One Man's Poison Is Another Man's Meat

Hotel executives grouse about how hard it is to build these days, but hotel construction is booming, and hotels are popping out of the ground at a record pace, particularly in the upscale and midscale without food & beverage segments. There are challenges but also opportunities. If you're a hotel developer who can't find the right site in the Southwest and the Southeast, the hottest domestic markets, look overseas, particularly to China and India.

Six years into what seem to be lodging's best times, with a proliferation of new brands and many others maturing, upscale and midscale without f&b are growing at an astonishing pace.

Still, there are obstacles. A spokesman for InterContinental Hotel Group and the head of a Chicago architectural firm specializing in luxury properties share some concerns.

In Kirk Kinsell's view and that of his franchisees, the key hurdle is “the race for real estate. Not only are we competing with others for the same sites, there are alternative uses for those sites,” says the senior vice president and chief development officer for IHG. Hotel companies must justify site costs of in terms of their use, the expenses involved in acquisition and permitting and “when these projects can be delivered,” he says.

At the same time, the recent housing slump may help hotels. “We just came through a cycle where residential development was very attractive so a lot of land was bid up on that basis,”he says. Now, the overbuilding of homes may free up land for hotel development.

At the same time, the entitlement process is becoming more complicated. “It's taking longer for communities to provide the kinds of support needed for plan review and approval, and sometimes, if alternative land uses are proposed, for zoning changes,” he says.

Despite such logjams, things aren't bad for IHG. As of March 31, its global pipeline was nearly 170,000 rooms, with more than 111,000 of them in the United States. Holiday Inn Express was its leader, with 601 hotels representing 57,670 rooms in the pipeline.

Like other development executives, Kinsell says money isn't a problem. And, like them, he suggests the Sunbelt is the land of opportunity, at least in the United States. Materials, too, aren't a challenge, though their costs, while moderating, continue to rise. Robert Loewen, Wyndham Hotel Group's executive vice president and chief financial officer, concurs: “Overall construction costs are increasing, but we are not seeing any construction delays due to material scarcity,” Loewen says.

“The big issue appears more to be on the labor side than the capital side,” Kinsell says, “and while labor has become more available in the Sunbelt-kind of states, it's at a premium in high-barrier markets because there's a limited set of qualified contractors.”

Like Kinsell, Vantage Hospitality Group's Roger Bloss and Steve Belmonte cite scarcity of labor and land as development issues. At the same time, Bloss, who is Vantage and Americas Best Value Inn President and CEO, and Belmonte, his counterpart at the Lexington Collection, have never experienced a more vital development era. “I've been in this business since I was a kid,” says Belmonte. “I've never seen a stretch like we're in right now.”

DEPTH OF FIELD

Future supply, though never so robust, is still just short of its peak, says Patrick Ford, president of Lodging Econometrics, a hotel real estate consultancy. At the same time, as befits a cyclical industry like lodging, there will be a downturn. But not for a few years.

“The pipeline is at an all-time high,” Ford says. “At the end of the first quarter, it consisted of 4,281 projects and 568,318 rooms. We anticipate it will top out sometime in ‘07 at around 600,000 guestrooms. I think it will peak and then gradually decline through the rest of the decade.”

Reasons for that gradual downturn include the rising cost of capital, which will lead to an increase in cancellations and postponements of scheduled projects. Meanwhile, the number of openings will grow through the end of the decade, Ford predicts.

Midmarket without f&b and upscale brands “are the fastest-growing pipeline segments and they will be the fastest-growing new-supply segments as the pipeline unfolds.” The reasons are the maturity of brands in these segments, availability of financing at low-interest rates and many “new, prototypical brand models ideal for suburban locations where a lot of the development has taken place.”

In addition, new versions of midscale without f&b, like high-rise Holiday Inn Expresses and Courtyards by Marriott, are being built in urban centers, not only the suburbs.

In 2007, says Ford, midscale without f&b and upscale will grow by 5.9 percent, dramatically faster than the industry's overall rate of 2.2 percent (up from 1.7 percent in 2006). No other segment in lodging, outside of casinos, exceeds a growth rate of 1.7 percent.

