Big City, Smaller Rooms:
Suburban Hotel Chains Go Urban

Reserve the room, hold the room service. Frill-free suburban hotels are moving uptown.

At the Hampton Inn in the Chelsea neighborhood of Manhattan, taxicabs blare their horns on busy 24th Street, steps from the entrance. The lobby is iPod-size, but with a chic touch. Its 144 rooms have flat-screen TVs, but the rooms are about a third smaller than those at a typical Hampton Inn. Guests looking for lunch or dinner have to leave the property -- all that's offered is a breakfast bar with cereals, bagels, coffee, and other morning fare. There's also no gift shop or conference rooms and certainly no spa.

The big city location is a sharp departure for Hersha Group, a Philadelphia-based holding company with businesses that develop, own and manage hotels. For its first 15 years of existence, Hersha built or bought cookie-cutter Hampton Inns and Holiday Inn Expresses along roadsides in suburbs and small cities like Newnan, Ga., and Danville, Pa.

Since building the Chelsea hotel in 2003, Hersha has put up three more limited-service hotels in Manhattan, including a 230-room Holiday Inn Express near Madison Square Garden that opened three months ago. Limited-service hotels lack the restaurants, bars and meeting space that make up a significant portion of full-service properties, and they put more emphasis on self-service.

Hersha will open eight Manhattan hotels in the next three years, plus one each in Brooklyn and Philadelphia, and just one in a suburban market (near Harrisburg, Pa.). Many of these new properties are being built from the ground up, though some are conversions of existing buildings.

Other suburban brands moving into the big city include Holiday Inn Express, Marriott International Inc.'s Courtyard by Marriott and Residence Inn. For hotel operators, such limited-service urban inns offer better returns. They don't have large areas for meetings and restaurants -- such spaces are largely unprofitable -- so they require less square footage than full-service hotels. And by locating in popular urban areas, these hotels command higher -- often much higher -- room prices than suburban sites.

Hampton Inn has 30 urban hotels now, up from just six in 2000. Many of them are skyscrapers stretching 20 stories high. The average rate for suburban locations of Hampton Inn is about $90 a night, according to the chain, owned by Hilton Hotels Corp. of Beverly Hills, Calif. In Manhattan, it's well above $200 and can reach $350 during peak season.

Despite that price difference, it still can be a bargain for travelers like Michael M. Barbour of Sugar Land, Texas. "Breakfast in a Hilton is going to be 15 or 20 bucks, and that's if you're not very hungry," says Mr. Barbour, owner of a small medical-laser business who was on a recent business-and-pleasure trip at a Hampton Inn near Times Square with his wife Barbara. "It doesn't cost 20 or 30 dollars in tips to get your luggage in and park your car."

The influx of more Spartan suburban brands into cities like New York, Chicago and Washington, D.C. -- typically dominated by full-service hotels from Hilton, Marriott, and Starwood Hotels & Resorts Worldwide Inc.'s Sheraton -- comes as the industry is on a tear. Hotel construction starts are up 47% over last year and the pipeline of planned projects is nearing a record as occupancies rise and room rates have risen sharply, giving the industry its best three years in a quarter century. The hotel business is outpacing all other construction sectors and will add 116,000 new rooms in 1,087 hotels in the U.S. next year, up from 81,000 rooms in 775 hotels this year, according to Lodging Econometrics, a Portsmouth, N.H.-based research firm.

"It's definitely happy hour in the hotel business," says Robert J. Habeeb, president of First Hospitality Group Inc., a Rosemont, Ill., hotel developer that is building limited-service hotels in cities in the Midwest.

But unlike previous construction rebounds, big-city developers aren't building many of the 500-room and 600-room Marriotts and Hiltons these days in dense urban areas that have traditionally been some of the most lucrative lodging markets. The sizable land parcels needed for such projects are expensive and hard to assemble, creating an opening for the limited-service hotels. "Demand levels have risen so markedly and supply has been so constrained, it has allowed these [suburban] hotels to come in and capture a very handsome rate and deliver a very high-quality product," says Kirk Kinsell, chief development officer for InterContinental Hotels Group PLC, the London company that owns Holiday Inn Express, among other brands.

Hersha's shift in strategy -- it now builds almost exclusively in Manhattan -- started with a gamble in 2000 to build a big Hampton Inn in Philadelphia's Center City district.

When that 11-story, 250-room hotel turned out to be a success -- bringing in rates averaging about $170 a night compared to the chain's national average of $90 -- Hersha looked northeast to Manhattan. The fact that the city is the ultimate high-barriers-to-entry U.S. market appealed to Hersha president and chief operating officer Neil Shah. In contrast, with suburban markets, he says, "you get the next cornfield, mow it down, put up the next two-story box and you have a competitor."

Hersha likes the operating margins of midscale urban hotels, which Mr. Shah says are 40% to 50% without the cost of food and beverage services, compared to 20% to 25% for full-service hotels.

At the same time, hotel developers have found that, contrary to previous conventional wisdom, travelers will pay up for a smaller room in the same chain. "It's been forever perceived that the suburban or roadside type of hotel had some kind of imaginary rate ceiling in place," says Phil Cordell, senior vice president of Hampton Inn. "This arbitrary rate ceiling has turned out to be false."

Not that the urban strategy doesn't have its drawbacks. Land, even in minute quantities, is hugely expensive these days, and it takes longer to build in cities, tying up invested capital. The urban hotels, which have historically been the riskiest class of commercial real estate, cost much more to build, requiring a bigger bet on these markets than in suburbs because of land and higher construction costs.

"Land prices are up, particularly in big cities where there's been a lot of residential construction like New York, D.C. and the other major metros," says Joe Green, president and chief financial officer of Winston Hotels Inc., a Raleigh, N.C.-based hotel real-estate investment trust.

Moreover, squeezing a suburban hotel into an urban-sized parcel -- Hersha's Hampton Inn in Chelsea is on a parcel 4% the size of a typical suburban hotel plot -- risks upsetting loyal customers used to bigger digs.

And for the hotel companies, limited-service models risk marginalizing their flagship products. "We've seen in some locations where those hotels achieve higher rate than the full-service hotels," says Jim Merkel, managing director of RockBridge Capital, a Columbus, Ohio-based hotel investment and lending firm. "The brands don't like to see that happen."

But for budget-conscious leisure and business travelers, the trend is welcome. Angie Williams, a small-business owner from South Carolina, and her daughter Tia, a congressional staffer, polished off their free breakfast on the ground floor of the Chelsea Hampton Inn one recent morning, preparing for a day of shopping. "I like the nice beds, the breakfast, the location, and the price," says Ms. Williams.

Mr. Barbour, the traveler from Sugar Land, Texas, is happy to see Hampton Inns popping up in big cities, allowing him to still accrue award points from the chain's owner, Hilton Hotels Corp. "As a sole proprietor," he says, "I've got to keep an eye on the bottom line."

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