Global Hospitality Advisor: 2008: Hospitality Industry Outlook

Industry Fundamentals—Where have we been? Where are we going?

Introduction

Industry Fundamentals—Where have we been? Where are we going?

Jim Butler is an internationally acclaimed hotel lawyer, author of the industry-leading www.HotelLawBlog.com and Chairman of JMBM’s Global Hospitality Group®. He recently chaired JMBM’s annual Hospitality Roundtable for 2008 with some of the industry’s leading experts. Here’s what they had to say about where the industry has been and where it is headed.

Jim Butler: Welcome, everyone. Shortly, we will talk about the exciting opportunities and challenges facing us in 2008 and beyond, but let’s start with your thoughts on what was important about 2007.

Mark Lomanno: 2007 will likely be remembered as the inflection point towards the industry’s “soft landing” Rate increases remained steady at a little less than 6% and occupancy grew slightly as the hotels that were conceived in the heady days of 2005 and 2006 hit the markets. We have not yet seen the full impact of the subprime mortgage crisis and the tightening of lending standards. The effect of these two forces on the hotel industry still remains to be fully appreciated.

However, with regard to the condo hotel phenomenon that has been so dominant for the past few years, 2007 was the year when much of the speculative froth was scooped off the top as capital tightened, residential sales sagged nationally in the housing slump and many developers and hotel brands moved back towards the hotel condo residential mixed-use model. In any event, our condo hotel pipeline declined sharply. A few condo hotel projects were abandoned and fewer came into the pipeline. With the right regime structure and balance, location and owner, condo hotels are too well-established as the “right” product to argue about it. But the “irrational exuberance” that has characterized this product type in many markets over the past few years finally deflated in 2007, and made room for more rational investors.

Jan D. Freitag: I think it is also interesting that the second half of 2007 was stronger than the first half. Demand increase through June 2007, was less than 1%, but for the remainder of the year, demand increased by approximately 2%. One of the reasons for the strong relative performance was that the comparables got progressively easier as the year went on.

We hope that in 2008 we will remember that “pricing power” at or above the level of inflation is possible, even when occupancies flatten or decline. As more hotel rooms come on line and older hotels feel the pressure, we remain cautiously optimistic that the industry learned its lesson post-9/11 and will keep average daily rate (ADR) growth positive.

Peter Connolly: As we speak, the price of oil is hovering at $100 per barrel and some of the largest investment and commercial banks report record losses and are firing their CEOs. Notwithstanding these harbingers of bad economic prospects, I believe that lodging fundamentals have never been stronger. In fact, every forecast I see shows Revenue Per Available Room (RevPAR) continuing to rise. And this continued RevPAR growth suggests that we have not yet reached that critical equipoise between the increasing supply growth and the declining demand growth where occupancy and rate both fall off.

Thus, I see 2008 as a year in which the threats to our success in the lodging business lie principally in events and trends which are largely beyond our control. Jim, as you wrote in one of your classic blog entries on www.HotelLawBlog.com earlier this year, “as goes the economy, so goes the hospitality industry—the ineluctable elasticity of demand.” If there is a recession next year, then industry fundamentals notwithstanding, hospitality will take its lumps with the rest of the economy. Hopefully, though, lodging’s strong fundamentals will help prevent the panic-driven price and service wars that were the hallmarks of earlier recessionary periods.

Daniel H. Lesser: I agree, Peter. Despite the uncertainty surrounding the highly publicized credit crunch that began in August 2007, I also believe that the economic fundamentals of the U.S. lodging industry continue to be strong. What started as a crisis in the U.S. residential subprime mortgage arena has bled into a re-pricing of risk across all asset classes, including commercial real estate. Worldwide, capital markets are skittish and there’s a heightened sense of uncertainty about the future. But judging from previous times of uneasiness (such as the October 1987 stock market crash, the 1998 Russian financial crises and, of course, September 11, 2001) the outlook for the near-term ranges from highly pessimistic to optimistic.

Butler: Let’s talk about some of the defining events of the past five years that are most likely to shape the next five years.

