Take Off the Rose-Colored Glasses

Last month's Americas Lodging Investment Summit in sunny Los Angeles had a schizophrenic feel to it. On one hand, 2,500 smug hoteliers, investors, lenders and owners crammed into the Hyatt Regency Century Plaza to revel in the hotel industry's current good fortune: rising RevPARs, high profits, low supply growth and tons of capital. Could life be any sweeter?

Yet, an undercurrent of ennui seemed to wend its way through the crowd of dark suits and power ties. The second question most people asked each other as they met was, “How long will this bull hotel market last?” (The first, of course, was, “Do you want to make a deal?”) I've written before about the danger of self-fulfilling prophecy, i.e., talking about a downturn so much and so often that everyone gets cautious and fear becomes reality. But this scenario has the potential to be worse.

A great majority of those attendees at ALIS (particularly those relatively new to the business, who can't appreciate the cyclical nature of the industry) believe this prosperity will never end, that hotel rates will continue to rise, supply will remain constrained and lodging will continue to be the darling of the capital markets. It's not going to happen.

Sure, the U.S. hotel industry has several more really good years ahead, and certain markets will do well far into the next decade. On the transactions front, a new study from Jones Lang LaSalle Hotels predicts that the boom will continue this year and into 2008. The company further believes that even more types of investors — including offshore and high-net-worth players — will be drawn to the lodging investment game.

But as Randy Smith of Smith Travel Research demonstrated in his ALIS presentation, percentage growth in room supply is approaching increases in room demand, and as we all know, once supply outpaces demand, occupancies, rates, profits and investor interest begin to wane. It's a simple law of economics.

Other sources of data confirm the imminent explosion of hotel construction — at least in certain markets and segments. Lodging Econometrics reports that the hotel construction pipeline — 511,056 guestrooms in some stage of development — reached a record level at the end of 2006 and was up a mind-boggling 23 percent over the previous year. And while high construction costs and other factors will suppress some of this development, it's still an ominous sign for an industry that's been living large for the past four years.

Announcements from the public hotel chains reinforce LE's numbers. In the past few weeks, Starwood and Hilton both touted the size of their development pipelines. Hilton, for example, says it will add 120,000 rooms to its system in the next three years, while Starwood says it has 100,000 rooms in its pipeline. Granted, some of these rooms will come from conversions, and a lot will be in properties overseas (particularly China and India), but both of these companies, as well as Marriott, InterContinental and others, are counting on a lot of new construction in the next few years.

I raise these issues not to be negative about the industry or to scare owners, developers or lenders. But it's important that everyone in the business — and this includes operators as well as owners — understands the fragility of this industry and the economy in general. Every decision you make should be leavened with some old-fashioned common sense and fiscal conservatism.

In other words, take off the rose-colored glasses before you sit down at a conference table to hammer out your next hotel deal.

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