Scarcity of new supply fuels urban gateway hotel investment

Concerns over significantly high hotel supply growth in urban gateway markets, including New York City, Boston, Washington, D.C., and Los Angeles, have subsided post-pandemic. These markets, popular locations for first-time U.S. travelers, have historically led the nation’s hotel pipeline activity. In fact, their aggregate supply growth reached a peak of 3.4% in the previous cycle. This, however, has since shifted significantly post-pandemic amid high construction costs and stringent government regulations. As of the first half of 2024, their aggregate supply growth was 1.7%, 170 basis points below the last cycle’s peak. 

In 2024, U.S. urban gateway hotel supply growth has so far remained well below pre-pandemic levels, stifled by an environment of elevated interest rates, high development costs and persistent supply chain disruptions. By the end of 2024, the year-over-year percent change of annual room inventory for urban gateway markets in aggregate is forecasted to be 107 basis points lower than 2019 and 55 basis points lower than the long-term average since 1990. This material slowdown in supply growth has created a foundationally favorable environment for hotel investment in urban gateway markets.  

Capitalizing on the Paucity

The scarcity of new supply has created a discount for hotel acquisition costs relative to their replacement costs. Urban gateway markets generally observe higher development costs relative to other locations given complex infrastructure and design needs, as well as higher land costs in today’s environment. As a result, these markets pose a more prominent discount to replacement cost where it is now more cost-effective to buy an existing hotel rather than build a new one.  

In 2023, the discount to replacement cost for full-service hotels in U.S. urban markets reached 39%. In addition to the wide gap between the cost-to-buy and the cost-to-build, there is also the opportunity to acquire at a time when the average price per key remains below pre-pandemic levels. In H1 2024, the average price per key for single-asset hotels in urban markets was $248,119, which is 24% lower than 2019 levels.   

Another driver of investment is the return of international travel in urban gateways. International travel plays a crucial role in driving hotel demand; in fact, hotel room nights sold across the top U.S. urban markets shows a very strong 90% correlation with foreign arrivals. The loosening of travel restrictions globally, along with China lifting its group travel ban in August 2023, has greatly contributed to the increase in international travel to urban gateway markets. The U.S. State Department’s record number of visa approvals for the second half of 2024 is expected to provide another boost. As a result, international travel is projected to continue its upward trajectory and be a positive signal for hotel investors to capitalize on the international recognition, diversity in demand and robust tourism of these markets. 

These lucrative opportunities have spurred increased investment activity in urban markets. Compared to H1 2023, the proportion of urban hotel investment rose to 33% of the U.S. total, marking a notable 7-percentage-point increase. Prominent deals include 1 Hotel Central Park New York, Hilton Boston Back Bay and AC Hotel Washington DC Convention Center, among others, all sold in prominent gateway markets at prices exceeding $100 million.  {

Deal Noise

The momentum in urban gateway investment activity is expected to continue, particularly for hotels that are on the opposite sides of the asset spectrum; namely, irreplaceable luxury properties, as well as select-service and extended-stay hotels, where there has been a significant increase in investment demand. In H1 2024, this sector’s portion of total U.S. single-asset hotel transaction volume increased 10 percentage points year-over-year to a record-breaking 57%. On the other side of the spectrum, luxury hotels remain in favor, maintaining their portion of total U.S. single-asset hotel transaction volume in H1 2024 at 23%, on par with the prior year. The strong appetite for marquee, luxury hotels is evident in urban markets where there is a growing demand base of high-net-worth travelers.  

While private equity remains the most acquisitive buyer type, a further boost is expected from foreign capital and real estate investment trusts in the remainder of the year. REITs are expected to increasingly put their balance sheets to work following nearly a year of pruning their portfolios. Furthermore, foreign investors accounted for 10% of total hotel transaction volume, marking the highest H1 portion since 2017.  

Anticipate that urban gateway markets will remain attractive for investment in the short-to-medium term due to a significant discount to replacement cost, price per keys below pre-pandemic levels and the return of international travel. Hotels on opposite ends of the spectrum—luxury and select-service—will continue to garner most of the investment interest. While private equity will be the most active buyer, foreign capital and REITs are anticipated to further boost investment in these markets.  

Story contributed by Ophelia Makis, Sr. Analyst, Americas Hotels Research, JLL Hotels & Hospitality Group