Unconventional Wisdom

Just northeast of Charlotte, N.C., John Q. Hammons Hotels & Resorts LLC is putting the finishing touches on its Embassy Suites Hotel Charlotte-Concord Resort and Spa set to open this month.

The 308-room hotel, which will adjoin a 42,000 sq. ft. convention center that's also built by Hammons, is about half a mile from Lowe's Motor Speedway, the site of five major NASCAR races each year.

This particular Embassy Suites property, which Hammons also will manage, is the speedway's official hotel. First-year occupancy is projected at 65%, with an average daily room rate of $131. The figures compare favorably with the estimated national average of 67.6% occupancy and an average daily rate of $114.92 for 2006, according to PKF Consulting Inc. All together, the developer is investing about $80 million in the Concord project, for which the city provided land.

A little northwest of Concord, the company also is developing a Marriott hotel with more than 250 rooms and a convention center in excess of 45,000 sq. ft. in Mooresville, N.C. The town is the headquarters of the Lowe's home improvement chain and a NASCAR mecca known as “Race City USA.”

Ahead of the curve

Hammons is a leader in the revved-up race to develop convention center hotels in cities like Concord and Mooresville. In second- and third-tier cities across the country, the Springfield, Mo.-based company has built or is developing dozens of convention center hotels.

Convention and conference properties make up at least 85% of its portfolio. CEO and Chairman John Q. Hammons says that years ago, he “saw the handwriting on the wall” for potential hotel profit in smaller communities along interstate highways.

Given that most top-tier markets already boast a full complement of full-service convention center hotels, and the land and construction costs in large metropolitan areas are considerably higher than in second- and third-tier markets, Hammons and other hotel developers are targeting cities from Erie, Pa. to Boise, Idaho.

Small to mid-size cities are eager to build convention centers and adjacent hotels as a way to revitalize downtown districts, pump up economic development and “put them on the map,” says Patrick Ford, president of Lodging Econometrics Inc., a lodging research firm based in Portsmouth, N.H.

Robert Canton, a director in the convention and tourism practice at PricewaterhouseCoopers LLP, says that when meeting planners are scouting sites, a convention center hotel is “less of a differentiator these days and just as much of a requirement as the ballroom or exhibition hall in the convention center. It's part of the package now.”

Proliferation of properties

Lured in many cases by public subsidies such as free land and tax breaks, hotel developers are gravitating toward second- and third-tier cities. But while lower costs might make the financial payoff higher for convention center hotels in smaller markets vs. major cities, the risk of failure also is greater, experts say.

Smaller cities are less likely to be hot destinations than their major-league counterparts, experts say, and are more likely to attract small-scale regional or local conferences than higher-dollar national meetings.

As more second- and third-tier convention center hotels come on line, those cities will be vying for the same pool of meetings, contributing even further to an oversupply of hotel rooms, says Rick Swig, president of San Francisco hotel advisory firm RSBA & Associates Inc.

“Several years ago, it seemed that every secondary and tertiary city bought the same research reports that recommended building a convention center and hotel to stimulate their economies,” he says. “As a result, there was a proliferation of new small-market convention centers and hotels.”

Swig does give a nod to John Q. Hammons Hotels & Resorts, though. He says the company's solid track record, strong relationships with lenders and powerful ties to hotel chains enable it to build second- and third-tier hotels en masse. “Hammons doesn't have to go through a learning curve,” he says.

Still, many small cities fail to maximize the use of convention centers because they treat them more like civic centers, says John Keeling, senior vice president of lodging advisory firm PKF Consulting in Houston.

These convention centers regularly host events such as bridal fairs, flea markets, wine festivals, gun shows and concerts, he says — events that don't result in many guests staying at the adjacent hotels.

Pricey projects

Whether it's in a big or small market, a convention center hotel is a costly proposition. These properties frequently feature big-ticket amenities such as expansive ballrooms, underground parking and spas.

That's why few convention center hotels can be built without some sort of public aid, including tax breaks or revenue guarantees. And debates over that aid can generate substantial political heat.

Over the past few years, the cost per room to build a John Q. Hammons hotel has risen more than 40%. A few years ago, the cost to build per room ranged from $100,000 to $130,000, and now that range is dramatically higher, between $150,000 and $250,000.

Those development costs are in line with industry averages, according to Canton of PricewaterhouseCoopers. However, he says some hotels can be pricier, with Baltimore's 757-room Hilton Baltimore Convention Center Hotel coming in at well more than $300,000 per room. The $305 million hotel is set to open in 2008.

Factors contributing to the high costs of convention center hotels include prime downtown land, high ceilings and building features such as a pedestrian bridge. Hammons says his company obtains municipal assistance for its convention center hotels about 40% of the time, but that it doesn't rely on municipal funding for convention centers.

The role of local government

John Q. Hammons Hotels & Resorts is in the minority when it comes to financing convention or conference center hotels. Observers say the vast majority of these properties are developed with some sort of public subsidy, particularly tax-exempt bonds.

