Hotel Deals Continue to Roll Along
The Allure of Luxury Lodging Assets
The Next Wave of Mega-Resorts
Deal Climate is Still Hot
On the heels of a record 2005 where we witnessed over $17.1 billion in upscale and luxury lodging transactions, 2006 has already surpassed that level, reaching $17.4 billion through the first three quarters. While fewer assets have changed hands this year, the price per room has increased significantly, rising 70% year over year through the third quarter.
High profit levels and a rosy outlook for the next two to three years,
coupled with the glut of funds targeting the lodging industry, have produced
a record level of deal volume in the upscale and luxury lodging sectors
over the past twelve months. During the period, over $22.5 billion in transactions
occurred. The average price per room over the trailing twelve months was
$239,000, a sizeable jump from the $169,000 level achieved in 2005.
Transactions Q3 2006 & YTD 2006
While the number of properties sold dropped from 60 to 45 year over year during the third quarter, the acquisitions volume rose from $3.5 billion to $4.2 billion.
U.S. Upscale and Luxury Lodging Transactions
The average deal size has grown as well. In 2004 and 2005, the average sale price was between $53 million and $57 million. This was similar to the prior market peak in 1998 when the average sale price was approximately $54 million. Through the third quarter of 2006, the average price per asset rose to $87 million. This is largely a result of transactions involving more high-end luxury assets which by nature generate a higher price, but certainly illustrates the price companies are willing to pay to enlarge their property portfolios.
U.S. Upscale & Luxury Lodging Facilities
The highest priced individual asset sales of the quarter were primarily luxury facilities, led by the Westin Kierland which was acquired by Host Hotels & Resorts for $393 million. Just up the road from Kierland, the Fairmont Scottsdale Princess was acquired by Strategic Hotel Capital for $345 million. The Ritz-Carlton Laguna Niguel, also purchased by Strategic Hotel Capital, garnered the highest price per key for the quarter at over $778,000. The top deals listed below accounted for over $1.5 billion in volume, or roughly 36% of the total transaction volume for the quarter.
Top Individual Upscale & Luxury Transactions
by Sale Price
Deal Activity on Pace with Our Forecast
As we previously projected, year-end 2006 deal flow is anticipated to
exceed the $20 billion level. As exhibited by the recent trends, fewer
assets are expected to change hands during the fourth quarter 2006 than
during the same period in 2005. Average price per room for 2006 is forecast
to be $227,000, slightly above the $222,000 we initially predicted.
The Allure of Luxury Lodging Assets
Rising Prices and Climbing Construction Costs Do Not Deter Investors
Since being heavily impacted by the economic recession and events of
9/11, the luxury lodging sector has experienced an exceptional rebound
in performance and consequently, price tags for hotels and resorts in the
segment have risen to new heights. Luxury asset[*] transactions are
surpassing record levels, with prices flirting with, if not surpassing
the $1 million per key level on many a deal. Nevertheless, despite high
prices, investors are not shying away from the sector. Quite the contrary,
transaction levels for U.S. luxury hotels and resorts are at an all-time
high. Over $5 billion in luxury lodging facilities have already changed
hands through September of this year. Another $1.5 billion in luxury assets
are expected to trade in the 4th quarter, bringing the year’s total close
to $7 billion. The bulk of these properties are being acquired by the usual
suspects like Host Hotels & Resorts, Lodging Capital Partners, and
Strategic Hotel Capital. However, many other lodging investment groups
are “upgrading” their portfolios with luxury assets as well. Companies
that have historically focused on moderate and upscale commercial hotels,
including Ashford, HEI, Highland, and Sunstone, have recently expanded
their portfolio into the luxury sector as they find high-end properties
to be appealing investments.
High Entry Fee
Buying into the luxury sector is certainly not easy from a financial perspective. The average price per room for a luxury hotel through the first three quarters of 2006 was approximately $490,000. If you think that price is steep, the cost to develop a new luxury hotel or resort is not for the faint of heart either. The ten luxury lodging assets that have opened in 2006 or are set to open by year end cost in excess of $578,000 per key. In comparison to the increasing development costs, the climbing sale prices will continue to look like bargains.
Construction costs declined in 2001 and 2002 due to the national recession.
However, the recovery and other external factors like Hurricane Katrina
have had a significant impact on costs over the past four years. Since
2002, the average cost per room for luxury hotel projects has increased
an average of 13.3% annually. During this period, the average cost per
unit has jumped from $351,000 in 2002 to an astounding $578,000 per unit
in 2006. While construction cost increases are anticipated to taper, they
are still expected to increase at 4.7% annually, which is higher than the
forecasted rate of inflation over the next four years. By 2010, the average
cost per room to construct a new luxury lodging facility is estimated at
$696,000 per key.
