December 11, 2003

Are hotels overbuilt or just overproposed?

  • High defaults, construction costs and risk face new projects
    Colliers International Hotels

    Photo by Sam Bennett
    The Camlin Hotel was recently bought by Trendwest, which plans to turn it into a time-share urban resort.

    Like most commercial development, new construction in the hotel industry generally follows an increase in demand. And like office, retail or multi-family, hotel demand is cyclical and tracks closely to our regional economy.

    So is the Puget Sound region ready for more hotel rooms?

    Most standard hospitality indicators — occupancy, Average Daily Rate (ADR), Revenue Per Available Room (RevPAR) and EBITDA (earnings before interest, taxes, depreciation and amortization) — would suggest that throughout much of Washington state, we have an oversupply of hotel rooms. Low occupancies, coupled with a drop in ADR for the last 24 months suggest supply continues to outpace demand.

    Much of the new supply has been added in secondary and tertiary markets as compression from urban and close-in suburban markets created an increase in incremental demand that had not existed before. With the on-set of the recession in early 2001, corporate malfeasance, the stock market collapse, 9/11, the Iraq war and the SARS epidemic much of this demand vanished. Unfortunately, the industry was left with highly leveraged new supply in questionable markets, with no real plan to service debt in a down market.

    For the first time in over two years, the Puget Sound region experienced both positive room rate growth and an increase in occupancy over a three-month period that ended in September.

    There are many who may say now is the time to start developing hotels to meet new demand created by the next boom in the stock market or for Boeing's potential from the 7E7 program. Unfortunately, a single month or quarter of positive results in the region is not a strong argument for adding new supply. On the contrary, we would be better off removing properties that are past their economic prime and perhaps functionally obsolete before adding new rooms.

    The disposition of the Camlin Hotel to Trendwest is a phenomenal example of removing room inventory from the central business district and at the same time renovating the property for an altogether different use.

    Getting into position

    So why do we continue to hear of possible new development on the horizon?

    Most of this is simply player positioning. There will be another hotel construction boom, nationally and regionally, just as there will be positive absorption for Class A office space followed closely by single-digit vacancy rates and finally new office development.

    In Bellevue, there is a 252-room Marriott select service project under construction, and no less than four other hotels proposed and over a half dozen entitled hotel projects in the pipeline. A full-service Marriott under construction in Redmond, a limited-service hotel in Eastgate and projects proposed in Kirkland and Issaquah round out the current development climate on the Eastside.

    South Snohomish County has two projects moving forward and, after several years, Bremerton has secured a 105-room Hampton Inn as part of its $40 million waterfront redevelopment.

    In Seattle, we continue to see a bit of jockeying for the next big mixed-use hotel development. Unlike major west coast markets such as San Francisco and San Diego, Seattle still has relatively few rooms and even fewer owners. There are numerous brands and branding opportunities for the region and there is no doubt that before long we will see a Four Seasons, Ritz Carlton, Delta or Intercontinental Hotels developed on one of the many proposed sites.

    Although there may be high barriers to entry in the CBD, there are currently no less than five projects either in the “proposed” stage or actually under development. Silver Cloud Hotels, a regional player in the select service market, has two projects close to completion: Interstate 90 on the Eastside and its first full-service development on Capitol Hill, near Swedish Hospital.

    Silver Cloud is an exceptional operator and, as a regional chain, the company understands the market and can move quickly to capitalize on the coming economic turnaround. Silver Cloud will be followed closely by new development both on the Eastside and in Seattle.

    Seattle is already seeing hotel proposals for sites around South Lake Union, Second and Pine, Rainier Square, Westlake and Olive, Denny and Westlake, First and Madison, First and Royal Brougham, the Seattle Center and someday perhaps Terminal 46.

    Timing is everything

    With any commercial development, timing is everything. As long and arduous as the permitting process is in most municipalities, there will always be projects in the planning stage. However moving from proposed project to opening day can be long, tenuous and, in the case of the Lincoln Center project in Bellevue, disastrous.

    Lincoln Center is the result of absolute poor timing. It is a case study for what can go wrong with commercial development when the unthinkable happens. It is less a function of poor judgement or planning than the result of numerous negative events culminating into a single catastrophic impact.

    Although Lincoln Center may be an isolated incident locally, it is certainly not the only stalled or bankrupt mixed-use or single-use hotel development in the United States. There are numerous examples from Phoenix to Salt Lake to Orlando. Lenders from Wall Street to Walla Walla continue to foreclose and take back hotel properties at a staggering pace.

    With the slow months of winter ahead many more will not survive. And although the default rate nationally remains low compared to the late 1980s and early 1990s, regionally the rate of default is higher than experienced historically.

    Until we see RevPAR growth in the high single or low double digits for at least four or five quarters, there is plenty of current hotel supply to fill demand. Fortunately, simple economics and hesitant lenders will keep new development to a minimum. High default rates, high construction costs and the inherent risks of hotel development mean the Northwest should not experience excessive new development for the foreseeable future.

    Barring any catastrophic events, economic or otherwise, and given the cyclical nature of the hospitality industry we will see new full-service and upper-tier hotel construction in Washington within the next 24 months. Expectations are that this will be limited to those markets that can absorb new rooms and sustain occupancy and rate growth, and ultimately succeed in a difficult environment.

    Chris Burdett is vice president with Colliers International Hotels in Seattle and provides hotel investment advisory services for buyers, sellers and developers throughout the Northwest.

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