Annual Hotel Chain Report: Development Sparse, Short-Term Supply Abundant
In the midst of the worst slump in a generation, the U.S. lodging industry can glean hope from one positive trend: The new development pipeline more or less has dried up. Unlike the industry downturn in the early 1990s, when developers aggressively continued to build—thanks to the availability of easy financing—lenders in this cycle are acting much more prudently, bringing new supply growth practically to a standstill.
Ordinarily, this development drought would be distressing news to travel buyers, because a shortage of new hotels coming online means existing hotels across the country have less competition and, hence, less motivation to negotiate favorable rates. However, until recently the pipeline had been so robust that, for the short term anyway, buyers can expect to see a steady stream of new hotels—at all price points—continue to open their doors.
Given the nature of the total development pipeline, it can take new projects a minimum of 18 months to 24 months from the point that early permitting is completed and construction begins to when the front desk is ready to check in guests. Indeed, the total development process for many deluxe and upscale properties can take three years to five years or longer. This especially is true for properties being built in downtown locations where the barriers to entry are formidable.
This delayed development not only signals that the increased industry competition that buyers benefited from will continue at least through 2003 and into 2004, but that buyers could benefit by new properties in a market tempting them with the most advantageous, "introductory" rates as a way of encouraging trial usage.
Given all the new products they have coming online, hotel companies—including such multi-brand giants as Hilton Hotels Corp., Marriott International and Starwood Hotels & Resorts Worldwide—last month went out of their way to promote the number of rooms they are about to open. The most prestigious, not to mention costly, new openings at their various chains particularly were highlighted.
"The project count for the total development pipeline, which includes all hotels under construction—those scheduled to start in the next 12 months and those in early planning—declined by 4.8 percent in the third quarter," said Patrick Ford, president of Lodging Econometrics, a consulting firm in Portsmouth, N.H. The decrease took the number of projects to below 2,000 for the first time since the firm began tracking the data. "The total room count in development, meanwhile, fell below 300,000 for the second quarter in a row. This represented a decline of 2.9 percent, to 272,531 rooms," Ford said.
To put this further into perspective, the decline represents a 50 percent drop from the peak in the number of rooms under development, which was reached in the third quarter of 1998, and is 22 percent lower than a year ago.
"The continuing declines virtually guarantee that net new guest room additions will be near a 1.5 percent low in both 2003 and 2004. That's good news for the industry, which still is recovering from the recession and the effects of Sept. 11," he said. Ford also cited the widespread cutbacks in business travel, which have had such an adverse effect on the industry, as a contributing factor. In many cases, the cutbacks in travel budgets also have resulted in companies implementing more restrictive travel policies.
Drilling deeper into the data, Ford explained that, compared with the second quarter, rooms under construction in these three months were down approximately 6 percent, while the number of rooms scheduled to start construction in the next 12 months was off by almost 4 percent. He estimated that a total of 90,400 rooms opened between the fourth quarter of 2001 and the third quarter of 2002, with the largest number (more than 26,000) being built in the midprice without food and beverage category. By contrast, the least development in the period occurred in the midprice with food and beverage sector, where slightly more than 5,000 rooms came online. For the entire year 2002, he projected that the total new room count would end up between 82,000 and 84,500.
Considering how much of business travel is directed to the gateway cities, buyers who bring a significant number of room nights to Boston, Chicago, Miami, San Francisco or Seattle should be in the most advantageous negotiating position going forward. Of the 12 largest U.S. markets likely to lag behind any recovery in development activity, Lodging Econometrics singled out these five as the most troubled. "They're of the most concern in terms of fallen demand and their ability to absorb new supply additions," Ford said.
Referring to the national market overall, Ford noted that, in light of the current industry slump, developers have begun to drag their feet. "Some are showing little rush to complete projects already started, nor are they hurrying to start construction on new projects," he said. In fact, he specified 52 such developments, representing more than 7,600 rooms, which were reclassified backward during the third quarter. Where they had been scheduled to start in the next 12 months, they were pushed back to early planning status.
Asked to sum up the underlying forces shaping the development picture at the moment, Ford said that interest rates were low, which was the one positive element. "Despite low interest rates, however, most developers can expect to have difficulty obtaining financing due to lenders' more challenging loan-to-value ratios," he said. Such difficulties are the direct result of both today's economic and political uncertainty. To obtain funding, many developers are being forced to resort to alternate financing or leasing arrangements.
Against this backdrop, such hotel companies as Hilton, Marriott and Starwood last month continued to trumpet their aggressive room count expansion plans. In its third-quarter earnings report, for example, Marriott chairman and CEO J.W. Marriott Jr. noted that the company had added 7,100 new rooms during the quarter and was on track to add between 25,000 rooms and 30,000 rooms each year in 2002, 2003 and 2004. Marriott, however, said that these counts included conversions from non-Marriott brands as well as new construction. Yet, in terms of the actual pipeline, Marriott International still had in excess of 50,000 rooms either in construction or approved for development worldwide at the end of the third quarter.
Similarly in Starwood's quarterly earnings report, chairman and CEO Barry Sternlicht reported that the company planned to open 50 new full-service properties containing approximately 115,000 rooms around the world by the end of 2003. This would not include growth plans for its midprice Four Points by Sheraton chain. In a separate announcement last week, Starwood said that 12 of these high-end developments are scheduled to open in the fourth quarter, including two in the Phoenix area, the 750-room Westin Kierland and the 500-room Sheraton Wild Horse Pass. Outside of the United States, Asia has been a prime focus of Starwood development. The 302-room Westin Shanghai and the 246-room Sheraton Krabi project in Thailand are among the 12 opening this quarter.
At Hilton, 38 hotels opened in the third quarter, though most of the activity was among the company's midprice brands. Hampton Inn, for example, debuted 18 hotels with approximately 1,500 rooms, while Hilton Garden Inn accounted for another 10 openings and about 1,400 rooms.
To be sure, the multi-brand giants have ample reason to promote their pipeline growth for as long as properties continue to come online. Rather than put them at a disadvantage, increased inventory can translate into important new distribution, assuming the properties are in the right locations in the right destinations. This distribution, in turn, becomes a form of competitive advantage for their brands, since they can claim to be in more of the locations where travel buyers are looking for coverage.
Many of the chains that are experiencing the greatest growth are midprice brands that are essentially franchise operations. In this business model, Hilton or Marriott, for example, mostly recruit developers, who then own and manage the properties and, in the process, assume most of the financial risk. At Marriott, such brands as Courtyard and Fairfield Inn, as well as the two extended stay brands Residence Inn and TownePlace Suites grew this way. As it happens, Fairfield Inn last month celebrated the opening of its 500th hotel in Rogers, Ark., while Residence Inn passed the 400th property milestone and TownePlace Suites its 100th in September in Philadelphia and Redwood City, Calif., respectively.
Tom Keltner, president of Hilton's brand performance and franchise development group, acknowledged these market dynamics when he said, "Regardless of the phase of the economic or real estate cycle, strong hotel brands tend to win." However, he added that financing may be more difficult to obtain in this market. Furthermore, developers and lenders are more likely to migrate to large established brands in difficult times as are owners of independent properties seeking to convert to well-known chains. "Historically, these brands have performed better and this trend certainly holds true today," Keltner said.