The path forward for new hotel development in the United States looks a little brighter than it has over the past few years.
With news that the Federal Reserve is done raising interest rates for now and will consider lowering rates in 2024, hotel developers are figuring out how this welcome news will play into their existing and future projects.
But for now, the current state of the development pipeline is the result of years of supply chain disruption, the higher cost of debt and expensive construction labor.
As of October, CoStar data shows the number of hotel rooms in construction was flat compared to a year ago at about 160,000.
“What that implies is that the pipeline is not shrinking,” said Jan Freitag, national director of hospitality markets analytics for CoStar. “If the pipeline change is flat, zero or minus one, what it means is that the projects that are opening are being backfilled by projects that are breaking ground.”
The final planning counts in October increased from about 110,000 in 2022 to 240,000 or so in 2023, he said. Many hotel owners probably had the land, the brand and plans, perhaps even a general manager in place, but they couldn’t get the financing in place to move forward with construction of the hotel.
A developer could reach out to 10 lenders only to hear that they aren’t lending to hospitality at the moment because of the uncertain macroeconomic outlook, Freitag said. Another possibility is the lender will finance the project, but the developer needs to go back to the equity partners because the lender will only do a 60% loan to construction cost instead of 80%.
The Federal Reserve stated at its latest meeting in December that it would hold rates steady again and that it planned up to three cuts in 2024.
That could influence when a developer wants to seek financing and then break ground, Freitag said. At the same time, developers know their competition isn’t sleeping and may be moving with a project. One option here is to move forward, take the higher interest rate and then try to refinance into a lower rate after the hotel opens its doors.
Pipeline Expectations
October data from CoStar shows that room supply grew by 0.7% year over year compared to the long-run average of 2%. The number of hotel rooms in construction dropped 1% year over year from 159,000 to 157,000. In contrast, the number of rooms in the final planning phase grew 31% year over year from 179,000 to 235,000. Hotels in the planning phase dipped 3% from 283,000 to 276,000.
The types of hotels in the pipeline heavily favor limited-service properties, accounting for about 70% of the total room count.
That developers, brands, guests and even bankers like limited-service hotels is not surprising, Freitag said, calling them the “workhorses of the U.S. hotel industry.” Those involved in the development process have likely built one before, so they have the experience, as opposed to perhaps a one-off luxury or upper-upscale hotel project.
“Those limited-service type properties from a branded stable are well understood, and the banker can get 10 years of experienced data for a specific project like that,” he said. “That makes them feel comfortable that this is how they're going to perform.”
There are some big-box hotels that are coming online, such as the Gaylord Pacific Resort & Convention Center in San Diego, Freitag said. There are about 20,000 upper-upscale rooms in construction, making up a 3% share of that phase.
“It’s not nothing, 20,000 rooms, but those are just far and few between,” he said.
Without a significant increase in the number of new, full-service hotel rooms with big meeting space and lots of food-and-beverage options, group demand will have to fit into the existing room supply, Freitag said.
“Group demand is increasing, but if the number of hotel stock for group stays the same, then obviously you get compression and that drives prices up,” he said.
During the pandemic and through the hotel industry’s recovery, everyone learned the extended-stay hotel segment is if not recession-proof at least recession-resistant, he said. That got a lot of attention, and owners were excited about the potential in this segment.
“That then spurred them on to talk to the brands to say, ‘Hey, if you ever decide to make one of those, I’m interested in building more of them and putting that flag onto my property,’” Freitag said. “I think that started that cycle of more brands being developed and more brands being launched and then more owners putting shovels in the ground and putting those brand flags on it.”
A Developer’s Perspective
At the moment, Peachtree Group’s hotel development pipeline has about 33 projects in the works ranging from negotiating letters of interest to under construction, said Michael Ritz, senior vice president of investments. Approximately 10 to 15 of those deals have owned land and are progressing toward construction or already are under construction. The remainder are under purchase agreements or a form of joint venture agreement in which the partner owns and controls the land or project.
The development pipeline is larger than it has been historically for Peachtree Group, Ritz said. Part of that is due to deals slowing down during the pandemic when development lending was a much more challenging environment to navigate. Along with trying to figure out the data to help make the deals pencil, construction labor costs grew thanks to a large supply pipeline for multifamily and industrial projects.
“We would go and bid out a project to two or three [general contractors,] and they will tell us they could get to it in like three to six months,” Ritz said.
Peachtree’s development team took a breath and reviewed its development pipeline, figuring out which projects were viable, and which needed to be cut, Ritz said. The bulk of them made it because they had favorable dynamics as performance in the local competitive sets started to pick up.
A third of Peachtree Group's pipeline are new internal projects in which the company got itself into markets that it has been successful in before or tangentially knew could support new development, he said.
Another portion of the deals is in the company’s joint-venture platform, Ritz said. It’s relatively new as Peachtree only started working on joint-venture deals less than 10 years ago. One of the catalysts to move in this direction was raising an opportunity-zone fund in 2018. What it found were two types of individuals: those with land who needed money, and those with money who needed land.
“We found ourselves luckily in between both of those where we had a few projects that were already in our pipeline that were in opportunity zones, so that kind of already fit the bucket of an [opportunity zone] fund and gave us somewhat of a seed to go plant and start that fund,” he said.
In any economy in which there’s a lack of liquidity, there’s going to be consolidation and group efforts to tackle deals, and joint-venture platforms will be a way forward for a lot of companies, Ritz said. A joint venture is a relationship, and it’s challenging to put together because there’s a lot of nuance involved, but Peachtree has done it enough now to know where the pain points are.
Banks take a similar approach, a process called syndicating, Ritz said. He’s noticed that while a lender may originate with Peachtree, the lender is actually syndicating the loan and selling it to two or three banks.
“That's how deals are getting done right now,” he said. “There's such a low volume of development capital in the lending space right now that banks are even grouping together to do both together. And, obviously, the more people involved, the riskier the project gets just because you've got more variables at play.”
Peachtree has received calls from companies that have worked on sites for two or three years and are set with entitlements, permits and labor but need more equity, Ritz said. That’s been a great opportunity for the company. Not every deal works, of course, but these situations have translated into 10-plus projects in the current pipeline.
Peachtree is “extremely brand-conscious” when figuring out which brands to choose for new projects because the company wants to build into the future of travel demand, Ritz said.
“We have seen that we’re getting a little pickier on brands,” he said, adding that the company has always been careful about which brands it chooses. “We would rather develop higher up in the chain scales or lower in the economy scales where we know that there’s going to be strong demand pull for it as opposed to some of those tweener brands.”
There are a number of reasons now is a good time to develop a hotel, he said. If a deal works in the current environment with the higher cost of debt, then it would have in a less challenging environment.
“If it pencils today, it took a lot of work, a ton of due diligence for getting to that point, but it’s also probably less risky than deals that otherwise would have been done in a lower-cost environment,” he said.
Those building now aren’t competing with many other developers because it’s so challenging to get started, Ritz said. When these projects open, they’re the newest hotel in the market and they’re competing in a submarket where not much new supply has been built. With fewer rooms coming online while demand grows, the new hotel’s occupancy will have upward pressure on it.
A new asset will also be attractive to potential buyers who may not have many options to choose from in a market, he said.
“Two or three years from now, there’s going to be a big list of buyers looking for two- to three-year-old assets, and that’s going to be a much smaller pool to pick from,” he said. “We hope that will generate a premium, too, when we sell into a market that’s looking for this vintage of hotel.”
*Correction, Jan. 8, 2024: This story has been updated to correct the location of a hotel project.