Why Midwest markets are ripe for development

From left to right: David Eisen, editor-in-chief at HOTEL MANAGEMENT magazine; Michael Kitchen, VP of acquisitions & development at Aparium Hotel Group; and Andrea Foster, SVP of development for Marcus Hotels & Resorts. (Navigating the web of growing secondary and tertiary markets in the Midwest U.S. requires a good eye, but if you can think like a local opportunities are everywhere.)

CHICAGO — The Midwest is a vast region supported by a few major cities and dotted with strong secondary and tertiary markets—markets the hotel industry is carving up as supply fills out tier-one destinations. At the Hotel ROI Midwest event, held at the Wyndham Grand Chicago Riverfront early August, Andrea Foster, SVP of development for Marcus Hotels & Resorts, pointed to her company's decision to open a new hotel in Omaha, Neb., as a decision made in reaction to the region showing promise for future expansion.

After investigating markets for development, Marcus came across a wealth of opportunities, eventually leading the company to Omaha. Foster said Marcus was excited about prospects in the city's entertainment district, calling it a "special location" the company was looking to be a part of. Foster also pointed to Des Moines, Iowa, as a healthy, young city that has yet to be served by the larger hospitality industry.

RELATED: Why hotel profitability starts with the state of your asset

This methodology has also been working out for Aparium Hotel Group, as the company’s model of developing, owning and managing unique, one-off hotel projects is more underserved in secondary and tertiary markets when compared to tier-one cities. Aparium acquired the Iron Horse hotel in Milwaukee in 2012, the same year the company launched, and according to Michael Kitchen, VP of acquisitions & development at Aparium, the company had no pipeline at all following the deal. This led the company to look outside of the standard recommended destinations, focusing on what Kitchen referred to at the time as “tough” markets, such as Detroit, in order to stand out.

“When we launched the company, people were saying that Nashville, Portland, [Oregon,] and Austin, [Texas,] were our markets, but we felt we were late to the party in many of those,” Kitchen said. “You are sometimes commoditized by what is happening around you in markets like that. We feel like the markets we are in, Detroit, Omaha, they are strong now and we are just now delivering products we started work on three to four years ago.”

Michael Kitchen, VP of acquisitions & development at Aparium Hotel Group.

Connecting the Dots

One bonus attached to developing within certain secondary markets is their access to larger tier-one destinations through location and accessibility, with lower construction and labor costs. Foster, said many major cities are surrounded by subcities like spokes on a wheel, leading to great opportunities if a developer can spot them. It's easier said than done.

“We’ve taken a hard look at some properties within Dallas, or Westminster, which is outside of Denver,” Foster said.

Though Marcus Hotels is a national company located in the top markets throughout the U.S., Foster said the company isn’t currently looking to develop in the top 10 markets’ central business districts. The idea is to focus on locations where people want to live, and build in those. Foster said to consider the state of transportation and traffic, which is increasingly becoming more difficult to navigate in Chicago. Locations that are able to bypass downtown areas of major cities are on Marcus Hotels’ map as well as areas that have access to labor and jobs.

RELATED: Three steps to take toward reducing hotel costs

Aparium deals in bespoke, unique hotels, so the company often leases structures and goes after historic tax credits to ensure it has the capital to go forward with a deal. The process of developing in a secondary or tertiary market grows more complicated as a destination enters into an upswing, something Aparium learned after the Little Caesars Arena in Detroit began construction April 2015, raising the value of the surrounding land and giving a boost to once mild construction costs.

“We got all the way to breaking ground in Detroit and a billion-dollar stadium campus started going up,” Kitchen said. “Construction costs came in at $250 per square foot. We lost six months on the project trying to figure that out, and we ultimately got them lowered to $205.”

Developers are flocking to these secondary and tertiary markets all at once, Kitchen said costs are going up everywhere Aparium looks. The company also has struggled to find skilled trades in these locations. International investors are also showing more interest outside of tier-one cities, and so Foster said EB-5 investment is a potential avenue for some developers looking to get a hotel off the ground in a risky location, but it is becoming more difficult to seal those deals.

“Our development in Omaha used EB-5 for financing, and from that experience… you have to know the right people,” Foster said. “There are very few people out there who know how to connect those deals together.”

Andrea Foster, SVP of development for Marcus Hotels & Resorts.

Home Away From HomeAway

One big asset second and tertiary markets have going for them is their distance from home-sharing companies. While the company has a presence that can be felt almost everywhere, Foster said they are a data point for hotels to look at but they aren’t much of a concern outside of major cities.

“What’s interesting is there is a direct correlation thus far between the number of Airbnb units in a city and the city’s occupancy,” Foster said. “San Francisco and New York City share the highest occupancy and Airbnb rooms. It seems correlated, as opposed to cannibalizing each other.”

Foster said Marcus Hotels is not only looking at Airbnb’s distribution, but also Uber and Lyft use to determine where to develop next. Kitchen, on the other hand, is in favor of the pressure Airbnb puts on the hospitality industry. From where he’s sitting, Airbnb’s continued success only helps differentiate who the primary audience is for hotels from those who just want to travel.

“Airbnb sells a commoditized product: a bed to sleep on,” he said. “Airbnb can do a lot of what the hotel industry can do, but it can’t promote service and experiences. So, side-by-side, Airbnb shouldn’t stand a chance.”