Checking Inn on Hotels
The Lodging Industry Adjusts to Economic and Overbuilding Concerns.
Amid the eighth year of the second-longest economic upswing on record, the hotel industry has begun meaningful reductions in development that are preparing the industry for a more moderate, less volatile, and softer future economic landing than envisioned earlier last year.
A significant, across-the-board slowdown in hotel development activity has occurred for several reasons. First, 1998 saw deep declines in lodging-oriented stocks of C corporations and real estate investment trusts. Investors now view lodging less as a growth-stock industry and more as a value-stock industry, with correspondingly lower earnings multiples. This turnabout in stock multiples caused serious compression in debt-equity ratios on corporate balance sheets, denying some companies further access to capital markets and bringing new development and asset acquisition programs to a halt for many.
Moreover, Wall Street and major institutional financing — which never really had returned to the levels of the high-flying 1980s — quickly retreated.
Finally, individual developers of 60- to 150-room projects that are concerned about future economic uncertainty have shown increased caution, despite only modest credit tightening by regional and local lenders that finance projects of this size.
Overall, development activity is a function of financing availability; the curtailment in financing has spurred a decline in hotel development, which, in an environment of future economic uncertainty, could be good for the industry. It will lessen the impact of any economic slowdown on industry-wide profits. It also will allow more time for the record number of new project openings in 1998 to be absorbed and will set the groundwork for a more even rebound early in the next decade.
New hotel openings peaked in 1998 for the most recent expansion cycle with the completion of 1,533 projects nationwide with 156,895 rooms, or an average of 102 rooms per hotel, according to Lodging Econometrics. As of first-quarter 1999, 1,242 projects with 169,946 rooms are under construction and will come on line in the next two years. These projects average 137 rooms, reinforcing that more large projects in central business districts, inner suburbs, and destination resorts are scheduled for the near term.
Nonetheless, how did credit market volatility in 1998 affect the development of different hospitality sectors?
Luxury, first class, and midmarket (full-service) segments have experienced significant changes. Many projects were canceled, put on hold, or delayed as Wall Street and large institutional lenders reacted to the credit crunch. Looking forward, only the highest-quality projects with the most experienced developers that got an early start on financing are likely to reach completion. Few new projects are expected to be announced as developers contemplate the impact of economic conditions in the months ahead. The weeding out of weaker, more marginal projects proposed or in early planning stages is well underway in many cities, including Boston, Chicago, Dallas, and Tampa, Fla.
Much of the cutback in development was concentrated within the extended-stay and all-suites segments, areas of earlier concern due to the fast pace of development.
Some publicly traded C corporations — many with new brands created earlier in the decade that have built furiously to reach critical mass in this expansion cycle — have brought future development activity to an abrupt halt. Changing balance sheets and tight credit conditions have caused a retreat from corporate development for brands such as Amerisuites, HomeGate Studios and Suites, MainStay Suites, Homestead Village, Extended StayAmerica, Crossland Economy Studios, and StudioPlus.
Some companies such as Candlewood Hotel have brought in new equity partners and turned to franchising to rekindle growth. Marriott International has expressed a willingness to consider loans and guarantees to developers in selective situations in order to continue momentum on some larger full-service projects.
After the Federal Reserve Board’s rate adjustments, a bit more stability prompted some companies to announce plans to increase development. Whether this happens or not ultimately is a function of near-term credit availability and an early read of the economy in the first half of 1999.
Activity in the midmarket, economy, and budget segments mostly is franchise-driven and, though the numbers are declining, still is progressing at a rapid clip. Most of the development involves individual projects and is financed regionally or locally. When the international crises reached a feverish pitch in third-quarter 1998, many franchise companies with large sales teams redoubled their efforts nationwide to bring projects to fruition, not knowing whether financing availability soon would contract. The result was an accelerated number of signed franchise agreements and a rush to get projects underway before the financing environment changed significantly. Franchises showing significant activity include U.S. Franchise Systems’ Microtel Inn and Suites and Hawthorn Suites; Marriott’s Courtyard, Residence Inn, and TownePlace Suites; Promus Hotel’s Hampton Inn and Suites and Homewood Suites; Bass Hotels and Resorts’ Holiday Inn Express; Cendant’s Wingate Inn, Days Inn, Super 8, and Ramada Inn; and Choice Hotel’s Comfort Inn and Suites and Sleep Inn.
Development should remain strong for these smaller 60- to 150-unit properties as long as reasonably priced financing remains available at regional and local banking levels.
Turning to regional activity, Sunbelt cities including Dallas, Phoenix, and Atlanta have been the favored lodging development markets of the 1990s. Among the fastest-growing population centers in the country with ever-expanding suburbs, these markets have low barriers to entry. For aggressive brands, they are the perfect areas in which to concentrate new, smaller developments that can be completed quickly.
In cities such as Chicago and Boston, many projects are larger, CBD-oriented and, if they come to fruition, will open in the early and middle years of the next decade. Boston, for example, has eight projects in permitting or early planning stages with 3,748 rooms in its Seaport District alone. This large new urban development site has as its centerpiece a new world-class convention center scheduled to open in 2003.
Because it is quite late in this economic expansion cycle, projects currently in the early planning stage likely would suffer high attrition — as high as 60 percent — if the economy were to dip into recession.
In the last 18 months, the national economy has dodged bullet after bullet, and remains surprisingly robust. The international financial crisis has not yet caused any serious economic slowdown. Correctional course adjustments by both the Treasury Department and the Federal Reserve have been enormously effective, although the three interest rate adjustments over a seven-week period in 1998 may have created too much of a good thing. The fourth-quarter gross domestic product increase of 6.1 percent represents the second-fastest quarter of growth in 15 years, causing some to wonder if the Fed’s action was overstimulative. The Dow Jones not only bounced back, but roared back, setting new altitude records.
What it all means to the hotel industry is that any contraction in demand has been slower in coming than originally thought. Coupled with a thinned-out supply pipeline, there should be improving fundamentals — barring a recession — and the landing zone in the short term should be softer than earlier anticipated.
Looking forward, a less-steep bottoming out should occur, bringing an earlier and more even, if not spectacular, growth pattern in the years ahead.
The lodging industry clearly has made the adjustments in the development pipeline that Wall Street and the investor community signaled as desirable. The industry awaits more-favorable recognition with higher earnings multiples and a separation in analysis between companies that own the real estate and those that generate managerial and franchise fee income, which should generate higher earnings multiples. That will produce higher stock values, restore the balance sheet, and improve access to the credit markets.