Midscale development hits a sweet spot4 Sep, 2013 By: David Eisen Hotel and Motel Management
|The roundtable was held at the Marriott Marquis in New York. A variety of issues were discussed—all related to the midscale segment and its sustained growth.|
A recent HVS hotel development cost report noted that new hotel construction is very much concentrated in the midscale and upper-midscale segments. Brands represented in this sector include Best Western, La Quinta Inn & Suites, Ramada, Comfort Inn, Hampton Inn and Holiday Inn, among others. There’s a reason behind this: These properties are characterized by lower construction costs, lower labor costs and higher profit margins than those of full-service hotels. Their brand affiliations are also important to lenders, enabling developers to secure construction loans.
There’s more. Besides the resort segment, according to PKF Hospitality Research, as of 2012, midscale hotels had the highest percentage gains in net operating income and total revenue (10.6 percent and 6.2 percent, respectively). Meanwhile, according to Lodging Econometrics, as of year-end 2012, upper-midscale—along with upscale—accounted for a whopping 76 percent of all projects in the pipeline.
This was the context for which eight midscale brand executives and the divisional dean of the New York University Preston Robert Tisch Center for Hospitality, Tourism and Sports Management discussed the reasons why the segment is such an attractive one for developers and customers, alike. So, what’s the deal here?
Stamoutsos: Financing. That’s the key right now. The amount of equity that you need now is typically 30 percent to 40 percent, and a lot of developers are looking at this midscale segment from the standpoint that it allows them to get into markets where, quite frankly, they couldn’t get into and get the financing before.
Burgett: If you look at most of the hotels today that are built, midscale is predominant and you can’t keep those developers down. The fact [is] that there hasn’t been a lot of financing for the last few years. I think what you’re seeing now is that they are just anxious to get back in. So, this is where you’re going to see new development.
Collins: It seems to have that sweet spot between what it costs to develop and what you can get for it. You are in a better position to increase the rates. If you have a budget hotel, it’s a little difficult to say all of a sudden, ‘I’m going to start charging a much higher rate.’ So it seems to have that sweet spot between I can build it up now and get a greater return and I still have the potential to increase the rates, as rates go up.
And what markets are seeing the biggest push in development? For most in the room, development in the midscale segment is still happening outside the top MSAs—and not only in the U.S.
Williams: Canada, Western Canada, Alberta and parts of British Columbia and now Saskatchewan are red hot and new construction is fueling that for us.
Another hot spot for development is North Dakota, in areas near the oil-producing Bakken Formation.
Junker: As far as the oil areas and places like them are concerned, we’re building in small markets that no one else will build in and in those markets that need hotels where in the past nobody would do it.
The attractiveness of the midscale segment is not just about economics but the type of product that is being constructed and designed today; it’s a big draw for value-conscious travelers, who still want a great experience.
Parker: From a guest’s perspective, it offers a great value proposition because you have those economy travelers that say, ‘I can trade up a little bit more,’ and trade up from that economy space, and you have the upscale guest who’ll say, ‘Hey, these midscale brands are evolving.’ That line is getting more blurred between midscale and upscale, so those upscale travelers will begin to trade down and save on the rate side and have a comparable experience; so from a consumer standpoint, it’s offering a great value.
While brands continue to thrive and plant their flags around the world, the independent hotel still has a place in the industry, though it faces stiff competition in the form of bigger brands and their heavy power to drive bookings.
Collins: Because the industry is so bifurcated between owners, operators, developers and real estate people, you’re always going to have somebody who says, ‘I’m going to build a midscale in here and I don’t really need a franchise.’ It’s the nature of our industry. I’ve been hearing for years and years how big brands are going to put little brands out of business but there are always going to be niche players. The market is going to decide how many brands will be there and the market is going to decide who survives and who doesn’t.
|Bjorn Hanson shared his thoughts and data points regarding the industry as a whole and the midscale segment’s place within it. Hanson, before he came to New York University, to head the hospitality program, led PwC’s hospitality and leisure practice.|
Independent of individual competition, from the franchisees’ perspective, slapping a flag on their hotel and plugging into that brand’s vast resources is still an attractive play, particularly in the midscale segment.