In upscale, the key brands are “Marriott Courtyards, Marriott Residence Inns, Marriott SpringHill Suites Hilton Garden Inns, Homewood Suites by Hilton, StayBridge Suites by InterContinental, and a couple of new brands: aloft by Starwood, Cambria Suites by Choice, Hotel Indigo by InterContinental and Hyatt Place by Hyatt,” Ford says.

The respective “power players” for midscale without f&b are, in order: Holiday Inn Express by InterContinental; Hampton Inn & Suites by Hilton; Comfort Inn & Suites by Choice; Candlewood Suites by InterContinental; and Fairfield by Marriott. Ford notes that in this segment, the properties are smaller than in upscale. So are their respective room rates, construction costs and, generally, size. The average-size upscale project in the pipeline is 122 rooms; for midscale without f&b, it's 85.

The top region for development is the South Atlantic, from Washington, DC south to Florida. West South Central is second: the Sunbelt states of Arizona, New Mexico, Oklahoma and Texas.

“Yes, the cliché is, costs are going up.” he says. “What's different this year is that the costs have been going up at a far faster rate than the rate of inflation and, up to just prior to the collapse of the housing market last summer, costs were crazy.” A shortage of work crews and of materials like cement, steel and petroleum-based products, tied to “a roaring housing market” and a “global construction boom,” pinched the domestic hotel industry, he suggests.

Cost increases have lengthened the timeline of a hotel development to the point where 16 months of a 30-month project are spent on construction, Ford says. In addition, “with the extra time it takes and the rapidly accelerating costs, the developer is constantly going back to the drawing board to redesign in order to fit within his budget,” he says. “His costs are crazy, his timeline is crazy, and he's expanding his own timeline because he has to constantly redesign and rebid trying to get done on budget.” And that's before a recent acceleration in lending rates began to nudge up lending costs.

ACCOMMODATING THE LANDSCAPE

The Chicago architect Lucien Lagrange likes joining the fray, but it can be tiring. The man behind the look of the Elysian, a $163.5-million, ultra-luxury condo-hotel under construction at Rush and Walton streets, he suggests that getting the community behind your development, whether condominium or hotel, is key. So is finding a site large enough — a particular challenge in gateway cities.

“There are two challenges,” says Lagrange. “One is the approval process, because you're inserting a building in an existing community and people are very concerned about what's going to change their lives — even if it's good. The second is the technical aspect, because the sites are getting smaller. Today, in Chicago, a 25,000-square-foot site is big. I'm working on some sites that are 12,000 square feet.”

For example, he's designing an 86-unit Ritz Carlton Residence (“a hotel without being a hotel”) at Michigan at Erie Street. The 40-story tower will share a site with a landmark building and open in late 2009. “There are always the same issues: traffic, shadows and views,” he says. “We show the community that the traffic is not that bad and doesn't affect them, and that the shadows won't affect their quality of life.

“If they choose to live downtown,” Lagrange says, “there will be traffic, there will be shadows. There's always a group of people who are opposed to what we do, but there's also a silent majority in favor of what we do. And what we do is always quality work.”

“Urban center development always is last to come online by virtue of the fact land is so expensive and you have to wait for room rates and occupancies to grow during the operating cycle so new development of the most expensive kind will feasibility out,” says Lodging Econometrics chief Ford.

The cycle that began in 2003 took hold in highway locations and outer suburbs with midmarket and upscale, he says. As rate and occupancy strengthened, development moved into city centers, “where it's more expensive and the project needs to be much bigger.”

Is a downturn in the cards? No, barring unforeseen economic collapse or some “geopolitical problem.” What's in store is a “soft landing,” signaled by a gradual decline in new project announcements.

Stay tuned — and smart.

For more information and related articles, go to LHonline.com.

THE BIG IDEAS

Build time into your development timeline. Budget and entitlement considerations are stretching the development process. Don't get caught short because you failed to build complexity into your plans.

Take advantage of the housing slump. The stagnant home market means labor and contractors are looking for work in the hotel field. Seize the opportunity.

Build your constituency, particularly in gateway cities. Getting a neighborhood on your side can make the development process much smoother.

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