Development Strategies in a Market of High Vacancies and Sticky Rates – The Case of the Hotel Industry

Abstract

This paper discusses the concurrence of vacancy and ongoing construction under inflexible rents, taking the hotel industry as an area of application. The prevalent modest occupancy in the hotel industry of the United States has led to questions about the ongoing construction of hotels, even if average daily rates (ADRs) have not been reduced to eliminate the excess supply. By constructing a framework based on a game theory approach in market equilibrium, developers can determine the optimal timing to construct the development. Given this option to build, both profit and a double-digit vacancy rate can coexist with inflexible ADRs that exceed the market equilibrium threshold. The option framework also allows the management to project occupancy rates and profits of their existing premises before entering price wars even if their rivals build new projects.