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by Patrick Quek

Much has been written about the cyclical nature of the hotel industry and the potential downturn that must be looming in the horizon.  Much of this unease is generated by the level of new hotel development occurring in several markets across the United States.  Quickly, memories of the over-building of the 1980s come to mind and send shivers down the spine of those with investments in the lodging industry.

In order to project what the future might bring, we feel it is important to know what’s on the minds of those people active in today’s hotel real estate market.  After all, the internal motivations of today’s movers and shakers ultimately drives tomorrow’s results.

In an effort to find out how the key decision makers of the hotel real estate business are looking at 1998, we conducted a follow-up poll of the respondents to our 1997 Hospitality Investment Survey.  The survey measured the level of investment activity expected for 1998, as well as favorite types of hotels and market areas.  In all, a total of 65 responses were received from a variety of lenders, investors, operators, brokers, and developers.

Less Cerebral In 1998

For investors, brokers, and developers, 1998 is expected to be a year of growth, however, at a slower pace than in 1997.  These expectations are consistent with the overall belief that the hotel industry is starting to stabilize.  PKF Consulting is projecting that the occupancy level for the 42 major cities it surveys will remain constant at 73.9 percent for 1997 and 1998.

The one group that had a more optimistic outlook view towards 1998 were the lenders that responded to our survey.  After experiencing a year of flat lending activity in 1997, the amount of hotel loans projected to close in 1998 is expected to increase somewhat over 1997.  This is indicative of both an increase in the amount of capital available, as well as increased confidence in the fundamentals of the lodging industry.

Least optimistic on 1998 prospects are hotel operators.  They are expecting a continuation of the difficulties they are currently experiencing in finding new management contracts.  With more owner/operators purchasing hotels, it is difficult for independent management companies to find pure third-party management opportunities.  An estimated 30 to 40 percent of management contracts written today require some form of equity or debt participation from the management company.
 

Top Of Market Is Top Of Mind

Across the board, all respondents rank upscale and luxury hotels as highly  favorable.  Due to the high cost of purchasing or developing hotels of this caliber, upscale hotels enjoy a relative degree of insulation from new competition.  Industry-watchers believe these properties will continue to precipitate high occupancies, as well as significant growth in room rates and profits, making this a desirable segment in which to operate, invest, and own.

On the other end of the spectrum, economy limited-service properties ranked at the low end for all respondents.  With all the new development activity occurring in this segment, lenders, investors, and operators fear that the market is becoming too crowded, therefore limiting the current and future potential performance of these properties.  In recent years, limited-service properties have experienced the slowest growth in ADR, REVPAR, and operating profits, compounded by sluggish occupancy performance.
 

A New York State Of Mind
 
When it comes to ranking the lodging markets in the U.S., the major gateway cities on either coast rise to the top.  San Francisco, New York, Boston, and Seattle represent the most favored cities among all players in the hotel real estate and financial community.  It is not surprising that all these markets achieve occupancies in excess of 78 percent and average rates in excess of $100.00.

The attraction to these markets is a somewhat of a doubled-edged sword.  Being relatively insulated from new hotel development, the projected future performance of these urban markets is quite bright, making them an ideal location in which to own, operate, construct, or broker a hotel.  Unfortunately, the same barriers to entry preventing excessive development in these markets also make it difficult to affordably buy or build a hotel, and therefore get into the market.

The common theme among those markets ranking as least favorable in the survey is the large amount of new hotel construction that has already happened or is projected to occur.  Noting the location of those least favored cities, you can track the path that hotel development has taken across the regions of the U.S.  Not only do South Central and Southeastern cities like San Antonio, Houston, and Atlanta appear near the foot of the list, but we’re starting to see Midwestern cities such as Detroit, St. Louis, and Cleveland also ranking near the bottom.  This regional movement is consistent with both the relatively low costs associated with entering these market areas (land, construction, labor, etc.), as well as the timing of the recovery of these regions from the recession of the early 1990s.

In PKF Consulting’s forecast for 1998, the occupancy for hotels in the South Atlantic region is expected to remain flat.  Meanwhile, hotels in the North and South Central regions of the nation are projected to experience a decline in occupancy.
 

Clear Heads Should Prevail

When analyzing the responses received in the survey, few things deviate from what would be expected.  What the survey has done is confirm some main themes that were thought to be true, but not documented.  They are:

• Hotel investment activity should experience growth in 1998, yet at a slower pace.
• Luxury and upscale hotels show the highest promise for continued growth.
• Everyone wants to be in the major gateway cities, but very few can enter.

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