Dicey Hotel Market Creates Opportunity for Savvy Investors

With so much bad economic news dampening lodging demand, it's easy to understand why a hotel owner, operator or lender might want to go straight to his room, hop in bed, and pull the covers over his head. Their outwardly cheery disposition belied the strain they must have been feeling during the Midwest Lodging Investors Summit (MLIS) held at the Sheraton Chicago Hotel & Towers in mid-July.

“Scared” is how Morris Lasky, CEO of Chicago-based Lodging Unlimited, a hotel management and consulting firm, described the mood of the show that drew 500 attendees and was co-sponsored by NREI and its sister publications Lodging Hospitality and Retail Traffic magazines. “People are saying, ‘Whoa, what are we going to do?’ You know why people are going to conferences? They want to talk with other people who they think may have an answer, and some do.”

But the answers don't come easily in this turbulent economy. A spike in home foreclosures nationally, mounting job losses, failed banks tied to subprime mortgages, gas prices of $4 per gallon, and a crisis of confidence among debt-laden consumers are all conspiring against a once hot hotel market. As the subprime debacle and credit crunch goes unabated, this industry finds itself wearing heavy-duty ankle weights.

What's caught forecasters by surprise is the drop in hotel demand — down 0.3% for the first half of 2008 compared with the same period a year ago and down 2.1% in June. That amplifies the gap between supply and demand, making any new supply appear more significant than is actually the case.

Lodging Econometrics, a global hotel research firm based in Portsmouth, N.H., reports that 1,218 hotels are expected to open in the U.S. in 2008, totaling 135,373 rooms. That new supply represents a gross growth rate of 2.9% for the year. In 2009, some 1,508 hotels and 165,425 hotel rooms are expected to open, resulting in a gross growth rate of 3.4%. “This is normal supply growth, not excessive, and would have been adequately absorbed had not the lending crisis and the housing crisis popped up, which are two very difficult economic things to reverse,” says Patrick Ford, president of Lodging Econometrics.

The researcher reports 785,000 rooms in the U.S. hotel development pipeline in the second quarter, up from 779,307 in the first quarter. “It's a lot of rooms coming on line when the economy is on a downward trend,” says Lasky.

Meanwhile, hotel REITs are taking it on the chin. U.S. lodging REITs posted a total return of negative 29% from Jan. 1 to July 24, according to the National Association of Real Estate Investment Trusts. Due to the headwinds buffeting the industry, PKF Hospitality Research has revised its forecast for growth in revenue per available (RevPAR) for 2008 from 3% to 1.5%. In contrast, RevPAR grew 5.7% in 2007.

Sensing buying opportunities as hotel fundamentals further weaken, Lasky is teaming up with an undisclosed investor to launch Lodging Opportunities Group (LOG), which will acquire U.S. hotels that are financially troubled. Backed by hundreds of millions of dollars, the new fund is targeting hotel properties with a minimum of 125 rooms. The hold period for properties acquired will be three to five years.

With average cap rates for hotels expected to rise from about 7.6% to 9.5% over the next two years, according to PKF, that means buyers are in the driver's seat for the foreseeable future. How long does Lasky envision this window of opportunity? About three years, he says, and he believes that's a conservative estimate. “Once [the hotel industry] starts to go down, it doesn't come back right away. The hotel business always lags in the worst possible way.”

Lasky and his financial partner decided about a year and a half ago to launch the fund after observing some telltale signs that the industry was getting overheated “You don't have to be a genius. You just have to be around long enough to see how the trends unwind, what they look like and where they're headed,” says Lasky. “I see that there are too many [economic] factors that are not going to get solved immediately.”

That means the savvy investors won't be hiding under the covers in this topsy-turvy market.

Contact Editor Matt Valley at [email protected].