Hotel Online Special Report

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2002 National
Lodging Forecast
Ernst & Young LLP
Lodging Trends
Lodging Industry Outlook
Lodging Industry
Segment Reports
- Luxury
- First Class
- Upscale
- Midscale
- Economy
- Resort
-
Lodging Trends

Lodging Stocks

According to Ernst & Young�s Lodging Stock Index, small-cap, mid/large-cap and REIT lodging stocks consistently outperformed the S&P 500 in the year-to-date prior to September 11th (9/11). The week following the tragic events, however, stocks plunged to 52-week lows, declining by as much as 36 percent as in the case of REIT stocks. Mid/large-caps and small caps did not fare well either, as they experienced declines of 28 percent and 13 percent, respectively. For the remainder of 2001, lodging stocks observed a steady recovery, led primarily by the small cap sector, which was the only segment to surpass pre-9/11 levels and continue to outperform the S&P 500. Despite improvements in lodging stocks, mid-term performance is anticipated to remain slightly below pre-9/11 levels due to the impact of an exacerbated decline in the economy, continued reluctance to travel and the overall discounting of lodging stocks by investors. Although there continues to be some good �buy� opportunities among major hotel stocks, investors should be cautious as loan defaults in early 2002 may further discomfort the financial markets and push stock prices down. Decreasing hotels values, nonetheless, may eventually turn out to be positive to hotel owners, as they may be able to obtain reductions in assessed values and receive substantial real estate tax savings. If the economy recovers substantially in the first half of 2002, E&Y believes much of this value loss will be recovered.

Hotel Values

Given increasing cash flow volatility, E&Y anticipates substantial erosion in hotel values in the near-term. In the aftermath of 9/11, hotel properties are anticipated to trade at discounts to construction costs given that an economic rebound may take longer than originally expected. These transactions, however, will not be as deeply discounted as in the early 1990s�when values decreased by as much as 30 percent � due to more responsible underwriting criteria in recent years. Luxury hotels have been the hardest hit given their dependence on transient leisure and upscale corporate demand, while limited-service and budget hotels have been able to better maintain their values. In aggregate, E&Y expects a 15 percent to 20 percent reduction in hotel values as a result of recent events.

Acquisition Activity

Transaction activity in the lodging sector came to a halt in 2001 and many lenders remain skeptical of our industry, as evidenced by a reduction in LTV lending thresholds and an increase in surveyed capitalization and discount rates from recent transactions. This may prove to be an excellent time for opportunity-funds and opportunistic buyers to focus on select assets at attractive discounts. Although sellers remained quite inflexible prior to 9/11�generally unwilling to reduce their asking prices�owners have now realized that the sector may take longer than anticipated to rebound and may be more willing to strike deals. The investment community, however, wants to see clear signs that the sector has bottomed out before making serious hard asset commitments. E&Y believes that timing may prove to be right for larger deals during the second quarter of 2002.

Development Pipeline

The lack of readily available hotel financing in today�s environment has been a catalyst in the decline of lodging projects in the development pipeline over the last two quarters of 2001. Projects seeking financing are being forced to re-evaluate the feasibility of their deal and recalculate their revenue and cash flow projections to take into account uncertain economic conditions. Only owners and developers with a history of sound balance sheets will have access to capital. E&Y anticipates this trend to continue until hotel occupancies recover in the latter part of 2002 and early 2003. Upscale and luxury hotels, which suffered the largest occupancy losses, accounted for the bulk of projects to be placed on the back burner. On a positive note, a thinner pipeline will help to mitigate the effects of demand declines and will play a role in the eventual stability for major urban and resort markets that were being swamped with additional supply.

Defaults and Foreclosures

E&Y�s initial read is that defaults and foreclosures are not yet occurring at any substantive pace. The abrupt slowdown experienced by the lodging sector, however, has negatively impacted RevPARs and further thinned debt service coverage ratios. Upper-upscale properties are at greater risk as corporate travel continues at levels below those of 2000 and properties are striving to maintain rate integrity and service levels in the face of necessary layoffs. Independent chains without broad distribution in multiple segments, small properties worth less than $10 million without deep operating reserves and hotels with poor management or no brand affiliation are also at an increased risk for loan defaults. Although lenders typically wait approximately 90 days on delinquent loans before foreclosing, E&Y anticipates significant maneuvering from borrowers to obtain extensions or special arrangements with their lenders. With this traditional grace period expiring in the first quarter of 2002, unless the industry observes a turnaround in business in the spring, some hotel failures could happen. E&Y anticipates loan defaults to more than double in 2002 despite recent tighter lending standards of 50 percent to 60 percent loan to value versus 70 percent to 80 percent loan to value ratios of several years ago.

