The hotels: Time to stop and rest (Fortune, 1963)

August 12, 2012, 5:00 PM UTC

Editor’s note: Each week we publish a favorite story from Fortune’s archives

. As the final weeks of summer approach, many will be taking that long-needed vacation. Some will fly to far off places. But equally as many, if perhaps not more, will hop in their cars for a road trip across the country. Somewhere between home and destination, they’ll rest in one of the many motels dotted along the interstate. Ever wonder how these temporary stays got “bigger and more elegant” over the years? Fortune chronicles the motel boom in a story from 1963.

FORTUNE — One curious phenomenon of the real-estate markets in recent years has been a kind of blurring of some familiar old distinctions. Previous articles in this series have already suggested, for example, that single-family houses and apartments are becoming more like one another. In the public-lodging industry, the blurring of old distinctions between hotels and motels has proceeded steadily, as the motels get bigger–and yet the blur has not, somehow, diminished the furious competition between the two. Right now the motels seem to be winning it.

The hotel industry’s great building spree of the past few years has been oddly deceptive. Businessmen who spend much time on the road have seen one tremendous new hostelry after another built, especially by the big chains, in just about every major city in the U.S. The Hilton and Americana in New York, Executive House in Chicago, the Sheraton-Lincoln in Houston, the Royal Orleans in New Orleans, the Portland (Oregon) Hilton, the Denver Hilton, the Jack Tar in San Francisco, the Sahara skyscraper in Las Vegas–even the traveler who has not got around to visiting them can scarcely have failed to note their breathtaking presence.

He must also have noted that there is a motel boom under way. This boom is nothing new, of course, but in the past few years the pace of building has plainly been stepped up along the big turnpikes and interchanges, and the product itself has steadily become bigger and more elegant. Motels have also shown up more and more in the same downtown areas that have those massive new hotels, and the motels are themselves fairly massive in many cases.

The broad impression created by all this building is of a lodging industry trying desperately to keep up with an inexorably swelling demand. The supply of lodging space, in any event, has been rising sharply. According to the most conservative estimates, in 1962 alone about 2,000 motels with 150,000 rooms were built, vs. about eighty hotels with 25,000 rooms; all together, the cost of these buildings was over $1 billion. By contrast, only about 340 new hotels were built in 1925, the peak year of the industry’s last great boom.

It is, nevertheless, a fact that over-all demand in the lodging industry is not rising substantially. The demand for hotel space and services is actually declining, and rapidly: since the mid-1950’s, average hotel occupancy rates have fallen from about 72 to 62 percent. Motel occupancy has held steady at around 70 or 75 percent, which suggests, given all the new building, that aggregate demand for motel space has been rising. But this rise has taken place at the expense of conventional hotels .

Howard Morgan, a professor of business administration at the University of Arizona, enlarges on this point in his forthcoming The Motel Industry in the U.S.: Small Business in Transition. After an exhaustive analysis of U.S. census data, he has concluded that, measured in constant dollars, the sales of the public-lodging industry as a whole remained virtually the same between 1948 and 1954, and showed only a modest increase between 1954 and 1958. But the sales of the motel sector alone tripled during the ten-year period (still measured in constant dollars), and have continued to climb ever since. Professor Morgan concludes that the growth of the motels has been based simply on a shift of patronage from the hotels.

The traditional hotel still gets the bulk of the lodging business, but it is still losing ground to its rival. In 1948, when total industry revenues came to about $3 billion (in 1962 dollars), the motels accounted for only 8 percent ($246 million) of this amount. But last year the situation was quite different: the motels’ share of total revenues, which were now up to $4.4 billion, had risen to more than a third ($1.6 billion). The bigger and grander motels have not stopped intensifying the pressure on hotel revenues and profits. To the casual business traveler, it may appear that the hotel industry is trying to solve its problems by building even bigger and grander, and at a fast look this policy may seem to be succeeding; it is a fact, in any case, that the big new hotels mostly seem to be doing well, and it is easy to conclude that the hotelmen’s miseries are all concentrated in their older buildings.

