HM roundtable looks at upscale construction trends, challenges

Dirt, dollars and development were in the spotlight during Hotel Management’s recent Executive Roundtable, sponsored exclusively by Choice Hotels International. The event, held in June at the Renaissance New York Times Square Hotel during the New York University International Hospitality Industry Investment Conference, brought together a varied group of hospitality leaders who examined aspects of the Executive Roundtable’s topic: “Trends and Challenges in Upscale New-Construction Development.”

With materials costs continuing to rise, labor shortages, parcel scarcity and high barriers to entry all in the mix, securing a great site with the best brand in the right market (emerging or otherwise) that will fulfill the industry mantra of location, location, location and also hold out the promise of a worthwhile and sustainable return on investment remains a key goal of owners and developers who go the new-build route in the upscale segment.

According to data compiled by Lodging Econometrics for the Executive Roundtable, the United States hotel-construction pipeline (by chain scale as of Q1; including unbranded projects) showed there were 1,523 upscale-segment projects representing 195,716 rooms, accounting for 28 percent (by rooms) of total projects.

“There’s very little development going on in the luxury end of the market right now. Much of it is concentrated in the upscale, upper-midscale segments of our industry,” said J.P. Ford, SVP/director of global business development, Lodging Econometrics. “And there are 578 projects [representing 98,417 rooms] yet to select a brand.”

He noted historically, 85 percent to 90 percent of those ultimately do select a brand. Calculating what that would mean for upscale construction, the original project number would then jump to 1,711 projects representing 233,187 rooms and account for 34 percent (by rooms) of projects.

Upscale is only surpassed by upper-midscale in terms of new hotel openings, noted Ford, who drilled down on what could be expected this year, next year and beyond. For 2019, upscale is expected to have a 4.4 percent growth rate with 276 hotels opening, representing 35,141 rooms. In 2020, the growth rate increases to 4.6 percent with 303 hotels opening, representing 38,710 rooms. In 2021 “and beyond,” Ford forecast 1,001 new hotels opening, representing 129,264 rooms, but did not detail a predicted growth rate.

At Choice Hotels International, Janis Cannon, SVP of upscale brands, said the company, which is marking its 80th anniversary this year, is “building our upscale category; building on strength to strength and we’re looking forward to having seven Cambria Hotels opening … At this point we’ve passed the 220 mark for our Ascend Collection on a global basis. We’re building our upscale category with a huge commitment on behalf of Choice as well. And we’re doing that through great partnerships, great sponsors but also investing our capital.”

Janis Cannon, Choice Hotels International’s SVP/upscale brands, has the attention of Lodging Econometrics’ SVP/Director J.P. Ford (left) and Schulte Hospitality Group CIO Eric Schwartz. Photo credit: Hotel Management

In terms of what the decision-making process is for tipping owners and developers in the direction of upscale new construction when choosing among the segments, Hotel Equities’ VP of Development Greg Presley noted the decision, as might be expected, is based on the market. “We have owners who are looking to grow their portfolios and that we manage. They’re trying to get into markets where the indexes are strong and when we go and run a pro forma, look at the indexes and they’re strong, you would want to put a brand in that market. We have to work with that owner to determine what brand makes sense and what that market will support and how it will absorb those rooms.”

“When we look at where we’re going to be, whether it’s a Comfort or a Cambria or an Ascend Collection, first thing we do is look at the strength of the [revenue per available room], because if there’s not enough RevPAR in the market to sustain an upscale brand or make that brand competitive and throw off the kind of margins we’re looking for, it’s not a market we’d be interested in,” added Cannon.

Toward this, she and her team examine the demand generators and drivers, if the market sustains both leisure and business travelers—“so we can fill a hotel seven nights a week”—whether there’s corporate demand and what kind of penetration the brand has with those accounts in the market. “We even go into MSA[metropolitan statistical area]-type of information to see what’s happening with the population, what type of businesses are moving in and out of the market,” she said.

Segment Challenges

In addition to finding the right location in a supportive market, there are any number of challenges associated with bringing an upscale hotel project out of the ground. For Thomas Penny, president of Donohoe Hospitality Services, one of the greatest challenges is getting access to sub-contractors who can perform. “It’s a challenge for the industry right now … It’s a challenge we’re all wrestling with,” he said, indicating not having good subs in place can increase the cost of a project.

Mark Shalala, Choice’s VP of franchise development-upscale, said one of the challenges his team has encountered with developers is availability of sites in markets in which they want to develop. “There seems to be plenty of equity available in the market, debt is still readily available and priced appropriately but it’s the lack of available sites where developers want to be in higher RevPAR markets,” he said, adding there’s also competition from multiunit housing developers who often are willing to pay more for sites, particularly in urban markets. “It’s not to say you can’t make deals happen; you just have to be a bit more creative in how you go about it,” Shalala said, pointing to investigating programs such as opportunity zones or various types of financing.

