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Weathering troubled times

In San Francisco, Kimpton Hotel and Restaurant Group has felt the nasty sting of the economic downturn. As of October, occupancies were off 30% and higher since Sept. 11 at some of the company's 16 hotels in the city. Advertised rates at the Prescott, a 164-room luxury boutique hotel near Union Square, had slipped below $190, down from $230 a year ago. Some 15% of all Kimpton workers had been laid off since Sept. 11, and more cutbacks may be in the offing.

“This is a critical time for us,” said Stephen R. Pinetti, senior vice president of sales and marketing at Kimpton, in a late October interview. “This is the period when corporations, convention groups, and wholesale tour and travel accounts negotiate for 2002 rates. But they are deciding either not to travel at all or reducing their travel, and it seems that almost everybody is expecting lower rates from us. We're vulnerable. People smell blood.”

Indeed, a slowing economy and the Sept. 11 attacks have created a situation that is bleak in many ways. The national hotel occupancy rate was 69.8% during the first half of this year, according to Hendersonville, Tenn.-based Smith Travel Research. By the week ending Oct. 31, usually a period of peak convention travel, the occupancy rate had fallen to 61.5%. Some major cities were suffering even more acutely.

However, occupancy numbers tell only part of the story. In October, revenue per available room (RevPAR), the equivalent of same-store sales, was down 17% from a year earlier, according to Atlanta-based Hospitality Research Group, a division of PKF Consulting. The average U.S. hotel room was priced at $82.63 in late October, down 8% from a year earlier, according to Smith Travel. Prices in New York City were down 31% to $172.36 per night.

As a result of these trends, more and more hotels are having trouble meeting loan conditions. In a survey of 5,000 hotel properties around the U.S. in 2000, Hospitality Research found that 16% were not earning enough to cover interest obligations on their debt. The research firm estimates that figure has risen to 20% this year and will rise to 36% next year. In a high-profile example, Trump Hotels and Casino Resorts missed a $90 million interest payment in early November on $1.3 billion of debt.

Delinquencies on loans stood at a slim 1.5% last year, but that total is likely to hit a troublesome 4% by early 2002 and could keep rising after that time, according to Hospitality Research Group.

“Hotel business began to erode rapidly in July, and then it went off a cliff after Sept. 11,” said Jack Corgel, managing director of Hospitality Research. “We were expecting that we would pull out of this tailspin, but that's not happening. We seem to be hanging in a trough now, with quite weak demand. Most economists are forecasting a rebound in the economy late next year and in 2003. However, it's not clear that the hotel sector can recover even by then.”

All in all, the hotel industry is facing its bleakest period since the recession of the early 1990s. Many industry experts foresee new construction projects winding down over the next year, with only the most compelling projects moving ahead as lenders scale back their commitments to hospitality. And yet hotel players are not entirely discouraged, feeling this period marks a chance to grow their portfolios as owners seek to rid themselves of troublesome properties.

A deal-making frenzy?

In mid-summer, Kimpton management set a goal of doubling the size of the company — which currently owns or manages 34 hotels — within the next three years. Other hotel executives share similar ambitions. That's because there is an expectation in the industry of existing assets coming to the market, potentially at valuations marked down 10% or more from a year ago. Well-capitalized companies like Kimpton, along with opportunity funds, will be hunting for bargains like a pack of hungry dogs sniffing out buried bones.

The performance of the hotel sector might put the goals of Kimpton and others within reach. Furthermore, a deepening recession or another terrorist event could bludgeon occupancy rates into a free-fall, creating wholesale shifts in asset ownership, particularly of older, more marginal properties.

But that's an extreme scenario. Most industry observers don't expect anything like a repeat of 1990, when over-leveraged owners were forced to sell out at steep discounts as the nation's economy faltered toward recession, and travel shriveled up. The industry didn't regain solid footing again until the middle of the decade.

“No two recessions are ever the same,” said David Hawthorne, president and CEO of Atlanta-based Lodgian Inc. “In the late 1980s, we had a lot of overbuilding and then the downturn hit, and we had to wait quite awhile for the economy to catch up to what we had built. It's different this time. I don't think the industry is overbuilt, though we may have more capacity than we need in some individual markets.” Orlando, Fla., and Las Vegas are two markets that industry observers fear may be overbuilt.

Also, if banks extend a helping hand to many of their troubled borrowers and prop them up by, for example, ignoring debt covenant violations, then all predictions of a firesale are likely to fall flat.

“We've sold a couple of properties in the past year, but this is a horrible time to be selling assets into this market,” said Thomas J. Corcoran Jr., president and CEO of Irving, Texas-based FelCor Lodging Trust. “Everybody is going to recognize that and try to hold on if they can,” he predicts.

The increased number of hotel properties having trouble meeting the conditions of their debt “doesn't mean we are going to see a rash of defaults,” said Corgel of Hospitality Research Group. “Hotel groups will use cash from healthy properties to support weaker properties. Some money-losing assets will be divested.”

