The Economic Feasibility of a

New Luxury Hotel in

Downtown Waco

Tom Kelly, Ph.D.

Baylor Center for Economic Analysis

June 1994

Introduction

Texas ranks fourth in total travel expenditures among the 50 states, behind only California, Florida, and New York. The 5.7 percent growth in Texas during 1992 exceeded the 5.1 percent growth rate for the nation. Among domestic travelers, Texas also experienced a 5.7 percent growth rate, compared with a 4.1 percent increase for the entire nation.

Waco, due to its geographic location on Interstate 35, is in a unique position to benefit from a rapid growth in visitor spending in the future. However, overnight stays may be limited by the lack of hotel space. This study examines that possibility based upon the projected future demand for hotel space in Waco, Texas.

The study consists of following four phases:

Phase one determines a baseline forecast of the demand for future hotel space in the Waco market based upon past performance.

Phase two considers forces that can alter this baseline forecast, including the competitive position of Waco's lodging facilities compared with other metropolitan areas in the state of Texas.

Phase three adjusts the baseline forecast for projected changes in local visitor attractions, including Big 8+ athletic events, an additional sports complex, added tourist attractions (such as an outdoor theater), and a more competitive convention package.

Phase four compares projected revenues with the costs involved in construction and operation of a new hotel in order to determine if a new hotel is feasible within the foreseeable future.

Baseline Forecast of the Demand for Hotel Capacity in Waco

The purpose of this phase is to determine future hotel/motel performance in the Waco MSA based upon time series information. This projection is a necessary step in formulating a plan for additional hotel capacity to be located in downtown Waco. Although past time series data can be viewed as representative of changes in the hotel/motel market, past data will not provide information about the possible loss of convention traffic that may have been due to the lack of adequate hotel/motel room space. Projections of past lodging industry performance must also be adjusted for projected changes in local visitor attractions. For this reason, the projection of past data provides only a baseline forecast that must be adjusted for changes in both visitor attractions and past capacity constraints.

The Forecast Methodology

Time series data consists of four components that may explain variation from one period to the next. These four factors can be described as trend forces that change in the long run, business cycle forces that change with the level of economic activity, seasonal forces that change within the year but regularly repeat from one year to the next, and irregular forces that consist of outside influences that either are not expected to occur again or can be viewed as random. In general, trend and seasonal forces can be projected into the future more easily than cyclical influences. Irregular influences may be removed from past experiences to provide a better picture of past changes, but they do not enter into future projections since they are viewed as either random or unlikely to reoccur in the future. (An example of a irregular influence would the be the Branch Dividian standoff, when government officials and media crowded into Waco due to an unusual event that is unlikely to occur again in the future.)

In order to determine the relative importance of these four sources of change in hotel/motel performance in the Waco market, quarterly data for lodging within the Waco Metropolitan Statistical Area is examined for the period 1988 through 1993 using the decomposition method. Both trend and seasonal factors are removed and the cyclical-irregular residual is identified. Removal of past irregular influences allows for the projection of trend values for hotel room revenues that provides a baseline forecast of future annual hotel performance in the Waco market. From these baseline projection the impact of future changes in the Waco travel industry are estimated.

Quarterly Hotel Performance in Waco

Room revenue (the combination of occupancy and average room rate) is the primary value used to determine changes in the demand for hotel space in the Waco market. Room revenue, occupancy rates, and average room prices for Waco's lodging industry for each quarter beginning in 1988 through 1993 are shown in Table 1. A visual inspection of the data shows that during the first quarter of 1993 the Branch Dividian holdout resulted in an irregular (exogenous) influence that contributed to substantially higher hotel performance than predicted by trend, seasonal, or cyclical influences.

Table 1: Quarterly Hotel Performance in Waco MSA

Yr/Qtr	Nights	Room	% OCC*	$ Rate**
	Sold	Revenue	(nts sold/	(avg price
	(thous.)	($thous)	nts avail)	per nt sold)

88/1	91.5	$3,313	43.5	$36.22
88/2	100.7	3,842	47.3	38.16
88/3	108.3	4,061	49.4	37.50
88/4	99.5	3,610	45.1	36.29
89/1	93.4	3,341	44.2	35.77
89/2	106.4	3,935	50.2	36.99
89/3	113.3	4,223	52.1	37.26
89/4	106.3	3,770	49.6	35.47
90/1	98.7	3,563	47.7	36.11
90/2	103.9	3,896	49.7	37.50
90/3	110.3	4,072	47.6	36.90
90/4	96.9	3,533	46.4	36.47
91/1	95.0	3,617	44.8	38.07
91/2	110.4	4,343	50.4	39.33
91/3	118.1	4,317	53.4	36.54
91/4	108.2	3,958	49.6	36.59
92/1	100.8	3,784	47.2	37.53
92/2	113.5	4,574	51.3	40.31
92/3	120.6	4,530	54.9	37.56
92/4	109.6	4,132	51.5	37.72
93/1	114.7	4,616	52.5	40.25
93/2	121.0	5,180	53.9	42.65
93/3	130.0	5,033	56.6	38.86
93/4	116.0	4,474	55.2	38.67

* Occupancy rate is nights sold divided by nights available for sale (x 100). ** Rate is the average price for each roomnight sold. Source: Texas Department of Commerce from Market Share/Source Strategies, Inc.

