HVS Global Hospitality Services | 111 N. Wabash Avenue, Chicago, IL 60602 www.hvs.com
HOTEL VALUATION FACTORS
INDIANAPOLIS, INDIANA
JUNE 2014 | PRICE $1,500Todd Isenstadt
Research Analyst
Hans Detlefsen
Indianapolis Introduction
Indianapolis is the state capital of Indiana and the county seat of Marion County, Indiana. The business environment experienced substantial growth in recent years. Some of the largest employers and most prestigious organizations in the state of Indiana have their headquarters in Indianapolis. It is recognized for its prime convention space and sporting facilities, which draw substantial crowds to the city. The city’s population growth has been modest in
comparison to other major United States cities. The city has a population in 2014 of nearly 845,000 people, an increase from the 1980 population of 701,000. Indianapolis maintains a low percentage of jobs in the manufacturing sector relative to the rest of Indiana. Instead, the city has developed a diverse economic base that spans professional services, pharmaceuticals, and tourism.
The Indianapolis hospitality market includes hotels ranging from luxury to economy
properties. The purpose of this article is to examine factors that influence hotel values in this market. The article first provides a historical overview of the Indianapolis market and examines supply and demand factors affecting the local lodging industry. The authors then discuss factors pertinent to the sales, cost, and income approaches often used by investors and valuation experts.
Historical Overview of the Indianapolis Market
The Indianapolis lodging market is bifurcated into two major submarkets, namely, the
downtown submarket and the airport submarket. Clusters of hotels also exist in other sections of the county on the north, east, and south sides of the metropolitan area. For the purpose of this article, the authors focus on the downtown submarket. Some information about the airport submarket is shown for comparison purposes.
The following figures show performance trends of Indianapolis hotels from 2000 to the present. We focus on two distinct submarkets – Downtown Indianapolis and the Indianapolis Airport Area – to show the performance distinctions between downtown and airport
properties. These performance trends are based on information from our proprietary HVS database of hotel performance trends.
Figure 1: Indianapolis Occupancy Trends
Source: HVS
Figure 2: Indianapolis ADR
Source: HVS 0% 10% 20% 30% 40% 50% 60% 70% 80% Downtown Airport $0 $20 $40 $60 $80 $100 $120 $140 $160 Downtown Airport
Figure 3: Indianapolis RevPAR
Source: HVS
In both submarkets, occupancy and RevPAR began to decline between 2007 and 2008, which coincided with a severe national economic recession. Strong healthcare sectors and other stable industries such as technology helped to protect the city against more severe
recessionary impacts observed in other parts of the country.
In recent years, the performance disparity between the downtown and airport submarkets has widened, highlighting the strength of the Indianapolis downtown submarket and the
continued softness of the airport submarket. From 2012 to 2013, we observe a slight decline in ADR and RevPAR trends in the airport submarket, reflecting the fact that the 2012 Super Bowl boosted hotel revenues significantly for the month of February in 2012. In the airport submarket, a year of moderate economic improvement was not enough to create a year-over-year increase in RevPAR. However, a more rapid economic recovery in the downtown submarket yielded a significant year-over-year RevPAR increase even though the Super Bowl impact temporarily increased 2012 performance. Recovery is taking place at a more rapid rate downtown. To provide greater context for these performance trends, it is necessary to investigate the Indianapolis airport and downtown demand generators in greater detail.
Demand Generators
Sports tourism, government activity, conventions, higher education, and health care are among the major lodging demand generators in Indianapolis. Increasing lodging demand in Indianapolis relates to the success of local businesses and institutions as well as tourism growth. Hotels in the Indianapolis market area benefit from a range of successful business, government, convention, sport, and tourism attractions. The following list highlights several important demand generators in this market:
$0 $20 $40 $60 $80 $100 $120 Downtown Airport
Bankers Life Fieldhouse Circle City Mall
Eli Lilly and Company Indiana University Health Indianapolis Motor Speedway
Indianapolis Convention Center and Lucas Oil Stadium Indiana State Fairground
Indiana Statehouse
The healthcare and pharmaceutical manufacturing industries are the largest employers in Indianapolis and the region. Indiana University Health employs over 20,000 people, and St. Vincent Hospitals employs over 11,000. With total patient admissions totaling over 143,000 per years, I.U. Health is a major demand generator for the lodging industry. The I.U. Hospital also has two of the three level-one trauma centers in Indiana. The hospital’s prestige
continues to increase, and in recent years it was named to U.S. News and World Report’s Honor Roll. I.U. Health also benefits from its partnership with the Indiana University School of Medicine. The organization continues to develop its research portfolio, and it offered over $267,000,000 in research grant funding for the 2011-2012 academic year.
