REPORT FROM THE U.S.—Two words are currently taboo throughout the hotel industry. But those two words, according to forecasts from industry data firms, just might end up yielding the biggest long-term returns for hoteliers.
Looking at the numbers, it’s clear absolute U.S. hotel demand will continue to increase at least during the next few years. Despite marginal increases in construction starts during the past few quarters, both STR and Lodging Econometrics predict a muted supply pipeline through most of 2012 and more likely into 2013.
The muted pipeline can be attributed to a single factor—financing. Developers looking to build hotels are forced to bring more equity to the table, and even then obtaining debt for new construction is a hard sell.
SVP of global development
But for private hotel real-estate investors who can wait a few years for big returns and don’t need to visit the banks for help, now is the time to break out the shovels.
“The smart money is building right now. The really smart money is opening right now, because they were building in 2009. But the smart money is also building right now,” said Jan Freitag, senior VP of global development at STR.
The supply pipeline, according to data collectors, is at the bottom of a U-shaped timeline. New supply will remain slow for “a while” because hotels take from one to three years to complete construction, said Patrick Ford, president of Lodging Econometrics.
“True supply growth is at least a couple years outward,” he said. “New openings take a couple years to exit the pipeline. It will be into 2013 and 2014—maybe the middle of the decade—before we see any real movement.”
There were 54,825 rooms under construction during the month of July, according to the STR/McGraw Hill Construction Dodge Pipeline Report released today. This represents a 10.1% decrease in the number of rooms in the total active pipeline compared to July 2010. Compared to the peak construction period in 2008, there are nearly 150,000 fewer rooms in construction in the United States.
“My guess is you’ll see pickup in the planning and pre-planning stages by the end of this year and into next year,” said Bobby Bowers, senior VP of operations at STR. “We’ll hit bottom in terms of construction this year and next. We’ll begin to see that number grow again, but not right now or for the next 18 months.”
Taking the muted supply into consideration, Ford suggests the current economics are creating a “hey day” for today’s hotel operators. If the economy moves forward even in the slightest, hotel operations will be performing through the roof, he said.
“There won’t be any headwinds to come,” Ford said. “If we could only get demand and room rates moving, it could be bonanza for the hotel industry.”
“You’d like to think that before too much longer the turnaround will accelerate,” Bowers said. “If you’ve got new product out there, you’ll be in a good position to capitalize on it.”
Brands under development
For that reason, brands are starting to tout their development pipelines.
Steve Joyce, president and CEO of Choice Hotels International, a franchisor typically aimed at conversions, said on Choice’s second quarter earnings call last week that his expectations are for 35 new-construction hotels to come online by the end of 2011.
“Typically for new construction contracts, the timeframe for openings is much longer than on the conversion side of things,” he cautioned. “Clearly, the success rate for a new construction hotel is not at the same degree a conversion hotel is.”
Dean Savas, senior VP of franchising for Accor’s Motel 6 and Studio 6 brands, said although banks still aren’t lending money, developers are realizing the benefits of building at the low point in a cycle. Motel 6 recently opened four properties in Texas and four more have broken ground, including hotels in North Dakota, Indiana, Pennsylvania, Texas. A Studio 6 in Texas also is under construction.
“There are certain parts of the country doing much better—the West Coast and Texas, those two areas are doing well,” Savas said.
He said borrowers looking for new construction loans must have a strong track record and have cash on hand. “What I see moving forward, for those developers who don’t need loose financing terms and believe it’s the beginning of the cycle, those are the developers that will control the market,” he said. “If you build at the top of the cycle it’s too late.”
Motel 6’s rollout of its Phoenix prototype, first introduced in March 2008, was adversely affected by the downturn. When the prototype was introduced, the business model for Motel 6 growth was 50% new construction and 50% conversion. During the past 24 months, the business model has shifted to 90% conversion and 10% new construction, Savas said.
New brands challenged with gaining traction in the U.S. market also are shifting development plans.
As Savas said, certain markets are faring better than others in terms of supply growth: New York City, Washington, D.C., Atlanta, Houston and Orlando, according to STR.
“Although we are seeing a slowdown in overall pipeline, we still see some areas that stand out,” said Vail Brown, VP of sales and marketing at STR, during the Hotel Data Conference.
Manhattan, for example, has far and away the largest supply growth. According to Bowers, 6,500 new rooms have opened in New York City since the beginning of 2010.
In June, STR reported 171 projects comprising 20,727 rooms in New York’s total active pipeline, with 48 hotel representing 5,853 rooms under construction.
“A lot of them are due to open by the end of year,” Bowers said.
“New York’s supply numbers are just … wow,” STR’s Freitag added. “New York has always been a lot like Vegas: If you build it, they will come.”