-- Unit-Level Profits Rise 11.4 Percent In 2004 --
|ATLANTA, Ga. (April 26, 2005) -- The typical U.S. hotel
achieved an 11.4 percent increase in profits in 2004 over 2003
according to the recently released 2005 edition of Trends in the Hotel
Industry published by PKF Hospitality Research (PKF-HR), an affiliate
of PKF Consulting. This improved profitability follows a
three-year industry recession that saw unit-level hotel profits decline
36.2 percent during the period 2001 through 2003.
While the turnaround in unit-level profitability is certainly welcome news, the average hotel in the Trends sample is just barely achieving the same bottom line dollars they did back in 1996. “It is important to know that hotels currently are quite profitable; however, it may not be until 2006 or 2007 that the average U.S. hotel will match the profit margins and dollars achieved in the late 1990s,” noted R. Mark Woodworth, executive managing director of Atlanta-based PKF-HR. “Looking at historical ‘financial recovery’ patterns for the lodging industry, the strongest gains in profits usually begin to occur in the third or fourth year of recovery.” PKF Hospitality Research projects profit growth in the range of 14 to 16 percent for 2005.
Industry-wide profits started to improve in 2003, but the greater number of hotels in operation influences this statistic. “Changes in unit-level profits are much more meaningful for hotel owners, operators, investors, and lenders,” Woodworth said. “Understanding unit-level changes in hotel profitability is critical to measuring management efficiency, incentive management fees, changes in values, return on investment, debt coverage, and industry solvency.”
The 2005 Trends in the Hotel Industry report marks the 69th annual review of U.S. hotel operations conducted by PKF. This year’s sample draws upon year-end 2004 financial statements received from more than 5,000 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
Profit Growth Outpaces Revenue Growth
In 2004, the hotels in PKF’s Trends sample enjoyed a 7.6 percent increase in total revenue, which eventually led to the 11.4 percent growth in operating profits. “In general, it appears that the larger hotels with higher room rates experienced the greatest increases in profitability during 2004,” notes Woodworth. “Of course, these properties were some of the most severely impacted during the 2001-2003 industry recession and, therefore, have the greatest losses to recoup.”
Of all the different property categories, resort hotels achieved the greatest increase in profitability in 2004. With total revenue growing 9.0 percent, operating profits in this segment grew 17.2 percent. At the other end of the spectrum, profitability for limited-service hotels experienced a gain of only 6.2 percent, but these “drive-to” properties held up better after 9-11. All other property types (full-service, suite, and convention hotels) saw their profits grow in excess of 10 percent in 2004.
Other Revenue Sources
Revenue from the rental of guest rooms accounts for 67.3 percent of the total revenue for the average hotel. In 2004, revenues from most of the other operated departments (beside Rooms) within a hotel increased for the first time since 2001. The lone exception was the Telecommunications Department.
“The combined revenues from the Food Department, Beverage Department, Other Operated Departments, and Rentals and Other Income increased by 6.3 percent from 2003 to 2004. Food revenues grew the most, at 6.9 percent, while Rental and Other Income increased by just 4.3 percent,” said Robert Mandelbaum, director of research information services for PKF-HR. “Since the number of occupied rooms grew only 4.3 percent for the year, it can be assumed that some of the increase in these additional revenue sources can be attributed to increased guest usage of hotel restaurants, lounges, retails shops, and recreational facilities. In addition, the cost of operating these other departments grew just 5.9 percent, thus indicating that these supplemental revenue sources also contributed to the increase in overall hotel profitability.”
Telecommunications revenue for the Trends sample dropped another 9.8 percent in 2004. This is the fourth consecutive year of Telecommunications revenue declines. Telecommunications revenue is derived from guest use of telephones, faxes, and internet connection services. “The increased use of cell phones and calling cards, along with the avoidance of surcharges by disgruntled guests, all contributed to the continued decline in Telecommunications revenue. On the other hand, increased internet connectivity charges helped to partially offset this revenue decline,” Mandelbaum noted.