Mixed-Use Developments

Multiple income streams generated from mixed-use developments have typically increased the attractiveness of many projects, as cash flows from distinct property types diversify risk exposure from any one real estate component. In the midst of a severe downturn for the lodging industry following 9/11, however, third party lenders will more closely scrutinize hotel components within mixed-use developments. Hotel construction is frequently funded with proceeds from residential sales early in the construction or pre-construction phase, thereby providing the funding necessary for the hotel component. The U.S. economic slowdown, however, is putting the brakes on new home sales, especially in the upscale and luxury markets, further siphoning financing available for hotel construction. In the mid and long-term, mixed-use development residential sales are anticipated to improve as the �empty nester,� Baby Boomer generation begins to seek smaller residences with the convenience of nearby retail and entertainment outlets. In the interim, E&Y anticipates that mixed-use developers will face continued strains financing their project�s lodging components, resulting in potential delays and cancellations.

Cost Containment

Payroll has been the major focus of cost containment for most hotel chains. It is estimated that more than one-third of the 260,000 hotel and restaurant workers represented by the Hotel Employees and Restaurant Employees International Union had lost their jobs as of December 2001. Cutting staffing levels by furloughing (temporary layoffs), reducing schedules of hourly employees, requiring mandatory vacations and cutting overtime have proven to be effective and inexpensive solutions to improve the bottom line. Clustering employees (e.g. sharing employees among area hotels) is another effective solution to reduce costly overhead. Removing turndown service, closing food and beverage outlets for certain meal periods, reducing hours of operation for businesses such as health clubs, and gift shops or eliminating 24-hour room service are additional cost reduction measures that are helping operators bridge the revenue and expense gap in a time of lower demand and, subsequently, rates.  E&Y is working to assist operators to develop and refine new and flexible strategies of cost containment that will ultimately strengthen the industry during the next cycle of revenue and profit growth.

Energy Savings

The stellar performance experienced in our industry for the past years coupled with the fact that energy expenses typically represent a small portion of a hotel�s operating expenses-generally between four percent to five percent of revenues�has resulted in complacency by operators to reduce energy use and improve operational efficiency. Rarely have energy issues been at the top of the priority list amongst hoteliers. During these trying times, however, operators have come to realize that they lack the necessary information to make strategic decisions about energy use. Defining a structured and detailed energy strategy, focusing on supply sourcing, conservation, implementation, and capital financing, can result in substantial savings for the bottom line in the long term. These measures can reduce operating costs, increase efficiency and improve the indoor environment without compromising business objectives. E&Y estimates that cost savings ranging from 15 percent and 20 percent can be achieved by successfully implementing energy strategies in hotel properties.

Security

On 9/11, a fundamental change occurred in the lodging industry. While managers previously focused primarily on personal guest security at the operational level, the events of 9/11 have forced hotel management companies to reconfigure their security efforts with a greater understanding of �strategic� or public security. While important, no longer do anonymous room keys and guestroom door peepholes seem to be the priority. Instead, the role, risks and exposure of the hotel as a high profile public use building is the topic of the day in a society still dealing with the realities of terrorism on its soil. This new security paradigm will undoubtedly be an integral component of overall asset strategy, as its strength or weakness will also affect asset value. E&Y anticipates that substantial changes will occur in the near future including more stringent hotel construction and design standards, comprehensive layout analyses, bomb threat procedures and evacuation training, and passive security systems for hotel properties.

Insurance Premiums

Hotel owners had no way of foreseeing the large increases in insurance premiums for 2002. Although insurance premiums have been on the rise in the past years�as a result of various economic factors and increased insurance claims�it was the events of 9/11 that have forced insurance companies to significantly increase their rates in 2002. National carriers are already demonstrating their lack of appetite for insuring the lodging industry by reducing coverage or withdrawing altogether from the sector�making it much harder for hoteliers to find proper coverage for their properties. E&Y anticipates that insurance premiums may increase by as much as 50 percent in 2002 for all policyholders, including those with good track records. These increases will directly affect the bottom line and challenge some operator�s ability to meet debt service obligations. As a result, hoteliers must be knowledgeable about renewing their policies and identify solutions that will neither leave them vulnerable and under-insured, nor create a heavy financial burden. As such, in certain circumstances, hotel companies may want to consider accepting larger deductibles to offset rate increases, implementing improved procedures to minimize potential losses and discussing their insurance needs with multiple carriers to promote competition and reduce premiums.

