Quarter 2, 1998
by John Campbell

Finding a hotel room in Boston during June college reunions or on Cape Cod during summer vacation has long been a fool's game. Sorry, we're booked. Over the past five years, that frustration has spread to other times of the year and other corners of New England. Pilgrims on a mission—business clients and colleagues, conventioneers, academic researchers, parents of college students, tourists from abroad—are traveling to the region in record numbers. Indeed, tourism and business travel have expanded, and a boom is under way in the construction of hotels, resorts, entertainment parks, and tourist attractions worldwide.

A growing demand for lodging has at last stimulated construction of new hotels and renovation of old ones throughout New England, and developers are lined up to build in areas of very strong demand, such as Boston and Providence. But many travelers still find there's no room at the inn. So city and town governments encourage development, sometimes with tax or lease subsidies, because hotels generate spending from outside the area, can be easily taxed, and provide lower-skill jobs. The whiff of glamour around major hotels, which inherit a tradition of dispensing hospitality, good cheer, and exotic visitors, adds to the allure. And in cities planning a new convention center, a larger stock of hotel rooms is an essential adjunct to the "big box."

But hotels are far from a sure bet, either for their owners or the areas in which they're built. Hotels are one of the riskiest forms of real estate, being labor-intensive, in need of regular investment to maintain their value, and dependent on a one-day lease. Development of new hotels, moreover, has historically come in waves that produce alternating gluts and shortages of rooms. History suggests that planning a steady new supply to accommodate shifts in demand is difficult.

LONG LAGS

All commercial real estate has an element of instability. Booms create new skylines and office parks, while busts show how transient market values can be. But the instability of hotels seems especially pronounced.

An accounting of the cyclical behavior of the U.S. lodging industry comes from William C. Wheaton and Laurence Rosoff of the Massachusetts Institute of Technology. Looking over the past three decades, they find that demand for hotel stays moves closely with GDP. Economic expansions spur both business and leisure travel, while recessions cause firms to tighten travel budgets, and individuals to curtail vacations.

By contrast, room prices and new construction move in patterns that bear little connection to short-term demand. In other property markets, rents respond sharply to changes in occupancy, and construction follows not long after. Hoteliers adjust room prices more slowly for several reasons. Customers tend to return to hotels they like because it's so costly to search for alternatives, but they may reconsider if prices have risen since the last visit. Customers who need to plan ahead, such as corporate groups, dislike volatile prices. And rapid price adjustments may hurt a hotel's reputation for quality.

Wheaton also notes that hoteliers are reluctant to quickly adjust prices because pricing is so complicated. A given room may have five or more rates, depending on the type of customer and when the room is booked. And, vacancy rates can swing from month to month, making it hard to discern a permanent shift in demand.

New hotel development, in turn, is spurred by rising prices fueled by rising occupancy rates. So, it's not surprising there are lags between changes in demand and development of new space. An additional factor, Wheaton observes, is the Byzantine structure of hotel deals. Constructing a large hotel typically involves at least four parties—developer, franchisor, operator, and lender. Requiring so many parties to agree on the site, financing terms, and operating and profit-sharing arrangements lengthens the process and further delays the stream of new supply.

EVEN LONGER IN NEW ENGLAND

The lag between demand and supply appears to have been especially severe in New England over the past decade. With more than 5 percent of the nation's work force in 1997, the region contained just 4 percent of existing rooms and 3 percent of rooms under development, according to Coopers & Lybrand's hospitality consulting unit. Yet, parts of the region, notably Greater Boston, have ranked among the strongest travel markets nationally, with occupancy rates rising for the past six years, and prices for five.

Hoteliers, developers, and others familiar with regional conditions cite several reasons that hotels take longer to come on line in New England. The real estate bust of the late 1980s caused construction financing to dry up until recently. Development costs are higher here. Winter weather can slow construction. And permitting can be lengthy and restrictive, especially compared with Sunbelt cities. University Park Hotel, in Cambridge, Massachusetts, has been under development for more than a decade. Built for business travelers and groups affiliated with MIT, developers had to address legal, financing, and community issues and will finally open this fall. (See sidebar.)

Construction of hotels started to bloom in significant volume throughout the region by early 1997. North-country ski resort owners have built hotels with conference centers to try to attract business retreats during the off-season. Entrepreneurs have opened upscale bed-and-breakfasts aimed at urban professionals on vacation. And new motels have been sprouting along the major highways.

Tourism has been a major spur and, in most rural areas, it still accounts for more than 80 percent of hotel stays. But even outside major cities, much of the new supply has been prompted by business travel, which has been growing at a faster pace. "The big driver . . . is commercial demand. The revenues are so much higher than tourism, and it's less seasonal," says Rachel Roginsky, an industry consultant at Pinnacle Advisory Group in Boston.

Portsmouth, New Hampshire, for example, once had just a handful of motels at "the Circle" on Route 95. In the past two years, five major hotels have opened in the city. Growth in tourist traffic to Maine and the White Mountains is partly the reason. But the greater spur has been the redevelopment of Pease Air Force Base to commercial activities, and the expansion of computer, insurance, and other firms in southern New Hampshire.

More powerful marketing and communications tools have allowed hotels to slice their markets into finer and finer cuts. The Microtel chain plans to build six hotels in Massachusetts this year that offer small, no-frills, inexpensive rooms designed for the business traveler staying one or two nights. Targeting a different set of business customers, extended-stay lodgings are popping up throughout the region. These offer larger suites with kitchens and various amenities that cater to relocated workers, consultants, and independent contractors away from home for weeks or months at a time.

