When analyzing the financial performance of hotels in the United States, a question we always ask is, “Have we seen this before?” At PKF Hospitality Research (PKF-HR), we have the benefit of reaching into our propriety Trends in the Hotel Industry database that contains detailed revenue, expense and profit data from 1937 through the present. Considering the lack of clarity and resulting volatility in the financial markets entering 2009, we thought it would be informative to examine the behavior of hotels in the United States during past periods of economic turmoil.
According to the Bureau of Economic Research, the United States has experienced 11 economic recessions since 1937. The duration of these recessions have ranged from six to 16 months. Using the Trends database, we measured the change in unit-level hotel financial performance for the years that correspond to the peak-to-trough contraction phase of the designated recessionary period.
The expected result of this analysis is that the decline in all hotel performance indicators mirrors the decline in the economy. What surprises did we learn?
Revenues and Profits
As expected, the most likely impact on lodging attributable to an economic recession is decline in both revenues and profits. During nine of the economic downturns, occupancy levels dropped because of decline in the demand for lodging accom-modations. Despite deteriorating market conditions, hoteliers aggressively sought to maintain room rates. In eight recessions, ADR actually increased during the contraction period.
Unfortunately, during seven earlier economic downturns, ADR gains fell short of offsetting decline in occupancy, leading to diminished levels of total revenue. In each instance when revenue declined, so did profits.
Expense Control
Prior to the 1990-1991 recession, hotel managers were rarely able to reduce operating expenses in response to declining levels of occupancy and revenue. However, management generally kept expense growth under control. Except for the downturns that were driven by inflation (1973-1975 and 1980-1982), expense growth during recessions before 1990 averaged less than 1 percent.
On the other hand, expense control was the saving grace for hotels during the recessions of the 1990s and 2000s. Facing declining occupancy and ADR, hotel managers actually cut costs in 1991, 2001 and 2002. Analyzing the Trends reports for these respective years, it is not surprising to find that operators looked at their payrolls to find the biggest source for cost cuts.
Impact of Inflation
Contrary to popular belief, U.S. hotel revenues and profits do not always contract during economic recessions. During the 1973-1975 and 1980-1982 recessions, high inflation was a primary contributor to the nation’s economic woes. Hotel managers responded by raising prices (ADR) in excess of 18 percent over the respective two-year periods. The increase in ADR helped to offset the decline in occupancy, resulting in revenue gains of approximately 11 percent.
While inflation helped grow revenue, operating expenses also accelerated. Tempering the benefits of the 11 percent growth in revenues were 13 to 15 percent increases in the cost of operations. Fortunately, hotels were still able to achieve minor gains in profits between 1 and 3 percent during the two previous recessions when high inflation also was present in the economy.
What To Expect
PKF-HR has developed an econometric forecasting model that relies on historical lodging data from Smith Travel Research (STR) and economic forecasts from Moody’s Economy.com to project the future performance of the lodging industry in the United States. As of early November 2008, economic forecasts from Moody’s indicate a recession that is estimated to have begun in November 2007 and to last into the third quarter of 2009. During this time period, the forecast calls for persistent reductions in employment and real personal income, the two most relevant drivers of lodging demand. Projections for growth in the consumer price index are modest, so the current downturn will not be an inflation-driven recession like we saw in the ’70s and ’80s.
As of Nov. 12, 2008, PKF-HR is forecasting lodging demand to decline a cumulative 3.9 percent from 2007 through 2009. Reduced levels of demand, combined with a 5.8 percent increase in the supply of hotels rooms, will result in a 9.2 percent decline in occupancy during the two-year period. By year-end 2009, occupancy is forecast to be 57.3 percent, the lowest level since STR began tracking national lodging performance in 1988.
Since the depths of the 2001 recession, we have observed yield management practices that have resulted in greater than expected gains in ADR. This implies that hotel managers will once again raise room rates during the current recession. However, given the depth of the anticipated decline in occupancy, PKF-HR believes it will be a challenge for hotel managers to continue this practice. While ADR is projected to increase 2.5 percent in 2008, the Nov. 12, 2008, forecast calls for a 2.5 percent decline in 2009.
While room rates are forecast to decline, we believe that hotel management will continue the recent historic trend of reducing expenses in the face of declining revenues. The incident of fewer occupied rooms and guests will automatically result in a reduction of the variable component of operating costs.
