San Jose (Silicon Valley) Market Overview - Written By: George A. Comitos (HVS International)

Throughout the defined region, high barriers to entry have historically existed for new hotels, marked by high land costs, onerous development requirements, and a moratorium on new hotel development in downtown San Jose (which lasted until the late 1980s). As a result, the region's hotel supply base was historically less represented by major U.S. chains than in most other areas of the country. Strong performance from 1997 to 2000 spurred new hotel development and redevelopment, as well as existing hotel expansion, renovation, and refurbishment. From 1997 to 2001, approximately 3,400 new hotel rooms entered the Silicon Valley market. Additionally, numerous other properties, such as Joie d'Vivre's 208-unit Wild Palms and 91-unit Hotel Avante, were renovated, refurbished, and repositioned in 2001. A wide variety of hotel types currently exist in the Silicon Valley market. Major U.S. brands have also increased their presence throughout Silicon Valley.

Historically, demand for hotels throughout Silicon Valley has been dominated by the commercial transient segment, with single-occupancy stays of three to four nights the norm; typically, these stays are from Monday through Thursday. Silicon Valley's economy has diversified from one based primarily on the manufacturing of semi-conductors to research and development and the production of a wide array of high-technology consumer electronics, computer software and multi-media applications, telecommunications, and Internet-related technologies. As a result, demand for extended-stay rooms has increased and is now second only to commercial transient demand, particularly in the North San Jose/Santa Clara hotel markets. Additionally, downtown San Jose hotels benefit from their location near the McEnery Convention Center, while Santa Clara properties located along Great America Parkway realize demand from the Santa Clara Convention Center. Drawing leisure demand has always been somewhat of a challenge throughout Silicon Valley, as there are few strong generators of this demand segment. Santa Clara hotels benefit from the presence of the Great America Theme Park, which draws significant weekend leisure, summer, and special-event demand.

Downward pressure on hotel RevPAR was not felt until the end of the first quarter of 2001. In March 2001, Cisco Systems, one of the market's largest employers, began a round of layoffs, cutting 1,500 jobs. In the first four months of 2001, ±51,600 jobs were lost due to failures involving Internet companies. Threats of a severe California energy crisis also began to negatively impact production throughout Silicon Valley, which affected corporate profits and curtailed the expansion of several technology-related companies. By mid-year 2001, SEMI (Semiconductor Equipment and Materials International) forecasted a decrease of 35.0% in expenditures for microchip manufacturing, testing, and assembly. The sale of high-tech goods, including computers, semi-conductor chips, and computer-related products declined by 31.0%. By year-end 2001, San Jose was among the five high-tech metropolitan areas that experienced the worst office and industrial vacancies since the high-tech crash (as well as San Francisco, Boston, Massachusetts, Seattle, Washington, and Austin, Texas).

Additionally, companies were subleasing office space or abandoning space, turning offices back over to landlords. According to BT Commercial Real Estate, the market for office space continues to decline in terms of overall performance, driven by negative net absorption and additional supply. Average monthly full-service office rents throughout Santa Clara County have decreased from $3.23 per square foot, as of year-end, to $2.83 per square foot through the second quarter of 2002. Available office space increased from 9.0 million square feet to 10.8 million square feet. Office vacancies increased from 14.4% in 2001 to 17.3% by the end of the second quarter of 2002, with negative net absorption of 5,542,265 square feet recorded in 2001 and 1,720,109 recorded in the second quarter of 2002. Similar trends are noted in the Santa Clara County research and development market.

Although several hotel submarkets throughout Silicon Valley have experienced slightly different trends as of late, our analysis provides data for hotels located in San Jose's Airport/North San Jose hotel market; these trends are generally reflective of those occurring in the various Silicon Valley submarkets.

Year-end 2000 occupancy was 77.2% in the North San Jose hotel submarket, with an average rate of $152.41 recorded concurrently. According to the San Jose Convention and Visitors Bureau, occupancy fell to a record low of 53.0% in 2001, while average rate decreased by 1.2%, to $150.66. Average rate was boosted only by the carryover of negotiated rates from the fourth quarter of 2000 positively impacting results through the first half of 2001. Hotel operators also attempted to preserve average rate levels in anticipation of improving economic conditions. Subsequent to August 2001 and the events of September 11th, 2001, average rates plummeted. The demise of Internet-related businesses, the economic retrenchment of well-established high-tech manufacturing companies, and decreased compression from (downtown) San Jose's McEnery Convention Center and the Santa Clara Convention Center, has resulted in a buyer's market in terms of hotel demand in the North San Jose submarket; decreased demand from cutbacks in business travel and price sensitivity prevail. Year-to-date data through May 2001 and 2002 indicate that the market has yet to experience a recovery. Occupancy and average rate results during comparable year-to-date periods through May were 61.1% at $169.74 in 2001 and 53.0% at $123.40 in 2002. This resulted in an overall RevPAR decrease of 36.8%.

On the supply side, Smith Travel Research reports that, as of year-end 2001, the San Jose Airport and North San Jose submarkets (including Santa Clara) contained roundly 11,300 hotel rooms. Including the now-completed 264-room expansion of the Fairmont Hotel in downtown San Jose, an additional 1,133 hotel rooms, or 10.0% of the existing hotel supply base, are expected to enter the market between the second quarter of 2002 and year-end 2003. In Santa Clara, a 150-unit Sierra Suites, a 225-unit Marriott Courtyard, and a 150-unit expansion to the existing Biltmore Hotel are currently planned. The Marriott Courtyard and Biltmore expansion are on hold, pending improved economic conditions. Among the most prominent new properties, the proposed 213-unit Hotel Valencia and the proposed 506-unit Marriott, were under construction as of the end of the second quarter of 2002. The proposed Hotel Valencia is expected to open in November of 2002, while the proposed Marriott is scheduled to open in early 2003. Other boutique and limited-service hotel projects, totaling approximately 1,300 rooms, are planned for development or redevelopment in San Jose; these projects were started prior to the market's downturn in 2001. Otherwise, in the near term, future supply additions are expected to be minimal due to the lack of available financing for hotels.

Although existing Silicon Valley hotels continue to enjoy significant barriers to entry, all submarkets (with the exception of Saratoga), have realized additions to supply resulting from economic conditions prevalent in the late 1990s and 2000. Existing hotel products have been renovated or refurbished, while new hotel construction has brought increased brand presence and a greater variety of hotels. In the year-to-date period through May 2002, the North San Jose hotel market has maintained occupancy in the low- to mid-50% range, with continued declines in average rate. We anticipate a return to strong occupancy levels, pending global, regional, and national economic recoveries, and increased demand for high-tech goods and services. Local experts predict a recovery in the tech sector in 2005; thus, we can anticipate gradual, moderate recovery until that time, when investors can expect a cyclical upturn in hotel performance.

George A. Comitos is a Senior Associate with HVS International's San Francisco office. He joined the firm in 1999. A graduate of the Cornell School of Hotel Administration, George's work experience includes executive-level hospitality assignments working for U.S. Pacific Air Forces and the North Atlantic Treaty Organization.