenues come from historically unpredictable and erratic sources that are reliant on a handful of tenants whose loss could require the City to make the entire $625,000 contribution every year to avoid financial default. Three of the most unreliable revenue sources used in the feasibility study are discussed in further detail below.
Ice Rental Fees of $2,207,400:
Ice rental fees make up the largest source of projected revenue for the complex. Rental fee projections are almost entirely reliant on the Complex Operators ability to sustain long-term thriving relationship with five tenants who generate over 80% of rental fee revenue. Per feasibility study “all tenant leases will be subject to multiple renewals. The prospect of non-renewal remains a significant risk…There is also no assurances that tenants’ hockey programs will operate as they do today. University, high schools and youth programs may disband or significantly reduce their ice time needs”. Three of the big five tenants do not have enough assets to fund one year of their rent commitments and the St. Louis Woman’s Youth Hockey Association does not have enough funds on hand to fund even one month of payments. The chances that none of these tenants choses to relocate to one of the thirteen other ice skating facilities in the region (or any new facilities built after the Complex) and remain financially solvent through three decades is slim to none making a cash funding shortfall all but inevitable.
Advertising and Sponsorship Revenues $937,700: According to the feasibility study advertising and sponsorship efforts are in the “early stages” and “once secured, advertising and sponsorship agreements have relatively short terms (up to five years). There is risk that multiple renewals over the course of the debt service term will yield lower revenues as the building ages”. The report also states that “the cost of securing sponsorship renewals can also be significant”. The operating partner has not secured any advertising or sponsorship contacts to date and once secured these contracts typically span five years or less. The inability to secure or maintain an agreement with a lead sponsor will create a cash shortfall which will continue until an agreement is put in place. As a new state of the art facility used by the St. Louis Blues it should be relatively easy to secure large sponsorship agreements before the Complex is complete. The chances that there is no time over the next 30 years that the Complex is without a lead sponsor and that demand for this type of sponsorship continues as the project ages and faces competition from new facilities is slim to none. This represents another area in which revenues are likely to fall short of projections at some point over the next three decades.
Grant Revenue Contract Expiration: The feasibility study states that it assumes “a steady rate of long-term growth” after all sources of revenue reach their full potential. In order to achieve this growth rate in 2021 after the loss of $165,000 in grant revenue the facilities operator is required to generate a growth rate close to double that of every other year. No explanation is provided to explain how this will be achieved. In the absence of valid explanation the City’s revenue projections are likely overestimated by $165,000 (or 5%) reducing the DSCR in 2021 tot 1.01.
When it became clear that the Complex was unlikely to meet financial projections over the life of the project the City should have downsized the project or required private interested to provide additional equity funding until they were able to find willing lenders without providing a financial backstop in the event of a cash flow deficit.
Reliance on an Inexperienced and Under Capitalized Operating Partner
Given the unreliable nature of the Complex’s revenues and significant cost to the City if projections are not met the financial benefit from conducting a formal process for soliciting and vetting the private organization selected to operate the facility is substantial. Going through a formal request for proposal process is common practice when a government entity is contracting with private entities . An example of the potential criteria used to select an ice sports complex operator is provided in Figure 3 courtesy of Charles County Maryland.
Instead of using a form selection process the City selected the first and only organization that presented a proposal to operate the facility. The St. Louis Legacy Ice Foundation (the “Foundation”) has no prior operating experience of any kind, no full-time employees, a volunteer Board made up of former youth hockey players and very limited financial resources.
Return on Investment: Risk vs. Reward Dynamics
Committing significant capital to fund a risky project that could deplete the City’s general fund by over $18.5 million can only be justified if the project has the potential to generate unusually high returns. Figure 4 shows that in the unlikely event that projections are 100% accurate the project is only expected to provide 1.5% return on direct investment. These projections assume prime ice time is utilized 83% of the time it is available. In a best case scenario this utilization rate would reach 100% generating a 20% increase in projected excess cash from the project.
- The fact that the ability to increase profits with increasing demand is capped by the limited availability of ice time makes the upside of this project significantly less than the upside associated with retail, restaurant space or service offices, etc.
- Forgoing self management in favor of hiring a private operating partner limits the potential of the City to generate revenue from operations.
- The projects location (which is in a flood plain, adjacent to a casino, 20,000 seat outdoor amphitheater) limits the affect its development will likely have on spurring additional development in surrounding areas limiting the upside from indirect tax revenue generation.
- The fact that only 7,600 Missouri residents (less than 0.1% of total residents) play an ice sport severely reduces the amount of residents who will benefit from the project vs. libraries, museums and parks that can be enjoyed by the majority of the population.
The City of Maryland Heights provided an up-front cash contribution of $5.8 million secured $55 million in loans through the issuance of municipal bonds making up over 80% of the total cost a project that serves only a small portion of the community, has relatively limited potential to spur surrounding development and is expected to generate a return on investment significantly lower than the return from investing in 30 year treasury bonds. When these characteristics are combined with the less than 8 month time period from initial proposal to project funding it is clear leadership at the City of Maryland Heights placed expediency over financial safety and/or return on investment.
Local governments are commonly criticized for in either investing in risky projects, contributing too high a percentage of total projecting funding or giving up too much future tax revenue to fund a project. Data driven reasoning for failing in one of the above mentioned area can provide a valid explanation in many of these cases. However, the City of Maryland Heights is among the worst offenders in the past decade in all three of these areas and this can only be explained by incapable or lazy leadership that should not be tolerated no matter the size and scope of the local government entity.
In order to prevent the use of general tax revenues to fund ancillary recreational facilities local governments should ensure only conservative revenue projections are used, require these revenues to be at least 125% of debt service costs in every year of the project and avoid allocating general government revenues to fund project deficits in all circumstances.
A private developer or operating partner should not be given $1 in public funding until going through a public request for proposal process to select the most qualified and financially stable team available. The structure of the financing should ensure private partners up-front investment and share of annual losses are sufficient to align the financial interests of the private and public partners involved in any project. The Foundation was not required to provide any equity up front and did not share in operating losses in any manner.
The return on investment in the form of direct tax revenue generated, indirect tax revenue generated from surrounding development spurred by the project and benefit to residents as a whole should be compared for all project alternatives.
Any project that does not contribute to attracting and maintaining optimal residents whose disposable income and lifestyles increase demand for best in class mixed-use, residential and commercial development within the community should be declined without further discussion.
An experienced tax incentive adviser should represent a local government in addition to traditional advisers to ensure a fair allocation of risk, capital commitment and benefit between private and public interests.
ALL DATA CITED FROM OFFERING DOCUMENT FOR BOND FINANCING