Numbers too good to pass up have the tide of investment in hotel/motel properties swelling toward flood levels. Occupancy in the 42 hospitality markets analyzed by Landauer advanced to 70.1% in 1995, up from an already sound 67.5% in 1994. Not only are there more guests, but they are spending more for their rooms. The average daily rate rose more than 4% during the year, with the majority of the markets in the nation pocketing 5% or higher rate increases. The industry is responding with a 12.9% gain in construction, with nearly S5.7 billion in new hotel/motel spending reported by the Commerce Department. Thus far, demand indicators suggest that the renewed building volume is well within the scope of room-night requirements for 1996.
What has prompted these high levels of hotel demand? Landauer sees at least three driving forces. First, corporate profitability is exceptionally high. As we noted in the opening chapter, 1995 earnings of U.S. businesses are exceeding the record pace of the late ,70s on an after-tax, inflation-adjusted basis. This has relaxed most of the cost constraints imposed on travel budgets earlier in the decade. Belt-tightening is history. Business travel is booming.
Vacation travel has also spurted. As employment indicators and confidence in the future rise, families are on the road again. From seaside resorts to ski areas and beyond, domestic tourism is boosting the bottom line for hostelries.
Third, the favorable foreign exchange rate is also keeping the U.S. high on the list of travel destinations. Overseas air travel for the key gateway cities serving Europe, Latin America and the Far East indicates strong flows of offshore visitors coming to sightsee, shop and take in entertainment. With the Olympics returning to the U.S. in 1996, the already robust volume will grow even higher. Secondary travel effects related to the Olympics will boost occupancies in most U.S. showcase cities.
Not surprisingly, the investment community's 1994 re-enchantment with hotels is deepening. It is not hard to see why. Hotel REITs logged a 12 month total return of 25.3% as of September 30th, with Starwood Lodging, FelCor Suite Hotels, and Jameson Inns the top performers. Limited service hotels such as Comfort Inns and Holiday Express have attracted the most purchaser attention, and prices in this sector now frequently exceed replacement cost. The new development activity is partly a consequence of limited service hotels surpassing this key feasibility hurdle.
Full service and luxury hotels are seeing less direct development activity, but are nevertheless benefiting from the improved climate. As financing becomes more readily available, the upper-end hotels are able to make key capital expenditures, thus shoring up asset values. This is important, since much of the limited service hotel investment is coming from "hot money" looking for top yields from operational income and is less concerned with fundamental value enhancement at the property asset level.
The industry may ultimately wind up thanking Wall Street for imposing some discipline. As conduit activity and structured financings become more widespread, underwriters and raters are scrutinizing income projections for capital reserves. If there is not a reserve of approximately 4% of gross revenue targeted for ongoing capital needs, many income statements are reconfigured to account for refurbishment and replacement items.
One sign of tighter linkage between the lodging industry and the capital markets is the alignment of hotel operators with investment firms. Marriott public market debt offerings totaled $1.2 billion in 1995. More firms are accessing public markets for the most competitive cost of capital and the hotel sector should be even more active in issuing securitized equity and debt.
Hotel operators and management companies should brace for more consolidations. This is a corollary of the intense REIT acquisition binge. As the investment trusts grow larger, small operating companies and owners are finding themselves with fewer properties of their own to manage and a shrinking number of third-party management opportunities. The most familiar brand names in the industry are growing even larger, and franchising activity will be intensely competitive in the remaining years of the ,90s.
The "re-flagging" of properties is emblematic of many of these trends. As facilities change hands, there is the expectation that a combination of physical improvement, re-marketing and specific management improvements will grow the bottom line. Expertise is at a premium in hotels, which may be the most management-intensive of all property types. Operators are realizing that guests now demand a higher level of amenities and satisfactions from the hotels. Delivering quality to the customer is becoming a top priority.
What are the areas of concern? Current high occupancy levels, for one, which are above the long-run stabilized norm. Projections which anticipate a continuation of 70% or better utilization rates are likely to prove overly optimistic. Second, the potential for technology to erode travel as more can be accomplished at a distance. Some believe that this will negatively affect both the frequency and duration of business travel. It is unclear, however, whether or not this will be balanced by a rise in the number of travelers as local business activity becomes more regional, national or international. And watch for property tax increases to start affecting net operating income and returns on investment as price recovery is reflected by assessors. No gain, it seems, can come without some corresponding pain.
