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New Hotel Development in Downtown Durham by Natasha Catrakilis

Introduction

Over the last two decades, Durham has undergone a significant revitalization of its downtown area. Both private and public investments have contributed to a large number of redevelopment projects that have transformed the face of a once decaying tobacco town into what is now considered one of the nation’s most desirable cities to live in (Carmichael). The transformation first began in the 1980s and 90s with the original conversion of Brightleaf Square, the completion of a downtown Civic Center, the restoration of the Carolina Theater, and the construction of the Durham Bulls Park Stadium – but the major turning point came in 2004 with the start of the American Tobacco Campus redevelopment project (Wong and Wolf, 9). The American Tobacco Campus, along with several simultaneous and subsequent large-scale downtown projects, led to the proliferation of new businesses, restaurants, bars, and shops that have contributed to the city’s “live, work, play” environment and growing economy.

Durham’s promising future has continued to attract both commercial and residential investors and developers who are seeking to capitalize on this growing market. More recently, however, there has been a rapid growth in the number of hotel development/redevelopment projects over the last five years. Much of downtown’s rebirth is the result of a strategic plan led by Durham’s city and county participation in public-private partnerships, and the recent influx of hotel developments is no exception. Four out of the five new hotels that will be opening their doors in downtown within the coming year are funded by city and county incentives. Although public sector financing in support of urban developments is a common practice, the trend in relation to the hotel industry is relatively new, particularly in Durham. For these reasons, my paper seeks to provide a two-part analysis explaining the new growth in public-private partnerships funding Durham’s downtown hotel development.

I will begin by providing a brief overview of the specific downtown area and the new hotels that have been approved for funding and development, followed by a general discussion about the roles of hotels within the city and the recent national trend towards public sector funding. Then I will analyze the trend in relation to Durham specifically: first, by discussing the motivating factors behind Durham’s city and county incentives for these new hotel projects – including the current supply shortage, perceived economic benefits, and historic preservation; and secondly, by addressing the concern of a potential oversupply – including demand indicators and generators and product differentiation. I will conclude with a brief overview of the analysis and final considerations regarding the future success of these investments. All numerical and statistical data used throughout this paper come from the Durham Convention and Visitor Bureau and the Durham Chamber of Commerce unless otherwise cited.

Downtown Durham

The downtown area of Durham, according to the Downtown Durham Inc., is approximately .751 square miles. As shown in Figure 1.1, the 6-distrcit area encompasses 14 x 12 blocks that span from the intersection of Buchanan Boulevard and W. Main Street to the intersection of Fayetteville Street and E. Main Street. The map in Figure 1.2 depicts the approximate downtown locations for each of the five new hotels that have secured funding and are scheduled to open their doors by the end of next year. They include the 21c Museum Hotel (opening March 2015), an Aloft Hotel (opening April 2015), the Durham Hotel (opening May 2015), a Residence Inn by Marriott (opening June 2015), and the Jack Tar Hotel (opening Q1 2016). While several other hotels have been developed in the surrounding neighborhoods, these are the only hotels that will be directly located in the delineated downtown area. The map also shows the only hotel that currently serves the downtown, the Marriot City Center, as well as several completed downtown development projects (ATC, DPAC, and the Durham Bulls Park) that have attracted many real estate developers to the area. With the Aloft Hotel being the only exception, all of downtown’s new hotel projects have been backed by some degree of city and county funding (data was taken from official City and County contracts and agreements from www.durhamnc.gov):

  • 21c Museum Hotel: 125 room project estimated cost is $48 million; received $5.7 million incentive from the city and $2 million from the county
  • The Durham Hotel: 54 room project estimated cost is $11 million; received $1.2 million incentive from city and county
  • Residence Inn by Marriott: 143 room project estimated cost is $29.5 million; received $1.3 million incentive from city and $400,00 incentive from the county
  • Jack Tar Hotel (74 room hotel included in the larger City Center development project): project estimated cost is $85 million; received $3.9 million incentive from city and county

*Note that this hotel is unique in that its development is in support of the lager 26-story mixed-use City Center project

It should be noted that all of these incentives are guided by specific requirements, including start/finish construction dates, and are “performance-based,” meaning the contracted firm will not receive any payments from the city or county until after the project construction is complete. In other words, public dollars will follow private performance and investment.

natasha1Figure 1.1 Source: DCVB

natasha2Figure 1.2 Source: Google Maps

Hotels, Cities, and Public Investment

Before I can analyze specifically why Durham’s local government approved a total of $10.6 million towards the development of five new downtown hotels opening within one year, it is important to understand the general role that hotels play in relation to the city, and why the public sector has increasingly become a major contributor to the funding of large hospitality projects. With regard to the hotel’s role within the city, McNeil (2008) asserts that hotels have become a crucial component to urban renewal strategies and the notion of the “circulatory” city. He notes that changes in hotel developments are part of a broader reconfiguration of the central business district, in which hotel location is increasingly driven by proximity to the “diverse workforce of office markets.” Hotels locate themselves in accordance to their market, and in turn they become nodes of circulation, “operating between fixity and flow, locating and refreshing mobile bodies, embedding them in relatively fixed networks within particular cities.”