This conclusion would be only partly valid. There are, in fact, good reasons for believing that the present surge of major-hotel building will soon have to subside–indeed, that it is ended already–but that the motel boom still has a long way to go.

Sons of the Grand Hotel

The underpinnings of the motel boom are by now well known. An article in FORTUNE pointed out some of these four years ago (see “The Motel Free-for-All,” June, 1959). In the first postwar decade it was already clear that longer vacations, expanding suburbanization, the increasing decentralization of industry, and the sharp rise in automobile travel had all combined to create a demand for better wayside accommodations–a demand that neither the older motel and “tourist court” nor the traditional in-town commercial hotel was able to satisfy.

The result was the Grand Motel, an ingenious kind of caravansary developed by an ingenious new breed of motel investors. Typically containing fifty or more air-conditioned rooms, it attempted to strike a balance between the tourist court and the resort hotel, offering free on-site parking and self-service devices along with swimming pools, free television, cocktail lounges, “gourmet” restaurants, and room and porter service (which, however, was optional) .

In general, motels are a much more attractive proposition to investors than hotels. Because the motel’s land, construction, and operating costs are all lower in relation to revenues, the return on investment for a grand motel is much higher than for a full-service hotel. Last year. a typical fifty-room motel with, say, a 75 percent occupancy rate earned about 16 percent on the investor’s equity. (Earnings would be calculated after payment of real-estate taxes and amortization of debt but before depreciation and capital improvements, in line with the industry custom.) Some well-situated and well-managed grand motels earned over 20 percent. By and large, hotel investors consider themselves lucky if they can earn 10 percent.

Thus stimulated, a sizable army of institutional and private investors–many of the latter business and professional men banded together in investor syndicates–began pushing money into the motel field in the early 1950’s. According to industry chroniclers, the first true grand motel was erected in the vicinity of Fort Worth in 1952. The edifice has since undergone numerous changes of ownership and is now barely recognizable to early patrons. But it has had numerous heirs. There are now upwards of 5,000 motels with fifty or more rooms, most of them professionally managed, accounting for about half of all motel capacity; 40,000-odd smaller motels have the other half. It is the larger units that are competing most vigorously with the hotels for the attention of the traveling public.

Traditionally, the demand for transient lodging and services has come from four main kinds of travelers: salesmen, touring families, executives on business trips, and convention-goers. All four groups were once dependent almost entirely on the railroads, which the older downtown hotels were built to service. Many of these travelers have long since switched their allegiance to automobiles; there are now 66 million passenger cars registered in the U.S., vs. 27 million in 1940; and the annual “vehicle-miles” recorded by these cars have increased from 250 billion to about 600 billion. Many of the executives and conventioners, of course, have switched to air travel, especially since the jets, but these travelers too have been ending up increasingly in motels–on the superhighways rimming or leading into town, or at the airports, or in the suburbs near the new industrial parks, and, recently, in downtown itself. The grand motel, in short, has moved in on all the older hotel markets for lodging business. Many also added banquet and meeting rooms to their properties recently, and now compete vigorously for social and business gatherings and small conventions, too. Indeed, the grand motel has come so far that it is often not very clear whether a given structure should be thought of as a hotel or a motel. (The formal distinction is that motels. should have “one-for-one” parking, i.e., space for as many cars as there are rooms, and should also offer non-service to those customers who prefer not to have doormen and bellhops under foot as they come and go. A less formal distinction is that motels generally have the television sets bolted to the wall.)

On the beach in New York

The effect on the older in-town hotels has been disastrous. First and hardest hit were the smaller hotels in the medium-size and smaller cities. It is hard to nail down the point statistically, but it seems clear that average occupancy of hotels with less than 200 rooms cannot be much above 50 percent, which suggests that most of them are losing money. (Ordinarily, a hotel would be able to break even at 50 percent occupancy only if it were owned free and clear.) Many have been forced out of business. In some cases their owners have converted the structures to other uses–e.g., made them into college dormitories, residences for retired people. A few of these hotels have been demolished and replaced by motor hotels. In fact, the big new hotel in many cities today is the motor hotel.

