The development world operates with a herd mentality.

This article will be featured in the August issue of “Harrisburg Commercial Real Estate Review”, a publication of the Bill Gladstone Group of NAI CIR.  You, dear Blog reader, get the preview:

The development world operates with a herd mentality.  When demand is up, development goes crazy.  When demand tips down as it is today, development virtually disappears.  Contractors and design professionals – whole companies – are vanishing from the landscape at an alarming rate because many developers have shut down completely.  Professionals who worked on at least one of our projects last year – a civil engineer, a landscaping contractor, a mechanical contractor and a drywall contractor –  are now extinct, and I’m afraid there will be more.

Why do developers let headlines dictate their businesses, and hang up the “Gone Fishing” sign when the environment turns tough?  Yes, investors are now demanding stronger returns to put their money at risk.  So?  To me, it’s a time like this when a professional hotel developer 1) focuses on excellence, and 2) takes advantage of the land, construction, and financing cost savings that surround him.

The land cost savings available today are staggering.  In York, we are putting a development parcel under contract for one fourth of its original, 2008 list price.  In 2008 we acquired land in Hershey to squeeze an 86-room Country Inn & Suites hotel, and the land cost $1.8 million.  It is open and hitting its sales targets, but its returns will always be constricted by its high initial land cost.  We are now working on a second Hershey hotel, and the land we have under contract will cost about $1.3 million and yield 25% more guest rooms.  The savings of nearly $9,000 per guest room will bring us a better margin and will make today’s more demanding private investors happy.

How about construction costs?  The development bubble of 2007-2008 created a shortage of construction labor that drove both contractor margins and labor rates sky high. Our developments saw hundreds of hours of overtime because crews were stretched too thin to keep on schedule any other way.  That has completely changed now, to the developer’s advantage.  Construction materials prices are rising.  Some petroleum-based products have risen 25% or more, and copper is also up sharply.  What folks forget, though, is that materials prices went down before they went up.  In today’s cauldron of negativity, many look at the increased prices and forget to focus see the competitive picture.

Our first Hershey hotel started construction in 2008, and the “box” cost us $107 per square foot at the peak of the development frenzy.  Recent budget pricing for our new Hershey hotel came in at $95 per square foot.  It may rise before we start construction, but I can take that 10% cost savings to make a better margin for Springwood and to drive a better return for our private investors.

What about financing costs?  First, getting financing at all is a challenge today that takes a stellar track record, cash, and a great relationship with your friendly banker.  Even then, you’ll need more equity money than you needed three years ago, and you may be required to put up “added liquidity”, also known as dead cash just sitting in the deal.  The good news is that if you can get it, money is cheaper than it was in 2008.  We just refinanced the Homewood Suites by Hilton, York that we developed in 2008.  Its original development loan at 7.35% was pretty good at the time.  Our new interest rate is 5.0%.  A one-third reduction in interest cost does good things for cash flow.  Today we are in discussions with banks about our proposed Fairfield Inn & Suites by Marriott in Hershey, and the interest rates we are hearing are lower than that “pretty good” rate from the prior decade; some are talking rates as low as 6%.

Taking advantage of today’s cost savings requires a “focus on excellence”.  I see three excellence focal points in the hotel development business: location, brand, and operations.  In 2008, locating a new hotel was easy: any cornfield with zoning and utilities would do.  Locating a hotel today requires professional homework.  Vigorous population growth covers a lot of mistakes, though it may no longer materialize.  What are the RevPAR (Revenue Per Available Room), ADR (Average Daily Rate) and Occupancy % of the competitive set in your proposed market?  Do the data indicate that your new hotel can be supported in the market today?  Future-casting is dead.  What about access?  Visibility?  Support amenities?  Is there convenient dining and shopping nearby?  Today’s market requires a stronger location advantage than in the past.

Brands differentiate the hospitality business in a way that retail, office and industrial developers do not experience.  Stronger brands are stealing market share from weaker ones today more than ever before.  Leisure travelers and business road warriors are looking to reduce the risk of an unpleasant stay and garner bonus rewards, because their dollars are more precious than ever.  Distinct hotel brands help travelers make their decisions.  I am delighted with our new affiliations with Hilton and Marriott because their brands benchmark excellence in our industry.  They are tough on franchisees because they demand quality and consistency across their brands.  We tolerate their harsh scrutiny because I can put their brand next to an inferior-branded competitor, and better their RevPAR by as much as one-third on brand alone!

A hotel, more than any other property type, is an operating business housed inside a piece of real estate.  Our leases are 12 hours long.  On-line sites like TripAdvisor.com shout our successes and failures from the internet mountaintop.  When our guests arrive, they are tired, strung out from the road, and sometimes cranky.  They want the comforts of home, they want them now.  Successfully managing a hotel, let alone a group of hotels, is a fine art that takes planning, systemization, a servant personality, and incredible hours of hard work.  Guest satisfaction wins the revenue war, and those who simply “run hotels” lose.

Excellent locations, brands and operations will help a a select few hotel developers thrive in today’s challenging, low-cost market.

Dave Hogg

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