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Weekly UpdatesVirtually all participants in the U.S. lodging industry had a good ride that lasted almost four years. The pervasive euphoria that characterized the hotel market during this period found its roots in the domestic recovery that began to take hold in the third quarter of 2003. Employment levels expanded in a vast majority of markets around the country, and personal income levels followed. The headwinds created by global unrest and the stench of terrorism threats did not negate the above-average profit growth that owners and managers realized throughout the middle years of this decade. But alas, as first noted by Chaucer in the fourteenth century and reprised by Ursula in The Little Mermaid, "All good things must come to an end."
A review of top-line performance data from Smith Travel Research (STR) reveals that history once again began to repeat itself as the national economy softened in late 2007, and lodging demand softened in most markets for virtually all property types. The onset of a financial panic in the third quarter of 2008 caused the demise of many venerable institutions as well as a severe decline in travel away from home. The effect of these and many other related events will cause a net decline in total U.S. lodging demand in 2008 and again in 2009--a two-year trend that has not occurred since STR began compiling data in 1987.
In a 2005 Cornell Hospitality Report, professor John C. Corgel noted that data regarding U.S. hotel markets' behavior now exist through more than one complete market cycle, as well as through the wide variety of environmental conditions since the late 1980s. (1) Those conditions include two general economic recessions, two wars, an unprecedented set of catastrophic events, and many local situations that affected travel and hotel market activity. Considering the economic run-up of the late 1990s fueled by the adoption of the internet and the resulting dot.com phenomenon, the polar extremes of industry highs and lows were established.
Will the panic on Wall Street and the ensuing global crises within the financial markets, combined with an unfortunate increase in new supply in 2008 and 2009 while the demand pool is shrinking, result in a new "low-watermark" for the U.S. lodging industry? We at PKF Hospitality Research (PKF-HR) do not think so, but the view on the near horizon is not a pretty one.
As noted in Exhibit 1, the typical U.S. hotel realized a 4.7 percent average annual increase in profits (2) over the past fifty years. During this time, annual declines in profits were realized fourteen times. Based on actual performance through the third quarter of 2008, PKF-HR forecasts that a net decline in same-unit profits will be realized in 2008 and again in 2009. Unlike the majority of most industry contractions since the late 1940s, this pain will be short-lived, as an anticipated economic recovery by mid-2010 should serve stimulate profit increases in that year.
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Labor Management Will Mitigate Revenue Loss
PKF-HR collects detailed financial performance data covering approximately six thousand U.S. hotels every year for its Trends in the Hotel Industry report. From this collection of data, the firm develops insights to trends in revenue and expense management for all lodging property types. From these data, we know that 43.0 to 45.0 percent of all costs related to the operation of a hotel are payroll and related expenditures. While a significant component of these costs is essentially fixed in nature (e.g., general manager, director of sales, chef), many are variable (for example, housekeeping personnel, restaurant and banquet staff).
As noted in Exhibit 2, history reveals that U.S. hotel managers have been able to lower labor expenses as revenues decline, and that will be the case once again during the current downturn. Thus, while the decline in same-unit profits in 2009 will be the largest seen since the catastrophic year of 2001, effective labor management practices should once again mitigate the downside.
The Level of Pain Depends on What You Are ...
Management's ability to offset declines in revenue through payroll and other expense control strategies is largely a function of the depth and breadth of services offered and the level of occupancy performance achieved prior to the onset of a performance decline. Concerning the former, full-service hotels--by definition those that offer food, beverage, and typically other ancillary services--employ more complex operating structures and require a greater level of administrative support to function properly. Conversely, limited-service hotels--those facilities that typically derive 90 percent or more of their revenue from the rental of guest rooms--are more streamlined in their labor structure.
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... And Where You Start
In the fourth quarter 2008 Hotel Horizons [SM] report, PKF-HR is forecasting approximately a 7.8 percent decline in revenue per available room (RevPAR) for 2009. To analyze the impact on unit-level profits of a revenue decline of this magnitude, we identified hotels in the PKF-HR Trends database that achieved a decline in RevPAR between 5 and 10 percent from 2006 to 2007 (the most recent periods for which data were available). Since the current and expected 2009 decline in RevPAR for the industry will largely be driven by lower levels of occupancy performance, only those properties that realized this type of business shift were used in the analysis, the results of which are summarized in Exhibit 3.
The results of our analyses revealed a consistent 10 to 15 percent falloff in net operating income (NOI) for limited service hotels that realized a drop in RevPAR similar to the level of decline forecast for 2009. Comparable declines in NOI were experienced irrespective of the occupancy level achieved prior to the loss of revenue. This outcome can be explained by the fact that a significant portion of the costs needed to operate a limited-service hotel are variable in nature. As such, property managers are able to eliminate expenses as their business volumes decline.
Such is not the case with full-service lodgings. For these types of facilities operating at a high occupancy level prior to the onset of a decline in business, management was able to achieve a meaningful increase in average daily rate (ADR) as well as a slight increase in total revenue. Thus, the decline in profit was only a slight 3.5 percent. As the leading year occupancy levels decline, it is clear that the ability to maintain ADR and total revenue increases is compromised, meaningful expense reductions are difficult to implement, and more severe declines in profits result.
Hoteliers of all property types and in all markets will find 2009 to be a highly challenging year, and a sharp focus on expense management should be the guiding principle as the industry weathers the current cycle storm.
(1.) John C. Corgel, "Eight Rules for Competing in Hotel Real Estate Markets," Cornell Hospitality Report 5, no. 13 (December 2005), Cornell Center for Hospitality Research, chr.cornell.edu.
(2.) Before deductions for capital reserve, rent, interest, income taxes, depreciation, and amortization.
R. Mark Woodworth is president of PKF Hospitality Research (www.pkfc.com). He is located in the firm's Atlanta, Georgia, office.
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