Laurence Geller: For me, the most significant change over the past five years that will impact the next five years is the shifting demographic base of our customers. Since the mid-1970s, hotels have been developed with the Baby Boomer in mind. Today, Gen Xers are driving much of our business. While Baby Boomers will be a key force behind longer leisure usage, it is the Gen Xers who will actually drive leisure. They spend more, travel more with kids (often with nannies) and they go on “togetherness” trips more—where groups of friends or families vacation together just to find time to meet in their increasingly busy lives.

Today’s meeting planners are also Gen Xers. As a result, hospitality usage patterns are conforming to their demographic requirements—and soon we’ll be conforming to those of Gen Yers as well. What are those hospitality requirements? Well, in my opinion, the needs of Gen Xers and Yers will increasingly revolve around customization and increasing amenities and services. Technology will not only have to be the great enabler but it will also have to be updated constantly—almost instantly. And those updates will have to be leading edge to satisfy the speed at which societal demands change.

Tom Corcoran: I think consumers are looking for more advanced connectivity, better beds and linens and overall bathroom improvements.

Lomanno: That sounds right from an operational viewpoint, but from an industry fundamentals standpoint, it has been “quite the ride.” Five years ago, we were less than a year into the post-9/11 era. Occupancy in 2002 was only 59%, the lowest since we started tracking the industry in 1989. Only 934 million rooms were sold, some 30 million rooms less than in the peak year of 2000. Hoteliers reacted to the occupancy drop with sharply decreasing rates, and ADR fell 1.5%, to $82.75 for the year.

Despite these rather startling statistics, the most compelling observation from this period remains the resiliency of the traveler and the hotel industry overall. Weekend occupancy never declined as much as mid-week occupancy, showing the strong desire of the American public to travel for pleasure, no matter what the geopolitical and macroeconomic trends were. Yes, lots of rooms stood empty and rates in some areas seemed to be in a freefall, but the sharp decline in demand was matched by an equally sharp increase just a few years later. Demand grew by 4% in the year 2004 and an additional 2.4% in 2005. Then in 2006 we finally broke the “sound barrier” of over 1 billion room nights sold in a single year.

Hoteliers who held on through the tough months and years after 2001 were richly rewarded, as we reported ADR growth at over double the rate of inflation in the years 2004 through 2007. There are great rewards for those who are prepared and have the stamina to “ride the cycle.”

Michael Cahill: Over the past five years, hotels have become an accepted, standardized class of investment grade real estate, and this evolution has provided the foundation for much of the debt and equity capital flowing into the market. In turn, institutional acceptance of hotel real estate as an attractive class of investment real estate has vastly increased the liquidity of property sales through expansive growth in the type and amount of potential buyers, especially when paired with an overall decreased cost of capital.

Robert B. Stiles: I agree. One of the biggest shifts over the past five years is the standing of hotels as a legitimate product type within the investment class of real estate. Today there are many more institutional investors who will consider hospitality investments than there were any time in the past. The result going forward is that there will be more capital available at a lower relative cost than in any period prior to the last five years. This liquidity washes across the equity, mezzanine and senior finance arenas.

Bruce Baltin: That’s right. Large amounts of new capital have poured into the industry because people, over the past five years, bought properties at peak values. We will find out over the next five years whether “normalized cap rates” have declined, and whether people bought with unrealistic projections of income growth.

Alan X. Reay: One of the most important events over the last five years has been the growth of the real estate investment trusts (REITs) and the availability of cheap financing. This has created a huge run up in sales volume as companies acquired assets, usually in portfolios. Over the next five years, with the cost of financing going up and the tightening of credit markets, we will probably see more seller-carried financing and more “creative” deals.

Jack Westergom: I’ve seen increased consumer demand in the leisure segment of the hospitality industry, fueled in part, by the extended apex of the real estate curve. Also, available credit has artificially forced room rates to go up beyond the normal industry growth. The current downturn in the economy will force operators to rethink current room and product pricing models. In addition, there has been significant growth in new luxury resorts—all focused on top tier clientele. This has also driven room rates higher and introduced new product initiatives. In the next five years, I see this luxury market becoming overcrowded, where only the best of the resorts will continue to secure top rates with the remainder losing RevPAR.