Table 1 also shows that the upward trend in room revenue in the Waco market is more a function of higher occupancy rates than an increase in average room prices. (One of the questions that will be addressed is the question of the relationship between occupancy rates and room prices and whether or not Waco can support a hotel with higher "luxury" prices.) In general, higher average room prices also accompany higher occupancy rates. Hence, room revenue is more representative of market demand than either occupancy rates or room prices and, therefore, will be the primary measure of hotel performance projected into the future.

Decomposition of Hotel Performance

Forces explaining changes in hotel performance consist of trend factors, such as demographic forces that affect tourism; seasonal factors, such as the weather, normal vacation periods, or Baylor University events that repeat within each year; cyclical factors, such as business performance that affects convention traffic; and irregular forces, such as the Branch Dividian holdout that are unusual events that are unlikely to occur again in the future. A starting point in time series forecasting is the application of the decomposition method to past time series data in order to determine the relative importance of each of these four sources of variation.

The long run secular trend may be estimated with a least-squares regression line, either in linear or non-linear form. Seasonal changes are eliminated using seasonal indexes derived by the ratio-to-moving-average method. Seasonal factors are reported that coincide with the Census X-11 program for time series decomposition. The combined R-squared of a model using trend and seasonal factors measures the percentage of past variation in hotel performance explained by these two influences. The remainder of one hundred percent is due to cyclical or irregular influences. This residual may be expressed as an index by dividing the observed value by the forecast value based upon trend and seasonal influences and multiplying by 100. The resulting cyclical-irregular relative will exceed 100 when actual performance exceeds the amount predicted by trend and seasonal factors and will be less than 100 when actual performance falls below the predicted value. To the extent that trend and seasonal forces are most important (high R-squared), future projections are more accurate than if business cycle conditions or irregular influences dominate. Cyclical influences are difficult to project very far into the future, and irregular influences cannot be predicted, since they are viewed as unusual events that may or may not occur again in the future.

Seasonal indexes for quarterly hotel revenues, occupancy rates, and average price per room were calculated for the period 1988 through 1992. (The year 1993 was not used because of the unusual performance during the first quarter as a result of the Branch Dividian holdout.) The results, shown in Table 2, indicate significantly greater seasonal variation in hotel revenues than in occupancy rates. Average room prices fluctuate even less from quarter to quarter due to seasonal influences. (Seasonal indexes average 100 for the year, exceed 100 when seasonal forces are favorable, and fall below 100 when seasonal forces are unfavorable.)

Table 2: Seasonal Indexes for Measures of Hotel Performance

Quarter	Room Revenue	Occupancy Rate	Average Room Rate

I	91.5	94.2	99.5
II	105.1	102.9	103.0
III	108.0	104.1	100.0
IV	95.4	98.7	97.5

Source: Computed from Quarterly Data from Texas Department of Commerce, Tourist Division

Trend - Seasonal Forecast of Hotel Revenue

A least squares regression model that assumes a nonlinear trend with a constant growth rate and a seasonal factor for each quarter, based upon the ratio-to-moving-average, explained 83.3 percent of the variation in quarterly hotel room revenue in the Waco Metro Area over the period from 1988 through 1993. (A nonlinear trend-seasonal model slightly outperformed a linear trend-seasonal equation that explained 82.9 percent of the variation in room revenue.)

Table 3: Sources of Variation in Quarterly Hotel Room Revenues

Year.Qtr	Room	Revenue	Cyclical-	Year.Qtr	Room	Revenue	Cyclical-
	Actual Value	Trend-seasonal	Irregular Relative	(cont.)	Actual Value	Trend-seasonal	Irregular Relative
	($thous)	Forecast	(percent)		($thous)	Forecast	(percent)