Expense Growth Mutes Profit Growth
While 11.4 percent growth in profitability should be considered strong, this level of profit improvement is somewhat disappointing relative to the pace of revenue growth. Back in the late 1990s, 7.0 to 9.0 percent growth in revenues produced 14.0 to 16.0 percent growth in profits.
The main reason for this relative under-achievement is the 6.4 percent growth in hotel operating expenses observed in 2004. Separate studies conducted by PKF Hospitality Research found that a spike in operating expenses is common during the initial stages of an industry recovery. “The hiring of staff to match the increased business volume, combined with the reinstitution of services and amenities that had been eliminated to cut costs, are the main reasons for this anomaly in operating expense growth,” Woodworth concluded.
At 45.9 percent of all operating expenses, labor and related costs represent the largest expense item for hotels. Therefore, the 6.3 percent increase in labor and related costs that occurred during 2004 contributed significantly to the 6.4 percent increase in total hotel operating costs. This also implies that all other operating expenses, excluding labor costs, grew at a pace greater than 6.4 percent.
There are two components to hotel labor costs: salaries and wages, and employee benefits. Employee benefits include items such as payroll taxes, payroll-related insurance, subsidized employee insurances and meals, and retirement plans. “The salaries and wages paid directly to hotel employees went up 5.5 percent in 2004. However, it is the 8.9 percent increase in employee benefits that concerns hotel owners and operators,” Mandelbaum said. “Hotel managers struggle to balance the desire to offer their employees benefits like health insurance and 401 K matching, with the cost of providing such benefits. In addition, some benefits are government mandated, with little room for management control.”
In the past two years, employee benefits have increased a total of 16.6 percent. This is the greatest two-year increase for this expense item since the 25.2 percent growth rate observed back in 1988 – 1989.
Undistributed Operating Expenses
Undistributed Operating Expenses rose 6.5 percent in 2004. This covers such costs as Administrative and General (A&G), Marketing, Property Operations and Maintenance, and Utilities departments. The majority of undistributed costs are “fixed” in nature and not heavily influenced by changes in the business volume at the hotel. Therefore, most increases in undistributed operating expenses can be viewed as intentional additional expenditures by management.
The largest increases in Undistributed Operating Expenses occurred in the Administrative and General Department, where costs grew 7.3 percent during the year. Of note is the fact that labor costs in this department grew at 5.8 percent, thus indicating that hotels boosted their relative spending on such items as information systems, security, credit card commissions, and human resources.
On the other hand, the majority of the 6.1 percent growth in marketing costs can be attributed to increases in labor-related expenses. “Total Marketing Department expenses grew 6.1 percent in 2004, while the labor and related costs within this department grew 7.0 percent. Apparently hotels believe an investment in personnel is needed to improve their market position, more so than advertising or promotion,” Woodworth remarked.
Hotel Utility Costs have fluctuated dramatically during the past few years. In 2001 and 2003 the industry experienced respective increases of 7.0 percent and 5.9 percent. However, in 2002, hotel utility costs declined 5.5 percent. During the first half of 2004, PKF believed there might be some moderation in Utility Costs for U.S. hotels. According to PKF’s mid-year Trends survey, hotel energy costs grew 4.5 percent during the first six months of 2004 compared to the first half of 2003. However, by year-end 2004, the annual Trends sample of hotels ended up with 6.0 percent more being spent for Utilities than in 2003. This implies an increase in energy costs of approximately 7.5 percent during the second half of 2004. Rising oil prices in early 2005 once again have U.S. hotel owners and operators concerned.
Insurance and Interest Go Down
Contrary to other operating expenses, it appears that hotel insurance costs have begun to stabilize. “On average, the hotels in our Trends sample paid 1.8 percent less for property and general liability insurance in 2004 than they did in 2003. Even with this one-year decline, Insurance expenses for hotels have doubled since 1999,” Mandelbaum noted.
What are not included in this statistic are the insurance costs for Florida hotels that were damaged or closed due to the many hurricanes in 2004. Early indications are that the insurance costs for these properties have started to rise dramatically in 2005.
