HDA Plan Rejected; City Loses $300k a Year

Update 9/30/2024:

I made a mistake in estimating the tax revenue impact of this project. While I originally estimated the city would have brought in $900k in annual tax revenue from the project, upon further review, the impact would have likely been closer to $300k annually.

For transparency’s sake, I would like to thoroughly explain what went wrong and how. The problems stem from my interpretation of this table, which I used to estimate annual hotel revenue.

I calculated that total revenue estimate using the following well-established formula:

Gross Profit Margin = (Gross Operating Profit / Total Revenue) x 100

We’re trying to solve for total revenue and we have the rest of the figures we need, so we simply plug everything in and solve for x to get total revenue in year 5:

10.4% = ($4,169,760 / x)*100

x = $40,093,846

Multiply that total revenue estimate by 0.015 (the city’s 1.5% sales tax rate) and you get an annual local sales tax revenue estimate from the hotel portion of the business of $601,407.

I figured that maybe hotels were just very low-margin businesses where the actual profits were modest (~$4m), but the gross revenue pre-overhead (the part that sales taxes get assessed on) was really really high (like ~$40m). Unfortunately, as one of my readers pointed out in the comments, this 1) does not pass the smell test and 2) is not compatible with the total revenue suggested by the other rows of the table.

Here’s another way we could use the table to estimate total hotel revenue:

Total Revenue = Average Daily Rate * 74 hotel rooms * 365 days * estimated occupancy

Plug in our figures…

x = $234 * 74* 365 * 0.72

x = $4,550,644.80

$4,550,644.80 * 1.5% gets you just $68,260 in local annual sales tax revenue.

$601k and $68k are two very different numbers, but both are derived using 1) correct formulas and 2) correct figures. So what went wrong? Well, I contacted the developers and asked. The problem is that the bottom two rows (gross profit and gross profit margin pertain to the full development including the sale of the 60 condos included in the project, whereas the ADR, REVPAR, and Occupancy pertain only to the hotel itself. Not how I would design a table, but alas, a discrepancy I should’ve caught.

So where does that leave us? Well, $68,260 in local sales tax revenue from the hotel plus $136k from the project’s street-front retail components, plus $15k in property tax revenue to the city gets you ~$220k to the city (and SBD). Then I think you sprinkle in another $80k from hotel revenue derived from other sales (the hotel bar, a gift shop, room service, banquet space rental, etc) and you get to somewhere in the ballpark of $300k in annual tax revenue to the city. The school district would get ~$150k annually, the Downtown Kirkwood Special Business District ~$10k, and the library district ~$7,500. $300k is not $900k but it’s still a whole lot more than $0.

Apologies for the mistake; I won’t happen again!

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Original Story:

Last Winter, Kirkwood City Council asked for development proposals for two city-owned lots in the heart of downtown, offering fairly strict criteria for what they wanted to see. They received six separate responses that broadly met that criteria. All six were rejected. Instead we’re left with this:

And this:

Together, the two lots generate $0 in tax revenue for the city, not even enough to pay for their own asphalt. I’ve covered four options for what we could have had instead. Here’s a look at Rejected Project Number 4.

HDA’s Proposal

In short, HDA Architects, in collaboration with Mashburn and Horizon development groups, submitted an RFP response that would have added 74 boutique hotel rooms, 60 condos, more than 16,000 sqft of retail space, and a net increase of 172 parking spaces across two buildings in the heart of Downtown Kirkwood. As submitted, both structures were in full compliance with the city’s existing zoning code.

The HDA submission also came with extensive renderings so we have a pretty good idea of what this thing would look like. Amongst the West Jefferson (i.e. the hotel) design details included in the submission packet:

• A central public courtyard/plaza with covered walkways that could be utilized for community gatherings or spill over of the adjacent retail spaces
• 27′ ceilings in the hotel’s lobby
• “A large digital board in the lobby highlighting Train Station information, Kirkwood shops, restaurants, and nearby attractions like the Magic House, Kirkwood Performing Arts Center and Grant’s Trail”
• A mezzanine level featuring a sleek bar overlooking the lobby
• A residential component on the top three floors comprising “a mix of unit sizes, some of which include private balconies and views of downtown Kirkwood.”
• A subterranean level featuring 76 parking spaces “and additional space that could be utilized as a fitness center or extra storage.”

The East Jefferson parking structure obviously sparkles less (at the end of the day, it’s still a parking garage), but it’s at least good to see the garage fronted by ground floor retail to try and liven up the pedestrian experience a bit:

The project seems to check a lot of boxes for the city:

• Attract a boutique hotel to Downtown, something literally listed as a goal in the city’s strategic plan ✅
• Build more homes downtown to improve options/attainability for residents, another thing literally listed as a goal in the city’s strategic plan ✅
• Add more parking in Downtown Kirkwood, something that is not a goal, but which most people think should be ✅

So what’s the issue? Well, again, I think the only conclusion we can come to is that the current Council does not believe in the strategic plan or perhaps have usurped its goals with goals of their own. Ones like “don’t let any more development in Downtown Kirkwood, especially if it’s right next to a nice house I built there.” If the issue is the aesthetics of the thing, the city had an unparalleled level of leverage to have one of the region’s top architecture firms redesign the project in a way they approved of. Instead of that, though, the Council decided to just go with the two parking lots thing again.

Financing & Impact

One thing we have not really explored in our review of these responses so far is the use of tax incentives in the financing package. The full estimated cost for HDA’ project was $48 million, of which $8 million was supposed to come from tax incentives provided by the city. Using some deduction, let’s talk a bit about what is meant by “tax incentives” and what their use here reveals about the overall fiscal impact we could expect the project to have on the city.