Indianapolis is known for its major sporting events. The Indianapolis 500 is a famous yearly automobile race that attracts over 300,000 attendees to the Indianapolis Motor Speedway each Memorial Day weekend. The Indiana University Public Policy Institute reports that the Indianapolis 500 generated over $63 million in out-of-state visitor spending in 2012. Major sports venues in Indianapolis include the Lucas Oil Stadium and Bankers Life Fieldhouse. Professional teams including the Indianapolis Colts and Indiana Pacers play home games at these facilities. Circle Center Mall consists of over 100 stores on four levels. It is the premier shopping center of the region. Nine hotels are directly connected to the mall. Eli Lilly is a global pharmaceutical company whose headquarters are in Indianapolis, and they are a large employer of area residents. Indianapolis is home to the company’s research and development headquarters with four sites in the area. The Indiana State Fairground features 20 event venues on a 250-acre campus. Finally, as the seat of government for the state of Indiana, there is a demand to accommodate meetings for government groups and public events associated with government activity. Local colleges and universities are another key economic driver. Area institutions include Butler University, Indiana University-Purdue University Indianapolis, the University of Indianapolis, and Ivy Tech Community College of Indiana.
Indianapolis Airport Expansion
The relatively poor performance of the hotel properties near the Indianapolis airport can be tied in part to the performance of the airport itself. The Indianapolis Airport passenger traffic is summarized in the following figure1.
Figure 4: Indianapolis Airport Passenger Traffic
We observe a substantial decline in passenger traffic between 2008 and 2009. This can be explained by a number of factors. First, the economic recession beginning in late 2007 led to a rise in fuel costs. In 2008, the Indianapolis-based ATA Airlines went into bankruptcy and ceased operations, citing fuel costs as a reason for their failure. This airline offered low fares and non-stop services to key business and leisure destinations throughout the United States, including service to cities in Florida and California. The failure of this hometown airline coincided with the opening of a new $1.1 billion terminal in 2008. When the feasibility of this airport expansion was evaluated in the late 1990’s and early 2000’s, the outlook was positive and this affected the City’s decision to plan for an airport expansion. ATA was growing at a significant rate and the industry had not yet experienced the damaging impact of the two most recent economic recessions. It seemed that a new terminal would be needed to handle the continued service expansions of ATA and other airlines. But with ATA’s collapse, the cost burden of the new terminal would fall on the remaining airlines, creating a further burden for the surviving airlines. As a result, some of these airlines cut back on marginally profitable flights, and mergers were taking place due to nationwide recessionary impacts. In 2009, for instance, the merger of Northwest Airlines into Delta led to a reduction of flights at the Indianapolis airport. These factors, taken in aggregate, serve to explain the decline in passenger traffic from 2008 to 2009.
The airport continued to be negatively affected by increasing fuel costs and corresponding increases in airfares in the years following 2009. Airfares rose over the study period from an average of $316 in 2005 to $388 in 2013, according to our interviews with the Indianapolis Airport Authority. The decline of air carriers and service routes, together with fare increases, drove passenger traffic down. Some signs of improvement have emerged in the past year. For instance, in early 2013, United Airlines began offering nonstop flights to San Francisco. As economic conditions improve and fuel prices stabilize, we expect modest growth to resume in the near-term.
0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000 2005 2006 2007 2008 2009 2010 2011 2012 2013
Indiana Convention Center Expansion and Marriott Place
The impact of major downtown demand drivers must be examined to understand the successful growth of the downtown hospitality market. The most substantial new driver for lodging demand in the downtown market is increased convention space and amenities. Major convention space is centralized in Downtown Indianapolis through a series of interconnected hotel, retail, and convention center developments and walkways. The Indiana Convention Center and Lucas Oil Stadium (ICCLOS) together represent a key economic driver for the city and the region.The Indiana Convention Center was built in 1972. It connects directly with the Lucas Oil Stadium, which opened in 2008 and replaced the RCA dome as the home of the National Football League’s Indianapolis Colts. Super Bowl XLVI took place inside the stadium in 2012, and it is also home to the Big Ten Conference championship games. In 2010, a $275-million investment in the convention center added an additional 274,000 square feet of exhibit space. The new space opened in early 2011. Together with Lucas Oil Stadium, the center now has a combined total of over 1,200,000 square feet of space for conventions, meetings, and special events.
