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Portsmouth, NH, USA –
National Hotel Realty (NHR),
has released its US
Construction Pipeline Report for Q2 2008, announcing 5,883 projects with
785,547 guestrooms in the Total Pipeline. Showing only a moderate
quarter-over-quarter (QoQ) increase, project and
guest room counts in the Total Pipeline are at new peak levels, but appear
to be cresting. New visibility on the economy, the lending crisis and
lodging operating trends emerged during the second quarter, which served to
dampen developer sentiment considerably. As a result, key development
metrics have softened, indicating that both project migration within the
existing Pipeline and the pace of New Project Announcements into the
Pipeline are beginning to ebb.
Total rooms Under
Construction are at a record high of 242,229. Further, Early Planning totals
of 1,423 projects/215,398 rooms are at historic highs, while those Scheduled
to Start Construction in the Next 12 Months, a total of 2,737 projects, are
at a record level as well.
All projects in the
Pipeline have dedicated land parcels, are being actively pursued by
developers and have been verified by the brands.
Availability of Lending
Drives Development
For the first time in this
cycle, the migration of projects up the Pipeline stalled significantly in
Q2, clearly demonstrating that the lending crisis is now creating a serious
drag within the Pipeline. Projects from the “Scheduled Starts Next 12
Months” stage did not flow forward proportionately into “Under
Construction,” and are likely to continue to be impeded.
For some time, there has
been no financing available at either the Wall Street or National Bank
level. During Q2, balance sheet problems began to surface in regional banks
and some community banks too. It is becoming more increasingly difficult to
source financing for 100-200 room projects, which account for 44% of the
Total Pipeline, as well as the majority of upscale and mid-market projects
currently in the Pipeline.
The withdrawal of lending
from the economy is growing more serious for developers. The highly
credentialed investor group with an exceptional hotel project, able to
invest a large equity slice and absorb difficult lending terms may gain
access to financing. However, the overall availability of financing is quite
thin, forcing many developers to the sidelines. With few signs that
conditions will change before mid-year 2009 at the earliest, Pipeline totals
will likely decline over the next 4-6 quarters.
In the months ahead, the
“Starts” stage will remain disproportionately large, as many developers are
required by their franchise agreements to start construction within 12
months. Numerous agreements are likely to be extended, as everyone awaits a
resolution to the lending crisis.
Since most New Project
Announcements enter the Pipeline in Early Planning, that stage will back up
as well, as developers continue project planning despite not knowing exactly
when financing will again become available.
Project Migration
Within the Pipeline is Slowing
As would be
expected,
Q2 Construction Starts declined to 381 projects/47,107 rooms,
down 78 projects/4,757 rooms from Q1. Despite the decrease, this is
still a healthy level that will contribute to New Hotel Openings
late in 2009 and in 2010.
Another sign of
shifting developer sentiment is the acceleration of Project
Cancellations. In Q2, 327 projects/48,452 rooms were officially
cancelled. This is the highest number seen since Q4 2001 in the
immediate wake of 9/11.
One Cycle Ends, Another
Begins
Developers had initially
hoped that the lending crisis would produce just an abbreviated pause to
this decade’s economic recovery. However, in Q2 everything changed as most
open questions about economic visibility were answered. The problems are now
seen as more widespread and more entrenched. We can now conclude that the
economic upswing was clipped short by the crisis and officially ended in Q4
2007, drawing to a close one of the most anemic recoveries in the post-World
War II era, and that a new downward cycle has begun, tempering developer
bullishness.
The housing crisis, failed
debt instruments, weakened Wall Street institutions, and national and
regional bank distress have all combined to effectively limit access to
credit. At the same time, prices for basic consumer needs, including oil,
food and transportation, are soaring. Oil prices at $130 per barrel and gas
at $4.00 per gallon affect everything. Tipping points have been reached.
One Cycle Ends, Another
Begins
Developers had initially
hoped that the lending crisis would produce just an abbreviated pause to
this decade’s economic recovery. However, in Q2 everything changed as most
open questions about economic visibility were answered. The problems are now
seen as more widespread and more entrenched. We can now conclude that the
economic upswing was clipped short by the crisis and officially ended in Q4
2007, drawing to a close one of the most anemic recoveries in the post-World
War II era, and that a new downward cycle has begun, tempering developer
bullishness.
The housing crisis, failed
debt instruments, weakened Wall Street institutions, and national and
regional bank distress have all combined to effectively limit access to
credit. At the same time, prices for basic consumer needs, including oil,
food and transportation, are soaring. Oil prices at $130 per barrel and gas
at $4.00 per gallon affect everything. Tipping points have been reached.
Without access to credit,
consumers have cut back substantially on discretionary spending, including
travel. In response, affected businesses have been consolidating operations,
conducting lay-offs and implementing cost reduction programs, including
cutbacks on both individual and meeting-related travel. Travel will continue
to soften, particularly in resort destinations, as airline carriers have
programmed significant capacity cuts for the fall and winter months.
Many other developed
countries are now mirroring our slowdown. They are already experiencing or
are set to see a fall-off in economic growth. For emerging economies like
China, Russia and India, it will be from a much higher growth rate plateau.
With this global economic slowing already underway, inbound tourism from
overseas, which has bolstered occupancies on both the East and West coasts,
could soften as other countries struggle with rising inflation and less
disposable income.