Beginning around 1958, the hotels in the very large cities and convention centers began to feel the pressure. Some of the big chains thereupon countered by throwing up huge new convention and luxury hotels in these cities; this response helped to account for the recent surge in hotel building–i.e., it has been largely defensive. But in making their response, the big hotel chains have been at a serious disadvantage. This arises out of the fact that the new hotels naturally compete with the existing hotels–which the chains also own in many cases. In an effort to minimize this competition, and strike back most directly at their real antagonists, the hotel chains have often built their new hotels so that they bear a closer resemblance to the grand motel than to the traditional “palace.” In San Francisco, for example, Hilton now has under construction a $30-million structure, designed by hotel architect William Tabler, that would seem to be, in effect, a vertical motel: rising eighteen stories over a vast underground garage, it is being built around an interior ramp that will permit guests on seven of the floors to drive their cars directly to their rooms and park right outside them if they wish.

Elsewhere, the hotel builders have made ingenious attempts to provide facilities for a variety of travel markets. Prudential and the Hotel Corp. of America, for example, are now erecting a twenty-nine-story hotel in Boston that will be a three-tiered structure: the lower floors are to be a motor hotel with drive-in registration; above that there will be a convention hotel with large meeting and banquet rooms; and on top will be luxury suites (up to $100 per day for one person). To entice travelers further, many new hotels incorporate some architectural features common to much grand-motel and resort-hotel design. An extreme example of this tendency is the Summit on New York’s East Side, designed for Loew’s Hotels by Morris Lapidus, who had previously made his reputation in Florida. (See the picture above.) Asked another architect, critical of the Summit, “Isn’t it a bit far from the beach?”

With the hotels building more and more like the grand motels, and with these still expanding their size, services, and facilities, the competition within the lodging business often appears to be a huge, blurred scramble. New York City and its metropolitan area is a case in point. In 1959, when the motels then lining the approaches to Manhattan were rapidly having a depressing effect on midtown-hotel revenues, Knott Hotels presented the region with its first big hostelry in a generation when it opened what is now the 520-room International Hotel at Idlewild Airport on the edge of the city. Almost simultaneously, a group of independent motel operators presented New York City with its first new downtown lodging place since the Waldorf-Astoria was opened in 1931; this was the 130-room, five-story Skyline Motor Inn on Manhattan’s West Side. Since then Manhattan has got, in addition to the Summit, three other major hotels—Loew’s 500-room Regency on Park Avenue, Loew’s 2,000-room Americana, and the 2,200-room New York Hilton, both of the latter making a special pitch for convention business. But it has also got or is about to get nine more big motor inns, three of which have been contributed by the ubiquitous Loew’s Hotels. Meanwhile, a score or so more have opened near the city’s two main airports, Idlewild and LaGuardia, in Flushing, close to the 1964 World’s Fair site, and elsewhere on the city’s peripheries.

Empty rooms in Manhattan

While New York hotel occupancy rates are among the highest in the country, the addition of some 12,000 new first-class rooms to the 50,000 or so others already available is bound to have a
depressing effect on many of the city’s better hotels, not to mention all the second- and third-class ones. According to Harris, Kerr, Forster, the hotel accounting firm, occupancy in forty-two New York transient hotels dropped slightly last year, from 72 percent in 1961 to 70 percent–even before the full impact of the new building had been felt.  Today at least a half-dozen of Manhattan’s older hotels are in trouble.

Some such pattern has been visible in all the major metropolitan centers. Almost every major city has its first big new hotel since the depression, and some have several; and every city of any size today has been invaded or surrounded, or both, by a clutch of grand motels. Just about everywhere, it appears, the older hotels have been confronted by sizable numbers of new first-class rooms: between 1958 and 1962 Chicago added 7,500; Washington, D.C., 6,000; Houston, 4,300; San Francisco, 3,000.

Not very surprisingly, lamentations about “overbuilding” are heard everywhere. Most of the clamor comes from the owners of the older hotels, who are the principal victims of the boom, and are ill equipped to cope with it. The fact is that the typical big-city hotel these days is forty years old and woefully maintained. Last year only 2,300 of the U.S.’ 29,000 hotels met the minimum standards of comfort, maintenance, service, and decency required by the American Automobile Association for recommendation to its members. How much more new competition will these older properties have to face?

