When the travel business began shaking off the post-9/11 doldrums in 2003 and 2004, investment money began pouring into major markets along both the East and West Coasts, eager to acquire hotels with brightening prospects. In the nation's interior, the recovery was slower in coming and the smart money stayed away.

But in the past year, with convention business returning and tourists flocking to new attractions like Millennium Park on the Lake Michigan waterfront, Chicago has suddenly emerged as the darling of the hospitality industry. Hotels have been changing hands in the Windy City lately like last year's golf clubs on eBay.

In the past 18 months, in fact, Chicago has emerged as the most active hotel acquisition market in the U.S. Blue-chip names such as the Drake, the Fairmont and the Ambassador East have all been sold, mostly with plans by the new owners for major renovation work.

Meanwhile, at least a dozen new development projects involving some 3,000 downtown rooms have been proposed, amounting to the biggest splurge in hotel building since the mid- and late 1990s.

Why the sudden enthusiasm? Between 2002 and 2004, travel volume to Chicago surged 11% to 32 million visitors, and most experts believe that the 2005 numbers, which aren't available yet, will show another big jump. Revenues at most establishments have been on a steep rise.

Investors figure the future looks even better: Work has begun on the expansion of O'Hare International Airport and construction is well under way on major additions at both McCormick Place — the city's major convention center — and the Art Institute.

Millennium Park by Lake Michigan has lured 5 million visitors since it opened less than two years ago. Local politicians haven't given up hope on a long-debated downtown gambling casino. Mayor Richard Daley is even lobbying to bring the 2016 Summer Olympics to Chicago.

Improved fundamentals are becoming obvious. The downtown occupancy rate averaged 72.1% in 2005, up from 70.6% the year before and the highest occupancy rate since 2000, when rooms were 74.7% full, according to Smith Travel Research in Hendersonville, Tenn.

The firm reports that daily room rates jumped more than 8% last year to $164.39 a night downtown. That was the best nightly tariff for hotel owners since the average of $166.62 recorded in 2000.

Buying into a recovery

More than 10% of metro Chicago's 619 hotels, totaling 97,400 rooms, were involved in sales transactions last year, according to Patrick Ford, president of research firm Lodging Econometrics LLC in Portsmouth, N.H. There were 65 deals in all, with 41 sales of 100% ownership stakes — compared with 13 in 2004 — and another 24 involving partial interest.

Miami was a distant second with 36 total transactions and Los Angeles ranked No. 3 with 34 (see chart below). Mighty New York City came in ninth place with a mere 26 hotel deals.

“Chicago was hit hard by the impact of 9/11 back in 2001, with big drop-offs in both business and leisure travel,” Ford says. He adds that Chicago's hotel recovery did not begin until 2005 while most of the industry began recovery in 2003.

“We've had business associates coming into Chicago this spring unable to find decent hotel rooms. That tells you travel is booming here again. Investors want to buy into the trend,” says Melinda McKay, a senior vice president at Jones Lang LaSalle Hotels, which brokered many of the big deals.

As buyers have looked in Chicago, they've found willing sellers. “Many hotel owners were waiting for the recovery to reach full force before they put their assets up for sale. Now, it seems, they've decided that it's time to sell,” says Rick Besse, a senior vice president with Horwatch Hospitality & Leisure LLC in Dallas, which has brokered metro Chicago deals.

Practically every property put up for sale is attracting intense interest from multiple bidders, and that's driving prices up. Early in 2005, private equity investor JER Partners of McLean, Va. bought the Westin Michigan Avenue Hotel for $137 million. In January, JER decided to flip the Westin, selling it to LaSalle Hotel Properties, a Bethesda, Md.-based REIT, for $215 million, or $286,000 per room, a record high for any Chicago hotel.

LaSalle, in fact, has been wheeling and dealing in Chicago. Early this year the company also bought the House of Blues Hotel while selling the 1,200-room Michigan Avenue Marriott, which it owned in partnership with the Carlyle Group, for $306 million, or $250,000 a room. LaSalle and Carlyle had paid $170 million for the Marriott back in 2000 and reported that they achieved an internal rate of return of 47% for the hold period.

Frothy conditions

Hans Weger, chief financial officer of LaSalle Hotel Properties, believes that Chicago's hotels are trading at bargain prices compared with some other large cities. The Four Seasons Washington, D.C., for instance, was recently acquired by Strategic Hotels & Resorts Inc. of Chicago for a titanic $800,000 per room. He reveals that LaSalle paid about 11 times projected 2006 earnings before interest, taxes, depreciation and amortization (EBITDA) for the Westin.

Weger says LaSalle Hotel Properties bought the House of Blues for 12.5 times projected 2006 EBITDA. “These prices are reasonable considering our own public stock trades for 15 times EBITDA,” says Weger, noting that prices of $300,000 to $400,000 per room aren't uncommon in other cities, such as San Diego.

