With capital continuing to pour into the New York City hotel market, industry experts note that newbie investors will have to take careful steps.
John Keeling, senior vice president at PKF Consulting, which tracks the industry, anticipates that capital in the New York hotel market will continue to grow for the next two to three years — as many see investment opportunity amid near record occupancy levels and room rates.
“Hotels are a very attractive investment to investors who have not traditionally been in the business,” said Keeling.
In the first quarter, New York hotels posted results that were even stronger than last year’s impressive performance, with a 9.9 percent increase in revenue per available room from first quarter of 2005, to $165.80, while occupancy levels saw a slight decrease of 1.7 percent to 78.3 percent full occupancy.
During the same time, average daily room rates increased by 11.8 percent to $211.80, according to PricewaterhouseCoopers.
But, investor, beware.
The hotel industry is “a one-night business” and, as a result, it’s been a riskier proposition than office buildings in the past, Keeling said.
Hotel investors face challenges ranging from increased property taxes to high insurance rates to union strikes.
“Rising costs of running a hotel are going up faster than rates of inflation,” Keeling said. “Investors need to think about the future cash flow.”
Hotel workers, represented by the union group New York Hotel & Motel Trades Council, are currently negotiating over pay increases and safety regulations with the industry group the Hotel Association of New York City. The deadline for the new contract is July 1, but at press time no agreement had been reached.
Nolan Hecht, director of hotel transactions at Cushman & Wakefield, said that the union talks aren’t having an impact on investors. “Buyers in the hotel market are willing to overlook expenses,” he said, “because they feel revenues will grow stronger than expenses, even if the union contract results in higher wages.”
Investors see an added draw in hotel investing because in some cases they can convert hotel rooms to condos as a backup plan, taking advantage of the still relatively strong residential market. Many New York hotels, including the Stanhope, Barbizon and parts of the Plaza Hotel, have been converted to condos in recent years.
“Investors see that the numbers work as a hotel and the property value doubles as a condo,” said Jeffrey Steiner, partner at Brown Raysman Millstein Felder & Steiner LLP and chair of the firm’s business and finance department. September 11 hurt the city’s tourism sector, driving down occupancy rates and diminishing profits for investors. But overall, the hotel industry has proven its resilience despite the impact of the terrorist attacks.
“After September 11, people were surprised to see the hotel sector hold up fairly well,” said Steiner.
Given that investing in hotels can be risky, the returns aren’t always that impressive. Investors seem willing to pay more for less return.
In New York, capitalization rates (the annual income expressed as a percentage of the property’s purchase price) are at 5 to 6 percent for hotels. The national standard is running 7 to 8 percent. Observers said that some companies are willing to overpay for a stake in New York.
“It’s a very pricey city for investing,” Keeling said. “These companies have a strategic reason for their willingness to overpay. They need to have a presence in New York.”
Competition is certainly pushing prices up. There are only a handful of hotel transactions in a market with substantial capital and it is extremely difficult to enter the market, Hecht said.
Adding to the demand, he said, is capital coming from overseas. The United Arab Emirates, for example, is putting a noticeable amount of money into the city’s hotel market. “International demand is double what it was two years ago for the hotel investment market,” Hecht said.
The most recent example was last month’s purchase of the Knickerbocker Hotel in Times Square by Istithmar, an equity firm owned by the Dubai government, for $300 million. The purchase followed another big hotel buy last September, when the Essex House on Central Park South was purchased by Sheik Mohammed bin Rashid Al Maktoum, now the ruler of Dubai, for $440 million.
Steiner said investors looking to enter the market should remember that hotels are a business and not just real estate.
“Hotels are operating companies,” he said, “and investors should carefully look at numbers and evaluate from the real estate value — and the operating company — standpoint.”