Rate, Occupancy Hikes Point To Healthy Hotel Market
<H1> Rate, Occupancy Hikes Point To Healthy Hotel Market</H1>By Daniel Lesser
As the hospitality industry continues its strong performance, occupancies continue to rise in most markets, and average rate growth is exceeding inflation.
According to Smith Travel Research, national occupancy was 65.3 percent through June 1996, compared with 64.4 percent for the same period last year. The national average rate was $71.40, a 6.2 percent increase from last year. Industry profitability increased from $5.5 billion in 1994 to $8.8 billion in 1995, a 60 percent increase in one year. The strength of the industry is attributed to revenue increases through occupancy and rate, increased expense efficiency and overall lower fixed charges. Many of the overleveraged properties of the 1980s and early 1990s have either been sold or restructured with financing based upon current market values.
Of the top 25 markets followed by STR, Orlando, Fla., had the greatest occupancy change for the first six months-a 6.7 increase from 1995-and also had the highest occupancy rate, 82.9 percent. With an 11.2 percent increase, Phoenix had the greatest rate increase between 1995 and 1996; New York City had the highest average rate of $141.12.
The most desirable markets for hotel investment include New York, Chicago, San Francisco and Hawaii, according to our own research. In spite of the barriers to entry, respondents to our survey view these markets as ones with strong occupancies and the greatest potential. Many of the investors interviewed believe the less desirable markets are Orlando, Detroit and San Antonio, primarily due to the potential of oversupply.
As a result of the strong performance results, and the ability to achieve higher yields than other real estate types, the capital markets now view the hotel industry as a preferred investment type. Debt financing is now more readily available from traditional sources such as commercial banks and insurance companies. Many of these lenders had stopped making hotel loans when the majority of the hotel markets were oversupplied, but today there are a number of new capital sources, including the public debt and equity markets.
Historically, hotel investors had limited access to public debt capital, as loans were typically sourced from the private sector. As Wall Street has entered the market, the access to various forms of capital is unprecedented in the industry. However, with loan-to-value ratios ranging from 50 percent to 70 percent, the overall underwriting is more conservative than in the 1980s. These programs make individual property and portfolio loans either through mortgage conduit programs or directly through investment bankers, and package the loans to sell to investors through the public debt markets. Hotel franchisers are now offering financing as well, through programs established with investment banks. This enables the franchisee to tap into a much larger source of financing than ever before.
Equity financing continues to increase with REIT offerings and IPOs for public corporations. Recently, Interstate Hotels Co., with an approximately $204 million offering, and Wyndham Hotels Corp., with an approximately $50 million offering, entered the public equity markets. Also, Extended Stay America recently raised $290 million in a 9.7-million-share offering.
In the past few years, there has been tremendous growth in public hotel companies. These companies have a much wider access to capital, which is being used to acquire additional hotel properties and retire debt. As evidenced by lodging stocks' most recent performance, the market views these stocks as good investments. Lodging indexes developed by Bankers Trust had returns between 22 and 30 percent over the past seven months, compared to a 6 percent return for the S&P 500.
The development cycle is occurring with limited-service and extended stay, all-suite properties, due in part to less restrictive barriers to entry, lower construction costs and less operating risk than their full-service and luxury counterparts. Still, wide-scale development of full-service hotels is two to three years away. Full-service hotels that are being developed usually involve some form of public subsidy or are located in gaming markets, and most full-service hotels can be acquired for less than the construction costs. Investors are assuming that with very few new full-service hotels on the horizon, they will be able to ride the occupancy wave and increase average rates beyond inflation, therefore increasing overall profits and resultant values.
Hotel operators are continuing to segment the markets further. The newest products being offered are middle-market and budget extended stay products. Based on the success of the traditional extended stay products such as Residence Inn and Summerfield Suites, the hotel firms perceive a market need for products targeting a segment that would rather spend $50 to $60 per night than $80 to $90. Examples of these products include Candlewood Suites, a joint venture between Doubletree Hotels and Jack DeBoer (the original founder of Residence Inns and Summerfield Suites), Choice's Mainstay Suites, Marriott's Townplace Suites and Extended Stay America. Studio Plus, a budget-oriented lodging concept with limited services, represents another niche product. Because these properties do not yet have a critical mass, it is not known whether the traveling public will discern the difference between the various suite products.
The hotel gaming sector continues to show strength through both operations and merger activity. Casino gaming profits have continued to rise since 1990. Hilton recently announced its acquisition of Bally Entertainment Corp. in a $2 billion transaction. Hilton will now have 15 casino hotels worldwide, with four more under construction in Las Vegas, Kansas City and Uruguay. ITT Sheraton purchased Caesar's World to expand its presence in the gaming market, and plans a major addition and renovation of Caesar's Palace in Las Vegas. Furthermore, Sheraton has formed a venture with Planet Hollywood to build a new hotel in Las Vegas.
Individual and portfolio transactions continue at a torrid pace. In the past year, Starwood Lodging has spent about $700 million to acquire 25 hotels. Recently, Starwood closed a $309 million acquisition of a portfolio from Teacher's Insurance and Annuity Association. The total price per room is less than $98,000 and includes Ritz-Carlton, Doubletree, Westin and Sheraton brands. The second is a $134 million transaction to acquire the Hotels of Distinction Ventures Inc.'s entire nine-property portfolio. The total price per room is $55,000 and includes Embassy Suites, Radisson and independently flagged hotels.
In other transactions, Omni Hotels was purchased from Wharf Holdings for $500 million; Patriot American purchased five hotels from Wyndham for $96 million, or $87,000 per room; and Polylinks, a Hong Kong-based group, recently acquired the Regent Beverly Wilshire Hotel for $100 million and the Four Seasons in New York for $190 million (see chart).
Our survey respondents reported that REITs are the most active hotel buyers, followed by hotel companies, pension funds, individual investors and international companies. Although respondents reported that international investors are the least active of the buyers, two of the major transactions this year were purchased by one international group. The most active sellers are the individual investor groups and international investors, and REITs are the least active.
When asked when average rates and occupancies will be high enough to justify new construction, full-service hotel respondents gave answers ranging from now to six years. Most respondents said 18 months to three years, with more leaning toward two years.
With regard to the value changes of both limited-service and full-service hotels, the respondents perceive that full-service hotels will increase 9 percent in 1996 and 1997 and 6 percent in 1998. Limited-service hotels are perceived to increase 3 percent in 1996, 1 percent in 1997 and remain flat in 1998. The potential for overbuilding in this segment is most likely the reason for slow growth in values.
When asked about increases in ADR over the next three years, the respondents said that full-service hotels would be able to increase rates on average 5.5 percent in 1996, 5.4 percent in 1997 and 4 percent in 1998. For limited-service hotels, the increases are perceived to be on average 3.5 percent in 1996, 3.3 percent in 1997 and 2.5 percent in 1998.
With limited amounts of new supply in the full-service and luxury sectors, investors perceive these hotels to have the strongest upside potential. There is some concern regarding the limited- service sector, as some markets could soon encounter plentiful new supply, which might dampen occupancy rates.
<I>Daniel Lesser is director of the Hospitality Valuation Group at Cushman & Wakefield, a New York-based commercial real estate company. The HVG's services include hotel appraisal and valuations, restructuring advice, asset management, property tax consulting and market repositioning studies.