Flying home for dinner

The recent wave of hotel building, to consider it first, would appear to need some explanation. After all, the grand motels on the new superhighways had siphoned off much of the business, especially the patronage of traveling salesmen and touring families. This left the bigger hotels in the largest cities increasingly dependent on visitors arriving by plane–largely executives and convention groups. But the advent of jet travel began to cut down on this business; the speed of the new planes permits a Houston businessman, say, to fly to New York, get a day’s work done, and return home that evening in time for dinner. The average stay of hotel guests in most big cities has declined sharply in the past few years–some New York hotelmen think by as much as 25 percent.

The surge of hotel building since the mid-1950’s was possible only because it was “subsidized” to a considerable extent. As Sheraton’s president, Ernest Henderson III, remarks,  “The cost of building a major hotel is so great that you generally need a subsidy of one kind or another.” The recent boom was subsidized in two different ways. First, the accelerated-depreciation provision of the 1954 tax law gave investors a special incentive to build; they could recover their costs rapidly and they had a tax “umbrella” over profits from the new hotel or any others they owned. A more important kind of subsidy derived from the vast effort at center-city rehabilitation that began when Congress, in the mid-1950’s, began to grant increasingly substantial sums to the cities to help condemn and redevelop slum areas. Just about every big American city has since set to work on a major reconstruction of its central business district. In going about this, local businessmen have almost invariably insisted that the new downtown include two facilities that might lure more business to town: a big convention hotel and a convention and exhibit hall.

In their eagerness to get the first, insurance companies and other business leaders in many cities have often been willing to provide financing at low interest rates. In Dallas, one major new hotel is owned by Southland Life Insurance Co., which built it in conjunction with its big Southland Center and leased it to Sheraton at a low rental. The two hotels that Hotel Corp. of America now has under construction are being built under similar lease arrangement by major insurance companies–one by Prudential in connection with its new Boston office-building complex, the other by Travelers as part of Hartford’s Constitution Plaza urban-redevelopment project. H.C.A.’s recently opened Houston hotel is part of Cullen Center, a development project of the Cullen family. In some cities the buildings have been financed by local bond issues supplemented by loans from local bankers and businessmen.

The action in Las Vegas

The older hotels have been hurt, not only by the creation of all these elegant new rooms, but by a significant change in the composition of demand for hotel services. Demand has been centered more and more in convention and group business; the Hilton chain now derives over 30 percent of its revenues from this source, the Sheraton chain 25 percent. At the same time the intercity competition for conventions has been heightened by those other subsidized facilities, the new public auditoriums.

The addition of Las Vegas to the resort centers with big convention halls has intensified the competition. Until the mid-1950’s, Miami Beach and Atlantic City were the only real resorts with big convention halls. In 1959, Las Vegas opened a convention center with 124,000 square feet of exhibit space, and since then so many conventioners have flocked to join the tourists at Las Vegas gaming tables that its hotels are now the most prosperous in the country: although its hotel-motel room capacity has increased by about 20 percent since 1959, to some 14,000 rooms, the hotels are still operating at 80 percent occupancy around the year.

In the battle for convention business, the big chains have occasionally found their proud new hotels hurting their older ones. The recent opening of the New York Hilton, with 2,200 rooms, four huge ballrooms, and 130,000 square feet of exhibition space, will have a grievous impact on Manhattan’s older convention hotels, including Hilton’s own Statler and the Waldorf-Astoria. Although it was opened only nine months after Loew’s equally massive Americana, only a block away, the new Hilton seemed an assured success even before it opened: it had already booked upwards of $35 mil lion in convention business. But as a result of the new competition, some New York hotels have begun to engage in a form of price cutting. “We find them doing things they never did before,” remarks the New York Hilton’s convention sales manager. “A lot of them are now offering the trade groups space for commercial exhibits without charge. It is not our intention to match them.”