Lodging Industry Outlook

What began as economic trepidation in the second quarter of 2001 has now, due to both foreseen and unforeseen circumstances, stood the lodging industry on its heels. In short, barring any future terrorist attacks on U.S. soil, the only silver lining for an industry left unbalanced by recent events is that the operating environment may slowly be on the road to improvement. For less efficiently managed or over-leveraged hotel assets, the skies are still dark and, unfortunately, still ominous.

Ernst & Young LLP anticipates that in the next 12 months the industry will begin to slowly reach normalization, with more foreseeable travel patterns and stabilizing corporate and leisure travel. The overall industry, however, is not anticipated to reach 2000 levels anytime soon. Stable RevPAR growth will reverse the upward trend experienced in the past seven years. Luxury and first-class properties, in particular, will experience substantial declines and cost overruns, creating significant challenges for the bottom line in these sectors. With these obstacles ahead, entities will need to continue to focus on operational strategies and manage cost levels for the foreseeable future. Economy and limited-service segments are anticipated to weather the storm somewhat faster, particularly those properties in drive-in markets and those that are gaining the benefit of �trade-down� among corporate travelers, such as midscale properties with food and beverage operations. A thinner development pipeline should prohibit occupancies from further declining in 2002 as demand begins to rebound during the third quarter.

Occupancy Stabilizes

An economy first weakened by the economic slowdown and then further by the shock of the events of September 11 and the ongoing United States war in Afghanistan will continue to cloud the industry�s prospects for recovery in 2002. Supply growth has slowed to 2.4 percent in 2001, while room demand has observed negative growth of 3.5 percent, significantly weakening fundamentals. U.S. occupancy declined significantly from 63.7 percent in 2000 to an estimated 60.1 percent at year-end 2001, lower than 1991 levels of 61.8 percent, the recessionary year of the Persian Gulf War.

In 2002, supply growth is anticipated to moderate as the development pipeline had already thinned last year in response to a tighter lending environment. Today, there are less hotel rooms under construction than any time during the past three years. Furthermore, markets on the verge of oversaturation prior to September 2001 are anticipated to experience more modest supply growth as more challenging market fundamentals weed out those with weaker deal structures. 

In terms of demand, reductions in air-travel, corporate belt-tightening, a fear of flying and continued lay-offs are anticipated to contribute to an elongated recovery timetable. The following factors are anticipated to be the primary drivers of recovery.

  • The general state of the U.S. economy;
  • The scope and length of U.S. military action; and
  • Air capacity in light of recent airline cutbacks. 
The second half of 2002 through early 2003 should bring improved performance to the lodging industry as supply growth slows significantly to 1.5 percent and demand exhibits growth of 1.2 percent, resulting in soft but stable occupancy expectations of 59.9 percent for 2002.

ADR (Average Daily Rate) Slightly Increases

In 2000, the national ADR reached $86. Rates declined during 2001, as a slow rebooking pace subsequent to 9/11 forced hoteliers to offer more attractive room rates for both transient leisure and commercial segments, resulting in an estimated ADR of $85 in 2001�a 1.2 percent decline from the prior year.

Significant declines in ADR will continue throughout the first and second quarters of 2002 as operators have already renegotiated group and contract rates for this period. As demand slowly recovers, we expect hoteliers to be able to maintain their rate integrity in the second half of the year, resulting in little or no rate growth overall for 2002 (approximately 0.3 percent). Luxury and first-class lodging properties will continue to feel the impact of corporate belt-tightening, while economy and limited-service properties will remain more resilient to travel cutbacks.

RevPAR (Revenue Per Available Room) Stagnates

RevPAR in the industry reached a high of $55 in 2000, a 6 percent increase over the prior year. In the aftermath of recent events, RevPAR declined considerably to $51 in 2001, an estimated decline of 6.8 percent compared with 2000. During the first and second quarters of 2002, RevPAR should decline and then recover slightly, resulting in little overall change for the year. Airport, urban, and resort markets such as Miami and Hawaii�typically more dependent on air transportation�continue to be most susceptible, while hotels situated in regional drive-in markets may be able to rebound better into 2002.

Industry Profits: Goodbye Glory Days

After nearly a decade-long streak of increasing revenues and profits, the lodging industry�s watchword is caution. Profits for 2001 are estimated to be $18.4 billion, down significantly from $22.5 billion in 2000, while 2002 profits are anticipated to be $19.9 billion.  Profit growth will increasingly become a function of efficient expense management, as well as extremely limited new development in select areas.