Theodore Mandigo, president of Elmhurst, Ill.-based T.R. Mandigo & Co., a hotel consulting firm, said he receives calls from opportunity funds every week, yet is counseling them to wait. Prices are bound to move lower, Mandigo reasons.

Most experts estimate that on average hotel valuations have fallen almost 10% in the past year. Doomsayers believe they are headed down another 10% over the next year. Still, for now there is a yawning gap between buyer and seller expectations.

Sellers are generally looking to divest at a capitalization rate of 8% to 9%, while buyers want a cap rate of 10% to 11%. (The higher the cap rate, the lower the purchase price.) The consensus bet is that beginning in the second quarter of 2002, sellers will swallow hard and give buyers the returns they want.

Rick Besse, president of Fort Worth, Texas-based Winslow Group Inc., figures that opportunity funds will be seeking internal rates of return (IRR) in excess of 20% in hotel deals during the coming year. More risk-tolerant funds will be looking for internal rates of return of 30% or more, he adds. Besse foresees some hotel assets becoming available in 2002 for as little as half their replacement value.

“I'm looking at one deal now where I'll acquire a hotel and do renovations and still be at 65% to 70% of replacement value,” Besse said. “My best guess is that medium-sized cities in the Midwest will become the investment focus in the next year — towns like Detroit and St. Louis and Omaha, Neb., that visitors can reach by driving. Those markets might be a smart place to put your money.”

Some companies could use the downturn to convert hotels into other property types. For example, Chicago-based M Development LLC purchased the 200-room Ambassador West Hotel in Chicago for $18 million from Dallas-based Wyndham International Inc. M Development plans to convert the property into a luxury condominium.

One factor influencing the volume of property transactions will be the state of the capital markets. Their dicey state caused FelCor, the nation's second-largest hotel REIT, to call off its acquisition of Washington, D.C.-based Meristar Hospitality Corp, the nation's third-largest hotel REIT, in the days after the Sept. 11 attacks. The $2.7 billion deal foundered on dim prospects for FelCor's plan to refinance some $1.7 billion in debt held by Meristar. Interest rates on borrowed hotel money had rocketed upward some 300 basis points, or 3%, in a matter of days.

“It suddenly seemed like hotel money didn't exist,” said Corcoran of FelCor. “The market for hotel paper didn't exist, or if it did it was at irrational levels that didn't make sense. Until there is more rationality in the capital markets, we can't do anything.”

Meanwhile, Pinnetti of Kimpton remains on the prowl for deals. “Strong investors behind you make all the difference in the world,” he said. “If we put 50% down on an acquisition, even if business is bad we can still make our mortgage payment. The hotel market will get better before long, and when it does companies will be glad they invested in assets when they did.”

Decreasing appetite for new construction

Not surprisingly, the current hospitality climate reveals at least a somewhat dampening enthusiasm for new hotel construction. Torto Wheaton Research, a Boston-based division of CB Richard Ellis Services Inc., estimates that 50,000 rooms were added to a pool of 1.2 million rooms last year in the 40 largest U.S. metro markets. The total will slip a bit this year and next to 45,000 rooms, and all the way to 20,000 rooms by 2003, the firm predicts.

The reason for the delayed effect is that hotels have a long planning and production cycle. A project often can take three or four years to complete, and there isn't a great deal of flexibility to instantly react to market conditions. Thus, Atlanta-based Six Continents Hotels Inc. is pushing ahead with the openings of 10 new Crowne Plazas in the next six months, with a dozen other properties under different brands also due to debut after that time.

Likewise, Kimpton could not put the brakes on new hotels it is opening in Silicon Valley and in San Francisco, where an old warehouse is being transformed into the 220-room Argonaut Hotel, due to open by Christmas 2002. The company also will open two new hotels in Washington, D.C., within the next year or so.

On the other hand, Englewood, Colo.-based Destination Hotels and Resorts Inc. shut down all major projects and reconsidered each individually. It decided to go ahead with a $2.5 million renovation of the L'Auberge Del Mar near San Diego and the $5 million acquisition and renovation of a health club adjacent to its 206-room Sun River Resort in Oregon.

“A down period can actually be a good time to invest in renovations,” explains Charles S. Peck, president and COO of Destination Hotels. “That's because it is easier to accomplish remodeling work if a property is 60% occupied compared with 80%.”

Prime Hospitality Corp. in Fairfield, N.J., which either owns, operates or franchises 230 hotels in 32 states, is usually a regular buyer and seller of assets. “Generally we have eight to 10 new deals in the pipeline, but we're working on just two at the moment,” said Doug Vicari, CFO of Prime Hospitality. He is particularly concerned about the company's franchisees. Prime has executed 50 franchise agreements for projects that haven't begun construction. “We're not sure what will happen to that franchise pipeline. Lending to franchisees is very tight right now,” Vicari admitted.

