Hotel Construction Pipeline Growth Pace Slides in 3Q 05. Developer Concerns are Rising - Is There a Slowdown Ahead?

Lodging Econometrics (LE), the Industry Authority for Hotel Real Estate, reported in the latest edition of its quarterly Lodging Development Forecast and Trends Report that total projects in the Construction Pipeline at the end of 3Q 05 stood at 2,792 hotels having 377,077 rooms.

It's the seventh consecutive quarterly increase from the bottom of 1,903 hotels/246,895 rooms set at the end of '03.

Patrick Ford, President, said, 'The lodging industry is in the third year of its economic recovery. With today's Pipeline totals nearly 30% less than the cyclical high set in 1998, the industry is still on pace for record profit growth in both '06 and '07 as the new supply forecasted to come online will not be significant.'

Quarter-over-Quarter (QoQ), the Pipeline increased by 197 hotels/23,586 rooms. So far, it's the lowest quarterly growth rate in '05. New Projects Announced into the Pipeline during 3Q, at 475 hotels/59,271 rooms, were also the lowest reported in '05, while cancellations and postponements were at the highest level since 3Q 03. These slowing trends in the Pipeline are modest, but they may be advance indicators of a new cautiousness on the part of developers concerned about: accelerating construction costs, a possible slowdown in the economy and reversals in consumer confidence.

Developer Concerns are Rising

Developers have expressed concerns throughout '05 about accelerating construction costs and the rising costs of operating hotels that can no longer be offset by technology savings. The economic aftermath of Hurricane Katrina has heightened their concerns and brought their projects under even greater scrutiny.

In the last two months, prices for building materials have skyrocketed. There are shortages in many parts of the country, and with construction labor migrating southward, wage rates are also escalating as subcontractors move to retain their work crews. Ford said, 'It's harder now than ever before for developers to open their hotels on budget and on time.'

For the larger economy, unemployment has ticked upward to 5.1%, although job losses following Katrina are fewer than expected. The Stock Market is stalled, perhaps tilting downward. Signs of inflation are now visible and the Fed has signaled that they will continue to increase rates for the foreseeable future. In September, consumer confidence had its biggest drop in fifteen years.

'LE's quarterly interviews with developers and franchise sales directors showed mixed reactions about the future,' said Ford. 'Some feel the economy is so resilient and the desire to get open and online so strong that these concerns will have little impact on the construction cycle. Others predicted that a slowdown in construction trends will definitely occur, characterized by fewer New Project Announcements, the postponement of many projects in Early Planning, and higher cancellation rates for marginal projects. Some franchise directors have already expressed difficulty in getting previously approved projects signed because of a heightened reluctance by developers to proceed. It will take a while to draw conclusions about the overall impact on lodging development caused by recent changes in developer sentiment and perhaps four to six months to witness those changes in Pipeline trends.'

Pipeline Observations

Ford explained that there are two competing forces at work in the Pipeline. He said, 'If developers are far enough along in the process, the mood is to get in the ground quickly. If they are in Early Planning, it's to slow down and re-assess conditions.'

In the Upper Upscale segment, rooms Under Construction increased 3,713 rooms, or 27%. In Midscale w/o F&B, rooms Scheduled to Start Construction in the Next 12 Months increased by 7,142 rooms, or 30%. These are large increases and a mixture of projects migrating forward in the Pipeline, but also an increase of New Project Announcements, mostly those less than 100 rooms on shorter construction timelines, which bypass the Early Planning stage altogether.

The Independent Chain Scale is Growing Rapidly

QoQ the Independent Chain Scale increased by 36 hotels/7,230 rooms Scheduled to Start in the Next 12 Months and 43 hotels/7,425 rooms in the Early Planning stage. In total, it's a 20% QoQ increase. Independent is the Chain Scale with the highest room count in the Pipeline. It's made up primarily of projects that as yet have not selected a brand.

It also includes the explosion of Condo Hotel projects, the majority of which will open as independents. Developer concerns are increasing about whether the drop in consumer confidence might also signal a change in market interest for their condo units.

'Similar concerns are surfacing in some large cities and destination resorts, where developers are building hotels with private residences,' said Ford. 'Will the expected slowdown in some residential markets and a topping out of prices curtail their high-end projects?'

Other Notable Development Highlights

LE's quarterly Report shows that Marriott, with 401 hotels/57,787 rooms, Hilton, with 471 hotels/56,207 rooms, and InterContinental, with 527 hotels/51,920 rooms have the largest Development Pipelines. 'Reflagging activity accounts for 10-13% of all guestrooms under development for these industry leaders,' commented Ford.

'The Top 25 Markets, which serve as a bellwether for the industry, are of note,' continued Ford. LE estimates that a combined 132 hotels/16,653 rooms will open in these markets in '05. It's a gross growth rate of 1.2% - virtually the same as '04. It's not nearly enough new supply to offset the growing number of rooms going offline for conversion to residential units, or closing because of obsolescence. Notably, 14 of these markets are reported to be running at a net negative supply growth rate in '05 - a strong indicator for industry profits in the next few years.

Summary

'Some are thinking that a recession and a large cutback in development is near. That's probably too pessimistic,' said Ford. 'The more likely answer is that a slowdown in the growth rate will occur, probably for two to three additional quarters, while developers evaluate all the concerns in the aftermath of Katrina. The momentum in the economy seems too strong and the availability of capital so plentiful that it's unlikely we'll experience anything other than a near-term pause in development activity.'

Lodging Econometrics (LE) of Portsmouth, NH is the Industry Authority for Hotel Real Estate. LE maintains over 80,000 individual database records throughout the U.S. and Canada for:

• The Census of Open and Operating Hotels
• Condo Hotel Development
• New Construction
• Timeshare Development
• Reflaggings
• Hotel Transactions
• Significant Renovation Programs

Records contain important project details including contact information for the Owner, Management, Developer and his project team members. Customized reports can be designed to meet a company's unique needs: Individual Database Records for project review and Summarial Reports of markets, chain scales and brands for Strategic Planning and Forecasting.

To learn more about LE's products and services or to inquire about ordering a customized report, please visit them online at www.lodging-econometrics.com or call (603) 431-8740, ext. 25.