The Marriott Place Indianapolis is also physically connected to the convention center via skywalk. The centerpiece of the five interconnected hotels in this development is the JW Marriott Indianapolis, which opened in 2011. With 1,005 rooms and over 103,000 square feet of meeting space, this is the largest JW Marriott in the world. Marriott Place offers five hotels ranging from the luxury-tier JW Marriott brand to the upper-midscale Fairfield Inn and Suites by Marriott. These hotels offer immediate access to convention spaces and serve as lodging for delegates, exhibitors, and attendees associated with the convention center and other facilities. The Indiana Convention Center and Lucas Oil Stadium are thus connected to a total of 4,700 hotel rooms.
In 2010, the convention center expansion was funded by approximately $275 million in interest-bearing bonds. These revenue bonds mature in 2039 and highlight the need for the City of Indianapolis to generate substantially higher lodging tax proceeds in coming years to pay off these bonds.
The following figure illustrates the growth in total convention attendance in Indianapolis during the past several years.2
2
Figure 5: Indianapolis Convention Attendance: Indiana Convention Center and Lucas Oil Stadium
The convention center represents significant potential as a long-term demand generator in the downtown submarket. The larger space can be characterized as attractive and affordable for many large conventions, tradeshows, and consumer shows. With the recent expansion, Indianapolis is now home to the sixteenth largest convention space in the country. The convention center is now competing on a national level. Evidence of the success of this space is already present. For instance, Gencon has been retained in Indianapolis for 2014 and the estimated 30,000 attendees will be utilizing the increased convention space. These major conventions are crucial to the tourism industry in Indianapolis, which supports over 65,000 jobs. A successful convention center is a key factor in our positive outlook for the
Indianapolis downtown submarket.
Hotel Sales Transaction Trends
Hotel sales transactions can be a key indicator of value trends. The following figure shows the combined number of hotel sales that occurred in Indianapolis over the past decade. For reference, we have also provided a figure representing transactions across the state.
Until recently, only a small volume of hotel sales transacted each year in the Indianapolis market area. The transactions that did take place range from budget to upscale. The nationwide recession is one explanation for the decreasing sales from 2005 to 2008. The recession decreased the availability of capital to finance hotel transactions, and also lowered the confidence of investors. In 2011, the impact of the Marriott Place developments on sales became clear. Investors hesitated to make transactions because it was unknown as to how the market would react to such a large increase in supply. Additionally, Super Bowl XLVI created a temporary surge in lodging demand. During the year leading up to this event, its uncertain impact may have led to a disparity between how buyers and sellers viewed the market’s potential, further curtailing sales activity in 2011.
0 500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000 2005 2006 2007 2008 2009 2010 2011 2012
Figure 6: Local Hotel Transactions and Price/Room - Indianapolis
Source: HVS Figure 7: Statewide Hotel Transactions and Price/Room - Indiana
Source: HVS $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $140,000 $160,000 $180,000 0 1 2 3 4 5 6 Transactions Price/Room $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $140,000 0 2 4 6 8 10 12 14 16 18 Transactions Price/Room
In 2013, the price per room increased dramatically, reflecting the fact that many sources of prior uncertainty had been quantified. The construction of the Marriott Place hotels did not decrease occupancy levels, which shows that the supply was absorbed more quickly than some investors had anticipated. Moreover, the Super Bowl had a substantial impact on both rates and occupancies in 2012.
The location and quality of the assets transacted also had a large impact on these trends. The sale of the Courtyard by Marriott in Downtown Indianapolis helps to account for the large increase in the price per room between 2012 and 2013. Another reason for the increase in sale prices per room is that financing for hotels could increasingly be provided by recovering banks. Access to capital has become more available as the national economy continues to recover. As leverage has become increasingly available, hotel values have increased. We expect hotel transaction prices to continue increasing in the near future, especially downtown, as economic conditions continue to improve and lenders increase the amount of capital available for hotel acquisitions.
