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The hotel market

Red carpets and liveried doormen couldn't be more apt symbols of the VIP welcome now greeting the return of investors to the hospitality market. This complex, business-intensive property type was surely unkind to many owners and lenders during the '80s. Hotel overbuilding truly merited the term "debacle." The rush of new money into this field comes as a stunning change of heart.

After a trough in 1990, hotels hit their stride in 1993: occupancies began to rise; room rates stabilized and then advanced; overall performance moved toward levels last seen in the late-'70s. About half the improvement could be attributed to supply/demand fundamentals. The balance came from debt restructuring and lower property taxes. Together, these influences buoyed expectations of earnings. The buyers began lining up.

A year ago, we alerted readers to "anticipate a pivotal move in investor pricing behavior in 1994. The profile of the hotel markets is distinctly stronger." This proved to be an understatement. Euphoria seems to be gripping buyers. We can only hope that the justifiably optimistic outlook for the industry as a whole does not obscure the reality that this highly segmented property class demands an extraordinary level of daily asset supervision.

Landauer's transaction records indicate more than 90 sales of individual properties or hotel packages in the first three quarters of 1994 - about one multi-million dollar hotel purchase every three days. And the final quarter of the year is usually the peak season for closings.

Operators such as Marriott figured prominently among the buyers, an encouraging sign. Foreign investors likewise displayed a strong appetite, and could crowd out domestic purchasers in 1995. It is the foreigners who can be expected to clear the logjam of unsold properties encumbered by long-term management contracts.

As in other property types, Wall Street made some of the biggest splashes. Morgan Stanley was especially active, orchestrating a $620 million purchase of 210 Red Roof motels, for a pension fund consortium. This followed resort acquisitions in Telluride, CO and Carmel, CA, marking an aggressive expansion of the institutional stake in the hospitality industry.

New hotel-oriented REITs entered the market this year, too. RFS Hotel Investors was the largest, actively purchasing facilities in the 100-250 room size range. Typical investments by REITs were in the $5 to $10 million range, for chain-affiliated facilities with good interstate highway visibility. Luxury hotels are generally not good candidates for securitization, since rules require their assets to be almost solely real estate. In luxury hotels, though, 15%-20% of the value may be in furniture, fixtures and equipment.

Segmentation strategies continue to proliferate, witness Holiday Inn's new Select and Sunspree formats, but consumers are already faced with a complicated array of choices. It is also far easier for economy hotels to enter the markets as the REIT buying binge fuels a round of construction. We expect the pendulum to swing toward the upper-end hotels, implicitly favoring whole-asset investors over securitized buyers.

Soaring corporate profits - the key to business travel budgets - should be bolstering demand for full-service hotels, helping raise the bottom lines at top-shelf establishments. From the Phoenician Resort/Crescent Hotel and the Ritz Carlton sales in Phoenix, to the Hotel Millennium acquisition in Manhattan, a wave of institutional quality properties is changing hands. Several life companies are planning to resume conventional lending for hotels. Hopefully, a more disciplined underwriting approach is in store. Time, and competition, will tell.

Investors will need to factor significant capital outlays into their proformas. During the lean years, many facilities did not even reserve a minimal 2-3% of revenues for capital improvements. Hotels built between 1985 and 1988 are now at an age when major refurbishment should be done, and a cavalry of new capital is arriving just in time.

The spread of legalized gambling has unquestionably challenged traditional venues like Las Vegas. But the real risks are in newer, smaller markets where developers made a high stakes bet on new facilities and where demand has come up craps. The saturation point is at hand, and a period of turbulent asset values is on the way.

Timesharing, by contrast, has turned out to be an attractive product for resort-market players like Disney, Hilton and Marriott. A hybrid approach combines hotel facilities with timeshare units. The hotel generates transient stays, bringing customers to an environment where timeshare promotion can work effectively. But, timesharing has only limited market appeal and the profits are largely in the business rather than in the real estate.

Occupancies rose to 67.5% across the 42 cities evaluated in this year's Hotel Market Equilibrium Index. Construction of hotels and motels was still at a cyclical ebb, running at $4.2 billion on an annualized basis, or only 40% of 1990's development volume. Landauer's analysis finds that cities with strong business travel components leapfrogged the tourism/convention markets. New York has emerged as a prime beneficiary, with occupancies surging to 74%, due largely to a 24% increase in convention attendance. The city scaled back its burdensome room tax in an effort to encourage increased visitor flow and the initial results are encouraging.

Washington, D.C. displays a similar recipe for strong hotel demand, now estimated above 70% in annual occupancy. Tourism has been strong, with a winning combination of increased domestic travel and large numbers of international visitors taking advantage of a favorable exchange rate.

The 1996 Olympic Games have not led to the rampant speculative hotel boom that special events have engendered elsewhere. Atlanta therefore looks to enjoy strong hotel revenue growth without the hangover of a glutted market later in the decade. Landauer projects a 2.5% yearly increase in demand for Atlanta hotel rooms through 1999, or about 4,800 more room-nights. With occupancy already running at nearly 72%, this should mean very healthy market conditions.

The primary resort markets - Las Vegas, Honolulu and Orlando - have paced the hospitality field. They do well again this year, but do not cluster at the top of the list. This is more a reflection of improvements elsewhere than weakness at the resorts, but there are some cautionary trends to watch.

Las Vegas is rightly attempting to supplement its gaming and convention base with more family-oriented entertainment. Robust demand matches the explosive expansion of the hotel inventory. Guest flow was excellent in 1994, but spirited competition will continue through the late-'90s.

Orlando, too, is in a phase of significant new development, led, naturally by Disney. Our forecast indicates Orlando will lead the nation in adding guest demand, at 5% per year, and we expect another 7,000 rooms by 1999.

Other Florida markets, especially Miami, are feeling the effects of last year's violent incidents. The palpable reduction in foreign visitors has dropped occupancies below 65%. A concerted effort to restore the state's battered image must be high on the hospitality industry's agenda. It appears investors believe a rebound is likely, since south Florida was one of the nation's most dynamic transaction markets.

Weakness in Honolulu is relative. Economic trouble in California and Japan kept demand levels flat, although Hawaii was spared a repeat of the unfortunate 1993 airline pricing strategies. Occupancy is still an enviable 78%, and it is unlikely that Honolulu's feeder markets will remain depressed indefinitely. Landauer anticipates annual demand growth of 4.8% through 1999, sending developers searching for new resort sites.

Phoenix, Chicago, Boston and Dallas count as notable turnarounds this year, mostly attributable to improved business travel. All moved to the approximately 70% occupancy point, and appear poised to reap the benefit of increased room rates.

The weaker end of the scale finds a concentration of California cities, including Los Angeles and San Diego. With a tough economic recovery ahead, these markets will improve only slowly through the end of the decade.

Finally, it will be interesting to track the maturing of markets like Charlotte and Salt Lake City. With excellent regional economies supporting them, they could become the next pleasant surprises in the hotel field.

On balance Landauer finds real reasons for encouragement in the hospitality markets. Euphoria, however, is definitely an over-reaction to the improvement. It is going to take an amalgam of expert management, capital upgrading and a commitment to quality guest service to stay ahead of the pack. That's hard work, and the best reason for reaffirming that this property type is best left to professional specialists.

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