Also over the past five years, condo hotels and resorts popped up as a “panacea” for everything ailing the hospitality industry. I believe that many of these condo hotels will not perform to expectations because of faulty fundamentals from the outset and bad regime structures that doom many projects to continuing decline and ultimate failure. These disappointments will give the condo hotel concept an undeserved black eye in some corners, but maybe that is what it takes to restore sound principles and good planning. Why does it take a debacle to prove out a sound concept and shake off the marginal players who should never have been involved?

Finally, there has been a proliferation of first-time hotel developers over the years who have been highly successful in other real estate product types, but they may struggle until they gain experience over the next few years. Learning curves can be steep . . . and expensive. That could be good news for asset managers, receivers and attorneys for years to come!

Connolly: I am reminded of Patrick O’Neal’s opening remarks at JMBM’s 2007 Meet the Money® conference, in which he accurately summarized the causes of what were then just the early warning signs of the current credit morass. In his view, too much money being placed by too many people with too little knowledge about real estate underwriting and lending would ultimately lead to disaster. He was, of course, prescient as usual, although roundly accused at the time by several panel colleagues of being a “curmudgeon.”

Marty Collins: I agree! I was just talking about that event and his opening session the other day. He was on the money.

Connolly: In any case, as I look at the next five years, it is clear that much of that period will be dominated by a rebirth of traditional underwriting in the financial markets, a return to relationship lending and the development of a more knowledgeable securitized market. I am not smart enough to predict spreads and the specific effects of those changes on valuations, but I can foresee more discipline in lending and the disappearance of “totally ignorant” (I prefer that term over “dumb”) capital. As a result, less capital will be available and cap rates will go up. Since I believe that hospitality will continue to be “the star” in an otherwise moribund real estate market, the effects of these changes may take longer to hit our marketplace and may even be less pronounced, but nonetheless, they will be felt.

Butler: Mark and Jan, I am curious what you think is most interesting about all the data you have gathered at Smith Travel Research.

Lomanno: We remain in awe at the pricing power that certain segments of the industry exert without noticeable consumer “pushback” in demand or occupancies. Luxury hotels increased their rates by 23% or some $60 since 2004 for a total of 50% since 1997! This means that an additional $2.6 billion in room revenue was generated since 1997, equaling the total amount that this segment generated that same year. In 2007, luxury rates increased by over 6.5%, while occupancy declined, but the decline was not caused by a decrease in demand. In fact, room demand increased again by 2%. Rather, the prolonged excellent performance in this segment has attracted a lot of attention by developers causing a room supply increase of 2.2%.

Midscale hotels without food and beverage had an equally impressive performance with double-digit room revenue growth over the last three years. In fact, room revenue almost doubled since the year 2000, from around $8.3 billion to almost $16 billion in 2007. This is certainly a function of the sharp increase in sold rooms, which increased by over 3% this year, on top of an increase of some 4% in 2006. At the same time ADRs increased by over 7% to over $87 in 2007.

Freitag: Another interesting phenomenon is the hotel industry in New York City. When we describe the performance of the Top 25 largest lodging markets, we always have to point out that New York City operates in a universe of its own. We reported room rate growth in 2007 at over 10%, the fourth year in a row of double-digit ADR growth. Average rates in New York City were well over $250 for the year. At the same time, occupancy grew by over 1.5% to over 86%, implying that most mid-week and Saturday nights the city is actually sold out. Growth rates for RevPAR in the luxury segment for Manhattan hotels are even more impressive, and reported new construction there will not have an appreciable impact on the existing hotels in the near future.

Butler: Okay, everyone. What are you forecasting for the industry in 2008? What are the most positive developments the industry can expect and what are the most concerning ones?

Corcoran: I expect we will have another year similar to 2007 with RevPAR growth in the 5-7% range. The big unknown is what effect oil prices, war and “other stuff we do not know” may have on the year.

Baltin: I forecast flat-to-slightly-declining occupancy with rate growth still above inflation and RevPAR growing at the 4-5% level. Also, we will see more separation of markets with some continuing strong growth and others flattening out as new supply is absorbed. The most concerning trend is new supply occurring “where it can” as opposed to “where it’s needed.” Thus, the absorption period for some markets will be longer than people might expect.

