Why secondary and tertiary hotel markets are pulling ahead

Columbus, Ohio, has myriad demand generators, including a university and medical complex.

No one is disputing that 2016 was an odd year, but many were particularly struck by the strangeness of it all when fourth-quarter earnings reports started to appear in February. According to one such report from financial services firm Robert W. Baird & Co., secondary and tertiary markets managed to outperform the top 25 markets in the U.S. by a wide enough margin to be noteworthy, a trend that is expected to continue to a lesser degree throughout 2017.

Michael Bellisario, VP, equity research and senior analyst at RW Baird, said the biggest factor related to this shift was underperformance in major urban markets. Even though occupancy is pushing to record levels in some of these locations, Bellisario said they are unable pull hard on rates to maximize gains because in many cases rates are already flying high, and travelers are becoming more price conscious.

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“Secondary markets are able to pull both the rate and occupancy levers right now, something many primary markets couldn’t do at the end of 2016,” Bellisario said. “On top of that it can be less difficult to push rates in those markets with lower competition and less exposure to Airbnb, and the stronger dollar also hurt primary markets in some ways.”

Secondary cities, such as Milwaukee, are benefitting from lower Airbnb penetration, among other factors.

Bellisario points out that a 5-percent increase in rate in Kansas at $100 per night only translates into a $105 rate, but a 5-percent increase in New York where many rooms sell for $400 per night hurts guests a lot more.

Bob Habeeb, president and CEO of First Hospitality Group, said by and large secondary markets within FHG’s portfolio pulled ahead of the rest of its supply. He also lamented the state of hotel supply in Chicago, but found satisfaction in cities such as Minnesota and Milwaukee, which are turning into a safer bet.

Related story: Oversupply concerns loom over Chicago

“There is a constant horse race taking place between supply and demand in secondary markets,” Habeeb said. “It seemed a few years ago everybody was excited about building in urban centers and nowhere else, and now our fear is that they will do the reverse and race back to the suburbs to overbuild.”

Sandi Kellman, global co-chair at law firm DLA Piper’s hospitality practice, said there are few drawbacks if any in purchasing within secondary markets right now, as long as you go into the market with some insight. She pointed to Austin, Texas, as a state capitol location with a strong university and tech base that is too often ignored, and Columbus, Ohio, as a market with a booming medical complex. Furthermore, she said many properties in primary markets are simply priced too high at this stage in the economic cycle.

“If you are looking to turn around or reposition a property, the opportunities are not in New York or San Francisco right now,” Kellman said. “Savvy investors should look elsewhere. We’re seeing more deals in Charlotte, St. Louis, Philadelphia, Charleston… There will always be deals to be made in New York and Florida, but there are more interesting markets right now.”