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Hotels Make Money in Bed, Not on The Street
by Robert Mandelbaum
 
PKF 3rd  Quarter 1998 Table
 
 
by Robert Mandelbaum / October 1998 

If you were to evaluate the performance of the U.S. lodging industry by the headlines of the Wall Street Journal, you could be missing the point and the profits.  Once again, a gap appears to exist between the fundamental performance of the hotel industry and investor perception of the publicly traded hotel companies.  While the value of hotel stocks has tumbled, hotel owners still continue to make money in a manner that speaks to all-time efficiency. 

Much of the trouble for the public companies originates from the disconnect between the factors that make hotels profitable and the factors that drive corporate profits.  For hotels, it all comes down to the balance between the demand for and supply of lodging.  For the public companies, interest rates and investors’ perceptions drive share value. 

By the end of the summer of 1998, unit-level operators and Wall Street investors were bombarded with news of the collapse of global economies and the high potential for a US recession.  Fortunately, the US economy has held up sufficiently to maintain a fairly favorable supply/demand position for hotel managers.  However, global macro-economic fears have had a chilling effect on the strategies of the publicly traded lodging companies, driving investors away and lowering share value. 

Be it the relative balance between various interest rates or artificial tax incentives, when hotel companies get away from the basics of the lodging industry in order to make money, they eventually get into trouble.  History has proven that making money in the hotel industry over the long haul comes down to the fundamentals of providing clean and safe accommodations at a price that is perceived to be commensurate with the product. 

Occupancy Nightmares 

The third quarter of 1998 continued the trend of growth in revenues and profits, yet at a slower pace than in the past.  After nine months of operation, hotels in the major cities of the US posted a 1.9 percent decline in occupancy.  The primary reason for this decline remains the impact of all the new supply additions.  The number of new hotel rooms in major cities grew an estimated 2.3 percent since the third quarter of 1997, while the demand for hotel rooms in these markets grew a mere 0.2 percent.  While a 0.2 percent growth in demand is considered a very slow pace, it should be noted that the overall occupancy rate still remains above 70 percent.  In fact, 26 of the 41 of the markets in our survey are achieving an occupancy level above 70 percent through the end of the third quarter of 1998.  In order to achieve such a high occupancy, most markets are reaching their respective capacity levels 3 to 4 nights a week, thus not allowing for much room for growth in accommodated room nights. 

Room Rate Fantasies 

Despite declines in consumer confidence, the increase in business and leisure travel through the first nine months of 1998 allowed hotel operators to continue to raise their room rates.  A very healthy 6.9 percent increase in average daily room rates helped to offset the 1.9 percent decline in occupancy, thus resulting in a 4.8 percent increase in REVPAR.  Both the increase in ADR and REVPAR are more than three times the estimated annual inflation rate of 1.6 percent. 

Given the recent declines in consumer confidence and news of the tightening of corporate travel budgets, it remains to be seen how long hotels will be able to continue to raise their room rates with such vigor.  While resistance from the demand side still counts considerably in the equation, the fact remains that hotel operators will keep most of the advantage as long as travelers all want rooms at the same time.  Automated yield-management systems, combined with recent aggressive practices by management, will result in rate premiums being achieved during the peak nights of demand.  Until such time as guests alter their travel patterns to avoid peak periods, the overall achieved ADR for hotels will continue to rise. 

Profits Just Napping 

Given the direct positive correlation between rate increases and profitability, it is believed that 1998 will be another year of growth in unit-level profits.  However, as mentioned before, the growth in profits does not appear to be buoying investor or lender confidence.  While it is true that the pace of profit growth is slowing down, profits are expected to continue to grow for at least the next few years.  The shrewd investor will not use the record growth rates achieved from 1994 to 1997 as the long-term basis for expectations of returns. 

There are many ways to make money in the hotel industry.  Currently, a long stroll along Main Street is preferable to a short sprint on Wall Street. 

Robert Mandelbaum is the Director of Research for PKF Consulting.  He resides in the firm’s Atlanta office.

* * *
 
For additional information contact 
Robert Mandelbaum at the firm:
email rmandel@pkfc.com
PKF Consulting
3391 Peachtree Road
Suite 420
Atlanta, GA  30326
phone  (404) 842-1150
fax  (404) 842-1165
 


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