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Bloomberg News
Luxury-class hotels like the Ritz-Carlton in Fort Lauderdale are not as profitable per room as other hotels, so some are being converted to a lower tier.

Profits beat luxury for developers

Room rates not rebounding, so fewer Five-Star hotels built

Bloomberg News
A bellhop moves luggage outside the Mandarin Oriental New York. Hotel developers are shunning luxury properties in the U.S. as room rates fail to rebound to peak levels.

– Developers are shunning luxury hotels in the United States as room rates fail to rebound to peak levels and profits are squeezed by the costs of offering swanky amenities such as spas and trendy restaurants.

Six luxury hotels are expected to open in 2013, the same as in 2012 and down from 23 just three years ago, according to Lodging Econometrics, a Portsmouth, N.H.-based research and consulting firm. Investors are instead focusing on the so-called upscale category, where new properties are forecast to climb 49 percent from last year to 131 hotels.

The decline in construction, combined with conversions of existing properties into cheaper options, signals there may be fewer five-star choices in the future for travelers seeking the highest-quality rooms and amenities. Lower margins for luxury hotels have made them less attractive for property owners, said Steven Goldberg, head of real estate investment banking at Robert W. Baird & Co. in McLean, Va.

“It’s nearly impossible to do a new five-star built in the U.S. that makes economic sense today,” Goldberg said. “The total number of luxury hotel rooms is very likely going to be less in five years from now as compared to today.”

Luxury projects currently under construction – which include Marriott International’s Clock Tower Edition New York and the Loews Chicago Hotel, developed by Loews and DRW Trading – are limited to six cities, according to STR, a Hendersonville, Tenn.-based research firm. The share of luxury hotel rooms as a percentage of the U.S. total fell to 2.2 percent last year from 2.6 percent in 2010, STR data show.

After the last recession, high-end hotels have had to reduce pricing to maintain occupancies because consumers are less willing to pay top dollar, said Nikhil Bhalla, an analyst at investment bank FBR & Co. in Arlington, Va. Luxury hotels’ revenue per available room, an industry metric of rates and occupancy, was $202 last year, down from the 2007 high of $213, according to STR. In the upscale segment, which includes such brands as Hilton Garden Inn and Wyndham, revpar has caught up to the peak at $84.

“There was a time when a hotel could super-charge the whole five-star experience to whatever they wanted,” Bhalla said. “That’s not the case anymore. Today, there’s a cap as to how much you can charge. After this last recession, things have changed. Consumers have changed.”

Net operating margins tend to be in the “mid-20 percent range” for upper upscale and upscale hotels, compared with the “mid-teens” for luxury, which have higher costs for employees and amenities, he said.

Luxury hotels, including such brands as the Four Seasons and Ritz-Carlton, and those rated as upper upscale and upscale – one and two notches below the top, respectively –- are different in the amenities they offer. Luxury properties have valet parking, 24-hour room service, multiple restaurants and full-service spas, said Jan Freitag, senior vice president at STR. Higher nightly rates accompany the superior service.

A room at the Four Seasons Hotel New York in Manhattan started at $895 a night during the week of April 15, according to its website. A stay at Starwood Hotels & Resorts Worldwide’s Westin New York at Times Square, considered an upper upscale brand by STR, started at $499 for the same week, while the upscale Courtyard New York Manhattan/Midtown East by Marriott had $399 as its lowest rate.

A subset of luxury hotels, particularly those in the heart of big cities, qualify for five-star ratings, the highest in the U.S., by the Forbes Travel Guide. For that classification, hotels must provide amenities including fresh flowers in guest rooms, the choice of at least two complimentary newspapers and wine by the glass presented in the bottle and poured in room, for room service. If pool service is available, “guests are proactively greeted and escorted to their chairs, and set-up assistance is provided or offered,” according to Forbes.

Properties in the category include the Peninsula Beverly Hills in California, the Four Seasons Hotel Chicago, the Ritz-Carlton San Francisco and the Mandarin Oriental New York.

Some luxury hotels already in existence are being converted to a lower tier. After buying Manhattan’s Essex House hotel on Central Park South for $362.3 million in September, Strategic Hotels & Resorts Inc. and KSL Capital Partners chose to rebrand the property as a four-star-style JW Marriott rather than sticking with a luxury name.

Rates at the JW Marriott Essex House during the week of April 15 start at $509, while a night at Marriott’s five-star Ritz-Carlton New York, Central Park starts at $895.

Megan Hakes, a spokeswoman for Chicago-based Strategic Hotels with Reputation Partners, declined to comment on the change.

Host Hotels & Resorts, owner of Ritz-Carltons in San Francisco and Phoenix, in 2011 agreed to buy the high-end 775-room New York Helmsley Hotel in midtown Manhattan. At the end of last year, the Bethesda, Md.-based real estate investment trust converted it into a Westin.

Gregory Larson, vice president of corporate strategy for Host, didn’t return telephone and email messages seeking comment.

Properties ranked below luxury are preferable in many urban settings because guests tend to focus more on room quality than costly extra amenities, said Abraham Hidary, president of New York-based developer Hidrock Realty. His company is building three hotels in Manhattan, including Courtyard and SpringHill Suites properties, considered limited-service upscale brands.

“Spas and restaurants require a lot of personnel to run them, which is very expensive,” Hidary said. “That’s not what guests are really coming for. They want to go to eat at local restaurants, not at the hotel. They care mostly about the rooms and without all the extra things you keep expenses much lower, but the revenue on the room will be pretty much the same.”

Publicly traded real estate investment trusts find the low margins of luxury properties increasingly unappealing, since those companies are focused on dividend payouts to investors, said Monty Bennett, chief executive officer of Dallas-based Ashford Hospitality Trust.

“The more luxurious, the lower the cap rate and margin,” Bennett said in a telephone interview. “These hotels are very expensive to buy and to run. You pay a high multiple on cash flow. If you expect to pay out some dividend, which a lot of REITs focus on, luxury isn’t good for that. Then you better go upper upscale and upscale or lower.”

“That is because the upscale and midscale tiers have recovered very, very nicely,” said Mark Woodworth, president of PKF Hospitality Research. “It’s the real sweet spot in terms of what we’re seeing in demand growth.”