Hotel Reservations

Lenders and investors have not checked in to smaller markets.

It’s a sign of the new normal that North Dakota has been the top market in hotel performance for the past two quarters, according to Marcus & Millichap. It scored 114.0 compared to the U.S. average of 104.2, when measuring year-to-date changes in supply, demand, average daily rate, and revenue per available room. North Dakota is also a hotbed of hotel development: 21 new hotels have opened in the past two years and 24 are under development, adding more than 3,000 rooms — at a time when the U.S. hotel development pipeline has decreased 6.4 percent from a year ago, according to STR.

But tourists aren’t flooding this High Plains state: it’s workers drawn by North Dakota’s oil boom who are finding very limited options for housing.

Spillover demand has also picked up next door in eastern Montana, says Steven A. Hall, CCIM, MAI, FRICS, president of Hall-Widdoss & Co., in Missoula. But in other parts of the state more reliant on tourism and business conferences, he sees little movement in occupancy rates and ADRs. And development? “We’ve seen very limited new construction since fall 2008,” he says.

And so goes the story for the hotel property market in secondary and smaller markets. Outside the major markets, investment activity and development is limited and highly dependent on local factors, a survey of CCIMs reveals. In every locale, the culprit most cited is the lack of available financing.

Established tourist areas and midsize cities with strong job growth have been attracting some investment attention, usually from all-cash or Small Business Administration-financed investors. But even in markets where demand is strong and boosting ADRs and RevPAR, there is little to no money for development and very limited financing for hotel investment transactions.

Tourism Locales

“In recent months, I’ve seen sharply increased transactional volume, but it has been highly preferential,” says Daren Hebold, CCIM, broker/owner of Lux Realty Group in Portland, Maine. “In oceanside resort destination markets, small independent boutique hotels and inns ranging from 20 to 80 rooms that possess extraordinarily high ADRs are in favor at this time and garner cap rates in the 5 percent to 9 percent range.”

Hebold adds that Northeast resort markets such as Ogunquit, Maine; Nantucket, Mass.; and Newport, R.I., “appeal to upscale and luxury travelers who have more discretionary income to spend and are driving hoteliers to create increasingly higher quality product. Upscale independent inns and resorts that have diligently reinvested in their properties will report record ADRsin 2012.”

The same could be said on the other side of the U.S. in California’s Napa Valley, north of San Francisco, says Rosemarie Corrigan, CCIM, of Artisan Sothebys International Realty, in Santa Rosa, Calif. “The ADRs have always been high and now the occupancy trends are increasing, having been flat for several years,” she explains.

Corrigan adds that both distressed assets and trophy properties are selling and she sold one of each in May: “The Christopher Inn, a 21-room property with poor performance sold for $3.1 million and the Chanric Inn, a seven-room small inn at peak performance sold for $2.75 million. Both properties are located in Calistoga, Calif.”

Hebold and Corrigan both say that local banks and credit unions are willing to finance hotel deals in their markets, often using the SBA 504 loan program, particularly for transactions under $10 million. “For larger transactions, regional and national lenders will lend, but only at conservative loan to values in the 60 percent to 65 percent range,” Hebold says, “and only for premium branded properties that are being acquired by strong buyers who are proven hotel operators.”

Franchise Activity

While well-off tourists are boosting occupancy rates in upscale locales, tourist areas farther afield are still suffering. High gas prices, limited business conference activity, and general economic uncertainty have resulted in weak demand and flat ADRs for Montana hotels, says Hall. As a result, “Very few full-service hotel sales have occurred over last four years. Most activity is found in the limited-service segment. Buyers tend to be local or regional operators with individual or small portfolio ownership. There has been a fair amount of re-branding; loss of franchise may have triggered sales,” he says.

In the Northeast, Hebold has also seen activity at the economy end of the scale. “New limited-service hotels with strong franchise affiliationslocated in retail hubs or jetport suburban marketshave sold swiftly during the past year, generally at 9 percent to 10 percent cap rates,” he says. And most new development he sees consists of limited-service hotels with 80 to 120 rooms under Hilton or Marriott brands. But, he warns, the lower end of the market is very competitive and price sensitive. “Operators who cannot afford to reinvest capital into their hotels are quickly marginalized by both the franchises and guests alike,” he says.

Outside of major markets, branded economy, select- and limited-service product have seen the most investment activity this year, with the number of transactions up 80 percent from midyear 2011 to midyear 2012, according to Marcus & Millichap. A number of factors are contributing to this trend. First, the cost of those properties is usually below $10 million, which makes them eligible for SBA financing and within the reach of single investors or regional investment groups who favor local properties. In addition, many investors believe prices for these properties have reached bottom and the lack of available construction financing is keeping competitive development in check, particularly in smaller markets.

Urban locations are also seeing franchise development and transaction activity. In Dallas, much of the activity is franchise driven, says David Schnitzer, CCIM, senior vice president of Venture Commercial in Dallas. “We are seeing need-based development in established entertainment areas or near corporate campuses. Few developers are attempting to get ahead of the growth areas at this time.”