“Direct municipal contributions are important to the success of these projects, especially in markets with a lower demand,” according to a recent hotel report from ratings agency Standard & Poor's. “It reduces the level of debt service the project must support from net operating revenues, especially if the city support is from a non-project source.” One source of non-project revenue is a citywide hotel occupancy tax.

Government subsidies come in various forms. For instance, empowerment zone bonds issued for San Antonio's Grand Hyatt convention center hotel, scheduled to open in 2008, are backed by a mix of hotel tax revenue and non-hotel tax revenue from the city.

A 6% state hotel occupancy tax, a 6.25% state sales tax collected from businesses at the hotel for the first 10 years of operation, and a 7% local hotel occupancy tax collected at the Hilton will be in place for the term of the bonds, according to Standard & Poor's.

A citywide 2% special hotel occupancy tax for all San Antonio hotels will be imposed while the bonds are outstanding. The Grand Hyatt also benefits from $77 million in private equity.

The amount of public subsidies for convention center hotels can vary greatly. In the case of Baltimore, a 25% public debt guarantee was promised, in contrast with 40% for the convention center hotel in Denver and 100% for the convention center hotel in Houston, says Drew Masterson, managing director of First Southwest Co. in Houston. The investment bank has participated in financing deals for five convention center hotels.

A substantial risk

Skeptics say publicly subsidized convention center hotels are a waste of taxpayer money and don't live up to advanced billing. A chief critic is Heywood Sanders, a professor of public administration at the University of Texas at San Antonio. Consultants who work on these projects typically argue that to make a convention center viable, a so-called headquarters hotel must be located next door.

“That message has been quite common, over time and over place. But as the financial performance has become clearer, the bond market has been less enthusiastic about financing them,” Sanders says. He points to convention center hotels in Denver and Phoenix as examples of projects that have been subject to tougher requirements from bond-rating agencies.

Sanders maintains that convention center hotels represent “a very substantial risk,” particularly based on their performance.

“In general, they're performing well below their pre-opening feasibility study forecasts. There's almost no evidence that they generate increased convention business,” says Sanders, citing the St. Louis convention center hotel's previous bond woes in the face of less-than-projected occupancy rates.

In 2005, occupancy at the St. Louis hotel was 61.7%, according to Sanders, and the average daily room rate was $117.69. That's far below the 73.3% occupancy and $139.24 room rate that had been forecast five years earlier.

One of Sanders' many critics, Steven Hacker, president of the International Association of Exhibitions and Events, dismisses the professor's arguments as flawed and biased “hogwash.”

Weighing the options

PKF's Keeling wonders whether it might be smarter for an investor to diversify risk by spreading, say, $120 million in equity among 20 Courtyard by Marriott properties rather than plunking all that money down on one 1,000-room convention center hotel.

Ross Woods, principal of Hotel Investment Strategies LLC in New York, says convention center hotels enrich contractors and operators, but “they wouldn't be the first port of call for developers, in my view.”

For developers who are going to pursue a convention center hotel, the view is clearly better in smaller markets, according to Woods. Second-tier hotels will outperform first-tier hotels for the remainder of this decade, Woods' lodging investment advisory firm predicts.

The projection is based on the notion that second-tier hotels outperform top-tier hotels in the middle to latter stages of an upcycle, while top-tier hotels outperform second-tier hotels during economic contractions, recessions and early stages of an upcycle.

Top-tier hotels generated annual growth in revenue per room (RevPAR) of 3.5% from 1992 to 2005, according to Hotel Investment Strategies, compared with 3.2% for second-tier hotels. Through 2010, the top-tier portfolio is likely to yield higher growth in RevPAR, but will be burdened by higher risk, tipping the balance toward second-tier hotels, according to Hotel Investment Strategies.

Roger Zampell, senior vice president of development at Atlanta-based real estate developer Portman Holdings LLC, is monitoring the second- and third-tier market for convention center hotels. With fewer opportunities for big convention center hotels available now than in the past six or seven years, Zampell says, “we're keeping our eyes open” for opportunities across the entire spectrum of convention center hotels.

Portman's architectural group designed the new 500-room Renaissance convention center hotel in Schaumburg, Ill. Zampell says that's an example of an “edge city” — in this case, a suburb of Chicago — that can support a full-service hotel as an alternative to higher-priced lodging in a larger downtown area.

Portman developed the Westin convention center hotel in Charlotte, N.C., and is building the Hilton San Diego Convention Center, the largest privately financed and owned convention center hotel currently under construction in the United States.

For his part, Hammons anticipates that not every convention center project planned for a second- or third-tier market will prove to be a success. His company typically acquires the land about three years ahead of pulling the trigger on a development. If the project doesn't come to fruition, Hammons says, “then sell the damn land at a profit and go on down the road.”

John Egan is an Austin-based writer.

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