By Cory Creath, Principal Architect at AXIS Architecture + Design
Image: The Americas Lodging Investment Summit 2016 keynote session, “Where’s the Peak?”, AXIS Architecture + Design archives.
In late January, members of the AXIS Architecture + Design team and I made our annual pilgrimage to The Americas Lodging Investment Summit (ALIS), this year held in Los Angeles. The Summit, recognized as the largest hotel and hospitality investment conference in the world, draws many of the most notable and knowledgeable personalities in the hospitality investment industry, many of whom provide the insightful data and industry perspectives companies like AXIS find useful for plotting our strategies for the coming year.
In the lead-up to the Summit’s kick-off the informal hallway chitchat echoed the event’s official theme – “Where’s the Peak?” Undoubtedly, attendees were approaching this year’s event with slightly more apprehension than seen in previous years – and who could blame them; the hospitality industry has been decidedly undecided whether the robust growth seen in recent years has reasons to continue, or whether the gloomy signals on the horizon are indicative of a coming change in the market. For attendees hoping ALIS would settle the debate, the Summit’s key takeaway likely left them unsatisfied. The overwhelming forecast? Cautious growth, but continue to prepare for the market to soften…sometime. When exactly, we’re not sure, and by how much, we can’t tell.
The fact that industry fundamentals and Wall Street have been at odds for a number of quarters illustrates the challenge in determining the amount of growth left in the market. From within the hospitality industry’s ranks 2015 was simply the latest year in a series of years with great-to-unbelievable growth: 2015 saw the highest US room demand on record with a 65.6% occupancy rate, and as Jan Freitag, Senior Vice President of STR reported in his “Let the Numbers Speak” session, RevPAR rose a healthy 6.3%, and room rates rose 4.4% last year. Combine those numbers with Lodging Econometrics’ data that hotel investment transactions hit an 8-year-high in 2015, and it’s easy to see why the industry is anticipated to grow a modest 2% year-over-year for the foreseeable future. Now, contrast that rosy news with the gloomy din from Wall Street, including the regular confirmation of general market volatility on account of wildly fluctuating energy prices, fewer financing opportunities due to increased lender vigilance because of that market volatility, and the ever-present threat of toxic Chinese debt, and it’s easy to appreciate the hospitality industry’s uncertainty.
But with experience comes wisdom, and with wisdom comes greater certainty. As one of America’s most prolific hotel and hospitality industry architectural design firms, AXIS Architecture + Design has some insight on navigating uncertain markets like these. From a hotel architect’s perspective, we present to you, The 3 Hospitality Development Opportunities Highlighted at ALIS 2016.
#1. Focus on minor markets – Many of the larger gateway markets where much of the growth was centered in recent years are starting to run out of margin. Projects in cities like San Francisco and New York are starting to become so expensive on the front-end (e.g. finding raw land to sink a shovel into, or purchasing an existing property to renovate) that the profit at the end of a multi-year project is diminished or questionable altogether. This issue is compounded by the fact that many prime and obvious opportunities for development in those larger and hotter markets have already been developed; a situation that further increases demand for real estate and further increases costs.
To reduce exposure to inflated project costs minor markets are more likely to offer opportunities for greater margins on account of their generally less expensive real estate costs and labor costs. As Jan Freitag also pointed out, weaker international currencies for the foreseeable future mean fewer international travelers to major centers, suggesting minor domestic tourism destinations in the Southern US could be prime for hotel development and renovation.
#2. Focus on smaller, more nimble projects – Success in the hospitality industry in recent years has been a tale of two segments – luxury hotels, and limited service/select service hotels. But with lenders starting to reassess their lending appetite with respect to debt service ratios and recollection terms on account of Wall Street’s skittishness, smaller loans with quicker repayment terms are likely to replace larger and longer-term loans. What does that mean for 2016’s hotel developer? Less expensive and quicker to develop limited service and select service hotels are likely to present fewer barriers to credit funding relative to more expensive projects with longer project timelines where lending profitability and project certainty diminishes. Moreover, if we are heading towards a significant softening in the market, select service hotels and limited service hotels are generally considered more recession-proof.
One caveat with respect to focusing on select service and limited service hotels: select service and limited service hotels represent over 66% of the rooms built in recent years. Given their arguable overrepresentation in the pipeline, if there is a softening in the market, the select service and limited service segments may see the largest contraction as a percentage of all segments as a whole – it’s simply the law of averages.
#3. When all else fails, renovate! – Moving into 2016 and beyond, cautiously tempered investing in the hospitality industry is likely to prove itself the winning approach. Renovations of existing hotels – whether to rebrand, whether to pivot to a different segment, or whether to increase competitiveness with refreshed and optimised service offerings – provide opportunities for accessing the market while limiting exposure to riskier projects, and provide better opportunities for accessing credit all while leveraging investments and decreasing construction costs with existing and established facilities.
Cory Creath is a Principal Architect at AXIS Architecture + Design, and regular speaker at hospitality industry trade shows and events. An expert on hospitality and hotel architecture, Cory’s comments will appears regularly here in On The AXIS, AXIS Architecture + Design’s official blog and sounding board.