Development Cost per Room
The decision for many companies to buy luxury assets rather than build new is well justified by the replacement cost ratio. While the ratio today might be 84.8% ($490,000 ÷ $578,000), that assumes you can decide to build and open the property instantaneously. The reality is that the time lag between buying and building a full-service luxury hotel or resort is roughly four years on average. A company can purchase a property today and theoretically receive a current return on investment; or develop a new property over the next few years and open in an unforeseeable lodging environment. As a result, comparing today’s average price to the average cost of properties opening today is inaccurate. By comparing the price-per-room trend to a cost-per-room curve that lags by four years, current acquisitions appear to be even more of a bargain. The ratio of today’s price-per-room to the projected cost-per-room of projects opening in 2010 is 70.4% ($490,000 ÷ $696,000).
Rising construction costs may have limited the feasibility of many new
hotel projects, but the pace of luxury hotel development has accelerated.
In order to make economic sense, most luxury lodging assets are being developed
with saleable residential units to subsidize the development. At a recent
conference, it was implied that new luxury hotels are no longer feasible
without a residential component. While this may not be completely true
in all cases, it is clear that luxury hotels with residential units are
now the norm rather than the exception. Between 2000 and 2004, roughly
1/4 of new luxury lodging facilities possessed a residential component.
However, of all the luxury hotel projects anticipated to open between 2006
and 2009, almost 70% of luxury lodging projects will contain residential
units of some type.
Even many existing properties are also taking advantage of the high-priced residential market. Prominent properties like the Hotel del Coronado and InterContinental Chicago are in the process of adding residential structures.
It is also important to note the reduction of rooms inventory that has resulted from the attractive returns on residential real estate. The Drake Swissôtel New York is being torn down to make way for a new condominium complex. The St. Regis Los Angeles has closed and will likely have the same fate. The St. Regis New York and St. Regis Aspen have converted a portion of their hotel rooms to fractional units. The Plaza in New York is undergoing a $350 million transformation from an 805-room behemoth to a more intimate 282-unit hotel with 152 residences. Many other urban hotels and destination resorts have residential plans as well.
More Brands, More Projects
Many luxury hotels possess their own brand identities, like the Palace in New York or the Beverly Hills Hotel. The uniqueness of many luxury properties prevents them from fitting the mold of a brand. Moreover, a large portion of luxury hotels are historic properties that have been around longer than the current market environment that is inundated with brands. In some cases, their individual trade names, like the Greenbrier or the Broadmoor, are as recognizable as any of the top hotel brands. Approximately 42% of existing luxury hotels and resorts are independent.
However, there is a growing tendency to brand luxury projects in order to gain instant name recognition and good will for new properties. Of the properties slated to open between 2006 and 2009, 72% will be affiliated with a brand.
At one point the landscape of luxury hotel brands was very narrow with
Four Seasons and Ritz-Carlton being the preeminent players and some of
the more exceptional Hyatt and Westin assets entering the fray. While these
brands are still dominant in terms of market presence, they are no longer
the only major players. In the past few years, Fairmont, Omni, and Starwood’s
St. Regis/Luxury Collection have gained ground in the luxury arena. Moreover,
with the new growth initiatives of other well-known luxury monikers like
Conrad, InterContinental, Mandarin Oriental, Shangri-La, and Trump, coupled
with the introduction of new brands like Montage, Solis, TWELVE, and the
Waldorf=Astoria Collection, luxury lodging supply is booming.
However, while there are more projects in the pipeline now than those spurred by the prior market upswing, the average size of these projects is much smaller. Between 2000 and 2004, new luxury hotel projects that opened average 307 rooms. Projects that have recently opened or are currently planned to enter the market between 2006 and 2010 average only 250 rooms. This equates to roughly 20% fewer rooms per development.
The Emergence of a New Development Cycle
The development pipeline rebounded much more quickly from the recession in 2001 and 2002 than it did from the recession in the early 1990s. Following the prior recession, there were very few new projects in the works for several years. Luxury supply growth between 1993 and 1998 averaged a mere 0.6% annually. The next stream of luxury hotel development did not begin until 1999. That wave of openings ended in 2004, but a new surge has quickly sprouted up in 2006.
