Fears of Glut Rise as Hotel Chains Continue Building More Rooms
A nationwide hotel building boom has raised concerns about a glut of guest rooms in certain markets and slower revenue growth in the years ahead.
The surge of construction might be bad news for hotel owners but it could prove to be a bonus for guests. In suburban markets where building has been heavy, travelers could see a reduction in room rates as new hotels seek to establish themselves and fill their rooms. Meanwhile, existing hotels may reduce rates too and renovate their properties to keep up with the new competition.
Construction began on nearly 149,000 hotel rooms last year--a level comparable to the industry building boom of the late 1980s. The current rate of building, which is far above historical levels, has contributed to a decline in occupancy rates and slower revenue growth only a few years after the industry staged a dramatic recovery. The average occupancy rate dropped to 70.4% in 1999 from 71.5% in 1998, and from a peak of 72.7% in 1997, according to PKF Consulting.
“We’ve had more supply than demand,” said Joseph V. Coccimiglio, a hotel industry analyst at Prudential Securities.
Much of the new construction--and potential for problems--is focused in the popular limited-service end of the hotel industry, which includes such chains as Fairfield Inn, Hampton Inn and Holiday Inn Express. This part of the market has more than doubled in size during the last decade and continues to add rooms at a rapid pace.
Industry giants Beverly Hills-based Hilton Hotels Corp. and rival Marriott International are in a race to open limited-service hotels. In the next two years, Hilton Hotels plans to open about 400 hotels--most of them franchised Hampton Inns--with a total of 60,000 rooms.
“Sure, you could say we are contributing to the supply,” said Hilton Hotels spokesman Marc Grossman. But investors “got the money; they got land; they’re going to build a hotel. We are going to do everything in our power to make sure that it’s going to be one of our brands.”
A notch above a motel, limited-service hotels offer budget-minded travelers the comforts of a fully appointed guest room without amenities found in more expensive hotels.
“Inside, the guest room is the equivalent of a [full-service] hotel room. Outside, it is more like a motel,” said Bjorn Hanson, who heads the hospitality and leisure industry practice at PricewaterhouseCoopers.
The formula proved successful during the recession of the early 1990s, when travelers were eager to trade bellmen, room service and a hotel restaurant for a comfortable room priced well below $100 a night.
Limited-service properties emerged as industry darlings when the recession battered full-service, big city hotels. Investors loved the concept because they could open a 100-room hotel on cheap land in an outlying location for as little as $5 million. In contrast, a full-service property downtown could easily cost $100 million or more.
As a result, the number of limited-service hotel properties ballooned to about 468,000 rooms during the last decade, according to PricewaterhouseCoopers.
But the same features that made the hotels so popular among investors have become weaknesses. “Supply comes pouring in when builders can build whenever they can,” said Los Angeles attorney Jim Butler, who is in charge of the hospitality group at Jeffer, Mangels, Butler & Marmaro.
The surge of new development has proved painful for full-service competitors--such as Holiday Inn--and independents, many of which have been forced out of business.
But as the construction boom continues--albeit at a slower rate--many suburban markets are on the verge of becoming overbuilt with limited-service hotels, industry analysts warn.
In California, most markets have seen little hotel development, but some pockets, such as suburban Sacramento and northern San Diego County, are expected to see large numbers of new rooms.
The construction boom has not created a “treacherous situation” but will force investors to be more selective and cautious about where they build, said Hanson at PricewaterhouseCoopers.
“It used to be that any hotel project would be successful,” Hanson said. “It was almost too easy.”
Individual investors--not the giant lodging chains that franchise the properties--stand to bear most of the risk from building too many stripped-down hotels, industry observers said.
The spike in mid-priced hotels and the ease at which they can be opened “is why we are typically not an owner in that end of the market,” said Grossman at Hilton Hotels.
The industry is expected to avoid a major hotel-room glut because lenders and investors have become more hard-nosed, lodging analysts said. Hotel developers who had been able to put up only 20% of their money to finance a project may now be required to come up with 40%, said Alan X. Reay, president of hotel broker Atlas Hospitality Group.
“Lending is getting tighter and tighter,” Reay said.
In a turnabout, investors are now more willing to finance the full-service, luxury hotels in major urban markets that were once out of favor. The difficulty and high costs of building new properties in central cities has kept a lid on competition and freed hoteliers to raise rates aggressively.
“It’s the economy end of the business that is suffering the most from the consequences [of the building boom],” Butler said. “Now, the greatest growth, the greatest profit and greatest stability is at the high end.”
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Building Boom
Hotel occupancy rates in the U.S. have dipped in recent years as a surge in construction has increased the competition for travelers, particularly those staying at limited-service hotels.
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Hotel construction is booming . . .
Construction starts, in thousands of rooms: 2003*: 116,566
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. . . but occupancy rates have dipped . . .
Average percentage of rooms occupied per night at all hotels: 1999: 70.4%
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. . . especially at limited-service hotels
Average percentage of rooms occupied per night at limited- service hotels: 1999: 65.3%
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Sources: PricewaterhouseCoopers, PKF Consulting
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