Assessing the Hospitality Industry

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

The New York Sun

More than 2,500 professionals from around the world were in attendance this week at the 30th Anniversary New York University International Hospitality Industry Investment Conference, and the topic du jour was whether the city’s hospitality industry can maintain its strength and resilience during the economic turmoil of 2008.

The stagnant economy and rising inflation and fuel costs have created an unhealthy dependency on foreign travelers in the hotel and restaurant industries, experts said, and industry leaders are divided on their predictions.

“Business is still holding up at historic record levels of both rate and occupancy,” a principal at BD Hotels, Richard Born, said. “The cheap dollar and the so far resilient world economy is keeping us going. Clearly, commodity price increases and continued financial market instability have the potential to derail this.”

The chief executive officer of Hersha Group, Neil Shah, said: “It is absolutely true that international travelers are sustaining the Manhattan hotel market. The slowing in corporate demand and increasing net hotel supply has been matched dollar for dollar, and then some, by international travel. We derive over 25% of our business from international travelers, corporate and leisure. These are individuals who are paying full rack rate, euro-infused, are transients ‘on holiday’ in the world’s largest discount store.”

“Things are looking up, down, and upside down depending on what spectrum of the market you’re looking from,” a principal at Thompson Hotels, Michael Pomeranc, said. “With a relatively weak dollar for the next couple of years, Manhattan hotels will do well. Fuel costs will come down and airlines will stabilize after some problems over the next six months. This has no real impact on end destinations such as New York City.”

“In New York City, the first four months of 2008 have been very strong, with occupancy essentially holding steady and average daily rate up over 8% year to date,” the managing director of the hospitality and gaming group at Cushman & Wakefield, Eric Lewis, said. “We primarily have foreign visitors to thank for that increase.”

He added, “We’re starting to see some softness in those markets where business travel is declining slightly, and the lost room nights are now being replaced by foreign visitors.”

“The ultimate impact of the cost of fuel and the weak dollar on New York’s hotel market has yet to be determined. While the cost of jet fuel will place upward pressure on airline ticket prices for foreign travelers, I am a believer the bargains they find here at hotels, restaurants, and retailers will outweigh any fuel surcharge on their airfare,” Mr. Lewis said. “As for domestic vacationers flying to New York, you could make the argument that they will opt to drive to a vacation closer to home, given the rising cost of air travel. If, however, their plans to go to Europe over the summer were quashed by the weak dollar, New York is an attractive and relatively inexpensive option.”

“There is no doubt that tourism has and will continue to play a very important role in the New York economy, especially with Wall Street slowing down,” a principal at W Financial, David Heiden, said. “Foreigners made up 16% of the demand for hotel rooms in 2007. I expect an increase of approximately 4.1% in demand overall for 2008.”

“Hotel fundamentals are up in New York, with an 8.1% increase in average revenue per room from April 2007 versus 2008,” the president of Gemini Real Estate Advisors, Will Obeid, said. “New York’s revenue per room to date commands a 67% premium over Miami, which is the next highest in the country.”

“The general demand is strong for hotel rooms in New York City from both business and leisure travelers,” the managing director of Hudson Realty Capital, Spencer Garfield, said. “Of course, foreign travelers are a healthy part of that demand, given the weak dollar.”

At least 125 hotels ranging from budget to six-star luxury are in various planning stages in the city. As a result of the credit turmoil, many of these developments, especially those in boroughs other than Manhattan and those planned by inexperienced developers, may not come to fruition.

“It appears everyone and anyone is attempting to build a hotel to take advantage of the strong hotel market today,” Mr. Heiden said.

Unfortunately, many of these inexperienced, undercapitalized developers will never have an opportunity to finish their projects.

Mr. Obeid said: “Despite the strong fundamentals, the development pipeline for new hotels is going to get further elongated because of the allergic reaction that lenders have had to the asset class recently. The herd of lenders has largely moved on from hotels, but the strays have an opportunity to pick up a few diamonds in rough if the projects are grounded in reality and can still take advantage of these great fundamentals that we enjoy in the city.”

