The Hyatt Hotel: a Classic Public-Private Partnership

In order to create the successful recreation and leisure project that was envisioned by the Inner Harbor Master Plan, in the 1960's and '70's, Charles Center-Inner Harbor Management, Inc. had to recruit a top-of-the-line hotel. This took more time and effort than any other aspect of the project, because the existing hotels in Baltimore were failing for lack of business — the effect of the decline of the central city. This turned out to be the most demanding and dramatic of all our tasks.

Under the urban renewal program, all acquired land had to be disposed of in a competitive fashion; so I went to all of the national hotel chains to see if they would participate in a competitive offering of the hotel site. I was turned down by all of them, until we finally combined the hotel opportunity with a prominent office building site — with the idea that a successful office building would subsidize the hotel development.

That worked, and we did attract the interest of prominent developers, but it was still a hard package to create. Before we found a commonality of purposes with the Hyatt chain, we had gone through competitions that resulted in conceptual deals with two other high-profile development teams, who brought in top-of-the-line architects but failed to perform. I was finally told to talk to the owners of the Hyatt chain because, as one hotel executive told me, "they're more sporting than the rest of us."

That turned out to be true, but it still took almost an entire year to put a workable deal together. That was done through the genius of the City's attorney, Eugene Feinblatt, combined with the acumen of A.N. Pritzker, the patriarch of the Pritzker family who owned the Hyatt chain. The Pritzker interests could obtain a mortgage for 2/3 of the cost, because of the large amount of business they did with Equitable Life. We finally put together a financing package that lacked only a third party to come in with the risk capital.

That turned out to be the Federal government, in the form of an Urban Development Action Grant (UDAG) under an ingenious but short-lived program set up by the Carter Administration. It didn't hurt that the program was administered by Robert C. Embry, the former Baltimore Housing Commissioner, who was then Assistant Secretary of the Federal Department of Housing and Urban Development. His staff understood the Hyatt project, and the benefits it would bring to the city.

In the Charles Center-Inner Harbor project, developers always paid full city and state taxes, plus the fair market price for land. The city would not donate the land for a private development. We were able to create a fair market ground rent, which didn't have to be paid until there was net cash flow to cover it.

The difference between the Hyatt deal and the deals BDC is making now (2008) is that in the Hyatt deal the City actually invested the UDAG grant in the form of the equity capital that made it possible to develop the hotel. It was invested as a $12 million Second Mortgage loan: $10 million from the UDAG grant to the city, and $2 million that we recovered from a previous developer who didn't perform.

The city's investment was made in the form of a pioneering "soft second" mortgage, on the same payment schedule as the first mortgage -- meaning that the second mortgage payments were not due unless there was cash available after payment of all the operating costs, taxes and first mortgage payments. This was projected to take 13 years to repay.

However, the thing that made it acceptable to the City was that when all of the operating costs and taxes and both the first and second mortgage payments were made, if there was still cash available from the hotel profits, it had to be applied to accelerate the repayment of the city's second mortgage — before the developer would realize any profit.

The Hyatt garage was a "whole nother" deal, as they say in Baltimore. The voters had approved an Off-Street Parking Loan of $5 million for that portion of the Inner Harbor, and so we loaned the bond money to the Hyatt Development Corp., and they paid the debt service on the loan, plus 1% to cover the city's expenses. As in the case of the hotel, if the garage made a profit over and above the debt service plus 1%, the excess had to be applied to accelerate the repayment of the city's second mortgage on the hotel.

The two Hyatt deals meant that I could go to the Mayor and the Board of Estimates and say truthfully that the city would get its investment back with interest before the developer would receive any profit. That was a true public-private partnership: both sides put their investment at risk, and both shared in the profits.

To be candid, the reason that A.N. Pritzker accepted this was that he didn't think the profits would ever be significant. He was counting on the value of the income tax shelter that would be created when the ownership of the Baltimore hotel was combined with his other hotels. For the same reason, I was able to persuade him to give the city 2/3 of the ultimate profits, after the second mortgage was repaid.

As it happened, the attendance at the critical mass of attractions around the Inner Harbor exploded after Harborplace and the Aquarium opened in 1980 and 1981. The Hyatt was so successful from the start that it became the most successful hotel in the Hyatt chain, and the city's second mortgage was repaid with interest in three years instead of 13. The city has been receiving up to $3 million a year in profits ever since, and the developer has tried several times to buy back the city's interest, but without success.

I got to know the Pritzker family on my frequent visits to Chicago to negotiate the deal, and our soft second mortgage has been imitated by many other public-private partnerships around the country. The success of the Hyatt justified the purpose of the Federal grant many times over: in the years immediately after the Hyatt was built, we had successful developers building or restoring 12 other hotels in the Inner Harbor area — without any government participation.

All told, the Hyatt development agreement sets up a sequence of 26 different priority claims on cash flow from the hotel and garage. Under the conditions of the Federal UDAG grant, the city's share of the profits must go into a separate UDAG account, which has to be spent on costs which benefit the deteriorated residential neighborhoods of the city.

Today, the city's investment more often involves direct loans or tax abatement, etc. — where justified by the benefits received by the city in terms of new jobs and taxes created (which would include the piggy-back income tax for residents who move in from the county), plus the acceleration of spending downtown in general. That also leads to a cycle of re-spending by the people with the new jobs, which is described as an indirect benefit, but which can be more than the increase in direct benefits. The question becomes whether the city's investment is needed to make a project successful, and whether that is essential for the well-being of the city as a whole.

Profit-sharing is often put in place to cover the possibility that the city's investment might make a project so successful that the developer reaps an excessive profit. In that case, the city would be justified in sharing in the excess profits. There is usually

one point in the deal that the media reporters do not understand: does the city's profit-sharing come after the developer has received a return on the total amount of private financing, meaning both debt and equity, or just the developer's equity investment? It can make a huge difference.

Martin L. Millspaugh