"Investors' concerns about the imbalance of supply and demand in some sectors of the lodging industry coupled with the generally slowing pace of lodging companies' earnings growth means lodging stock valuations will contract before they expand," Ader observes. "Lodging stocks have been a terrific group for investors during the last four years, but I expect the all-star team of stocks at the end of 1998 to be much smaller than it was in 1997, 1996 and 1995," he adds.
Companies operating in the limited-service sector of the hotel industry are most vulnerable to overbuilding, the 1998 Bear Stearns U.S. Lodging Almanac reports. In the limited-service sector, very high supply growth, low project costs, readily available capital and low barriers to entry combine to put pressure on hotels' revenues per available room (RevPAR) in many U.S. markets, Ader says.
"With very few exceptions, we would not be owners of companies with limited-service hotels at this point in the cycle," Ader comments. "Looking forward, success in the limited-service sector is likely to be confined to franchisors that have limited capital exposure -- and gain more from incremental unit growth than they lose from weakening RevPAR," he adds. Promus Hotels and Choice Hotels are examples, Ader says.
Bucking the limited-service hotels' negative trend are those brands that are "category killers" in their competitive segments, according to the Almanac. These limited-service hotel brands have competitive characteristics vastly superior to their peers and therefore substantially outperform the segment. Examples are Marriott's Courtyard and Prime Hospitality's AmeriSuites brands. "Companies with leading brands appear best positioned to withstand pricing pressure in a cyclical downturn," notes Bear Stearns vice president Robert LaFleur.
More rosy than the outlook for companies with limited-service hotels is the outlook for companies operating extended-stay hotels -- those intended for stays of five nights or more, the Almanac reports. Extended-stay rooms continue to enjoy rapid absorption in most markets. In 1997, for the U.S. overall, potential demand would have supported 262,700 extended-stay rooms -- approximately 2.7 times the number of extended-stay rooms that actually opened, the Almanac says. But there are markets, such as Atlanta and Dallas (among the first to have extended stay hotels) where supply is abundant.
"Extended-stay companies are moving fast to grab market share, and the companies that have the strongest capital base, the most effective development programs and the broadest diversity of product and markets will succeed," Ader observes. "We estimate the potential demand for extended stay rooms will be approximately 300,000 by the end of 2000, and that the supply of rooms will be approximately 270,000," Jason Ader of Bear Stearns says.
Least affected by concerns about hotel overbuilding are companies operating in the full-service hotel sector, the 1998 Bear Stearns U.S. Lodging Almanac reports. At the end of 1997, there were just 16,623 rooms under construction in the deluxe, luxury and upscale brand segments as defined by Bear Stearns. That's only 2.7 percent of the existing U.S. hotel inventory of 608,594 rooms, the Almanac says. Further, construction of deluxe, luxury and upscale projects is geographically dispersed across the nation, with few markets having significant levels of multiproject development. "Our analysis reveals luxury and deluxe hotels in major urban markets should continue to enjoy revenue growth as the U.S. economy continues its expansion," Ader says.
Hotel Industry Consolidation
While the U.S. hotel industry experienced a record level of mergers and acquisitions in 1997, $25 billion, the industry is nearer the end than the beginning of an MA wave, according to the Almanac. Asset prices are being bid up and yields are falling, the Almanac asserts. Consequently, the lodging industry's buy versus build ratio may be reversing -- and it may soon become more economical to build hotels than buy them, the Almanac says.
"The number of acquisition candidates has shrunk, and many would-be acquirers are asking, 'Who's left to buy?'" Ader notes. Furthermore, the recent CapStar/American General Hospitality, FelCor/Bristol and Servico/Impac announcements seem more driven by tactical than strategic concerns, as C corporations see their traditional growth paths as limited and choose REIT partners to facilitate expansion.
"Some of the C corporations have a 'If you can't beat them, join them' mentality," Ader observes. "At this point, we would be very selective in pinpointing the beneficiaries of the consolidation game. Companies that strike the right balance among strategic vision, operational integration, realization of synergies and creation of value will be winners," Ader predicts.
The Outlook for Paired-Share REITs
"Concern about proposed legislation's affecting paired-share REITs is overdone," says Bear Stearns REIT analyst Christopher George.
The Clinton administration's proposal that would prohibit paired-share REITs from acquiring a majority equity interest in and from operating additional hotels appears likely to pass Congress as part of the IRS Restructuring bill, according to the Almanac. But paired-share REITs would still be allowed to own and operate their existing portfolios.
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