88.1	$3,313	$3,319	99.8	91.1	3,617	3,752	96.4
88.2	3,842	3,753	102.4	91.2	4,343	4,242	102.4
88.3	4,061	3,847	105.6	91.3	4,317	4,392	98.3
88.4	3,610	3,534	102.2	91.4	3,958	3,994	99.1
89.1	3,341	3,458	96.6	92.1	3,784	3,908	96.8
89.2	3,935	3,909	100.7	92.2	4,574	4,419	103.5
89.3	4,223	4,047	104.3	92.3	4,530	4,575	99.0
89.4	3,770	3,681	102.4	92.4	4,132	4,161	99.3
90.1	3,563	3,602	98.9	93.1	4,616	4,071	113.4
90.2	3,896	4,072	95.7	93.2	4,574	4,603	99.4
90.3	4,072	4,216	96.6	93.3	4,530	4,766	95.0
90.4	3,533	3,834	92.1	93.4	4,474	4,334	103.2

Source: Computed from quarterly data supplied by Texas Department of Commerce

Table 3 shows the actual values, the trend-seasonal forecast, and the cyclical-irregular relatives for each quarter. The least squares regression results indicate that hotel room revenues increased an average of 1.02 percent each quarter from 1988 through 1993 due to trend factors, holding the effect of seasonal changes constant. The mean absolute percentage error of the trend-seasonal forecasting model was 3.1 percent.

The cyclical-irregular relative, shown for each quarter in Table 3, provides a measure of the expected accuracy of quarterly forecasts based solely upon trend and seasonal forces. If actual room revenue equaled the amount predicted by trend and seasonal forces, the cyclical-irregular relative equal 100. The cyclical-irregular relatives show than in only three quarters were predicted values based upon trend and seasonal factors more than five percent different than actual values. Room revenue in the third quarter of 1988 was 5.6 percent more than predicted. In the fourth quarter of 1990, actual hotel room revenue was 7.9 percent below the amount predicted by trend and seasonal forces. In the first quarter of 1993, actual hotel room revenue exceeded the amount predicted by trend and seasonal forces by 13.4 percent.

The year 1990 was the beginning of a cyclical downturn that resulted in less travel for both business and tourist purposes. The largest impact of the business cycle on hotel revenue occurred during the fourth quarter of 1990. Since that time, the cyclical component of travel demand has generally improved. The unusual increase in hotel room revenue that occurred during the first quarter of 1993 was due to the Branch Dividian holdout that brought worldwide media attention and visitors to Waco. Without major irregular influences and reasonably steady business cycle conditions a quarterly forecast of hotel revenue based upon trend and seasonal forces would result in no more than 5 percent error from actual values.

Long Term Trend Projections

Annual data does not exhibit seasonal variation that occurs within the year. Annual data also allows for averaging of irregularities that occur from quarter to quarter but offset each other throughout the year. The residual from trend changes does reflect the influence of cyclical influences and major irregular events that are not offset during other periods of the year. Hence, these irregular influences need to be removed from past observations in order to reflect more accurately trend and cyclical influences.

In order to determine a trend projection for Waco's hotel revenue, annual data was examined over the period 1988 through 1993. However, the major irregularity that occurred during the first quarter of 1993 (the Branch Dividian holdout) was not considered in making future projections. In order to remove this influence, annual data in 1993 was adjusted to reflect the forecast value for the first quarter of 1993 (shown in Table 3) rather than actual hotel revenue. The amount of actual hotel revenue during the first quarter of 1993 amounted to $4,616 thousand, while the projected value based upon past trend and seasonal forces amounted to $4,071 thousand. The increase in 1993 hotel revenue by an estimated $545 thousand due to the Branch Dividian holdout is removed when determining the baseline forecast of annual hotel revenue based upon a trend projection.

A non linear model that assumed an average growth rate was the preferred model to project the annual trend value in hotel room revenue. (A average growth rate model explained 93.4 percent of the variation in hotel revenue from 1988 through 1993 as opposed to a linear, average change model that explained 92.6 percent of the variation.) The projected trend and calculated cyclical-irregular relatives for the years 1988 through 1993 are given in Table 4.

Table 4: Annual Hotel Room Revenue, Projected Trend Values, and

Cyclical-Irregular Relative*

Year	Hotel Revenue	Trend	Cyclical-Irregular
		Forecast	Relative

1988	$14,826	$14,407	102.9
1989	15,268	15,081	101.2
1990	15,063	15,787	95.4
1991	16,235	16,526	98.2
1992	17,020	17,300	98.4
1993 1994 1995 1996 1997 1998 1999 2000	19,395	18,110 18,958 19,845 20,775 21,747 22,765 23,831 24,947	107.1

Source: Computed from Data by Texas Department of Commerce, Tourist Division. *CI relative is computed by dividing actual revenue by its trend and multiplying by 100.

