Hotels, new flavor of month, give developers taste for more.

Feverish fundamentals in the hospitality industry continue to fuel a gold rush by developers looking to replace the thousands of hotel rooms lost to condo conversions in New York.

According to the latest hospitality research report from Marcus and Millichap, heady times are expected to persist for the sector, driven by a projected two percent increase in business travel and 1.8% gain in leisure travel.

Nationally, builders are expected to deliver over 90,000 rooms this year-a two percent increase on last year. In New York, more than 5,000 rooms, including 1,000 rooms in the outer boroughs, are either planned or expected to begin construction soon.

"It's going on everywhere," said Faith Hope Consolo, chairman of the Retail Leasing and Sales Division of Prudential Douglas Elliman, who is exclusively marketing the retail space at Muss Development's mixed-use Brooklyn Renaissance Plaza, which includes a 280-room expansion of the New York Marriott at Brooklyn Bridge.

"From the fringes of Times Square to the Financial District and all the way down to Soho and the East Village-that's the trail."

Marcus and Millichap associate, Mike Forrest, admitted hotels are the "new flavor of the month" and noted that, as the housing market begins to experience "a little bit of correction, a lot of those development sites that were slated for condominiums are now looking at a mix, with condominiums on top and a hotel play in the base."

Indeed, Forrest revealed that he just overhauled his marketing campaign for an east side site located in the mid 30s. "Initially, we started marketing it for conversion to residential, but we noticed that we were getting more activity from hotel people.

"We always thought the price we were marketing it at precluded it as a hotel, but demand is so great and, because of the perceived or actual pull-back in the condo market, hotel buyers are willing to pay a lot for these sites." According to Forrest, the flattening of the condo market has yet to impact land prices that continue to remain extremely high in the city. As a result, hotel developers are seeing more opportunity in buying up buildings they can convert.

"They don't see value in building a hotel from scratch," said Forrest. "But if they go through all of the costs [associated with conversion to hotel] it makes sense to pay $400,000 per key for an asset that, on the outside may not appear to be worth it. It has become easier to stay the course and go 100% hotel than it was couple years ago."

Developers such as McSAM Hotel LLC are also bucking the trend towards high-end hotels and blazing the current trail of boutique developments, which Forrest predicts will gather even more steam this year.

"McSAM is building a boutique hotel mid-block on West 26th Street that's really breaking the mold," said Forrest. "Before, you really had to achieve a certain amount of keys to justify the costs of running a hotel, but the boutiques have done so well in Manhattan-those located on side streets with 75 to 125 rooms on 50ft lots and not the 350 room corner lots that were so typical of New York in the past--and are demonstrating there's enough demand for those rooms without having all the bells and whistles of a five-star hotel."

Consolo agrees the new boutiques have a bright future, explaining, "We have so many European tourists and that's what they seem to gravitate to--they have major hotels back home, but many more boutique hotels and that's what makes them feel like they have a home away from home."

She said the sector will make good watching over the next several months as the jittery residential market finds its footing. "We'll have to wait until the last quarter to see how many of the condo conversions actually get done," explained Consolo. "These sites may be snapped up by hoteliers to fill the glut."

But while the boutiques are booming, bigger scale projects are not being ignored either. Developers are mulling proposals for a Javits Convention Center Hotel; Madison Equities is to build a 500-room hotel at West 55th Street, at Eighth Avenue and Macklowe Properties is reported to be planning a hotel-condo development at the corner of Madison Avenue and 53rd Street.

Bottom line, according to Forrest, is there seems to be room for everyone right now as the tourism market shows now sign of slowing.

"People didn't think the tourism market or the economy would come back as quickly as it did after 9/11 and those factors together have led to unyielding demand for hotels."

Jose Alvarez, senior vice president of the hospitality and leisure division at Trammell Crow, agrees the 5,000 hotel rooms in the pipeline will not saturate the market any time soon.

"New York City's lodging market is significantly under supplied," said Alvarez. "With market occupancies in the mid 80% range, many guests are forced to pay tremendous rates and will just not stay in the city; or worse, are being turned away and forced to stay in markets outside the city.

"Furthermore, as the national and local economies continue to be strong, more business and leisure demand will visit the city and fill these new rooms."

Alvarez expects hotel guestrooms will continue to be converted to condominiums in the short term, citing the most recent sales of the Drake Sofitel Hotel, which is to be torn down and new condominiums built in its place. He said, "So long as the residential fundamentals remain strong and the capital markets remain lose, developers will see an arbitrage, albeit a smaller one than a year ago, to convert certain, tired or out-of-favor hotels into condominiums.

"I believe that New York would need to see all 6,000 guestrooms to be built and operational within a year or two. before we realize an adverse impact on market fundaments."