Although not part of a hotel’s operating statement, another cost item that declined slightly in 2004 was interest expense. For those hotels that reported an interest payment in PKF’s Trends survey, this expense declined 3.1 percent. “Since our Trends survey consists solely of ‘same-store’ properties that provided data for both 2003 and 2004, the reduction in interest expense can most likely be attributed to re-financing,” Woodworth explained. “With profits increasing and interest payments on the decline, the percentage of properties in the Trends sample that were able to generate sufficient cash from their operations to cover their interest payments rose from 79.9 percent in 2003 to 84.3 percent in 2004.”
ProfPAR, Not RevPAR
During the recent recovery of the U.S. lodging industry, much attention has been given to the growth in top-line performance measurements. Numerous articles have been produced exalting the growth in occupancy and average daily room rates. “After reading these analyses, one might think that the hotel industry lives on RevPAR alone,” Woodworth commented. “Not mentioned nearly as frequently are the gains in bottom-line profits (ProfPAR) being achieved by U.S. hotels.”
“Certainly, growth in revenue is important and obviously a strong contributor to growth in profits. Management and franchise companies are acutely aware of changes in total hotel revenue since their compensation is frequently dependent on changes in this line item. However, for management companies with incentive fees, owners, investors, and lenders, the profits generated from hotel operations dictate their income,” Woodworth added.
Given the increases in revenue projected for the next few years, the ability to control costs will dictate unit-level profitability. As a benefit to its data partners and clients, PKF-HR offers Benchmarker, a service that allows hotel owners and operators to compare the financial performance of their properties against a select group of comparable properties.
* * *
To purchase a copy of the 2005 Trends in the Hotel Industry survey or a Benchmarker report, please visit the firm’s online store at www.pkfc.com, or call Claude Vargo at (404) 842-1150, ext. 237.
PKF Hospitality Research (PKF-HR), headquartered in Atlanta, is the research affiliate of PKF Consulting, a consulting and real estate firm specializing in the hospitality industry. PKF Consulting has offices in New York, Philadelphia, Washington DC, Atlanta, Indianapolis, Houston, Dallas, Los Angeles, and San Francisco.
R. Mark Woodworth
|Also See:||Plying the Per Diems: How Market Forecasts Should Impact Hotel Rate Strategy / Gregory J Miller / PKF / February 2005|
|Hotel Construction Signs Along the Road to Recovery; Measuring Hotel Developer Intent / R. Mark Woodworth and Robert Mandelbaum / January 2005|
|Understanding the Recovery Occurring in the Meeting’s Market; Surveying the Meeting Planners / Robert Mandelbaum / December 2004|
|First Half 2004 Hotel Profits Solidify 2005 Outlook; Industry Still Lags Far Behind its Past Peak Performance in 1998 / HRG & PKF Consulting / December 2004|
|Room Rates Across the Top 50 Hotel Markets in the U.S. Will Increase by 3.7% in 2004; Five Highest and Five Lowest Average Daily Room Rate Hotel Markets in 2005 / December 2004|
|Perspectives on the Road to Recovery - U.S. Lodging Industry 2005 / HRG & PKF Consulting / November 2004|
|Other Revenue Is Good Revenue / Robert Mandelbaum / November 2004|
|Uncanny! Hotel Occupancies “Key Indicator” of Presidential Election Outcome / October 2004|
|Is the Hotel Industry Smart Enough to Avoid Overbuilding; Ten Reasons Why Real Estate Markets Become Overbuilt / Jack B. Corgel / July 2004|
|PKF Consulting/HRG Survey Forecasts Banner Year for Hotel Transactions; Investors Favoring the Full-service Segment / May 2004|
|First Uptick for Hotel Industry in Three Years; Full-Service Hotels Lead the Way In U.S. Hotel Profits for 2004 / Hospitality Research Group / March 2004|
|Demand in the Full-service Hotel Sector is Expected to Increase by 6.3% in 2004; Best and Worst Hotel Markets in Terms of RevPAR Growth / PKF Consulting / January 2004|