The downturn represents the first decline in hotel profitability since 1991, and the largest single-year drop recorded since 1938.  Given the firm's projections for a continued decline in hotel revenues in 2002, they estimate that the average U.S. hotel will be less profitable this year, as well.

The 2001 results come from the firm's recently completed annual Trends in the Hotel Industry survey, an annual review of U.S. hotel operations conducted since 1935.  This year's sample draws upon year-end 2001 financial statements from 3,737 hotels across the country.  Profits are defined as income after management fees, property taxes, and insurance, but before capital reserves, debt service, rent, income taxes, depreciation, and amortization.

"Going into 2001, we were projecting a modest 5.6 percent decline in hotel profits.  Clearly, the events of September 11 exaggerated the drop and contributed to the worst single year deterioration in hotel performance ever," says R. Mark Woodworth, Executive Managing Director of Atlanta-based HRG.  "In 2002, we continue to see hotels struggle to maintain their top line revenues, which will ultimately result in yet another year of falling profits."  Based on an estimate of flat occupancy, together with a 4.6 percent drop in average daily rates in 2002, HRG is projecting that the average U.S. hotel will suffer an 11.0 percent decline in operating profits for the year.  "While market conditions are expected to improve somewhat during the third and fourth quarters, the lodging industry has started out the year in a pretty deep hole," says Woodworth.

Performance Varies by Property Type

While all hotels suffered in 2001, the magnitude of decline in performance did vary by property type.  In general, those hotels with fewer rooms and lower room rates suffered less of a drop in revenues and profits than the larger, higher-rated properties.  Of all the different hotel categories, limited-service hotels experienced the smallest declines in revenues (5.4 percent) and profits (9.4 percent).  Convention hotels, on the other hand, endured the greatest fall-off in revenues (12.9 percent) and profits (24.3 percent).

"While profits have fallen for all property types, the average profit margin for the properties in our sample was 29.4 percent," says Woodworth.  "This is four percentage points greater than the 25.3 percent average margin achieved by US hotels from 1960 through 2000.  Hotel owners and operators certainly don't like to lose ground, but they are not losing money."
 

Expenses Cut In Response

In response to falling revenues, US hotel managers did implement policies and procedures that reduced the average operating costs of the typical hotel by 5.2 percent.  Unfortunately, this is less than the 9.9 percent reduction in revenues.  Therefore, the average operating profit margin was lowered from 32.8 percent in 2000 to 29.4 percent in 2001.

"With payroll and related costs comprising 44.1 percent of all operating expenses at the typical US hotel, labor is one of the first costs that gets the attention of hotel management," says Woodworth.  In 2001, hotel managers were able to reduce their labor-related costs by 6.6 percent.  These savings were accomplished through a combination of salary cuts, reduced hours, and the elimination of jobs.  "Talking to operators, careful consideration was given to reducing or eliminating those positions that had the least direct effect on customer service."

Two expenses that appear to have been beyond the control of hotel management were utility costs and insurance premiums.  In 2001, utility costs increased 7.0 percent, while insurance payments grew a staggering 18.9 percent.  "Given all the pronouncements from the energy companies in late 2000, we knew utility costs were going to be a big issue for hotel managers in 2001.  The spike in insurance premiums was amplified after September 11 and unfortunately continues to be a concern in 2002," adds Woodworth.

Interest Coverage

With profits off 19.4 percent, the ability of some hotels to cover their interest payments was challenged.  A special analysis of 562 hotels in the PKF survey sample finds that 25.6 percent were unable to generate sufficient cash from their operations (after capital reserve) to cover their 2001 interest payment obligations.  This represents a 38.5 percent increase from the number of properties unable to pay their interest in 2000.  "While this is certainly a significant increase, it could have been more pronounced had the interest payments not been reduced by an average of 8.4 percent," says Woodworth.  "The reduction in interest paid can be attributed to workouts, re-financing, and some degree of lender forgiveness."  A total of 78.1 percent of the properties in the survey sample reported a decline in their interest payment from 2000 to 2001.

On average, full-service hotels were able to cover their interest payments in 2001 at a coverage ratio of 2.01.  This was down from 2.31 in 2000.  For limited-service hotels, the interest payment coverage ratio dropped from 1.97 in 2000 to 1.84 in 2001.  "Given the more stringent lending requirements of the 1990s, the higher contribution of equity, and a realistic understanding by the lending community of the current options for hotel real estate, we have seen far fewer bankruptcies and foreclosures during this industry recession as compared to the early 1990s," Woodworth says.

The Importance of Benchmarking

Given the projected declines in revenue, the ability to control costs will once again be a primary focus of management in 2002.  "Many current hotel owners and managers are new to the industry and have never experienced operating in a recession.  They are asking us to assist them monitor expenses and profits in an environment of declining revenues," Woodworth notes.

In response to this increased demand for expense and profit data, HRG offers its clients Benchmarker, a service that allows hotel owners and operators to compare the financial performance of their properties against a select group of comparable properties.  Hotel owners and operators interested in HRG's Benchmarking products can contact Claude Vargo at (404) 842-1150, ext 237.
To order a copy of the 2002 edition of Trends in the Hotel Industry, call (404) 842-1150, ext 223.

The Hospitality Research Group (HRG), headquartered in Atlanta, is the research affiliate of PKF Consulting, the international consulting and real estate firm specializing in the hospitality industry.  HRG, along with PKF Consulting and the PKF Consulting Capital Markets Group, are wholly owned subsidiaries of Hospitality Asset Advisors International, a U.S.  Corporation.  HAA International has offices in New York, Boston, Philadelphia, Washington DC, Atlanta, Houston, Dallas, Los Angeles, San Francisco, and Singapore.