In recent years, the public sector, either on its own or in partnership with the private sector, has gradually become a major contributor in the urban renewal of cities across the nation. Tress (2003) emphasizes that a key component of urban revitalization often begins with or incorporates the development of a large hospitality projects. However, the high risk of hotel development, primarily due to high replacement costs, often results in less available returns on investment than those desired by private investors. Furthermore, Tress points out that private sector investment in the hotel industry has become increasingly conservative – loan to value (LTV) ratios have shifted downward and debt service coverage (DSC) ratios upward, further emphasizing the associated high risk with the hotel industry. As a result of these two trends, the public sector has emerged by providing incentives to alleviate some of the risk and bridge the gap between return on investments.

Public Sector Motivations

There are several reasons that motivate the local public sector to provide the financial support of hotel development projects. In the context of Durham, the most obvious reason is the significant shortage in the supply of hotels directly servicing the downtown area. Until very recently, the only hotel located in downtown Durham has been the 190-room Marriott City Center, which opened in 1986 and was last renovated in 2008 (Oleniacz). Adjacent to the hotel is the 40,00 square foot Durham Convention Center. The convention center is equally co-owned by Durham City and Durham County and until 2011 was managed by Shaner Hotels Group, the owner-operator of the Marriott City Center (Oleniacz). Historically, convention centers have acted as loss leaders, but several factors contributed to the DCC’s largely increasing operating deficit. Under new management by Global Spectrum, the center’s operating deficit has significantly decreased (Oleniacz). However, the fact remains that the Marriott City Center hotel only has 20% of the necessary guest rooms for a convention center of its size (Arai). One of the primary motivations, thus, behind Durham’s public sector funding of these new hotel developments is to provide the necessary additional hotel rooms that would help generate convention center business.

Aside from the obvious supply shortage of hotel rooms in the downtown area, another important motivating factor behind public sector funding is the economic benefits that are expected to come from these developments. The economic impact of hotels is most commonly assessed by the fiscal (tax base revenue), direct (job creation), and induced (visitor spending) impact (Tress). In each one of the incentive agreements signed by the city and hotel development companies, approval was given because of the likely expansion to Durham’s tax base from new property, sales and occupancy taxes and the creation of new jobs in accordance with the Durham-Based Business Plan and Durham Workforce Development Plan (which stipulate good faith efforts to engage Durham-based firms in the construction work for the project and engage the Durham JobLink Career Center System in efforts to hire temporary and permanent staff related to the project). Based on each hotel’s proposed agreements and contracts, below are numerical calculations of their respective estimated fiscal and direct impacts:

  1. 21c Museum Hotel
    1. Fiscal Impact: over $1.9 million in incremental property taxes and $8.5 million in occupancy and retail sales taxes would be generated as a result of this project, yielding a net revenue gain to the City of over $2.6 million over 20 years
    2. Direct Impact: project is slated to create more than 150 permanent jobs with a substantial percentage paying in excess of livable wage
  2. The Durham Hotel
    1. Fiscal Impact: over $107,363 in incremental property taxes and $686,213 in occupancy and retail sales taxes, yielding a net revenue gain to the City of over $188,576 over 7 years
    2. Direct Impact: project is slated to create 91 new permanent downtown-based jobs and over 100 temporary construction jobs
  3. Residence Inn by Marriott
    1. Fiscal Impact: over $640,736 in incremental property taxes and $1,138,000 in occupancy and retail sales taxes would be generated as a result of this project, yielding a net revenue gain to the City of $446,634 over 8 years
    2. Direct Impact: new jobs, expected to be created by the project, would consist of 14 part-time positions and 31 new full-time paying jobs with benefits; including 8 salaried positions
  4. Jack Tar Hotel
    1. Fiscal Impact (included in the larger City Center development project): over $4,911,118 in incremental property taxes and $3,402,472 in occupancy and retail sales taxes, yielding a net revenue gain to the City of $4,340,446 over 15 years
    2. Direct Impact: new jobs, expected to be created by the project, would consist of 250 construction jobs, 500 office workers, 75 retail-based employees; and 10 hotel jobs with benefits

While the fiscal and direct impact of a hotel can be numerically calculated and predicted, the induced impact associated with the “spillover effect” – the money that visitors spend on services in other downtown industries – is often more difficult to assess. According to the DCVB’s data on Visitors’ Economic Impact on Durham in 2014, the number of visitors in Durham has steadily increased of the last decade with approximately 9 million visitors spending a collective total of $765.8 million each year. Most visitors spend the largest proportion (26.7%) their money in the food & beverage industry – reinforcing downtown Durham’s vibrant and prolific local restaurant industry. Consequently, all of the city’s and county’s approvals for the public funding of these projects were made with the belief that they will bring more visitors to downtown, thereby increasing visitors’ net economic benefit for Durham.

