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No room, no room

28 April 2004 by

They survived 9/11, prospered through the second invasion of Iraq, and grew during the SARS epidemic. In recent years, budget hotels have proved to be the most resilient sector of an otherwise beleaguered market.

Last year brought little respite to an industry still reeling from the decline in international tourism. But there is evidence that budget hotels, in some key markets, actually gained from an increase in domestic tourism. London has fared slightly worse than the regions, but this has not stymied the sector's rapid growth in the capital.

However, future expansion of this sector is being jeopardised by something far less sinister than international terrorism or exotic diseases. The availability of affordable sites, especially in greater London, is proving to be the major concern for budget hotel operators everywhere.

In its UK budget hotel survey 2003, covering 90% of the budget hotel market, consultants Deloitte & Touche said that nearly 100% of respondents thought the cost of sites was a threat to their growth.

Richard Arman, franchise development director for Choice Hotels Europe, says: "There is a limit to the room rate we can charge. On the M25, because of land values, we would have to charge £120 to £140 per room per night, but Greater London will only sustain £65 to £70.
Competing with residential "We compete against residential development in some cases. We had one franchisee in Hackney, east London, with an acre of land, but after an economic appraisal it was determined that better value could be got from residential."

This dynamic particularly affects Choice Hotels' Sleep Inn brand, which is at the premium end of the budget sector. Arman says he wants to develop up to 50 more
Sleep Inns over the next five years in the UK. If, of course, he can find appropriate sites.

One commentator says that budget operators simply have to take budget sites, but it is not that simple. It is necessary for the chains to find high visibility sites with "window wallop and curb appeal", as Arman puts it, and often secondary locations do not provide that.

In addition, many want to be near commercial areas to appeal to business users, which further limits the areas they can consider. As a result, the sector has not grown as quickly as it might, and certain brands are not represented as widely as their agents would like.

"Land values will always be a problem for the budget guys," says Knight Frank partner Dominic Mayes. "As a result we haven't seen Accor's Formule 1 rolled out as it cannot afford the land prices." There are currently 10 Formule 1 hotels in the UK and, according to Deloitte, this particular brand experienced zero growth in 2002.
But the reality is that land prices are not going to automatically adjust to suit budget hotel operators. Limited-service hoteliers need to think out of the box to develop in suitable areas.

Large operators can benefit from co-developing with other arms of their business. For example, Express by Holiday Inn has developed on land owned by brewer Bass when both companies were part of Six Continents.

Going into partnership Also, when Whitbread opened the UK's largest budget hotel last year - the 590- bedroom Travel Inn at Heathrow - it incorporated its stand-alone conference centre brand into the scheme.

Options also exist for firms that are not part of a conglomerate. To date, many budget operators have managed to locate in mixed-use schemes, either by convincing developers a hotel would add overall value, or because planners have insisted on a hotel as part of a consent.

Gerard Nolan, head of FPDSavills' hotel department, believes this type of operation in a mixed-use scheme is a magnet for investors, provided institutional leases are attained. He says: "Investors are seeking tenants who will take a 25-year-plus lease with a share of improving profit.

"A current example is the Days Hotel in Kennington. The 160-bedroom hotel was on the market for £13.25m. In three weeks of marketing, we had 116 enquiries with
numerous bids higher than the bid price. There was such high demand that a 72-hour closing date had to be set."

But being part of a mixed-use scheme does have its downside. Most budget hotels can be constructed very quickly, but being involved in a mixed-use scheme can often considerably slow the process.

Choice Hotels' Arman is looking into developing on office campuses and has made tentative enquiries with Slough Estates and Land Securities. He believes business park owners with a few spare acres could benefit from a hotel on site, not least because most activity around the hotel would be at night and would not conflict with office users.

Quite often the relationship the hotel operator has with the contractor can be a means of reducing costs. Contractor Midas claims that it is able to produce a four-star product at budget prices.

Andy Smith, business development director for Midas, states: "Developers can keep capital costs down through working in long-term partnerships with contractors to ensure economies of scale in supply chain management, and through tapping into the new modular and prefabricated technology. With shell construction costs reduced, there is greater scope to upgrade interiors and fittings."

Another simple way of reducing capital outlay is to spend less on the land purchase. Golden Tulip Hotels is building an eight-storey Tulip Inn hotel in Gateshead so the
115 beds can be sited on a smaller piece of land. Golden Tulip managing director Peter Roberts says: "We look to develop tall buildings because, otherwise, what you are paying for is car parking. Our land-take in Gateshead is really quite small."

However, Roberts has a further trick up his sleeve when land costs make budget development non-viable. In that instance, the company will often develop its middle-range brand, Golden Tulip, rather than its budget brand, Tulip Inn.

High land values Some property professionals believe the growing pains are simply a reflection of market forces that will lead to the diversification of the sector. Kevin Casserly of London-based surveyors Fleurets thinks that the restrictions on traditional sites will lead to the utilisation of a greater variety of locations.

"The lack of affordable sites will not curtail the growth in the hotel sector, but will merely act as a market mechanism to ensure that different types of hotels will be developed in different locations," says Casserly.

Perhaps such a view can be interpreted as a warning about impending saturation. Until that point is reached, new ways will need to be found to satisfy market demand for limited-service hoteliers.

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