Be vigilantly aware of new supply

Recently, the US lodging industry achieved a noteworthy milestone with the number of available rooms surpassing five million. Lodging construction is increasing faster than residential, public, and broader private non-residential construction growth. New supply makes individual hotel operators sensitive to raising their room rates, even if they are at peak occupancy. With more than 65% of all US hotel construction over the past two years in the limited-service upscale and upper-midscale segments, the superior value proposition of new select service offerings is generally creating negative pressure on full service RevPAR growth.

Room additions are accelerating and at this juncture many of the nation’s submarkets have upwards of five to 20 hotel projects which are either rumored, proposed, or under construction. While it is a tribute to the strength of these markets that so many new hotel facilities are being considered for development, it is evident that these markets would be devastatingly overbuilt if all of the rumored and proposed projects actually came on line.

Economic, governmental and environment factors render the development of new hotels an intricate process that depending on the lodging product type and/or location, can take anywhere from eighteen months to several years to complete.  Developers compete with one another for prime sites, building permits, zoning variances, brand affiliation, and construction mini perm financing.  Advantages rest with the development team that completes its hotel first, since every addition to the market dilutes the existing supply and diminishes the economic feasibility of succeeding projects, thus hindering additional development. Overbuilt markets evolve when subsequent sponsors believe that too much time and/or money have been invested into the various development phases and are unwilling to reevaluate  economic feasibility or abort their project(s) altogether. 

Similar to where the market is today, during the mature phase of a lodging cycle similar those sponsors that keep their heads in the sand may very well end up rudely awakened to a situation where the value of their completed hotel is significantly less than the cost of development. Invariably many of these projects end up becoming economically feasible for a second or possibly third owner whose financial basis in a deal is meaningfully below that of the original developer.

A word to the wise: Be vigilantly aware of new supply.