As the economy continues to recover and the hotel industry regains its footing, the question for developers has begun to shift from when and how to where. The Lodging Market Potential Index (L-MPI), first introduced last year at the Midwest Lodging Investors Summit, helps answer that question, ranking the 25 largest lodging markets in the U.S. by long-term potential for hotel investment. Developers and investors—looking to buy or build—now have a comparative analysis of the markets with the most potential.

For the second straight year, New York City topped the L-MPI as the market with the most potential. San Francisco remained second, and Honolulu, which wasn’t ranked last year in the index’s pilot with 16 cities, cracked the rankings at No. 3. Washington D.C. climbed to fourth, and Orlando saw the biggest drop, from fifth to 21st.

The L-MPI as a systematic and formal analysis was developed by The School of Hospitality Business and Michigan State University to identify aggregate market potential and ranking for major lodging markets in the U.S. Faculty researchers from the school presented the research and development of this project and the pilot version at the Midwest Lodging Investors Summit in Chicago last July. A panel will discuss the latest index at MLIS this July in Chicago.

The L-MPI covers the top 25 lodging markets as tracked by Smith Travel Research and ranks them to show long-term potential of lodging investment. This article takes a closer look at the top five and the bottom five cities. Click here for the index in an interactive form allowing you to rank the cities by the different categories and for a complete description of how the index is determined.

TOP FIVE

It is no surprise, based on the 10 dimensions and 30 indicators, New York City ranked first in the overall index rank. The key drivers for New York’s performance have been its large economic base, albeit growing at a slower pace; strong purchasing power in the market; and tourism trends, which have resulted in a strong hotel market performance compared to the other 24 cities analyzed.

San Francisco ranked second in the index with a score of 95. While the gross domestic product for San Francisco is about 30 percent of New York, the growth in its overall economic base has been relatively high and ranked seventh on the index. This was primarily due to the growth in its regional GDP and relatively high growth in finance, insurance and real estate (FIRE), wholesale trade and services employment in relation to other cities. This is also reflected in its high ranking (ninth) for tourism trends and performance of commercial real estate (eighth). The strong performance of these underlying drivers helped San Francisco maintain a high relative ranking in hotel market performance (third) and hotel market growth (second). Room supply growth in San Francisco was also relatively low in 2009, which further helped to elevate its overall hotel market performance score.

Honolulu was not analyzed in 2009, but ranked third this year with an overall index score of 76. The regional stability of the island of Oahu ranked high (fourth) on the index. The high relative performance of commercial real estate (fifth), low hotel supply growth (sixth) and high hotel market performance and growth (second and seventh) resulted in a high L-MPI ranking.

Washington D.C. moved up from seventh to fourth with an index score of 70. Several of the performance drivers—consumer purchasing power, tourism trends, and commercial real estate performance—ranked within the top five in relative performance.

Miami ranked fifth, however it maintained its index score of 66, which was the same in 2009 when it was tied for second with San Francisco. Negative tourism trends and lower commercial real estate market performance impacted it marginally.

BOTTOM FIVE

Ranking 25th on the index for the last two years, Detroit displayed all the classic symptoms of economic malaise with low economic growth and weak market consumer purchasing power as a result of high unemployment and weak commercial real estate performance. This resulted in its weak hotel market performance and growth.

Phoenix ranked 24th on the overall index. Despite ranking second in the growth of its economic base, and relatively high ranking in tourism trends (ninth), its commercial real estate performance for last year was weak, and increase in hotel supply was high, which resulted in a low market area occupancy percentage, as the additional inventory was not sufficiently absorbed.

New Orleans ranked 23rd on the overall index. The city appears to be slowly recovering from the aftermath of the Hurricane Katrina in 2005. Low growth in its economic base; high instability in its economic indicators; such as GDP, population trends and employment; and very poor tourism performance (24th) have resulted in a downward pressure on hotel performance. However, signs of change are indicative in its relatively high commercial real estate performance (seventh) and hotel market supply absorption (12th).

Norfolk, VA ranked 22nd on the overall index. Starting with a relatively small economic base (24th), its specific drivers of performance—such as consumer market purchasing power, tourism trends and growth—contributed to keep hotel performance depressed (22nd). Fortunately, a low growth in hotel room supply marginally helped its overall performance.

Surprisingly, Orlando ranked 21st on the overall index. This was a dramatic drop in its overall ranking from fifth last year. However, analyzing the individual index dimensions makes it clear that a relatively high growth in room supply and reduced hotel room absorption (20th), depressed the hotel market performance (14th) and hotel market growth (23rd).

Since we conducted the pilot study last summer, the other most significant change in the overall ranking was for Houston, which dropped from four (of 16 cities in the pilot index) to 13 in the current index. While the underlying economic and demographic performance drivers remained fairly strong, including commercial real estate, hotel market performance ranking was negatively impacted (eighth last year to 18th) as a result of a relatively large increase in hotel supply.

The development of this index would not be possible without the cooperation of many professionals. Dr. Tunga Kiyak, from Michigan State University’s International Business Center was most helpful in designing the mathematical equations resulting in the L-MPI. Stephanie Stephens, a student in the school’s hospitality and real estate specialization program and Michael Kitchen, with Paramount Lodging Advisors worked closely with the faculty researchers on design, research and analysis of the data. The Hospitality Business Real Estate Development Advisory Council at Michigan State University, a group of 42 real estate professionals, assisted in the design and development of the index. The private sector data providers for hotel market performance data for the index are Smith Travel Research, and Jones Lang LaSalle and CB Richard Ellis provided data for the commercial real estate performance. Raymond S. Schmidgall, Ph.D., CPA, is the Hilton Hotels Professor at The School of Hospitality Business at Michigan State University. A.J. Singh, Ph.D., ISHC, is an associate professor at The School.