Many important decisions in the economy come from comparisons of the descriptive – what is – and the normative – what should be! Stock selection for investment based on fundamental analyses provides one of the best examples of this type of decision making. Investors have a descriptive valuation of a stock from the moment-by-moment record of the stock price.

To determine if the market has priced the stock 'correctly' in fundamental terms, investors will introduce a model(s) designed to find the normative value. Trust in the model's ability to capture fundamental drivers of stock pricing is obviously the key to committing capital, but given that such trust exists, when modeled valuations exceed the current prices investment in stocks have analytical support. In this article we apply the same descriptive and normative comparison principle to determine the extent to which the current pipeline of hotel construction projects is serving the needs of the market as indicated by supply fundamentals. Specifically, we use an extended version the PKF Hospitality Research Hotel Horizons® supply forecasting model to indicate how many new hotel rooms should be constructed across the various chain scales and top 50 city markets and then compare these results to what will appear on the ground from pipeline data during the remaining months of 2014 and in 2015. The results of our analysis provide guidance to developers, equity investors, mortgage lenders, and analysts regarding the potential success of future hotel construction projects. We find that more than one-half of the markets forecast by the PKF Hospitality Research Hotel Horizons® will experience supply growth during the next six quarters less than the growth indicated by supply fundamentals specific to those markets.

Comparing Pipeline and Modeled Supply

'Pipeline supply' is defined here as the projects included in the STR pipeline data base that are currently under construction and scheduled to be completed in the next six quarters. The 'modeled supply' is the output from Hotel Horizons® supply models when allowed to run naturally, that is, supply comes solely from the influences of variables in the model.

The normative modeling effort indicates what supply should be in the market given the historic, current, and future economic and market-specific conditions affecting hotel construction. We compare these numbers side-by-side to the supply forecast from the pipeline data. The modeled supply (MS) is subtracted from the pipeline supply (PS) and assess both the sign, either positive or negative, and the magnitude of the difference and (i.e., PS – MS = +/- Difference). Analyzing this difference not only gives us insight to where the market resides in the cycle, but it also helps identify markets that may be in danger of overbuilding and the possibility of occupancy decreases. The following definitions apply:

  • If Difference is negative then that market is undersupplied through 2015 and prime for additional construction.
  • If Difference is positive then that market is overbuilt through 2015 and caution should be followed when contemplating additional construction.

By Chain Scale

When analyzing the hotel industry, branded hotels are grouped by ADRs into six chain scale segments. These chain scale segments are Luxury, Upper Upscale, Upscale, Upper Midscale, Midscale, and Economy. We run the econometric supply models on each of these chain scales and then calculate the number of room additions to each chain scale as of the end of 2015. After compiling the number of modeled rooms, we compared it to the number of room scheduled to open by 2015 that are currently in the pipeline and classified as either under construction or in final planning. The number of new rooms entering the market by the end of 2015 for both the modeled supply and pipeline supply for each of the chain scales is shown, side by side, below in the following exhibit.

Hotel Supply Fundamentals Provide a Roadmap for future Construction — Photo by CBRE HotelsHotel Supply Fundamentals Provide a Roadmap for future Construction — Photo by CBRE Hotels
Hotel Supply Fundamentals Provide a Roadmap for future Construction — Photo by CBRE Hotels

To compare the model and the pipeline, we take the results from the two charts above and subtract the 2015 pipeline supply from the 2015 modeled supply for each of the chain scales. What resulted is what we labeled the total chain scale supply gap, which is shown for each chain scale in the following exhibit.

Hotel Supply Fundamentals Provide a Roadmap for future Construction — Photo by CBRE HotelsHotel Supply Fundamentals Provide a Roadmap for future Construction — Photo by CBRE Hotels
Hotel Supply Fundamentals Provide a Roadmap for future Construction — Photo by CBRE Hotels

Since the chain scale supply gap is equal to the number of rooms in the supply pipeline minus the forecast supply from our models, positive number means the segment is ahead of what the model shows should be in the market and negative numbers mean that what is in the pipeline supply is less than what should be according to our models. Out of these six chain scale categories, Upper Upscale, Upscale, Midscale and Economy show negative supply gaps. On average for each of these chain scales, the supply level is not reaching what the supply model indicates. Upper Midscale shows a positive gap and Luxury is about at supply equilibrium.

By Market

Next we analyzed the 50 Hotel Horizons® markets by comparing the pipeline supply to the supply growth rate from the forecast models in the same way as was done with the chain scale categories. The results of this analysis are contained in the 2014 edition of PKF-HR's Trends® in the Hotel Industry report.

The full article, along with a list of the 50 under- and oversupplied markets, is contained in the 2014 edition of PKF-HR's Trends® in the Hotel Industry report. To purchase a copy of the 2014 Trends® report, and the full version of the analysis, please click here

About CBRE Group, Inc.

CBRE Group, Inc. (NYSE:CBRE), a Fortune 500 and S&P 500 company headquartered in Dallas, is the world's largest commercial real estate services and investment firm (based on 2021 revenue). The company has more than 105,000 employees (excluding Turner & Townsend employees) serving clients in more than 100 countries. CBRE serves a diverse range of clients with an integrated suite of services, including facilities, transaction and project management; property management; investment management; appraisal and valuation; property leasing; strategic consulting; property sales; mortgage services and development services. Please visit our website at www.cbre.com.