Preliminary review of possible tax increment assistance for 101-121 East Main Street and 118 South 2nd Street; by request of Hotel Mankato, LLC.

Review and discussion. The EDA has the following options:

1. Request staff to provide clarification or provide additional information to be reviewed at a future meeting; or
2. Adoption of a motion directing staff to prepare materials for a hearing on October 15, 2024 regarding creation of tax increment district No. 50-1 noting the desired term of the tax increment district and approval of a development agreement after obtaining a preliminary letter of commitment for project financing from a private lender; or
3. Decline to proceed with considering assistance.

The City of Mankato has received a redevelopment proposal for 101 East Main Street, 121 East Main Street and 118 South 2^nd Street from Hotel Mankato, LLC (the “Developer”). The proposal involves demolishing two vacant buildings and constructing two adjoining hotels totaling approximately 250,000 square feet with a total of 282 hotel guest rooms, a rooftop restaurant including an outdoor patio, 168-stall underground parking garage and nine surface parking stalls. At the intersection of Riverfront Drive and Main Street, a four-story extended stay Element by Westin is proposed which will include 126 all-suite guest rooms. At the intersection of Second and Main Street, a 10-story AC by Marriott is proposed with 156 hotel guest rooms. The two hotels would be adjoined by a common lobby with a direct connection to the existing City skywalk, providing hotel guests with direct access to the Civic Center. The hotels will share common guest amenities, including a pool, fitness center, guest laundry, lounge spaces, business pods, and a conference room. A coffee shop at the main level is planned along with a restaurant on the 10th floor of the AC hotel that will include a rooftop patio overlooking the Minnesota River Valley. A courtyard area will be provided between the Element and common lobby with grilling stations, fire pits, and an outdoor social lounge area.
 
The estimated total project cost is $92,710,000 and construction is anticipated to begin in late 2024 or early 2025 and be completed in 2026. It is anticipated there will be a total of 116 full-time equivalent jobs created for both hotels and the rooftop restaurant.
 
The City Council will review a request for a conditional use permit, certificate of design compliance and vacation of an alley for the redevelopment at their August 12, 2024, meeting.
 
Tax Increment Financing Review
 
The Developer is requesting financial assistance in the form of pay-as-you-go tax increment financing (TIF) from the City through the creation of a redevelopment TIF district. The TIF assistance would be used to assist with the redevelopment of the site, including building demolition, site demolition, soil corrections, earth retention, site improvements, site lighting, water, sanitary, storm, dewatering. These are additional costs as compared to developing a “greenfield” vacant site that wasn’t previously developed.
 
The Developer is documenting extraordinary costs that may be eligible for assistance under the City of Mankato’s Economic Development Guidelines. The Developer is seeking TIF reimbursement of up to $16,834,000, which includes costs for building demolition, site demolition, soil corrections, earth retention, site improvements, site lighting, water, sanitary and storm hookups, dewatering, construction fencing, site preparation, parking and other improvements. The request for assistance is summarized in the table below:

 

TIF Application Requested Costs	Amount
Site Development Costs
Building Demo ($215,257 inc. Landmark Prep)	$1,499,000
Environmental & Soil Correction	$175,000
Site Prep, Utilities Reroute, Soils etc.	$4,099,000
Sidewalks & Lighting	$588,000
Site Concepts & Design Fees	$655,000
A&F Fees for Eligible Costs	$649,000
Contingency 5%	$309,000
Carrying Costs, Utilities, RE Taxes, Int	$584,000
Interim Property Insurance	$120,000
TIF & Dev Consulting Fees	$300,000
Subtotal	$8,978,000
Acquisition
CC Hotel	$5,717,000
Landmark Site & Surface Parking Lot	$2,030,000
Closing Costs	$109,000
Subtotal	$7,856,000
Total	$16,834,000

The City also submitted an application to the Minnesota Department of Employment and Economic Development (DEED) for a redevelopment grant on August 1, 2024. The application requests up to $1,859,385 for building demolition, site demolition, soil corrections, earth retention, site improvements, site lighting, water, sanitary, storm, dewatering and construction fencing. The identified TIF-eligible costs and DEED grant costs exceed what the projected tax increment revenues would be from a redevelopment TIF district. It is anticipated DEED will announce grant awards in September 2024. 
 
The City would not upfront the funds as that would require either internal City debt financing or bond issuance. Instead, the developer would receive two payments per year after the property taxes are paid for the term of the TIF District, depending on whether the reimbursable costs are repaid earlier.
This is referred to as pay-as-you-go reimbursement. During the term of the reimbursement, the local taxing jurisdictions will still collect and retain the taxes associated with the original tax capacity as part of ad valorem taxes.
 
The City contracts with Baker Tilly to review financial assistance requests. The table below summarizes the tax increment revenue estimates over 10, 15 and 26 years, and are also detailed within Baker Tilly’s attached financial analysis memo.