“Many guys still think they are going to build boutique hotels for a $500 average daily rate, with 90% occupancy, with a hopping club on the roof,” he continued. “That will be very, very tough in this market unless you are one of a few top boutique hoteliers.”

Mr. Garfield said, “There are many hotel rooms in various stages of development and predevelopment, but the ‘good news’ is that lenders have become much more conservative and as a result many of these projects will not get built, thus limiting new supply.”

“Today there is very little aggressive capital available, in general, for any asset type including hotels. In order to obtain financing, you need 20% to 30% equity, a flag, or a national franchise that works, or a boutique concept that works, experienced management and developers, and a good location,” he added. “There have been many hotels proposed for pioneering and/or secondary locations that just won’t demand the average daily rates that better-located properties would.”

“Reputation takes on a new meaning, and if you’re a good guy, certain banks will continue to offer the hotel developer support and money — perhaps on different terms than before, but nevertheless they’ll be there,” Mr. Pomeranc said. “If you’re a novice and a newcomer, then pack your bags and head out.”

“I would have thought that the current credit environment would have discouraged more projects, but that has not fully happened,” Mr. Born said. “There is no question in my mind that this avalanche of new inventory of hotel rooms will have a marked effect on both rate and occupancy. If this is accompanied by recession, domestic and/or worldwide, there will be significant pain out in the market.”

Mr. Shah said: “Developers and financial investors are driven by delivering product rather than prospering from its long-term ownership. To deliver their product, they need to leverage the hell out of either development or growth in cash flow and capital appreciation. Today leverage is dead and cash flow is slowing. Capital appreciation is anyone’s guess.”

“Today it’s hard to get 60% leverage, and it’s 40% more expensive to build than over the past five years. Only the investors with a lot of equity and the ability to sustain low cash flow will get projects and transactions done,” he continued. “If the credit markets led to the hotel development recession, both by slowing growth and not financing new deals, then the construction market reinforces it. With $400 to $500 per square foot hard construction cost, premium land selling at $500 per buildable foot, and inflationary soft costs, it is hard to deliver hotels at less than $600,000 per key. In today’s capital market environment, it’s difficult to ultimately capitalize more than $500,000 per key. Consequently, there are a ton of huge projects across Manhattan. Some will find mezzanine and equity financing to bridge the gap; others won’t happen. Either way, it’s going to require a lot of effort and a lot of fresh capital to get their projects done.”

The executive vice president of Cushman & Wakefield Sonnenblick Goldman, Mark Gordon, said: “There has been a return to the fundamentals with regard to hotel lending. Costs are being more carefully scrutinized, and hotels need to be managed by experienced operators and in many cases flagged by globally recognized brand companies. If these points are all in check, financing is available in the 65% to 70% loan-to cost range, which is a good thing, from a historical perspective.”

“Obtaining financing for construction of new hotels is supremely challenging these days,” a principal at W Financial, Gregg Winter, said. “Over the past six months, the amount of financing available has been decreasing, where a developer might be lucky to end up with a loan of 75% loan-to cost, but be prepared to settle for 65% to 70%.”

“Mezzanine financing for a new hotel development presents even more risks and a longer time frame, with greater vulnerability for a lender than many other types of development,” he added.

The president of the City Investment Fund, Thomas Lydon, said: “Of more concern today is the increase in the supply of limited service hotels at a time when demand has passed the peak. These hotels were underwritten at very high occupancies and assumed favorable financing markets. The equity in a number of these transactions may have to be significantly increased to refinance from a construction loan and show very low yields if the economic cycle is more severe than forecast. However, longer term should still be favorable because supply is being restricted for starts in 2008-09 due to the lack of construction financing, and high cost of mezzanine financing and equity.”

All in all, the fundamentals of the hospitality industry in New York City continue to be strong, but many of the planned projects will be put on hold, especially those planned outside Manhattan. As Mr. Winter said, “One must remember that a hotel is an operating business wrapped into real estate.”

Nevertheless, I concur with Mr. Shah when he says, “This is a market for long-term investors today, and probably will remain so for the next three to four years.”

Mr. Stoler, a contributing editor of The New York Sun, is a television and radio broadcaster and a senior principal at a real estate investment fund. He can be reached at mstoler@newyorkrealestatetv.com.


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