No Room At The Inn? Wait A Few Quarters
by M. Abigail, Economist
Torto Wheaton Research
The past two quarters have brought a hint of slower demand growth for hotel rooms. One thing that could compound this nascent slowdown is something that the industry has not seen in quite a while: meaningful construction of new hotel projects. In 2005, the number of new hotel rooms "added" to the hotel sector was actually net negative. Conversions of hotels to condos and apartments without replenishment caused supply to decline outright. Construction in 2006 didn't break any records either-not by a long shot. Presumably, it was high construction costs that kept new hotel construction at bay, at least for a bit. Now, however, with returns to hotel investors well ahead of other asset types, construction has finally begun to pick up speed. Full-service supply is expected to grow by 2.4% in 2007 and limited-service by 1.2%; both of these rates, while still relatively moderate, are significantly higher than what we've seen in recent years. We expect that these supply shocks will only compound the moderation in household expenditures in the quarters ahead. But all hotels are not created equal. What exactly is being built? There has been at least one new type of hotel to come about since the last construction boom. The condohotel is a recent phenomenon in the hotel industry. Acting as both a rentable hotel room and a scaled-down condo, condohotel rooms have taken off with investors. You can see in the chart below, the surge of condohotel rooms in the hotel sector began in the second quarter of 2005 and lasted for about 3 quarters. This surge in condohotel room construction reflects the increase in speculation with all types of condominiums. Since that surge, condohotel construction in the pipeline has flattened out, if not declined; this does not however reflect as quick a decline in fortune as the market for condos is seeing. New condohotels will enter a tough market; that is, if their format is not changed before they are completed.
Full-Service Hotel Construction
Source: TWR/Dodge Pipeline
The chart above also illustrates why full-service construction is set to increase by 2.4% in 2007. Three out of the six subclasses of hotels-upscale, extended-stay and luxury-are riding an accelerating trend in new rooms started or underway. The luxury subclass includes brands such as the Ritz-Carlton and the Four Seasons, the upscale subclass includes hotel brands such as Le Meridien and Marriot. Marriott International, which operates the Ritz-Carlton brand and the Marriott brand, saw ADR increase 9.7% in 2006, handily outpacing average full-service ADR growth, and well above average rent gains among other asset types. Recent success among these full-service brands is supplying the motivation for adding additional rooms. Meanwhile, although the limited-service sector is expected to underperform the full-service sector in terms of new supply, limited-service developers are certainly not going to let that deter them. The construction of the economy subclass of hotels has been consistently flat over the past several years. Economy hotels such as Motel 6 and Days Inn charge some of the lowest room rates in the industry, so it seems that operators and developers are looking toward another subclass of limited-service hotels: mid-market without food and beverage. In terms of number of rooms started or underway, the mid-market without food and beverage subclass has the most rooms in the pipeline, even more than the best performing full-service subclass. Holiday Inn Express and Comfort Inn classify as mid-market hotels without food and beverage, and posted in 2006 RevPAR increases of 10.7% and 8.5%, respectively. Thus, although limited-service hotel construction may not add up to the full-service pipeline of construction for 2007 there certainly continues to be interest in developing specific types of limited-service hotels, and we expect that that interest will continue to grow over the next couple of years.
Mid-Scale Limited-Service Properties Leading the Way
Source: TWR/Dodge Pipeline
Unfortunately, as the hotel industry grapples with increasingly frugal leisure travelers in 2007, affected by the slowing housing market and high gas prices, the last thing it may need is a growing construction pipeline of new rooms. But that's exactly what it is going to get.
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