Collins: Well, it’s my view that the industry has been rebounding from a decimating national catastrophe, and we are now in the wake of a historic rebound. Today we are optimistic in what we see as just the “6th inning” of an exceptional baseball game. Though construction costs remain high and there is a lot of sediment still in the water surrounding all credit issues, we are still encouraged by the corporate side of the economy, including the hospitality and mixed-use industry.

Cahill: I believe 2008 will keep showing increased property values for lodging assets that continue to maintain overall cash flow growth. Cap rates should be relatively flat. We see more prudent, market-justified hotel development as very positive for the industry.

Reay: In 2008 we will see the volume of sales declining. The slowdown in the housing market will have both a positive and negative effect. On the negative side, homeowners will be less inclined to take vacations as they feel the pinch of declining equity, while on the positive side, developers looking to build new hotels are already reaping the benefits of lower labor costs as the demand for general contractors has gone down dramatically.

Dr. Donald Wise: There are a lot of hotel trends to watch. For example, as Tom Corcoran has suggested, a majority of business travelers will find a premium quality mattress and premium quality bed linen extremely important features when selecting lodging for business travel. Consumers in general are looking for more in their rooms, and hoteliers would be wise to make guest rooms appear larger by removing unnecessary furniture. That means armoires are out and wall-mounted flat panel TVs are in. Automated phone systems and outsourced customer service departments are also out; and onsite property staff is in.

Consumers are also looking for hotels that are more than just “accepting” of furry guests, opting instead for properties that actually pamper pets. And of course, everyone is interested in green properties and moving toward environmentally friendly business practices. Finally, the hospitality industry is just beginning to understand and embrace the potential of Travel 2.0—or “Social Networking”—the interactive phenomenon that empowers our guests to share photos, videos, comments and travelogues with others who frequently browse travel websites.

Lesser: As far as I’m concerned, the outlook for the U.S. lodging industry remains positive as a whole, with profits anticipated to continue growing to record levels. While the current credit crunch has caused a temporary slowdown in sales and financing transaction activity, the economic fundamentals of the hotel sector remain strong. History has proven many times that markets overreact at times resulting in panic at one end of the spectrum, and irrational exuberance at the other end. Smart money recognizes that the world is currently experiencing an adjustment that was due, but that an overcorrection is most likely occurring.

Long-term, the United States will benefit from the world’s emerging markets’ need for American goods, services and technology. Furthermore, new middle classes are rising in many parts of the world, including India and China. They will soon travel in droves to visit and stay in U.S. hotels. Additionally, U.S. hotel property prices are relatively inexpensive when compared with other markets around the world, and international investors continue to perceive the U.S. as a safe haven to deploy capital. Sophisticated U.S. hotel investors, who buy for a long-term hold, believe that pricing for U.S. hotel assets will continue to rise, but at a slower rate than the recent past.

Butler: What are the biggest changes you see as we move forward? What opportunities should we be ready to embrace and what cautions should we be on the lookout for? Who will be the winners and who will be the losers?

Cahill: One of the biggest changes to watch for is what happens with the flood of new brands. They are still far from reaching “critical mass.” Will they ever, and if so, WHEN? Many developers are betting big on the long-term future success of new emerging brands from Hyatt and Starwood. Moreover, these developers risk building “generation one” versions that could have shortened economic lives as the new products rapidly evolve. Also, the limited long-term brand conversion potential of some of these new products might become an investment issue six to eight years down the road.

Reay: The losers are going to be the “flippers”—those buyers that jumped into the market in the hopes of riding the appreciation wave. Now that buyers and lenders are no longer willing to price based on projections, owners will have to manage their assets for results. This means that the winners are the true hotel investors who purchased for cash flow, and not to just flip. These investors will also benefit as the flippers slowly start to realize they paid too much and have to start giving hotels back to their lenders.

