With lenders today having virtually no appetite for large-scale resorts or convention hotels, developers in search of financing for high-end product are faced with two alternatives — trim the size of their projects significantly, or add condominiums to their plans.

Why are condos so attractive to hotel lenders? For starters, proceeds from the sale of the units can be used to pay off part of the construction loan. And because condo units supply a revenue stream before the property even opens, lenders are willing to provide a 75% loan-to-value for condo-hotels compared with a 60% loan-to-value for a traditional hotel project, explains Frank Nardozza, chairman of REH Capital Partners, a Fort Lauderdale, Fla.-based hotel investment company.

“There's hardly any other way to get a major new-build project financed today,” Nardozza emphasizes.

Condo-hotels also produce higher returns for investors. Leveraged returns for a condo-hotel can exceed 30%, says Nardozza, while leveraged returns for a standard hotel range between 15% and 25%. Still, the complications involved in developing condos — including the need to set up pre-sale offices and form neighborhood associations to represent the individual owners — discourage some companies from going that route.

Top 5 Hotel Markets — Number of Rooms*
Existing Supply Recently Opened** Under Construction
1. Orlando 115,075 2,209 5,009
2. Chicago 99,553 1,699 2,147
3. Los Angeles 97,291 706 749
4. Atlanta 90,312 792 2.475
5. Washington, D.C. 87,685 1,172 3,175
*As of July 2003
**Recently opened: Hotels that opened in past 12 months.
Source: Smith Travel Research/PPR/FW Dodge

Revenue from condo sales is used to finance the property, so condos become part of the project's equity, explains Ted Darnall, president of the real estate group at White Plains, N.Y.-based Starwood Hotels and Resorts Worldwide Inc. (NYSE: HOT). “Even though the pure, traditional hotel economics aren't necessarily supporting the level of growth that we've seen in the past in our industry, there are new economics created by these [condominium] projects,” emphasizes Darnall. “It's a means of finding equity that you couldn't find in other environments. It's a very good, successful model.”

As a result, Starwood has revamped its growth strategy by including condos in the mix. The company, an owner and franchiser of luxury hotels, previously specialized in destination resorts such as the $180 million, 735-room Westin Kierland Resort & Spa in Phoenix, which opened in November 2002. However, in late July Starwood unveiled plans for two W hotels — the company's trendy, boutique-style brand — that were designed to appeal to today's skeptical lenders.

Although the W Dallas Victory Hotel and Residences and the W Fort Lauderdale Hotel and Residences will feature less than half of the hotel rooms of the Kierland resort, they will be the first W properties to offer condo units. The hotels are scheduled to open in late 2005 and December 2006 respectively. The Fort Lauderdale property, which will be owned by Capris Resorts LLC, will contain 346 hotel rooms and 171 condo units, while the Dallas property, featuring 251 hotel rooms and 94 condos, will be owned by Gatehouse Capital Corp., Hillwood Development Co. and Southwest Sports Realty. Starwood will manage the properties.

The Economy's Influence

The condo-hotel trend picked up steam about three years ago when New York-based Millennium Partners developed several Ritz-Carlton and Four Seasons projects in markets such as Boston, San Francisco and New York.

Starwood's new strategy of including an ownership-unit ingredient in its projects is part of the plan for the Aladdin Resort in Las Vegas. In August, Starwood partnered with investors from Orlando-based Planet Hollywood and offered $635 million for the casino, which went bankrupt in September 2001. The team plans to convert 600 units into timeshares. In early September, the offer was under review in U.S. Bankruptcy Court.

There's good reason for hotel lenders to be skittish. The industry has yet to post consistent revenue gains since the Sept. 11, 2001, terrorist attacks. The total revenue per available room (RevPAR) nationwide dropped from $41,335 in 2000 to $35,753 in 2002, a 13% decline, according to the Hotel Research Group, a division of San Francisco-based PKF Consulting.

The three-year slump in hotel revenues also has taken its toll on overall development activity. As of July, the total number of hotels in the construction pipeline dropped 27.4% compared with July 2002, according to Henderson, Tenn.-based Smith Travel Research.

The number of upper upscale hotels under construction fell to 44 in July of this year compared with 70 in July 2002, according to Smith Travel Research. The Smith Travel upper upscale category is a wide grouping of chains ranging from Sheraton to Four Seasons, which the hotel companies themselves more commonly label as upscale and luxury hotels, respectively.

