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February 22, 2013 City of Duluth Department of Planning & Development j Ms. Melissa Muscato Development & Project Manager City Hall, 2nd Floor 3167 Main Street Duluth, Georgia 30096 Dear Ms. Muscato: In accordance with our engagement letter, we have prepared a market analysis and projections of occupancy, average daily rate (ADR) and cash flow for a proposed 100-unit select-service hotel to be located in downtown Duluth, Georgia. This report sets forth our findings and the support for our conclusions. EXECUTIVE SUMMARY Metropolitan Atlanta Overview R With a population of nearly 5.5 million, the 28-county Atlanta-Sandy Springs- Marietta metropolitan statistical area (Atlanta MSA) is the ninth largest in the United States. It serves as a center of commerce, finance, culture and transportation for the Southeast. R The economy of the MSA is dominated by the trade and services sectors, with a relatively minor contribution from manufacturing. Total nonagricultural employment for the Atlanta MSA contracted at a compound annual rate of 1.0 percent over the past five years, caused primarily by a precipitous drop in 2009. July 2010 was the first month to show positive growth in employment (as compared to the same month in the prior year) since April 2008. Growth of 1.3 and 1.5 percent were experienced in 2011 and 2012, respectively. R Critical to the metropolitan area’s positioning is an extensive transportation network, including the world’s busiest and one of its largest airports. Over 95 million passengers were served in 2012. PKF Consulting USA, LLC * 4314 Pablo Oaks Court * Jacksonville, FL 32233 TEL: 904-821-0690 * FAX: 904-821-0242 * www.pkfc.com City of Duluth Department of Planning & Development February 22, 2013 Page 2 Site and Neighborhood Evaluation R Duluth is located approximately 23 miles northeast of downtown Atlanta. It had a 2010 population of 26,600. R The City of Duluth has identified four potential hotel sites in the downtown area. R Downtown Duluth is relatively vibrant, with numerous shops, restaurants and businesses lining Main Street. Revitalization of the downtown area is being approached in phases. The first two included development of the town green followed by construction of a new 44,000-square foot city hall and pedestrian improvements around Church Cemetery. The third phase of revitalization is to encompass The Block, a 3.3-acre parcel including the former city hall and warehouse space. It is to be redeveloped into a restaurant district with eight to ten outlets and perhaps a salon or spa. Completion of The Block by the end of 2015 is a critical assumption to our analysis. Recommended Facilities R There are no hotels within the Duluth city limits at present. Thus, given the pioneering nature of the subject, we recommend pursuing development of a relatively small (approximately 100 units) select-service hotel with a strong, high quality brand with broad appeal to business travelers and leisure guests alike and which will help drive demand through its reservation system. This combination of size, orientation and branding will help minimize project costs and the financial risks of the project. R Amenities prototypical of the brand selected should be provided with perhaps an expanded complement of meeting space, say 1,500 to 2,000 square feet. Some select-service brands require the inclusion of a restaurant. For purposes of analysis, we have assumed such a property would offer a restaurant leased to and operated by a third party. R Again because of the subject’s pioneering nature, we believe it is critical to its success to be distinguished from the competitors via design elements and support amenities. There are clear synergies resulting from the presence of several hotels at a given location. A single hotel is therefore challenged to gain adequate market exposure, absent a unique location or physical characteristics. R For purposes of this analysis, we have assumed a January 1, 2015 opening date. City of Duluth Department of Planning & Development February 22, 2013 Page 3 Supply and Demand Analysis R There are six properties with a total of 716 guest rooms which would potentially compete with the subject hotel. Three of the hotels are located proximate to the Interstate 85 (I-85)/Sugarloaf Parkway interchange while the other three are in the Johns Creek area. R Market area occupancy and ADR were 67.3 percent and $97.76, respectively, for 2012. The properties garner 56 percent of their accommodated demand from business travelers, 22 percent from groups and 22 from leisure guests. The Sugarloaf properties tend to perform best. R We have identified no additions to the competitive supply of guest rooms other than the subject hotel. R Considering recent trends in the market, base growth rates are expected to be moderately strong at the beginning of the projection period, tapering thereafter. An additional