Baltin: I think we’re going to see a continuing evolution of design-based, boutique hotels and a continuing effort by the chains to keep up with the trends. Likewise, design trends will become more refined and targeted to an increasing number of niches. The winners will be the ones who keep an edge and the losers will be the ones who don’t evolve (or who try to get by with superficial renovations). The other change will be a greater need to confront rising operating costs because revenue growth won’t cover up margin erosion.

Stiles: I am concerned that the market has come to expect the hospitality industry to continue outperforming other sectors. Current values and financing have been sized and priced on the basis of this “momentum” continuing, but at increasingly moderate rates. If there is a real slowdown in the economy coupled with the higher cost of capital now imposed on all classes of debt, we will begin to see some cracks.

Wise: I see a big upside for hotels and resorts in leisure markets, especially for European travelers with current exchange rates for the Euro at 0.69 and the Pound at 0.48. The weak Dollar helped boost profits at theme parks as more tourists were lured to the U.S. with attendance rising by 5% in the last quarter and spending by visitors rising by 2%. Hotels and resorts should benefit by these same trends, although not as dramatically. Business travel in general, however, remains flat—no upside there in the near future.

Richard Conti: Timing is everything. Those who were able to execute the condo hotel model from 2002 through 2006 probably did very well. After that, in many markets, those who tried to sell condo hotel units into a declining housing market probably had trouble. Unfortunately, it is nearly impossible to sell units in today’s market, except for a few unique locations like destination resorts and New York City. The developers caught in midstream will be forced to continue to own the unsold units and operate them as a hotel. This can be accomplished successfully if their cost basis and the development of their property were within reason relative to their specific hotel’s market fundamentals. However, if their cost structure was high and a lot of condo hotels were built in their market, it could take them years to create a profitable situation.

Accordingly, developers will have to determine if they have the financial capacity to stay in the deal for the long-term or if they need to exit immediately. If they decide to abandon a project which has not opened yet, they must also consider the liabilities that may be created by closing down—liabilities to lenders as well as buyers of pre-sold condos. This may present a new twist for hotel developers when a project goes bad. These liabilities really need to be evaluated prior to developing a workout solution. But, by all means, we recommend completing projects or selling to a group that can finish them, in order to help limit potential liabilities.

Butler: What’s happening to hotel finance and development—when does it come back? Is there a “new normal”?

Stiles: We are still in a moment of high volatility. There are too few trades in the CMBS space to really define pricing and, as a result, risk is now overpriced. Underwriting standards are currently more retrospective than prospective and pricing will settle in—eventually above where it was, but below where it is now. Many borrowers are still being financed but typically at lower leverage and higher spread points.

Collins: I think there is a disconnect in the financial markets as a result of this “consumer-induced” issue. Hotel finance and development will come back and is already coming back, however, it will rely on more equity, lower cap rates, more pre-sales—in short, going back to basics.

Baltin: I agree, Marty. There still seems to be plenty of capital out there, and at reasonable interest rates for primary debt. Underwriting criteria have stiffened as the pool of available capital has contracted, but money still needs a home. As long as the industry continues to perform on a macro-level—and it should, albeit with slower growth—there will be financing available for well-thought-out, well-financed, market-based deals. It’s like every other cycle. The strong will survive in an environment that is still reasonably healthy, but not frothy.

Cahill: On the debt side, the key is availability. While underwriting has become somewhat more conservative over the last several months, overall terms are still relatively attractive when compared to long-term trends over the last 25 years. And more importantly, debt financing is still readily available.

Reay: Development remains very strong and this will continue. Financing is still readily available from local lenders at the “under $25 million” end of the market, which is not really impacted by the conduit problems. We will see the market coming back to “normal” in the next 6 to 12 months.

Westergom: I hope you guys are right, but I foresee significant tightening of underwriting standards over the next 24 months and only then a gradual softening of those requirements. The “new normal” will be available capital for new growth but under significantly more stringent debt requirements. And as Jim Butler and his team have been preaching for the last five years, hotel-enhanced mixed-use will become essential for all full-service hotel and resort financing.