An examination of the cyclical-irregular relative shows that for the year 1988 Waco hotel revenue exceeded its trend value by 2.9 percent. Business cycle conditions in 1990 resulted in a substantial decline in hotel revenue, reaching 4.6 percent below its trend level. The business cycle recovery and the development of additional visitor attractions improved Waco hotel performance over the past three years. However, the cyclical-irregular relative in 1993 of 107.1 reflects not only improvement in the economy and more visitor attractions, but it also reflects the Branch Dividian irregularity that is included in actual hotel revenue but not in the trend estimate. The elimination of $545 thousand in 1993 hotel revenue attributed to the Branch Dividian holdout reduces the cycle-irregular component to 104.1, or 4.1 percent above the estimated trend.

During the years 1988 through 1993 (adjusted for the Branch Dividian holdout), Hotel room revenue in Waco experienced an average increase of 4.6 percent each year. When trend forces are used to project future hotel room revenue, almost $25 billion in annual hotel room revenue is projected to occur in the Waco lodging market by the year 2000.

Figure 1: Projected Trend in Hotel Revenues in Waco, Texas

Through the Year 2000

Source: Calculated for data supplied by Texas Department of Commerce, Tourist Division

Figure 1 shows the projected trend in hotel room revenues through the year 2000 based upon recent performance. This baseline annual forecast was generally too high during for the three year period beginning in 1990, primarily because of the slow recovery from the 1990-91 economic recession. However, hotel revenue performance during 1993 was well above the predicted trend, even after the Branch Dividian adjustment. In all likelihood the trend projection to the year 2000 is conservative, provided the economy continues to perform reasonably well and Waco continues to develop its tourist attractions and convention activity.

The trend in hotel revenues is a reflection of both an increase in average occupancy rates and an increase in the average price for each roomnight sold. Annual totals for each of these measures from 1988 through 1993, in addition to the average number of hotel rooms available and the number of nights sold, in the Waco metropolitan area are presented in Table 5.

Table 5: Annual Hotel Performance in Waco Metropolitan Area

Year	Nights Sold	Room Revenue	Occupancy	Average
	(thousands)	($ thousands)	Rate (%)*	Price/room ($)**

1988	400	$14,826	46.4	$37.07
1989	419	15,268	49.0	36.40
1990	410	15,063	47.8	36.76
1991	432	16,235	49.6	37.60
1992	454	17,020	51.2	38.29
1993	484	19,395	56.8	40.07

While the annual growth rate in room revenue from 1988 through 1993 averaged 4.6 percent, the number of nights sold grew at an average annual rate of 3.2 percent, the occupancy rate increased an average of 3.4 percent annually, and the average room price increased 1.3 percent annually. During the same five year period the number of hotel rooms in the Waco market remained virtually unchanged (2,362 rooms in 1988 to 2,372 rooms in 1993).

Competitive Factors Affecting Hotel Performance

The success of a new "luxury" hotel in Waco of about 200 rooms (the Hilton Hotel has 196 rooms) will depend upon continued growth in the total lodging market as well as the competitive position of a new hotel among existing hotels in the market. Waco's lodging industry is experiencing both higher occupancy rates and higher average room prices. Table 6 shows that a positive correlation between occupancy rates and average room rates exists not only over time but also among a cross section of hotels in Waco and in the state of Texas. This suggests that, within limits, hotel rooms are a luxury good. Table 6 also shows that Waco has higher occupancy rates than the state average for all but the lowest priced rooms offered by hotel chains. However, Waco suffers from the absence of higher priced luxury rooms that add substantially to hotel revenues in major metropolitan areas. In Waco, the highest prices rooms have an average nightly rate of about one-half the average rate of the highest priced rooms in the state.

Table 6: Occupancy Rate and Average Price per Day of Hotel Rooms, 1993

	Waco	Chains	State of Texas Chains
Price Range	Occupancy %	Rate $	Occupancy %	Rate $

$00-29.99	55.3	26.73	54.4	$26.52
$30-39.99	54.4	34.74	56.9	35.09
$40-49.99	66.2	45.97	61.9	45.21
$50-50.99	68.9	53.12	64.9	54.74
$60-60.99	73.4	63.83	67.8	65.10
$70-79.99	a	a	69.0	75.10
$80-89.99	a	a	71.0	84.37
$90-99.99	a	a	70.8	93.80
$100-109.99	a	a	71.3	103.67
$110+	a	a	72.6	126.24
a: none reported	Source: Texas Department of Commerce, Tourist Division

The demand for luxury hotel space is derived from an area's relative attractiveness as a tourist and business destination. This, in turn, is largely a function of area income and population density. There are some relatively isolated tourist attractions that support luxury accommodations, but they are generally accompanied by a unique, immovable resource, such as beach frontage. Waco is rapidly developing a tourism package that can attract overnight visitors. It also has an advantage with its central location for regional conventions that are attended primarily by automobile travelers. However, in order to move to the next level of room rates, it must develop accommodations that offer an advantage over existing facilities. A new facility could charge marginally higher room rates and, at the same time, experience above average occupancy rates. To the extent that existing hotels did not modernize, there would be a room "filtering" effect that could lower the demand for lower priced, older facilities in Waco, and result in a shift in the market in favor of a new hotel.

