1999 Hotel Development Costs Increased

The cost of developing U.S. hotels rose anywhere from 3.7 percent to 6.2 percent last year, depending on category, with the cost of luxury hotel development understandably coming in at the high end. By contrast, the national Consumer Price Index rose 2.2 percent last year. At the same time, these development costs were in line with higher building costs across all U.S. construction segments.

The development cost picture is not good news for the lodging industry, nor is it particularly welcome news for travel buyers. Higher development costs, after all, discouraged developers from undertaking hotel projects and financial institutions from underwriting them. This, in turn, tightens the rate of supply growth of new hotels. Assuming the rate of demand growth remains strong, particularly in key gateway cities, this would keep the pressure on maintaining rates, putting buyers at a disadvantage in negotiations for 2001 and beyond.

The reasons hotel development costs remained high could be summed up in one word: competition. "Hotel developments continued to compete with commercial and residential projects in many areas," said Elaine Sahlins, a director of HVS International. Sahlins' conclusions are included in an HVS hotel development cost survey released this month. "The construction of new office buildings, residential subdivisions, high-tech industrial space and large public infrastructure projects in 1999 propelled the construction industry into its eighth straight year of growth," she added.

According to HVS, the demand for subcontractors and basic building materials in the past 12 months pushed building costs above the rate of inflation. "As a result, some hotel construction projects, including new construction, expansions and renovations exceeded initial budgets," Sahlins said.

At the same time, hotel industry market forces continued to support the development of new hotel rooms in some U.S. markets. "The pipeline of new hotels is expected to continue at a 3 percent to 3.7 percent rate over the next three years," Sahlins said, "while the pipeline of other real estate projects also continues apace." Likewise, construction costs are expected to increase above the rate of inflation this year.

Evidence of a slowdown this spring in U.S. hotel room construction, meanwhile, was found by a lodging industry security analyst. "U.S. hotel construction starts decreased 8 percent in June to an annualized pace of 80.9 million square feet over the prior year," said Keith Mills, who covers the industry for PaineWebber. This translated into an estimated 134,900 rooms, assuming 600 square feet per room, including public space. Year-to-date construction starts were down 7.7 percent. Mills expects starts to continue to decline during the remainder of the year. Compatible with HVS' projections, he estimated that supply growth would increase 3.1 percent in 2000, having grown 4.2 percent in 1999.

When it comes to land acquisition costs, HVS estimated that these prices rose 3 percent to 5 percent last year as good hotel sites became more difficult to secure and competition among developers intensified, particularly in the more densely developed markets.

Separate from the cost of new construction, but related to it, was the cost of renovations of existing properties. These rose last year as well, driven by increases in the cost of labor and materials. For economy and budget hotels, costs increased 3 percent to 4 percent, while at the luxury end, they rose 5.5 percent to 7 percent.

Another area Sahlins analyzed—known in the industry as furniture, fixtures and equipment—saw costs rise from 2 percent to 5 percent. But a factor at work here was unexpected. According to Sahlins, the increases reflected what she termed business travelers' "growing sophistication and individual needs." Specifically, she cited Marriott Hotels & Resorts' "desk that works" and Westin Hotels & Resorts' "heavenly bed" promotions as evidence that furniture and design had become a marketing tool.

"Business hotels getting wired for high-speed Internet access is further evidence that the quality and design of guest rooms and public spaces are more important than ever," she said.