“You can't get construction financing today without signing away your life,” says Jack Corgel, senior advisor with PKF Consulting and professor of real estate at Cornell University's School of Hotel Administration. “It's a big issue because it's keeping a lot of projects out of the pipeline. No developer wants recourse financing, whereas lenders do—they want a guarantee that if it doesn't get completed, they can come take away your Porsche.”

He continues, “The riskiest venture for a lender is a construction loan on a hotel because there are no leases and construction financing is riskier than acquisition financing.”

With concern for that risk ever present, lenders are being cautious, and wisely so, several hotel industry executives assert.

“In this cycle there is a lot more discipline in lending, with the primary construction capital going to seasoned developers,” says Geoff Davis, president and senior principal of HREC Investment Advisors.

Adds Stephen Hennis, director, Smith Travel Research, “It's more difficult now to prove that your deal is worthwhile. You need to either be a proven developer or someone connected to a management company with a record of success around the brand you're trying to develop.”

Banks and other lenders also are doing their homework more diligently, he says, “There's a lot more intense underwriting to make sure that the market a developer is eyeing can sustain new development and that the area can absorb supply in the long-term, like for three to five years, versus just in the short-term.

Still, sometimes the market's demographics create feasible financing conditions, at least sporadically, says Davis. “In certain attractive markets, we have seen up to 85% loan-to-cost with only completion guarantees required. It is on a case by case basis.”

Explains Mark Owens, managing director-hospitality group at the Ackman-Ziff Real Estate Group, “The cost to hold the construction paper is more expensive for lenders because the Federal Reserve, and regulators, make a lender pay more to hold it on their balance sheet, which reduces the amount of product available.”

In addition, he notes, “Doing a construction loan requires a lot of infrastructure, it's much different than lending to a hotel that's cash flowing. That limits the number of lenders that have the wherewithal to provide construction financing.”

Given those circumstances, hotel industry advisors are giving prospective buyers and developers some new advice.

“Lenders are requiring substantially more equity as part of their conservative underwriting for construction financing,” says Owens. “We spend a lot of time advising clients on their capital stack and making sure they and their partners are aware of the lender requirements for new construction.”

For owners of—and investors in—existing properties, there's a different story playing out. Record-breaking levels of success, in numerous metrics, are cause for elation.

“If you're holding a position in a hotel right now, you're just printing money,” says PKF's Corgel. “Demand is so strong and supply is very limited, so it's a great time to be running a hotel.”

Just how strong is demand, and how limited is supply growth? According to several industry analysts, both numbers are at levels that should have hoteliers doing cartwheels.

“The number of rooms sold is the highest it's ever been in eight months and we expect roughly 1.8 billion room nights to be sold by year-end, also setting a record,” reveals Jan Freitag, SVP of Smith Travel Research. “There's really good demand growth, occupancy and room rates are going up, we put out good numbers and the industry is happy, which brings in developers and investors. Plus, supply growth is at about 1% and should be closer to 2% at this point, so we're in a booming environment.”

[IMGCAP(1)]

Adds JP Ford, SVP and director of business development at Lodging Econometrics, “At the close of the second quarter, there were 970 hotel properties under construction—or 126,380 rooms—in the United States, and the total pipeline was 3,011 hotels, or 421,387 rooms. That's a relatively easy number to absorb on a macro level.” By contrast, he notes, the peak of new supply in the last cycle was in the second quarter of 2008, when there were 5,883 projects, or 785,000 rooms, in the pipeline.

Looking forward, says Ford, “We expect development to continue getting stronger but we're looking at only a 1.4% overall increase of new supply, which is still below the norm. That's a relatively easy number to absorb on a macro level.”

However, he cautions, there could be a different situation facing prospective buyers or developers interested in a particular area. “It's important that people pay attention to their backyard and that they don't overlook what's happening in their market. All real estate is local so industry participants need to have a good handle on the market. Some have a lot of new supply while others don't.”

For some developers, or buyers, the barriers to entry in already-crowded markets such as gateway cities are simply too high. As a result, they're looking beyond MSAs and toward secondary and even tertiary markets.

“It appears that the large markets have been picked over,” says Corgel. “The opportunities in those markets have really thinned out. Instead of the top 20 markets, we're hearing from fund managers that they're looking at markets like Denver, Tampa, Nashville and Savannah.”

