Full to Capacity? New Downtown Hotel Proposals are Overblown

The spate of new hotels being heralded for downtown Knoxville is likely to assure that none of them will happen. Plans for at least four new downtown hotels with a total of almost 600 rooms have been announced at a time when low occupancy and room rates at existing hotels indicate that the market won't sustain any more—at least in the near term.

As a result, the prospect of a room glut is likely to preclude any of them from getting the financing needed for construction. Indeed, a nationally recognized leader in hotel finance consulting ridicules the old "Build it and they will come" canard.

"In Knoxville, current results of hotels are disappointing, and those numbers would discourage me as a developer from taking the risk of adding more rooms to the inventory of that market," says Hank Fonde, director of investment services at PKF Consulting USA. "Can Knoxville support 600 additional rooms? The simple answer is no. Those rooms should not be built or somebody is going to be in a lot of pain."

As a rule of thumb, Fonde offers that occupancy rates well above 60 percent and average room rates well above $100 a night in a market are needed to justify—or get financing—for a new hotel. According to Smith Travel Research, the compiler of record for hotel operating data, the 2013 occupancy rate for hotels in Knoxville was 56.4 percent and the average room rate was $76.13.

If the Knoxville market were showing signs of growth, then the climate might be more encouraging for new development. But such is not the case. Again, according to Smith Travel, the occupancy rate declined from 58.1 percent in 2012 and 60.8 percent in 2011. Another measure—revenues from Knox County's 5 percent hotel-motel tax—shows that these collections have been essentially flat for the past two years after recovering from a decline of more than 10 percent during the Great Recession.

The prospective glut has already had a chilling effect on plans for the one new hotel that was furthest down the path toward fruition. That would be conversion of the drab state office building on Henley Street adjacent to the Holiday Inn World's Fair Park into a sleek 120-room companion hotel named the Tennessean. When developer Nick Cazana announced his acquisition of the office building for $550,000 about a year ago, its $16 million transformation into an upscale complement to the 286-room Holiday Inn, which he already owns, was due to be completed in time for an opening by this September. And the president of Visit Knoxville, Kim Bumpas, heralded its advent as a big boost to convention recruitment efforts, which she leads, by providing a 400-plus room property in close proximity to the Knoxville Convention Center that's long been considered a requisite for its success.

However, Cazana now reports that the Tennessean is "still under design" and that there is "no target date" for when work will even start. While he won't come right out and so say, it seems apparent that financing is the problem. "When you have 600 rooms coming on the market, it's a concern," is as far as he will go.

The other announced plans for downtown additions include: (1) a 120-room Residence Inn on the vacant State Street site that once quartered the News Sentinel; (2) a 135-room hotel component of a grandiose $84 million mixed-use development proposal by Gateway Knoxville LLC that was competitively selected for the former State Supreme Court site between Henley and Locust; and (3) most recently a proposed $40 million restoration of the 190-room former Farragut Hotel on Gay Street by a Sacramento-based developer.

Combined, these proposals would beget close to 50 percent in downtown's present total of 1,283 hotel rooms, which includes the Marriott (378), the Hilton (320), the Holiday Inn (286), the Crowne Plaza (191), the Hampton Inn (80), and the Oliver (28).

The would-be developer of the Residence Inn, Atlantan Nick Lakta, is frank to say that he is "sort of in a holding pattern." Lakta has exclusive right to that brand in the downtown area and was shocked to learn that Gateway Knoxville had included a Residence Inn in its original proposal for the Supreme Court site. Subsequent to its selection by the city's Industrial Development Board over four competing proposals, Gateway has switched to another hotel brand.

In many ways, the most appealing of the proposals is the restoration of the Farragut, which was downtown's premier hotel from its opening in 1919 until the 1960s. Similar restorations have become landmarks in several other cities, and bringing the now-dormant building back to life would just about complete the revitalization of once-downtrodden Gay Street.

But PKF's Fonde scoffs at the $40 million price tag that's been placed on the restoration by its lead developer, Brian Larson. "That's a cost of over $200,000 per room, and you'd need an average room rate of close to $200 just to break even, which is beyond the realm." Larson claims that historic and other tax credits could bring down the developer's cost to the point where the Farragut can "stabilize" with 68 percent occupancy and an average room rate of $147. But that still seems a stretch, and the city should be wary of making a $2 million "contribution" that's been requested.

The city would also do well to revisit its selection of a Supreme Court site developer. A more realistic proposal for an apartment complex with a garage and some retail from a firm headed by Philip Welker included the proviso that, "Current hotel rates are not high enough to support the cost of building a new full-service hotel with the quality desired for a ‘Convention Center Hotel.' Furthermore, we feel the Holiday Inn has done an excellent job with renovations and the plan to add another 125 upscale hotel rooms in the State Office Building serves that niche."