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High Cost of Capital Drives Down Hotel Values

NEW YORK — Hotel values are dropping even as net income in the industry rises. The value per hotel room in the United States fell from $95,000 in 2007 to $91,000 in 2008, according to Stephen Rushmore, president and founder of Mineola, N.Y.-based HVS Hospitality Services, who spoke at 30th annual New York University International Hospitality Industry Investment Conference.

The 4% loss in hotel values projected for this year follows a 5% loss in 2007. Despite the lower values, net income in the industry rose 11% in 2007 on average to more than $8 million for a typical hotel and has already gained 3% this year.

Rushmore attributed the decline in values to rising capitalization rates. As mortgage interest rates rose, however, so did cap rates, offsetting the increase in hotel net income. The mortgage constant, a ratio of debt service payment on a mortgage to the total value of a loan, rose. “The higher cost of capital has caused values to go down in the United States,” Rushmore concluded.

In 2007, the mortgage constant for hotel properties stood at 9%, and has risen to 10% this year. Cap rates jumped from 8.6% in 2007 to 9.2% in 2008. Back in 2006, the mortgage constant and cap rates for the hotel industry were both at a little more than 7%.

Overall, Rushmore sees 2008 as a great time to buy into the industry, considering that hotel values have bottomed out. However, financing is still difficult to obtain. There were only 43 hotel sales transactions at the end of April.

Another speaker, Mark V. Lomanno, president of Smith Travel Research, Hendersonville, Tenn., pointed out that despite the reduced availability of credit, and given the economic environment, the fact that hotel room rates have not declined is encouraging.

Lomanno doesn’t expect growth in revenue per available room (RevPAR) — an industry metric that examines room revenue in a hotel property divided by the number of rooms available — to become negative. For the first five months of this year, RevPAR was at 2.6% in the United States.

The average daily rate (ADR), another hotel industry measure that looks at room revenue in a property divided by the number of rooms occupied, was up 5.4% at the end of May, Smith reports. And RevPAR was also up 4.6% at the end of May.

Still another piece of good news for the industry is that while supply is growing, it is growing at the “low end of historical norms,” Lomanno said. At the end of April, hotel supply was up 2.2%.

Overall, Smith Travel forecasts supply growth of 2.4% by 2009 and demand of only 1.3%. RevPAR is likely to drop to 2.8% by 2009, after growing 3% in 2008.

“The industry will still be extremely profitable but will not necessarily generate enough RevPAR growth to cover the increased cost of doing business,” Lomanno said.

Weekday occupancy is providing more revenue for hotels — a new trend, he says. At the end of April, weekday business accounted for more than $24 billion in hotel revenue, up from more than $23 billion in revenue for the same period of 2007.

And regionally, there was good news for the industry, as well.

New York topped the list of HVS Hospitality’s ranking of cities in which hotel rooms gained the most value for 2007, with a 33% increase. Other big gainers included Miami (21%), Boston (20%), San Francisco (19%), and Huntsville, Ala. (16%).

Cities in which hotel rooms declined in value include New Orleans, down 42%; Tallahassee, Fla. (35%); Boca Raton, Fla. (23%); Greensboro, N.C. (23%); Dayton, Ohio (22%); and Sacramento, Calif. (22%).

By 2011, HVS expects the value of a New York hotel room to be the highest in the nation at $823,000, followed by San Francisco where a hotel room’s estimated value will be $505,000, and Boston, $430,000.

However, these markets are among the riskiest in terms of the volatility of returns, with both New York and San Francisco ranking near the bottom of the list for volatility. Compared with overall U.S. volatility of 15%, New York carries a 42% chance of not realizing an expected return, while the risk in San Francisco is as high as 28%.

A safer strategy for investors may be to target hotel markets such as Seattle, San Diego, Santa Fe, Portland and Baltimore, where HVS expects hotel rooms to show relatively higher gains in value with relatively lower risk.

Markets that hotel investors might want to avoid, considering that they offer the prospect of relatively low gains in room values combined with a high risk factor, include Greensboro, N.C.; Hartford, Conn.; Chicago; Tallahassee, Fla., and Charlotte, N.C.

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