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Performance Potential of Mid-Scale Hotels: Less May Be More

Hotel stakeholders have to know the right place, time, and hotel category to maximize investments. In the present economic climate, mid-scale, limited-service hotels may be a good bet.
Daniel McCoy

During the last decade, mid-scale, limited-service hotels have been one of the fastest-growing and most successful segments of the lodging industry. Relative to their upscale and full-service counterparts, mid-scale properties can provide an equal or even greater return on investment to owners and developers. Taken as a whole, mid-scale, limited-service hotels have also fared better than higher-end properties during the course of the current economic downturn.

Recent Performance

Cutbacks in corporate and consumer spending have hurt performance in all hotel chain-scale segments, but the impact on mid-scale hotels has been mitigated in part as budget-conscious travelers trade down from upscale to mid-scale brands. The table below shows weekly RevPAR declines for the month of August. Overall, it’s clear that the mid-scale, limited-service segment has fared better than the upscale segments and the collective market.

Weekly RevPAR Change in August of 2009 from Previous Year

Week Ending
All Segments (%)
Mid-scale without Food & Beverage (%)
Upscale (%)
Upper Upscale (%)
Luxury (%)
August 8th
-16.5
-14.7
-17.4
-18.0
-20.3
August 15th
-16.2
-13.9
-17.1
-18.6
-24.7
August 22nd
-16.7
-15.2
-18.0
-19.0
-25.1
August 29th
-22.0
-21.9
-21.3
-21.2
-26.8

Source: STR Weekly Hotel Reports as reported in the Daily Lodging Report


Transactions Market

The recession has brought to bear a major distinction in the financing and transactions markets for limited-service and full-service hotels. While the sale and financing of larger, more expensive properties virtually ground to a halt as banks called a moratorium on large-scale loans, the market for limited-service assets, which typically range from $3 to $10 million, has continued to hum along, even if that humming is faint compared to pre-recessionary years. Even loans of less than $10 million are difficult to chip out of the frozen credit market, and the terms are significantly more conservative than those that were available before the credit crunch. Yet, most of the financing for these transactions comes from local and regional banks, which by and large have emerged healthier than many institutional funding sources for larger transactions.

To Buy or to Build?

For investors looking to establish or expand their presence in the realm of mid-scale, limited-service hotels, one fundamental question will underscore investment decisions over the next six to twelve months, namely, whether to buy an existing property or to build a new one. The answer depends on factors specific to an individual market. Markets that have remained relatively insulated from the ongoing recession may be primed for new development in the next twelve months; markets that have been more severely impacted may present opportunities to acquire quality assets at a discount.

Development

Numerous secondary and tertiary markets across the U.S. have avoided the brunt of the economic downturn. Smaller markets that are anchored by stable demand generators such as military installations, educational institutions, government agencies, and regional medical centers may be prime locations to begin planning future developments. Even if demand levels are not yet high enough to support new development, the next twelve months may be an opportune time to acquire a site and begin the planning process. A mid-scale, limited-service property can be constructed more rapidly and with less money than a full-service hotel, enabling developers to quickly capitalize on increasing demand levels when the market begins to trend upward. Such timing is crucial to attaining projected revenue levels before other developers flood the market with additional rooms.

Acquisition

Many markets have experienced an influx of new room supply and an erosion of demand over the past two years. These markets may be ideal for exploring acquisition opportunities. Prospective buyers should be wary of markets that have seen demand eroded by the loss of a major employer or industry. In contrast, markets that have relatively stable demand generators but an oversupply of rooms are rife with opportunities for hotel acquisitions. In these markets there may be newly constructed hotels that are unable to cover debt service or refinance out of a construction loan, forcing owners to sell at a discount. With a lower debt load, these properties could be reestablished in the market to generate positive cash flow.

Another type of opportunity is a branded hotel that is beginning to show its age. If current ownership hasn’t initiated updates and renovations, the hotel’s performance has likely declined with the introduction of newer, higher-rated properties in the market. Owners that have not kept adequate reserves may be unable to maintain brand standards and could lose their hotel’s flag. This situation presents an opportunity for a new investor to acquire the property at a discount and perform subsequent renovations. The result is a newly renovated property with a significantly lower debt load than its recently constructed competitors.

Conclusion

Whether you are building or buying, it is essential to know the dynamics of the market and the risks of a particular property type. The rewards of a well-planned investment can provide strong incentive, but there can be plenty of unexpected pitfalls between an initial investment and the projected returns. The guidance of a hotel firm with proven experience in the mid-scale, limited-service product tier is vital in determining the appropriate steps to take. Please contact us to learn more.

About Daniel McCoy

Dan McCoy, MAI is the Managing Director, Senior Partner of the HVS St. Louis office. St. Louis is one of over 30 cities across North America where HVS has experts living and working, providing insights and solutions to clients. In the Midwest, HVS leaders are located in Chicago, Detroit, Minneapolis, Nashville, Cincinnati, and Omaha, in addition to St. Louis. Dan, a native of St. Louis, earned his bachelor's degree from Truman State University in Missouri and has front-line hotel experience with Hilton and Denali Park Resorts. Dan is a Designated Member of the Appraisal Institute (MAI) and a certified general appraiser in Missouri and surrounding states. Contact Dan at (970) 215-0620 or dmccoy@hvs.com.

1 Comments

  1. Raymond ChanOct 10, 2009

    Great article. What is your view on China leased-and-operated mid-scale, limited service hotel segment?

    • Dear Mr. Chan, Thanks for your kind words. The Asian American Hotel Owners Association (AAHOA, www.aahoa.com) and the Taiwan Hotel and Motel Association of North America (www.thmana.com) are two major, respected associations of Asian hotel owners and operators. Both have a large stake in the mid-scale, limited-service class of hotels in the United States. If you’re referring specifically to the mid-scale segment in China, our HVS office in Beijing can assist you. If I can help answer any specific questions for you or refer you to someone connected with these organizations, please contact me at dmccoy@hvs.com or 970-215-0620. Thanks, Dan

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