Development Cost Ranges
Development costs are another factor that can influence hotel values. We evaluated development cost estimates for two types of hotels in Indiana. Our data represents upper upscale (e.g. Marriott, Sheraton) and upscale (e.g. Hyatt Place, Cambria Suites) chains. The following figure shows development costs for two types of hotels in the state of Indiana.
Figure 8: Estimated Development Costs For Recently Planned Hotels
Development Cost Upper Upscale % Upscale %
Building Construction $155,000 68% $75,000 55%
Furniture, Fixtures, & Equipment $22,000 10% $15,550 12%
Land and Other Costs $51,000 22% $45,000 33%
Total Development Cost/Room $228,000 100% $135,550 100% Source: HVS
The cost per guestroom is the most relevant unit of comparison. These estimates indicate total development costs that average roundly $136,000 per guestroom for upscale select-service hotels and $228,000 per guestroom for upper-upscale, full-service hotels. These figures include entrepreneurial incentive and land, but not contingencies. Building construction represents the largest component of a hotel’s cost, between 55% and 68% of the total
estimated development cost of these hotels. Furniture, fixtures, and equipment often represent between 10% and 12% of total development costs. Land and other soft costs represent the remaining development costs.
Income Capitalization
Income capitalization techniques are often most reliable in evaluating hotel values. The capitalization rate, or cap rate, is an expression of the ratio between the net operating income of a property and the sale price of the property.
The following figure illustrates capitalization rate trends for the state of Indiana as they compare to national averages over the past several years. Information was gathered using the extensive HVS database of hotel transactions and income statements, data from RCA, as well as HVS interviews with buyers and sellers. Indianapolis made up a large percentage of the sales in Indiana and these cap rates may broadly represent trends in the local market. However, the authors do not recommend relying on overall capitalization rates for the purpose of valuing individual hotels.
Figure 9: Capitalization Rates for Indiana and the United States
Source: HVS
A higher cap rate reflects a higher cost of capital or a lower perceived potential for income growth. Cap rates can also be thought of as a reflection of perceived risk; so, a higher cap rate reflects a “riskier” transaction. The preceding figure thus illustrates that transactions in
Indiana were perceived as being riskier than the national average until 2013. As the economy in Indiana has strengthened, cap rates have fallen below even pre-recessionary levels. This trend may also reflect an influx of higher-quality and newer hotel products in the Indianapolis market as well as economic growth and the perceived stability of major demand generators in downtown Indianapolis that were analyzed earlier in this article.
Although capitalization rates are often cited as a key valuation factor for commercial properties, direct capitalization techniques are generally not appropriate for complex properties, such as hotels. A discounted cash flow analysis and various mortgage equity techniques, which HVS frequently employ in our consulting and valuation work, are often
0% 2% 4% 6% 8% 10% 12% 14% 2005 2006 2007 2008 2009 2010 2011 2012 2013 National Cap Rate
more appropriate. So, the data presented in this article are not intended to be used in isolation when estimating hotel values.
Conclusion
This article observed several valuation factors affecting the Indianapolis and Indiana hotel markets. Indianapolis has demonstrated strong trends in performance in its downtown sector in recent years. It is a national convention destination with a diversified economic base. Hotel performance downtown has exceeded pre-recessionary levels; the Indiana Convention Center and Lucas Oil Stadium appear to have played a significant role in these trends. This is a market that is emerging on the radar of national hotel investors and the near-term economic outlook is positive in the state and local market. Additional summaries of our proprietary research may be located on the HVS website at www.hvs.com.
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About the Authors
Todd Isenstadt is an analyst at the HVS Chicago Office, where he specializes in hospitality industry research. Mr. Isenstadt graduated with honors from the College at the University of Chicago, where he majored in philosophy. He can be contacted by telephone at (312) 526-3782 or by email at [email protected] Hans Detlefsen, MPP,, MAIis Managing Director of HVS’s Chicago office, specializing in hotel consulting and valuation. He holds a Masters Degree in Public Policy from the Harris School of Public Policy Studies at the University of Chicago, where he received the Harris Fellowship. He graduated magna cum laude from the University of Notre Dame with a Bachelor of Arts in Government and Economics. Mr. Detlefsen can be contacted by telephone at (312) 526-3885 or by email at [email protected].
