What a difference a year makes – in the 2022 edition of Trends® in the Hotel Industry, we wrote that major markets were still attracting developers and that new supply growth among the nation’s 65 major markets was expected to record an annual gain of 1.7%, which is above the long-run average of 1.5%. However, over the past year, the market conditions have changed with rising construction costs, rising financing costs, less financing options caused by the recent turmoil in the banking industry, and market uncertainty coming to the forefront, along with the recovery from the COVID-19 pandemic still playing a factor.
The cost of construction materials, labor and land has been increasing steadily in recent years across the country. Depending on the property’s specific location, class and franchise, hotel construction costs have increased between 10% and 20% in most markets recently, which is cutting into the developer’s profit for a given development. With that said, it appears construction costs may have peaked, and going forward, more typical, inflationary level increases in construction costs are expected in the near-term.
Financing costs have risen over the past year and recent turmoil in the banking industry caused by the collapse of Silvergate Bank, Silicon Valley Bank, and Signature Bank are also making it a challenge for developers to secure financing for new projects. The Federal Reserve began interest rate hikes in March 2022, attempting to curb inflation. As of the date of this publication, CBRE is forecasting interest rates to peak in mid-2023 and the Fed could begin cutting interest rates later in 2023. Certainty on the interest rate outlook will provide some stability for capital markets activity once that occurs. However, the Fed’s policies may initiate a recession in 2023 or 2024 – CBRE’s economic forecast as of March 2023 calls for two consecutive quarters of negative GDP growth during the last half of 2023. If a recession comes to fruition, there is uncertainty regarding the magnitude of the recession and how long it will last.
As a result of all these factors, it has been difficult for hotel developers to identify feasible hotel developments. The supply growth of new hotel rooms decreased in 2020 through 2022 as the hotel market faced challenges from COVID-19 and the recovery from the unprecedented pandemic. With the previously noted headwinds the market is currently facing, this trend is likely to continue over the next several years.
Looking back, from 2016-2019, the average annual rate of hotel room supply growth across the United States was 1.8% compared with the average annual rate of room night demand growth of 1.9%. New supply growth dipped to 1.2% in 2020, 1.2% in 2021 and 0.5% in 2022. The February 2023 edition of CBRE’s Hotel Horizons® projects new supply growth to rise above the 2022 level increase at an average rate above 1% for the next three years. This pace is well below the amount of new supply growth experienced before the COVID-19 pandemic, and less than the 2.5% pace of demand growth over the next three years.
These supply and demand growth rate figures are national figures, and the impact of slower supply growth is more pronounced on a market level. The following two lists rank the Top 10 markets for forecasted new supply growth and room night demand growth over the next five years.
As is illustrated, only two markets (New Orleans and Nashville) appear in both lists. Not surprising, as is shown in the following illustration, all 10 of the top demand growth markets are forecasted to experience strong occupancy gains over the next five years, well above the occupancy growth rates forecasted for the United States as a whole, which is projected to more or less level out beginning in 2024.
The reduction in new hotel supply growth could cause several outcomes for the hotel market, including higher occupancy rates, rising room rates for existing hotels, and repositioning opportunities for older, inferior hotels. If actual demand growth rates exceed what is forecasted in our models, the hotel market could be facing a hotel room supply shortage, which would fuel the growth in occupancy rates and room rates. This will be a welcomed reprieve for the operators of many existing hotels that are pursuing higher occupancy rates, closer to pre-COVID-19 levels. With that said, franchisors and market forces will likely place higher property improvement plan requirements on existing hotels to justify higher rates and maintain a competitive advantage in the wake of lower hotel supply growth in many markets. Further, speculative hotel developers banking on a stronger than expected recovery may benefit from the gamble if the market outperforms expectations.
With the downturn from COVID-19 mostly in the rearview mirror, an apparent moderation of construction costs, and interest rate increases likely to peak in 2023, we await the impacts from the Fed’s policies to see if a recession occurs and to what extent the potential recession impacts the overall economy and the hotel market more specifically. Once that becomes clearer, we will have a better idea of how the reduced new hotel supply will actually impact the hotel market. As always, we will continue to update our forecasts and models as we receive new data points.