Eric Schwartz, chief investment officer, Schulte Hospitality Group, said his company has been speaking to a number of developers who bought sites before they knew they were in OZs. “What it really does is it pushes the project over and also expedites the timeline significantly because they might have capital gains that they’re trying to shelter quickly. So, it’s really hit the go button on a number of projects we’re looking at, which has been quite exciting,’ said Schwartz.

“Land availability and land costs, coupled with construction costs, is one of the biggest issues we’ve run into,” said Mathew A. Jalazo, EVP of development, Winston Hotels. Compounding that are non-hotel developers and land speculators who are coming into major markets with strong fundamentals. “One of the craziest things we’ve seen … is they’ll buy up parcels for $6 million and flip it for $10 million before we even have a chance to look at it,” he said. “The availability of land and land you can easily build a hotel on is very hard to come by, and even when you do come by it, construction costs have gone up so much that it’s hard to find the perfect combination.”

Group One Partners’ Principal Harry Wheeler (right) listens as Winston Hotels’ EVP of development Mathew A. Jalazo discusses upscale segment construction. Photo credit: Hotel Management

Bad weather, compromised logistics, strained budgets and unforeseen factors also need to be considered before the first shovel goes into dirt.

Harry Wheeler, principal at Group One Partners, noted five or six years ago his team would know from a development/design standpoint it was building Brand X over the next 12 months. “Now we’re seeing that fluctuate during the entitlement process. We’re getting down the road and realizing: ‘I really wanted to do Brand X, but I need something that’s going to generate more ROI so we need to flip the script, and now we’re going to an upscale property versus maybe we were going to go mid-tier. So we’re seeing the brand-selection process can be ongoing until we break ground; it’s a much more fluid process making everybody’s job around the table much more difficult. It’s just reactionary right now and that’s because it’s such a strong economy,” he said.

Justin Jabara, VP of development, Meyer Jabara Hotels, observed, “All those things—construction costs, a highly competitive market—it adds to the timeline of the development because you need to keep going back, going after the subs, getting the costs back in line, possibly redesigning the hotel; we’ve some projects where the hotel’s been redesigned two or three times already.”

Flexibility Needed

Penny suggested brands need to be flexible in their incentives and how they work with hoteliers/developers to get projects done.

“For example, we’re doing a project in D.C. in an opportunity zone, [for] which we paid a premium for the land. This is actually a Cambria. It was the incentive package that Choice presented that made that deal go,” said the executive.

Shalala jumped in to say one of the reasons Choice has been able to grow the upscale Cambria brand so aggressively over the past few years “is because we have been aggressive with our balance sheet. We’re reacting to the market and we’re able to come in with different types of incentives, depending on the project. It might be key money, it might be debt, sometimes a [joint venture]; whatever it really takes to make sense to maximize return for our developers.”

According to James Carroll, president/CEO, Crestline Hotels & Resorts, “Building at the top of your comp set buys you insurance down the road,” something his long-term owners agree with. “I think you can go smaller and smaller [in terms of room size] when there’s so much demand that occupancies are running above the 80s and people will take the room because they need one,” he said. “We’re not going to stay in that environment forever.”

One aspect of upscale new-construction that was a hot topic several years ago centered on Leadership in Energy and Environmental Design certification, which the panel agreed did not seem “de rigueur” right now, although being sustainable does. “We look at it and if it pencils and makes sense, we’ll go through that,” said  Jabara. “It doesn’t always pencil and the technology isn’t there and the costs aren’t there, so it doesn’t work into the model.”

When it comes to labor—or the lack of it—the panel agreed it can really sway a project’s progress. “It’s not even just labor; let’s take it one step further,” said Winston Hotels’ Jalazo. “It’s the relationship with the sub. We’ve had contractors we’ve worked with where literally we’ll have an entire electrical sub and his entire team on a project and they’ll get offered a higher rate on a project next door and the entire team will leave and we’re just stuck high and dry looking for a new set of subs. That delays us weeks, if not longer.”

Cannon noted Choice has begun leaning into modular construction as one solution, with two hotels already constructed via this method.

Wheeler added some 10 percent to 15 percent of projects his company is involved in discuss modular construction. He cautioned it’s a process that needs to be committed to early on. “It’s not something you can switch once you get some pricing back and you don’t want to do it anymore,” he said.

“You have to make sure you know what you’re doing when you get into modular,” agreed Hotel Equities’ Presley.