Despite difficulties securing financing for new construction, the Manchester Financial Group hopes to break ground this year on a highrise hotel in downtown San Diego.

BY LORI WEISBERG | JAN. 18, 2024 10:30 AM PT

The pace of hotel construction in San Diego County rose slightly last year compared to 2022, bucking a statewide trend of slowing development amid rising interest rates and lenders’ lack of enthusiasm for financing new projects.

A newly released statewide survey from Atlas Hospitality Group reveals that six hotels with 2,191 rooms were under construction in San Diego — a year-over-year increase of 3.5 percent. Accounting for the vast majority of those rooms is the 1,600-room bayfront resort hotel in Chula Vista, which broke ground in 2022 and is part of a $1.2 billion project that also includes a convention center and 1,600 parking spaces. It is the largest of all hotels under construction last year in California.

Meanwhile, just two properties — each under 200 rooms — opened in San Diego County last year. Those were the 145-room AC Hotel in downtown San Diego and the 122-room Extended Stay Suites property in San Marcos.

Statewide, Atlas reported that 53 hotels with 6,280 rooms opened in 2023, which represented a 10 percent decline from the nearly 7,000 new hotel rooms that came on line in 2022.

Given the long period of time it takes to plan, finance and construct hotels, last year’s development activity doesn’t yet reflect current market trends that are making new projects much more challenging, said Alan Reay, president of Atlas Hospitality Group. He expects that development will slow considerably in the near term given the high costs associated with construction and difficulty securing financing.

“Interest rates have gone up, and any lenders who were in the market to do hotel construction loans are pulling out of the market entirely,” Reay said. “In California, the cost of construction has gone up quite a bit, and in California, compared to other states, there are a lot of rules and regulations that drive up the cost.”

In his year-end survey, released this week, Reay concludes: “For those developers who have hotel projects in planning but have not yet obtained financing, we predict that very few will move forward.”

He added, “The fact that we see strong headwinds facing new hotel development, combined with so many California hotels now being purchased for alternative use — homeless housing/affordable apartments — will create upward pressure on values.”

At the same time, however, increasing numbers of distressed hotel properties, some of which have been going back to the banks, could depress the future pace of new development. Some hotels, Reay said, are selling at 40 percent of what they sold for in 2018. That, however, is not happening in San Diego County, he was quick to add.

Alex Guyott, San Diego-based development manager for the development arm of Hensel Phelps Construction Co., said he’s concerned about the impact distressed hotel sales could have on prospects for development, although such sales have not shown up locally.

Hensel Phelps is part of a development team — including Portman Holdings and Lankford & Associates — that plans to submit a proposal for redeveloping a 3.4-acre property at 1220 Pacific Highway that is being vacated by the U.S. Navy. While the team is not disclosing its specific plans, it is likely to include hotel rooms.

That is the same team behind the adjacent Lane Field hotels — the Marriott SpringHill Suites-Residence Inn and InterContinental San Diego at Broadway and Pacific Highway.

“Right now it’s kind of the perfect storm between construction costs that really haven’t come down meaningfully yet and the high cost of capital, so these deals just don’t underwrite very well right now,” Guyott said. “We’re obviously invested in San Diego with our current hotel assets, and that’s why we’re pursuing 1220 Pacific Highway, but if we were to go out for financing today it would be very difficult to get across the finish line.

“So we are trying to plan projects in areas we believe in, and when the capital market is better and costs are under control, it will be a better time to finance these projects.”

The Manchester Financial Group, which announced plans in 2022 to build a 36-story, 1,150-room hotel — also near downtown San Diego’s waterfront — is having to weigh current market conditions as it prepares to seek an equity partner and construction loan for the $550 million project, said Manchester president Ted Eldredge.

“We’re waiting for interest rates to stabilize a little bit, and we’re not under the gun to build right away,” Eldredge said. “Our timeline is as soon as possible. The project is completely ready to go, and we could break ground tomorrow but the debt market has changed quite a bit, and capital markets are not real excited with ground-up construction. They’re financing existing hotels where they can.

“But we do have a superior site and we are in a good market as well. Once interest rates stop going up and the capital market stabilizes we’ll go out to market and build.”

It’s Eldredge’s hope that the project could break ground some time this year.

Reay said it’s clear that demand for hotels will remain strong in San Diego County given its appeal as a tourist destination, but also because supply is not growing that much. In fact, it may be declining slightly because of the hundreds of hotel rooms that are being sold to help house the homeless, he said.

“So we’re actually looking at a net loss of supply in California and definitely San Diego,” Reay believes. “So what does that mean? That means as a traveler you’ll have to pay more to stay in San Diego. But it’s also hard to see how, over the long term, you’re not going to make good money on a hotel investment.”