Obviously, hotel investors and builders will continue to find irresistible special situations calling for new hotels. If all goes well, Alcoa and Zeckendorf Property Corp., in association with Western Hotels, plan to put up a twenty-two-story, 800-room luxury hotel, with an all-aluminum skin, in Beverly Hills just down the street from the 450-room Beverly Hilton. Gordon Bass, senior vice president of Western Hotels, declared recently, “This new job will be built despite the fact that many hotel operators believe Los Angeles has too many hotels already. We’re going in because Beverly Hills is a special growth area.”

But the great wave of big hotel building that began in the mid-1950’s appears to have exhausted itself. The big chains now seem disinclined to hurt their older properties any more; and even if they felt differently, they would probably be restrained by the insurance companies, which provide virtually all the mortgage money for big hotels–and which also have major investments in those older hotels.

In addition, one of the few important incentives to build may soon be modified. The Administration has been trying to sell Congress a proposal designed in part, as one Treasury official has put it, “to get the fast-buck boys out of the business”; the proposal would both eliminate the fast write-off provision from the tax code and drastically modify the capital-gains treatment accorded real-estate sales. At present, an investor who sells a piece of property after holding it for six months can get capital-gains treatment on any excess of the selling price over the depreciated cost. Under the Administration’s original proposal, a real-estate investor would get such capital-gains treatment only if he held the property for at least fourteen and one-third years; all sales at a profit would be taxed as ordinary income if they were made within five years, and as a combination of income and capital gain from the sixth year onward. As this article went to press, this proposal and several alternatives were still before the House Ways and Means Committee.

And so the hotel segment of the boom is already subsiding. Sheraton and most of the others have begun to follow Hilton’s lead in shifting their building activities overseas. Hilton itself has intensified this overseas effort: by the time all its current construction is finished, over half of its eighty or so hotels and motels, and about one-third of its rooms, will be abroad. “The profits overseas,” Hilton Vice President Joseph Binns explains succinctly, “are much, much higher.”

The unsaturated franchisers

While the big hotel builders have moved overseas, or subsided entirely, the motel men are still generally bullish, and there is no gloom at all among one group of operators: the motel “franchise chains.” The biggest of these, Holiday Inns of Memphis, the TraveLodge Corp. of El Cajon, and Howard Johnson of Boston, remain as expansive as ever. “Those fuddy-duddies!” an official of one of the largest of these chains recently characterized the hotel outfits. “They make me mad with their talk of saturation. Sure, some old hotel and motel rooms are empty, but that’s because they’re obsolete. I promise you, there’s no slow-up at this end of the business.” If anything, there appears to have been a speedup: the three biggest networks, which together control 800 grand motels with 70,000 rooms, now have about half as many more under construction or committed for opening by 1965. Furthermore, most of the motels in their current inventories have been built in the past five years, while all of the hotel chains except Loew’s, which began from scratch in 1960 and has a completely new plant, still operate many aging hotels.

The franchise chains have other advantages. Unlike the hotel chains, which ordinarily own their properties, or at least own the leaseholds on them, and thus have a large investment to protect, the motel franchise chains are networks composed chiefly of individually owned units; the owners enjoy most of the advantages of chain operation–central purchasing, referral systems, etc.–but still have their own properties. The Holiday chain owns only about one-fifth of its 400 current operations. Howard Johnson, with 150 lodges, owns none at all. Only TraveLodge, with about 250 units, has a considerable equity in its properties: it shares the ownership and profits on a fifty-fifty basis with the manager.

Doctors and dentists in motels

Even aside from the smaller participation required of the franchise operators, it is a lot easier and less expensive to build motels than hotels. The big-city grand motel is, of course, still smaller than the big-city hotel–it has perhaps sixty to 250 rooms, vs. upwards of 500 for a big new hotel. Moreover, it is not encumbered by big lobbies, ballrooms, and other public rooms, and so its construction costs per room are lower: perhaps $8,000 to $13,000 for the grand motel vs. $15,000 to $22,000 a room for the first-class hotel.

The ready availability of mortgage money for the motels is also important. While major insurance companies finance the big hotels, smaller lenders, who tend to be less rigorous in their examination of new projects and considerably more open-handed, ordinarily supply the motels’ money. A number of pension funds have recently entered the motel field, but the great bulk of motel financing is provided by local savings banks and other thrift institutions. In recent years many of these have raised their interest payments on deposits and have consequently been under great pressure to put the savings to work.

