Iron Horse Hotel developer Tim Dixon (center) is very happy about the funky money that helped finance his boutique hotel project in Milwaukee.

To hear Tim Dixon tell it, “funky money” is the new gold in boutique hotel development financing. Dixon, the celebrated developer and owner of the very successful Iron Horse hotel in Milwaukee, told an audience at last week’s Lifestyle/Boutique Hotel Development Conference he was able to access $22 million in tax credits (which he converted to nearly $10 million in cash) to develop his 100-room, three-year-old hotel.

“The success of the Iron Horse is based on a lot of things, but all things being equal it’s the capital stack that makes the hotel successful,” said Dixon during a panel discussion on new approaches to boutique hotel development. “Milwaukee is a $180,000 per-key [of development cost] market. We spent $300,000 per key, all in, but what we did differently than everyone else is we received nearly $10 million in free money.”

Dixon admits the process was complicated, time consuming and expensive (he spent $2 million in attorney fees). The key element was the property’s location in a qualified census tract that ultimately enabled Dixon to procure a laundry list of tax credits: new market, historic, state, tax increment financing and a few grants. As Dixon explained it, the federal government designates qualified census tracts as geographic areas with low income and high levels of unemployment. “And, instead of passing those credits to the benefit of the investors, we brought down the development costs, helping us create a lean capital stack and a property that stands out in the market.”

Taking advantage of these credits created other advantages, said Dixon. The financing piece that includes the credits is viewed as subordinated debt or equity and sits underneath’s the project’s first mortgage in the capital mix. The credits are in effect for seven years, “and on the seventh year they disappear from my balance sheet and all I’ll have is my first mortgage.

“That works really well for hotel projects because seven years is typically when an owner will recapitalize the hotel to refresh the property,” he said. “And, all of a sudden, nearly $10 million of obligation is gone. It’s a perfect scenario for a hotel.”

“That’s the power of tax credits,” noted another panelist, John Campo, president of Campo Architects and an expert in applying tax credits to development projects. “It’s a strategy that’s been around since the 1970s, but not many people know about its power or they’re just scared because it’s complicated. It has landmines all over the place, but at the end of the day the result is a quality product in a great location with a competitive edge because those tax credits form its basis.”

Federal historic tax credits have been used for many years by many developers, noted Michael Kitchen, an associate with Paramount Lodging Advisors. He said between 1995 and 2010, the program helped finance 17,000 properties, including 950 hotels with credits worth $8.8 billion. “There’s a lot of money out there and you would be surprised how many properties can qualify for it,” he said.

Both Campo and Dixon said it’s important for developers seeking financing through credits to surround themselves with experienced and knowledgeable advisers. “At the very beginning of the project, you need accountants and tax lawyers who specialize in this concept,” said Campo. “And, if possible, it’s good to have a lender on board that understands and has attorneys who understand the complexities of a deal like this.”

The panel also discussed EB-5 financing, another federal tax credit program that’s been available for a number of years but has come into vogue recently as money from banks and other lenders has dried up.

“EB-5 is the newest kind of funky money because it means, in essence, you’re creating your own international bank,” said Dixon. As he explained, properties in qualified census tracts are often also in targeted employment areas, a requirement for the EB-5 program. Under the scheme, foreign investors (many of today are from China) who invest at least $500,000 in a business in a targeted employment zone that creates 10 indirect or direct jobs can receive a green card for them and their direct families. The green cards can lead to permanent residence status in five years if the investment remains in the business.

“In one of the deals I’m looking at, we hope to raise $22 million through this program, which means I’ll need to generate 440 directly and indirect jobs,” said Dixon. “That’s why the program works so well for hotel projects, because hotels create a ton of construction jobs, permanent jobs in the business and indirect jobs in the community.”

Dixon is currently exploring development project in a Scottsdale, AZ zipcode but on Native American tribal land, which will enable him to access a range of credits.

“That’s how we’re looking at all of our future development because it you don’t have a tremendous amount of funky money or credits or free money, banks and equity investors won’t work with you,” he said.

The 3^rd annual Lifestyle/Boutique Hotel Development Conference was held at the Fontainebleau Hotel in Miami Beach. Lodging Hospitality and HVS Hotel Management are founders and producers of the event. The School of Hospitality Business at Michigan State University is the conference academic partner.

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