Table 7 shows that most of the state's metro areas offer higher priced rooms than Waco. It also shows that among these metro areas the higher priced rooms often experience occupancy rates well above the average occupancy rate for the area. However, the highest priced "luxury' rooms selling above $124 per night occur only in Dallas, Houston, San Antonio, and Austin.

Table 7: Prices Per Room and Percent Occupancy Among Texas Metro Areas

Metro Area	Price with	Occupancy	Highest	Occupancy	Average
	Highest	Rate at	Price/day	Rate of	Occupancy
	Occupancy	This Price		Highest Price	Rate

Abilene	$67.98	76.5%	$73.76	70.7%	52.9
Amarillo	44.45	67.5	61.07	62.5	55.3
Austin	92.89	73.1	137.58	65.1	64.3
Beaumont/Pt Arthur	64.56	61.9	70.91	51.4	47.8
Brownsv/Harlinton	113.22	79.9	113.22	79.9	48.2
Bryan/Col Station	63.32	66.2	63.32	66.2	58.2
Corpus Christi	119.64	70.9	119.64	70.9	48.9
Dallas	84.64	72.3	135.98	72.3	61.7
Ft Worth/Arlington	92.83	72.3	92.83	72.3	57.3
El Paso	87.76	78.8	92.18	70.2	61.4
Houston	84.22	70.9	125.81	65.9	60.6
Galveston	104.01	63.5	104.01	63.5	47.7
Brazoria	82.71	52.7	82.71	52.7	53.4
Laredo	52.82	85.0	74.59	77.4	68.8
Killeen/Temple	67.73	63.4	82.82	59.2	54.2
Longview/Marshall	53.53	59.4	53.53	59.4	51.5
Lubbock	102.36	94.1	102.36	94.1	57.1
McAllen/Edinburg	101.26	78.6	101.26	78.6	60.9
Odessa/Midland	61.38	57.7	61.38	57.7	41.3
San Angelo	58.16	65.2	58.16	65.2	51.6
San Antonio	104.43	79.1	124.07	73.8	68.7
Sherman/Dennison	51.39	55.7	123.64	35.7	44.4
Texarkana(TX)	42.53	58.3	54.56	53.8	39.0
Tyler	62.66	66.4	80.42	71.4	53.2
Victoria	43.71	62.0	50.48	59.3	54.5
WACO	63.83	73.4	63.83	73.4	56.8
Wichita Falls	55.28	66.5	55.28	66.5	54.3

Source: Texas Department of Commerce, Tourist Division

Waco's average occupancy rate of 56.8 percent in 1993 was very close to the state average of 57.7 percent. Partly because of the Branch Dividian holdout, but also because of the growth in tourist attractions, Waco was the fourth fastest growing market in the state in 1993. Room revenue increased 13.3 percent compared with the state average of 5.9 percent. When 1993 room revenue is adjusted for the Branch Dividian holdout the 1992-93 percentage increase amounts to 9.6 percent, still well above the state average. With the Branch Dividian adjustment it drops to the fifth fastest growing market, slightly below Texarkana. .

Source: Texas Department of Commerce, Tourist Division

Figure 2 shows the state metro areas that experienced the fasted growth in room revenue in 1993 from the previous year. Killeen has been experiencing a housing shortage due to the relocation of troops to Fort Hood, and hotel occupancy has helped to provide temporary housing. Geographically, the four central, contiguous metros of San Antonio, Austin, Waco and Killeen grew 13.5 % in the year and accounted for over one-half of the state's total lodging gains, double their historic importance in the market.

Additional Forces Affecting Waco's Lodging Market

Although the average rate of trend growth for hotel room revenue is 4.6 percent, there is reason to expect that future projections based upon past averages are conservative. The most recent increase in hotel revenue, after adjustment for the Branch Dividian holdout, was over double the historical average. Waco has made great strides in developing its tourism industry. The Sport's Hall of Fame, the Cameron Park Zoo, the Dr. Pepper Museum, to name a few, are attractions that have been added to the traditional menu that includes Fort Fisher and the Armstrong Browning Library. Attendance at local tourist attractions increased by 7.3 percent in 1993 compared with the previous year.

