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Reduced Credit Availability Stalls Hotel Construction

As hotel owners and investors continue to fight a slowing economy and the declining availability of credit, the lodging industry faces a number of challenges that it hasn’t seen since the months following 9/11.

Diminished access to credit for hotel projects is creating a drag in the pipeline, according to a second-quarter construction pipeline report from Lodging Econometrics. The Portsmouth, N.H., hotel research company reports 381 project construction starts, totaling 47,107 rooms, at the end of the second quarter, down by 78 projects and 4,757 rooms compared with the first quarter.

In another sign of changing developer sentiment, Lodging Econometrics finds that there has been a high level of project cancellations. In the second quarter, 327 projects totaling more than 48,000 rooms were canceled. This is the highest number of cancellations since the fourth quarter of 2001 following the aftermath of 9/11, when the lodging industry went through one of its darkest periods in recent times.

“New visibility on the economy, the lending crisis and lodging operating trends emerged during the second quarter, which served to dampen developer sentiment considerably,” said Patrick Ford, president of Lodging Econometrics. “As a result, key development metrics have softened, indicating that both project migration within the existing pipeline and the pace of new project announcements into the pipeline are beginning to ebb.”

In another sign of the times, lodging operations have been impacted by the stalled economy. The housing crisis, failed debt instruments, and the distress of Wall Street institutions and Main Street banks have taken a toll on the economy, along with oil prices of more than $130 per barrel.

Reacting to these economic conditions, businesses and consumers have cut down on travel. This has resulted in growth of revenue per available room (RevPAR) of 1.5% at midyear, whereas forecasts at the beginning of the year called for RevPAR growth of 4.4%.

Demand for guest rooms also is down 0.3% at the end of the second quarter, compared to the second quarter of 2007. Lodging Econometrics expects demand growth to continue to be negative for the year. This represents the first year of negative demand growth since 2001, and the third in the last 25 years.

At the end of the second quarter, there were 5,883 projects comprising 785,547 rooms, taking into account all stages of the pipeline, from planning to construction. Even though this measure is at a peak, it appears to be cresting. Total rooms under construction have reached a record high of 242,229. Also at a record level are early planning projects and rooms —1,423 projects are being planned, comprising more than 15,000 rooms.

“For some time, there has been no financing available at either the Wall Street or National Bank level,” says Ford. “It is becoming increasingly difficult to source financing for 100-200 room projects, which account for 44% of the total pipeline, as well as the majority of upscale and mid-market projects currently in the pipeline.”

Lodging Econometrics expects that pipeline totals will decline over the next four to six quarters, considering that financing conditions are not likely to change before midyear 2009 at the earliest.

Ford says that the “starts” stage of the pipeline will remain “disproportionately large” in the next few months since franchise agreements require many developers to start construction within the next 12 months. A number of agreements are likely to be extended while everyone watches for an end to the credit crisis.

The hotel research firm also expects the early planning stage of the pipeline to back up as more developers continue with their project planning, despite uncertainty about when financing will become available again.

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