Experts Predict Overbuilding Will Soften Room Rates

<B>Experts Predict Overbuilding Will Soften Room Rates</B>

By Bruce Serlen

Citing the latest construction data, hotel industry analysts are projecting that overbuilding in certain U.S. markets could lead to falling occupancy and a softening of room rates.

"Right now, we're sailing into a headwind of too much construction through at least 2001," said Mark Mutkoski, managing director and senior lodging analyst for Deutsche Banc Alex. Brown. "Specifically, we're seeing overbuilding in secondary and tertiary markets like Phoenix and Dallas, mostly in the economy, midmarket and extended-stay sectors."

For travel buyers, overbuilding could have the effect of tipping rate negotiations in the effected markets in their favor. "Overbuilding will soften these markets," said Julie Hylton, director of hotel consulting for American Express Consulting Services. "In fact, we're seeing early signs of the negotiation picture starting to cycle back. After a number of years of sellers having the advantage, we're starting to see more of a balance in favor of the buyer in these markets."

Other overbuilt markets of this type cited by analysts include Kansas City, Indianapolis and Tampa/St. Petersburg. Of the 15 major urban U.S. markets, Deutsche Banc Alex. Brown has identified two potential "hot spots" for overbuilding: Philadelphia and Miami.

The hotel industry has experienced three consecutive years of supply growth in excess of 3.5 percent, compared with an average growth rate of 2.7 percent, according to Mutkoski. He believes the streak will be extended this year and possibly next. "Each year the current development cycle continues will leave the industry increasingly vulnerable," he said.

Short of a precipitous drop in the national economy, however, the effect of the overbuilding should be contained. "It takes time for the effect of the overbuilding to be felt across the board and that won't happen unless there's a substantial economic slowdown," Mutkoski said.

According to Lodging Econometrics data, 279,974 hotel rooms either were under construction or in the permit phase as of year-end 1999. This compares with 284,407 rooms at the end of the third quarter. Rooms in the early planning stage, meanwhile, jumped more than 6 percent in 4Q99, with nearly 25,000 more rooms in the planning stage than at the end of 3Q99.

"Pockets of overbuilding may exist on a micro basis, but not on a macro basis," said Eric E. Pfeffer, chairman and CEO of the Cendant Hotel Division, whose eight brands include Ramada, Wingate Inn and Super 8. He said that since 1995, the industry has re-educated itself in regard to development and is much more cautious today.

"There may have been a flattening of occupancy rates over the past 24 months, but we continue to have increases in demand on the macro level," said Bill Weatherford, senior vice president, franchise operations at Choice Hotels International, whose seven brands include Comfort Inns and Quality Inns. "Lodging cycles tend to run seven years and we are in the mature phase of the cycle."

According to Pfeffer, demand for rooms only went down "during special situations like the Gulf War." Where there have been occupancy declines, he said, it's been a result of the growth in supply outstripping the growth in demand.

"Proceding with caution is certainly good as we move forward," said Jim Burba, senior managing director of Insignia/ESG Hotel Partners, a real estate brokerage firm. He added that while supply growth is increasing, the overall economy remains healthy, keeping demand high.

"It is important not to broadbrush the entire industry," said Daniel H. Lesser, senior director for the hospitality industry practice at Cushman & Wakefield, another real estate broker. "Rather, the industry is fragmented by market and product type, so you need to look at submarkets within a market where there may still be significant demand."

Burba called hotel markets "street corner markets," adding that "the hotel industry is driven by individual markets."

This is especially true, for example, in a market such as Phoenix and the limited service sector, Lesser said. "Historically, there was a lot of vacant land available and a boom or bust mentality prevailed, which resulted in a building surplus."

Choice's Weatherford said markets such as Phoenix "are not economically diverse enough or densely enough populated, which is why they're feeling the effect of overbuilding first."

Companies, such as Choice Hotels, have development people based in the field, monitoring activity in specific submarkets.

"We track the history of demand in that market, examining existing supply and supply coming on line," said Weatherford. "In the Atlanta market, for example, there's tremendous supply and the pace of development may have started to cool. But there are still pockets of growth opportunity, such as at the airport."

Another key factor in the hotel overbuilding question concerns the break-even point.

"In recent years, we have seen a decline in this break-even point--what is required for a property to remain profitable," said Cendant's Pfeffer. "According to industry sources, occupancies of 68 percent used to be necessary. Today that number is 50.8 percent, partially because hotel properties are less expensive to finance, among other reasons. So even in overbuilt markets, it is possible for a property to be profitable.