In the next several years Baylor University is expected in add significantly to its already important impact on the number of visitors into the area. Big 12 sporting events are likely to have a major impact. The Baylor Athletic Department is projecting 10,000 additional visitors for each Big 12 football game in Waco. These events are likely to result in similar effects on Waco's lodging market as Baylor Homecoming has had in the past, namely 100 percent occupancy rates, especially for the higher priced segment of the market.

Waco is already a central location for many statewide sporting events, such as the state Little League playoffs. Statewide softball tournaments are expected to have an increased importance as Waco expands its recreational facilities.

Improvement in business conditions and active recruiting of convention visitors is expected to add to the number of potential visitors in the future. There have been times in the past when conventions have been forced to locate in other metro areas, such as Arlington, because of a lack of hotel room capacity. Convention hotels around the state are another reason for the highest growth rate in occupancy among higher priced segments of the market.

Although it is impossible to determine exactly what the impact of all of these changes will have on Waco's future hotel market, one would be safe to say that if all of these forces had been intact in 1990, Waco's lodging industry would have grown at least as fast as the state average. This constant market share growth rate would have averaged 6.5 percent.

Applying a constant market share growth projection to the baseline projection of hotel revenue results in a forecast for area room revenue to the year 2000 of almost $30 million, or $5 million more that the baseline projection. (See Figure 3.)

A constant market share projection is a conservative forecast of future hotel room revenue in the Waco market for two reasons. First, the Interstate 35 corridor is growing much faster than the state average. In 1993, state room revenues increased 5.9 percent while room revenues increased 13.5 percent within the San Antonio, Austin, Killeen-Temple, and Waco contiguous areas. Second, additional attractions and facilities are expected to improve Waco's competitive position for tourist and convention travelers.

Source: Projected from Texas Department of Commerce data.

Economic Feasibility of a 200 Room "Luxury" Hotel

The long-standing trend of all growth occurring at higher prices in the Texas market continued in 1993. In 1993, there is no gain in the total room revenues of hotels in the state priced under $60, while revenue gains from rooms priced over $60 amounted to 11.7%. The significance of this relationship is that even though area hotel room revenue may experience an average annual growth of 6.5 percent, a new "luxury" hotel is expected to grow faster than the average. Older, lower priced motels could experience little, if any, room revenue growth with most of the increase in room revenues received by newer, higher priced segments of the market.

Table 8 shows the number of rooms, percent occupancy, and average room rate for all hotels/motels for the period 1988 through the first quarter of 1993 for the Waco Metropolitan Statistical Area and for the Hilton Hotel, the hotel at the highest priced end of the market The average occupancy rate for the Hilton Hotel over the period presented is 67 percent, compared with 49 percent for the all hotel/motels in the area. This higher occupancy occurred despite room prices that averaged over $15 per night higher. From the first quarter of 1988 to the first quarter of 1993, the average annual increase in occupancy rates was 11.1 percent for the Hilton Hotel, compared to 3.8 percent for all area hotels/motels (including the Hilton). Average room prices, over the same period, increased at an average annual rate of 6.2 percent for the Hilton, compared to 2.1 percent for all area hotels/motels. The increase in room prices for all hotels/motels combined failed to keep pace with the overall inflation rate in Central Texas that averaged 3.5 percent yearly over the same period. Clearly a hotel in the upper price range of the market will outperform other, lower-priced hotels/motels in Waco, as in the state of Texas.

Table 8: Occupancy Rate and Average Room Price of All Area Hotels/Motels

Compared with the Hilton Hotel, Quarterly from 1988.1 to 1993.1

Year.	Waco Metropolitan Area			Hilton Hotel
Quarter	Rooms	% Occ	$ Rate	Rooms	% Occ*	$ Rate

88.1	2,337	43.5	36.22	196	46	46.63
88.2	2,337	47.3	38.16	196	56	49.13
88.3	2,381	49.4	37.50	196	54	49.65
88.4	2,395	45.1	36.29	196	57	49.65
89.1	2,349	44.2	35.77	196	59	49.72
89.2	2,330	50.2	36.99	196	64	50.93
89.3	2,363	52.1	37.26	196	67	52.55
89.4	2,330	49.6	35.47	196	61	49.95
90.1	2,300	47.7	36.11	196	72	49.52
90.2	2,295	49.7	37.50	196	68	52.73
90.3	2,522	47.6	36.90	196	75	50.09
90.4	2,267	46.4	36.47	196	70	49.94
91.1	2,357	44.8	38.07	196	72	54.26
91.2	2,407	50.4	39.33	196	73	58.28
91.3	2,406	53.4	36.54	196	79	49.08
91.4	2,370	49.6	36.59	196	75	52.00
92.1	2,375	47.2	37.53	196	69	54.98
92.2	2,431	51.3	40.31	196	66	60.78
92.3	2,386	54.9	37.56	196	66	57.48
92.4	2,313	51.5	37.72	196	72	57.57
93.1	2,426	52.5	40.25	196	78	62.88
Average	2,366	49.0	37.36	196	67	52.75
*Occupancy is estimated roomnights sold divided by rooms available

Projected Room Revenue

Gross room revenue (derived from taxable revenue times an adjustment factor) for the Hilton Hotel for the period above is shown in Table 9, along with an accompanying graph. A new, luxury hotel, is expected to experience similar occupancy rates and could support slightly higher room rates than the Hilton.