What is remarkable is that
with so much economic change being absorbed, the US downturn is still more
moderate than what was feared last fall. So far, not a very sharp fall-off
or a deep recession, both the economy and the lodging industry have been
oscillating, plus or minus, around the zero growth line. A sideways
continuation, even prolonged, would not be an unfavorable outcome.
Changing Trends in Lodging
Operations
These changes have combined
to significantly affect lodging operations. Occupancies are falling, putting
increasing pressure on room rates. RevPAR growth, with a consensus forecast
of a meager 4.4% at the beginning of the year, finished at +1.5% for the
first six months and will likely continue downward as a slow-starting summer
travel season unfolds.
Guest room demand is the
major culprit at –0.3% year-over-year growth at the end of Q2. Demand growth
is likely to be negative for the year, an unhappy consequence and a rare
happening. It would be the first negative growth year since 2001 and only
the third in the last 25 years.
Most of the larger
questions are now answered, but an important one still remains: How long
will the downturn last? With a hyperactive Treasury Department and Federal
Reserve Bank fashioning solutions and taking bold action to set a floor to
the financial fallout, LE’s expectation is that it still could persist for
another 12 to 18 months. The metric for operators to monitor, as it is for
lodging developers, is the return to a normal lending environment. All
growth is stymied, and a turnaround cannot begin without greater access to
lending.
New Project Announcements
Slowing Down
New Project Announcements into the Pipeline are the best
metric for measuring developer sentiment, which, in addition to the
availability of lending, is now beginning to be influenced by
declining trends in existing operations.
Exceeding 100,000
rooms for three consecutive quarters, New Project Announcements
reached a cyclical high of 125,442 rooms in Q1, then tailed off
sharply in Q2 to 90,793 rooms, a QoQ drop of nearly 28%.
LE expects quarterly New Project Announcements to continue to
fade until capital markets are restored. As the average 150-room
project is in the Pipeline for approximately 30 months, these
declines will not impact New Openings until mid-2010 and early 2011.
New Openings On the
Rise as the Pipeline Unfolds
In 1H, 580 New Hotels opened, adding 67,491 guest
rooms to Current Supply. From a record peak, the Pipeline is now
unfolding in earnest.
LE’s Forecast
for New Hotel Openings calls for a total of 1,218 hotels/135,373
rooms to open in 2008, a 2.9% gross growth rate, and 1,508
hotels/165,425 rooms to open in 2009, a 3.4% gross growth rate. The
net change for New Supply will likely be ± 0.3%-0.5% lower. With
1,723 projects/242,229 rooms currently Under Construction, LE’s
Forecast for the next 18 months is virtually certain.
For the first time and however tentatively, LE is forecasting
1,464 hotels/170,974 rooms to open in 2010, also a 3.4% gross growth rate.
That’s far less than a Pipeline of this size would normally produce. The
2010 Forecast anticipates delays, cancellations and further declines in New
Project Announcements. Understandably, the variables are very difficult to
tie down with any certainty. The forecast will almost certainly change as
more information about the economy, operating trends, the banking crisis and
loan availability is gleaned moving forward.
LE’s Outlook at Mid-Year
Questions have been
answered and visibility is certain. It is not an interruption in the
previous growth cycle, but the start of a new, downward cycle that hopefully
will lead towards a soft landing.
With both the housing and
lending bubbles bursting simultaneously, the downturn is likely to be
prolonged. As of yet, it is not steep or recessionary. It is a unique and
unusual challenge in that it requires lenders to raise capital in order to
re-enter the lending business. They need to rebuild their balance sheets:
take write-downs, consolidate and sell assets, cut dividends, find new
equity investors, and so on. The process will certainly be long and tedious.
The hope is that the
economy does not falter much further while that scenario unfolds. Being tied
heavily to the retreating consumer and retrenching businesses, the lodging
industry can do nothing but wait for the country’s financial problems to
resolve while struggling through a period of negative demand growth,
pressure on prices and rising operating costs. Margins will suffer and
profits will decline, albeit from record peaks established in 2007.
At this time, developers
cannot access lending at reasonable terms. If their projects are already in
the Pipeline, they cannot progress towards construction. As a result, the
Pipeline will likely stall and “bunch up” over the next 18 months.
Cancellations will increase, as they did at the end of the dot-com bubble
and again after 9/11.
New Project Announcements
into the Pipeline will continue, but at a significantly reduced rate. With
New Openings leaving the Pipeline at an accelerating rate, Total Projects in
the Pipeline will recede over the next few years, clearing the way for the
next development cycle in the middle of the next decade.
On the plus side, the
credit crisis will sharply curtail future supply growth, but not until late
2010. In the near term, there will be the appearance of overbuilding because
of a widening supply/demand imbalance. In reality, it is not overbuilding
but the collapse of demand growth, a rare occurrence. The rate of New Supply
coming online over the next 30 months would have been easily absorbed, had
the economic recovery not been clipped short.
For now, the consensus is
that the slowdown in lodging operating trends will last at least into the
second half of 2009, and will likely be followed by a slow, moderate
upswing. It’s hard to discern what the next economic growth engine will be
and when the necessary elements will coalesce to propel it. Only time will
tell.
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