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The High Cost of Raising Room Rates

The High Cost of Raising Room Rates

The highlight of the recovery from the recent recession has been the strong rebound in lodging demand. According to Smith Travel Research (STR), occupancy levels at U.S. hotels increased from a low of 54.5 percent in 2009 to 61.4 percent in 2012. With occupancy levels approaching the long-run average, hotel managers have become more aggressive with their pricing policies. Average daily room rates (ADR) rose 4.2 percent in 2012 and are forecast to nominally eclipse the pre-recession peak ADR in 2013.

Gains in both ADR and occupancy resulted in a 6.8 percent growth in revenue per available room (RevPAR) for all U.S. hotels in the STR sample during 2012. But while hoteliers have enjoyed strong growth in room revenue, the same can’t be said for other sources within their hotels. Based on a sample of operating statements collected from approximately 6,500 U.S. hotels in PKF’s 2013 edition of Trends in the Hotel Industry, room revenue increased by a healthy 6.3 percent from 2011 to 2012; however, total hotel revenue grew by just 5 percent. This means the combined revenue earned from food and beverage, other operated departments, and rentals and other income increased only 2.3 percent per available room (PAR), or a mere 0.5 percent when measured on a dollar per occupied room basis (POR).

This finding is consistent with other research conducted by PKF. According to our annual survey of meeting planners for ConventionSouth magazine, the rising occupancy levels have indeed led to limited availability and higher room rates. However, to keep control of meeting and travel budgets, planners have had to place limitations on the amount their clients can spend on ancillary services and amenities. This, in turn, has led some hotel owners and operators to reduce food and beverage service levels at their properties.

That’s right, when faced with the challenge of boosting their revenue, hotel managers responded once again by controlling costs. Total hotel operating expenses—before deductions for capital reserve, rent, interest, income taxes, depreciation, and amortization—for the properties in the Trends sample increased by 3.3 percent in 2012, compared to the 4.3 percent rise observed in 2011. Because of the high degree of variable costs at hotels, part of the decline in the pace of expense growth can be attributed to the reduced pace of occupancy increases. Nonetheless, when measured on a POR basis, operators were able to limit expense growth to just 1.5 percent in 2012.

Limits of Cost Control
In 2012, labor related expenses accounted for 45.3 percent of total operating expenses. Total labor costs increased by 3.6 percent from 2011 to 2012 but grew by only 1.8 percent on a POR basis. This implies that managers improved employee productivity. During 2012, salaries and wages increased by 2.9 percent, while payroll-related expenses (benefits) rose by 5.4 percent. Many U.S. hoteliers are concerned that this could be a foreshadowing of future escalation in government mandated taxes and benefits.

With labor costs being the most significant component, operated department expenses increased by just 3.5 percent in 2012. And since revenues grew faster than expenses, operated department profits increased by a healthy 6 percent. In general, undistributed expenses are considered more fixed in nature compared to the operated departmental costs. Therefore, at first glance, the 5.3 percent rise in sales and marketing expenses, along with the 5 percent increase in management fees, appears to be a cause for concern. However, changes in revenue and profits influence these two expense categories. Franchise fees (considered a sales and marketing expense), as well as sales bonuses, rose in large part because of the increases in room revenue. Management fees are almost exclusively driven by changes in revenues and profits, thus explaining the relatively strong growth in this expense item.

The greatest percentage change in an individual expense category was observed in insurance. The amount paid by hotels for property and liability insurance grew by 6 percent in 2012. According to the firm Swiss Re, 2011 saw the second greatest dollar volume of worldwide-insured losses ever. It appears that the insurance companies needed to recoup their 2011 outlays by raising premiums in 2012.

On a positive note, utility costs declined by 3.4 percent from 2011 to 2012. We attribute this reduction to the continued implementation of green and sustainable operating practices, the purchase of energy efficient equipment, and a 0.9 percent increase in the cost of energy over the course of the year, according to the Bureau of Labor Statistics.

Net operating income (NOI)—before deductions for capital reserve, rent, interest, income taxes, depreciation, and amortization—for the average hotel in our Trends sample grew by 10.2 percent in 2012. Resort hotels enjoyed the greatest gain in NOI (10.6 percent), followed by limited-service (10.6 percent) and full-service (9.8 percent) properties. Lagging in profit growth were convention hotels (5.7 percent), suite hotels with food and beverage (7.7 percent), and suite hotels without food and beverage (8.1 percent). Resort hotels benefited from the greatest increase in ADR, while convention hotels were impacted by the lag in the recovery of the group market segment.

Based on the March 2013 edition of Hotel Horizons, PKF is forecasting double-digit growth in NOI for U.S. hotels through 2015. Strong growth in ADR will be the main catalyst of bottom-line improvement, along with limited growth in expenses. Our outlook for restrained increases in expense growth is driven by Moody’s Analytics’ forecasts for modest increases in inflation, as well as subdued growth in variable operating costs attributable to the slowdown in the pace of occupancy gains.

Managers will continue to be challenged to grow other revenue sources, especially since travelers will be offered an increasing inventory of select-service properties. Alternatively, owners will benefit from increases in property value resulting from improving profits.

Robert Mandelbaum is director of Research Information Services for PKF Hospitality Research; www.pkfc.com

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