Parker: It’s the ROI. You are keeping your construction costs down in all the brands. We are trying to make these boxes and make them as cost-effective as possible to get the best return. The midscale brands are evolving so we can keep fixed costs down but go into high-ADR markets. That’s the sweet spot to get the best ROI.
Watters: The market is key. When you start to differentiate between the secondary and tertiary markets and have a good solid piece of land in, say, Nashville, or one of the suburbs, then you’re starting to look going midscale because you’re not going to build economy. You’ve got the right sensitivity that in some of the markets in and around Nashville there is hardly a growing population area; you’re talking about $75 to $250 ADR and that just screams midscale.
|Brian Parker is focused with growing Choice Hotels International’s equity brands—Comfort Inn and Comfort Suites, Ascend Collection, Mainstay Suites—on the East Coast.|
While building a midscale hotel has a great value proposition for a developer, it’s also a great value proposition for the customer—not only from a cost standpoint, but from a service standpoint, too. Today’s midscale hotels are as much about a good price as they are about good service and amenities.
Stamoutsos: Rooms have to be clean and breakfast has to be of great quality because there is competition for the same guest. You have to have Internet; you have to have the Wi-Fi: it’s the biggest thing. I was talking to someone and he says, ‘What are you doing in the hotel business?’He goes, ‘I went to a Marriott and they wanted to charge me for Wi-Fi and I went to a midscale property and I get it for free. That’s ridiculous.’
|Doug Collins, CEO of Amerca’s Best Franchising, which last December acquired the Jameson Inn brand. ABF is now offering franchise opportunities for the brand for the first time.|
Williams: But service and amenities are two different things. Service has to be there: I don’t care if you’re staying at a budget hotel or high-end or midscale, it’s got to be there. On the amenity side, everybody here in the midscale has the free Wi-Fi; they have the hot breakfast, and they have an exercise room. There are things guests want when they travel. So those amenities have to be a constant.
Collins: The reason there is ROI is that they have those certain things. Midscale travelers are smart. They go with their pocketbook. That’s what makes the midscale so successful because it’s the best deal.
|Brendan Watters, CEO of Boomerang Hotels, which just announced the opening of an 80-room Settle Inn in Marquette, Mich. Boomerang also franchises hotels under the GuestHouse name.|
Junker: That’s why the term full-service is a joke. Full-service: you get the room and you’re paying for everything else.
Watters: It comes back to what Warren Buffett said, ‘Price is what you pay and value is what you get.’ I’ll find value at $59.99 on the interstate in a Red Roof Inn.
Hanson: As you think about the Internet access, management contracts are based on a percent of total revenue. Midscale mostly pays the franchise fee, royalty fee and a percent of the room rate. There is an argument to be raised for the midscale brands. Would you rather have the room rate be just a little bit higher to participate in the royalty fees, whereas the upper-upscale and luxury brands would rather have a management fee of 3 percent plus an incentive fee based on that incremental revenue? There is incentive for different models. There is also a little bit different nature of use of high-speed Internet access in luxury and upper-upscale hotels. There is a lot more downloading of massive files for business travelers; a lot more downloading of media; so it costs them to provide much higher Internet services at the full-service hotel. The numbers to meet current needs are coming up to $40,000 and $50,000 per property in the upper-upscale and luxury segments. They are not as high in midscale.
|Gus Stamoutsos, who leads franchise efforts at Wyndham Worldwide, which represents more than 15 brands, says midscale is the hottest segment going both domestic and global.|
The New Midscale
One thing is certain: The line between midscale and upscale design has blurred. Some of today’s product, particularly in the upper-midscale space, looks as good if not better than some upscale products. What has happened in the preceding years to lead up to this?
Parker: The guests are demanding that. You get the upgraded bedding package; you get the larger flat-panel TVs. You give all the things that the guests are demanding and see that creep into the design element in the prototypes in the midscale product.
Collins: Particularly in the rooms. Going to a new Comfort Inn or any new mid-price hotel, it’s difficult to see how that’s different from a full-service Marriott. Really it’s the public areas that are different, but the rooms are becoming very similar and I think the luxury hotels are finally opening themselves and saying, ‘What else can I give them that they are not getting somewhere else?’
|NYU’s Hanson said that the average daily rate in 2013 for midscale properties will probably end up around $77; for upper midscale, the number will be around $102.|
Parker: Hanging out in the lobby, that’s what full-service is known for. Midscale is going for that. It’s going to be interesting and we’ll see how it plays out.
