San Francisco's growth stunt

San Francisco may have some of the strongest hotel industry fundamentals in all the U.S., in turn making it a highly attractive city for development. Turns out, it’s one of the toughest markets for developers to make inroads. The city has one of the highest occupancy levels among the top 25 markets in the country, and according to a report released by investment management company Jones Lang LaSalle, San Francisco is on target to see 10-percent to 12-percent RevPAR growth in 2015.

The report, titled “Hotel Intelligence San Francisco,” showed that San Francisco’s average daily rate growth exceeded 9 percent for each of the previous four years, and achieved the second highest rate of ADR growth last year. The number of visitors to San Francisco increased 6.5 percent in 2014 to 18 million, generating $10.7 billion in visitor spending. Occupancy is 84.1 percent, only 70 basis points lower than New York City. Among all this, the report said the market has fewer than 2,000 new hotel rooms under construction, less than 4 percent of its existing room inventory.

How does a market with such consistently strong fundamentals receive so little new supply year over year? According to Thomas Callahan, hotel and resort investment advisor for PKF Consulting, the process for acquiring entitlements and approvals for construction is more difficult than many markets in the U.S. Even then, the hotels being built are between 150 and 200 rooms and all are limited service.

“San Francisco is very tiny and highly built up, but that’s not the biggest barrier to building a large hotel,” Callahan said. “It’s a strong union town, and hotel construction encounters many challenges from the unions during the approval process, especially hotels with [food-and-beverage] components. But with high construction costs and a heavy union focus, all of the sudden the economics of the town look good.”

Lodging Econometrics reported that San Francisco has five hotels currently under construction, seven more scheduled to start over the next 12 months and eight in the early-planning stages. This is not a significant number for a market in need of supply, especially since all of the properties currently being worked on are fewer than 180 rooms. In fact, a 174-room Hampton Inn opening this year will be the first new hotel opening in the city in several years. 

Though there is little new construction, the report from JLL highlighted the expansion of San Francisco’s Moscone Center as a boon for the convention market. The Center is the third largest convention facility in California, and is undergoing a $56-million expansion to add 305,000 square feet of event space. This will assist the city’s convention market, which has the most hotel rooms situated within a one-mile radius of its convention center (as well as the most room per square foot of exhibit space) among the country’s major convention markets.

Additionally, transaction volume is on the rise, with the JLL report stating that transaction activity in San Francisco has exceeded $900 million annually since 2012. The previous peak for transaction volume occurred in 2006 at more than $1.4 billion.

At this rate, the city is on track to overcome its previous transactions peak, with transaction volume through May 2015 so far over $1.1 billion due to the sale of the Mandarin Oriental San Francisco (now the Loews Regency San Francisco).  REITs accounted for more than half the hotel acquisitions in 2014 and have remained a major player this year, representing as many as one-third of the buyers to date. 

According to Callahan, what the city needs is a new large convention hotel. The last such property to open was the InterContinental, a 32-floor, 554-room hotel that opened in 2008 (and was the largest hotel to open in San Francisco since the 1,500-room San Francisco Marriott opened in 1989).

“San Francisco has been stuck without a new convention hotel for a long time,” Callahan said. “We need a group-oriented hotel but the economics won’t allow it to happen without a public-private partnership, and there is no political desire to make that happen.”

Instead, if you want to build a hotel in San Francisco, Callahan recommended pitching a small, rooms-oriented property because it will be more affordable and will give instant returns on opening thanks to the city’s high occupancy. Even then, the process of getting approval for a new hotel is still a difficult battle.
“It’s a very provincial market; you have to build neighborhood consensus to begin construction,” Callahan said. “It’s a journey.”