Final Thoughts

The lodging industry has not experienced zero RevPAR growth in more than a decade; however, the unforeseen circumstance in which the industry finds itself is one of the greatest demand challenges it has ever faced. Before the economy and world events settle to the point where the American public is willing to resume business and leisure travel in force, lodging managers will be left focusing on the expense side of the operation to squeeze additional value from their operations, continuing a decade-long focus on operational re-engineering, financial restructuring, and a highly disciplined adoption of appropriate new technologies.

Lodging Industry Segment Reports


Luxury

Overview

The Luxury segment�s performance, already exhibiting signs of over-supply in 2001, was further weakened by the events of September 11 following declines in transient leisure and executive-level corporate demand. Operating margins for the segment are anticipated to be placed under pressure in 2002 given the high fixed costs associated with luxury operations and the minimal RevPAR growth anticipated for the sector.

Service Standards � The labor-intensive nature of the segment has increased the pressure on luxury hotel operators to maintain their service standards in the face of necessary layoffs. As such, property managers are being forced to manage their staffs more efficiently by cross-training and creating multi-tasking job descriptions in an attempt to not compromise service levels. As labor costs represent a large portion of a luxury property�s variable costs, this creative approach by operators should minimize unnecessary expenses due to operational inefficiencies and help the bottom line.

Luxury

Source:Smith Travel Research,Lodging Econometrics,Ernst &Young LLP

Occupancy and Rate Decreases � Occupancy in the Luxury segment is anticipated to continue to decline in 2002, as a result of reduced transient corporate travel and the use of meeting alternatives, such as video conferencing, by the corporate market. For the first time in more than seven years, ADR decreased for the segment due to rate discounting measures associated with recent events. The resulting pressure on the bottom line has forced some owners and operators to offer room blocks through online clearinghouse services, a trend which is anticipated to continue through 2002.

Performance

Luxury hotels are anticipated to suffer the second largest occupancy decline among lodging segments in 2001, after the Resort segment. Occupancy should drop 10.1 points to 62.6 percent in 2001 as a result of the economic recession, lack of consumer confidence and oversupply in major markets. These declines are anticipated to continue in 2002, resulting in an occupancy of 62.1 percent for the year. Although room rates are anticipated to decline 4.0 percent in 2001, ADRs should observe a modest 1.5 percent increase to $248 in 2002, as demand picks up during the third and fourth quarters due to an economic recovery and improvements in business and consumer confidence. Despite the anticipated occupancy declines, the modest ADR growth is expected to result in a 0.6 percent RevPAR growth in 2002 to $154.

Outlook

As the Luxury segment is not anticipated to rebound until 2003, the near-term focus should be on maintaining market share in light of supply increases. The segment will be under pressure, however, given its limited flexibility to lower overhead through labor reductions given its high service standard requirements.

Development Pipeline � In 2001, sales for mixed-use luxury developments were temperate as investors pulled away from Luxury market investments. Residential sales, however, are anticipated to rebound in the third and fourth quarters of 2002, bringing much needed investment for these projects, as Baby Boomers seek low maintenance, convenient second residence options with the convenience of nearby retail and entertainment outlets. It is anticipated that urban markets such as San Francisco, New York and Miami, will be saturated with new Luxury supply in 2002, due to the new development in the late 1990�s spurred by a booming U.S.  economy, with little hope that fundamentals will find their balance through 2003.

Operational Challenges � Luxury hotel operators and owners are anticipated to face significant operational hurdles as they struggle to maintain service standards while still providing acceptable bottom line results. Hoteliers are anticipated to focus on yield management and cost containment issues to improve operational efficiencies, while hotel owners may look into asset management services to protect their investments. 
 

First Class

Overview

With a large portion of its demand base consisting of commercial group demand, reductions in corporate travel and meeting expenditures have resulted in a direct impact on the First Class lodging segment. Following the events of September 11, many fourth quarter 2001 meetings were either postponed until later in the year or early 2002 or were cancelled altogether. Meeting and conference absentee rates have also increased, as air travel continues to be depressed and corporate budget constraints result in lower convention attendance. In light of these events, hotel operators will be under pressure to lower rates by corporate meeting planners who are in the process of renegotiating contracts. 

Trade Downs � The First Class segment stands to lose a portion of its demand to consumers who are directed to trade down to the Upscale segment during these difficult times. As the First Class segment consists of several chains that offer strong guest loyalty programs, it is also likely that consumers will trade-down to more economical brands within the same corporation.

