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Hotels Are Profitable and Property Prices Are Firm - 
What Is All the Whinning About?
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by: John B. (Jack) Corgel, Ph. D., October 2003

An unusual economic climate together with the unique and unfortunate series of non-economic events over the past two years is affecting hotel financial performance in ways never seen before. Much has been written about the hardships inflicted on the hotel industry during this period of economic and political turmoil. 

Truthfully, times have been worse, and as recently as the late 1980s and early 1990s when the industry lost money and property values fell far below replacement costs. The hotel industry today operates in the black with billions of dollars to spare. Our Trends in the Hotel Industry – USA data for 2002 indicate that over 80 percent of hotels are profitable at the unit level. Recent transaction information suggests that buyers are willing to pay handsomely for good hotel properties. In the corporate world, only a couple of mid-sized companies sought the protection of bankruptcy laws since 2001 and one of those companies (i.e., Lodgian) has reorganized and reemerged. Lenders are experiencing more delinquencies in recent months, although most of the problem loans involve older hotels, hotels located in secondary and tertiary markets, independents, or hotels with weak brands. The bad news is that hotel revenues are way down from their peak in 2000. The good news – almost everything else also is down that helps hotels, particularly labor costs and interest rates while real estate market conditions remain quite favorable!

The Trends data yield the following factual evidence:

  • From 2000 to 2001 revenues declined by 9.9 percent, expenses fell 5.3 percent, and profits were down 19.4 percent. But, profits continued to be positive at $10,866 per available room and margins slid to a still healthy 29.2 percent.
  • From 2001 to 2002 revenues declined by 4.0 percent, expenses fell 1.7 percent, and profits were down 9.6 percent. But, profits continued to be positive at $9,823 per available room and margins remained above early -1990s levels at 27.5 percent.
‘Bubbleitis’

Granted, it is hard to find comfort in declining profits unless the realization becomes clear that hotel performance during the years leading up to 2001 were extraordinary. As with other luxury goods, hotel room consumption accelerates in boom periods. Closely followed markets, such as San Francisco and New York achieved occupancy percents and ADRs that well exceeded historic highs and long-run equilibrium levels during the late 1990s. The industry was injected with a growth hormone that produced ‘bubbleitis.’ Recovery from this condition requires sacrifice in the form of lower profits, which more importantly, translate to lower returns on investment. Nevertheless, in a world in which investment returns on competing investments are declining at a more rapid pace than hotel returns, the sacrifices of recovery become more tolerable. It is like the story of the campers being chased by the bear. As the campers begin running and one camper pulls away from the others he exclaims, “I don’t need to outrun this bear, I just need to outrun you guys!”

Revenue Preoccupation 

The intense focus on hotel demand weakness and revenue decline during the past two years may have created an overly pessimistic view on the health of the industry.  Because the prominent franchise and management companies in the hotel world derive nearly all of their revenues from property room revenues, the patterns of room revenues are very closely watched. Each week, Wall Street lodging analysts and media prepare their responses to the latest RevPAR report from Smith Travel Research. Implicitly, the consumers of these reports are led to believe that a three percent RevPAR decline in the nation, for example, means that the industry suffered a three percent economic loss. If however, interest rates, labor costs, and energy prices coincidently declined it is possible that both hotel income and wealth increased as revenues fell.  

All the Moving Parts are in Sync for Full Recovery

The future of the hotel sector appears bright because all three of the critical moving parts of the return engine are now moving in the right direction. First, our econometric model, produced with Torto Wheaton Research, predicts a steady improvement in hotel revenues over the next ten quarters. The improvement begins with occupancy increasing, then ADR growth once occupancy percents approach long-run equilibrium, followed by property development once ADRs reach the feasibility point. Income growth and the slow pace of hotel construction activity will support revenue recovery. Second, a weak labor market, softening energy and insurance costs, and steady interest rates mean that expenses could remain in check and perhaps decline during the next year or two. Finally, an already favorable hotel real estate market should become stronger as risk premiums decline to normal levels and as transaction volume picks up because of the narrowing of bid ask spreads.  

We see no evidence that the demand for hotel rooms in the U.S. has been permanently disabled due to the events of the past two years. Some realignment will likely occur in the industry, but these changes should not prevent a full and complete recovery.  

John B. Corgel, Ph. D. is Managing Director of Applied Research for the Hospitality Research Group of PKF Consulting.

Contact:
Jack Corgel, Ph.D. 
Managing Director 
Hospitality Research Group 
3340 Peachtree Road, Suite 580 
Atlanta, GA  30326 
(404) 842-1150 x227
Also See: Will Full-service Hotel Capitalization Rates Go Up or Down? / Jack Corgel / Aug 2003
Will Hotel NOIs and Property Prices Follow Revenues in Their Downward Spiral? / John (Jack) B. Corgel, Ph.D / Hospitality Research Group of PKF Consulting / June 2002
Hotel Loan Problems On the Rise Again; Prolonged Hotel Market Weakness Taking a Toll / PKF / June 2003


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