And the Peripheral New York City Lodging Markets Are Headed......? By Zubin Saxena Tuesday, 3rd November 2009

A discussion on the existing lodging demand fundamentals and outlook for peripheral New York City hotel markets. The article also discusses why these areas may present good investment opportunities for hotel investors.

Long Island City – and for that matter other peripheral markets such as Brooklyn, Queens, North Bergen, et al – have historically served as secondary lodging markets to New York City’s Borough of Manhattan. In the past, these secondary markets have accommodated a large amount of lower-rated overflow demand from Manhattan.

These peripheral markets, at their peak, posted occupancy levels in the high 70% to low 80% range. The reason is simple – during the market peak (2006 through the second quarter of 2008) hotels in Manhattan witnessed robust occupancy levels well in excess of 80% coupled with extremely high average rates, causing unaccommodated demand to overflow into these lower-rated secondary markets.

However, the collapse of Lehman Brothers in the third quarter of 2008 and the ensuing credit crunch and economic crises have caused Manhattan occupancies and average rates to decline significantly through the third quarter of 2009. Depending on the location of the hotel, RevPAR levels within the borough have dropped anywhere from 25% to 35% below where they stood last year.

In response, Manhattan hotels have adopted a steep rate discounting strategy to sustain their occupancy levels. Thus, a lot of the demand that previously traded-down to the lower-rated secondary markets is now opting to stay in Manhattan. We believe that this dynamic is here to stay, at least for the short term, i.e., until the time when demand starts exhibiting some strength again.

It seems that the only thing good that has come out of the current market conditions and the general lack of financing is that many new hotel projects that were in various phases of development until late 2008 have now stalled – and are expected to remain at a standstill for quite some time. This holding pattern, in the long run (and of course, the short term too), is most definitely a good thing for existing hotels.

Although we expect the peripheral New York City markets to continue to witness RevPAR declines through 2009 and perhaps 2010, given the city’s status as a world-class destination and its deep and diverse lodging demand base, these areas are expected to post steep RevPAR increases beginning in 2012-2013, which will be significantly supported by the lack of new supply due to a somewhat dried-up supply pipeline at the present time.

So what’s the moral of the story? In the short term, given the impact of the dynamics of the Manhattan lodging market, Long Island City and the other peripheral markets will most definitely suffer – maybe at a steeper rate than Manhattan. This factor, combined with the currently high cost of capital, will certainly impact hotel values in the short term, causing values to decline by 30% to 40% from their previous peaks.

However, when the markets turn around, and they surely will, the New York City area, including Long Island City, Secaucus, the Meadowlands, North Bergen, Brooklyn, Queens, et al, will be at a distinct advantage for posting strong value gains, especially in an environment that lacks new supply.

From an investment perspective, this may be the best time to get into these markets if you can find a deal that fits into your overall investment strategy. Lodging assets are trading at a significant discount to development cost, making it a good time for acquisitions.

This time, the recovery will be solid for New York City and proximate markets, and is anticipated to bring in healthy double-digit value increases.

The recipe for the turnaround in hotel values this time around essentially involves three ingredients: solid demand recovery beginning in 2012-2013 as the market regains its intrinsic strength + lack of new supply + more favorable cost of capital in the medium to longer term.

If you consider these factors in light of the looming refinancing crisis in the commercial real estate market, it might present the opportunity of a lifetime for hotel investors. So what is our advice to hotel financiers looking to venture into this neck of the woods?…Go for it!

About Zubin Saxena
Zubin Saxena is Senior Vice President with HVS - New York. Since joining the firm in December 2003, Zubin has performed hundreds of complex national and international hotel consulting and valuation assignments.

These assignments have ranged from individual and portfolio asset valuations and feasibility studies, to identifying target markets and formulating global expansion strategies for prominent international luxury hotel brands. Zubin also specializes in the area of Hotel Management Contract Negotiations, operator searches, and management contract valuations. 

www.hvs.com