PHOENIX—The life cycle of a hotel project begins long before a lender becomes involved, but that’s the most critical juncture during the current economic landscape. If an owner or developer isn’t prepared to meet a lender’s requirements, they might as well kiss their project goodbye, according to speakers in “The Life Cycle of a Hotel Project” think-tank session held during the Lodging Conference earlier this month.
Bob Olson, CEO and president of R.D. Olson Development said a lender has three basic questions when considering a hotel project:
- Is the project economically viable?
- What’s the experience of the developer, the brand, and the architecture and design team?
- What’s the developer’s ability to repay this loan in the event of default?
“Banks are extremely uncomfortable right now even with experienced developers,” Olson said. “But things are easing up … lenders are confident things are turning around, and they’re willing to step out. Banks are in the business to lend money. They need to do business, too.”
With hotel development in the United States at a virtual standstill during the past couple of years—supply growth has been hovering at approximately 1% during that time, according to STR—the speakers agreed that it’s not a bad idea for developers to refresh their memories regarding project necessities. STR is the parent company of HotelNewsNow.com.
Lenders are more than ever looking at the soundness of the economics of a project, said Tom Lander, VP and GM of Mortenson Development.
“Location is key,” he said. “Lenders will look for market analysis, brand pro forma that’s supported by market analysis, brand strength, developer strength. You need to focus on the experience of your team. Presenting the strength of the team and the underwriting … that’s critical.”
Mark Purcell, VP of North American development for Starwood Hotels & Resorts Worldwide, hammered home the experience factor.
“If you haven’t been the lead developer on the project, you need to make sure you have a well rounded team with a vast amount of experience to convince a lender to take a chance,” he said.
While building the capital for new construction remains a challenge for developers, they need to approach the process with a stable budget plan that maximizes available resources.
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| Lalaine Tanaka (center) of JCJ Architecture discusses the importance of budgeting as David Tracz (left) of Studio3877 Architecture and Bob Olson of R.D. Olson Development listen during the Lodging Conference. |
“Maintaining budget is a team effort,” said Lalaine Tanaka, design principal for JCJ Architecture. “Having the whole team look at the major parts is important. For instance, looking at the guestroom and saving one square foot per hotel room starts to add up. Those are the things you need to start working with.”
“That’s opposed to design, hope and pray, which is a disaster,” Olson said.
Save some for a rainy day
A budget contingency is always nice to have, but it’s not always a luxury in a climate where cash is hard to come by.
Lander said he’s comfortable going in with a 3% to 5% contingency. “A new developer coming into a project has to have a bigger contingency than that. I would not go below 3% contingency going into a new-build project.”
David Wani, CEO of Twenty Four Seven Hotels, a California-based hotel management company, said the number is substantial higher for adaptive reuse projects.
“You need a 15(%) to 20% contingency just to be on safe side because you never know what you’re going to get into,” he said, noting that unseen obstacles in a building skeleton can quickly push up costs.
The timeframe of a development can be as varied as the projects, Lander said.
“Once you’ve got the project conceived, entitlement done and financing in place, then the race begins,” he said. “The whole challenge is (tighten) the development time as much as possible.”
Olson said vendors and service providers to the industry should have the same “speed wins” philosophy as developers.
“It is absolutely to your advantage to figure out how to be the fast deliverer of goods or services to market,” he said. “Delivery time can trump price often—as long as you’re close (on price).”
Branding is vital
The speakers said choosing a brand for the property early in the process is essential.
“Brand is paramount—it’s the first and most important decision,” Wani said. “Look at unaccommodated demand in the market, the brand’s performance and the exit strategy the brand provides.
“We’ve walked away from three or four deals in last few years because of brand—we wouldn’t consider doing a hotel without a brand,” he added. “Most of our equity is positioned for an exit strategy game. The brand gives it quite a bit of value.”
Wani said many lenders focus on brand as much as location.
Localizing a brand’s décor package whenever possible should also be decided on early in the project’s life cycle, speakers said.
Tanaka said making those early decisions allows for more of a value-engineered design experience—including using all the wasted space that exists in many brand prototypes.
“It requires an experienced team that utilizes all the space,” she said. “Most of the public spaces are never going to be used 100% at the same time … They need to be created to be utilized during down times.”
“Understand the brand you are working with and what their touch points are,” said David Tracz, partner with Studio3877 Architecture. There are technical points, as well, including how the code’s going to work among others.
Knowing everything about the hotel’s location is essential, according to Tracz.
“Understanding the climate of the place you are in from the environment to what kind of people that live nearby to what kind of guests you can expect makes the entire development process more efficient,” he said.
“We always want to keep a semblance of the brand experience,” said Starwood’s Purcell. “For upscale brands, we have a guestroom package we want to make sure is in place, but we provide a little more flexibility in the public space so it’s a unique experience for the guest. A sense of place is important.”
What’s ahead?
Even as financing remains tight, the speakers are optimistic about what’s coming down the pike for hotel development.
“We have a cautiously optimistic outlook,” Purcell said. “The key issue there is financing.
“The inability of developers to secure debt is holding new-construction projects back,” he added. “For most people the best use of capital is to buy an existing property because it’s lower than replacement costs and the lenders know that. It’s going to take time.”
“In certain markets there’s strong development potential,” Wani said. “In the western U.S. there are markets that are showing demand imbalance. In those markets the local and regional banks are showing interest that they would lend on those projects.”
“On the development side, we’re looking on the West Coast,” Olson said. “Two years ago there was nobody at the doorstep to talk to land owners about potential development. A year ago people started sniffing. Now there are two, three or four interested in projects, and if a broker has it, seven, eight or nine (letters of intent) are coming in.”
“If you have the opportunity to develop today, now is the time.”