Hospitality Industry Comeback Proves No Myth in 1995: Best Year in More Than a Decade
MIAMI, FL, FEBRUARY 5, 1996--No doubt about it, 1995 was a good year for the hospitality industry, says KPMG Peat Marwick's National Real Estate and Hospitality Practice. In fact, the industry is performing better than it has in the past ten years, a trend the Practice expects to continue through 1996.
"We're no longer talking about a recovering industry," says Frank Nardozza, KPMG Peat Marwick National Hospitality Practice Leader. "We're talking about a strong industry where profits are at an all time high due to increasing occupancy and room rates and strong overall values." According to KPMG Peat Marwick, industry profits are expected to be up by as much as ten percent over 1995. Both occupancies and average room rates are expected to increase by two to three percent nationally over 1995 levels. At the same time, operating costs are expected to be further trimmed as a result of operations re-engineering efforts going on within most major hotel companies.
"This strong growth cycle should continue for the next several years," Nardozza said. "The wild card is whether or not there will be too much new supply given the recent building boom in the industry, particularly in the limited service segment."
During 1994 and 1995, a large number of rooms were added to the limited service supply. Based on the number of projects planned or under construction, another 10,000 new rooms could be added in 1996. This is causing some fears of overbuilding in the mid-priced, limited service segment.
"Development has returned to the industry," Nardozza said. "In 1996, expect for the first time in many years to see full-service hotels built. With several markets in the U.S. reporting occupancies in excess of 70 percent, and some lenders showing signs of interest in construction financing, opportunistic developers will resurface and begin building."
Extended Stay is the Hot New Segment
"The extended stay segment is likely to prove itself as the hot new segment for 1996, a niche that has not been adequately served in the past," Nardozza said. "The result is that there exists much pent up demand."
Extended stay hotels are targeted to the traveler who will be staying beyond the traditional two- to three-day visit, such as construction workers, consultants and other professionals. These types of accommodations offer the equivalent of an apartment and typically include a kitchen, living room, bedroom and bathroom.
Wayne Huizenga, owner of the Miami Dolphins, who was responsible for turning Blockbuster Video into an industry giant, has launched a new chain of budget-oriented extended stay motels, called Extended Stay of America. Doubletree Hotels is in the process of doing the same with a competing chain of extended stay motels, and others are expected to follow suit.
The Practice expects that the overall industry expansion will come from growth in the extended stay segment as well as the vacation ownership and mid-priced limited service segment.
Occupancy and Room Rates Responsible for Strong Industry Performance
"The U.S. lodging industry performed better in 1995 than in 1994, a trend that will continue in 1996, but improvements will not be as pronounced," Nardozza said. "This slowdown is to be expected now that the market has reached equilibrium with the value of accommodations and there is not as much room left to grow.
Most of the improvement came from increases in average room rates, the Practice said. Room rates are estimated to have climbed nationally to $66.50 in 1995 compared to $64 in 1994. Average occupancies nationally are estimated to have grown by only one to 1.5 percent in 1995, climbing to 65 percent from 64 percent in 1994, a significantly lower rate of growth than that reported in 1994.
Growth in room rates were consistent across most price segments and geographic regions excluding the mountain region, which had a slightly higher rate increase. Occupancy increases were fairly consistent across most price segments but showed significant differences across geographic regions. The lowest occupancies were reported in the budget segment at 63 percent, and the highest occupancies in the luxury segment at 73 percent.
According to the Practice, the industry can expect modest increases in occupancies in the range of one percent to 1.5 percent in 1996. The luxury and upscale price segments are quickly approaching their peak levels of occupancy without much room for further increases. Occupancies in the economy and budget segments are likely to remain near their present levels in the 60 to 65 percent range in 1996 due to the continued oversupply in these segments and the large number of supply additions expected for the year.
Hotel Values Up -- It's Looking Like a Seller's Market
Hotel values are continuing to climb in all segments and in most regions of the country due to improved hotel earnings combined with downward adjustments on rates of capitalization used to set purchase prices. In 1995, hotel values were up nearly ten percent over 1994, based on completed transactions. Values are predicted to climb in 1996 at about the same ten percent rate.
"Today's lower capitalization rates signify' a stronger seller's market for 1996," Nardozza said. "On the buyer side, finding good hotel investment opportunities will be even tougher in 1996, with many of the bargain-basement deals already completed. In fact, expect the successful bottom fishers from the early 1990s, mainly strategic hotel investment funds, to begin cashing out at huge gains in 1996."