Slowing Pipeline � The First Class segment�s development pipeline increased at a rate of 2.7 percent in 2001, while additions to supply during 2002 are estimated to increase at the lowest growth rate since 1998, 1.8 percent, with the addition of over 8,500 rooms. A more constrained pipeline in 2002 is primarily the result of a stricter lending environment for this segment following the uncertainty related to the slowing economy and the events of September 11. 

First Class

Source:Smith Travel Research,Lodging Econometrics,Ernst &Young LLP

A decline of 9.0 percent in room demand coupled with an increase of 2.7 percent in room supply resulted in an anticipated occupancy of 64.5 percent in 2001, over eight percentage points below 2000 levels.  Rate discounting by hotel operators also contributed to a 4.1 percent decline in ADR to $143, resulting in an overall estimated RevPAR decline of 14.9 percent in 2001. A constrained pipeline, coupled with an anticipated 2.5 percent increase in demand, should lead to a modest increase in occupancy of approximately 0.5 percentage points to 65.0 percent in 2002. ADRs are also anticipated to experience modest growth of 1.5 percent to $145, positively impacting RevPAR performance to $94.

Outlook

A recovering economy and rebounding corporate travel anticipated for the latter part of 2002, should help the sector recover some lost ground in rates. Transient leisure is also expected to assist the segment�s recovery, as a rise in leisure travel should help boost occupancy and lead to rate growth.

Convention Space � New convention and meeting space additions are anticipated to further generate commercial demand, leading to a rebound in meeting and convention activity by late 2002 or early 2003. Approximately 94 convention centers will be expanded, renovated or constructed within the next ten years throughout the U.S. The McCormick Place Convention Center in Chicago, for example, will add over 800,000 square feet, making it one of the largest meeting spaces in the nation, with a total of approximately 3 million square feet.

Declining Profit Margins � The First Class segment is anticipated to experience moderate declines in average profitability per property and more frequent cost overruns in the near-term, given its high overhead expenses associated with labor costs, further challenging the bottom line. As such, First Class hotel operators must continue to focus on cost containment strategies in order to soften the impact of lower to stable demand on gross operating margins. With profitability anticipated to decrease in the short-to-mid term, lowering debt service coverage ratios, we believe that there will be a moderate number of debt restructurings, foreclosures and assets purchased by opportunistic buyers for the end of the first quarter and second quarter of 2002. Conservative hotel lending criteria, including higher debt service coverage requirements and lower loan-to-value ratios, have nonetheless yielded more rational, stable debt and equity structures for the majority of hotel properties.  In addition, E&Y anticipates significant maneuvering from distressed borrowers to obtain extensions or special arrangements with their lenders and avoid defaults in the in the First Class segment.
 

Upscale

Overview

The development pipeline for the Upscale segment has moderated in the past 24 months allowing the market to better absorb the new supply introduced in 1999. Although the segment will experience some supply growth in 2002, demand is expected to outpace supply, strengthening the sector�s fundamentals and poising it for a rebound in the second half of 2002, with RevPAR increasing moderately from 2001 performance levels.

Trade-downs � As some corporate travelers trade down from Upscale to Midscale hotels, to comply with corporate travel restrictions, hoteliers will have a greater propensity to offer rate discounts to retain corporate accounts. Although operators in general strive to maintain rate integrity, some are aggressively discounting room rates to stabilize occupancy and ancillary revenues. With less airport traffic in 2002, airport hotels in major hub cities such as Atlanta and Dallas, will continue to see a negative impact on ADRs and less volume from airline crew accounts.

Amenities � For management companies that can procure the necessary funds, either from reserve accounts or from ownership, 2002 will be a
great time to improve facilities through value-added refurbishment. Given a more challenging operating environment, operators should first attend to basic guest demands such as adopting more stringent cleaning and laundering standards, and subsequently offer valued amenities such as smart rooms equipped with cordless telephones, high speed internet access and voicemail systems to try and improve market share.

Performance

Occupancy should increase slightly by 0.1 percentage point to 64.7 percent in 2002, as room demand is anticipated to increase by 6.0 percent, outpacing a 5.8 percent growth in supply. In 2001, occupancy declined an estimated 5.6 percentage points to 64.6 percent and, although room rates decreased an estimated 0.6 percent in 2001 for the first time in four years, ADR is anticipated to increase by 1.0 percent to approximately $99 in 2002. Adverse economic conditions in 2001 resulted in an estimated RevPAR decline of 8.6 percent to $63, but as occupancy and rate are anticipated to recover as the year progresses, RevPARs are anticipated to reach approximately $64 in 2002.