Wise: The toxic “subprime residential mortgage” has died, and land is no longer in the same category as income-producing or core investment property types. Conduit spreads of 110 basis points over the 10-year Treasury yield are a fond memory—look for spreads in the 160 range on a go-forward basis—but this may take until the first or second quarter of 2008 to settle down to that level. In the near term, expect mid- to even possibly high-200 range spreads until the markets settle down and all the major lenders taking massive write-downs can close their books. Hotel magnate Bob Falor and the rest of the condo hotel developers are vacationing in the Bahamas—perhaps permanently. 85% loan-to-cost hotel construction loans are a thing of the past. The”"new normal” will be 65% to 75% loan-to-cost construction loans with 1.40 debt coverage ratios.

Corcoran: There is a gray cloud over our head today as to financing for development. I do think it happened at a time when it appeared it was going to get out of hand. Some lending practices were getting very aggressive. If it had continued for a longer period of time there could have been a serious adverse impact. I think this is a necessary correction—not a crisis. The big positive effect will be that supply will not get out of hand and this is good for all existing hotel owners. Things probably do not get back to normal until the summer of 2008 when a “new normal” will focus on the quality of sponsorship, brand and more equity. This will be the normal until it gets out of hand the next time.

Butler: One of the things we see as the “new normal” involves the greening of the hospitality industry. What do you see happening on that front?

Ray Burger: Two years ago “GREEN” was just another color. Now, every lodging-related conference has GREEN on the agenda. There’s no doubt, going green will become standard operating procedure during the next two to three years.

Collins: GREEN is a permanent feature of our landscape going forward. I am amazed that some folks continue to debate the issue as if it’s an option. That’s absurd! All of our projects are sustainable now.

Corcoran: It is becoming chic to be green and greening is the most often-asked question I get from people as to what is happening. Building green is easier to understand than how to be green from an operating standpoint. However, the industry needs to be clear as to what “GREEN” actually means and what you should be doing to achieve it. People need to understand what the financial impact is to the operating statement in “going for green.” I am encouraging the American Hotel & Lodging Association (as its newly inaugurated chairman) to take a leadership role in developing a “green certification” process for hotels with a third party so that the industry knows there are options and what they can do.

Connolly: A funny thing happened on Oscar Night. As Marty Collins suggested during JMBM’s most recent Hotel Developer’s Conference™, on Oscar Night 2007, GREEN became mainstream. Most major cities now have green development and building operation initiatives that have moved out of municipal environmental departments and into the mayoral offices. Here in Chicago, for example, Mayor Daley announced very ambitious carbon reduction goals in the keynote speech of a two-day conference that probably would have been a breakfast meeting a couple of years ago.

More practically, as Jim Butler has pointed out so well in his www.HotelLawBlog.com articles, developers are realizing that building green is not as difficult or as expensive as they once feared. Complying with the current requirements of the Chicago building code, for example, produces a building that meets roughly 90% of the LEED-certification requirements, so becoming LEED-certified is not a terrible challenge or expense.

On the operating side, we have all known for years that greener operations are more about training our personnel and making modest changes to guest expectations. It’s not so much about capital expenditures anymore as it is about changing behaviors. Recycling, for example, should begin in the room, not in the trash area. And, in our new greener society, the presence of a bin for bottles might not be viewed as an anti-luxury accoutrement, but as a standard necessity.

There is a danger in green becoming politicized, however. Too often, the proponents of green tend to commingle “environ-mental friendly” practices with an agenda promoting a particular perspective on social responsibility. Companies in our business should be encouraged not required to embrace both at the same time, or green will face a much longer evolutionary period.

Reay: That is interesting. So far, at Atlas Hospitality Group, we have seen very little in the way of “greening” on the development or sale side. At this time, it appears that building to strict “green” specs, is too expensive for the entrepreneurial hotel developers we are dealing with. Only those with deep pockets and long holding patterns can afford this kind of development.

Butler: That is interesting to me too, Alan. From my perspective as an ultimately pragmatic hotel lawyer, most of the people we are working with are coming to believe that they cannot afford NOT to go green. If you blinked, you may have missed it. I say that 2007 will go down as the year the hotel industry hit the tipping point on going green. We will see where this goes.

