This is an article that looks into the economic issues faced by the U.S. lodging industry since 1994. The phenomenon of mergers and new brand developments will continue to grow. The industry is in the process of a major consolidation, and the strategic alliance has become the growth vehicle for the second half of the 1990's (Hotels, July 1997). The purpose of this article is to discuss the strategies undertaken by the lodging industry and their responses to the current economic issues. The projected forecasts regarding the future of the industry's operations are presented based on current available statistics. In certain cases, data has been combined to provide a more meaningful picture.
THE CURRENT U.S. LODGING INDUSTRY
The constant growth in the U.S. market is expected due to the stable economy. The economy is enjoying a rare mix of low inflation, low employment, and stable GDP. Despite the fears of over development and another downturn for the lodging industry, almost all prognosticators are projecting hotel profitability to continue to grow in the market. The continued productivity gains, constant demand growth, and moderate supply growth will dramatically strengthen the industry's profitability.
The industry has shown an increase in profits from $5.5 billion in 1994 to $1 1.3 billion in 1996 , and the average operating profit margin increased from 25 percent in 1995 to 27.3 percent in 1996 (PKF Consulting, May 1997). During the same period, lodging stocks have gone up by more than 20 percent and real estate investment trusts jumped nearly 33 percent (Hotels, July 1997). On a per-available room basis, profits will improve from $3,300 in 1996 to $5,300 (forecast) in 1999 (Hospitality Directions, February 1997).
The U.S. lodging industry has taken an aggressive posture in pricing
its product and services due to the increasing in demand. The mid-price
and economy segments will have the lead in demand and supply growth, and
the leisure travelers are expected to provide most of the stimulus for
demand growth over the next few years (PKF Consulting, September 1997).
The combination of demand growth is at an average rate of 2.3 percent per
year between 1994 and 1996, and the supply growth is at an average rate
of 1.7 percent per year during the same period (see Table 1). The
average room occupancy has also recovered after 1991, and has continued
increasing through 1996 (see Table 2). In 1996, the average daily
rate (ADR) reached $69.91, up 6.2 percent from the previous year (see Table
2). The ADR increased at least 9.2 percent in major cities where occupancies
ranged from 70 percent to 80 percent (Hospitality Directions, February
1997). With mild inflation prevailing throughout the year, the increase
in ADR surpassed consumer price inflation by 3.5 percentage points, the
biggest margin since 1987 (Hospitality Directions, February 1997).
|Table 1: U.S. Lodging Supply and Demand|
|Market Segment||% Change in Supply||% Change in Demand|
|Mid - scale w/ F&B||.8||-1.0||0.0||2.5||-0.1||-0.4|
|Mid - scale w/o F&B||11.3||13.9||15.0||14.1||12.1||12.5|
|All Hotels in the U.S.||1.0||1.4||2.8||3.0||1.7||2.3|
|Source: Bear Stearns & Co.; Smith Travel Research; Coopers & Lybrand L.L.P.|
|Table 2: U.S. Lodging Occupancy and Average Daily Rate (ADR)|
|Source: Bear Stearns & Co.; Smith Travel Research; Coopers & Lybrand L.L.P.|
After U.S. economic growth stalled at the end of 1995, signs turned positively for the lodging industry. Many huge projects are taking place such as new casinos in Las Vegas. Many lodging properties are also under going major renovations to improve their competitive strength. For example, the Point Hilton Resort at Tapatio Cliffs in Phoenix started its major renovation in the summer of 1996. The centerpiece of the project is a 40-foot waterfall that cascades into 12 meandering travertine pools and tranquil poolside terrace gardens. The waterfall, inspired by the Havasupai Falls in the Grand Canyon, will flow from natural mountain formations on the northernmost portion of the resort's property. The entire project is estimated at $7.5 million (Lodging, September 1996).
The operating efficiency has also significantly improved the industry's profitability. The number of the hotel employees per 100 rooms has declined sharply since 1991 , and this reduction has reduced the labor costs significantly. Although this factor is not related to the occupancy or average daily rate growth, the low guest - employee ratio has effectively lowered the economic break-even in the industry (Bear Stearns U.S. Lodging Almanac, 1997).
