The world’s largest franchisor of hotels, Wyndham, makes a persuasive case that the U.S. is entering a multi-year boom in the franchising of economy — and midscale — hotels.
With turmoil rattling the markets short-term, it’s easy to overlook factors that signal long-term optimism. Wyndham Hotels & Resorts executives touted on Wednesday an upswing in the number of hotel investors that believe the U.S. is entering a “supercycle” of growth that might last for a decade.
“Our franchisees are feeling that they’re beginning a cycle that hopefully is going to run another 10 years,” said president and CEO Geoffrey Ballotti during an earnings call with analysts. “Their leverage is down. Their balance sheets are in much better shape.”
The term “supercycle” refers to above-average growth that defies the gravity of a typical economic boom and bust cycle. Historically easy-to-obtain financing at low-interest rates, a spike in government spending on infrastructure, and forecasted comparative weakness in alternative real estate assets may push the franchising of roadside, economy, and midscale hotels into a multi-year expansion.
War, supply chain bottlenecks, labor pressures, and rising interest rates are all factors worrying some travel executives in the short term.
But Wyndham, the largest hotel franchisor in the U.S. and the world, is focused on causes for long-term optimism for its brands, which include Ramada and Super 8.
“Most of our franchisees believe that there’s never been a better time to build a select-service hotel than there is today,” Ballotti said. The term “select service” refers to branded hotels that don’t offer full-service amenities but aren’t bare-bones either.
A Few Factors Fuel Franchise Growth
Certain types of hotels appear more promising than alternative investments, such as commercial real estate and retail construction — both of which are pressured by uncertainty over long-term trends in demand for workplaces and shopping malls because of a rise in online alternatives.
“ROIs [return on investment forecasts] in the hotel space are still really attractive versus other real estate asset classes,” said Michele Allen, chief financial officer.
Government spending is another factor that may support long-term guest demand for roadside hotels, which attracts the interest of franchisees. Congress’s recent passage of a U.S. infrastructure bill includes about $550 billion in new spending on “core infrastructure projects” over the next five years. Companies contracting to build roads, bridges, levees, dams, ports, and waterways will need places to stay in the coming years, posing an opportunity for hoteliers.
So-called infrastructure accounts made up more than half of the newly negotiated business contracts that Wyndham’s sales team signed in the first quarter.
Interest in New Construction
Investors interested in hotel franchising can obviously choose to buy properties or build new ones, and current market conditions often favor new construction.
“The rule for buy-versus-build is to buy hotels when they’re trading below replacement cost and then to build when they’re trading above replacement costs,” Allen said. “Today, hotels are trading at or above 2019 levels in many markets, particularly in the chain scales that we have the most exposure to, which would bias owners toward building.”
Construction costs are rising, and interest rates for loans may rise soon, too. So the calculation depends on the investor. If a potential franchisee has capital that they’re looking to deploy right away, they will lean toward buying an existing property. If they’re opportunistic and willing to wait, they’re going to build.
One bullish sign Wyndham executives cited was that its new construction activity had ticked up for its brands, including Microtel and its new extended-stay concept.
Wyndham said 79 percent of its pipeline of 204,000 rooms in signed projects is new construction. Digging has commenced for a third of these new properties. Microtel Moda is its most popular brand for investors looking to build new properties. Wyndham’s pipeline of projects contains nearly 10,000 rooms from its newest brands Altra, Registry Collection Hotels, and an as-yet-unnamed extended-stay brand.
The Numbers Supporting New Construction
For a typical new construction project for a 70-room economy hotel this year, Wyndham estimated the average franchise up-front investment, based on average land costs, at $1.575 million. It forecasted that annual revenues would be $1.354 million in the first year.
Wyndham’s hypothetical scenario implies that it may take as little as five years for an owner to recover their investment, assuming resilience and overall stability in the factors at play.
In the first year, Wyndham assumes operating expenses at $745,000, on average. Taking a 5 percent interest rate, loan expenses would be $184,000. Wyndham charges franchisees fees as a percentage of revenue, which in this example would amount to 20 percent, or $115,000. So the hotel would be left with a cash return of $310,000, or about 20 percent of the upfront investment.
One risk over the next five years is a possible recession. Inflation in operating costs might outpace a falloff in travel demand and revenue, delaying the recovery of invested capital.
Wyndham reported that it had an especially profitable first quarter. It generated $106 million of net income on $371 million in revenue.
Net income was five times the pre-pandemic first quarter of 2019 and four times the first quarter of 2021. Adjusted earnings before interest, taxes, depreciation, and amortization were $159 million, 64 percent more than first-quarter 2021 and 41 percent more than in first-quarter 2019.
Wyndham drove almost all of the profit from royalties on stays at franchised hotels. Franchisees pay the brand royalties and fees for marketing and reservations. The fees are based on a percentage of gross room revenues.
Total revenue was up 22 percent year-over-year, reflecting a spike in travel as the pandemic restrictions eased.
In at least the short term, several factors may sustain the strength of revenue and profitability for at least months to come.
“The trend is that our franchisees are feeling that the summer of ’22 could replace the summer of 2021 as the best ever,” Ballotti said.
His sales teams are leaning into the enthusiasm to attract franchisee interest.
“We had the absolute biggest team we’ve ever had at the Asian American Hotel Owners Association meeting in Baltimore, where we had the busiest trade show booth we’ve ever had,” Ballotti said.
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