Pressures of pandemic slow California hotel pipeline

Pressures of pandemic slow California hotel pipeline

01 SEPTEMBER 2020 8:04 AM

Projects continue to enter and remain in California’s hotel construction pipeline, but the reality of the coronavirus pandemic is that many projects will never be completed.

REPORT FROM THE U.S.—California hotel development slowed over the first six months of 2020, but the full impact of the coronavirus pandemic on new hotel projects likely won’t be realized for years.

The latest mid-year hotel development survey from Atlas Hospitality Group found a significant decrease in construction and openings during the first half of 2020 compared to the record-setting pace of the first part of 2019. The number of hotels under construction fell from 234 in the first half of 2019 to 194 this year, a 17.1% decrease. While the number of hotels opening so far was down by just one (35 compared to 36), the number of rooms opening was down by 22.5% (from 4,515 to 3,500).

Conversely, new projects in planning grew by 9% compared to the first half of 2019, with new rooms in planning growing by 5.7%. However, those growth figures don’t tell a complete story.

California still has a healthy pipeline of hotels opening in the second half of the year, Atlas Hospitality Group President Alan Reay said. The pace may slow further this year and into 2021. Several hotel projects were completed during the first half of the year, but openings were delayed. In addition to what Atlas Hospitality normally tracks, it is now watching projects being deferred or abandoned.

Hyatt Hotels Corporation’s partly built Andaz Palm Springs is now in bankruptcy, Reay said. The incomplete Hotel Indigo Coachella has been shut down. Work on the Tova Hotel in Palm Springs has also stopped. Many of these projects were in trouble or faced delays before the pandemic began, he said.

“If you’re struggling to make it work in some of the best of times in the hotel business, 2018 and 2019, when you look at it today, post-coronavirus, it’s just going to be impossible,” he said. “We put pressure on revenue, pressure on net operating incomes and, really, your construction costs are still the same. In some instances, these projects are going to cost more to finish then what they got appraised for.”

The downturn has hurt lenders as well, not just for hotels, but in retail and other product types, Reay said. If lenders start to go under, construction money will run out, leaving many projects only partially built and unlikely to get finished. Some developers now are even looking at changing the use of a property partway through construction. Depending on the build, many are looking at residential use, further reducing future supply.

Reay also noted a lack of new projects starting up. One of the main reasons is that lenders aren’t even looking at financing existing hotels today, let alone new projects, he said.

“From a time standpoint, if you’re not already under construction, with a construction loan in place, I really don’t see people proposing new projects for the next 24 or 36 months,” he said.

Developers likely won’t even buy land to hold onto until conditions improve for building because holding costs become very expensive, he said. Unless the property is owned free and clear, the project likely is carrying some sort of debt.

When new projects do start up again, extended-stay hotels will likely be popular given the demand during the pandemic, Reay said. While hotels in the economy segment have also performed well, that’s not something he expects to see more of in the pipeline given the cost of construction.

In the last major downturn, developers and owners still interested in hotels bought existing properties and renovated, which was well below replacement cost, he said.

“Anyone that’s looking to build a convention center hotel or a resort property is going to have a really, really hard time moving forward,” he said.

Developers’ experiences
R.D. Olson Development has three hotel projects in the works in California, said President and CEO Bob Olson. The firm is moving ahead with deals that have long lead times and in markets that are a good long-term investment, but has dropped out of a few deals made before the pandemic started.

Financing, if available, is incredibly difficult, he said. Lenders have turned off the spigot for 99% of deals until they can figure out what’s happening in their markets. The pandemic is playing out longer than anyone anticipated, but it will eventually turn around and the ramp-up should look like a typical recession recovery, Olson said.

For developers who are in early planning or about to start construction and have access to financing, this is likely the best time to develop as prices are coming down, Olson said. Timing-wise, the project would deliver in a rising market.

The combination of years of dramatic construction price increases and the staggering negative effect on revenue per available room from COVID-19 has created an extremely challenging underwriting process for new hotel construction, said OTO Development VP of Real Estate Todd Turner via email. Most hotel projects in planning across the state will be impacted, with many shifting to some other type of use.

California has a large percentage of big tech companies that currently operate in a work-from-home scenario, OTO Development CEO Corry Oakes said via email. Long term, the company believes tech employees will miss the collaboration and culture-building that comes from being together. For the short term, however, the work-from-home approach translates to reduced hotel demand, making underwriting decisions more difficult and pushing out the start of new construction projects.

“Hotel profitability has disappeared, and the resulting financial stress will wipe out a significant portion of hotel equity, forcing a change of financial ownership of many assets,” Oakes said. “We believe these issues will need to work through the system before development picks up any meaningful momentum.”

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