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.

Market Adjustments
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.

Regional Markets
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.

Looking Ahead
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.

Patrick H. Ford, CCIM

Patrick H. Ford, CCIM, is president of National Hotel Realty in Portsmouth, N.H., which provides brokerage, management, and consulting services, as well as hotel real estate information services through its research subsidiary, Lodging Econometrics. Contact him at (603) 431-8740 or Focus: Israel: A Unique Hospitality Market Located along the eastern edge of the Mediterranean Ocean, Israel is a unique tourist destination for visitors from all corners of the world. It is considered by many as the Holy Land, sacred to Jews, Christians, and Muslims. Its year-round sunshine, attractive beaches, stunning landscapes, and 3,500 years of archeological wonders also draw more than 2 million tourists per year.In 1993, as a result of the Oslo accords and peace process efforts, hotel development in Israel boomed with room demand reaching an unprecedented peak in 1995. In 1996, periods of unrest tempered tourism but not hotel development.Two reasons for the continued development have been the celebration of Israel’s 50th anniversary in 1998 and the increased number of religious pilgrimages expected for the millennium. About 17 million tourists visited the Middle East region in 1997, and more than 21 million are expected in 2000, according to the World Tourism Organization.A number of foreign hospitality companies have recognized the opportunities that exist in Israel. In 1990, foreign hotels operating in Israel included Hilton, Hyatt, Ramada, Sheraton, and Gauer. Today these companies have been joined by Accor, Africa Israel, Dan, Days Inn, Golden Tulip, Holiday Inn, Howard Johnson, Inter-Continental, Isrotel, Le Meridien, Marriott, Park Inn, and Radisson.According to Israel Hotel Association statistics, Israel has 40,000 hotel rooms in full operation, accounting for 16.5 million overnights annually, including foreign visitors and domestic tourism, which is on the rise. By 2000, Israel is expected to have more than 45,000 hotel rooms, and an overall occupancy rate of 62 percent, up from 54 percent in 1997.Hotel accommodations range widely throughout the country. Deluxe five-star hotels are found in most of the major tourist areas such as Haifa, Tel Aviv, Jerusalem, the Dead Sea, and Eilat. Demand is building for facilities that cater to families on short vacations, are economically attractive, provide limited service, and are close to favorite domestic tourist areas.The government’s interest in integrating its skills, knowledge, and product into the global economy has increased foreign investment, and a competitive business environment has made Israel an attractive location for foreign investors. Israeli laws encouraging capital investments — both foreign and domestic — provide diverse benefits such as tax incentives, grants, and favorable loans to qualified companies and enterprises.Israel also has enacted new real estate licensing laws, which are similar, in many aspects, to those in the United States. Many qualified Israeli real estate professionals are well versed in the hospitality environment. A good starting point for interested brokers is the Israel Hotel Association (, which provides data; printed, audio, and video library references; courses; and on-site training programs.Although the thrust of construction to capture the anticipated millennium visitors almost is complete, there is room for further hotel development in Israel that meets the needs of a wide range of foreign and domestic travelers. The overall feeling within the region is that the peace process will continue and therefore will generate a wide berth of opportunity.— by Aytan A. Dove, CCIM, vice president of the international division of Weinstein Realty Advisors in York, Pa., and CIREI’s ambassador to Israel. Contact him at (717) 848-6777 or


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