Downtown Houston Hotels are losing their Sparkle Sometimes Bigger Isn t Always Better By Bruce H. Walker

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1 Downtown Houston Hotels are losing their Sparkle Sometimes Bigger Isn t Always Better By Bruce H. Walker Houston s not hot, at least for hotel developers. We re oversupplied, and the market will not correct itself for a number of years. Here s why, and the situation was entirely predictable. By ignoring economic realities and relying on faulty research, Houston City leaders have jeopardized viable hotels. The surge of new hotels in downtown Houston has caused many developers to lose interest. Occupancy levels have plummeted from 79% to 47%, well below the breakeven mark for many hotels, thus causing a storm of concern amongst hotel operators. Hotels base earnings on REVPAR (Revenue Per Available Room), which reflects a hotels average daily room rate (ADR) multiplied by its occupancy rate. REVPAR is a great indicator of how much money a hotel makes per room per day. The latest information showed downtown Houston hotel rooms generating a $62 REVPAR, compared to a $99 REVPAR in The Houston hotel market is an example that shouldn t be taken lightly by other cities. Room Count Doubles The rapid growth of the hotel market in Houston means there are more hotel rooms than occupants to fill them. The number of hotel rooms in Houston has doubled following an economic recession that started just before September 11, 2001 and included the fall of Enron. During that period the room count more than doubled from 2,200 rooms to 4,700 today. This uncontrolled growth is to blame for most of today s current low revenue. 1 In the Second quarter of 2004, a 46.8% occupancy and a $ rate. In 2000, a 78.5% occupancy and a $ rate.

2 Page 2, Source Strategies, Inc. If the room count had not doubled, the hotel market would have recovered along with the rest of Houston. Overall, the total metro area generated 58% total occupancy compared to only 47% downtown. These findings show the importance of growth management to a city s infrastructure. City Government Enters Hotel Business Not For Profit The additional 2,500 new rooms were caused in large part by the City of Houston, which built the 1,200 room Hilton Americas next to the George Brown Convention Center with public funds, and also offered tax abatements to attract some of the other 1,258 new rooms. Build It and They Will Come The city entered the hotel business to enhance their convention business, and the goal was to attract more and bigger conventions. The rationale for Houston putting on its capitalist hat was that a new headquarters hotel adjacent to the existing convention center would make the city better able to compete for conventions. However, the evidence shows a gloomy picture. First, demand for convention space is about half of what it was in the 1990 s ; 2 There are a number of reasons for this, and the economic downturn is only one of them. Others include increased travel cost and fundamental changes in the paradigms of how industries do business. Improving teleconferencing and other trends in technology and supply chain management all contribute to lower demand for conventions. For example, large retail chains are replacing small independents everywhere (e.g. Home Depot, Lowe s and WalMart versus the neighborhood hardware store). Second, local governments all over the country keep adding convention space, worsening a major situation of over-supply. Since 1990, some 80 cities have significantly expanded their convention center space and added convention hotels. 2 Convention attendance demand has been deeply depressed for the past four years, with few signs of a recovery in sight. Trade Show Week reported an average 111 million convention/trade show attendees per year for the six years 1995 through This was followed in 2001 through 2004 with attendance of 75 million, 56 million, 40 million and 51 million projected for 2004, respectively. This means that demand for conventions has declined by 50% for the last four years compared to the previous six years (110.8 million prior average compared to 55.5 million current average).

3 Page 3, Source Strategies, Inc. Third, adding another convention hotel does not increase the demand for convention space. 3 Fourth, new city-funded convention hotels cannibalize the market demand for existing, privately-owned hotels. Private operators knew the hotel was a probable failure and would not develop it. No Return To City of Houston The Hilton Americas hotel generated $59 REVPAR in the Second quarter. Year-todate, the REVPAR averaged $72 because of the bump in Houston demand created by Super Bowl week in the First quarter. These REVPAR numbers are very similar to those generated in recent feasibility studies we did to examine the economics of a 1,200 room Marriott in downtown Dallas and a 600 room Hilton in downtown Fort Worth. The downtown markets of Dallas and Fort Worth are very similar to Houston: badly oversupplied with hotel space and a resulting low occupancy rate. The current performance of the Hilton Americas Houston is poor. The return on capital will probably be a three percent cash-on-cash return, similar to the hotels in Dallas and Fort Worth. Since municipal borrowing rates are twice the expected return, the project will probably not support debt service requirements, resulting in a net loss for Houston. A key side effect of this cash drain is that the Houston hotel occupancy tax receipts will probably have to be used to cover debt service, resulting in little or no marketing funds to market Houston! In other words, too many downtown Houston hotel rooms and very little money to market them. Free Enterprise Hoteliers: Many Face Financial Ruin We also examined the downtown market excluding the Hilton Americas. This graph reveals the real effect of city involvement in private enterprise on the downtown hotel market. The difference is that the entire market gain in roomnights sold has gone to the new public Hilton rather than to the existing, 3 See Sourcestrategies.org on the web to download PDF file of the study of the effect of large hotel openings on market demand and the financial feasibility study of a downtown Dallas Marriott convention hotel.

