Why conversions will continue to fuel growth for brands

INTERNATIONAL REPORT – To further drive investment liquidity, JLL anticipates hotel brands continuing to lean on conversions, partnerships and M&A to stimulate net unit growth, especially as new construction remains limited in the short-to-medium term.

Zach Demuth

JLL’s Global Head of Hotels & Hospitality Research Zach Demuth said high-interest rates are only one-factor driving conversion growth. “The primary driver is high construction costs coupled with supply chain disruptions. While the latter has begun to abate, the former still remains quite strong, driven by higher material costs stemming from ongoing U.S.-China tensions and other geopolitical volatility.”

Demuth said if interest rates start to fall in the second half of 2024, construction financing will likely become easier to access and less expensive, but this will not necessarily stop the influx of conversions.

Limited construction globally

The JLL data shows that the growth of new hotel supply and construction has been limited at a global level because of high costs, elevated interest rates, and development expenses. Year-end 2023 numbers showed the global hotel room supply was up by only 3.4%, which is 140 basis points lower than the growth in 2019. 

Construction activity has seen the biggest drop off in EMEA, down 230 basis points from 2019, followed by the Americas, at 160 bps. The impact is less pronounced in the Middle East and Greater China because of the construction and financing costs disparity. 

Demuth says the U.S. is the global leader in conversions, followed by Europe and the broader Asia Pacific (excluding China) and the Middle East.

“U.S. conversion has been much stronger due to the discount-to-replacement dynamics, with cost-to-build significantly higher than cost-to-buy in most markets,” he said. “This is particularly pronounced in city/urban markets [where] land acquisition is extremely challenging coupled with increased zoning/building regulations.”

Demuth said similar dynamics are at play across Europe, but generally at a slower pace.

“The U.S. has been impacted more by high construction costs due to increasing tensions with China, which has historically been the source of many building materials,” he said. 

See the chart below on historical global hotel room conversions since 2015.

Fueling the NUG

Because of the elevated costs, JLL says conversions have become even more important to brands because they help fuel their net unit growth (NUG), which accounts for 50% of their shareholder value.

The number of conversions globally hit an all-time high of 21,000 rooms in 2023, with conversion-only brands like Spark by Hilton emerging over the past year. In addition, hospitality brands have looked to convert other asset types like office spaces. Brands have also pursued M&A as a growth strategy (Hilton’s recent acquisition of Graduate Hotels and Marriott’s partnership with MGM are recent examples).

Demuth said there’s been strong conversion activity in upper-upscale lifestyle hotels and midscale extended-stay hotels. “[Upper upscale] is driven by conversions from one asset type to another (office to hotel), as lifestyle hotels inherently benefit from buildings with a clear narrative, such as the recently acquired BT Tower in London.”

Demuth said JLL expects to see further growth in this area, particularly in urban cores, as investors seek creative ways to deploy capital. He said extended-stay hotels have also seen a surge post-COVID from one brand to another or as a conversion from multifamily.

“Look for this segment to see further conversion activity in the coming months driven by rising consumer demand and a likely increase in M&A from the major brand families as they look to drive net unit growth absent new construction,” Demuth said.