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A Developer's Dream: Midscale Hotels

Abuilding boom is under way in the limited-service hotel sector, also known as midscale without food or beverage. Approximately 25,800 rooms are under construction — and another 17,898 rooms are in the planning stages.

Despite the growing supply of midscale rooms — 661,895 as of September 2005 — the final chapter has yet to be written. Oil prices, a potential shortage of building materials resulting from a record hurricane season and consumer confidence could waylay projects in the construction pipeline.

So, what's the main attraction? For starters, midscale hotels are less costly to build, yet typically reap higher returns than their full-service hotel cousins.

According to Smith Travel Research, the midscale sector encompasses 32 brands. The crowded playing field includes Hilton Hotels' Hampton Inn, InterContinental's Holiday Inn Express, Marriott's Fairfield Inn, La Quinta, and Choice Hotel's Comfort Inn. With so many brands to choose from, developers gravitate toward the chains that offer strong consumer appeal.

This is partly why Holiday Inn Express and Hampton Inn stand out as the fastest growing brands in this segment, say industry experts. Both have poured resources and money into upgrading the mainly franchised chains, enabling the properties to grab higher occupancy and room rates than some of their competitors. Strong toll-free reservation systems and frequent traveler clubs also serve to entice travelers, and hence, developers.

“Developers look at a lot of things [when deciding what brand to build]. Ultimately, they look at profits and how much they are going to take to the bank,” says Phil Cordell, senior vice president of Hampton Brand Management.

Kerry Ranson, vice president of operations at Birmingham, Ala.-based HP Hotels, agrees. “We build hotels which are going to give us a high return on our investment.” HP operates 26 hotels, including five Holiday Inn Expresses and five Hampton Inns, which they own. And the company plans to open three Holiday Inn Express hotels and one Hampton Inn between now and August 2006.

A typical Holiday Inn Express with 75 to 80 rooms costs about $50,000 to $60,000 per key to build, says Verchele Mills, vice president of brand management for Holiday Inn Express. Similarly, an average Hampton Inn with 80 rooms costs between $6 million and $8 million to build, or $60,000 per room. Yet, investors can quickly recoup these costs, especially as occupancy and room rates continue to rise, says Hampton's Cordell.

Hampton Inn and Holiday Inn are reporting healthy vital signs. For the three months ending June 30, 2005, occupancy at Hampton Inn hit 76.1%, up from 71.8% the previous year. The average daily rate (ADR) was up 6% to $87 and revenue per available room (RevPAR) jumped 12.4% to $66.18 in the same period. RevPAR during the first half of 2005 rose 12.7% to $61.60 from $54.68, exceeding Smith Travel Research's current year-to-date RevPAR of $60.44 at midscale hotels without food and beverage.

Room rates are even higher — about $100 per night — at Hampton Inn & Suites. These hotels have about 100 rooms — 30% to 50% of which are suites with living rooms, separate bedrooms and kitchen areas. InterContinental, a publicly traded company based in the UK, does not break out brand RevPAR, yet room rates at Holiday Inn Express average $70 to $80 per night, says Mills.

“The Holiday Inn name has a lot of cache. People like the product and they're willing to pay higher room rates,” she says.

The gift that keeps giving

The upside at both brands is that oftentimes the room rates rival those at full-service properties with restaurants, meeting rooms and fitness centers. Consumers, however, are willing to pay the price. HP's Hampton Inns and Holiday Inn Express, for example, are located mainly in the suburbs of cities in Southern states, yet travelers don't seem to balk at paying an average of $86 a night, says Ranson. “We've dispelled the myth that Hamptons can only charge $69 a night,” adds Cordell.

The best part of the deal is that because of the relatively high room revenue, the franchises are consistently cheaper to build than their full-service brethren. Michael Hoffman, president of Turf Hotels in Albany, N.Y., says his company spent about $50,000 per key — excluding land — to build its one Holiday Inn Express 10 years ago. That same 121-room hotel would cost about $75,000 per room to build today.

But that's still a bargain because it would cost upwards of $90,000 per room to build a full-service hotel, such as a Holiday Inn, says Hoffman, whose small company also owns two Holiday Inns.

Turf's Holiday Inn Express operates at a 79% occupancy rate with room rates at about $105 per night. Without a big staff to pay and no food and beverage operation to run, more of that room rate drops to the bottom line. “It's given us a wonderful return on our investment,” he says.

HP, on the other hand, spends about $60,000 to $65,000 per key on its Holiday Inn Express hotels and about $67,000 to $75,000 on Hampton Inns, says Ranson. The cost is significantly less than what the company spends on building full-service hotels, which require restaurants, fitness centers and large common spaces.


