Hope Springs Eternal

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hopespringseternal

As Canada emerges from the dark days of the downturn, the hotel community looks forward to a stronger 2010

With the change in season, hoteliers across the country are hoping the winter of their discontent is truly over. When the recession hit in 2008 and sideswiped the industry, few could have imagined the depth of the economic maelstrom. Almost two years later, Canada’s hotel community has passed through a period of latent survival and it’s now looking to the future with renewed optimism.

But what does tomorrow hold for Canada’s 8,000 accommodation properties? Is hotel investment poised to return and, if so, what form will it take now that REITs have lost their luster? When will RevPAR increase to the record levels of 2000; will occupancy inch forward and, more importantly, how much will tomorrow’s guests be prepared to pay for their rooms, given the rock-bottom rates of the past year?

 

Adding another layer to the unfolding drama is the influx of new luxury hotels set to open in Toronto in the coming months. Just how much will these five-star properties affect the occupancy rates of other hotels in Canada’s largest city? For investors, one wonders if the bloom is off the rose, or might they target hotels as the ideal place to put their money, as Canada is now considered among the strongest economic nations in the G8?

“We believe this is a great time to invest in the hotel business,” says Hubert Joly, president and CEO of Carlson Hotels, speaking at the company’s recent annual conference in Orlando, Fla. According to Joly, the hotel business started its ascent in late 2009. His company is currently investing US$1.5 billion to upgrade existing properties in North America, with plans to add five flagship hotels in key cities. Joly believes that shrewd hotel investment comes down to buying at the right time in the up-and-down economic cycle. Among his core beliefs is that the hotel industry is “tied to economic expansion. It’s coming back and it’s poised for long-term growth.” *

In Toronto, Scott Duff, Senior Director, Development, Canada, at Starwood Hotels & Resorts, concurs, though there’s a hint of caution that underscores his commentary on the subject. “From a development perspective, 2010 is encouraging, given the number and quality of projects to focus on, but we still don’t see this year matching the deal flow we experienced prior to the collapse of the credit markets.” Duff says tomorrow’s deals will focus more on conversion than on new construction. “High-quality sponsors are needed to get deals across the finish line.”

Despite the challenges, Starwood opened 83 new hotels last year, including six in Canada, and it signed 77 new deals around the globe. It plans to open an additional six new properties in 2010. “Conventional financing has certainly constrained new construction in the near term; however, there are always examples where a developer is able to bring a lending relationship to the table to get deals done,” says Duff. Given the limited conversion opportunities out there, he says it’s tough to penetrate certain markets like Atlantic Canada. “That said, we were very pleased to welcome the former Fairmont Hotel Newfoundland to the fold as the Sheraton Hotel Newfoundland in 2009,” says Duff. New construction will continue to be slower, he adds, particularly in the upscale through luxury segments, due to “disconnects in cost-to-build, appraised value and lack of financing sources.”

Like Starwood, InterContinental Hotels Group (IHG) also experienced strong growth over the past two years. “From 2007 to 2009 we opened 46 hotels,” says Toronto’s Stuart Laurie, Franchise Sales & Development, Canada, with IHG. “Seventy-four per cent of those hotels came through new development, with the rest conversions,” he adds. Laurie anticipates another 14 hotels will join the portfolio this year, with a total of 38 in the pipeline. He attributes IHG’s strong growth to solid relationships with franchisees. “Our pipeline is sponsored by existing IHG franchisees,” he says. “These are people that are well capitalized and have strong balance sheets. They’re not the newbies we experienced in the past five years.”     
Still, after years of record hotel building and trades, analysts believe supply should soften over the next few years. “There will be a period of very little supply growth in the coming years, as lenders stopped financing new hotel development in 2008,” says Curtis Gallagher, vice-president, CB Richard Ellis Limited, in Toronto. “It remains a challenge to secure financing for new hotel development.” However, he’s quick to add that smaller limited-service hotels in certain underserved markets with sound economic growth prospects, such as Regina, will likely see new development.
Moving forward, a significant equity investment into any new deal will be required as leverage should only be in the 50 per cent range, says Gallagher. “Financing is a big issue for most people,” agrees Laurie, “and equity requirements are much greater today. Other than the 14 hotels that will open this year, it’s difficult to secure financing for the rest of the pipeline. [But] we’ll continue to manage it, as our franchisees are waiting for lenders to loosen their purse strings,” says Laurie.

Adding to the complexity of the deal-making environment is the number of distressed properties in the U.S. market. “We are competing with Canadian equity that’s going south of the border for cheap buys,” explains IHG’s Laurie. “We’re not seeing the same number of distressed assets in Canada. In some cases in the U.S., they’re trading at $25,000 a key.”

