The coming year is shaping up to be a dark hour for the lodging industry. In 2002, in the aftermath of the terrorist attacks on 9/11, average hotel occupancy in the United States fell to 59%, the lowest level since Smith Travel Research started tracking the lodging industry in 1988.

With the nation now in the grip of recession, PKF Consulting of Atlanta predicts that the occupancy rate will slip a full four percentage points to an average of 58.3% nationally, falling below the previous low point established in 2002.

The decline is being fueled by an untimely collision of circumstances. Both leisure and corporate travelers are retreating just as a flood of new hotels — many planned in 2005 and 2006 when occupancies were on the rise — hits the market.

Facing the toughest competitive conditions in years, hoteliers will be able to raise their room rates a scant 0.1% this year, forecasts PKF, while revenue per available room (RevPAR) tumbles 4.3% and hotel profits decline, on average, 7.9%.

Hotels in New York, traditionally the nation's most vibrant market after Las Vegas, have reduced their room rates by a nearly unprecedented 6% this year, a sign of the new discounting psychology.

“When the panic began on Wall Street, there was an immediate and significant decline in corporate travel,” says Mark Woodworth, president of PKF. “It's been surprising to see the fundamentals of the lodging industry fall so far, so quickly. New hotels coming to the market are exacerbating the falloff in demand.”

Some projects shelved

There are signals from developers, however, that the pipeline of new projects is suddenly shrinking. Lodging Econometrics of Portsmouth, N.H., reported in October that 740,000 rooms were either under construction or planned, down 6% from the 785,000 in the pipeline at mid-year. In a sign of the times, plans for a Mandarin Oriental hotel in Dallas were put on hold, while construction of a Westin in the suburbs of Dallas was suddenly halted with four stories already erected.

The cancellations have risen for three consecutive quarters to levels not seen since the period after 9/11, says Patrick Ford, president of Lodging Econometrics. “We expect cancellations to continue to increase until hotel developers can get loans again,” he says. “There is little or no lending available right now, which affects both construction financing and transactions.”

Mark Gordon, head of the U.S. hotel group for Cushman & Wakefield in New York, says that big convention cities such as Chicago, Dallas and Atlanta that are dependent on corporate travel are likely to suffer the most in the downturn. Slowing leisure travel to Orlando will hit that market hard, too, Gordon believes. “More diverse markets like San Francisco, New York and Washington, D.C., that attract a lot of global travelers are typically less exposed in a down cycle like this.”

Full-service hotels in big cities are feeling the brunt of the falloff in demand and are struggling to obtain financing. Many experts predict that the limited-service sector, particularly roadside hotels along interstates with brands such as Holiday Inn Express, will fare much better.

Mega-hotel deals are tough to complete now, Gordon says, but regional banks are still financing loans for deals under $20 million.

Financing costs escalate

Just how troubled are hotel owners right now? So far, there are few signs of panic. “Capital markets have been prudent and the levels of leverage aren't as high as what we saw in the recession of the early 1990s, when hotel owners were feeling a lot of pain,” says Woodworth of PKF. “Hotel owners who don't have to sell will wait. That may change later in 2009 as we see some borrowers with loans maturing who have to go out and find new debt. Then we may begin to see some visible signs of stress.”

Most hotels in late stages of the development pipeline have their financing in place. Kimpton Group Holding LLC in San Francisco and its development partners plan to open the Epic Hotel in Miami by Christmas and then the View Hotel in New York in January. The latter is a 225-room adaptive reuse of an old warehouse building. But the company has put projects on hold indefinitely in Milwaukee and Austin, Texas.

Joseph Long, Kimpton's executive vice president for acquisitions and development, reports that lenders who a year ago would finance hotel construction at an interest rate of 6% are now demanding 12% and more. For a $50 million construction loan spread over two years, he notes, that amounts to an extra $4 to $5 million in project costs. “That's tough for developers to absorb,” Long says. “These extra costs will kill a lot of deals. It's a tough time for our industry.”