Slower Pace of Hotel Supply Growth Could Be a Years long Phenomenon in the State

By Bryan Wroten | Hotel News Now | January 17, 2024 | 5:20 AM

The number of hotel rooms opened in California in 2023 dropped 10% compared to 2022, and that’s likely a sign of what’s to come with hotel development in the state.

Atlas Hospitality Group’s California Hotel Development Survey 2023 Year-End reports that 53 hotels with 6,280 rooms opened in California last year. That’s down from the 57 hotels with 6,993 rooms that opened in 2022.

Since Atlas started tracking California hotel development in 2010, the average number of hotels opened each year is 46, Atlas President Alan Reay said. The low point was nine hotels in 2011, and the peak was in 2019 with 92 hotels. Given the current development and lending conditions, it’s likely this is the start of a slowing in pace for hotel openings in the state.

“For 2024, I think that we will start to see the beginning of the slowdown of new hotels opening up in California,” he said.

The drop from 2022 to 2023 was not a surprise, Reay said. The difficulties owners and developers face in California are the same others face across the U.S., namely higher costs for construction labor and materials as well as fewer lenders active in the hotel development space. On top of that are the other barriers to new projects, such as the entitlement process.

At least 10% of the hotels that Atlas counts as under construction are shut down, he said. While the projects have broken ground, progress has stopped because of funding, legal disputes or other issues. Some of those hotels “may never, ever open,” Reay said.

He said he expects the number of hotels opening each year to trend down to the mid-30s.

The survey reports there are 107 hotels with 14,225 rooms under construction across the state. By year-end 2022, the state had 114 hotels with 15,352 rooms in construction. The survey records 1,245 hotels with a total of 163,829 rooms in planning, a category that includes hotels that CoStar separates into planning and final planning stages. The 2022 numbers show 1,245 hotels with 165,585 rooms in planning.

A key hurdle in moving from the planning stage to in construction is financing.

Many of the downtown areas of cities such as Los Angeles or San Francisco just don’t have market conditions that make deals pencil for lenders, he said. Developers may have better luck in resort areas and the wine country, but many of those also are well established and have the capability of building those properties using only cash or taking on little debt.

There’s the possibility of interest rate reductions this year, but it’s unknown how long-term those reductions will be or whether they’re permanent, he said. Many developers expect it will become easier to start new projects when rates drop, so that’s injecting optimism into the industry. But the other factor is whether lenders will return to the hotel development space.

“A lot of these lenders, they pulled out of the market entirely, so I don’t think two or three rate drops — unless it’s a substantial rate decrease, I don’t think you’re going to see lenders rushing back into the market,” he said. “I think they are very much a ‘Hey, let’s wait and see what goes on here.’”

When the regular lenders don’t step up, that leaves developers with private or hard money, and they don’t reduce rates much, so developers will still face 12% to 13% in interest.

The other factor to consider with interest rate drops is how that will affect hotel transactions, Reay said. There’s been a big disconnect between buyers and sellers of hotel valuations, but if interest rates come down, that could make hotel deals more attractive, especially compared to the cost of building new.

“I think we’ll start to see some of these transactions selling at or below replacement cost,” he said. “That then brings up, ‘Am I better taking on the risk of a new development, or am I better off buying a deal below replacement cost and then fixing it up?’”