Financing isn't a problem for LaSalle Hotel Properties, which has a credit line of $1 billion with its lenders. For the Westin, the company financed $140 million of the deal with Wells Fargo Bank at a fixed rate of 5.75% for 10 years. The loan is interest-only for the first five years. “We were ecstatic with those terms,” Weger says.

Super REITs like Strategic account for some of the froth. Strategic, which has invested nearly $2 billion in hotel acquisitions since it went public two years ago, spent more than $300 million for the Fairmont and InterContinental hotels in Chicago. Laurence Geller, Strategic's president and CEO, expects to spend another $150 million on renovations and upgrades at the Fairmont alone, with a spa and ballroom both planned.

“We're making a big bet on Chicago,” Geller says. “You can't find land in most of downtown, so there are great barriers to entry for developers. And we like the fact that business leadership is so committed to the city.”

Signs of trouble

Business is committed, yes, but there are some dark clouds around the edges of Chicago's future. A major labor contract at downtown hotels expires this summer, and workers have made it clear they're willing to strike for higher pay.

Hoteliers are looking forward to the completion next year of an $850 million addition to McCormick Place, expanding the nation's largest convention center by nearly 800,000 sq. ft. to more than 3 million sq. ft.

Yet, the Food & Marketing Institute says that 2007 will be the last year it brings its trade show, which draws 40,000 attendees, to McCormick. Other show organizers at McCormick are seeking to move, too, saying that the labor unions make exhibitions too expensive.

There are, moreover, other hang-ups. A casino long proposed for Chicago's downtown looks like it has a remote chance of state approval. The Olympics bid is a distinct long shot. Meanwhile, Chicago-based United Airlines announced in early May that it was considering a move of its headquarters to Denver.

In search of yield

None of these issues seems to bother the new breed of Chicago hotel owner. “Investors have felt they were getting priced out of cities on both coasts and out of Las Vegas,” says Daniel Marre, a partner at the law firm Perkins Coie LLP in Chicago, which advises clients on hotel deals. “They still want to be in a primary market, and between the two coasts Chicago is the best market there is.”

Many of the Chicago deals have involved assets that were old and run down, with investors counting on renovations leading to higher revenues. For example, Sage Hospitality Resources LLC of Denver paid $18 million to buy the historic 335-room Blackstone Hotel on Michigan Avenue in December from a religious group. Sage expects to spend well over $100 million on rehab.

The total investment could come to $300,000 per room, but federal tax credits of $12 million and City of Chicago assistance of $18 million in tax-increment financing should lower the total price to approximately $240,000 per room.

“We'd like to see our room rates at the Blackstone, which we expect to reopen next year, come in at about $225,” says Kenneth Geist, executive vice president of development at Sage. “At $225, with interest rates so low, we can earn a nice return on our investment of $240,000 a room.”

Peter Dumon, the president of Harp Group Inc. of suburban Lombard, feels the same way about his investment in the Ambassador East. He is part of a partnership that paid $47 million for the 285-room Ambassador in December, amounting to $165,000 per room.

Dumon is prepared to spend another $20 million to fix it up, which would still bring his total outlay, at less than $70 million, well below the $85 million to $90 million he estimates it would take to build the Ambassador new.

“With business so good, we're in no hurry to renovate,” Dumon says. The Ambassador, in the face of surprisingly strong demand for rooms, has raised its nightly rates 30% from a year ago and is still running at a healthy 72% occupancy. He adds that he's received unsolicited offers for the Ambassador nearly 20% higher than the price he paid in December, but he has rejected those offers.

Many hotel investors in Chicago are already planning their exit strategies. Case in point: Lodging Capital Partners LLC of Chicago acquired the 311-room Le Meridien Hotel in November for about $75 million. Lodging Capital closed the deal with several partners including Goldman Sachs Group, which supplied close to 80% financing. It's investing less than $10 million in remodeling the establishment and repositioning it under the new name Conrad Chicago.

“We're targeting a hold period of three to five years for the Conrad, after which we expect to sell and be out of the investment,” says Steven Kisielica, a Lodging Capital principal, adding that he believes room rates of $250 per night are achievable. Most hotel experts say that Chicago should enjoy rising hotel demand for the next three to five years.

Burgeoning pipeline

On the new construction side, many projects are positioned in part or entirely as hotel condominiums. The developers include local firms such as the Elysian Development Group, which is slated to open its 188-room Elysian Hotel in the wealthy Near North Side community next year, with asking prices for suites running from $450,000 to $925,000.

Chicago-based Palladian Development LLC heads the partnership behind the 250-room Mandarin Oriental Hotel, which will break ground in the fall and open in 2009 with prices ranging from $500,000 to $10 million. Christopher Kenny, a Palladian partner, thinks that Chicago may lead the nation in hotel condos. “This kind of product suits people's needs and lifestyles today,” he says.