Although construction is on the wane in most markets, the exception to the rule is Orlando. As of July, there were 5,009 hotel rooms under construction in metropolitan Orlando, up from 2,838 rooms in July 2002, according to Smith Travel Research (See sidebar on page 42).

“Financing has been very hard to come by over the last couple years for most companies,” says Scott Johnson, vice president of development at Omni Hotels, which holds an ownership interest in most of its hotels. The Irving, Texas-based company has three projects under construction, including the 511-room, $124 million Omni San Diego scheduled to open in spring 2004.

But Omni Hotels has yet to announce a new project this year. The company, which also purchases properties for conversion to the Omni brand, has not been able to find a property to buy this year because sellers are expecting higher prices than their properties are worth in the current operating environment, says Johnson.

In another signal that these aren't the best times for developing large-scale luxury hotels, Ritz-Carlton has cut back its development plans in the U.S. after opening properties at a torrid pace in the past few years. The luxury hotel company, a division of Bethesda, Md.-based Marriott International Inc., has opened five hotels in the U.S. in the past 12 months, but now only has one project under construction and one other project in the pre-planning stages.

Although there are several U.S. markets the company considers candidates for Ritz-Carlton properties, including San Diego, Seattle, Dallas and Beverly Hills, Calif., the company wants to focus on managing the properties it has recently opened before embarking on more U.S. projects.

“We have defined our goals for the next five years, and most of those plans involve new hotels in Europe, the Middle East and Asia, rather than North America,” says Simon Cooper, president of Ritz-Carlton.

Thinking Small

With lenders wary of committing to large-scale resorts, some hotel companies are concentrating on expanding their portfolios by developing smaller hotels. They're also venturing into unglamorous secondary markets where there is more room for new supply. Starwood is developing a 150-room to 250-room prototype for its Westin and Sheraton brands geared toward secondary and tertiary markets. Hilton, meanwhile, is gearing up for an expansion of its Conrad brand, which is a boutique-style luxury hotel.

Starwood estimates that there are 20 Sheraton hotels and 15 Westin hotels in various stages of development modeled after the company's new prototype. The scaled-back hotels, which offer many of the same amenities as the larger Sheraton and Westin properties, are part of a strategy to grow market share against its two main rivals, Marriott and Hilton.

“We think there's a solid opportunity for growth there,” says Darnall. “We're happy with the construction pipeline for the Sheraton and Westin prototypes.” The company plans to own about 10% of the prototype properties and franchise the rest.

Hilton is becoming more aggressive in developing its Conrad luxury brand, which opened its first U.S. property in 2001 in the Waldorf Towers section of the famous Waldorf Astoria in New York. The company will open its first new-build Conrad hotel in Miami in January 2004 as a part of the Espirito Santo Plaza, a mixed-use plaza in Miami's financial district. Hilton will manage the 203-room property and Estoril Inc., a division of the Portugal-based Group Espirito Santo banking conglomerate, will be the owner.

To make future Conrad projects more attractive to lenders, Hilton plans to add condo units and is looking into planting the Conrad flag in markets such as Seattle, Indianapolis, Las Vegas and San Diego.

“If you have the right destination and the right location, and the market is not saturated, they can be optimal ventures. Keep in mind these are smaller boutique hotels,” says Dieter Huckestein, president of owned and managed hotel operations at Hilton.

Hilton also has been busy growing its Embassy Suites and Doubletree properties, most of which have less than 300 rooms. The company plans to open 10 Doubletree hotels and five Embassy Suites this year.

A Rare Exception

Although lenders are shying away from large-scale luxury hotels, they are sometimes willing to make exceptions for unique projects in strong locations. U.S. Bank agreed to provide construction financing for a 396-room Hard Rock Hotel in Chicago in November 2001, two months after the terrorist attacks caused hotel revenues to plummet nationwide.

John McDonald, president of Mark IV Realty, the Chicago-based company that is developing the project in partnership with a private investment group, says lenders were impressed by the project's prime location on North Michigan Avenue and the strong brand. The hotel will be located near the theater district, museums and the Loop central business district, as well as the city's famed Magnificent Mile. A total of $11.1 million in tax credits helped offset the $90 million cost of the restoration project.