Upscale

Source:Smith Travel Research,Lodging Econometrics,Ernst &Young LLP

Outlook

As fundamentals improve with additions to supply remaining in check and demand growth beginning to improve by mid-year, a rebound beginning in the second half of 2002 should position the Upscale segment on the path to recovery.

Acquisitions and Consolidations � With asset prices generally anticipated to decline during the first quarter of 2002, the industry should be ripe for consolidation, with Six Continents Hotels and their funds from their brewery divestiture leading the effort. Possible brand consolidation may also take place, with multi-brand lodging corporations assessing whether some of their niche brands are generating sufficient brand equity to justify the operational and marketing costs to operate them separately from core brands.

Extended Stay � Upscale corporate extended stay properties may suffer initially from office vacancies in major urban areas, which are anticipated to reduce corporate business demand for this growing segment. Value-added amenities such as full- or mini-kitchens, Internet-ready telephones and grocery shopping services, should continue to sustain the competitiveness of these properties, poising them to benefit from the anticipated rebound in corporate demand by the second half of 2002. As these properties operate with lower fixed costs than other hotels within the Upscale segment, thus achieving higher gross margins, they are anticipated to weather 2002 better than traditional hotels.
 

Midscale

Overview

Demand in the Midscale lodging segment is anticipated to be the most resilient during 2002, as the recent shift in business travel patterns, in response to constrained corporate travel allocations, positively impacts the sector. Midscale properties are anticipated to observe signs of recovery by the second quarter of 2002, resulting in modest RevPAR increases for the year.

Conversions � The Midscale with Food and Beverage segment experienced a loss of more than 12,000 rooms between 1998 and 2001, representing a cumulative supply decline of approximately 1.9 percent, as a result of outdated properties and brands that converted to Midscale without Food and Beverage or Economy hotels. Existing properties in the Midscale with Food and Beverage segment have been adversely affected by a lack of attention to product renovations and upgrades, rendering them less competitive with the product characteristics of new Midscale without Food and Beverage facilities.

Franchising � The Midscale segment is dominated by franchising companies that have substantial recognition yet often lack the necessary differentiation to allow for a clear distinction across products. Instead, similar property types with thin price differentials have encouraged a commodity-type environment, as consumers tend to not discern any unique benefit or characteristics of one brand over another.

Lending Environment � The lending environment for the Midscale segment remains reasonably optimistic given the right local market conditions. Although it is anticipated that limited debt capital for the right projects will be made available to the segment throughout 2002, lender conservatism will rightfully reign in certain saturated markets.

Performance

The Midscale with Food and Beverage segment was already observing year-to-date occupancy declines of 2.4 points prior to the events of September 11. Following the attacks, however, more substantial declines in demand were observed, leading to an estimated occupancy of 55.7 percent for the year. In 2002, however, room demand is anticipated to increase by 3.0 percent over 2001 levels, with a moderate 0.7 percent growth in supply, resulting in an increased occupancy of 57.0 percent. ADRs are also anticipated to experience modest inflationary growth of 2.5 percent to $75, as demand recovers during the second and third quarters of 2002. The rebounds in ADR and occupancy, led by increased demand and moderate supply growth, are anticipated to result in a relatively strong performance for the segment given current economic conditions, a 4.9 percent RevPAR growth in 2002 to $43.

Midscale with Food and Beverage

Source:Smith Travel Research,Lodging Econometrics,Ernst &Young LLP

The weakening economy contributed to a decline of 2.5 occupancy points for the Midscale without Food and Beverage segment in 2001, to 62.1 percent. In 2002, however, room demand is anticipated to increase by 7.0 percent, outpacing a 6.6 percent estimated growth in supply and resulting in a 0.2 percentage point increase in occupancy to 62.3 percent. ADRs increased 3.4 percent in 2001 to $69, as demand remained increasingly resilient in the fourth quarter of 2001, a modest positive trend expected to continue in 2002, as ADRs increase 2.5 percent to $71 and RevPARs increase by 2.9 percent to $44.

Midscale without Food and Beverage

Source:Smith Travel Research,Lodging Econometrics,Ernst &Young LLP

Outlook

The Midscale segment is anticipated to perform relatively well in 2002, with the Midscale without Food and Beverage surprisingly outperforming the RevPAR levels of the Midscale with Food and Beverage segment. Strong brand names are expected to play major roles, although a lack of product differentiation will continue to present challenges to operators. The implementation of operational efficiencies is anticipated to be particularly crucial for the Midscale segment, as occupancy levels anticipated for 2002 remain below recent historical levels of performance.