Today's acquisition prices are yielding lower annual returns and are now typically in the range of nine to ten percent compared to 12 to 13 percent just two years ago. The luxury hotel segment is one of the few segments holding promise for buyers in 1996. They can still be purchased at substantial discounts from original costs of construction, albeit not as deep as in the past. Luxury properties have greater upside potential since there is still room for room rates to climb. Foreign banks, particularly Japanese, working out problem loans are expected to be the primary source of acquisition opportunities in the luxury segment in 1996.
Traditional Financing Scarce Despite Strong Industry
Despite the strength of the industry, property financing will remain somewhat scarce in the lodging industry in 1996. Some commercial banks and insurance companies are back in the market, but overall, traditional lenders are generally shying away from the lodging industry.
"The traditional lenders are still soothing their wounds from the late 1980s," Nardozza said. "Their hesitancy to jump back into the industry also stems from concerns about how long the upward trend will last."
Wall Street continues to fill the void, the Practice reports. On the debt side, loans from mortgage conduits and direct mortgage securitizations are expected to continue to be a major source of financing for the lodging industry in 1996. Equity funding with REITs and other types of investment funds will remain a primary source of hotel acquisition funding.
A line is forming for hotel companies planning to go public in 1996, Nardozza said. There were a couple of sizable hotel companies that completed initial public stock offerings in 1995, including Renaissance Hotels and Red Lion Inns, and many are in the pipeline, including the Red Roof Inns offering in the last week of January. Several other hotel companies already public are planning secondary and tertiary offerings.
Hotel Real Estate Investment Trusts (REITs) Are Hot
"The hotel REIT market was re-energized in 1995 by the success of two of the largest ever hotel REIT offerings: Starwood Lodging Trust and Patriot American Hospitality, Inc. In July 1995, Starwood Lodging Trust completed a public offering of 10.3 million REIT shares, which were paired with an offering of shares by its hotel operating affiliate, raising approximately $250 million. In October 1995, Patriot American Hospitality, Inc. completed an initial public offering of 14.6 million shares of common stock and raised in excess of $350 million. The success of these offerings demonstrated to the marketplace that there is an appetite for hotel REIT shares," Nardozza said.
Hotel REITs in general were among the best performers of all REITs during the first three quarters of 1995 with share prices climbing by more than 50 percent during the year. With interest rates expected to head downward in early 1996 and based upon the success of the two large 1995 deals, the Practice expects other major REIT offerings to be completed in 1996.
"In spite of the good news, it's possible that the window of opportunity for hotel companies to raise public funds from share offerings may only last another 12 to 16 months," warns Nardozza. "While industry analysts predict values to increase at a rate often percent this year, investors are becoming less optimistic that hotel values and earnings will continue to rise at their present pace beyond 1996."
According to Nardozza, chances are good that the current merger activity going on between apartment and retail REITs will spill over to hotel REITs. Hotel REITs formed in 1993 and 1994, such as RFS Hotel Investors, Equity Inns, FelCor Suite Hotels, InnKeepers USA Trust, and others are potential targets for consolidation.
"The number of hotel REITs remains small in comparison to other real estate segments. But REITs can take advantage of their current overall strength by merging, particularly those that haven't performed as well," Nardozza said.
Active Corporate Mergers and Acquisition Environment
A number of hotel company mergers and acquisitions took place in 1995, including the purchase of Westin Hotels & Resorts by a joint venture between Starwood Capital Group and Goldman Sachs & Co. and the purchase of a substantial interest in Ritz Carlton Hotels by Marriott International.
The corporate merger and acquisition mania that started in 1995 will continue into 1996, according to the Practice. The sales of the Omni, Travel Lodge and Sterling Suites hotel chains are expected to close some time in the first quarter of 1996. There also has been discussion of a takeover of the Trusthouse Forte Group based in the U.K., which owns several hotels in the U.S. In addition, there is speculation that Sheraton's new Four Points Inns brand will be spunoff later this year.
"Divestitures and spin-offs of hotel operations and assets will likely be more common place in 1996," Nardozza predicts. "The stock market had a tough time pricing shares of companies with multiple lines of businesses, such as gaming, lodging and hotel operating companies, all of which have very different risk factors. The perception is that the overall value of the separate and distinct pieces is greater than the market value of the whole pie," Nardozza added.
Marriott began the trend several years ago when it split its property company, Host Marriott, away from its hotel management arm, Marriott International. ITT Corporation recently completed a spin-off of Sheraton Hotels into a separate company. Promus Company spun out its gaming operations as a separate entity from its hotel operations, and Hilton is currently considering doing the same. Candidates for divestiture of real estate assets or spin-offs of hotel operations include Holiday Inn Worldwide, Wyndham Hotels, Hyatt Hotels, and Walt Disney World Resorts.