It is possible to examine the feasibility of a new hotel from two perspectives. First, the market can be examined to determine at what time in the future projected room revenue in the Waco Metro Area would be sufficient to absorb the added room capacity of a new hotel without causing "undue harm" on existing establishments by reducing their existing revenues. Second, based upon projected construction cost of a new hotel versus projected revenue, the economic viability of the hotel can be examined in terms of its investment return compared with industry averages.

Table 9: Hilton Hotel

Annual Room Revenue

Year	Room
	Revenue

1988	$1,566,254
1989	1,561,311
1990	2,265,395
1991	2,476,341
1992 1993	2,467,836 2,914,732

Source: MarketShare Source Strategies, Inc.

The Hilton Hotel has experienced a substantial increase in room revenue over the past several years, despite sluggish economic conditions that adversely affected area hotel room revenue during the early nineties. However, without an increase in room prices its future room revenue has, in effect, reached a capacity limit. Hotels attempt to manage their capacity by offering special rate packages during off peak periods of the week or year, especially the weekend when business travelers are less frequent or during months when vacationers are less likely to travel. Because of normal seasonal changes in demand, however, it is very difficult for a hotel to achieve, even through the best of management and marketing skills, an average occupancy rate in excess of 70 percent. In 1993, the highest priced segment of the Waco hotel market (the Hilton Hotel) operated at 73.4 percent capacity with an average room price of $63.83 per day (see Table 7).

A new hotel of similar size and location as the Hilton can be expected to benefit from the luxury end of the market that is currently being served by the Hilton Hotel. Moreover, by the time a new hotel could be constructed, say in the middle of 1996, there is reason to believe that it could charge higher room prices. The highest priced room in Tyler averages $80.42 per day, in Abilene $73,76 per day, and in Killeen-Temple $82.82 per day. (See Table 7). The average of these three prices of $79 per day is a reasonable scenario for a new "luxury" hotel in Waco at the beginning of its operations. At this price, a new 200 room hotel that experiences a 56.8 percent occupancy rate (the present market average) would generate $3.275 million in revenue.

Based upon the projected increase in area hotel room revenue presented in Figure 3, total growth in the area's lodging market would support this increase without a reduction in total room revenue received by existing hotels by the spring of 1998. Hence, by that time enough market demand would exist to absorb the projected room revenue of a new hotel without causing "undue harm" to existing hotels/motels in the area.

The ability of a new hotel to generate revenue in the market would, of course, depend upon its management and marketing skills. However, if the total market increased at only 6.5 percent each year (the constant state market share pace) and the new hotel increased its annual revenue at the same pace, there would be sufficient demand by the middle of the year 2000 to support a 73 percent occupancy rate in the new hotel at a average price of $79 per day. Of course, if room rates increase during this period, the same revenue projections can occur with lower occupancy rates.

Room revenue projections for the new hotel and the projected market share of the Waco lodging market for the first five years of the hotel are shown in Table 10 based upon an annual increase of 6.5 percent each year. Although the share of existing hotels will fall initially when the new hotel enters the market, the same growth rate results in a decreasing market share for the new hotel in the future. Based upon the experience of the Hilton Hotel, these revenue projections based upon total market growth are conservative.

Table 10: Projected Room Revenue, for Waco Market Area, and

Percent Market Share of a New Hotel

Year	Room Revenue	Waco Market	Market Share

1996	$3,275,000	$23,298,000	14.06
1997	3,448,000	24,812,000	13.90
1998	3,639,000	26,425,000	13.78
1999	3,829,000	28,143,000	13.60
2000	4,037,000	29,972,000	13.47

Construction Costs of a New Hotel

Construction costs for a hotel depend upon its classification (A-D) and type (excellent, good, average, fair, low cost). A "luxury" hotel in Waco would consist of an good Class A facility. A good Class A facility has face brick, metal or concrete panels and an individual designed exterior, good detail, carpeted, highly decorated public rooms, good lighting, radio and TV circuits, good plumbing fixtures, and hot and chilled water (zoned). Construction costs nationwide average $89.71 per square foot but about $80.74 locally. To allow for increased foundation costs, 2 percent is added to the square foot cost of the foundation for each 10 foot average story height. The additional cost of hoisting materials and increased labor cost, a multiplier of 0.25 percent is applied to each story over three. A seven story hotel is likely to cost approximately $85 per square foot to build in Waco.