New Supply � The Midscale without Food and Beverage segment added the largest number of rooms of any industry segment since 1998, representing an estimated cumulative growth of 43.9 percent, or 168,000 rooms, through 2001. During the same period, however, demand is anticipated to experience a cumulative increase of only 34.2 percent, resulting in a downward trend in occupancy. While declines in demand pointed to a necessary moderation in the segment, as fundamentals can rapidly change given the sector�s shorter construction timeframe.development pipeline, the Midscale without Food and Beverage segment continued to add more rooms during 2001, albeit at a slower pace due to tightening public financing sources. This construction boom has been driven by public lodging companies with high growth strategies aimed at not just improving their market presence and brand recognition but also to pleasing Wall Street with short term improvements in year-over-year revenue growth. Certain overheated markets such as Orlando, will continue to face the negative effects of an oversupplied market, leading to continued price-based competition.
 
 

Economy

Overview

Despite an industry-wide decline in leisure and commercial travel, the Economy segment is anticipated to experience one of the most moderate RevPAR declines in 2002, followed by the Midscale without Food and Beverage segment. This modest decrease is attributed to the resilient characteristics of the segment�an affordable, leisure-and commercial-oriented product that relies mostly on regional drive-in demand rather than fly-in demand�as well as moderate trade down from users of Midscale products. Hotel values within this sector have also been maintained in the past years, as a result of strong supply and demand fundamentals and horizontal brand extension�the creation of new products, such as extended stay properties, within the same sector-which has prevented deep rate discounting in the segment.

New Supply � The Economy segment has observed strong supply growth since 1998, especially in markets with low barriers to entry. In the mid-term, however, the development pipeline is expected to cool down leading to reasonable stability in 2002. Despite this positive trend, operators should closely monitor new developments in the segment, as fundamentals can rapidly change given the sector�s shorter construction timeframe.

Travel Patterns � As business travelers conform to tight corporate travel budgets, the focus has shifted to value; recently opened properties with high curb appeal, marketed and flagged with well-known national brands, are anticipated to increase their local market penetration in 2002 as a result of consolidated marketing and reservations systems. As travelers seek short vacation options close to home and opt for drive-to versus fly-to destinations, Economy properties proximate to or within regional resort areas should observe improved occupancies in 2002. RevPARs are anticipated to surpass 2001 levels beginning as early as the first quarter of 2002, as limited supply growth and increased demand from a shift in travel expenditures, strengthens the segment�s fundamentals.

Performance

Occupancy decreased to an estimated 56.0 percent in 2001 from 58.1 percent in 2000. In 2002, room demand is anticipated to increase by 3.5 percent, outpacing a 1.7 percent growth in supply, leading to an increase in occupancy of 1.7 percent to 57.0 percent. ADRs increased marginally in 2001 by approximately 0.5 percent, the lowest increase since 1998, as the events of September 11 stifled prospects for higher real rate growth. In 2002, however, ADRs are anticipated to grow 3 percentage to $49, the highest ADR growth since 1998, as the segment should be the first to begin recovering from the difficult fourth quarter of 2001. RevPAR is anticipated to decline 3.2 percent in 2001 to an estimated $27, primarily attributable to a 3.7 percent decline in occupancy. Occupancy and ADR growth in 2002 are anticipated to yield a $28 RevPAR for the segment, the highest level since 1998 and an estimated 4.8 percent increase over 2001.

Economy

Source:Smith Travel Research,Lodging Econometrics,Ernst &Young LLP

Outlook

Recent additions to supply have introduced appealing, fresh products into the Economy lodging segment. As such, both leisure and corporate transient travelers have found the segment to be a satisfactory substitute for more costly lodging products. This trend has carried the Economy segment through the challenging periods of 2001 and will continue to sustain its performance through 2002 as travel rebounds.

Operating Margins � As properties within the Economy segment typically operate at higher aggregate margins than other segments that include food and beverage operations, ADR improvements are anticipated to generate moderately higher profits in 2002. Lower fixed costs associated with the Economy segment allow operators to benefit from more efficient operations. As the Economy segment continues to be populated with independent, small operators, their properties often prove to be the most resilient in hard times as they are able to streamline their operation, reducing overhead costs associated with maintaining the standards of a franchise affiliation. 
 