Junker: You have to be careful though. I’ve seen so many concepts that have been new, modern and contemporary. At a midscale, guests don’t want over-the-top modern and contemporary. They want clean lines, neutral colors.
Burgett: Especially with an $87 rate.
Hanson: This year, midscale probably will end the year at $77 and upper midscale at about $102.
Burgett: The new designs give a more residential feel. We can pull that off in midscale. You need to continue to be pushing the trend. And I think you just need to capture the trend and keep it branded as long as you can, and try to get a five- to six-year stretch on it without needing a new room design.
|Wyndham’s Stamoutsos says there is still opportunity to acquire distressed assets for 20 to 30 cents on the dollar, a move that in the long run can be better than building a new property.|
Stamoutsos: One of the additional things that a lot of us are doing is not being as prototypical in our designs and creating that flexibility. If you are in the Midwest, what’s the feel of that property versus if I’m in South Beach or New York City?
To Buy or Convert?
Hanson: STR issued its 2012 profit numbers and I took the number of available rooms and divided it into the profits and the peak profit number according to STR was in 2007, $40.2 billion, and in 2012 it’s about $39.5 billion. You’re adding in an increased number of rooms and profits are down just about 7 percent in nominal dollars, not even adjusted for inflation from where they were in 2007.
|Jessica Junker, CIO of Cobblestone Hotels, with hotels primarily in the middle of the U.S., says her company is building in small markets that no one else will build in but need quality hotels.|
Williams: New development is down; it’s not even close to what it was in 2007.
Stamoutsos: You can go out there and buy something that’s in need of a lot of renovation, 20 or 30 cents on the dollar, put in that 30 cents and you’re still below building a new product. You’re seeing still more conversion than new construction.
Junker: We’re seeing the exact opposite. We did nine new builds last year and we’ll do 15 this year, probably closer to 20 and we can’t keep up with our new builds.
Stamoutsos: When we say new construction I mean we’ll do the 60 to 70 new constructions this year. So on a relative basis you are still doing some construction, but the ratio of deals that you’re doing is mostly conversions.
|Raj Trivedi, EVP franchise and CDO at La Quinta Inns & Suites, says that while U.S. brands historically have expanded overseas, brands that are more recognized in other parts of the world may soon expand to the U.S. He is flanked by Junker, right, and Ron Burgett, EVP, lodging and brand development, Red Lion Hotels.|
Williams: We are about 30 percent. So far this year we’ve done 20 new constructions and that’s a good mix between Canada and the U.S. Canada is bouncing back because money is good there.
Meanwhile, in order to get projects off the ground, financing helps. But in recent years, bank loans, particularly for new construction, have been scarce. However, the more familiar a bank is with a brand, the better chance a developer has of securing financing. The question is: Are banks loosening up and allocating money toward new hotel development? Or, are we still a ways off?
Parker: They have a familiarity. They understand it. How hard is it to understand 80 units with just breakfast in the morning? Limited service is an easier model to grasp from an operational standpoint. Can I get $8 million to build a midscale hotel? That’s what we’re seeing at the local and regional bank level. I don’t think there are a lot of major national players that have come back, though. Not yet.
|Ron Burgett, EVP of lodging and brand development for Red Lion Hotels, which last year unveiled a soft brand called the Leo Hotel Collection. Red Lion owns about half its portfolio.|
Collins: Money may be coming back but it’s never going to be the same and the thing that keeps our industry in check is really the banks. We’ll grow hotels as long as somebody gives us money. The only thing that curbs hotel development is the lending and for the better of the industry lending has changed forever.
Hanson: I think there will be more underwriting but underwriting hasn’t been a good protection of the investment on our lending in the past. I don’t know if it will be next time. I’ve been through 11 cycles and it hasn’t really ever changed. We’ll get back up to 70 percent, it’s just about the time it takes for the economy to exit recession.
|La Quinta’s Trivedi said that for a brand to be successful, it needed to focus on and be aware of two specific areas: 1) strategic international expansion; and 2) strategic marketing to international guests that are coming to the U.S. “The web has made it easier to achieve this,” he said.|
La Quinta Inns and Suites operates only one brand, while Choice Hotels International has 11 (as of press time). So, how many brands is enough? Can the market continue to absorb new brands? While there are varying opinions, the emergence and continued variance of distribution channels allows brands to proliferate without much concern for demand. In today’s hotel landscape, ‘if you build it they will come’ is increasingly apt.
