California exceeds supply expectations with record 2017
 
California exceeds supply expectations with record 2017
25 JANUARY 2018 9:26 AM

California set a record in 2017 for the number of hotel rooms opened, which sources believe illustrates the state’s ability to absorb new supply. California is on track to see another record year of development in 2018, but some are wondering how much more supply the state can take in without hurting performance. 

REPORT FROM CALIFORNIA—All signs pointed to 2017 being a good year for hotel development in California. As it turns out, it was so good that the state saw the highest number of openings of new guestrooms ever.

“We haven’t seen hotel development in California like this since 2008,” said Alan Reay, president of the Atlas Hospitality Group, author of 2017 California Hotel Development Survey. “It was a very strong year for construction companies, developers, construction lenders, all of that.”

Atlas had predicted a strong 2017 for California hotel development, he said, but no one there expected the number of new room openings to hit 10,793 in 66 hotels, surpassing 2008’s record of 10,286 new rooms.

There were several contributing factors, Reay said, including a strong California economy, record revenue growth for the state’s hotel markets, low interest rates and an availability of construction financing, which had previously been tough to get. On top of those factors, older assets, even those older than 30 years, are selling above replacement cost.

“Those factors are in play for 2018,” he said. “It could be another record. It’s on track to beat 2017 handily, just looking at the number of rooms under construction.”

Betting on Los Angeles
Out of the entire state, Los Angeles County saw the most new rooms opened with 4,309, according to the survey. Riverside County came in second with 1,236.

Many of those numbers are in response to the expansion of Los Angeles’ convention centers and the new business they have attracted, Reay said. Officials at the local convention and visitors bureau said that to get larger conventions, the city would need more hotel rooms, he said. Most of the new rooms added into Los Angeles County were in downtown Los Angeles.

InterContinental Hotels Group opened the InterContinental Los Angeles Downtown in 2017, which with its 889 guestrooms was the largest hotel to open in the state last year. It also opened the 350-room Hotel Indigo Los Angeles Downtown just a few blocks over, as well as the 216-room Kimpton Everly Hotel Los Angeles. The city overall had 23 new hotels open in 2017 for a total of 4,309 new guestrooms, a year-over-year increase of 292%.

Los Angeles was a market in which IHG believed it was under represented, said Elie Maalouf, CEO of the Americas at IHG.

“Los Angeles is really not one city; it’s many cities within a city with very distinct neighborhoods,” he said. “Each hotel is going after a different market segment in a different neighborhood.”

IHG takes a long-term view, he said, because these are assets with a presence that will cut across generations, not just two or three years. Cities like Los Angeles have strong continuing fundamentals as business centers for various industries, not just entertainment, he said, and these global gateway cities continually attract foreign capital and travel as economic hubs.

“That translates into pretty steady demand growth over the years—you see that in New York City, too—and then from time to time projects get planned that deliver multiple years later,” he said. “You never really know when your project’s going to deliver in these high-barrier-to-entry cities that will deliver supply in a lumpy manner. If you take a long-term view, you would continue to bet on industry first then hospitality in Los Angeles and hospitality in all the major cities in North America.”

Looking at the numbers
Supply growth for the state is only 1.2%, while the national average is 1.8%, said Jan Freitag, SVP of lodging insights at STR, parent company of HNN. He noted the percentage change number was relatively low even with high absolute numbers because the state, and it’s hotel inventory, are so vast.

Hotels in the state overall have been selling out three-quarters of their rooms, compared to the national average of two-thirds, he said, but rate growth has been anemic. Overall, supply growth appears to be in equilibrium with demand.

Looking at the specific markets tells a different story, he said. San Francisco was an outlier this year because of the ongoing expansion of the Moscone Center, which led to room demand falling 1.1% year over year. Occupancy is still strong at 84%, but the uncertainty pushed rates down 0.6%.

The number of hotel rooms in Los Angeles increased 2.2%, Freitag said, which is healthy given that room demand increased as well. Occupancy did decline somewhat, he said, but overall occupancy was at 81%.

“The impact of new supply is felt in L.A. today,” he said. “It’s going to be interesting to monitor how room rates fair through Q1 and Q2.”

San Diego has seen limited new supply (an increase of only 1.1%), while demand grew 1.7%, Freitag said. Room rates have grown at a healthy rate of 4%, he said.

“San Diego had a strong meeting year,” he said. “It’s also a smaller market, so you can have some pricing power.”

Development among new supply
Reay said his company raised concerns at the end of 2016 about developers starting new projects in light of new supply coming online in 2017, but the market has absorbed that handily.

“The big question is, how long can we continue to add this record number of new rooms without it affecting RevPAR?” he asked.

Developers with projects on track to open in California by 2020 should be alright, as many of the current positive factors will continue, he said. However, developers looking to start a new project now that won’t open for years need to consider all the future unknowns.

“Interest rates will be higher,” he said. “If there’s a slowdown in the economy at the time when they’re adding more and more rooms that will have a negative effect.”

The number of rooms currently under construction in California is about 18,000 in 123 projects, Freitag said, which is just a little less than New York City. That would amount to a 3% increase in supply if they all opened tomorrow, he said, but it averages to a moderate 2% increase over two years. There are another 25,000 rooms in final planning, some of which will move to under construction.

“Overall, these are moderate numbers for the state,” he said.

The major metro markets are more attractive, he said, which mirrors total U.S. developer sentiment.

Also, larger markets attract more developers, more development funds and more owner interest, he said.

STR has reported on the total U.S. pipeline declining, Freitag said, and part of that is financing not being as readily available. A reason for that might be that the lending community feels the industry is long into the current RevPAR upcycle, he said, with December marking the 94th month of growth.

“They might be asking, ‘Do we want to lend into this environment when the property is going to open two to three years from now, given we’re this far into the cycle and new supply is popping up pretty regularly in those three major metros?’” he said.

Outside of San Francisco, Los Angeles and San Diego, it’s a street-corner-by-street-corner story, he said. Developers will look to local lenders who want some of their portfolio to include local hotels, he said.

“I’m not saying there aren’t any good ideas out there,” he said. “In the major markets, it will be exceedingly hard to get a standard project done.”

Editorial director Jeff Higley contributed to this report.

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