Keeping Chicago Competitive: The Hotel Supply Wave

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A Wave of Supply

Chicago’s hotel market is preparing for a supply wave. In the next few years, the Windy City expects to add an additional 12,000 to 13,000 new hotel rooms to its arsenal. To many, this isn’t shocking news. Hotel developers and operators in Chicago have enjoyed a steady climb in RevPAR since 2009. However, in 2016, we saw Chicago’s first decline in RevPAR in 6 years, a sign which some say is reason to worry about the incoming hotel room supply.

Market consultants and policymakers point to a potential oversupply problem as the source of their worries.  Under basic supply-and-demand principles, these critics essentially say that if there are too many hotel rooms in a market, then the price of each hotel room in that market will, on average, decrease.  There will be more hotel rooms than Chicago needs to accommodate its visitors and with more hotel rooms than hotel guests, the argument is that each hotel will get a smaller piece of the pie. We believe that these claims are blown out of proportion and fail to acknowledge any of the upside. While the argument is fairly simple and logical, the critics are erroneously oversimplifying the market and overlooking the micro and macroeconomic consequences. Our business team at EquityRoots wants to make sure investors and hotel owners are not oversimplifying Chicago’s market and then making assumptions on those generalities.

A robust supply of hotels are critical in establishing continued economic growth in Chicago.

Other regions in the United States outside of Chicagoland (San Antonio, New York, and Seattle, to name a few) have similarly seen the development of new hotels in their respective markets. These brand new hotels attract additional business and travel, and keep their cities competitive in the hospitality market. Cities that fail to upkeep their hotel inventory can lose out on significant business opportunities and city revenue. This includes Chicago, which stands to lose much ground to other established and on-the-rise metropolitan areas. If Chicago wants to remain a world-class city that is capable of handling large conventions and attracting major corporations to set up shop, it needs to keep things fresh with updated hotel products.

The Chicken, or the Egg?

If you’ve been watching Netflix recently, you might have stumbled upon “The Founder,” which takes a look at the entrepreneur Ray Kroc and his role in making McDonald’s a worldwide brand. For Ray Kroc, business growth is a supply and demand issue. Which comes first, the chicken or the egg? Ray Kroc believed that new supply attracts new demand, building the McDonald’s restaurant empire on this theory.  

Likewise, EquityRoots.com believes that the threat of oversupply is overhyped, particularly for the newest hotels to enter Chicago’s market. While it is true that there will be more hotel rooms available in Chicago from a sheer numbers standpoint, the newest constructed hotels will drive others to improve. Newer hotels that are slated to open in Chicago – including a Cambria hotel in Chicago’s Loop and a dual-brand IHG hotels in Schaumburg – introduce updated and upscale venues with cutting-edge floorplans that appeal to old and new visitors to the city. Modern additions including rooftop venues, new technology, and newer beds are likely to attract the majority of incoming travelers, and this is a standard that corporate travelers have come to expect in other markets across the country. This means that the pressure falls to older hotels to reinvest and renovate, especially those that are 20 years old or more. For example, developers are already spending about $20 million to renovate the Talbott Hotel in the Gold Coast in order to keep the asset competitive. Other older Chicago hotels are also expected to renovate and update their rooms and designs to avoid the risk of becoming outdated. Chicago’s hotel room supply will continue to be updated.  Increased expenditure and capital improvements will ultimately raise an owner’s basis, driving rental rates higher to obtain the same return.  As a result, the entire market responds by increasing average daily rates.  The supply of total rooms will go up, but so will quality.  This gives all hotels the edge in competing for corporate and leisure travelers. As a whole, competition will drive up the quality of hotel services and products offered in Chicago, which lead to positive experiences and can encourage even more travelers to visit the Windy City and drive demand.

Moving forward, Chicago is expecting more travelers, which is great news since the number of conventions and meetings held last year in 2016 was atypically low for the Windy City. When you couple that with high-publicity events like the Chicago Cubs’ World Series win last year, EquityRoots.com expects that the future still remains bright for Chicago’s hotels.

 

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So, what caused the 2016 decline?

If it wasn’t primarily oversupply that pushed Chicago’s downward RevPAR dip in 2016, what was the source? Chicago is facing microeconomic issues.  For starters, the city’s current lodging supply is outdated compared to other cities.  It’s also worth noting that Chicago was in the running as a host city for the 2016 Summer Olympics. During the bidding process, corporate travelers shied away from booking in Chicago because the Olympics typically creates a lot of traffic, congestion, and delay in the way of a busy work/meeting schedule.  A number of conventions and businesses avoided booking travel to Chicago during the time frame that the 2016 Olympics would be occurring, opting to hold their conferences and meetings in other cities like Detroit, Indianapolis, Las Vegas, or Minneapolis.  When Chicago wasn’t awarded the 2016 Summer Olympics bid (which went to Rio de Janeiro), the city got a 1-2 punch. The city not only missed out on the opportunity to capitalize on a huge wave of tourism for the games, but also was hurt by the void of typical corporate travel avoiding the market. As 2017 and future years pose more typical operational years, we believe the hotel industry will continue to improve in Chicago.

Chicago needs to stay competitive to keep up with other leading primary markets in the United States, including New York and San Francisco.

Staying Competitive

Freezing free market activity and slowing down updated prototypes will push Chicago laps behind in a race against other cities. America and capitalism thrived on encouraging innovation and progress.  If Chicago were to halt new development for fear of oversupply, it will have comparatively lower quality lodging than other cities, which will make it more difficult to attract travelers and other demand drivers to come here in the first place. We are seeing incredible market strength in cities like Seattle, NYC, and Boston – cities that happen to offer the latest and greatest hotels and amenities.  Chicagoland needs to put pressure on the status quo, create pressure to improve, and bring in the latest and greatest facilities so that we can attract more businesses and travelers to come here.

Sources

Gallun, Alby. “Hotel market falters after six-year run.” Crain’s Chicago Business. Sept 26, 2017. 

Gallun, Alby. “Will the downtown hotel market bounce back in 2017?” Crain’s Chicago Business. Jan 30, 2017. 

Hoisington, Alicia. “Oversupply concerns loom over Chicago.” Hotel Management. Mar 6, 2017. 

Ori, Ryan. “Talbott Hotel to shut down for $20 million renovation.” Crain’s Chicago Business. Dec 8, 2016. 

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