With ready mortgage money and the prospect of a 20 percent return on equity, it is not surprising that the motel field has been invaded by many general contractors and small-investor syndicates. In Memphis, which is headquarters for Holiday Inns, the Downtowner chain, and a number of smaller motel organizations, and is also the seat of a large medical center, it is the local doctors who appear to be the most enthusiastic investors. “Hereabouts,” notes a Downtowner executive, “if you’re an M.D. and don’t own a piece of a motel, they won’t let you into the medical association.” In Atlanta, it appears, the dentists have the lead as motel investors.

A few corporate entrepreneurs in related fields have also got into motels. The most notable, perhaps, is the Washington, D.C., Hot Shoppes restaurant chain, which began its motel operations in 1957 with the huge Marriott Motor Hotel across the Potomac from Washington. Hot Shoppes has since built in, among other places, Dallas, Philadelphia, and Atlanta, and has a total motel investment of over $50 million today. In the past year or so a number of big oil companies–they include Pure Oil and Gulf–have also invested in motels, but in a more limited way. In Pure Oil’s case, the arrangement involves a three-way partnership in which it will operate the gas pumps and Quaker Oats will operate the restaurants, while the motels themselves will be built and managed by TraveLodge. Gulf Oil’s agreement with Holiday Inns of America provides an interesting outlet for the oil company’s cash. Under the agreement, Gulf has guaranteed up to $25 million of the motel chain’s first mortgage bonds on newly acquired or newly built motels and will, in addition, provide a $6-million revolving credit fund for new motel construction. Gulf will run service stations at many of the Holiday motels.

The time bomb on the road

Inevitably, given the volume of motel building, and the number of amateurs in the game, a fair number of properties have run into trouble. There are, indeed, some brokers who now spend as much of their time trying to salvage existing motel properties as in putting together new deals. One such broker, Stephen Brener, of New York, explained recently that a local builder will often spot, say, a 100-unit motel that appears to be doing well. Acting on the assumption that another 100 units nearby will do equally well, he puts them in place with as little cash investment as possible, usually by pyramiding a series of second, chattel, and other mortgages on top of the first. He then sells his thin equity to an investor syndicate, and takes back an operating lease, which, in turn, he sells to a motel operator, thus ending his own involvement entirely. This operation ordinarily leaves the builder with a fair profit, but the new owners and the operator may have a time bomb on their hands. The dynamite lies in the high debt charges that the owners are obliged to pay on such properties–charges that become onerous if the property does anything less than a near-capacity business.

But if the motel industry has suffered from some irresponsible building, it has been spared the fatal affliction–a slackening in demand for its services. Right now the motel chains are showing a special interest, and pushing ahead most rapidly, in two interesting markets. One of these was apparently discovered by the Downtowner Corp., of Memphis, which now specializes in this market exclusively. It might be called the downtown “leeching market.” The Downtowner strategy, which is now emulated by all the chains in” some degree, is simple in the extreme. “The idea,” explains one of the company’s executives, “is to throw up a hundred or so rooms across the street from the big convention hotel in town and operate them without frills. That way, we can leech off the hotel’s traffic the way the variety shop down the street leeches off the department store.” The strategy has been eminently successful, and Downtowner now has twenty such operations four years after it got into the business, with thirty-five more in construction or planned.

The other market in which interest has been expanding is a kind of “discount” version of the grand motel. The chains have discovered that there is a tremendous unsatisfied demand for facilities that are clean and modern, but entirely without frills, for a price well under the standard $10 or $12 a room. Holiday, TraveLodge, and others are experimenting with what one motel man calls an “instant motel”–a unit consisting of, say, thirty-two rooms that can be mass-produced and put into place quickly wherever high-density traffic develops, and can be rented for $5 a night. Speaking of such operations, a Holiday Inns executive observed recently: “What we’re trying to do here is finish the job that” Henry Ford began. Ford put a set of assembly-line wheels under the average American. It’s up to us to supply the assembly-line lodgings.” As the analogy suggests, the speaker thinks his industry is still in its infancy. He may be right, at that.