Hotels are so hot that former office developers such as Michael Reschke, chairman and CEO of Prime Group Inc. in Chicago, are jumping into the category for the first time. Reschke owns a half-vacant vintage 1914 office building at 208 S. LaSalle St., in the heart of the financial district that he's partially converting into a 360-room hotel. The cost is $100 million. Reschke hopes to open the hotel by 2008.

“Hotels in Chicago are experiencing 10% to 20% revenue gains a year, and they're forecast to do that for the next couple of years,” Reschke notes. “That makes them very interesting to us.”

H. Lee Murphy is a Chicago-based writer.

Insatiable condo appetite

Residential condominium development is crashing suddenly in cities like Miami and Phoenix where downtowns saw supply get far ahead of real demand. Critics have complained in the past year amid a flurry of high-rise construction that Chicago faces its own day of reckoning. But the construction goes on, and the evidence suggests that the new units coming to the market are finding buyers.

The scale of some of the new projects is breathtaking. Donald Trump has sold nearly 80% of the 472 residential and 286 hotel condos in his $775 million, 92-story Trump International Hotel & Tower, not expected to open until early 2008.

In March, Chicago officials gave preliminary approval to local development firm Fordham Co.'s concept for a screw-like spire rising 124 stories, or 2,000 feet, on Lake Shore Drive containing 300 condos and 150 for-sale hotel rooms. The architect is the Zurich-based Santiago Calatrava. The cost is pegged at $550 million with ground-breaking likely late this year and completion proposed for 2010.

Can Chicago absorb all these projects? Research firm Appraisal Research Counselors in Chicago estimates there were 8,162 condo unit sales in downtown Chicago in 2005, up from 6,298 the year before. Currently, there are 8,400 more condo units under construction — 6,700 of those are already under contract to be sold and another 4,150 are planned, according to Appraisal Research. Real estate experts say that's not an unreasonable pipeline considering that many of these units won't be available until 2008 or later.

Christopher Huecksteadt, a director with Metrostudy, which tracks condo development from its regional headquarters in suburban Hoffman Estates, predicts that annual absorption levels in Chicago can rise to 8,000 units a year, up from 5,000 to 6,000, as the city adds jobs and population. He calculates that prices have risen at least 10% over the past year.

“That tells you the market is healthy. If you keep adding more condos to the market and they don't sell, then you become concerned if you're a developer,” says Huecksteadt. “But that doesn't seem to be happening. Condos continue to sell at a healthy pace, and that's why we're bullish on condos in Chicago overall.”
— H. Lee Murphy

CHICAGO - BY THE NUMBERS

POPULATION OF METRO AREA: 8.4 million
Source: U.S. Census Bureau

UNEMPLOYMENT RATE: 5.2%
Source: Illinois Dept. of Employment Security

LARGEST EMPLOYERS:

  1. U.S. Government
    78,000 employees
  2. Chicago Public Schools
    43,783 employees
  3. City of Chicago
    39,675 employees

METRO AREA VITAL SIGNS

Office:

15.1% vacancy, 1Q 2006
15.7% vacancy, 1Q 2005
$29.59 rent per sq. ft., 1Q 2006
$29.52 rent per sq. ft., 1Q 2005
Source: CB Richard Ellis

Multifamily:

5.4% vacancy, 1Q 2006
6.2% vacancy, 1Q 2005
$976, asking rent, 1Q 2006
$962, asking rent, 1Q 2005
Source: Reis

Retail:

7.52% vacancy, 1Q 2006
7.32% vacancy, 1Q 2005
$20.77 rent per sq. ft., 1Q 2006
$20.64 rent per sq. ft., 1Q 2005
Source: CB Richard Ellis

Industrial:

8.5% vacancy, 1Q 2006
9.4% vacancy, 1Q 2005
$4.22 rent per sq. ft., 1Q 2006
$4.29 rent per sq. ft., 1Q 2005
Source: Grubb & Ellis

Hotel:

73.8% occupancy, March 2006
67.2% occupancy, March 2005
$167.98 average daily rate, March 2006
$138.71 average daily rate, March 2005
Source: Smith Travel Research

MAJOR PROJECTS:

Trump International Hotel & Tower, a 92-story tower on the Chicago River with 79% of the 472 residential and 286 hotel condominiums sold at prices as high as $1,200 per sq. ft., a record for Chicago.

Cost: $775 million

Developer: Donald Trump

Completion: 2010

Fordham Spire, a 124-story, 2,000-foot spire in a dramatic corkscrew shape designed by the Swiss architect Santiago Calatrava. It will include at least 450 hotel and condo units plus 640 parking spaces. The height would top Chicago's Sears Tower by 500 feet.

Cost: $550 million

Developer: Fordham Co.

Completion: 2010

Mandarin Oriental Tower, a 65-story hotel and condo tower (500 units in all) encompassing 1.3 million sq. ft. on Michigan Avenue with construction to begin this fall. Prices range from $500,000 to $10 million for residences.

Cost: $500 million

Developer: Palladian Development LLC and partners

Completion: 2009