With the price of materials such as lumber and steel falling from last year’s highs, U.S. hotel developers had been counting on a reprieve in building costs, which would allow them to add or update inventory as travel demand returns to and exceeds pre-pandemic levels.
Unfortunately for those developers, the cost of a hotel builder’s most important material — money — has since spiked.
“In this current environment, interest rates for construction loans can be in the high single digits, and we haven’t seen those in a long time,” said Vipin Nambiar, founder and managing partner at Dallas based hotel developer HN Capital Partners, which has a portfolio that includes the Rosewood Mansion on Turtle Creek in Dallas and Hotel Per La, formerly the NoMad, in Los Angeles.
“Those aren’t the kind of interest rates that provide much leverage on deals,” he said.
In an effort to stifle inflation, the U.S. Federal Reserve has hiked the federal funds rate seven times, with the most recent 0.5% increase in November bringing the rate to about 4.3% — the highest since the Great Recession started in late 2007, when the rate topped 5%. The central bank’s 2022 cumulative interest rate increase of 4.25% was the most in one year since 1980.
As a result, some hotel development projects likely will be put on hold, unable to take advantage of a resurgence in demand for hotel rooms until the debt markets loosen up, developers and industry analysts said.
“Lower [materials] prices may make it a little easier to get deals done, but there are lots of other inputs going in the other direction. Interest rates are causing more heartburn, and then you get into the finishes like carpet, wall coverings and [furnishings, fixtures and equipment] costs and lead times are still way above where they were pre-pandemic,” Steve Schrope, director of hospitality management at real-estate firm CBRE, said.
“I’d love to have better news.”
U.S. hotel developers had been playing catch-up since the end of the Great Recession ushered in an era of surging travel demand between 2009 and 2019. While revenue per available room rose almost 70% in that decade, available hotel room nights increased about 11%, according to CoStar, indicating that room supply failed to keep pace.
“There’s always been a shortage of hotels,” said Teague Hunter, president and CEO of Atlanta-based hotel-industry consultancy Hunter Hotel Advisors. “We were behind in 2019.”
At the height of the pandemic, as demand dropped sharply, hotel development slowed and supply dipped as some hotels permanently closed. Developers on the sidelines prepared for a rebound similar to what happened after the Great Recession.
As the global economy reopened, however, the price of hotel building materials such as lumber and steel surged.
The price of framing-lumber futures jumped sixfold between March 2020 and May 2021, and then approached record highs in March 2022. The price of steel futures followed a similar trajectory, quadrupling between March 2020 and August 2021, and then again surging in March 2022.
Since then, however, lumber futures fell from more than $1,300 to less than $400 in early January as new-housing starts leveled off. Steel futures fell from about $1,500 last March to as low as $650 late last year before rising to about $730 earlier this month.
Hotel development numbers still remain below pre-pandemic levels.
As of December, the U.S. hotel-construction pipeline — including the number of hotels either under construction, scheduled to start construction during the next year or in the early-planning states — totaled 5,241 projects encompassing 612,524 rooms, according to STR. That room count was down 2.6% from a year earlier, 3.5% from two years prior and marked a 6% drop-off from 2019.
“Obviously, when construction costs come down, that puts upward pressure on economic feasibility, but you have all these other variables at the same time,” said Daniel Lesser, president and CEO of New York-based LW Hospitality Advisors. “You have the spike in interest rates, and the diminishment of availability of inexpensive capital. Everybody’s walking on eggshells wondering if we’re going into a recession. Supply chain is still a huge issue, and that puts upward pressure on the cost of labor and overall construction. It’s loosened a tad, but it's still relatively tight.”
Looking forward, Nambiar and Hunter said there are opportunities for developers to buy up and earmark property for future development, especially given that the interest-rate increase has made it more difficult for apartment developers to make their deals pencil out. Both also say that lead times on materials are falling in part because China has ended its zero-COVID policy.
“We have a really beautiful, unique property in east Austin that’s on the waterfront, and it’s entitled for a 60-ish-key, very high-end boutique resort. We were getting ready to ramp it up before market-driven challenges had shown up,” Nambiar said. “Clearly, supply chain issues are abating. More capacity should be coming online [in China], so I see the cost side generally getting better.”
Hunter addeD: “If you can afford to land-bank, it’s a good time to be buying pieces of dirt, start the planning process and let the financing markets come back. I do think the supply chain is working itself out, but it’s really choppy. ... Good hotels in the right markets will continue to be developed.”