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An Inappropriate Supply / Demand Relationship
by Robert Mandelbaum
 
PKF 2nd  Quarter 1998 Table
 
 
by Robert Mandelbaum / July 1998

The Presidents of the United States’ hotel companies can no longer deny that the new wave of properties entering the market have caused an inappropriate relationship between the supply and demand for hotel rooms in the nation.  Looking towards the future, the hotel industry will have a difficult time achieving the profits they have come to enjoy.

Four Years, Forty-Million Room Nights

Since 1994, the pace of new hotel construction has averaged approximately 40 million new room nights of available hotel rooms per year.  At first, the majority of these new rooms were located in the rural, suburban, and secondary markets of the nation.  However, as the profitability of the industry has improved, the ability to economically justify development in the major urban areas has become a reality.

For the first time since 1991, PKF Consulting’s survey of major city lodging markets in the U.S. is estimating a decline in occupancy for 1998.  This trend of supply growth exceeding demand in the urban centers is projected to continued into 1999.  In fact, nearly half of the markets surveyed will experience a decline in occupancy for both 1998 and 1999.

However, the diverse geographic pattern of development activity in the 1990s continues to impact the industry in a different fashion than the building boom of the 1980s.  While the overall levels of new supply additions have surpassed the number of new rooms built in the last decade, the development patterns have been more disparate in terms of property type and location.  The uniformity of development in the eighties has not been duplicated in the nineties.

The result has been an avoidance of the sharp nation-wide decline experienced across the board in the late 1980s and early 1990s.  Despite the recent surge in new competition, eleven markets of the 41 markets in our survey will be in a growth mode by 1999.  In general, most markets are still achieving occupancy levels at or above their long-term average.

Chastened Rate Growth

Of more concern for hotel owners and operators than the decline in occupancy is the recent slowdown in the pace of growth in average daily room rates.  Up until 1998, most markets were able to mitigate their declines in occupancy with strong increases in ADR.  However, starting in the first quarter of 1998, we began to track a slowdown in rate growth, that when combined with the declines in occupancy, results in revenue improvement that can best be called “temperate”.  For 1998, 11 markets are estimated to experience a decline in REVPAR, while another 12 markets will average REVPAR increases less than inflation.  This trend is expected to slaken somewhat in 1999 driven by a slowdown in the pace of occupancy decline, not by an improvement in ADR growth.

What Tie Is He Wearing?

In the lodging industry, a direct tie exists between the ability to raise room rates and the growth in hotel profits.  In recent years, despite declining occupancies for most hotels, ADR growth in excess of inflation allowed for double-digit growth in profits.  Therefore, these signs of a slowdown in ADR growth should raise red flags for industry investors.

Consumers, however, shouldn’t expect to see a broad-based decline in room rates.  With the aid of automated yield management systems and revenue management practices, hotels will still continue to push room rates during peak weekdays and their in-seasons.  In order to find discounts, business people, tourists, and meeting planners need to be flexible with their travel plans and allow the hotels to steer them towards dead-spots on their calendars.

Don’t Be Stupid.  It’s The Economy

When looking at the future, it is safe to say that the industry is approaching a period of slower growth or potential decline in some sectors.  Two potential stimuli exist that will influence the extent of the next industry recession or downturn;  over-development and the economy.  The implications of an industry recession induced by over-development, as opposed to an economic slowdown, are quite different.

Most people in the industry have concentrated on observing and measuring new construction activity as the indicator or catalyst for the next downturn.  As we emphasize, the industry has been able to handle the current development surge more successfully than it did in the 1980s.  We know that over-development will create a more competitive market, lower occupancies, and eventually a slowdown in rate growth.  However, if the economy stays healthy, demand continues to grow, and consumer confidence remains high, there should be a continuation of the diverse performance levels among markets and product types that we have seen in the 1990s.  An industry recession caused by over-supply will be a series of moderate cyclical fluctuations that allow for some to thrive while others fail.

On the other hand, an industry recession caused by a slowdown in the national economy has much greater implications.  If there is a sudden cutback in the volume of travel, the negative impact of all the new supply will be compounded.  An economic recession will also cause a tightening of corporate, as well as personal, travel budgets.  The combination of greater room availability plus intolerance for high prices will create an environment that could lead to a decline in room rates.  And, as we stated before, a direct correlation exists between growth in ADR and profits, so a decline in ADR would most likely lead to a decline in profits.  Hotel managers get scared when they look out their windows and see another new hotel under construction.  They should also pay equal attention to the business section of their newspapers.

No Need For Repentance Here

Industry cycles are inevitable, and it looks as though the hotel industry is approaching a downturn.  However, relative to previous industry recessions, the near-term future looks relatively good if the economy holds. Although we should continue to see some fall-off in the overall numbers, individual pockets of strong performance will appear on a geographic or property segment basis.  Best of all, improved productivity plus some degree of growth in REVPAR, should result in the continuation of profit growth, although at a pace that is hardly record-setting.  Fortunately, the US lodging industry does not seem to be repeating some of the grievous sins of the past that it has historically been known to commit.•

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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