 

Tax Increment Revenue Estimates

Existing Land Value	$2,643,400
Original Net Tax Capacity (Base)	$51,368
Estimated Total Completed Value	$24,253,900
Total Tax Capacity	$484,328
Captured Tax Capacity (Total less Original)	$432,960
x 2024 Local Capacity Rate	95.377%
Estimated Total Gross Tax Increment Revenue (less OSA fee of 0.36%)	$411,457
Less: 5% for Administrative Expenses (Maximum Percentage is 10%)	$20,573
Estimated Net Annual Available Revenue	$390,884
Total Estimated Gross Tax Increment (10 years)	$3,884,077
Estimated City Retained (5%)	$194,205
Total Estimated Net Tax Increment (10 years)	$3,689,872
Total Estimated Present Value Net Increment with 5% interest rate	$2,675,964
Total Estimated Gross Tax Increment (15 years)	$5,941,362
Estimated City Retained (5%)	$297,070
Total Estimated Net Tax Increment (15 years)	$5,644,292
Total Estimated Present Value Net Increment with 5% interest rate	$3,665,430
Total Estimated Gross Tax Increment (26 years)	$10,467,389
Estimated City Retained (5%)	$523,373
Total Estimated Net Tax Increment (26 years)	$9,944,016
Total Estimated Present Value Net Increment with 5% interest rate	$5,152,848

The City Council’s policy decision has been to limit the tax increment reimbursements to 15 years to account for the additional tax capacity to be realized before significant depreciation in the asset is realized. The Developer is requesting the maximum term of assistance, which is 26 years. The Developer has stated that the maximum term of assistance will be necessary to attract equity investors and provide desired and market returns as necessary to provide an additional funding source to offset the extraordinary redevelopment costs of the project site.
 
Based on Baker Tilly’s financial analysis (attached) and available financing assumptions, without financial assistance, the project would not be feasible due to the extraordinary redevelopment costs mixed with current market conditions. The analysis found the developer’s return without the proposed TIF assistance is 7.36%, which is below the feasibility benchmark; therefore, Baker Tilly concluded that the project would be unlikely to proceed but for the requested TIF assistance. Baker Tilly also reviewed the estimated impact on project returns with assistance for a term of 10 and 15 years. The projected return on 10 years of assistance is 8.01% and 8.67% with 15 years of assistance. The Developer has indicated that it would fall far below the desired and necessary return threshold and may impact the ability of the project to proceed as proposed. The table below lists the returns without assistance and with assistance over 10, 15 and 26 years.

 

Scenario	Unleveraged IRR
Without Assistance	7.36%
With Assistance (10 Years)	8.01%
With Assistance (15 Years)	8.67%
With Assistance (26 Years)	9.10%

 
Baker Tilly’s financial analysis also included a review of third-party benchmark surveys, which are nationwide surveys of real estate investors, which identify the return benchmarks the responders would need to realize in order to pursue a project. Baker Tilly notes the benchmarks can be used for establishing the likelihood of a proposed project proceeding without assistance (“But-For” Test), as well as the reasonableness of the assistance request. The Price Waterhouse Cooper (“PWC”) Rest Estate Investor Survey was reviewed, which identified a national average of desired unleveraged returns for investment in hotels ranging from 9.00% to 12.00% with an average of 10.5%. The PWC benchmark is a conservative benchmark and represents the responses of major institutional equity real estate investors who are primarily investing in institutional-grade property on a national level. Assistance over 10 and 15 years does not fall within the PWC benchmark, but a term of 26 years would fall within the PWC benchmark.
 
Additionally, Baker Tilly’s analysis included a review of the Debt-Coverage Ratio, which is another measure for evaluating the project feasibility. Baker Tilly found the estimated debt coverage ratios indicate that public assistance will be required to obtain debt financing for the project.
 
The City’s Economic Development Policy states eligible projects include infrastructure improvements and demolition of underutilized industrial and commercial sites to reuse previously developed land/buildings. The project specifically aligns with principle 3.09 “Fostering the successful redevelopment of vacant and underutilized commercial and industrial properties”.
 
In summary, the EDA is asked to review the proposal and provide comments and request additional information if necessary. If acceptable, the next step in the process would be to direct staff as to the desired term of the tax increment district and to obtain a preliminary letter of commitment for financing from the Developer and then prepare tax increment documents for a public hearing. The public hearing could be set on August 16, 2024, for the October 15, 2024, meeting. It is recommended to obtain a preliminary letter of commitment for financing before preparing tax increment documents because there have been recent instances where a TIF District was created, and the project didn’t begin. It results in certified districts that haven’t or don’t proceed. In this case, the applicant has received a preliminary letter of commitment for private project financing. Should staff be directed to prepare tax increment documents, that would also include preparation of documents to decertify TIF District No. 43-1 which was created in 2022 in reference to previous redevelopment plans for the Landmark building (121 East Main Street and 118 South 2^nd Street). A new TIF District would be created to encompass the entire redevelopment site of 101 East Main Street, 121 East Main Street and 118 South 2^nd Street.