The redevelopment of the long-empty Mercantile Commerce building wouldn’t have happened without the newly implemented state historic tax credit. We got the details from the developer, NewcrestImage managing partner Mike Patel, and Munsch Hardt’s Phill Geheb.
Bisnow: Last year, NewcrestImage acquired 1700 and 1712 Commerce St to redevelop. What’s the plan?
Mike: The 22-story Mercantile Commerce building at 1712 Commerce St was vacant for 25 years. Its neighbor at 1700 Commerce housed multiple tenants. Both are being redeveloped into three new downtown hotels with more than 400 rooms.
Phill (who facilitated the deal): Construction started in the fall for a Residence Inn and Dallas’ first AC Marriott Hotel at 1712 Commerce. There will be a Hampton Inn & Suites hotel built at 1700 Commerce.
Bisnow: What made you look to Downtown Dallas and redevelopment?
Mike: We were looking for a Downtown building. We acquired 1700 Commerce St and were looking at 1712 Commerce at the same time and thinking about what kind of programming we could do on each. They had sat vacant for 25 years with nothing open in 1712 Commerce and only Class-B office space in 1700 Commerce. These sites were a game changer for us. We were able to bring back the history to it the buildings between the ‘60s and mid-‘90s. It has a good memory on it. The dual brand in 1712 Commerce is the only true dual brand hotel in the market. We’re bringing something unique with a lifestyle center. The AC Hotel by Marriott and Residence Inn residential extended stay are both very lifestyle brands.
Bisnow: So, where are you in the process now?
Mike: We’re looking at how to use the history behind it. There are a lot of challenges and headaches that come with a building with this long vacancy; we have to create the whole wow factor. Demo is more than halfway done through the building and we started framing this month. We have about $55M in 1712 Commerce and about $35M invested for 1700, or about $90M all in. We ran the numbers and think we’ll make our money back in about seven to 10 years.
Bisnow: Is this something you’ll stabilize and then sell or is it a long-term hold for you?
Mike: It’s a long-term hold. We have done a similar project in Amarillo that was 11 stories converted to a Courtyard by Marriott. Our first AC Hotel is in New Orleans. AC is a European brand out of Madrid that was bought by Marriott. It has 80 locations in Spain and then there is the one we have in New Orleans. The Amarillo and New Orleans projects were both historic buildings, too.
Bisnow: Why redevelop historic properties?
Mike: There is a risk and reward in historic projects. It is a significant time investment because of the physical condition of the building, the remedial process and its challenges dealing with the old design. But, sometimes you can overcome those challenges and the rewards include the historic ambiance that you’re able to preserve and the guests are wowed at the restoration.
Bisnow: What are some of the historic features you’ve managed to keep?
Mike: For one, the elevators with gold-plated doors. No one includes those kind of features in buildings today because it is cost prohibitive. We’ve also been able to keep all the terrazzo in the first-floor lobby and on the exterior entrance. We couldn’t even estimate the cost of installing those elevator doors; you have to be delicate in handling them. It’s also rewarding to have those historic elements in a modern building.
Bisnow: How did the historic tax credit played a role in the project’s financing?
Mike: The project received three forms of funding, including a $35.6M construction loan, $7.8M in federal tax credit equity and $8M in state historic tax credit equity.
Bisnow: How crucial is that state historic tax credit?
Phill: When the federal tax credit was created in 1986, it was designed to restore buildings that were built before 1936 or were otherwise historically significant. The program is now 30 years old and we’re seeing a lot more of these interesting rehab projects that are taking mid-century modern buildings and doing adaptive reuse. With the new state historic tax credit, it’s more economically viable to bring new life to these buildings built around the 1960s. The Texas historical commission has indicated almost 40% of all historic applications are in the City of Dallas. By law, there are two incentives—a federal and a state credit—with the federal tax credit (which is applied to federal income tax) equal to 20% of qualified rehabilitation expenditures. The Texas tax credit (which is applied to Texas franchise tax income) is equal to about 25% of the same qualifying rehabilitation expenditures. Most of the hard costs and some soft costs of rehabbing a project are considered qualifying rehabilitation expenditures. The federal income tax credit can be syndicated out to a large bank to use the tax credit and the investor becomes a partner in exchange for contributions to the project. The state incentive is ultimately sold to end users like insurance companies and banks. When you combine the federal and state programs, a developer can get tax credits equal to 45%, which nets out after transaction costs, pricing and fees to to be around 30 to 35% of capital costs, which is a pretty significant incentive to rehab a historic building.
Bisnow: How familiar is the commercial real estate world with the historic tax credits?
Phill: Texas does not have a great reputation for utilizing federal income tax credit programs, and I have found that the lending community typically needs more instruction and education on the value of the program and how the loan should be structured. For 1712 Commerce, we had a lender who was not familiar with the program, but saw the benefit and worked with us to work through the capital structure to accommodate their needs as a lender and the needs of the investor to generate the tax credits.
Bisnow: It sounds pretty complicated. How long did it take to get the financing set up?
Mike: It took about six months. People are scared when you talk about complex transactions. With historical buildings, the construction has many hurdles that you have to overcome. So, it’s a series of challenges, but I think the end result of building a project with a lot of historic element attached to it is worthwhile. That’s how we are looking at it.
Bisnow: Are these projects a catalyst for Downtown Dallas’ redevelopment efforts?
Mike: For the last 10 years, the people who live there and those who believed in Downtown have been changing everyone’s perceptions. You must have the mindset of transforming a building and taking risks. As an entrepreneur, we are doing our part. We see a great opportunity for people to invest, stay local and do business here. One person can’t change Downtown; everyone has to be on board and investing. Centurion American, which did the Statler Hilton, was able to figure out what to do with it. There are many leaders like that.
Phill: When the state historic tax credit was adopted in 2013 and then went into effect in 2015, we saw of lot of interest from companies like HRI and others buying the old LTV and One Main Place. It’s a chance to stick a flag in the ground and take over these large products and create value in larger empty buildings. These big players may not have participated in this type of rejuvenation without that incentive, but now we’re starting to see more developers come in. There’s probably around $500M in historic renovations ongoing or announced in Downtown Dallas right now.
Bisnow: When will the project be up and running?
Mike: We are scheduled to open 1700 Commerce in Q2 2016 and 1712 Commerce in Q4 2017.
By: Tonie Auer