Landauer's Hotel Market Equilibrium Index is strengthening once again. This measure, which estimates the ability of hospitality markets to balance supply and demand forces over a five-year projection period, indicates that all but five U.S. hotel markets will be in sound condition by 2000.The top eight markets, in fact, appear likely to require meaningful supply additions over the period.
Las Vegas has managed to generate the traffic it needs for the huge addition to its room count since 1994. But, can visitor volume be sustained? For now, with occupancy close to 80%, there seems little reason to question Las Vegas, ability to retain its allure for high rollers and to provide more family-oriented venues. Although its growth is likely to moderate, we see sufficient demand to rank it as the top hotel market on the Index. Business cities are well represented on our Index. New York is extraordinarily well-positioned to capture increased business travel and overseas tourism. Special events like the papal visit and the UN's 50th Anniversary boosted room demand by nearly 4.5%. If the city can successfully improve operations at its convention centers, we see new construction on the horizon.
Visitors to the Olympics will inundate Atlanta. It should be a banner year for hoteliers, but will skew the statistical performance in the post-Olympic period. Even though the city has not gone overboard with spec hotels, it is reasonable to expect that all hotel performance measures will fall in 1997 and 1998. Atlanta's prospects are excellent. It is a city destined to rise in the U.S. urban hierarchy.
Chicago achieved 4.3% growth in its average daily rate last year, with occupancy nearing 70%. This is gratifying, since the market saw a substantial supply bubble in the late ,80s. Chicago is buttressing its downtown drawing power with a $200-million renovation of the Navy Pier including meeting and exhibit space, an IMAX theatre and 40,000 square feet of retail and restaurants. McCormick Center is undergoing a $987 million expansion and will add one million square feet in 1997.
Rounding out our ranking of the top five markets, Phoenix qualifies as this year's surprise. Many see the market as still oversupplied, but occupancies stand above the national average and room rates climbed 9% year-over-year. The seasonal extremes of Phoenix, travel pattern may account for the difficulty in tracking the trendline locally. Several years of economic rebound, and strong conference bookings at area resorts provide a good foundation for its outlook.
San Francisco occupancy levels rose 5% to 77%, and room rates grew by 4%. The Mosconi Center is planning a major expansion, and the tightening of office vacancies indicates strengthening business activity, a good indicator of hotel demand. Los Angeles is considered among the weaker lodging markets, but there are signs that activity is picking up. The Beverly Hills Hotel re-opening created a splash, and demand at the high end is brisk. Also, the elite Bel-Air Hotel sold for a stunning $60 million. The booming entertainment industry is positively effecting many LA locations.
Washington, D.C. slips a bit on our Index. Occupancy growth lagged the national average over the past 12 months, and average daily rate increases only tracked a modest inflation rate. The nation's capital should only tread water.
Philadelphia is also listed in the cluster of middle-quality markets, despite the stimulus provided by its convention center. While drawing more traffic, the new facility has also caused at least four new Center City hotels to be announced. Occupancies will therefore remain slightly below the national average.
Boston, on the other hand, can expect a combination of tourism, conventions and general business travel to push its hotel performance strongly upward. Both Dallas and Denver have moved up in their rankings, a result of broad strengthening in local business activity. Limited service hotel development is flourishing in Dallas, and room rates are up 7% from 1994. Denver's new airport is shifting the hotel markets, and there will be an apparent spurt in new supply which must be put into the context of the economic obsolescence of facilities located near the old Stapleton airport. Houston's performance is not expected to improve materially from current lackluster levels, and what new rooms are being added are largely in budget facilities.
For the coming year we expect hotels to burnish their restored image as legitimate investment vehicles. As more interest in these properties is expressed, rates of return may fall. Perhaps the easy money has been made in the past two years. But hospitality should be a good sector for investors in 1996, and an exceptional rise in full-service facility values is a strong possibility later in the decade.