McDonald says the building's Art Deco design is expected to be a big draw when it opens in December. Luciene LaGrange Architects, the locally based firm that designed the Park Hyatt Hotel Chicago, is in charge of preserving the exterior of the hotel, which will be located in the Carbide and Carbon Building that originally opened in 1929. “People come from all over to Chicago for the architecture — there is no better venue for architecture than Chicago,” he says.

There are several large convention hotels under construction across the country, but these projects benefited from public subsidies rather than private financing. Hilton has won contracts to manage three convention hotels. The biggest project is the $285 million, 1,200-room Hilton Americas-Houston, which is being partly funded through the city of Houston's hotel occupancy tax.

A Tough Road Ahead

When revenues rebound, hotel owners are likely to have better luck finding lenders willing to finance their projects. However, analysts say luxury hotel companies may have difficulty increasing room rates because their customers have grown accustomed to the bargain rates operators have been offering to fill rooms.

“It's a segment that has been buying business, and when things get better, the question is whether guests will be willing to pay the rates they were paying in the year 2000,” says Bjorn Hanson, a managing partner in the hotel division of New York-based PricewaterhouseCoopers. “Or have these rate cuts created a new rate expectation at upper upscale hotels?”

Ritz-Carlton's Cooper hopes that isn't the case. “Success for the owners,” he emphasizes, “is really going to depend on getting revenues to at least mid-1990s levels sooner rather than later.”

Steve Webb is a Jacksonville, Fla.-based writer.

Visions of Grandeur? Orlando's building boom continues even as fundamentals remain weak.

Orlando is known as a fantasyland, which may explain why developers seem unconcerned by the reality of a down market as they continue building hotels at a dizzying rate. At a time when hotels have been slashing rates to fill rooms, metropolitan Orlando leads the country in new construction with 5,009 rooms in the pipeline as of July 2003, according to Smith Travel Research.

The number of rooms under construction in Orlando was up 43.3% in July over the same period a year ago, while the pace nationwide dropped 27.4%, including a 37.1% decline in the upper upscale segment, according to Smith Travel. With a supply of 115,000 rooms, Orlando already has a bigger inventory than any other market in the nation except Las Vegas, which has a total of 140,000 hotel rooms.

Hotel companies, most notably luxury chains, are lining up to open hotels in a market that has been struggling to emerge from a three-year slump. To be sure, developers are counting on Orlando to rebound in 2004 along with the overall economy. But hotels have been offering discounts to win customers, and it will be a challenge to raise prices in this price-cutting environment, says Scott Smith, a vice president in the Atlanta office of the Hospitality Research Group. “I think the overall Orlando market is soft, from economy to [luxury],” he says. “There's no rate integrity in that market.”

Although occupancy levels are finally beginning to inch upward in Orlando, rising to 72.2% in July, a 3.1% increase year over year, revenues are still lagging. Revenue per available room (RevPAR) dropped from $54.11 in July 2002 to $53.59 in July of this year, according to Smith Travel.

Despite the building frenzy, analysts say there is still room for luxury hotels because that segment is under-represented in Orlando. They point to New York-based Loews Hotels as proof that new resorts can thrive if they're in strong locations and offer a unique experience for guests. Loews Hotels made the bold move of opening 2,400 rooms in the Orlando market in a three-year span: the 750-room Portofino Bay Hotel in September 1999, the 650-room Hard Rock Hotel in February 2001 and a 1,000-room Royal Pacific Resort last fall.

Analysts say Loews is succeeding because the resorts are located on the grounds of the Universal Orlando theme parks, which guarantees a steady stream of business. In addition, the distinct theme of each of the hotels is a big hit with customers.

“Loews is a great success story,” says Chase Burritt, a managing partner at Burritt Associates LLC, a Miami-based hotel advisory firm. “They offer unique products in a very competitive market.”

The company's hotels are outperforming the Orlando market, says Jack Adler, president of Loews Hotels. He points out that the occupancy rate at Loews hotels consistently exceeded 80%, compared with 65.7% for the overall market from January through July 2003.

Other luxury and upscale brands that have opened in the marketplace include a 1,000-room JW Marriott, a 584-room Ritz-Carlton and a 1,400-room Gaylord Palms Resort. And the luxury construction boom isn't over. Omni Hotels is building a 730-room resort, while Hilton and Hyatt are looking into building hotels with 1,000-plus rooms.
Steve Webb