A typical room size for an executive suite of a hotel is about 437 square feet, with other rooms about 356 square feet. Based upon an average of 400 square feet per room, it would take about 80,000 square feet of room space to provide for 200 rooms. Because of hallways and elevators, specific square footage for room space is about 85 percent efficient. Hence, it would require about 94,200 square feet to provide for the space needed to generate room revenue. Hence, the construction cost necessary to provide 200 hotel rooms would amount to about $8 million.

The space requirements of a restaurant and bar and meeting rooms add to the cost of the hotel, but at the same time they add to potential revenue. In general, these facilities may be assumed to support themselves as specific profit centers that generate sufficient revenue to warrant their construction. However, the cost of the first floor lobby, pool facilities, parking facilities, land acquisition, and architect fees can be assumed to be supported by room revenues. (This assumption ignores joint costs and spillover benefits of the restaurant and bar and meeting room facilities for generating hotel room revenue. These influences are assumed to offset each other in determining the overall feasibility of the hotel.) A swimming pool, 140 parking slots, and architect fees are expected to add an additional cost of about 7 percent to total construction costs, including restaurant and bar and meeting rooms. The cost of a 1600 square foot lobby area would amount to about $140,000. The total construction cost of a 200 room hotel facilities that must be supported by hotel room revenues is estimated to be about $8,700,000, exclusive of the cost of land acquisition.

Economic Feasibility of the Hotel

Projected gross room revenue would be sufficient to cover the construction cost of 200 rooms after a period of 2.5 years. However, the net profit from the projected room revenue depends upon operating costs and other expenses, including debt service, advertising, depreciation, management costs, and taxes. Based upon industry averages (Dun & Bradstreet, SIC #7011), a hotel of the size being considered would experience operating expenses at about 85 percent of sales, and all other expenses (net) of about 9 percent of sales. Hence, operating income would amount to about 15 percent of sales and net profit before federal income taxes would amount to about 6 percent of sales. These percentages are average values, however, and can vary considerably among hotels of the same classification and size.

Since hotels consist of considerable fixed assets that are financed with long-term debt, their net worth is generally about 20 percent of total assets. An investment of $8.7 million in a new hotel, therefore, would result in a tangible net worth of approximately $1.74 million. Hotels of the same size classification as the proposed hotel experience average profits before taxes of about 14.5 percent of tangible net worth, although before taxable income averages only about 2.7 percent of total assets.

In order to achieve a return of before tax income of 2.7 percent of tangible assets an $8.7 million investment hotel would have to generate a net profit before taxes of $234.9 thousand. If the new hotel meets the average in operating efficiency, this amount of net profit can be achieved from gross revenue of $3.915 million. An examination of projected revenues shows that by early 2000 gross room revenue from the new hotel would be reach this level.

It is next to impossible to determine the present value of future cash flows from the hotel without better information on operating revenues, debt expenses, and depreciation and amortization. However, we can venture a guess based upon industry averages. The expected life of a hotel is 60 years, although it is depreciated for tax purposes over about 31 years. The lump sum value of the investment at the end of 31 years is expected to be positive because the hotel, if properly maintained, will still generate positive net income. Based upon industry averages of net operating income, straight-line depreciation over 31 years, and expected federal income tax rates, the present value of future expected cash flow discounted at a nine percent rate over a period of 60 years amounts to over $10.5 million, assuming a zero scrap value at the end of that period. At any time during that period the present value will also include to lump sum value of the hotel at that time.

Conclusions

There is sufficient market potential to warrant additional hotel capacity in the Waco Metro Area. However, the success of the hotel is likely to depend upon its entry at the "luxury" end of the market. A "twin towers" concept with the Hilton Hotel might be a beginning scenario, since it would allow for a sharing of some of the managerial and marketing expense, and increase the profitability of meeting rooms, restaurant, and bar facilities already in hand.

The location of the hotel proximate to the convention center would also increase the utilization rate of its meeting rooms, while generating greater room occupancy in the hotel.

This study suggests that a new hotel will be economically feasible within five years based upon conservative projections of the lodging market in Waco Based upon these findings, Waco civic leaders should actively approach potential investors. The period of time for an independent marketing study by a new investor, and the construction period of a new hotel will result in significant capacity constraints on lodging for conventions and special events unless the process is started immediately.