One final motivating factor behind Durham’s public sector support for downtown’s recent hotel development is the city’s emphasis on historic preservation. Many of downtown Durham’s older buildings lend themselves to this nature, and in fact all of the publicly incentivized hotels in downtown are planned to either preserve or include some historical element unique to Durham in their design. The Residence Inn by Marriott is of particular importance because its public funding was needed primarily to cover the increased costs associated with preserving certain architectural elements of the historic McPherson hospital into the hotel structure (Hoyle). Similarly, the Jack Tar Hotel project would also involve the rehabilitation of a contributing building that is part of the Downtown Durham Historic District. The developer of the boutique hotel has agreed to maintain as much original material as possible while designing the project in order to preserve the building’s unique connection to Durham’s past (Hoyle). On a similar note, both the 21c Museum Hotel and the Durham Hotel are boutique hotels that have structured their design to reflect and incorporate the art, culture, and history of Durham in some form. McNeil (2008) points out that boutique hotels are often located “within the discourse of urban renaissance fostered through the refurbishment of historic buildings (including ex-factories and warehouses),” which is very much the type of landscape that defines downtown Durham.

Concern for Oversupply

The second part of my analysis regarding the new hotel development occurring in downtown Durham involves addressing the primary concern of a potential oversupply to the area. Upon completion of the five new downtown hotels, the inventory of hotel rooms in Durham will nearly triple in size, jumping from 190 to 530 rooms in less than a year. Although the need for more hotel rooms in downtown was previously stated as a primary motivation for public investment in these projects, this drastic increase has, nonetheless, caught the concerning eye of government officials, industry leaders, and local residents.

The belief of many Durham leaders in support of the development, however, is similar to the “Field of Dreams” theory suggested by Culligan (1990), which is, “If you build it, they will come.” After looking at both supply and demand in the hotel industry from 1965 to 1990, Culligan noted that growth in demand occurred in remarkably close relationship to growth in supply, and in some cases, such as with new niche hotels, supply could actually stimulate demand growth. His conclusions are based on the simple assumption that the market tends toward equilibrium, but his evidence comes only from historical examples in which demand growth followed supply booms.

Geoff Durham, president of Downtown Durham Inc., said he believes demand will exceed expectations for the new downtown hotels because of the “success and growth” in the entertainment, restaurant, and retail venues downtown and “to a large extent, these new hotel developments are playing catch-up to this demand,” (Oleniacz). On the same note, Shelly Green, President & CEO of the Durham Convention and Visitors Bureau, told City Council that the economic and domestic tourism demand in Durham could accommodate 1,200 rooms (Oleniacz). She further explained that greater marketing efforts by the DCVB will help fill the additional hotel rooms. The DCVB receives a third of the occupancy tax revenue collected by hotels and uses that for marketing to attract more visitors: “As the inventory of hotel rooms grows we have more marketing dollars to fuel that demand and visitation,” (Oleniacz).

The evidence in support of this increased visitor demand comes largely from the city’s two major leisure attractions, the recently built Durham Performing Arts Center and the Durham Bulls Park Stadium. Built in 2008, DPAC is a 2,800-seat multi-use performance theater that houses nationally renowned Nederlander productions, including Broadway shows and various other performances throughout the year. A year-round schedule of national entertainment acts supplemented with local entertainment events has added marketing and entertainment cache to the thriving Durham arts scene. According to the Durham Convention and Visitors Bureau, total visitor spending by DPAC guests in Durham exceeded $66.3 million last year, with an economic impact of $48.4 million. The Durham Bulls Athletic Park was originally built in 1995 through public funding and has served as an integral catalyst to downtown’s revitalization. The stadium, home to the Durham Bulls as well as the Duke Blue Devils’ and North Carolina Central Eagles’ college baseball teams, was renovated this past year in preparation to host the 2014 Triple-A All-Star Game. This nationally televised game brought in visitors from across the country for a 5-day festival, resulting in an estimated $3.3 million in visitor spending to the area. The $20 million renovation has made an enormous impact on the stadium’s success, with last year’s final paid attendance equaling a record high of 533,033. The amount of visitors that come to Durham to attend events hosted by DPAC and the Bulls Stadium indicates that there is an unmet demand ready to fill the new supply of hotel rooms in downtown. Developers of these new hotels have strategically placed them in the downtown location to be in close proximity to Durham’s demand generators, hoping to capitalize on a market of visitors who would stay longer/overnight – and thereby spend more money in downtown – if more hotel options were available.