Hotels have sharply decreased its expenditures over the years in order
to boost the profitability. The department expenditures, property operation
expenses, maintenance expenses, energy expenses, and fixed costs have all
dropped significantly from coast to coast in recent years. Among all hotels,
the average department expenses decreased from 44.4 percent in 1990 to
38.5 percent in 1995, and the average operating expenses reduced from 29.6
percent in 1990 to 26.8 percent in 1995 (see Table 3). According
to the Bear Stearns' 1997 US. Lodging Almanac, the declining interest rate,
reevaluated property taxes, and restructured debts have contributed to
a huge reduction in fixed costs in the U.S. lodging operations. In 1990,
the average fixed costs in the full-service hotel segment was 30.3 percent,
and it reduced to 19.5 percent in 1995. The limited-service lodging segment
faced an even greater impact; the average fixed costs dropped from 41.3
percent in 1990 to 20.6 percent in 1995 (see Table 3).
|Table 3: Expenses as a Percentage of Sales (1990-1995)|
|U.S. Lodging Industry||1990||1991||1992||1993||1994||1995|
|Undistributed Operating Expenses||29.7||30.8||28.7||28.2||27.2||26.9|
|Undistributed Operating Expenses||29.2||31.4||29.1||27.7||27.6||26.4|
|Weight Average of All Hotels|
|Undistributed Operating Expenses||29.6||30.9||28.8||28.1||27.3||26.8|
|Source: Bear Stearns & Co.; Smith Travel Research|
As the U.S. pulls out of its recession, the investments in real estate
have grown significantly. The year 1996 marked the beginning of a period
of higher supply growth in the lodging market. The new room openings reached
an estimated 92,500 rooms in 1996, a 45 percent increase from 1995 (Hospitality
Directions, February 1997). The researchers at Smith Travel Research also
found out that in 1996, one out of every 31 lodging properties (20 rooms
or more) in the U.S. was a new build, down from one out of every 77 properties
in 1992. And the new build lodging properties are most likely to be mid-priced
properties in suburban and highway locations (see Table 4). From
a supply perspective, many of those mid-price marketed properties with
newer limited-service concepts are particularly attractive to developers
because they are relatively inexpensive to build and have a low break-even
occupancy of about 61 percent (Hospitality Directions, January 1996).
|Table 4: U.S. New Lodging Properties Added in 1996|
|By Market Segment||By Locations|
|Mid - Price||452||8,107||Highway||660||15,272|
|Source: Smith Travel Research; Hotels|
The F. W. Dodge Pipeline database has indicated that south Atlantic
and Pacific regions have the highest construction projects undergoing,
and it counts nearly 40 percent of all constructions from coast to coast.
These regions' share of construction projects is consistent with their
share to the total room supply (see Table 5). The south Atlantic
has experienced a consistently high level of construction during most of
the post-1991 recovery, and has the largest number of products in the budget,
extended-stay, mid-scale without food and beverage operation, and upscale
segments. The Pacific region started catching up with the rest of the country
after mid 1995, and this region has the most projects in the luxury segment
and in unclassified categories such as small chain operations and independents.
The West Central region follows this; it has the most number of economy
and mid-scale projects in recent years. Among the states, the most new
constructions are in Nevada, Texas, California, and Florida (Bear Steams
U.S. Lodging Almanac 1997). In Las Vegas, Bear Stearns estimated 6,450
new rooms opening in 1997, 3,600 in 1998, and 13,300 in 1999.
|Table 5: U.S. New Constructions / Projects by Regions (1996)|
|West South Central||15.0||10.2|
|East North Central||10.8||11.7|
|Mid - Atlantic||8.3||8.8|
|West North Central||5.5||6.8|
|East South Central||5.4||6.3|
|Source: F.W. Dodge; U.S. Department of Census; Bear Stearns & Co.|
When hotel companies could not use all the newly acquired funds to build
hotels, they went out to buy. According to Lodging Magazine published in
May 1996, there were 2,784 lodging properties sold between 1991 to 1995
and 378 of them were in excess of $10 million each. In 1994, there were
83 major transactions (sales over $10 million) with a total worth of $2.3
billion. The number of acquisitions increased to 164 in 1996 with a total
worth of $4.5 billion (see Table 6). Of these 164 major sales, Real
Estate Investment Trusts (REITs) represented approximately one - third
of the buyers (Bear Stearns U.S. Lodging Almanac, 1997).
|Table 6: U.S. Major Real Estate Transactions (Lodging)|
|Sales (single transactions more than $10 million)||41||40||83||111||164|
|Worth (volume of major hotel sales (in billions)||$1.1||$1.2||$2.3||$3.2||$4.5|
|Source: Hospitality Valuation Services; Bear Stearns & Co.|
REAL ESTATE / INVESTMENTS
The lodging industry returned to favor with the investors in 1994 (Hospitality Directions, April 1995). The stable economy continues to drive up capital investments, and many investors were willing to take the risk in lodging investments. From 1995 through mid-1996, the industry saw an explosion in the volume of public offerings. The Wall Street raised more than $11.2 billion in public funds for the industry including public offerings of stock, REITs, secondary stock offerings, and public debt issues (Lodging, October 1996). The private investments are considered to be the major sources of capital to the hotel investment market. In 1994, private sources generated 50.3 percent of the total investment (Hospitality Directions, August 1995).
