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Los Angeles pushes downtown hotel construction amid building boom

Several large new hotels have opened or are expected to open in the coming years in Downtown Los Angeles, and the city's government is pushing ahead with a policy of using tax breaks to encourage such construction, even as critics argue the subsidies are no longer necessary.

In the most recent large deal, the City Council voted in December 2017 to grant breaks of roughly $103 million to Fig + Pico, a project in which Lightstone Group LLC plans to develop two towers containing more than 1,100 hotel rooms, adjacent to the Los Angeles Convention Center.

The long-overlooked downtown district has blossomed in recent years into a residential and leisure destination, and its population more than tripled between 1999 and 2016 to 65,100, according to HVS, a lodging consultant firm.

Over that period, large mixed-use development initiatives have brought new hotels that include a cluster of Marriott International Inc.-branded properties at the L.A. Live entertainment complex and an 889-room InterContinental Hotels Group PLC property in the 73-story Wilshire Grand tower. Developers of both projects benefited from city tax abatements, including breaks in a 14% levy on hotel rooms known as the transient occupancy tax.

City agencies estimate that the area around the convention center, in the southwestern corner of Downtown, needs several thousand more hotel rooms if the facility is to compete with counterparts in other West Coast cities. But HVS analyst Greg Mendell cautioned in an email that, if a planned-but-delayed expansion of the convention center does not come to pass, some hotels in the area could struggle to fill up amid stiffer competition. In a January note, Mendell called the current pace of hotel development in the area "astounding," with roughly 1,500 hotel rooms under construction and nearly another 5,000 in the development pipeline.

Persistent shortage

In 2013, Los Angeles set a goal of having 8,000 hotel rooms within walking distance of the convention center by 2020 — a figure that would mean the facility could accommodate roughly 90% of the demand generated by a large national convention. The following year, a city report found that hotel rooms within that radius could accommodate 74% of such a convention's hotel room requirement, compared to figures of 92% to 99% in San Diego, Anaheim and San Francisco.

As of the end of 2017, the area was still short on hotels, with 5,351 rooms open or under construction within walking distance of the convention center, according to the city's Department of Convention and Tourism Development.

Critics of the tax breaks argue, though, that the city should be more selective. Given the recent construction boom, the Los Angeles Times editorial board wrote in December 2017, "why does the City Council continue to dole out tax breaks to major hotel projects as if downtown was still some blighted redevelopment zone?"

Under the current system, the paper noted, developers pay for an economic analysis of their project, and then, if their project's cost surpasses its expected revenue, they seek permission from the city to keep a portion of the taxes they would have had to pay over the next 25 years. City leaders, the Times wrote, "rarely question whether the developers' economic analysis is reliable or whether the project really needs public assistance."

Jeff Lugosi, a managing director at CBRE Hotels who co-heads the consulting firm's Southern California practice, said many developers have had trouble building new properties near the convention center without tax breaks in recent years because of high construction, materials and labor costs. In particular, he said, the types of properties that would typically serve convention attendees — large high-rise properties with ample meeting rooms and food services — are especially expensive to build and run.

"It turned out, essentially, that you could not build a full-service hotel in downtown Los Angeles for the financial performance that the hotel would generate," Lugosi said in an interview. "From a market standpoint, the hotels were necessary, but from a financial feasibility standpoint, they weren't."

Increased scrutiny

Lugosi, whose firm does consulting work for both the city and for hotel developers seeking tax breaks, said individual planned projects have drawn more scrutiny and criticism as the number of proposed developments downtown has grown.

There are also anecdotal signs that hotel rooms downtown are easier to find on all but the fullest nights. Robert W. Baird lodging analyst Michael Bellisario said in an interview that, unlike in previous years, investor contacts seemed to have little trouble booking rooms for the most recent Americas Lodging Investment Summit, a well-attended industry conference held each January in the J.W. Marriott at L.A. Live.

If the new construction were to tip Downtown into oversupply, owners of existing properties, especially those overdue for renovation, could suffer. The largest downtown hotel, the Millennium Biltmore Los Angeles, is owned by a unit of Millennium & Copthorne Hotels PLC. Among publicly traded real estate investment trusts, Chesapeake Lodging Trust owns two major properties in the area, the Ace Hotel Downtown Los Angeles and the Hilton Checkers Los Angeles.

Still, while the amount of planned new supply is "somewhat unprecedented," Mendell said, many of the hotels in the early planning stages will likely not be built. Lugosi, too, said oversupply is not likely. While "a very long list of people" have considered constructing projects downtown, he said, "the amount of new hotels that are going to open is not going to be as great as the ones that have already opened."

Lugosi predicted that the number of hotels that will eventually be built will be readily absorbed into the market. Meanwhile, he said, developers near the convention center, but outside of Downtown, are considering applying for hotel-tax breaks. Whereas the city's efforts have traditionally focused on boosting construction in the downtown area, CBRE is now doing studies for developers in Koreatown, west of Downtown, and in the area near Figueroa Street to the southwest.

"Initially it had to have an economic benefit to the convention center and that surrounding area, because that's where they wanted the hotel rooms," he said. "It's kind of morphed out. ... Are they going to get them? I don't know."

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