Trivedi: Concepts will continue to emerge. All in all, the brands that are solid will continue to have a growth pattern and brands that emerge will take a longer time than it did 10 to 15 years ago to reach a critical mass.
Hanson: I agree with the critical mass issue totally. The Internet makes things more possible than in the past. So it may be that some of the former brands have to go away but there are 280 brands, and could we say there are too many? We probably would but I’m not sure consumers would say there are too many brands and some have to go away. So it’s a meritocracy; the ones that don’t have merit and can’t be justified will be lost. But I don’t think there is any limit to the number of brands that could be introduced and the Internet makes it easy.
Trivedi: Another trend: American brands are used to going to other parts of the world. Brands from other parts of the world may come to America also, as the recognition in Asia or Europe changes.
Stamoutsos: We acquired the TRYP brand. There is an opportunity to look at those properties and those brands that are out there; that makes sense here in the U.S.
Parker: Brands will evolve and they will try and tackle the evolving consumer who is health conscious, etc. It’s inevitable that you are going to see more and more brands.
Collins: There is always going to be new brands just because of our industry and it is [around] the idea of critical mass. We’ve been talking that critical mass is more in the eyes of the franchisor having enough properties so they can make money.
Williams: But when you look at a midmarket brand, you are going to want 200 of those products throughout the U.S., both in secondary, primary and possibly tertiary markets, to achieve that because if you’re sitting there with 50 for 10 years, have you really achieved critical mass? I don’t think so.
Trivedi: A single hotel could become successful in the market but we’re a cyclical industry. And critical mass becomes necessary when you’re going into a downturn and when you’re competing with other known brands or the brands that have critical mass. Regardless of market that you belong to, you would be better off if you are a part of a brand that is well recognized by consumers and well recognized by various corporations. So that’s when critical mass comes into question.
Winning Over the International Traveler
In recent years, hotel operators here in the U.S. have made concerted efforts to make their hotels even more hospitable to international customers by offering them the creature comforts of their home (think breakfast items, such as congee for Chinese guests). And it makes sense when you realize that the occupancies of U.S. hotels are increasingly being composed more and more by foreign travelers. In addition, the hotel industry today is a global business with U.S. hotel companies having a vested interest in overseas development. Making sure synergies exist between hotel inventory here and abroad is key to building brand loyalty.
Stamoutsos: We have so many properties overseas and what eventually happens is that you have to create the synergies with not only your international properties but your U.S. properties as well because that’s a great opportunity to have loyalty. You have to have programs and the biggest thing for groups is the rewards program, the loyalty program. I think that’s one of the biggest things that helps drive loyalty amongst the travelers here in the U.S. as well.
Hanson: You look at New York, for example. When I stay at one of your hotels in Manhattan, there are more Europeans than there are Americans in the hotels, for the most part. They come to the large cities; they want to experience America and they have the SPG cards, [for example]. It’s familiarity. It’s not necessarily catering to one group in particular, but rewards are universal.
Watters: Brand recognition is huge. If you’ve got brand recognition outside of the U.S. and if you’re large enough or have penetration to those markets, that makes all the difference. I don’t have that international name recognition compared to a Best Western, for example. I mean it is a major opportunity that if you don’t start to reach out and do that in some capacity, then there is a lot to be left on the table.
Trivedi: The Internet has made it easier to get in front of the international traveler—much easier than what it was 10 or 15 years ago.
Hanson: It’s also made midscale much easier for international inbound travelers because they don’t need a concierge.
Parker: One of the things that the brands need to be cautious of or cognizant of is making sure that we are ready to receive this influx of global travelers just from a product standpoint, because the last couple of years the economy has been soft and we had a lot of differed maintenance. It’s going to be a lost opportunity when they show up and say, ‘This hotel is old, it’s tired, it’s dated.’ We have to make sure from a branding standpoint that we’re ready to receive them and we must hold our franchisees accountable.
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