level of “supply-driven” growth is anticipated to be generated by the opening of the subject. Estimated Levels of Utilization R The proposed hotel is expected to achieve penetration levels approximating its fair market share in all three demand segments. R Projected market penetration, occupancy, ADR and revenue per available room (RevPAR) are presented in the table below: ESTIMATED MARKET PENETRATION, OCCUPANCY, AVERAGE DAILY RATE AND REVPAR PROPOSED 100-UNIT SELECT-SERVICE HOTEL 2015 THROUGH 2019 Average Daily Rate Occupancy Constant Inflated RevPAR Year Penetration1 Occupancy 2012 Dollars Dollars2 (Inflated $) 2015 88% 59% $ 96.00 $105.00 $61.95 2016 97 66 98.00 110.25 72.77 2017 100 69 100.00 116.00 80.04 2018 98 69 100.00 119.50 82.46 2019 96 69 100.00 123.00 84.87 1 Presented as a percentage of fair market share. 2 Inflated annually at 3.0 percent and rounded to the nearest $0.25. Inflation rates were based on the results of recent investor surveys and forecasts by the U.S. Congressional Budget Office. City of Duluth Department of Planning & Development February 22, 2013 Page 4 Financial Projections R Projected cash flows from operations before debt service and income taxes, in inflated dollars, are depicted in the following table. PROJECTED CASH FLOWS FROM OPERATIONS BEFORE DEBT SERVICE AND INCOME TAXES PROPOSED 100-UNIT SELECT-SERVICE HOTEL 2015 THROUGH 2019 Inflated Year Dollars 2015 $546,000 2016 752,000 2017 865,000 2018 892,000 2019 917,000 The projected cash flows generate an unleveraged internal rate of return (IRR) of 7.29 percent and a leveraged IRR of 9.76 percent based on typical investment parameters and development cost. These returns are unlikely to be sufficient to entice a qualified hotel developer to pursue the project. Accordingly, some level of incentive must be considered if the property is to reach fruition. The foregoing projections of occupancy and ADR reflect the performance of the hotel on any of the four sites being considered. In other words, these levels could be achieved on the least desirable site. It is important to note, however, that the projections could differ depending upon the site selected. As noted, it is our belief that development of The Block is critical to the subject property’s viability. Accordingly, immediate proximity to restaurants, retail and entertainment options could enhance the proposed property’s performance. It is our recommendation that the projections be updated and adjusted once a specific site and brand have been selected. City of Duluth Department of Planning & Development February 22, 2013 Page 5 METROPOLITAN ATLANTA OVERVIEW An analysis of the economic characteristics of a given market area is critical in assessing historical and future growth patterns and their impact on levels of lodging demand. Such an analysis also contributes to a proper evaluation of market risks. For instance, a market heavily oriented towards a single demand generator (e.g., a military installation) often carries a high level of inherent risks. Conversely, a market having a diverse economy typically is less vulnerable to downturns. Further, the sheer size of a market can impact risks through its ability to recover from conditions of oversupply. The City of Atlanta is the capital of Georgia and, along with its surrounding metropolitan area, is the largest and most important city in the southeastern United States. Once a second-tier city along with Memphis and Birmingham, Atlanta’s progressive leadership in the 1960s and 1970s placed the area at the forefront of the trend toward migration to the Sunbelt which began at that time and continues today. In so doing, Atlanta unseated the region’s traditional major cities, New Orleans and Miami, and became one of the principal metropolitan areas in the United States. Today, Atlanta is the primary center for commerce, finance, culture, transportation and the federal government within the Southeast. The maps on the following pages depict the metropolitan statistical area’s location within the state and region, and the subject’s location within the metropolitan area. Population: Population growth is an important factor in determining the economic strength of a given area. Although the growth of a local population is not related directly to room-night demand for hotels, it does reflect employment growth and future employment concentration which, in turn, typically influence levels of commercial room-night demand. The 28-county Atlanta MSA is the ninth largest in the United States with an estimated 2012 population of nearly 5.5 million. During the period from 2007 to 2012, the population of the MSA grew at a compound annual rate of 1.6 percent. Gwinnett County, which encompasses the subject site, contains approximately 15.6 percent of metropolitan Atlanta’s population. It grew 2.2 percent compounded annually over the past five years, reflecting one of the strongest rates within the MSA.