In San Antonio, “Increase in consumer travel and business demand has led to modest increases in RevPAR and stabilization of newer product built and opened in past three years,” says Gerard R.C. Pastrano, CCIM, a senior adviser with Sperry Van Ness who brokered two limited-service hotels to foreign investors in San Antonio this year.

He expects continued revenue increases and development in Central and South Texas, mainly in the Eagle Ford Shale area. “There’s a very high demand from oil field service providers,” he says. “Over 10 new hotels have been built in the 22-county area, everything from independents to national flags in very small markets.”

EB-5 Financing

In the Midwest, foreign investors are helping to finance some of Milwaukee’s current hotel development, due to the use of the EB-5 federal program, which grants visas to foreign citizens who invest $500,000 to $1 million in projects that create at least 10 jobs. The two-year visa can be converted into a permanent U.S. resident status for investors and their spouses and children.

Most of the activity involves redevelopment of older properties. For example, 30 Chinese nationals invested $500,000 each with Gorman & Co., the developer of a 90-room extended-stay hotel in the former Pabst Brewery in downtown Milwaukee. Gorman is also using federal historic preservation tax credits by maintaining many of the original brewery features, such as the brewing kettles and a two-story stained-glass panel. Scheduled to open in 2013, the property will be an independent boutique hotel.

Developers of a 200-room Marriott in downtown Milwaukee are also financing the $50 million project through the EB-5 program, combining it with new markets tax credits, a federal program for spurring investment in low-income areas.

This activity has turned Milwaukee into a hotbed of hotel development, unusual for a secondary Midwestern market. Although the city’s occupancy rates have returned to pre-recession levels, ADRs and RevPARs have not. In fact, current hotel operators are wondering whether the city can support the burgeoning pipeline of new rooms. Along with these two projects, a turn-of-the-century office building is being converted into a new Hilton Garden Inn; together the three projects will add more than 400 rooms to downtown Milwaukee.

Meanwhile, 60 miles west in Madison, Wis., “As far as new development goes, there is none — yet,” says Rob Zache, CCIM, president of Central Place Real Estate in Madison. Wisconsin’s state capital has 4 percent unemployment, with jobs fueled by a Big Ten university as well as the state government. He says a top-notch development site in a prime submarket was put under contract a year ago by a preferred national developer.

“The developer was financially qualified to do the deal and had the franchise secured but ultimately decided to let its contract terminate because of the uncertainty of the general national and local economy and the continued weakness in the state and local submarket,” Zache says. “While Madison has been called one of the 10 best markets in the country, the developer’s lenders said that the two most toxic things a lender can consider are vacant land and hotels.”

But Zache adds that Madison’s occupancy rates and ADRs are close to pre-crash levels. “The area is really in a state of the strong becoming stable again, and the weak still suffering,” he explains. “Outside companies are just now coming into the area looking for existing properties to take over, or for new-build development deals for the first time since the crash.”

The good news is that private equity firms are building up their cash reserves and starting to look in secondary and even tertiary markets for hotel assets, according to reports from the annual New York University International Hospitality Investment Conference. Six new private equity funds ranging from $500 million to $2 billion closed last quarter and, to avoid competition with real estate investment trusts in major markets, they are turning their attention to solid assets in smaller markets. In addition, regional portfolio operators, foreign investors, and single-asset buyers are continuing to look for product in solid but less-competitive locales.

Conference panelists said the current lull in deals is due to lack of properties on the market, as owners take advantage of improving fundamentals. But more assets are expected to come to market in the second half of the year, creating more opportunities for deals to be made.

Sara Drummond is executive editor of Commercial Investment Real Estate.

A Major Difference

In the major gateway cities, hotel investment is a totally different — and much more positive — story. U.S. hotel transaction volume hit $5.1 billion at midyear for assets $5 million and above, according to Jones Lang LaSalle. The average price per key was $194,000, 5 percent above 2011’s annual average. Single-asset transactions accounted for 70 percent of the volume. Private equity investors and real estate investment trusts made most of the purchases.

In a market such as San Francisco, “It’s just too expensive and complicated to build,” says Anwar Elgonemy, CCIM, director of investments for Equinox Hospitality. “Investors can get a much higher return on investment if they buy existing, cash-flowing properties.”

And, he adds: “The absence of new lodging supply is significantly benefiting the San Francisco hotel market in terms of occupancy and average daily rate.”

Analysts predict more of the same for hotel investment in the major markets. According to JLL’s June hotel investor survey, 46 percent of the respondents said they would be buying in the next six months, and the number of respondents selling was at a high mark as well. Strong buy markets included Hawaii, Chicago, Boston, and Miami, which have all seen double-digit room rate growth in the past year. Sell markets included Orlando and Tampa, Fla., and Dallas.

Mark Bratton, CCIM, vice president of investment properties with Colliers International in Honolulu, says “All local market factors are positive: occupancy, room rates, ADRs, RevPAR, tourism counts — Waikiki and Maui are particularly strong,” with both institutional and Chinese investors showing interest.

“In a word, the forecast is ‘upbeat,’ Bratton adds. “There are four major waterfront hotels in Hawaii that will soon hit the market. Investors are eager to invest while demand is strong and before interest rates start to rise.”


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