4 Page 4, Source Strategies, Inc. privately-owned hotels. Tax incentives contributed to the explosion in new hotel supply downtown, as well as the consultant-driven hype that major new convention volume was on the way. To date, we know of no significant increase in the rates of booked convention business for the future. Lastly, much of the increase in downtown volume is probably due to attracting business out of the Medical Center and the Galleria areas with low prices. Predicting the Future What is in store for Houston? With only a 47% occupancy rate to be expected at least through the first half of 2005, occupancies are clearly below break-even, considering that many downtown hotels are full-service operations. Look for closures or conversions to residential usage. Many cities have the notion that if you build it they will come. In an age of continued growth and development, many cities need to consider the overall impact that development will have within a city, both long term and short term. For the city of Houston, what should have been a straightforward analysis has turned into a costly mistake. For the market to return to near-normal occupancy levels, approximately 1,000 hotel rooms would have to close; this is about 20% of the available rooms in the market in early The graph here shows that the roomnight volume in the Second quarter of 2004 was basically the same level as the entire period from 2000 through The future outlook is for more of the same. What follows is the key data that led to the above conclusions.

5 Page 5, Source Strategies, Inc. Downtown Houston Lodging: History & Projection # Room- Total Htls nights $ Rooms Year & and # sold Revenues % $ $ % Growth Vs. Prior Quarter Mtls Rooms (000's) (000's) OCC Rate RPAR Rms Real ADR Rev , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Projection: , , , , , , , , * 18 5, , * Second quarter 2005 should mark the last quarter of known additions downtown

6 Page 6, Source Strategies, Inc. Here is the Second quarter breakdown between the total metro, downtown and the balance of the metro: Houston Metro, Downtown, Balance of Metro Lodging Market Second Quarter Change: Rooms Available # % Total Metro 56,700 59,700 3, % Downtown 2,808 4,650 1, % Balance of Metro 53,892 55,050 1, % Roomnights Sold (000's) Total Metro 2,938 3, % Downtown % Balance of Metro 2,821 3, % Room Revs - $ (000's) Total Metro 211, ,782 41, % Downtown 16,432 26,073 9, % Balance of Metro 194, ,709 32, % Occupancy % Total Metro % Downtown % Balance of Metro % BRUCE H. WALKER Founder and President of Source Strategies, Inc., a consultancy and publisher in the lodging industry since Practice includes 75 Texas hotel feasibility studies annually. Clients include developers, Texas Governor s Department of Economic D evelopment & Tourism, banks, major accounting firms and appraisers. Testify regularly as an expert witness. Publisher and writer of The Hotel Brand Report and the Texas Hotel Performance Factbook. Database of 3,500+ Texas hotel/motels created and maintained continuously from Based on Texas tax records, the SSI database of hotel performance names names and individual hotels and allows analysis of almost any major question in the industry. A Harvard MBA, Walker learned marketing as a brand manager for Procter & Gamble (Crest, Scope, Secret). He was then Assistant to the President at Howard Johnson before becoming Senior VP of Marketing and then Strategy at Holiday Inns, Memphis. There, he managed the classic ad campaign, The Best Surprise is No Surprise, founded the first frequent traveler program, The Inner Circle, and launched the Hi-Net satellite reception network to Holiday Inn hotels, offering HBO, CNN and ESPN. With the Boston Consulting Group, created prototypes and strategic plans for new chains Hampton Inns and Embassy Suites, and recommended sale of Holiday Inn chain (sold 1989 to Bass PLC). Walker is a Harvard MBA with a BA in Economics from Amherst College.