PKF-HR is forecasting expense reductions of 6.4 percent during the two-year period of 2008 and 2009. Unfortunately this is not enough to cover the anticipated 8.5 percent decline in total revenue during the same period. The net result is a forecasted 13.5 percent drop in unit-level profits for the typical hotel in the United States during the current recession.
Despite the grim forecast, unit-level profit margins are expected to remain in the high 20s. PKF-HR does not foresee an abundance of hotel foreclosures.
R. Mark Woodworth is president of PKF Hospitality Research. Robert Mandelbaum is the director of Research Information Services for PKF-HR.
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Mixed Outlook
The immediate future doesn’t look so good, but there are bright spots.
by Jan D. Freitag
As we embark on the 2009, the U.S. hotel industry faces a tougher operating environment than during the last few years. With an inventory of about 4.5 million guestrooms at 50,000 hotels nationwide, it appears that the U.S. hotel industry will have a challenge at nearly every turn as 2009 unfolds.
The biggest issue on the immediate horizon is the addition of more supply. In 2008, the expected growth rate of new supply was 2.5 percent, which was nearly double the supply growth rate during 2007. Smith Travel Research (STR) expects the supply growth pace to actually increase during the first quarter of 2009 before slowing down to a more moderate pace.
Many projects that were under construction during the fourth quarter of 2008 will likely be finished during the first half of 2009, and the attrition rate that is historically around 3 percent for projects under construction might slightly increase.
Because of the faltering economy, projects in earlier phases—including those for which ground has not been broken—might face additional scrutiny and possibly even the renegotiation of financial terms, which could delay construction.
With the capital markets frozen, new construction likely will be impacted through the end of 2009. After the busy first few months of the year, supply additions will be reduced, and STR projects the total supply growth for 2009 to be 2.4 percent. We expect the growth rate of new supply to be 1.2 percent in 2010.
This bodes well for existing properties as operators of those facilities will be able to focus on existing competitors rather than spending time worrying about new hotels in their markets.
The increase in new rooms is unfortunately being met by a decrease in demand. We expect the year-end 2008 demand to drop 0.5 percent from the year-end 2007 demand. We project demand to drop another 1 percent in 2009. As the general economic conditions start to improve, which is expected to occur in the third or fourth quarter of 2009, business and leisure travel will again pick up. Therefore, we currently are expecting a slight 0.6-percent increase in demand during 2010.
As the imbalance between supply growth and demand growth widens, occupancies deteriorate. Through the first 10 months of 2008, occupancy dropped 3.4 percent. The last two months on record—September and October—were particularly hit hard with occupancy drops of 6 percent and 6.5 percent, respectively. Our expectations are that occupancy will decrease around 3 percent in 2008 compared with year-end 2007. We project occupancy to decrease an additional 3.5 percent in 2009 before recovering slightly in 2010 with a more moderate decrease of -0.6 percent.
The strong supply growth mentioned earlier, along with the weak economy, have led to a declining nationwide occupancy rate. Total U.S. occupancy is expected to check in at 61.2 percent for 2008, but we expected it to dip below 60 percent
for 2009 and 2010—something that has not happened since 2002-2003.
In this environment where the majority of influencing factors are “given,” the one variable hotel operators can control is the average rate. STR has always been a strong proponent of healthy rate growth around the level of inflation (about 3.5 percent).
As the cost of supplies, utilities, insurance and labor have increased, greater pressure has been placed on profitability. As hotel operators continue to improve their amenities and services with better beds and bigger televisions, it stands to reason that they should be compensated for their high expenses.
As we first reported post-9/11, the cuts in average daily rate that were implemented over a short period of time in late 2001 and 2002 were so steep that it took the industry about six years to regain the lost ground. Hopefully the industry learned its lesson from that experience and realizes that while rate cuts may be a short-term solution, they are nothing more than a long-term mirage.
Cutting rates indiscriminately hurts not only profitability, but the practice also dilutes the perception of value in the consumers’ minds. It is with this background that STR projects average daily rate growth of 3.4 percent in 2008, 1 percent in 2009 and 2.1 percent in 2010. The corresponding revenue per available room increases are mixed with a 0.4-percent increase in 2008, a 2.5-percent drop in 2009 and a 1.5-percent increase in 2010.
We will continue to report as the industry makes its pricing decisions, and we’ll keep a close eye on demand numbers as they are reported by our participants.
Jan D. Freitag is vice president of global development at Smith Travel Research.
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