Resort

Overview

Declines in discretionary income and spending during 2001 have led to a decrease in demand for the Resort segment during 2001, which is anticipated to continue throughout 2002. Furthermore, additions to supply�a development market inefficiency due to the long lead time to plan, design, construct and open a new project�are anticipated to cause the Resort segment�s recovery pace to lag other lodging segments, with recovery not anticipated to take shape before early 2003.

Development Pipeline � Due to the nation�s sustained economic growth during most of the 1990s and the previously existing development opportunities in certain resort markets, the segment�s active pipeline includes more than 9,500 rooms to be introduced to the market in 2002. Certain markets are particularly oversupplied with Resort properties, driving down the segment�s rates. Phoenix, for example, is anticipating approximately 2,200 additional resort guest rooms by 2003. Even previously resilient destinations such as Las Vegas and Orlando, are experiencing supply-demand issues, as leisure travelers stay closer to home and corporate and incentive meetings are postponed, cancelled or made more modest. The more conservative attitude toward incentive meeting spending is also in response to corporate image concerns of frivolous spending in times of war and recession.

Brand Affiliation � During 2002, chain-affiliated resorts are poised to benefit from brand name recognition and nationwide reservation systems, while high profile independent resorts attempt to drive revenues without the additional franchise fees burdening the bottom line. Both chain-affiliated and independent resorts, however, will face cost containment challenges, as high overhead ancillary departments such as golf, spas and other recreational operations suffer with the decreases in occupancy.

Performance

Occupancy is anticipated to experience the largest declines of any segment, approximately 11.4 percentage points, in 2001, while ADR should observe the lowest growth rate in four years, a modest increase 1 percent. The resulting estimated decline in RevPAR is approximately 15.6 percent for 2001. An anticipated 10.5 percent increase in supply, coupled with a 6.5 percent increase in demand, should result in a 3.6 percent decline in occupancy to 55.9 percent in 2002. ADRs are anticipated to experience a modest gain of 1.0 percent to $191. As the Resort segment�s recovery period is only anticipated to begin in early 2003, RevPAR is estimated to decline 2.7 percent in 2002 to $107, the lowest estimated RevPAR in recent years.

Resort

Source:Smith Travel Research,Lodging Econometrics,Ernst &Young LLP

Outlook

It is anticipated that commercial group business will help begin to place the Resort segment back on track toward the latter part of 2002 and early 2003, as the U.S. economy begins to strengthen and corporations become more aggressive in scheduling face-to-face meeting activity. In addition, if resort properties with sufficient capital reserves to complete needed renovations take advantage of the current window of opportunity, as a result of lower occupancies, they may well gain market share and be better poised to capture the additional demand anticipated for 2003. In the near-term, resorts located proximate to higher-income urban areas, such as San Diego, Santa Barbara, Las Vegas, Cape Cod, the Hamptons and others are anticipated to recover sooner than dedicated fly-in markets such as Miami and Hawaii.

Mixed-use Resorts � Resort communities that are integrated with substantial fractional vacation ownership properties, such as the Ritz-Carlton Bachelor Gulch and the Four Seasons Aviara, are anticipated to fare better than stand-alone resorts in 2002. Not only are high-end resort consumers less price-sensitive but fractional owners who utilize resort amenities also generate significant ancillary revenue.

Resort properties with land available for development may consider creating mixed-use environments with the addition of diversified products such as residential, retail, golf or marina components. While capital is limited under current circumstances, certain projects still make sense. The Greenbrier Resort, for example, recently announced the addition of 400 to 500 residential homes, boosting the resort�s overall value and guaranteeing additional contribution to the resort�s ancillary departmental revenues.

The Ernst & Young 2002 National Lodging Forecast contains an analysis of data compiled from many sources, including Lodging Econometrics and Smith Travel Research. The content of this forecast is for reference only, not to be used as business advisement or to set standards on policies or actions. Statistics provided by Lodging Econometrics represent projects in the Development Pipeline as of September 30, 2001. Caution should be utilized when forecasting the number of projects that will actually come to fruition. Based on historical experience, the attrition rate for projects In Permitting can be up to 25% and the attrition rate for projects in Early Planning can be up to 60%.

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Also See 2002 California Lodging Forecast / Ernst & Young LLP / Feb 2002
2002 Manhattan Lodging Forecast / Top 10 Thoughts for 2002 and Beyond / Ernst & Young LLP / Feb 2002
2002 Florida Lodging Forecast / Major City Market Reports / Ernst & Young LLP / Feb 2002
Canadian Hotel Investment Report 2002 / Colliers International Hotels / Feb 2002


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