Of course, investing in such markets raises some issues too. “Pay attention to both the sponsorship and the equity partners,” Owens advises. “Ask: have they built a hotel before? Do they have a good equity partner or their own capital? From a sponsorship basis, banks want to see that they have the net worth and the equity because you have to be able to pay the debt service and also if there's a cost overrun, it has to be paid or the deal will fall apart. Also, location is key.”

Davis adds, “You must be careful going into secondary and tertiary markets, they can easily get overbuilt and supply can outpace demand with one or two new hotels.”

As for what types of secondary and tertiary markets are of interest, he states, “University markets remain hot because they are stable. And both Marriott and Hilton have come out with interesting boutique brand concepts, such as the Autograph Collection and Curio.”

On its website, Marriott describes Autograph as “an evolving ensemble of strikingly independent hotels.” Similarly, Curio, A Collection by Hilton, is meant to be an assortment of unique hotels. It was introduced this summer with just five hotels but is expected to scale to 350 hotels within the next five years.

Adds Owens, “Make sure it's a market you're comfortable being in for the long haul. Look at demand both historically and in the future, as well as the barriers to entry.

“People like Austin, TX a lot,” he continues, “because it's accessible both from highways and airports, there's a big university, and the government and private sector are there. If a secondary market is relying only on the production of widgets by one company, when those widgets are no longer in demand, investors are in trouble. You want to find markets where if one leg of the stool breaks, there are other legs to support it.”

[IMGCAP(1)]

Another market like this, Owens says, is Albany. “The city has been creating a technology hub and focusing on education so business isn't coming just from state government. It's similar to Austin, where Dell has become an incubator for technology and Toyota, along with other car manufacturers, have moved their factories there. So if one thing were to fail, there are five other; it's a diversified risk. These markets are all over the country, it's just a case of finding them.”

For the most part, construction is concentrated in the nation's gateway cities, says Ford. However, that doesn't mean they're the place for everyone. “Who you are and what your experience level is plays a big role in getting projects done,” he says. “You may not be able to get into a Downtown Philadelphia or Boston, but some of the secondary cities and submarkets of those CBDs are pretty darn good too.”

The hot hotel type in the current market is select-service, such as Courtyard by Marriott and Hilton Garden Inn. But in certain cases, regardless of geography, investors are bypassing the industry darling of the moment in favor of a higher-end property type.

“If you look at publicly traded companies and REITs, they've been moving up the food service chain,” says Sean Hennessey, clinical professor for the NYU School of Professional Studies, Tisch Center for Hospitality, Tourism and Sports Management, who teaches the hotel valuation course at NYU's Schack Institute of Real Estate. They've been moving more into full-service hotels in the Marriott, Hilton and Hyatt brands and out of select-service because the fundamentals have improved there in recent years.

“This shift is pretty pronounced,” he continues, “because these investors feel the profitability of the full-service hotels have a good chance of stepping out and there hasn't been construction, so in terms of having the pie of revenue divvied up, less risk because less supply. So they're positioning themselves for the next five to seven years.”

Examples of this trend include the September purchase of the Long Island Marriott by Starwood Capital along with the sales this month of the JW Marriott San Francisco to Chesapeake Lodging and the Park Hyatt Chicago to Westmont Hospitality.

Starwood Capital, which owns the luxury Baccarat and One Hotel brands, purchased the 618-room Marriott in Uniondale, NY for $66 million, according to Long Island Business News. Chesapeake purchased the JW Marriott San Francisco Union Square for $147.2 million, or approximately $437,000 per key, while the Park Hyatt Chicago was picked up for $100 million, reports sister publication GlobeSt.com. In the JW Marriott transaction, the Trust assumed the existing management agreement with Marriott International Inc., as well as the existing ground lease covering the property, which expires in 2083.

A spokesman for Starwood declined to comment. Real Estate Forum was unable to reach Westmont or Chesapeake Lodging.

The trend is likely to evolve into even higher-end investment by public firms, says Hennessey. “I suspect that institutional investors will move from full service to luxury, not in next six to nine months, but as the recovery moves farther along.”

No matter investors' chosen markets though, the busy market is keeping advisors on their toes, notes Marc Sallette, SVP, debt and structured finance at CBRE. “We'll work with anything from a Hampton Inn refinancing to the monies needed for a 1,000-room new convention hotel. There are so many transactions out there to work on.”

Further, he says, whether developers can't line up financing, are in crowded markets or facing other obstacles, they seem predetermined to overcome obstacles. “Developers are entrepreneurs and eternal optimists. They always will find a way to get their projects done.”