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NYC Hotel Supply to Hit Another High Note in 2018

Although RevPAR Performance Ties to Number of Rooms the Market Can Digest, Industry Insiders Say There’s Some Room for Optimism
May 2, 2018

Much like a restaurant patron halfway through a particularly heavy meal with three more courses coming before dessert, the New York City hotel sector is facing the approach of peak supply levels this year, and the market must be able to digest those rooms if fundamentals are to improve.

Industry watchers with their eye on supply are optimistic that 2019 should bring better days for hotel revenues after the market absorbs all the new rooms and construction slows.

In 2018, 6,272 rooms are projected to be added to the market, according to CoStar Market Analytics, but only 2,232 rooms in demand are forecast. This year’s delivery figure is quite close to the peak thus far this cycle, which came in 2014 when 6,348 rooms came on line. However, demand for rooms was projected to be a healthy 5,913 that year. This year, CoStar forecasts occupancy to reach 81.8 percent, compared to 2014, when occupancy hit 83.7 percent.

According to CoStar market data, the gap between supply and demand in New York City's hotel market should shorten by 2020, and then stabilize by 2022. On the revenue side, the data shows revenue per available room (RevPAR), a key industry metric, ticking upward in 2019 before flattening out by 2022.

The wave of new construction is beginning to erode the city’s hotel-sector fundamentals, said Jeff Myers, managing consultant with CoStar Portfolio Strategy. Occupancy levels have peaked, he says, and New York City’s hotels are experiencing slowing room revenue growth.

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So-called select-service models are driving the bulk of new construction right now. They generally have a shorter planning and entitlement window and are easier to build, said Mark Van Stekelenburg, managing director of CBRE’s Hotel Advisory Group.

Bolstering this hotel class was the use of several parcels known as M1 for development, which are generally smaller and have been as small as 5,000 square feet, he added. The size and character of M1 parcels are typically not workable for large, full-service hotels.

  For the Record:  M1 is New York City’s zoning code for light industrial and manufacturing districts, which are located next to residential or office zones, acting as a buffer against heavier industrial and manufacturing districts. Hotels have been permitted in M1 districts, but a new M1 Hotel Text Amendment making its way through city legislature could restrict that by requiring special permitting.

"It is very difficult to build a substantially-sized hotel for a number of reasons, including the increasing development costs, the increasing zoning restrictions and the limited but growing debt capital available," said Jared Kelso, managing director of global hospitality at Cushman & Wakefield.

Both in New York City and across the country, developers who seek to build full-service hotels have had to evolve to more flexible, mixed-use models.

"The industry in general is adjusting by becoming a little bit more flexible in offering a full-service experience, but they have been able to replicate the full-service experience via mixed-use developments, i.e. a retail and amenity podium with a separate hotel tower, but to the guest it appears as a full-service hotel. There has been a prevalence of that, mixed-used buildings with a hotel component," said CBRE's Van Stekelenburg.

In addition to the hotel rooms underway now, there have been significant delays in opening some hotels in New York City. Completion timeframes appear to be getting pushed further and further out, according to Warren Marr, managing director of PricewaterhouseCoopers.

In fact, a number of projects have been abandoned altogether, added Van Stekelenburg. That means 2018 and 2019 could be deciding years for the direction of the city’s hotel cycle.

"The real question is, how many of those will actually open? A lot of 2017 rooms got pushed back into 2018 and even 2019. We should be nearing peak here, if those all go up," Marr said. In 2017, 6,285 rooms were projected to open in 2017 but only 1,998 ended up opening, noted Marr, citing the advisory firm’s numbers.

Source: CoStar Market Analytics.

In New York City, banks have taken note of the impending supply and its associated hiccups, so that financing for new projects is now a challenge.

"Only triple-A locations or global banks are breaking through," said Van Stekelenburg. "Financing is relationship-based or sponsorship-based."

Traditional lenders and primary mortgage lenders are financing on up to 60-percent leverage, while mezzanine capital is lending on up to 75 percent. EB-5 continues to play a role as different parts of the capital stack, but not the whole solution, he noted.

But in a common motif this cycle with other asset classes, debt capital is keen to step up.

"Over the past year, interest by debt lenders to finance hotel projects in NYC has increased dramatically," said Dustin Stolly, vice chairman and co-head of capital markets debt and structured finance at Newmark Knight Frank. "We are seeing debt capital lend on forward-cash-flow projections."

There’s Reason for (Reasonable) Optimism

"I am fairly bullish on NYC hotels--supply growth should be choked off by the end of 2019. In Midtown west and midtown east, we are expecting a strong rebound in the second half of 2019," said Jeffrey Davis, international director of the hotel and hospitality group at JLL. He says he expects revenue to firm up in the second quarter of 2019.

Kelso expects hotel development will taper off following the third quarter of 2018.

"Combine that with ever-increasing demand in the city, and we anticipate strong RevPAR growth in 2019 and 2020," he said.

Despite the impact from all the new supply, New York City remains well-above the national average for occupancy. But industry experts said tourists have become more price-sensitive over the last year.

Manhattan hotel occupancy finished last year at 87.6 percent, compared to 65.9 percent nationally, and achieved an average daily rate of more than double the U.S. average, Marr noted. Nevertheless, PwC calculated a 1.6-percent year-over-year decline in ADR in 2017, indicative of what Marr calls "a shift in demand" by leisure travelers, who comprised the bulk of New York City’s lodging business.

"Tourism was strong last year despite concerns of weakness because of rhetoric coming out of Washington, D.C. It did well, but there was strong price sensitivity among this segment. When price sensitivity is stronger, [room] rates trend lower," he said. "A strong dollar last year was not good for lodging industry, particularly in gateway markets. The dollar's strength is waning now but is still strong relative to other currencies."

Group and convention travel is down overall, and whether corporate tax cuts bolster business travel remains to be seen, added Warren.

"The hope of the lodging community is that corporations will loosen their purse strings on their travel budgets. But it is too early to see whether that happens. We will have to wait to see until the high season for business travelers – in the latter half of March, April, May [and] June," he notes.

Cost Creep

Although New York City is recording strong occupancy figures, there has definitely been pressure on price, said Van Stekelenburg, noting that ADR has experienced roughly four years of decline.

"And expenses are growing at a three- to four-percent rate on top of that," he explained. "Labor is the single largest operating expense within a hotel and can be upwards of 50 percent of the operating expense. What that creates is additional restrictions or challenges. Flow-through and profitability of hotels has been hit."

As the market builds smaller and contends with both delivery delays and pricing concerns, a two-fold challenge faces finished hotels: Workers are harder to come by and labor itself has grown more expensive.

With a good portion of hotel labor in New York City being unionized, work-rules impact the ability to control costs, analysts said. Specific staffing structures and work-rules can make it more challenging to implement quick changes such as adjusting the hours of operations within food and beverage establishments at hotels.

Robin Trantham, an analyst with CoStar Portfolio Strategies, says:

It’s putting a crimp on the hotel industry, which is already competing for shrinking workforce, more so than other property types," "The ratio of hotel workers to hotel rooms has been decreasing. Fewer hotel workers per room, wages will increase for hotel workers. It’s a tight employment market, with about 4 percent unemployment. Hotels also generally employ immigrant workers, and the recent tightening of U.S. immigration policies could also impact the availability of new staff. At the same time hotel construction ramps up - right now we are in an environment with a lot of hotels delivering and a slowing labor market.

Diana Bell, New York City Market Reporter  CoStar Group   

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