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Hotel Developers Look Outside the Gateway Metros

Demand for hotel rooms is increasing throughout the rest of the country, in cities where there is not as much new construction, not just the top 25 markets.

Hotel developers now have to work harder to find attractive markets for new properties.

The hotel sector is performing, but it’s also experiencing the addition of thousands of new hotel rooms—nearly as many as were built during the last market peak. Developers planning new construction projects now have to struggle to find markets where strong demand for rooms has not already been matched by high volumes of new construction.

Some developers may be looking outside of the largest cities for the next opportunity. “The occupancy rates are increasing in the markets outside the top 25 hotel markets,” says Jan Freitag, senior vice president of lodging insights with research firm STR Global.

Construction boom continues for hotels

In June 2017, there were 191,000 new hotel rooms under construction nationwide. That’s up 16 percent compared to the same period a year ago. That rate of growth is not as fast as it has been in recent years, but the inventory is still growing.

Nearly half (47 percent) of all of the new hotels now under construction are being built in the 25 largest hotel markets, including New York City and Los Angeles. The inventory in these top markets increased 2.5 percent in just the first five months of 2017. These markets are also attracting a lot of guests to their hotel rooms—the number of room sold increased 2.4 percent in the first five months of 2017, according to STR.

“The growth in demand is basically on par with the supply of new room,” says Frietag.

That’s great news for developers who have already started construction, but at this stage in the cycle, it may not be the best time to start new projects, even if the outlook for hotels remains optimistic. “Our forward-looking indicators are trending higher, which suggests demand growth [for hotels] should once again turn higher,” says Wes Golladay, analyst for RBC Capital Markets.

At the same time, demand for hotel rooms is increasing throughout the rest of the country, in cities where there is not as much new construction, not just the top 25 markets. The number of hotel rooms sold grew 2.6 percent in these smaller markets, where the inventory only grew by 1.5 percent.

Some of these small markets may be benefiting for a short-term increase in demand, but a few may still present opportunities. For example, in Colorado Springs, Colo., the revenue per available room (revPAR) grew 16.6 percent in the first five months of 2017. But the inventory of rooms only grew by 1.7 percent over the same period. Colorado Springs has had consistent growth in demand in recent years. In Hawaii, revPAR grew 12.9 percent, but the inventory only grew by 0.8 percent.

Of course, smaller markets like these present their own challenges. They may be far away from the places most investors are familiar with. Also, it’s much easier for a few large projects to overwhelm a smaller market.

Buying existing hotels

Some investors are avoiding the challenge of new development entirely by buying existing hotels. “There’s no construction risk—you can step into an operating entity and start generating cash tomorrow,” says Freitag.

But buying property has its own challenges at this point in the cycle. Through the first half of the year, the capital markets have been deeply uncertain about the likely direction of federal policies.

The number of hotel properties bought and sold in the first five months of 2017 is down 14 percent compared to the year before. The year started very slowly, but has begun to recover, especially for sales of individual properties, according to Real Capital Analytics, a New York City-based research firm.

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