In 2006, over $1 billion in new luxury hotels will enter the market,
signifying the arrival of the next phase of luxury developments. In the
proceeding years through 2009, another $7.7 billion in new luxury hotel
projects are expected to open. Supply growth for the luxury sector is projected
to average 3.9% annually through 2010, which is below the 4.5% average
annual supply growth from 1999 through 2004.
New Rooms Entering the Market
The Next Wave of Mega-Resorts
Extra Large is Not Just a Shirt Size
Mega-resorts[†] require a hefty investment of both time and money, yet they can be some of the biggest cash cows in the industry. While they often lack intimacy, mega-resorts are factories that churn out room nights, banquets, golf rounds, and spa treatments in bulk quantities.
Mega-resorts are not a new breed of properties in the lodging industry.
They have been around since the early part of the 19th century, with renowned
properties like the Breakers, Boca Raton, the Broadmoor, the Greenbrier,
and the Hotel del Coronado among the first large-scale resort projects.
There are only 124 mega-resorts in the United States, yet they comprise almost 100,000 guest rooms (roughly 800 rooms each). The vast majority of these properties are situated in warm weather climates to attract guests year-round. Arizona, California, Florida, and Hawaii are home to 86% of the properties in the segment, with Florida being the predominant location by a large margin.
Time and Cost Limit New Construction
Due to their size and extensive facilities, these large group houses can take a decade or longer of planning and construction before opening. Moreover, it costs hundreds of millions of dollars to construct such resorts. The long timeframe and large capital outlay are deterrents to many developers. This provides an inherent barrier to entry within the segment. Thus, mega-resort supply growth is typically below that of most other lodging segments.
The development of such projects slowed significantly in the 1990s with new mega-resort rooms supply averaging only 0.9% annually from 1990 to 2000. However, that has changed in the current decade. Between 2000 and 2006, mega-resort rooms increased by 2.5% annually on average, still a relatively low growth pace. This momentum is expected to continue through 2010 as several large resorts are currently under construction or scheduled to break ground in the near future. Over $5 billion worth of mega-resorts will open over the next four years.
The recent peak in mega-resort openings occurred in 2002 when 6 new
properties opened, adding 5,583 new rooms to the market. Between 2001 and
2003, twelve of these large developments opened containing 10,380 units.
The next phase of major openings is anticipated in 2009 and 2010. Over
the two-year period, eight new mega-resorts totaling 8,710 rooms are slated
for completion. There are also several large projects on the drawing board
for beyond 2010, but it is too early at this point to predict which ones
will come to fruition and what their timing will be.
New Rooms Entering the Market
[*]Luxury lodging assets are defined as hotels and resorts with facilities and service levels equivalent to or better than the Mobil 4-Star and AAA 4-Diamond criteria.
[†] Mega-resorts are defined as full-service lodging facilities with
500 rooms or more and located in resort destinations; excludes casino properties.
Hospitium is a hotel consulting firm that specializes in the upscale and luxury sectors of the lodging industry. From the early stages of development or deal negotiation through asset disposition, Hospitium delivers timely and useful research, analysis, and insight that assist the various needs of owners, developers, management companies, and financial institutions. Hospitium provides a wide array of advisory services and products, including feasibility studies, due diligence, underwriting, appraisals, and strategic planning.
Stephen Hennis has over twelve years of experience in the analysis of lodging investments. Prior to becoming Managing Director of Hospitium, Mr. Hennis served as Vice President of Hospitality Investments for Lowe Hospitality Group and Destination Hotels & Resorts. During his tenure at Lowe, he was involved in the underwriting, negotiation, and acquisition of over $400 million in luxury hotels and resorts. Mr. Hennis previously served as Vice President and Director of Research for HVS International where he specialized in the analysis and valuation of large portfolios for cross-collateralized securitizations and oversaw the redevelopment of HVS’ analytical models. At HVS, Mr. Hennis appraised and evaluated over 500 lodging facilities. Mr. Hennis is a graduate of the University of Denver’s School of Hotel, Restaurant & Tourism Management.
Data and information for the Lodging Ledger is collected by Hospitium, LLC. Hospitium, LLC is merely a conduit for the data, and assumes no responsibility or liability for its accuracy, usability, confidentiality, or other matters related to this survey. Information herein is believed to be reliable and has been obtained from sources believed to be reliable, but its accuracy and completeness cannot be guaranteed. Use of the data herein may not be resold, distributed or otherwise utilized for commercial use or profit without the expressed written consent of Hospitium, LLC.