Caught In A Bind: In Robust Market, Capital Dries Up

<B> Caught In A Bind: In Robust Market, Capital Dries Up</B>

By Maria P. Vallejo

It's an interesting time to be in the extended stay business. Occupancies are high, inventory is low and it's a perfect time to be building. But the tightening of the financial markets governed by Wall Street and the instability of international economies has sent executives at Extended Stay America, Residence Inn, Staybridge Suites and Suburban Lodges America on a search for new funding resources. These executives all have reported that the time is right to expand--but that finding funds to do so is more of a challenge than ever.

Just when the market for extended stay properties is at its hottest, players looking to grow are being stifled by constrained capital markets, forcing extended stay companies to slow down their development plans and focus instead on alternative financial growth vehicles and improved customer service.

Hospitality stocks are continuing to spiral downward and local financial avenues are offering less financial backing. As a result, many extended stay hotels are turning to franchisers, their parent companies and joint venture partners for support.

Unfortunately, the capital slowdown comes just at a time when analysts predicted great opportunities for the extended stay market, where demand is running twice the size of supply.

"The capital markets have had contractions since August of this year as a result of the economic pressures from foreign countries, and that has impacted all companies funding areas for growth," said David Krischer, chairman of the American Hotel & Motel Association's extended stay subcommittee. "All areas of real estate are cutting back their growth."

But even while there is "no question that extended stay companies are cutting back," Krischer added, they still have a real opportunity to grow in 1999 "based on internally generated funds."

The expected construction and development slowdown in the extended stay sector may be a mixed blessing for the industry as well as for travel buyers. With less time and money being spent on expanding their product, companies can refocus their energy on existing properties, from services to products, Wilson said.

Extended Stay America and Staybridge Suites officials said they plan to use the opportunity to concentrate on the needs of their buyers.

"There has been such tremendous growth in the past couple of years that slowing down to absorb the supply in the industry is a good thing," said James Anhut, senior vice president of Holiday Hospitality, who also serves as vice chairman of the American Hotel & Motel Association's extended stay subcommittee. "It will give us the time to focus on the consumer, tighten our operations and concentrate on that side of the business. Maybe it's a time of introspection within our niche to really improve our quality and customer service. It takes the ownership's interest and eyes off of the grow, grow, growth. Now that the money is not there, let's improve, improve, improve."

The financial hardships once contained in Asia and Russia now are infiltrating the domestic capital markets, making their presence known through dropping stock prices of U.S. hotel companies (<I>BTN,</I> Sept. 14). The low stock prices also are attributed to shareholders reacting to fears of a possible recession. In either case, the falling prices are preventing hotel companies from issuing new stock, and therefore reducing the capital they have available for expansion projects.

"The global financial turmoil is having a ripple effect. Wall Street is cutting back, money-centric banks are cutting back and capital is tight," said Cristina Ampil, senior lodging economist at PricewaterhouseCoopers in New York. Still, she noted, "This may be a temporary set back."

In the short term, though, industry observers will notice a drop in the number of development projects completed during the next few years, versus the original number of projects proposed earlier in the cycle. Given that most extended stay developments require new construction, many such projects--especially in the upper tier segment--are too costly at the current price of financing. Extended Stay America, for example, has announced it will continue to grow its product, but at a slower pace than originally expected.

"There was a tremendous proliferation of products proposed, and half of that or less will come to reality in the coming years," said Anhut. "If you are a large consumer of capital, and relying on Wall Street capital to grow and keep earnings growing, you're going to have a tough couple of years while earnings burn through into the next up cycle. Many enterprises do not have that ability--they don't have internal cash available to drive development. You have to have a tremendous amount of cash flow for development projects."

Expansion cuts also may help quell the concerns of various industry experts who recently predicted that the extended stay market was headed for super-saturation in certain key markets, such as Atlanta, Dallas, Houston, New Orleans and San Antonio (<I>BTN,</I> Oct. 27, 1997).

"You're going to see an industry slowdown for new products coming out of the pipeline," said Brad Garner, a Smith Travel Research analyst. "That's a good thing. They're being cautious. People are cutting back, which is a smart thing to do. While they still are putting supply and new properties in, I don't think they will have such robust plans."

When high demand and slower supply meet in the marketplace, insiders expect to see a boost in occupancy levels at extended stay facilities. During the first half of 1998, the upper tier properties were running occupancy rates 10 percentage points higher than upscale hotels. The lower tier properties had occupancy rates 11.3 and 6.9 percentage points higher than the economy and budget hotels, respectively, according to PricewaterhouseCoopers, Bear Stearns & Co. and Smith Travel Research.

"The supply cutbacks are a silver lining for the extended stay companies," Ampil said. "A lot of investors greatly feared overbuilding in that segment. With less supply pressure, they can maintain very high occupancy levels."

The upper tier extended stay occupancy rate was 79.8 percent and lower tier properties clocked 68.4 percent from January to August (see chart, this page), according to Smith Travel Research. Extended stay rooms account for less than 3 percent of the room inventory in the majority of the 173 lodging markets tracked by Smith Travel Research.