About Connections: Love it or hate it, history is a map. Those who hate history think it irrelevant; many who love history think it escapism. In truth, history is the clearest road map to how we got here: America in the 21st century.
Why are hotel and motel chains overbuilding in Berkshire County? Do they believe there is demand for all those new rooms? Do they estimate off-season occupancy is growing? Do they think in-season occupancy is sufficient to carry the business year-round?
Wall Street Journal, Jan. 23, 2004: “In the old days, construction statistics and other business data were closely guarded secrets. Developers can now look at competitors’ numbers and tell at a glance if an area is becoming overbuilt.”
If that is true, if lack of accurate information is not the reason, what motivates them?
For our purposes, overbuilding is defined as additions to supply from new construction even when current supply of space clearly meets or exceeds demand for space. Why overbuild?
One theory is that demand eventually catches up with excess space so new builds are good business. However, according to a study conducted by John B. Corgel, professor at the School of Hotel Administration, Cornell University, two other things occur before demand catches up:
“First, continuing construction of buildings no one needs is an obvious misallocation of society’s resources. Second, overbuilding imposes financial pressures on existing property owners who may then default on mortgage loans.”
Corgel’s finding would mean, as more motels and hotels go up, extant hostelries have to lower prices to attract market share. The result could be that older properties are unable to meet their financial obligations and close. So does demand actually catch up? If you build it, they will come? Or does overbuilding drive out the older businesses and, for that reason, the new builds fill up? Actually the net number of rooms available does not increase?
In the Berkshires this is a very important question because there is an environmental impact that could, in itself, lower demand. Large hotel/motels surrounded by impermeable surface parking lots change the look of the countryside. If Berkshire becomes more urban, fewer tourists may come.
Moreover, the older inns and B&B are likely to be smaller, renovated structures. Reuse of extant buildings does not exhaust as many resources as new builds, and the smaller, older structures better suit the character of Berkshire County.
Corgel continues, “In the past three decades, hotels became the most overbuilt among property types.”
In his study, Corgel found that builders did not look at current statistics closely enough because they believed demand is cyclical over time. They ascribed to the theory that demand would catch up.
However, in their study, William Wheaton and Lawrence Rossoff from the Massachusetts Institute of Technology found that the hospitality industry was “less conforming relative to those of the general economy”.
The hospitality industry experienced longer lag times; demand did not catch up with space available as quickly as in residential or office buildings. Wheaton and Rossoff concluded, “Property types with longer lag times are the most prone to overbuilding.”
In another study, Wheaton found that a burst of increases in occupancy may be incorrectly interpreted as a long-term change and trigger development.
So if Tanglewood books a great season, we get three more Marriotts? Maybe, but there is more to it than that.
In an earlier study, Wheaton found that property types with high rates of obsolescence experience relatively high frequency of and persistent demand for replacement. This characteristic raises the probability of overbuilding. Hotels are the prime example. The public demands something new in a hotel more often than in office space or even residential space. So hotels build new exactly because they believe they can outperform the older properties.
In Hong Kong, Wang and Zhou found “developers will knowingly oversupply the market at the first sign of opportunity because of the high cost of holding land.” Development increases the value of the land whether or not the hotel they build makes a net profit.
At the Department of Hospitality and Tourism Management, Purdue University, a study found “The lodging industry has incentive to maintain excess capacity.”
Why would oversupply be considered beneficial?
First, that is not exactly the proper phrasing. Those in the industry know oversupply depresses profitability; even so, there are still incentives to create excess capacity. There is more money available at better rates for new builds. Tax deductions for depreciation help carry the new hotel even when it is not profitable. Spreading loss over a chain of hotels, some very profitable, may also be a benefit. The objection to obsolescence makes resale, hotel swapping and flipping advantageous. It is even more advantageous after the tax deduction for depreciation expires. Finally, the increase in land value by building enhances resale.
So, at the end of the day, even though it may negatively impact the community aesthetically, may negatively impact extant businesses, there are reasons to overbuild. The incentives may be more cynical than an honest net profit and serving a public need. The reasons may be revenue-neutral or actually produce a negative cash flow for the new build; nonetheless, expect more and more permit applications.