Cahill: For green hotels to be successful as a development product, the key will be “forced demand” or usage from consumers who either choose or are told (by their government or private employers) to use this type of product. If the purchase is strictly discretionary, many consumers may not select green hotels, especially if there is a significantly higher price attached.

Westergom: I agree that “going green” has started to gain mainstream acceptance, but the industry is still struggling to find a way to do it cost-effectively. Green construction is still widely perceived to be cost-prohibitive, although the material costs are coming down. At any rate, until the industry finds ways to bring all the costs down, building green will remain a challenge. My forecast is that building green in our industry is four to six years away.

Baltin: Green is here to stay. Consumers, especially at the upper end of the spectrum, are attuned to it and willing to seek it out.

Butler: I’m sure we’re going to be hearing a lot more about this in the near future. Moving on, what is happening with this seeming “flood” of new brands? Are there too many? Do we need them all? Which brands are working and why?

Corcoran: The current flood of brands is a natural extension of a trend that started many years ago and further segmentations will continue to occur. Are there too many? No. Are they needed? No. What works? “NEW” always works.

Baltin: The new brands coming into the focused service segment are needed and they are good. But they are strengthening this segment at the expense of older, full-service hotels and motor hotels. Some of the later properties are being well-repositioned and will survive, while others will drop from the inventory or be downgraded. In the luxury segment it’s not as positive. It appears that a number of brands were being created to sell high-end residential as opposed to filling a market need. Not all will make it. Mike Cahill was right—the proving out period may prove perilous for developers of some untested brands that don’t make it.

Cahill: Many of the new brands are needed simply from a fall-back perspective. For example, many strong market areas are saturated, with all of the well-known flags represented. These new brands often become the top choice by default, as the well-established brands are already represented and not available.

Reay: The flood of new brands continues to dilute the market. The winners are going to be the stronger companies, such as Marriott and Hilton. The lack of availability of certain brands in so called “hot” markets is helping push the proliferation of new brands, but we have more examples of failed brands than we do of successful ones. As always, “buyer beware.”

Connolly: How many new brands is enough? It does seem like every time I open an industry rag, someone is announcing the creation of a new brand. To me the most noteworthy part of this phenomenon is not the number of new brands, but rather who is creating them. It is, by and large, the existing brands who are creating new monikers, not new industry entrants. At a time when every major market seems saturated by the major companies, they have found that the simplest way to continue brand distribution is to clone their existing products under new names, changing the lobby lighting ever so slightly to make it more “trendy.”

The problem is that the number of real competitors is not growing. It is unlikely that the Hyatt Place and Summerfield Suites will compete in any meaningful way on franchise terms, just as it is unlikely that Westin and W will provide responses with substantively different economics to an RFP. At the same time, the existing management depth and infrastructure available to the new (and old) brands by the big brand companies will help choke out truly new entrants. Thus, while we may see new brands from the usual suspects, I believe that such a proliferation of new names under the same roof will lead to further consolidation in an already consolidating industry.

Stiles: Brands can be powerful and hence the focus on developing more responsive ones to changing consumer tastes. The issue for capital, however, is that many of these brands have no real history, which in turn, can create challenges in the capitalization process. Owners of brands really need to fund a rapid initial rollout of standard-defining product to jump-start the process.

Westergom: I think there are too many brands with very little product or service differentiation. There is too little emphasis on service and too much emphasis on technology. In the future, new brands need to force others to “clean up” their act.

Geller: I am a great believer in brands. Changing societal demands revolve around brands, sub-brands and brand extensions. At Strategic Hotels & Resorts, our higher-end hotels have to be hotel-enhanced mixed-use developments in which the room’s brand is merely the “anchor tenant.” By the end of the next five-year period, we will no longer be able to survive with brand-interchangeable-all-things-to-all-men-and-women products. We will have to have customized products with specifically targeted demographic customer bases.

Butler: How about global predictions for the industry?

Lomanno: Our global forecast is mostly sunny with some isolated clouds. The continued slide of the U.S. dollar against other major currencies will again make the U.S. an attractive destination for tourists from Europe, Latin America and Asia. The travel and tourism industry will continue to demand, and hopefully see, improvements to Homeland Security protocols to welcome visitors from foreign countries. Major global financial centers, such as London, Paris, Mumbai, Dubai, Tokyo, Hong Kong and New York City, will attract both leisure and business travelers and report strong rate increases. In addition, Beijing and Hong Kong and some secondary Chinese cities will benefit from the Olympics this summer.