Timeshare - 1996 a Year of Consolidation and Change
According to Jon Simon, a partner and director of the KPMG's vacation ownership/timeshare consulting group, 1995 was a record year for the timeshare industry with almost all of the major hospitality players increasing their presence or plans. The year saw a number of new entries to the landscape.
Aside from Marriott, Hilton and Hyatts presence, Raddison hotels entered into an exclusive agreement with Buena Vista Hospitality Company in Orlando. Choice Hotels is actively looking to promote a new international brand, and Renaissance Hotels is scouting for the appropriate opportunity.
Four Seasons recently secured funding for the hotel component of its Aviara project and is supposed to be very close to obtaining the financing for the 200 plus unit timeshare development. This will mark the first true luxury entry into the market. Marriott is the first of the majors to go international with its project in Marbella, Spain. Look for more projects by Marriott in Europe and Asia in 1996, predicts Simon.
While timeshare sales approached the $5 billion dollar mark in 1995, change is in the wind with new players entering. "The industry, despite all the recent publicity and new players, remains unconsolidated and dominated by under capitalized developers," said Simon.
1996 will see the entry of some of the premiere Wall Street firms which will bring an abundance of capital and some savvy deal making to this emerging industry. As with any industry in a high growth curve, mistakes are made and the stronger players move on. According to Simon, "Wall Street loves unconsolidated industries. Further, the profit tied up in the financing component of the timeshare industry has attracted the capital-oriented perspectives of some of the major investment houses.
"To many traditional players in the industry, the financing was just a way to move the dirt," Simon said. "However, with its low default rates and coupons on the receivables running at 500 to 700 basis points over prime, there's a lot of money to be made in the paper. Look for some industry loaders and key players to be acquired or merge in 1996," he said.
Concerns for 1996
New construction may jeopardize the current hospitality run. Although the market appears to be able to absorb most of the new supply in the limited service segment, a genuine risk exists for overbuilding of this segment in the future, warns Nardozza. This should result in some investment caution and more restrained expectations of continued improvement in the lodging industry beyond 1996.
Another threat to the continued strength of the industry is the uncertain future of interest rates. Although, favorable interest rates are expected to continue throughout most of 1996, at least up until the presidential election, if interest rates were to jump in late 1996 or early 1997, the flow of capital into the industry might slow down and stifle industry expansion.
"Complicating matters are the present fears of a slowdown in the U.S. economy, which could derail the strong lodging earnings growth expectations for 1996," Nardozza said. "Some Wall Street investors are sensing a less favorable environment for the lodging industry since there isn't as much upside potential left for earnings growth in the future in many segments.
If this view becomes widespread, it could slow the flow of funds into certain types of lodging investments, such as REITs, IPOs and REMICs. Money from these sources is greatly needed by the lodging industry to fund hotel acquisitions and desperately needed property renovations as well as to refinance a significant amount of maturing bank debt."
Another major concern is the growth in litigation, which is impacting many major hotel operators. In 1995, several largely publicized lawsuits by owners of hotels were filed against well-known hotel operators blaming the operators for the financial woes of the properties. Depending on their outcome, these suits have the potential to trigger an avalanche of similar lawsuits against hotel operators throughout the lodging industry.
All in All, the Outlook Is Positive
"All in all, the outlook is positive. Earnings are likely to be up and investors should still be willing to make investments in the lodging industry in 1996. We expect that lodging investments will continue to be made at a robust pace, particularly by REITs," said Nardozza. "Overall there is a prevailing sense of optimism that 1996 is going to be a good year for the lodging industry."
About KPMG Peat Marwick LLP
As a leading real estate industry advisor, nationally as well as internationally, KPMG Peat Marwick LLP's Real Estate, Hospitality and Construction Practice provides a full range of integrated consulting, taxation, auditing and investment services to clients in commercial and residential real estate, hospitality, construction, REIT and REMIC industries, as well as real estate portfolio investors. Some of the services the Practice's professionals provide its clients throughout the globe include international investment strategy, portfolio management, performance improvement, financing sources, acquisitions and dispositions, economic impact and feasibility studies and financial modeling.
KPMG Peat Marwick LLP, the U.S. member firm of KPMG, is The Global Leader among professional services firms. KPMG has more than 6,000 partners and 72,000 professionals serving clients through 1,100 offices in 136 countries. In the U.S., KPMG partners and professionals deliver a wide range of value-added assurance, tax, international and performance improvement services to clients doing business in the following markets: financial services; manufacturing, retailing and distribution; health care & life sciences; information, communications and entertainment; and public services.
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