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  Is the Hotel Industry Smart Enough to Avoid Overbuilding; 
Ten Reasons Why Real Estate Markets
Become Overbuilt

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July 2004 - Are we seeing a decline in the risk of overbuilding in hotel markets?  No matter how rosy the economic picture, the bogeyman of oversupply is always lurking around the next corner.  Given recent experience, is the hotel industry now smart enough to avoid this bully?  In a current report, Jack Corgel, Ph.D., looks at the whole phenomenon and presents a list of ten reasons to explain overbuilding in terms of real estate market cycles. 

1. Long Delivery Lags – It takes considerable time to plan and construct operating properties, and thus supply adjusts quite slowly to demand changes. Property types with longer delivery lags are the most prone to overbuilding.

2. Economic Base Structure – As basic employment slows, non-basic employment continues to grow, giving false signals to developers about opportunities.

3. High Cost of Holding Land – Developers are prone to oversupplying the market at the first sign of opportunity because of the high cost of holding land.

4. Demand and Supply Elasticity Differences – Overbuilding occurs when long-run supply price elasticity greatly exceeds the price elasticity of demand.

5. Mistakes Due to Myopic Expectations – Given the short-run supply inelasticity of real estate, immediate increases in rents and occupancy may be interpreted as long-run changes, thus triggering development. With such myopic expectations, future rents are capitalized at a constant rate into prices.

6. Lease Contract Friction – Persistence patterns in rents and occupancy occur because of certain landlord behaviors in leased properties, thus creating sub-optimal development options.

7. Mistakes Because of Unpredictable Demand Growth and Volatility – Rapid demand growth and volatility create difficult forecasting environments that result in mistakes, especially given that exercise of the development option is difficult to reverse.

8. Mistakes Caused by Inability to Determine “Who Will Win the Beauty Contest?”  Market failure in the form of overbuilding occurs because developers involved in the early phases of concurrent projects cannot determine which competing projects will come to completion. 

9. Interest Rate Volatility – Rapid downward movements in interest rates over-stimulate development.

10.  High Rate of Economic Obsolescence – Property types with high rates of obsolescence experience relatively high frequency cyclical patterns because of persistent replacement demand. This characteristic raises the probability of overbuilding.

John (Jack) B. Corgel, Ph.D. is a professor in the School of Hotel Administration at Cornell University and the Director of Applied Research at the Hospitality Research Group.  The list above is excerpted from his article, “Is Overbuilding Risk Declining? Evidence from Hotel Markets,” which is available in the 2004 edition of PKF Consulting’s Trends in the Hotel Industry-USA.  In that article, Corgel analyzes hotel market data through the most recent business cycle and determines why it is that hotel markets experience severe overbuilding.  He also provides a comprehensive list of references to major studies from the past 20 years that delve into the details of the overbuilding phenomenon.

The 2004 edition of Trends in the Hotel Industry-USA is a statistical review of financial and operating data on US hotels and is compiled from 4,000 hotels around the country.  Information is presented from five hotel types: Full-Service, Limited-Service, Convention, Resort, and Suite hotels.  Annual Trends can be ordered online at www.pkfc.com or by calling Claude Vargo at (404) 842-1150 ext. 237. 


 
Contact:

Robert Mandelbaum
Director of Research Information Services
The Hospitality Research Group
3340 Peachtree Road, Suite 580
Atlanta, GA 30326
(404) 842-1150, ext 223
robert.mandelbaum@pkfc.com
www.pkfc.com

Also See: Demand in the Full-service Hotel Sector is Expected to Increase by 6.3% in 2004; Best and Worst Hotel Markets in Terms of RevPAR Growth / PKF Consulting / January 2004
PKF Consulting/HRG Survey Forecasts Banner Year for Hotel Transactions; Investors Favoring the Full-service Segment / May 2004
Maintaining the Marketing Investment; Examing How U.S. Hotels Answered the Marketing Investment Question During the Industry Recession / Robert Mandelbaum / May 2004


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