Although Comfort Inn & Suites, with 1,854 hotels, is still the largest midscale brand without food and beverage, Holiday Inn Express and Hampton are the industry's two fastest growing brands, says Patrick Ford, president of Portsmouth, N.H.-based Lodging Econometrics.

Holiday Inn Express, with about 1,400 hotels as of October, has the biggest construction pipeline in the hotel industry with 349 hotels in some form of the planning or building phase, according to the company. Hampton Inn and Hampton Inn & Suites, a close second with 1,319 hotels, has 341 properties in either the design phase or some form of construction, according to Hampton.

The midscale segment without food and beverage is typically the fastest sector to rebound after a construction downturn in the industry, says Ford. The most recent leveling-off period was in the fourth quarter of 2003. “The new construction cycle, which picked up in the first quarter of 2004, always kicks off with small hotels in small markets,” he says.

Building these hotels, which are flexible in size depending on the market and available land, also is a major attraction for developers. “They are really designed to place anywhere in America,” he says. In addition, these properties are easier to sell than other flags, making them prime targets for developers and buyers looking to perhaps sell down the line.

“Hampton has the highest demand [from sellers], followed by Holiday Inn Express,” says Al Calhoun, managing director of Jones Lang LaSalle Hotels' select-service division in Atlanta, which recently sold two Hampton Inns. Both had several prospective buyers and the deals closed within 90 days, says Calhoun.

Equity Inns Inc., a Memphis-based hotel REIT with 122 hotels, is the largest owner of Hampton Inns in the country with 53. In the last 18 months alone, Equity has purchased 11 Hampton Inns or Hampton Inn & Suites. “It's an excellent brand,” says Silver, adding that occupancy at the Hampton Inns for the second quarter hit 74%, and daily rates were $82 or more. Equity is looking to buy more Hampton Inns, he says.

Upgrades galore

Both Hampton and Holiday Inn Express have enhanced the brands in the last couple of years by adding more amenities and services. Holiday Inn Express, for example, introduced its Express Start breakfast bars in 2003 to all of its properties. The franchiser then hit the showers last March for its SimplySmart bathroom upgrade, which included the rollout of about 120,000 new showerheads and more than a million plush towels.

In September, Holiday Inn Express announced its latest brand enhancement: SimplySmart bedding, a $53 million investment in duvet blankets and high-quality sheets that will be rolled out to North American hotels in April 2006. The program is expected to be fully implemented by September 2006.

Hampton Inns has just completed the first phase of its highly touted “Make it Hampton” program, one of the most comprehensive upgrade programs in the hotel industry. Brand enhancements in the first phase included a hot “On the House” breakfast bar, new bath amenities, redesigned interiors, and enhanced in-room technology — including its signature alarm clock with easy-to-find music stations and simple instructions for setting the alarm.

The second phase of the “Make it Hampton” program, which kicks off this month, includes a new bedding package. All told, the brand will spend upwards of $80 million on the innovative program. In conjunction with “Make it Hampton,” the brand also introduced a new prototype, which includes larger guest rooms, wider hallways for easier luggage handling, and bathrooms with more storage space, according to the company.

Although these costs are passed on to owners who pay higher franchise fees, developers say the benefits far outweigh the lofty price tag.

“The amenity packages are tailored to drive strong demand and higher average daily rates,” says Jay Shah, president and COO of Hersha Hospitality Trust, a Philadelphia-based hospitality REIT that owns nine Hampton Inns and seven Holiday Inn Expresses.

Hersha owns 49 hotels and is continuing to add these two brands to its portfolio either through acquisitions or new development with joint-venture partners.

“We find them to be category killers. They are the market leaders in their segment,” says Shah.

Tough times ahead?

With a record number of Hampton Inns and Holiday Inn Express hotels in the planning stages, some industry experts say that developers may be in for a rough ride. They may not be able to complete hotel projects on time or within budget. In some cases, they may have to abandon construction plans altogether.

So, what's casting a dark cloud over this seemingly bright future? Rapidly accelerating construction and energy costs, coupled with a shortage of construction labor.

Over the last several months, building material costs have risen sharply. To make matters worse, commodities are now in short supply. The combination of the sheer amount of resources needed to rebuild the Gulf Coast coupled with the current condominium wave also is diverting supplies away from new hotel construction, say analysts.

“Both systems [Hampton and Holiday Inn Express] have record levels of development activity in the pipeline. The real issue now is how many deals will get done,” says Mark Woodworth, executive managing director at PKF Consulting in Atlanta.

Unknowns such as rising energy costs, beginning stages of inflation, and the drop in consumer confidence are factors causing some experts to temper their bullish views on the growing midscale segment.

“I'm working with the development community to monitor how it is wrestling with the issues,” says Ford of Lodging Econometrics. “My intuition says there will be a slowdown in new projects.”

Robyn Parets is a Boston-based writer.

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