California building boom leads to worries over supply
California building boom leads to worries over supply
15 AUGUST 2016 8:43 AM

California has enjoyed an extended period of strong development, according to the latest Atlas Hospitality Group hotel development survey. That in turn has led to some concerns about growing supply.

REPORT FROM THE U.S.—An extended period of strong hotel development has led to some supply concerns across California, but some markets are expected to remain strong as they enjoy favorable fundamentals and conditions that will keep supply growth to a minimum.

Atlas Hospitality Group’s 2016 midyear California Hotel Development Survey notes that the state is in the “midst of a hotel building boom” that is helping to make up for the “lack of new construction from 2009 to 2013.”

Supply growth in the state during that period was very moderate, according to Atlas President Alan Reay, and Californian hoteliers enjoyed strong revenue per available room growth. He said the dynamics get a bit more difficult with RevPAR growth shrinking and supply growth ramping up.

Flattening RevPAR growth “is coming at a time when a lot of product is coming online,” he said. “I won’t say we’re at the tipping point because some say we’re getting to where we should be because we didn’t do new construction for a few years.”

He said some markets have more reason to worry than others.

“There are pockets with a tremendous amount of supply coming in,” Reay said. “In downtown (Los Angeles) and north San Diego County, you definitely want to be cautious. If you’re not already out of the early planning stages, you need to be mindful of (new supply). And I think lenders will look at that more carefully.”

The building boom
The Atlas survey claims that California accounted for 10.5% of the rooms under construction in the U.S. in the first half of 2016, with 17,236 total rooms.

Los Angeles County leads the state in pipeline development in rooms (19,800) and hotels (133). That county has 37 hotels with 6,772 rooms under construction, but just two hotels with a combined 326 rooms opened in the first half, according to the survey.

Reay said pockets of Los Angeles, like Santa Monica and west LA, will always have attractive dynamics and supply should stay down because of their high barriers to entry. But that isn’t true everywhere.

“I’d be concerned (developing) in downtown LA because of the new product coming in,” he said.

According to the survey, the largest hotel under construction in California is the 900-room InterContinental Los Angeles Downtown.

Brian De Lowe, principal and president of Los Angeles-based Kor Group and principal and co-founder of Proper Hospitality, said his companies got to experience both the good and the bad of difficult-to-enter markets around Los Angeles. He said his company is working on a project in Santa Monica that first started 12 years ago and has yet to start construction.

“As much as we get frustrated by how difficult it is to develop in many markets in California, once you have projects open, it makes it less likely that there will be issues with massive supply,” De Lowe said.

Reay said developers should be concerned about the amount of supply in parts of San Diego County and the Bay Area, especially San Jose. But he said supply-demand dynamics remain strong in pockets of those areas as well, with San Francisco looking strong and La Jolla enjoying “very high RevPAR because of its location and huge barriers to entry.”

De Lowe said Proper’s next hotel will open in San Francisco, which is a market he is optimistic about.

“It’s such a phenomenal hotel market,” he said. “Demand has far outweighed supply for a number of years.”

San Diego County saw six hotels with 1,017 rooms open in the first half of 2016 and has four hotels with 957 rooms under construction. The county has 52 hotels with 10,439 hotels in the planning stage.

San Francisco County saw no new hotels open in the first half of 2016, while three hotels with 470 rooms are under construction. A total of 25 hotels with 3,175 rooms are in planning.

Development challenges
Suresh Patel, president and CEO of San Diego-based Excel Hotel Group, said that even though concerns about supply are growing, development in general is becoming more difficult and expensive in California.

“With everything we’re doing, the costs are going up 15% to 20%,” Patel said. “It just doesn’t make sense right now with the cost of construction, and it’s tough to get a construction loan now unless you have 40%.”

He said a significant driver of those costs is labor.

“Labor costs keep going up in California,” he said. “The minimum wage keeps going up, and so do other benefits. It’s hard to find good people to run hotels right now, and it’s a tough labor market.”

Patel said he worries about some of California’s tertiary markets, which could struggle because of supply levels if performance significantly slows or even declines.

Patel added that some pockets of optimism remain, particularly in Ventura Country. He said his company is working on developing in the San Fernando Valley, but land in the area is difficult to find and is pricey.

He also noted that a slowing transactions market in general discourages development, as developers worry about their exit strategy in a down cycle.

“Who will buy from us?” he asked. “The (real estate investment trusts) aren’t buying.”

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