Projects Entering Construction Phase Expected To Decline Over 18 to 24 Months

By Bryan Wroten
Hotel News Now

July 31, 2023 | 6:13 AM

Fewer hotels opened in California in the first half of 2023 compared to last year, according to a new survey.

Atlas Hospitality Group’s California Hotel Development Survey 2023 Mid-Year shows that 20 hotels opened in the state during the first six months of the year, a 31% year-over-year drop. The number of rooms opened was 3,561, also a 24% decline.

The number of hotels under construction increased by 5.2% to 122 while the number of hotel rooms under construction remained relatively flat at 16,321 compared to 15,958 last year. Atlas forecasts a significant decline in the number of new hotels entering the construction phase over the next 18 to 24 months.

The figure that jumped out for Atlas President Alan Reay was the 60% decline in hotel openings compared to the first six months of 2021.

“But I think it’s no surprise to anyone,” he said. “Unless [your hotel was] actually under construction, the number of those projects is definitely drying up now, and primarily because of what’s going on in the marketplace — [rising] interest rates and most lenders today are completely shying away from any new hotel construction loans.”

New Development

Not only is new hotel supply slowing, it’s decreasing in California, primarily due to projects converting older hotels to other uses, mostly housing, Reay said. The state-funded Project Homekey is a major driver of this change. An industrial company last year acquired a hotel in Orange County to knock down for industrial conversion, which Reay said was a first.

“All of these things would lead me to believe that for the long term, California is going to be a good place for people to invest — at the right numbers,” he said.

Reay said for the next 24 to 36 months, he expects little competition for new hotel products entering the marketplace. An owner that can generate a premium on average daily rate and revenue per available room could justify a new-build project.

Full-service and luxury hotels will remain difficult to develop, Reay said. Extended-stay properties in suburban locations, such as a Home2 Suites by Hilton or Residence Inn by Marriott, have a better chance of getting financed.

However, that’s all subject to how much the developer is going to put down, he said. The days of 70% to 75% loan-to-value construction money are over. Now developers will need 50% to 55%.

“For those well-heeled and well-capitalized borrowers, I think that you will see them be able to get deals,” he said. “But again, it’s going to be primarily in that limited-service, extended-stay platform.”

A limited-service hotel will likely take 18 to 24 months to develop, he said. Full-service projects are between 36 to 42 months from start to finish. Both timelines are the longest in Reay’s memory.

Even if a hotel project breaks ground, that’s not a guarantee it will open on time, or at all.

“In all the time that we’ve been tracking hotel development in California, I have never seen so many projects running into financial difficulty mid-construction,” Reay said.

Developers’ initial budgets have ballooned due to labor availability and the resulting increase in costs, he said. Raw materials remain expensive.

There are about a half-dozen projects in the Coachella Valley alone that are completely closed and out of money, he said. One of the largest projects there, the 250-room Hotel Indigo Coachella, has filed for bankruptcy and is in the process of being sold.

Financing Challenges

There are some big construction lenders still active in California, such as Bank of the Ozarks and Hall Structured Finance, Reay said. There are also some regional lenders, but they’re working with developers they have existing relationships with. Banks are clamoring for deposits, so if a developer has a relationship and sufficient deposits at the bank, the bank may be more inclined to lend on a project.

“But if you’re just someone coming in off the street and going to a bank as a brand-new customer, no deposits — you’re not going to get a loan,” he said.

Developers are working with private sources of debt, or hard money lenders, Reay said. Commercial property-assessed clean energy lending is another big source of funding that developers are using alongside construction loans to get their projects completed.

Another issue, though, is if there are ownership companies who stop servicing their loans or selling off properties, the hotels are going at prices below replacement cost, he said. A developer will need to get a project appraised, and the banks might not be as interested.

“The bank’s going to look at the appraisal and go, ‘Well, wait a minute. You’re talking about a construction cost of $180,000 to $200,000 per room, and we’re now seeing hotels trading at $150,000 a room. That doesn’t make sense,’” he said. “That’s going to play into it.”