BOOKED IN BOSTON

Of all cities in New England, Boston epitomizes the dynamic instability of the hotel industry. The city has a long tradition of grand hotels, starting with the Tremont House, which when opened in 1829 was the first modern, first-class hotel—at 170 rooms the world's largest and boasting innovations such as water closets and gas lighting. (It was demolished in 1895.)

Boston's hotel stock ebbed and flowed with the local economy. Prosperity in the 1920s brought a boom in office buildings and hotels; the city had more hotel rooms than at any other time save the 1990s. Then followed a long depression, and the stock of hotel rooms declined sharply; many hotels in the Fenway/Kenmore Square area, for example, were converted to college dormitories. By the 1970s, demographic and industrial shifts unleashed a wave of demand for new office buildings. Law firms, venture capitalists, mutual funds, and other professional-intensive firms expanding downtown wanted modern hotels nearby to put up clients and colleagues. Even in manufacturing, Greater Boston's high-tech industries employed more professionals such as engineers and marketing personnel, generating a tremendous demand for suburban office space. Hotel developers followed the rush of high-tech development along Route 128.

The real estate bust of the late 1980s deflated hotel demand. Suburban room occupancy rates dropped below an annual average of 60 percent, estimates Rachel Roginsky. (An industry rule of thumb holds that developers won't consider construction until annual occupancy exceeds 70 percent.) Many hotels that relied on the minicomputer and defense industries for business tumbled into foreclosure.

Today, as the economy has improved, demand is stronger than ever. The average occupancy rate in Boston and Cambridge is running about 80 percent, with the suburbs at 75 percent—far above the U.S. average of 68 percent. Room prices continue to rise as well. Unlike rural New England, the customer mix in Boston and Cambridge is heavily weighted toward the business traveler, including conventions and university research. Thus the 12,600 rooms in Boston (and those in Cambridge) often sell out on weekdays between April and November. Demand then spills out as far as Route 495, which rings the outer suburbs. Travelers can easily find a room in January, when the hassles of bad weather cause the occupancy rate to dip. But, considering demand throughout the year, the city's capacity is topped out. One downtown hotel reported that it turned away 20,000 potential guests last year.

In response, developers are building top-tier hotels downtown and renovating existing ones, usually to upgrade business-related facilities. Meanwhile, nearby towns with public-transit access to downtown are seeing new mid-priced hotels.

No one knows when the new supply will be adequate. The Boston Redevelopment Authority, based on the goal of reaching a 74 percent occupancy rate for Boston, estimated late last year that the city needed more than 2,000 rooms (equivalent to eight to ten hotels) to accommodate existing demand; another 3,100 rooms over the next decade to meet projected growth in demand from business and tourism; and an additional 3,800 rooms for the proposed new convention center once it is operating at full capacity in 2009. The goal of almost 9,000 rooms over a decade makes many assumptions about national and local economic conditions, tourist patterns, and the viability of the new convention center. One-third of those rooms are now under development and scheduled to come on line by 2000. The boom of the 1980s expanded hotel inventory on a similar scale, so it may be reasonable to expect that this first burst of new supply will be absorbed.

Such projections remain highly uncertain, as do forecasts for other parts of New England. Demand could accelerate sharply, aggravating the shortage. Or the region could fall into recession, or the planned convention centers in several cities might not draw the expected business, and demand could wane just as a large volume of hotel rooms comes on line. Then the region could see a prolonged glut of hotels, leading to layoffs and writeoffs. But at least the perennial pilgrims would be able to find a room.

CHAINS AND NETWORKS

Branding is firmly entrenched in the U.S. travel business, with 75 percent of properties now under chain management or franchise. The rise of chain ownership began in the hotel heyday of the 1920s, bringing many strategic advantages that also benefited consumers. Scale economies in purchasing, the comfort that comes from repeated interactions with the same product, the development of professional managers, and accounting systems all helped stabilize hotel companies and improve the quality of services. The Holiday Inn chain, for instance, pioneered market research to determine how guests' needs differ depending on the purpose of their visit.

In New England, however, the independents still hold a relatively high market share, which consultant Rachel Roginsky attributes to the enduring tradition of the country inn. Independent hotels can offer a unique style and personal service that's difficult to replicate. Some trade on impeccable locations, such as the Copley Square and Lenox hotels in Boston's Back Bay. But Jeffrey Saunders, president of the two hotels, says location is not sufficient: "You cannot survive today without some affiliation to an airline." Thus, the Copley Square ties into a reservation system widely used by travel agents in Europe.

The smallest of independents can compete effectively by affiliating with a network. In Vermont, the Stowe Area Association has marketed local hotels, inns, and bed-and-breakfasts for 60 years through printed brochures and telephone sales. Growing use of the Internet for travel planning has extended the network's reach, says Executive Director Tom Kaiden. "Our web site is very efficient by consolidating all our members in a single place. Customers have more detailed information when they call us, and that makes them more comfortable."

EVOLUTION OF A HOTEL

1970 MIT buys a parcel of land, west of the campus. Over the next 25 years, it continues to buy additional parcels in the neighborhood, including some that contain residential housing.

1996 As the economy revives, the pace of activity quickens. Doubletree is chosen to run the hotel, now dubbed "University Park Hotel at MIT." And financial backing is lined up. But MIT decides to provide credit enhancements (and Doubletree also invests), so other funding sources emerge. The winner: BankBoston. Suffolk Construction is hired and building begins.

1998 University Park Hotel is scheduled to open in August.
—Jonathan Church