Butler: Okay, to wrap it up, tell me about the most significant things happening with your company, your clients and others in the industry as we move into 2008.

Collins: At Gatehouse, and in the industry at large, our challenge is growth “in the time of (financial) Cholera.” We have a real need to bridge into this more conservative financial environment in mid-2008 without knowing exactly what "it" really is.

Lommano: As 2008 is an election year, we expect it to be an “average year” for the industry—neither memorably great nor memorably bad. We will again sell over 1 billion room nights, with 2008 ADR growth around 5.2% (to $108.85), but overall, supply and demand growth will be in equilibrium; and nationwide, occupancy will be the same as in 2007, 63.5%. Normally, election years have a slightly more positive outcome, but the increased new room supply will make it harder for existing hotels to improve performance.

Cahill: At Hospitality Real Estate Counselors, we anticipate that 2008 will be a strong year from the perspectives of both our advisory and investment banking groups. The key is market movement—as long as debt funding and property transactions continue, we will be well positioned to assist our clients. The worst-case scenario is a “market freeze,” where participants stop doing deals due to uncertainty or lack of debt or equity capital.

Reay: We are gearing up for more land and hotel development deals because the margin between existing and new hotels is very narrow. When we get close to the “crossover,” it becomes more attractive to develop new product rather than pay premiums for old product.

Stiles: Those with cash are viewing the shift in the market as an opportunity—both for acquisitions and for providing financing (whether equity, gap, or mezzanine). Those with hotels are thankful that the current market will slow down the new development pipeline and will add performance-driven value to their hotels.

Wise: Our challenge at Johnson Capital is to remind our borrowers that we have never been an overly active conduit lender, and of the 800 institutional lenders and life companies that we work with, many of them are portfolio lenders and relatively unscathed by the current capital market’s turbulence. We have 20 years of experience with many of these banks and life companies—that does matter and it makes a very big difference in what is still—(and always will be) a relationship-oriented business.

Lesser: The CB Richard Ellis Valuation & Advisory Services Hospitality & Gaming Group continuously monitors the major U.S. hotel sales transaction market—where sales for a single asset exceed $10 million and are not part of a portfolio allocation. Observations relative to the more than 80 trades reported the third quarter of 2007 include:

  • Hotel investments in and surrounding major markets along both U.S. coasts continue to be highly sought after.
  • Due in part to high land and construction costs, which create high barriers to entry for new hotel product, trades of U.S. hotels continue to occur at levels below replacement cost.
  • 17 (more than 20%) of the U.S. hotel sale transactions of $10 million or more traded in excess of $100 million each.
  • Sophisticated hotel investors continue to price assets on a discounted cash flow analysis that factors in perceived upside potential rather than applying stabilized capitalization rates to “in place” cash flow.

Connolly: At our luxury end of the market with the Mandarin Hotel & Residences in Chicago, downward trends tend to have less impact simply because the people who pay to stay in a 5-star property or to purchase a residence with 5-star hotel services, tend to be less exposed to recessionary events. Those people don’t stop traveling and don’t generally decide to move down the food chain to the economy sector. Moreover, with the greenback continuing to slip against the Euro, Western European investors will continue to perceive U.S. real estate and hotel rates in the luxury sector as being downright “cheap.” With luck, the currency relationship will mitigate some of the effects of a general downturn.

Baltin: As we move into 2008, what has surprised and encouraged me the most, has been the continued strength of the hospitality industry and the deal flow in light of the substantial uncertainty in the economy.

Butler: Thank you for participating in JMBM’s Hospitality Industry 2008 Outlook Roundtable. I hope to see you all soon and throughout the new year, particularly at the UNLV-JMBM Hotel Developers Conference™ on March 11-13, 2008 and at our Meet the Money® conference May 6-8, 2008. For more information, please contact me or visit our Web site at www.jmbm.com\ghg\conferences.