A sea change in financing techniques is one reason hotel construction will be slower than in the recent past. Mandigo of T.R. Mandigo & Co. notes that in the past developers often put “soft equity” into hotel construction deals, usually represented by the cost of their land. That won't fly with banks in today's market, he warns. Most lenders will require at least 35% equity in a construction deal, and it will have to be all cash, or hard money. Some deals in less-proven locations will require 50% equity.

Limited-service doing better than the rest

A possible firesale of hotel properties and decreased construction are trends that may not affect the roadside limited-service hotel sector greatly. These hotels are finding that their auto-dependent clientele are continuing to hit the roads.

“Our Hampton Inns are holding up the best,” said Ted Middleton, senior vice president of development and finance at Beverly Hills, Calif.-based Hilton Hotels Corp. “They are typically smaller hotels in secondary cities that are often reached by car. They're dependent on the traveling shoe salesman who is still servicing his route.”

Tourists and conventioneers, however, are cooling their heels at home. “Our Hilton chain is suffering the most,” Middleton continued. “The Hiltons in places like Hawaii and San Francisco are really feeling the downturn. They are dependent on conventions, and the convention traffic is way down.”

The hardest-hit segment of all has been luxury hotels. In Chicago, the Peninsula and Le Meridien both opened earlier this year with room rates advertised at $350 and up. But both were forced to discount to less than $200 in a desperate attempt to attract guests. Meanwhile, plans for an Adam's Mark and Mandarin Oriental nearby just off Chicago's swank Michigan Avenue were put on the back burner by developers in the face of downtown occupancies that were running less than 60%.

In the light of these trends, many hotel companies have turned their advertising strategies upside down, enticing visitors to cancel their Caribbean vacations in favor of more modest excursions closer to home. The Heidel House Resort in Green Lake, Wis., for instance, ran ads in Chicago newspapers through November with the headline, “By the time you board your flight, you could be arriving at our doorstep.”

Also, the management of Kimpton's 122-room Hotel Burnham in Chicago has been particularly aggressive in marketing to the weekend leisure traveler, said Christine Lawson, vice president of hotel sales for the company. She added that the boutique hotel has not experienced as severe a drop-off in corporate travel as have some of the company's other hotels. “We have an emphasis on being sensitive to the fact that many people don't want to fly.”

H. Lee Murphy is a Geneva, Ill.-based writer.


The hotel industry is struggling due to the economic recession and the aftermath of the Sept. 11 terrorist attacks. The chart below lists the hotel occupancy rates in some major metropolitan areas for the week ending Nov. 17, 2001, and the percentage change compared with the same period in 2000.

Week ending Nov. 17 % change from same week in 2000
Atlanta 61.9% -21.6%
Boston 61.3% -29.4%
Chicago 68.3% -9.2%
Dallas 58.2% -18.8%
Detroit 57.7% -13.4%
Los Angeles-Long Beach 64.5% -17.8%
New York 78.9% -13.6%
Orlando 59.7% -21.7%
Philadelphia 68.3% -13.5%
San Francisco-San Mateo 59.5% -31.4%
Washington, D.C. 66.2% -18.4%
Note: The survey doesn't include hotel properties with 15 rooms or less.
— Source: Smith Travel Research

Arlington Hospitality continues to build in hotel industry's troubled times

The hospitality industry as a whole may be in the midst of troubled times, but you wouldn't know it from looking at Arlington Hospitality Inc.'s statistics. The Arlington Heights, Ill.-based company, which builds, operates and manages limited-service hotels such as AmeriHost Inns (above, in Freeport, Ill.), reported that revenues per available room (RevPAR) in October were up almost 2% compared with October 2000.

“The corporate segment continues to deteriorate, but leisure travel is alive and well. Our weekends are stronger than ever,” said Michael P. Holtz, Arlington's president and CEO. “People are traveling in their own backyards. We've begun marketing heavily to people in our own communities, reminding them that we have a pool and welcome kids.”

Armed with a credit line of $20 million from Stamford, Conn.-based G.E. Capital, Arlington, which operates approximately 75 hotels, is going ahead with plans to build an 80-room AmeriHost Inn near Toledo, Ohio, next year and another near Sacramento, Calif. In fact, the company hopes to build 13 new hotels in 2002, up from eight this year.

How will Arlington do it? The company has devised a cookie-cutter approach to new construction that allows it to build an 80-room hotel, land included, for less than $3 million, or $46,000 per room. The company estimates that project costs would run 20% to 30% higher without the cookie-cutter approach.

Also, Arlington can begin recording positive cash flow when it gets occupancies above a bare 50%. It has generally been accepted in the hotel industry that a project doesn't become fully profitable until its occupancy rates are about 70%. When operations are stabilized, Arlington can often sell the hotel to investors for as much as $60,000 a room, earning a tidy profit in the process.

“If you have a track record and can show you know what you're doing, you can get money for construction,” Holtz insisted. Nevertheless, he predicts that many rivals will reduce plans for new development, a cutback he gleefully anticipates. “If new hotels aren't coming to the market,” Holtz said, “that means that any rise in demand can be spread among existing hotels.”
H. Lee Murphy

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