David Larone, director with Toronto-based PKF Consulting, also projects moderate supply growth for the industry. “It should be at one per cent, more or less, as we try and absorb the supply that was built in the past few years. It will not be a ramp-up like we saw post 9/11 or SARS. Think 1993 to 1999,” he says.

And, with limited supply coming on stream, hoteliers are hoping occupancy and room rates begin inching back upwards. “The summer is shaping up to be very good for our hotels across the country,” says Starwood’s Duff. “There is a considerable amount of pent up demand from travellers, who may have chosen not to go away in 2009 and are ready to travel again.”

To appeal to those travellers, there are a number of large events taking place across the country this summer. The return of the Grand Prix in Montreal, the G8 and G20 Summits in Ontario, the Calgary Stampede and the Telus Skins Game in Victoria should all bolster travel to, and within Canada. Of course, hoteliers are hoping the success of the 2010 Olympics in Vancouver will translate into more international visitors, too.

Conversely, the rising Canadian dollar might also inspire many to take trips down south, or to Europe, as the loonie’s strength against the Euro is the highest it’s ever been. Analysts believe it should stay at par against the U.S. greenback for at least the next year, with it hitting $1.05 later this summer.

Nevertheless, some believe Americans are ready to start travelling to Canada once more. “U.S. visitors will continue to travel to Canada, and as their economy improves that growth should accelerate,” says CBRE’s Gallagher. “It’s encouraging that passport applications rose, which suggests a willingness by U.S. residents to continue to travel to Canada,” he adds, noting that border-crossing delay issues also seem to have dissipated as alternative forms of ID are gaining traction. Though Gallagher believes “the currency exchange issue will have greater impact than the passport issue.”

“The current strength of the Canadian dollar will further discourage U.S. travellers from considering travel to Canada, unless it’s for business purposes,” says Gopal Rao, vice-president, Canada, IHG. He’s encouraged, however, by CVBs and organizations like Tourism Toronto taking the approach that in order to continue to attract U.S. visitors to Canada, we have to demonstrate better value. “One plus side of the strong currency is that we are able to get better purchasing power that can be put to use when negotiating for attractions or, say, for bringing high-quality theatre productions to Canada, that make for a better value proposition,” says Rao.

Even with solid numbers in place, occupancy rates aren’t expected to increase to pre-recession levels. “Transient/corporate rates will rebound modestly in the latter part of 2010, but that’s not the case for group rates,” says Gallagher. “It likely won’t be until 2012/13 that there’s a marked improvement in overall industry performance,” he says.

Always the realist, PKF’s Larone reminds operators, “It took until 2006 for rates to recover after SARS, and that was a defined event with measurable parameters. And, in Toronto, 2006 was the best CC year since 2002. We’re looking at four to six years, depending on the specific market, to get rates back.” He’s not so sure the tough times have ended. “This is going to be a very flat recovery of business — not just lodging — as we go through a global de-leveraging process and we wring out excess capacity in every facet of our economy.”

Rao agrees with Larone. “As an industry, we saw extreme rate erosion during this recession that far surpassed even that of post 9/11 or SARS. It is going to be an extremely hard and long climb back to get to normalcy, although the recent optimism in the Canadian economic recovery (relative to the U.S.) should help.” He believes pricing and price optimization will remain a huge challenge and a great opportunity in the years to come. “This is where strong brands can play a leadership role. If you believe that rates should always be a true reflection of intrinsic value, and that demand is largely inelastic, needless discounting should be avoided. That’s our challenge as an industry.”

With several new luxury properties set to open their doors in Toronto over the next few months, it’s likely they will be challenged to achieve the rates they projected during the underwriting process. “Some general adverse occupancy impact will be felt in these markets,” says Gallagher. “But new flagship hotels can also serve as showpieces for attracting new business to their respective cities. The brands can create awareness through focused marketing efforts.”

Certainly, the industry can expect a slowdown in hotel development, but analysts and operators believe Canada is well positioned for recovery. “We learned some lessons the last time around,” says Laurie. “Lending practices were always stricter here and we’re already practising what the norms are today. Owner/operators probably won’t commit to a project unless they have their debt secure,” says Laurie.

Despite the debacle of the past 20 months, Gallagher believes the industry will see modest improvement this year, with accelerated growth in 2011 and 2012. Like most Canadians, however, he’s quick to add a disclaimer. “Provided no additional major economic crises lie ahead, and the capital markets continue their thaw, we should be in much improved condition in 2012.”
* With files from David Wilkening

Illustrated by Eva Tatcheva/agoodson.com

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