The light at the end of the tunnel appears for US lodging demand


PKF Hospitality Research (PKF-HR) announced today that, according to its June 2009 edition of Hotel Horizons(R), rooms revenue per available room (RevPAR) will reach its cyclical low point in the third quarter of 2009. This will bring to a close the escalating trend of declines in RevPAR that began in the third quarter of 2008, according to Smith Travel Research (STR).

In May 2009, Moody’s downgraded its outlook of a 2.9 percent national employment decline to 3.8 percent, causing PKF-HR to revise its RevPAR forecast for the year. Given the correlation between employment and lodging demand, the new expectation is for RevPAR to decline 17.5 percent in 2009, followed by another 3.5 percent decline in 2010.

“The good news is that the bottom of the current cycle for the US hotel industry is soon to arrive. The bad news is that 2009 will be the weakest year on record for the domestic lodging industry, and 2010 is going to be disappointing as well. Accordingly, industry participants need to calibrate their expectations when analyzing lodging performance measurements,” said R. Mark Woodworth, president of PKF Hospitality Research. “If you are wondering when we’ll start to see actual growth in RevPAR, then you’ll have to wait until 2011. However, if you want to know when the operating environment is going to get a little less painful, that’s happening right now.”

While many markets are experiencing the lingering effects of new supply openings, the light at the end of the lodging demand tunnel has now appeared. “According to STR, hotel demand first began to contract in the first quarter of 2008,” noted Woodworth. “We expect this to persist through the end of this year; thus, we are now more than half way home towards a demand turnaround.”

“We have identified the turning points and inflection points on the current business cycle. Knowing these milestones allows hotel owners and operators to properly prepare their operating and capital budgets, as well as investment strategies, for the remainder of 2009 and the years to come,” said Woodworth. “Given where we are at in the cycle, turning points denote the bottoming out of a measure, while inflection points mark when the important indicators exhibit positive growth. Accordingly, all the major lodging statistics turn in 2009, but occupancy won’t begin to inflect until 2010, and ADR will not exhibit growth until 2011,” concluded Woodworth.

Hotel Horizons(R) is a quarterly series of reports containing five-year forecasts of performance for the US lodging industry and 50 major markets across the country. The lodging forecasts presented in the June 2009 edition of Hotel Horizons(R) are based on Smith Travel Research (STR) hotel performance data through March 2009 and Moody’s’s May 2009 economic forecast for the nation.

Less of a Decline

Year-over-year quarterly declines in the demand for US lodging accommodations started in the first quarter of 2008 and peaked at negative 8.0 percent in the first quarter of 2009. The June 2009 edition of Hotel Horizons(R) forecasts demand to decline each of the remaining quarters of 2009, but at a diminishing pace. The projected quarterly declines in demand for the remainder of 2009 average just 4.7 percent. Beyond 2009, the forecast calls for average annual increases in demand of 3.2 percent for the next four years, well above the 1.9 percent long-term average.

Concurrent to lower declines in demand is a similar reduction in the opening of new hotel rooms. “As we progress through 2009 and into 2010, we will begin to see a contraction in residual effects of the construction activity that started in 2006 and 2007,” said Woodworth. New hotel openings peaked in the first quarter of 2009 when year-over-year supply grew 3.2 percent. For the remainder of 2009, supply growth diminishes each quarter. In 2010, the annual change in supply is forecast to drop to 1.4 percent.

“The deceleration in supply growth is a bit deceiving. The investment money that funded the current surge in new hotels is all chasing the same customer,” Woodworth observed. “If you look at the types of hotels that will open up in 2009 and 2010, they are heavily concentrated in two chain-scales. Just over 76 percent of net room growth this year and next occurs in the upscale and mid-scale without food and beverage chain-scale segments.”

“Despite the overall slowdown in hotel openings, the extreme reductions in demand will still cause the national occupancy level to decline in both 2009 and 2010. However, the pace of the occupancy diminution will ease considerably as the reality of new competition subsides.” PKF-HR forecasts occupancy to decrease by 8.1 percent in 2009 and another 0.2 percent in 2010.

Pricing Power Plummets

“In an environment with all-time record low occupancy levels, the pressure on hotel operators to discount their room rates is significant,” said Woodworth. “Best practices may state that discounting does not induce demand, and we know the negative impact that rate reductions have on the bottom-line. However, we are simply in a time and place when the laws of supply and demand trump a more optimal practice. At every hotel there is a fixed minimal level of operating expenses that needs to be offset by any revenue that a manager believes they can get.”

PKF-HR is forecasting average daily room rates to decline 10.2 percent in 2009, and decrease another 3.3 percent in 2010. “We’ll see the greatest degree of rate concessions this summer, but the level of discounting will diminish from then on. Nine consecutive quarters of year-over-year reductions in room rates (fourth quarter 2008 to fourth quarter 2010) is great news for travelers, but a major cause of concern for hotel owners and their lenders,” noted Woodworth.

Local Markets Vary

The RevPAR inflection points for the nation’s largest hotel markets do vary from city to city. “Our research has found that 70 to 80 percent of a hotel’s performance systematically is linked to the local economy. Given the variations in the economic outlook for the different regions of the nation, our forecasts of RevPAR growth differ accordingly,” said Woodworth. Fourteen of the 50 markets in the Hotel Horizons(R) universe are forecast to achieve year-over-year gains in RevPAR during the first half of 2010, while another 30 cities will not enjoy RevPAR growth until the last half of next year. RevPAR increases for the remaining six markets are delayed until 2011.

Brutal Bottom Line

Given the forecast 17.5 percent decline in RevPAR for 2009, PKF-HR is projecting total hotel revenues to decrease 16.0 percent for the year. U.S. hotel managers, as they have in the past, will cut costs by 7.5 percent, but that will not be enough to avoid a decline in the typical hotel’s net operating income(1) (NOI). PKF-HR is forecasting that the typical U.S. hotel will suffer a 37.8 percent decline in NOI in 2009 and an additional 9.2 percent in 2010. It should be noted that U.S. hotels will continue to generate a positive NOI. However, given the projected declines in NOI, hotel profit margins are forecast to be well below the long-term average of 25.7 percent.

“Fewer guests paying lower prices is a recipe for evaporating profits,” said John B. (Jack) Corgel, the Robert C. Baker professor of real estate at the Cornell University School of Hotel Administration and senior advisor to PKF-HR. “Add to that the potential for an increase in fixed charges such as utility costs, insurance, and property taxes and the situation could get ugly quickly. Not many current industry participants were around 72 years ago, the last time PKF-HR recorded a unit-level profit decline in excess of 20 percent. Needless to say, profit declines in excess of 30 percent have a wide-ranging impact on hotel values, debt coverage, default covenants, and solvency.” As of June 9, 2009, TREPP was reporting that 3.2 percent of the commercial mortgage-backed securities lodging loans that they track were in delinquency. This is up from 0.5 percent in June of 2008.

Strong Inflection Beyond 2010

While the cumulative declines in revenue and profits during the current industry recession exceed those of previous industry downturns, the magnitude of forecast recovery will be exceptionally robust. In 2011 and 2012, PKF-HR forecasts that RevPAR will increase on an average annual basis of 9.2 percent, while profits will rise at a 17.8 percent pace. “If you are an owner, investor, or lender that can weather this year and next, the return to prosperity should be strong and quick,” Woodworth observed.