Risks as Growing Construction Pipeline Spreads Beyond New York City

Philly’s Convention Center Draws Hotels

The surge in hotel development activity in New York City has been supported by a succession of banner years for tourism. Development downtown anticipates a further rise in tourist visits to the World Trade Center as monuments and buildings approach completion. But New York City is not alone in the growth of its hotel-room inventory. In markets from Savannah to Chicago, new hotel projects are getting underway. In the latter, work is underway on a three-hotel project at 501 North Clarke Street that will introduce more than 650 rooms to the city’s inventory in 2013, coinciding with the opening of the 320-room Langham Hotel in Mies van der Rohe’s 330 North Wabash Avenue. A harbinger of things to come, Chicago’s Radisson Blu is nearing completion and is scheduled to open on Nov. 1.

Albeit on a smaller scale, hotel projects are getting underway in Philadelphia as well. Marriott Hotels, Liberty Property Trust and Ensemble Hotel Partners announced the development of a new, 168-room Courtyard by Marriott at Philadelphia’s master-planned Navy Yard Corporate Center. Subject to Ensemble’s negotiation of project financing, the new hotel is projected to come online in the second quarter of 2013.  The announcement followed less than a month after the Sept. 15 groundbreaking on a 268-room Kimpton Hotel that will overlook Independence Mall. Parkway Corporation announced plans in late September for a Hilton Home2 Suites hotel near the expanded Philadelphia Convention Center. That project, estimated to cost $60 million, has been facilitated by at least $10 million in H.U.D. Section 108 loans and other low-cost assistance.

A few blocks from the campus of the University of Pennsylvania, construction is underway on a 136-room Hilton Homewood Suites. The project represents Campus Apartments’ first foray into hotel development and has been facilitated by a low-leverage loan supplemented with a bevy of public and private financing sources and access to the New Markets Tax Credit program. Chandan is tracking at least two other Philadelphia projects that are in the early stages of planning, including one at the Convention Center and another in Philadelphia’s Old City. Three hotels opened in the City of Brotherly Love during the recession.

Taking Risks

In the absence of a collusive supply response, individual commitments to large-scale construction inevitably represent a degree of risk-taking by developers and their lending partners. The apartment sector may be the one instance where the downside risks are mitigated by a weak economy’s drag on housing outcomes. Even in this case, however, markets where real and artificial barriers to entry are weak may suffer a destabilizing period of overreaction as new rental units flood the inventory. Overall, the same tempering of enthusiasm that qualifies the economic and labor-market outlook should inform our assessment of loss mitigation strategies when extending credit for property development. As compared to stabilized assets, lenders’ loss severities are generally much higher for these projects; in today’s environment, the probability of that loss depends inordinately on factors that are external to real estate.

dsc@chandan.com

Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.