In addition to these demand generators that target leisure travelers (who make up 73% of Durham’s visitors according), Durham also has several indicators that support an increase in the business traveler demand. Several studies show that a strong economy and employment rate are signs of increases in demand for the hospitality industry (O’Neill). The 2014 edition of PKF Hospitality Research states that rising levels of employment, combined with increased geographic expansion of the national economic recovery, will result in revenue per available room growth in excess of long-run averages for all hotel markets from 2014 through 2017. In fact, PFK projected demand growth to outpace changes in supply in the U.S. through 2016. Durham currently has an unemployment rate of 4.4%, which is below the national average of 6.3%. Over $1.3 billion dollars in private and public investment have been put forth into new development projects that will generate even more employment opportunities for downtown. Downtown’s proximity to Duke University and Medical Center, major global companies, and a wealth of entrepreneurial activity ensure further employment growth. According to Durham’s Chamber of Commerce, Durham County has enjoyed a 10.2% increase in jobs located within the county since 2000, far exceeding North Carolina’s 2.7% growth. Another important factor to consider is that hotel demand in university towns has generally proven to be more stable than national averages, which has proven to be true for Durham for the past two decades (O’Neill).

One final point should be made addressing the potential concern for oversupply, and that is the product differentiation in the types of hotels that will be developed. From boutique to branded, select- to full-service, each of the five hotels caters to a relatively different market of customers with little overlap. The 21c Museum Hotel and the Durham Hotel provide truly unique “boutique” experiences for guests that might be willing to pay a higher price for greater amenities and personalized service, while the Residence Inn and Aloft Hotel primarily cater to travelers who value convenience and practicality over luxury. This creates a variance in the price scale for hotel rooms serving the area, making sure that the new supply of hotel rooms reaches all spectrums of the market.

Conclusion

In summary, whether built by the public sector or private sector, a crucial element in deciding to build a hotel is evaluating and ensuring sufficient demand for the rooms once built. When the private sector provides a significant portion of the financing needed to build a hotel, this is a good indication the demand is there. Public sector funding for urban development purposes is a common practice, but has not been as common for hotel development projects until recently, especially in Durham. Throughout this paper, I have provided reasons explaining the new growth in public-private partnerships funding of hotels specifically in Durham’s downtown, focusing on the motivations on behalf of the public provide these incentives, and addressing the potential concern for an oversupply of hotel rooms in the area. Although the success of these new development projects can not be properly assessed until hotel operations have been underway for a substantial amount of time, many other cities across the United States have provided significant public funding and financing for downtown hotel projects when faced with similar challenges — the lack of downtown hotel rooms. Nonetheless, the key factor to ensuring that the supply of these new hotel rooms is met relies heavily on the effective marketing strategies for each hotel. None of these new hotel development projects (aside from the Aloft Hotel) would have been feasible without the financial support of Durham’s city and council. Public sector involvement has been crucial in the revitalization of downtown Durham, and the development of these new hotel projects will further enhance the city’s goal for continued growth and a strengthening economy.


Bibliography

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Culligan, Patrick E. “Looking Up: Lodging Supply and Demand.” Cornell Hotel and Restaurant Administration Quarterly 31.2 (Aug. 1990): 32. Web. 24 Feb. 2015.

Hoyle, Amanda Jones. “Hotels in Downtown Durham.” The Triangle Business Journal. American City Business Journals, 25 Nov. 2014. Web. 5 Mar. 2015.

McNeill, Donald. “The Hotel and the City.” Progress in Human Geography 32.3 (2008): 383–398. Web. 24 Feb. 2015.

O’Neill, J.W. “Improving the quality of hotel feasibility studies: Evaluating potential opportunities for hotel development and acquisition in university towns.” Journal of Quality Assurance in Hospitality & Tourism 14.1 (2013): 391-411. Web. 5 Mar. 2015.

Oleniacz, Laura. “Durham to see influx of hotel rooms next year.” HeraldSun.com. The Herald Sun, 25 May 2014. Web. 5 Mar. 2015.

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Visitors’ Economic Impact on Durham Spending, Value Added, Jobs Supported, and Taxes Paid 2014. Durham Convention & Visitors Bureau Data.

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Foster St. (Washington to Chapel Hill Rd.)

Foster St. was more commercial than the other areas we visited. There was a great deal of signage for points of interest in Durham along the road, indicating that Durham is still working on marketing itself to its visitors. We also passed the site of the Durham farmer’s market, the YMCA, and the Marriott, implying that this road is an integral part of life in Durham, providing important centers for it’s inhabitants, and facilitating the influx of its visitors. The drive down this part of the street has a very good view of some of the most recognizable structures in Durham as well.