As Chicago Hotel Well Goes Dry, Investors Dive Deep For Opportunity

Chicago's pipeline of hotel properties is running dry as the Windy City lags far behind other top U.S. markets for new construction — leading investors in the space to pivot their strategy.

The no: developing new properties. The go: acquiring existing properties instead of building new ones as Chicago hotels become available for a relative steal versus comparable markets.

Panelists at Bisnow’s Chicago Hospitality Summit at Loews Chicago Hotel said the best local investment strategy for hotels in the near future is acquisitions — and their wisest advice is to line up deals now as sellers and buyers begin to bridge a persistent bid-ask spread that has hampered sales everywhere.

“It’s a phenomenal opportunity to enter this market right now,” Nate Sahn, CBRE executive vice president, hotel brokerage and investment said.

Chicago is well behind the cream of the crop among top U.S. markets ranked by the total number of hotel projects in the construction pipeline as of Q3 2023, per data provided to Bisnow by Lodging Econometrics. The city has about one-third of the projected hotels and rooms in the pipeline that industry-leader Dallas does. Just nine Chicago hotels are currently under construction.

It is still difficult to invest in Chicago because the ceiling on rates operators can charge for hotel rooms is lower than in New York and Los Angeles, Oxford Capital Group’s Chief Operating Officer Sarang Peruri said. Consumers can go to luxury hotels at lower rates in Chicago, which is good for them, but makes it more challenging to justify development, he said. 

Yet, evaluating the fundamentals of the few hospitality assets that have come to market and traded, Chicago remains a great place to invest, said Nate Sahn, CBRE executive vice president, hotel brokerage and investment sales. While uncertainties are impacting the city — like unpredictable property tax assessments — Sahn said he thinks it’s still a great time to enter the market, especially once capital markets and interest rates begin to stabilize.

“It’s a phenomenal opportunity to enter this market right now,” Sahn said. “When you compare Chicago, what you can buy hotels for here compared to its peer global cities around the U.S., it's a bargain.”

Meanwhile, building new hotels is not feasible in the current market, panelists said.

New construction starts are low because most sectors — not just the hospitality industry — are dealing with the same issues as the industry as a whole: The costs of capital and construction are too high to justify it, Peck Hotel Consulting President Jon Peck said. 

That means that absent factors specific to a particular owner, acquiring properties is preferential to new developments, Arbor Lodging Partners CEO Vamsi Bonthala said.

“If you're just thinking on an unemotional, dollar-in-dollar-out basis, it's acquisitions,” Bonthala said. “Obviously, if you have other drivers like building your brand and things like that, those are unique underwritings and analysis that are going to differ owner by owner, but for the most part right now, I think that it's much more compelling to buy.”

When investing in Chicago’s hotels today, Peruri said it’s important to have a longer-term outlook. If investors have the capital to do so, they should invest with time horizons of up to 10 years in mind, not three to five years. 

It will be tough for industry players over the next 12 to 24 months as interest rates stay high and margins are squeezed, Peruri said. But if stakeholders can make it through the tough economic climate, he said, existing owners will come out on top because supply will be constrained just as demand is projected to continue to climb. 

“I wouldn’t bet against Chicago in the long term,” Peruri said.  

Peruri added that there are a lot of reasons investors are still drawn to the city, and some investment is still happening. As of today, though, the cost of operating in Chicago largely drives lenders and investors to other markets.

What's more, panelists noted that a proposed real estate transfer tax, which would raise taxes on the sales of high-end properties and will head to voters’ ballots in March, is another cost that could impact investment strategy.

Speaking about a deal Arbor Lodging Partners is considering making a loan on, Bonthala said the firm is still considering it despite the potential impact of the tax because it is on the lower-risk side. Bonthala said his firm is still feeling sanguine about the tax’s impact on its role as a lender, though equity partners in a deal might feel more significant jitters. 

Similar taxes in other major cities like Los Angeles and New York City suggest the effect of any CRE tax would soften over time, Bonthala said. 

“It will get normalized through transactions,” he said. “Ten years from now, it won't be as big of a deal. But if you're on the transition part of that, that's a really bad place to be.”

Peruri, whose company has assets in San Francisco and Los Angeles, said the transfer taxes those cities passed had a compounding effect on transaction values. The transfer taxes don’t just impact one company’s decision to invest, but every other investment decision moving forward, Peruri said. 

“When this vote happens in March, I think it's incumbent on all of us here to be thinking through that and advocate so that that doesn't pass,” Peruri said.

Developers, buyers, long-term holders and private equity owners all have different goals for what they want out of an investment, Bonthala said. Depending on how they see the market, they should target different types of properties, he said.

“All of this is a little bit in the eye of the beholder,” he said. “At the end of the day, you've got to not just look at the deal itself, but you have to tie it to the right capital stack and figure out if it's going to work or not.”

While a slow construction pipeline might mean acquiring existing properties is the preferred strategy for CRE players now, that's short-term advice, panelists said. Projections indicating the pipeline for new hotel rooms in Chicago 2026 is “close to zero” suggest ripe opportunities in the market in the near-term.

“It's going to [eventually] be an appealing market for ground-up development,” said Rani Gharbie, CitizenM Hotels managing director, investment & development, Americas.