Somewhere in the Middle

The Midwest makes up the center of the country, but it's far from the focal point of the hotel world. Los Angeles and New York City grab all the headlines, but the Midwest is a vibrant part of the U.S. lodging landscape.

As gas prices and news of a recession escalate daily, the hotel industry faces challenges on many fronts. The credit crunch and rising costs have limited transactions and development, while occupancy and in some cases RevPAR have flattened, or worse, as leisure and business travelers scale back. The wave of recent supply is coming online after years of prosperity, just as demand begins to dip.

Is the Midwest in better or worse shape than the rest of the country? According to most Midwest hoteliers and industry insiders, the pulse of the heartland beats strong, buffered in a way from the bigger swings of fortune on the coasts. News and numbers to the contrary in some cases, “cautious optimism” abounds from Minnesota to Missouri and back up to Ohio.

DEMANDING TIMES

A recent survey indicates that almost one-fourth of Americans said they altered their Memorial Day weekend travel plans due to rising gas prices. Twelve percent said they canceled trips and 11 percent planned to vacation closer to home. The automotive and airline industries are struggling to survive and consumers are facing rising prices everywhere they look.

Occupancy dropped from three to six percent in the top 10 Midwest markets in March, according to Smith Travel Research (See chart on Page 38). The good news is ADR saw increases in eight of those locations, meaning RevPAR held close to even.

Chicago was down 3.2 percent in occupancy through the first quarter, but up $5.07 in ADR and off less than a dollar in RevPAR. “We had a dismal first two months, but that was predominantly weather-oriented,” says Ted Mandigo, director of TR Mandigo & Company, a Chicago-based hotel consulting firm. “April was very strong and I think we'll finish the year down about two percent in occupancy, with increases in rate of five percent.”

Peter Psihas, director of sales and marketing at the recently restored Blackstone in Chicago, says he's seen a significant dropoff in the convention business. “Some conventions are dropping a day, maybe folks are leaving a day early or there's a little lack of attendance,” he says.

The 332-room Blackstone, a Renaissance Hotel, reopened in March after a $128-million restoration. Business has been good, Psihas says, thanks to strong advance group bookings, but he's expecting a dropoff in June, July and August. He believes revenue will make a “pretty good comeback” next year, but he'll continue to chase group sales, “erring on the side of occupancy.”

The silver lining to increased gas prices, if that's possible, is consumers may be shortening vacation plans and staying closer to home at local resorts, a staple of the Midwest. The idea has even spawned a new word: staycation.

“We're holding steady,” says Matt MacLaren, Ohio Hotel & Lodging Association executive vice president. “There's been an uptick in leisure travel, a downtick in business travel. It seems like even though people aren't taking that huge vacation, they're still taking a vacation.”

David Merritt, senior vice president of development for Marcus Hotels & Resorts, has seen that in Lake Geneva, WI. Resorts there are “not impervious to the economy, but close,” he says, noting the two Marcus resorts market to Chicago's affluent North Shore, only an hour and a half away.

Despite pockets of growth, occupancy on the whole declined throughout the Midwest. In March, Kansas City suffered the smallest drop (2.7 percent), while Columbus, OH (6.4 percent) and Cleveland (6 percent) fell the most. The key, though, is that rates have held.

“We've learned some lessons from previous recessions,” Mandigo says. “We had the knee-jerk reaction of many properties chopping rates in 2001-2003. It took us into 2006 to get back to where we were in 2000. Wholesale rate cutting doesn't help create demand.”

Psihas, at the Blackstone, has already seen some rates dropping around Chicago, though. That should only be a last resort, he says, adding that hotels need to get more creative to increase occupancy. One property trying something different is the MGM Grand Detroit. In a city crippled by declines in both the housing market and automotive industry, the MGM is offering its Grand Destination Package for $349, which includes a one-night weekend stay; a $100 credit for dining, shopping or spa services; a $50 gas card; and complimentary valet parking, access to the spa, fitness center and Wi-Fi internet.

DEVELOPING PROBLEM?

Hans Detlefsen, director at HVS Global Hospitality Services in Chicago, knows development has slowed as a result of the credit crunch, but his office is still getting calls every day about appraisals and feasibility studies.

