Hotel Market Ready for New Construction

BY CRAIG SCHAFER
Colliers International

1995 was a banner year for owners and operators of Seattle area hotels. Market area occupancies approached 80 percent and average daily room rate increased by more than double the CPI growth rate. As a result, the value of hotels in the area have reached historical highs. Another reason for the substantial increase in value is a strong domestic investor interest for hotel acquisition in the Seattle market, mainly driven by Wall Street and private funds.

While this is good news for owners, there are a number of new construction projects in various stages of development that could create a significant shift of market conditions by the end of this decade.

Based on the results of the 1996 Colliers Hotel Investment Report, average value per room for Seattle area hotels increased by 10 percent in 1995 and have returned to their previous high achieved in 1990. Markets tracked in the Seattle are include, downtown Seattle, Bellevue, and SeaTac/Southcenter. The report cites two major reasons for the record increases: a large amount of investment capital chasing a limited supply of hotels for sale and strong 1995 market occupancy and average room rate increases in all the individual markets.

Hotel occupancies in downtown Seattle were the highest of all the major west coast cities in 1995. The average room rate of approximately $120 was the highest ever for downtown Seattle and was the second highest of all major west coast cities, surpassed only by San Francisco. As a result, the average value per room of downtown Seattle hotels increased by 10 percent during 1995.

Additional momentum for the value increase resulted from the abundance of capital currently available to purchase hotels. Investor interest in acquiring and/or developing a hotel in downtown Seattle is extremely active and has been this way since the late 1980s, although few properties have traded during this period. Hotel owners have shown little motivation to sell their property, expecting higher returns from holding their investment.

This strategy has proven wise. Average value per room for downtown Seattle is approaching $130,000 and is projected to exceed its previous peak value recorded in 1990 when an abundance of off-shore capital fueled the hotel investment market.

Owners are currently enjoying the benefits of strong operating cash flow as well as a steady increase in the value of their real estate. These owner benefits are due to the excellent 1995 market occupancy and average daily room rate which has improved operating profit, and the high level of investor interest which has lowered the market's average capitalization rate.

As expected, these excellent results have led to a number of new construction projects that are in various stages of planning including approximately 375 rooms to be added this year. While some of these projects have a high probability of being completed during the next three years, a number of others may take longer due primarily to the economics of new construction. Although average room rates are outpacing inflation, a few more years of substantial growth are necessary before construction of first class or luxury full-service hotels becomes feasible.

Even if half of the planned projects are completed these would significantly change downtown Seattle's marked dynamics. Seattle is still considered a small market relative to other major U. S. cities and any additions to the inventory of hotel rooms can have a significant effect on the operating performance and value of existing hotels.

Bellevue continues to achieve operating results that have made it one of the nation's premier suburban hotel markets. 1995 occupancy was close to 78 percent and average room rate approached $85. These excellent results were driven by a strong corporate demand base buoyed by Microsoft, and the numerous high technology companies located in greater Bellevue. The resultant 1995 average value-per-room increase of 16 percent was the highest of all the Seattle area submarkets.

While the record 1995 market occupancy and average room rate was a major factor, the value increase was also spurred by the sale of the Bellevue Hilton and the Courtyard by Marriott. These aggressively priced transactions lowered the market's average capitalization rate. Both these transactions were all cash sales to large U. S. based institutional investors. This type of transaction is currently the most common throughout the nation and is indicative of the availability of large pools of capital, both equity and debt, that are currently seeking individual and portfolio hotels.

Whether this trend continues will depend on how well these investment pools perform on their recently acquired assets. Some of the more entrepreneurial individual investors have moved to the sidelines as the pricing levels have moved significantly higher than they are willing to pay. Investor interest in Bellevue is strong because it is viewed as a high quality corporate hotel market with significant barriers to entry.

Despite these barriers, there are currently six new construction projects in the development process including three extended-stay hotels, one mid-market hotel and two limited-service hotels. These projects could add up to 850 rooms, a 40 percent increase in the inventory of hotel rooms in Bellevue. Additional hotel development sites are under consideration in Issaquah, Redmond and Bothell. If completed, these locations would likely impact the Bellevue market. There are also a number of full-service hotel development sites in downtown Bellevue, however average room rates still remain below levels that could support new full-service hotel construction.

SeaTac/Southcenter's 1995 market operating results have increased significantly since 1992/1993 downturn. 1995 market occupancy was in the mid 70s and average room rate approached $75. These results contributed to the 12 percent increase in average value per room for this market. This is a significant improvement for a market that lost approximately 33 percent of its value between 1989 and 1992.

During this period the market's decline in average value per room resulted from a combination of factors including a Boeing downsizing in the Kent Valley, a national recession that reduced business travel to the area and a significant increase in room supply.

At the end of 1995 SeaTac/Southcenter had recovered almost two thirds of its loss in average value per room. The value rebound in this market is not surprising. There is strong investor interest in the market, even though only one transaction was recorded in 1995. Owners have shown little interest in selling as they perceive a greater economic benefit from continuing to own.

The market has a strategic location relative to SeaTac International Airport and the interchange of I-5 and I-405 which provides direct access in the entire Seattle metropolitan area. The market is driven by a huge commercial demand base that contains approximately 62 million square feet of industrial and distribution facilities and six million square feet of office space. Also, growth in annual passenger arrivals at Sea-Tac Airport increased by 8.7 percent in 1995.

We expect that two or three aggressively priced hotel sales will occur in the market during 1996. These transactions will lower the average market capitalization rate and cause average value per room to continue its upward trend. Over the long term the dynamic of this market will change. There is a limited amount of developable land in the Kent Valley. This is good news for Southcenter hotel owners and operators who are protected from new competition, however, it may be offset by a leveling of commercial demand increases as new and expanding companies seek alternative locations.

At Sea-Tac Airport a number of new projects are in the pipeline including a 149-room Holiday Inn Express to open in June of this year, four additional 100 to 150-room limited service hotels and a 350-room full-service hotel adjacent to the main airport terminal. These projects should cause a leveling of decline in existing hotel values as investors begin to anticipate the reality of new competition in their investment models.

These shifting market conditions would have the most effect on the hotels located near Sea-Tac Airport along International Boulevard because the majority of new hotel development is slated for this location.

Craig Schafer is a broker with Colliers International Hotel Realty in Seattle.

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