| PKF 4th Quarter 1997 Table |
As we leave 1997, we can look back on another year of strong performance for the U.S. lodging industry. Once again, average daily room rates grew well above inflation, thus allowing for another year of record growth in profitability. However, the negative effects of the current wave of development did surface. While the overall occupancy for our survey of major U.S. cities did improve a slight 0.3 percent, 22 of the 42 markets in our survey did experience a decline in occupancy. U.S. hoteliers now look towards the horizon as they worry how much longer they will be able to keep these good times afloat.
Rate Growth Creates High Tide For Some
For those markets that did experience a decline in occupancy in 1997, the ability to mitigate the negative effects by increasing their room rates was mixed. The 22 markets experiencing a decline in occupancy achieved an average increase in ADR of 6.0 percent, compared to a 7.3 percent growth in ADR for those markets that experienced an increase in occupancy. More importantly, the average REVPAR for the 22 cities with declining occupancies was only 3.1 percent, compared to a strong 9.4 percent for the cities showing growth in both occupancy and ADR. Only 6 of the 22 markets experiencing a decline in occupancy achieved an increase in ADR sufficient enough to grow their REVPAR greater than 5.0 percent.
Excluding the Atlanta market, which experienced a decline in ADR due to the premium rates charged in 1996 for the Olympics, those markets showing actual declines in REVPAR achieved some of the lowest ADRs in our survey. The obvious inference is that those markets historically dominated by economy and mid-market properties were most susceptible to the new surge in economy and mid-market hotel development.
On the other end of the rate spectrum, upper-tier hotels in markets with declining occupancies tended to perform well. With few exceptions, the upper-tier hotels in markets with declining occupancies did achieve the highest growth in ADR in their respective markets, and even performed relatively well when compared to national averages. While the competitive influence of the new lower-rated hotels did have a negative effect on the occupancies of some upper-tier properties, the aggressive stance taken in pricing enabled these hoteliers to sustain strong growth in revenues.
Strong Ocean Influence
Coincidental or not, seven out of the top ten markets in REVPAR growth were located in states that border either the Pacific or Atlantic oceans. As has been well documented, the gateway cities of New York, San Francisco, and Chicago are among the leaders in occupancy and ADR growth. However, it is interesting to note that some lesser-heralded lodging markets like Houston, Orange County, and Sacramento also achieved some of the greatest percentage gains in REVPAR during 1997.
For the major urban areas, the strong growth is still a function of relatively limited increases in new supply and healthy local economies. However, for markets like Houston and Orlando, the news of growth in occupancy and ADR is welcome in the face of all the new hotels that have been built in these markets during the past few years.
Icebergs Spotted Ahead
Looking towards 1998, a big concern among people active in the U.S. lodging industry is the new hotel development activity occurring in most markets in the U.S. While it is easy to view all the construction cranes as potentially the tip of the iceberg of overdevelopment, it is important to look at who, what, where, and why these new hotels are being built. When this analysis is done, one can properly chart a course that will allow them to operate, and dare we say develop, successfully in 1998.
Pricing Preservers Perpetuate Profits
For 80-plus years, PKF Consulting has looked at those factors that have influenced the change in hotel room rates. Tracking hotel pricing versus a variety of economic, demographic, and lodging indicators, it becomes obvious that average daily rate fluctuations most closely follow the ups and downs of hotel occupancy, as opposed to such measures as consumer confidence, GDP, CPI, or even growth in supply. This coincidence of ADR tracking most closely with occupancy is indicative of the schooling most hotel managers have received in the past; “cut rates in order to retain occupancy”. A closer examination of the recession of the early 1990s finds that the hotel industry probably discounted too severely and could have avoided some of the financial trauma that occurred.
If at all possible, hotel management should think twice about cutting their rates in an effort to maintain or increase occupancies. Most indications are that 1998 will be another year of moderate economic growth and restrained inflation. In addition, the combination of a congressional election year and a lame-duck president should result in little dramatic legislation at the federal government level. All this should lead to sustained consumer confidence and continued moderate growth in business and leisure travel.
In the past few years, we have seen several instances where individual hotels and entire market sectors have preserved their room rates, and although they suffered a bit in occupancy, they increased their profits by double digits. Yes, the growing pie of demand will be cut into more and smaller pieces. However, the new emphasis on REVPAR driven by a well-thought-out pricing strategy should allow for most hotels to withstand the impact of new competitors, if not on a market basis, then on a profit basis. The wise manager will look at the influence of rate strategy on the bottom line, not just on the top line.
More Sharks In The Water
New competition, especially that which is successful, should not be discouraged. It is unfortunate that existing hotel operators often take a few shots to the bow when a new competitor comes on line. However, as long as new hotel development is driven by market need and financial feasibility, you should not deny someone else the opportunity to enter the business.
The challenge for the existing operator in an increasingly competitive environment is to take advantage of your current knowledge of the market. Re-enforce relationships with existing clients and make any necessary renovations to your property. Get active in your local convention and visitors bureau or economic development agency to bring more visitors to your market area. The only thing you can’t change is the location of your property. It should be easier for you to retain existing clients than for your new competitor to steal them.
In an attempt to swim with all the new sharks, it is evident that some hotels are having an easier time than others achieving their desired levels of market penetration. What we are seeing is the new properties achieving higher occupancies than the existing competition by offering not only a higher level of facility, but frequently at a lower price. The ability of a hotel (new or old) to penetrate the market is closely allied to the perceived price/value it represents in the market. A high level of perception can be achieved by either raising the value through offering a higher quality of services and/or facilities, or lowering the price. If a property is new or old, you can control your quality and your prices.
Controlled Steam Ahead For Development
Today’s relatively restrained lending community is forcing the majority of new hotels considered for development to prove there is both a market need for them and that the economics of the deal make sense. Currently, the greatest source of capital flowing into the industry comes from Wall Street. We believe that the make-up, motivation, and legal obligations of these public entities actual bodes well for the future of sound hotel development and operations.
Unlike institutional owners or wealthy individuals who simply viewed their lodging investments as just “an investment” or “vanity play”, the entities purchasing the majority of today’s hotels are “in the hotel business”. Today’s owners possess significant industry experience, as well as the willingness to practice proper operating fundamentals.
The implications of involved and knowledgeable ownership are many.
Just as there were those who thought the world was flat and Columbus would inevitably sail off the end of the earth, so too are there pessimists who believe the hotel industry must fall over the edge and into a recession in the years to come. Like the changes to our economy (technology, global commerce, etc.) that have allowed for the current period of sustained economic growth, we believe there are distinguishing differences in the current fundamentals of hotel operations, development, and finance that will allow for this period of prosperity to be sustained.
Certainly, no industry, like no ship, is unsinkable. We believe
that, with a disciplined lending community, development activity that is
targeted at markets in need, further enhancement of hotel facilities and
operations, and pricing that is product-justified and demand-warranted,
the industry can effectively manage those factors it can control.
Now, only such uncontrollable factors as weather, war, a macro-economic
collapse, or a large iceberg will prevent the U.S. hotel industry from
a successful cruise through 1998.
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