By: Francis J. Nardozza, Partner, KPMG Peat Marwick LLP
National Hospitality Industry Director
Summer, 1997 - The lodging industry has been on a tremendous ride upward over the past five years. Occupancies and room rates have steadily increased, fresh investment capital has poured into the industry, and industry-wide profits have never been higher. Despite all the euphoria, there appears to be some early sign of anxiety surfacing regarding what the future holds for the industry. The lodging industry has reached a critical crossroad.
Industry Fundamentals Still Bode Well For Continued Profitability and Growth
Industry-wide profits remain very strong to date in 1997. For the full cal-endar year. profits are likely to equal or exceed the $lO.5 billion record level set in 1996. Revenue per available room (RevPAR) nationally is expected to increase by 6 to 8 percent overall in 1997. As in the past, a high percentage of RevPAR increases are likely to flow to bottom line profitability. RevPAR increases are expected to be attributable mainly to room rate growth. In most segments and geographic regions, occupancies are expected to either remain flat with 1996 levels or decline slightly. the exception being upscale and luxury properties where occupancies are expected to increase in the range of I to 2 percent. Room demand is expected to remain strong. but supply additions are constraining occupancy growth. offset-ting demand increases.
Debt and equity capital remain plentiful for hotel acquisitions, renovations, and refinancings. Money is still avail-able for construction of new hotels in the mid-priced, budget, and economy segments. Funding is becoming more available, albeit slowly, for new construction of full service upscale and luxury hotels, particularly in major gateway cities and prime resort destinations. The U.S. economy is growing at a steady, but moderate rate, and for the most part the global economy is also expanding. Travel and tourism growth trends still point upward. All these factors point to a generally healthy lodging industry.
What Could Derail the Present Lodging Industry Growth Cycle?
The three issues that I believe have the greatest potential for derailing the present lodging growth cycle are:
Hotel overbuilding within the next five years is a genuine industry threat. According to Smith Travel Research, there were approximately 77,000 net available hotel rooms added to the U.S. lodging supply in 1996. On a gross basis, this equates to an estimated 85,000 to 90,000 new hotel rooms built in the U.S. in 1996. This level of new construction is comparable to the peak levels experienced in the 1980s. Based on current data regarding U.S. lodging construction starts. gross room addi-tions for 1997 are likely to exceed 100.000.
For the most part, new room additions have been heavily concentrated in the economy and mid-priced segments, with the exception of large casino hotels. However a new building boom is about to begin in the upscale and luxury categories. At the time of writing of this article, plans for seven new upscale hotels had already been announced for New York City alone.
Economic Downturn?
Since the turn of the century, the U.S. economy has experienced an economic slowdown, on average every 7 to 10 years. The last recession occurred in 1992. Therefore many economists pre-dict the next economic downturn to occur sometime between 1999 and 2001. Lodging industry slowdowns in the U.S. have historically trailed overall economic slowdowns by 12 to 18 months. This could be a serious threat to the lodging industry over the next five years.
Wall Street Retreat?
The old adage, perception is realty, may hold significance to Wall Street and its relationship with the lodging industry. A wave of hotel public stock offerings coupled with a large volume of activity in securitized hotel mort-gages has made Wall Street the present king of funding for the lodging industry. Institutional investors have been buying up hotel shares and securitized hotel mortgages at a rapid rate. In recent months, though, questions have been surfacing regarding the ability of the lodging industry to sustain double digit earnings growth in the future. Many institutions are heavily invested in hotel stocks and REIT shares and Wall Street is testing their appetite for more. If a broad-based perception takes hold that the lodging industry may not be able to sustain the same levels of growth as achieved in the recent past, this could trigger a Wall Street retreat from the lodging industry. Hopefully, the strong performance of lodging stocks in 1996, and the solid profitability predicted for the industry for 1997 will sustain Wall Street's current high level of interest in the lodging industry
Consolidation in the Lodging Industry Is Continuing
Industry consolidation will be a topic of primary interest for the lodging industry in upcoming months. "Bigger is better" has been and likely will be the driving fundamental triggering hotel company mergers and acquisitions. Motivations for consolidation are wide-spread. Some of the more common ones include geographic and product diversification, better operating economies of scale, better access to capital at a lower cost, and market dominance. Still a trend exists toward separating hotel franchise and management operations from hotel ownership. Many companies are now finding it more difficult to grow internally through normal business development functions because fewer hotel properties are available for acqui-sition at affordable prices and adding management contracts on a piece meal basis is very time consuming and costly. Many are turning to corporate acquisitions for growth as a quicker and more cost effective means.
Strategic Planning Is Back in Vogue
With the lodging industry at a crossroad in terms of its present lodging cycle, hotel companies are placing renewed emphasis on strategic planning to meet shareholder expectations for profitable growth. Much of the business process reengineering is complete now, and profitable revenue growth is the primary business objective. What's new in the strategic planning process is the focus of hotel companies on increasing share prices as the ultimate objective of strategic planning, since so many hotel companies have recently gone public.
KPMG has developed a comprehen-sive business tool referred to as Eco-nomic Value Management (EVM) to help lodging companies more effec-tively and objectively address strategic planning issues. The EVM program is built around three modules designed to help clients measure and maximize enterprise value. These include Economic Value Assessment. Value Strategy Development, and Organizational Effectiveness Analysis. Economic Value Assessment measures economic profit across business units, regions, product lines. and customer segments and deter-mines an appropriate activity-based allocation of operating and capital costs. Value Strategy Development is designed to implement options that help maxi-mize the company's economic value by identifying key business drivers of value and the development of strategies that leverage them. Organizational Effective-ness Analysis is to help ensure that all elements of the company's organization serve as an effective platform for eco-nomic value creation.
Summary
The lodging industry is still healthy and is expected to remain so in the near term. However, industry revenue growth is slowing. particularly due to flattening or slightly decreasing occu-pancies. Industry overbuilding is a gen-uine threat over the next five years. Wall Street has for the most part been primarily responsible for funding the strong lodging industry recovery but could retreat from interest in the industry if profits and growth significantly deteriorate. This probably will not occur in the near term due to the current strong profitability of the industry. Consolidation is happening in a big way and will likely continue well into the future. The industry is at an impor-tant crossroad in terms of its present growth cycle and companies are turn-ing to strategic planning to help meet shareholder expectations for sustainable and profitable growth in the future.
The Real Estate Report is published by KPMG's National Real Estate, Hospitality, and Construction Practice. © 1996 by KPMG Peat Marwick LLP All rights reserved. For additional information email KPMG.
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