“It's really tough to get a whole deal financed right now if you're looking for a traditional mortgage-equity mix,” he says. “Those standards have changed drastically in the last 12-18 months. But that hasn't stopped developers from trying to get ready for the next project.”

Walker Geyer, managing director of capital markets for Paramount Lodging Advisors, says the bottom fell out when the commercial mortgage-backed securities market dried up. “A whole portion of the debt market stopped,” he says. “So really what we're left with is banks, life insurance companies and non-bank lenders. And some lenders have fallen out of the market completely.”

Loan-to-value rates, as high as 80 percent in recent years, are down to 65 percent as lenders tighten their belts. Mortgage rates have risen as well, making the cost of doing business higher for those that can land financing. “It's a totally different finance environment than it was a year ago,” Geyer says. The end result, not surprisingly, is development has slowed in many markets.

“No doubt it's more rigorous,” says Bob Habeeb, president of First Hospitality Group, a management and development company. “That's a very positive thing. It's always the stupid deals that mess up the marketplace.”

FHG has 36 hotels in its portfolio, all in the Midwest, with another five under construction and five in pre-development. “Deals are out there if you can get the financing,” Habeeb says. As pricing has gone down, capitalization rates have increased to almost 10 percent, up from seven just a few years ago, making it a great time to buy. Merritt says even Marcus Hotels & Resorts, a conservative company by nature, is looking to expand. “We're going to be a buyer again,” he says.

According to Lodging Econometrics, the Midwest — Michigan, Wisconsin, Illinois, Indiana, Ohio, Minnesota, North and South Dakota, Iowa, Nebraska, Missouri and Kansas — has seen 181 hotels open in the last 12 months, with another 253 under construction. Chicago, by total volume, has the fourth most rooms in the pipeline behind only Las Vegas, New York and Washington.

Only time will tell if many of these announced deals come to fruition. But it's a sign that developers can find money and believe they have a reason to. Cleveland, often the butt of many economic jokes, has had two major deals recently announced: a Hotel Indigo and a 1 Hotel & Residences. Indianapolis and Cincinnati have enjoyed a surge of growth as part of their urban revitalizations. Even smaller markets, like the Quad Cities in Iowa and Illinois, have seen gains. Several new hotels opened there in the past two years and the new Jumer's Casino & Hotel will open later this year in Rock Island, IL.

“Developers remain positive,” says Patrick Ford, president of Lodging Econometrics, a global lodging real estate specialist based in Portsmouth, NH. “Terms are higher, but they're returning to normal. The period we came out of was very loose excess.”

So what happens when the record levels of construction come online at the exact moment of a recession and dipping demand?

“That all would have been acceptable and would have been easily absorbed if we had not had this surprise financial crisis,” Ford says of the 133,000 rooms projected to open nationwide in 2008 and 170,000 in 2009. “With guestroom demand softening and expected to continue softening, (those numbers) may look a bit problematic. What happens this summer from an operating statistical point of view might alter developers' attitudes.”

MIDDLE OF IT ALL

The Midwest, like the rest of the country, has its share of good and bad. The hurdles are definitely higher in Rust Belt cities, where manufacturing has taken hit after hit. The weakening dollar, bad news for most of the Midwest, helps gateway cities like L.A. and New York and tourism hot spots like Orlando and Las Vegas with foreign travel.

Still, most hoteliers say they aren't experiencing doom and gloom and don't expect to.

“The Midwest seems to be steadier,” says Tim Benolken, Hilton's senior vice president of operations Central Canada, U.S., Mexico and South America, who notes the company has its largest pipeline of approved deals worldwide, ever. “It's proving to be more insulated to the ups and downs than a New York or a West Coast. Maybe it's the conservative nature of the business and society here. We don't have as much volatility.”

Joe Wheeling, CEO of Columbus, OH-based Red Roof Inn, believes the worst has passed. His brand is outperforming the economy chain track, he says, and he expects his new “NextGen” prototype to provide plenty of fresh development.

“No doubt there's been a slowdown in the economy,” he says. “I think the Midwest has gone through the tough times already with the auto industry and manufacturing. The last three to four years of boom times in other parts of the country really haven't hit the Midwest.”

The reality, like the geography of the Midwest, is probably somewhere in the middle.

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