Betting that the travel slowdown will soon pass, some brave owners and operators of branded hotels are sprucing up their properties. That means converting lobbies, redoing rooms, adding new signage and shelling out big bucks to bolster the brand.

How do they justify these expenditures at a time when vacancies are climbing and revenues are dropping? Low interest rates have made it easy to borrow money cheaply. Branded hotels also are using the renovations to jumpstart their marketing campaigns before an economic rebound accelerates.

Still, there's no guarantee these projects will reap profits for those who undertake them, though the alternative is no less menacing: If your competitors are upgrading now, hoteliers who simply cut costs and wait until the market turns could lose customers.

Will History Repeat Itself?

Owners and analysts predict better times in 2004. If the pattern of the last recession and the aftermath of the last Gulf War hold up, they could be right. In 1991, the Gulf War, combined with a lingering recession, led to a total RevPAR drop of 2.4%, according to PricewaterhouseCoopers.

In 2001, revenue per available room (RevPAR) — the combination of occupancy and average room rate — dropped 6.7%, according to Smith Travel Research. There was a decline of 2.5% in 2002. Smith Travel projects that RevPAR will increase in 2003 by 0.5% — signalling a cyclical bottom.

With recovery just around the corner, it's a great time to resume renovations and other improvements that were shelved as the economy stalled.

“The lodging industry has been in lockdown mode for the past few years,” says Michael Sullivan, managing director of Denver-based HVS Capital, a real estate investment bank that specializes in the lodging industry. “Now is the time to do renovations because it's easier to displace customers when they're not there,” he explains, adding that the industry will see a jump in the number of renovations industry-wide across all hotel classes over the next six to 12 months.

A cornerstone of hotel brand maintenance is consistency from property to property. Starwood Hotels & Resorts Worldwide, a White Plains, N.Y.-based hotel owner, operator and franchiser, has instituted an aggressive campaign to ensure that all of its properties — both owned and managed — offer the same quality product. The same is happening at Silver Spring, Md.-based Choice Hotels, the world's second-largest lodging franchiser.

Some owners made the investment last year. Boston's Marriott Copley Place spent $21 million on renovations in 2002, remodeling over 1,000 guestrooms. The entire renovation translated into an upgrade of $18,000 per room. “The real problem for the past two years is that nobody could say how far down the market was relative to the bottom, but now people are more optimistic that this down market might be coming to a close,” says Sullivan.

Lenders, too, appear to be more optimistic about the hotel industry than they have been for some time. Hotel lending declined sharply after the 9/11 attacks. But the numbers seem to be rebounding. Through March 31, $1.6 billion in hotel loans have been securitized vs. $1.8 billion for all of 2002, according to New York-based Trepp LLC, a CMBS research firm. With little development in the pipeline, it stands to reason that many loans have been applied to renovation campaigns at existing hotels, as well as refinancings.

Near-Term Hurdles

For now, the investments are not about immediate returns: Smith Travel reports that the occupancy rate fell to an average of 60% at the end of the first quarter of 2003 from 63% in March 2002. The average room rate also declined from $84 to $83 during that period. Hotels have made deep cuts over the past few years, eliminating jobs and scaling back on services.

And, for all the talk of recovery, budgets are not yet reflecting a rosier future. PricewaterhouseCoopers' lodging division projects hotels will reduce capital spending for renovations and upgrades this year to roughly 2.9% of revenues. Before 2001, that ratio was about 3.75% of revenues.

On the other hand, money goes a bit further these days. With interest rates still low, it's a great time to borrow money. And one lodging source says it's an even better time to invest in the “guts of the hotel” — furniture, fixtures and equipment (FF&E). “Prices have never been better for FF&E. There's less demand for these products, so pricing is very good now,” says Alan Benjamin, managing partner of Benjamin West, a Colorado-based FF&E purchasing firm whose customers include hotel developers and hotel renovators.

Benjamin also is convinced that optimism on behalf of the lodging sector is driving these upgrades. “As long as people believe that there will be a recovery soon, they'll spend money on improvements,” he says. Another reason, he believes, is that it's essential for hotels to do this work in a down market. “Three years ago, it was okay to have a mediocre hotel, but not anymore,” he says.

Cutting Costs

Lodging franchiser Choice Hotels began an aggressive brand management campaign last year, creating new prototypes and advertising for its Comfort and Quality Inn franchises. But Choice is still cutting costs — only with the input from exhaustive guest surveys that pinpoint cuts that won't affect customer satisfaction. “Over the past 18 months, we've actually removed prototype requirements that the guests just didn't care about,” says Thom Hall, vice president of brand management and strategy for Choice Hotels.

For example, every Sleep Inn, a major Choice brand, was designed around a spiral staircase in the lobby. Now, the lobbies of new Sleep Inns have been converted to exclude the staircase, saving about $3,000 on each staircase. Choice also is actively converting properties that formerly belonged to independent hoteliers. “Last year was a banner year for conversions, and 50% of our growth was through these conversions,” says Hall.

Most rooms in the U.S are labeled under a national brand, says Dale Anne Reiss, global director of real estate at Ernst & Young. Reiss says that franchising and management fees make operating under a national brand more expensive for the owners, but branded hotels generally fare better than independents in both good and bad markets. (For more on franchising fees, see Data Points on p. 2.)

And, it is common for owners to trade up to stronger brands. “Existing hotels have been re-branded under stronger global brands in an effort to capture or maintain market share,” says Reiss.

For Starwood, brand maintenance concerns led the firm to start a sophisticated guest feedback process. By hiring J.D Power to conduct targeted guest surveys, Starwood overhauled its homegrown surveys.

“We learned that we had disparities in quality. Our capital plan ensures that everything in our hotels at the end of its life span is replaced — with the most up-to-date product,” says Ted Darnell, president of real estate at White Plains, N.Y.-based Starwood.

Shelf-Life Issues

The Sheraton chain has undertaken several major renovations and re-branding efforts over the past year. According to Darnell, the Sheraton full-service prototype targets upscale guests in secondary and tertiary markets. So far, 2,100 locations have been selected for these turnkey developments. “We are looking at some major renovations so that we are ready for the recovery,” says Darnell, who adds that every Property Improvement Program (PIP) that Starwood has rolled out has been “revenue neutral.”

PIPs are part of a franchise contract's “milestone clause,” which dictates that after a certain number of years or a change of ownership, renovations are necessary. Since they are in many cases pre-ordained, a down market is no guarantee that a manager won't have to spend money to upgrade. In fact, franchisers can demand that managers abide by them, says Benjamin.

Conversions are another form of brand maintenance that has gained momentum. Branded hotels want properties with “good bones” that can be quickly and affordably converted into new hotels. “These buildings must have a good structure, no major ADA (Americans With Disabilities) issues and require only cosmetic work,” Benjamin says.

The reason for the constant upgrading is simple, says Thomas McConnell, senior managing director at Insignia/ESG's New York office. “The last thing you want to be doing is renovating in an up market.”