Again, I’m not an expert here and all I have are a couple of line items of a sources and uses table, but here’s what I think is going on. The most straightforward application of tax incentives is a vehicle known as tax increment financing (TIFs). Kirkwood has used Tax Increment Financing before to facilitate the construction of the Kirkwood Commons (home of Target) in the wake of the Meacham Park annexation. Here’s (briefly) how TIFs would work on this project:

1. The two Jefferson parking lots currently (infamously) generate $0 in tax revenue for the city
2. If we allowed a private developer to build on the lots, the property would begin to generate tax revenue for the city
3. Because Kirkwood is guaranteed this future tax revenue, the city can go to a bank and say “look, give us $8 million now, and once this thing gets built, we’ll pay that $8 million back to you (plus interest) using the tax revenue we think these properties will generate in the future”
4. The bank says “sure, sounds great,” and hands Kirkwood the $8 mil.
5. Kirkwood takes the $8m and uses it to help finance the parking garage or other needed infrastructure for the project, thus reducing the costs to the developer
6. Once the full project (both lots) is complete, the developers pay tax revenue to Kirkwood each year like they usually do
7. Instead of the money going into the City’s general fund, 50% of it goes to the Kirkwood School District and the other 50% is used it to pay off the bond (plus interest) the city got from the bank
8. Once the full bonds are paid off, the tax revenue generated by the property is just treated like regular tax revenue.

Now, it’s a little more complicated than that. The city doesn’t really guarantee the bond itself, but rather works through an intermediary entity known as a “TIF District” (that way the district is on the hook financially rather than the city itself, thus eliminating any risk to Kirkwood itself should the tax revenue not come in as anticipated), but that’s the gist.

So, is the use of TIF here a bad thing? Well, legally, TIFs are only supposed to be granted if they fulfill what is known as a “but for” test. That means if the project is something that would likely be built even if you didn’t grant the TIF, then there’s no need for the tax break and you’re not supposed to give it. When we apply this test to the HDA project, the boutique hotel/apartments West Jefferson portion of this project seems very likely to fail the but-for test (i.e. it seems very likely profitable), but the parking garage passes the but-for test. Parking garages are expensive to build and we currently charge $0 for parking in Kirkwood, so building one, even with some added ground floor retail revenue, does not pencil out financially without public subsidy.

The other thing these financial details allow us to do, however, is model how much tax revenue the city could expect the project to generate, much like we did with the PJ’s proposal previously. And guess what? It would be an absolute cash cow:

By year 5, the developers expect the boutique hotel alone to bring in ~$40 million in annual sales. Using Kirkwood’s 1.5% local sales tax rate, that figure gets you somewhere in the ballpark $600k in local sales tax revenue annually from the hotel alone.

Then, if we factor in the sales generated form the project’s 16k sqft of ground floor retail space across both the parking garage building and the hotel building using PJs sales-per-sqft figures as a rough estimate, we’re looking at another $136k in annual sales tax generated from extraneous retail space.

Estimating property tax revenue from the two sites is a little more difficult, so I’ll just recycle the PJ’s project’s annual property tax estimate of $180k per year (the PJs site included more acreage property but this project likely would have been assess higher).

When we add in the property tax revenue, the boutique hotel sales tax revenue, and the retail sales tax revenue, we’re looking at a total annual local tax revenue estimate of ~$917,400 per year.

Remember, Missouri stipulates that half of that ($458.5k) will go to the Kirkwood School District while the TIF is in place, and the rest goes towards servicing/paying off the debt. In Missouri, these TIF arrangements can only last a maximum of 23 years (after which the TIF dissolves and the Bank is on the hook for any outstanding debt with no risk to the city’s credit rating), so as a spot check on my estimate, we can make sure that these estimated tax revenues line up with paying off the $8 million within the 23 years.

If we divide the initial $8 million debt by the $458.5k annual revenue that I estimate will go towards servicing it (remember, the other 50% of the tax revenue has to go to the school district), we can calculate that it would take about 17 years to pay off the $8 million principal leaving you 6 years to pay off the ~$3m in interest that accumulated over that time (assuming interest rates fall a bit going forward/we can refinance like we did at the Target TIF). That sounds about right to me and indicates to me that the $917k annual local tax revenue estimate is in the right ballpark.

That is an incredible amount of revenue for the city, library, the Downtown Kirkwood Special Business District, and the school district in the long run. Sure, under this scheme, we’d have to use a big chunk of that money to pay back the debt on a parking garage but that’s just because the city prioritized a parking garage here. You could just do the hotel/apartments West Jefferson part of the project and make 95% of the same revenue and not have to service any debt. Most of which would come from non-residents spending money on stays at the hotel.

An additional $600k+ (stripping out the school, library, and special business district portions of the tax revenue) paid directly into the city’s coffers each year by people who mostly don’t live here, send their kids to school here, or consume almost any city resources would be a massive boon to the city. When you consider that those hotel visitors are disproportionally likely to spend their money at other Kirkwood business (travelers eat out more and shop more than locals) and generate even more tax revenue, the picture gets even rosier. And when you realize we’re really just talking about the impact of putting one empty lot to a more productive use and we could do the same thing on a lot of other city-owned empty lots and have millions of more dollars for the community to show for it, it makes you start to dream?

How should we use all that tax revenue? For a community center actually worth of the Queen of the Suburbs? To repave our roads without raising tax rates of folks, like the city is currently planning to do with TDD? To fund the pensions of our firefighters and police officers? To build more parks? There are endless, complicated answers. But none of those answers are possible unless the city first gives a very simple one: “Yes.”