Leveraged equity investors and owner-operators are expected to dominate the buyer's market. According to Coopers & Lybrand L.L.P., the major buyers in the U.S. market are institutional investors, foreign investors (specifically those from the Pacific Rim), pension funds, vulture funds, and existing REITs. Among the sellers, the insurance companies and banks are the favored sellers.
Real Estate Investment
As the lodging industry recovers, hotel real estate prices soared nearly
20 percent in 1995, to the highest level in this decade (Lodging, May 1996).
The average selling price per room for 531 hotels tracked by National Hotel
Realty in 1995 has been $54,255, up 19 percent from the previous year's
$45,533 (see Table 7). Real estate prices in each lodging segment
are responding differently. For example, the success of limited-service
concepts introduced in the last decade such as Marriott Courtyard has,
in some cases, driven acquisition prices past those new constructions (Lodging,
May 1996). Prices in the full-service mid-market, first-class, and luxury
segments are experiencing the fastest increases (see Table 7). As long
as the interest rates remain low and revenues per available room improve
constantly, the industry will continue to attract investors. Hotel owners
who are not long-term real estate holders must carefully weigh their options
and sell as the market begins to reach its apparent peak, so as to limit
any possible risk.
|Table 7: U.S. Real Estate Selling Price and Estimated Cost of Replacement|
|Budget||11,804||25,000 - 30,000|
|Economy - Limited Service||20,538||30,000 - 40,000|
|Economy - Full Service||19,239||35,000 - 50,000|
|Mid - Market: Limited Service||42,244||35,000 - 50,000|
|Mid - Market: Full Service||42,117||45,000 - 70,000|
|First Class||65,174||80,000 - 150,000|
|Source: National Hotel Realty Advisor|
The PKF Consulting has calculated the trends value on a per-available-room basis, taking into account such factors as prevailing operating profits, capital reserve requirements, and capitalization rates for each of the years under study. It is projected that by the end of 1997, the trends value of the average hotels will have improved nearly 75 percent from 1990 . This trends value does not reflect actual sales prices for properties bought or sold in any given year. The value improvement of limited-service operations occurred earlier in the recovery process and is expected to taper off in the future, as market conditions temper this segment's profit performance (Lodging, May 1997). The full-service hotels normally take a longer time to recover their capital investments, and it will have the potential for future value improvement. The resort properties, on the other hand, lag in profitability improvement and have shown to have the least ability in value recovery.
In 1996, the volume of equity offering by C-Corporation tripled to approximately
$3.3 billion from $791 million in 1995 (Bear Stearns U.S. Lodging Almanac,
1997). The bull market has helped nine companies gone public with the initial
public offering (IPO) of $754 million worth of stocks in 1996 (see Table
8). Among these companies, the Red Roof Inns, Wyndham, and Interstate
have been in business for many years under private hands before the initial
|Red Roof Inns||8.00||16.00||128.0|
|CapStar Hotels Investors||7.40||18.00||133.2|
|U.S. Franchise Systems||2.33||13.50||31.4|
|Candlewood Hotel Co.||3.85||10.00||38.5|
|Source: Securities Data Corporation; Coopers & Lybrand L.L.P.|
Real Estate Investment Trusts (REITs) Equity
The number of lodging properties owned by real estate investment
trusts increased more than 1,300 percent between 1993 and 1996 (Lodging,
July 1997). The number of lodging properties in REIT portfolios has grown
to 299 properties during those same years (Lodging, May 1996). REITs were
generally perceived as enjoying a competitive edge in making hotel acquisitions
because of their ability to raise cash quickly. REITs by law must distribute
95 percent of its earnings to shareholders in order to retain the tax-advantage
status, and these tax advantages have contributed to the growth of REITs
(Lodging, May 1996). In 1994, the REITs generated approximately $600 to
$650 million in capital (Hospitality Directions, April 1995). And for the
year 1995 and 1996, the REITs generated approximately 1.3 billion and 1.7
billion (Bear Stems U.S. Lodging Almanac, 1997). Overall, the market capitalization
of hotel REITs increased from $142.2 million to more than $5 billion over
this past four-year period (Lodging, July 1997). The REIT initial public
offerings generated more than $1.7 billion for the year 1994, 1995, and
1996 (see Table 9).
|Table 9: U.S. Lodging REIT Initial Public Offering (1994-1996)|
|Felcor Suite Hotels||4,075||21.25||86.6|
|Innkeepers USA Trust||4,690||10.00||46.9|
|1995||Sunstone Hotel Investors||5,910||9.50||56.1|
|Hospitality Properties Trust||7,500||25.00||187.5|
|Patriot American Hospitality||10,160||24.00||243.8|
|1996||Host Funding Inc.||0.500||10.00||5.0|
|American General Hospitality||7,500||17.75||133.1|
|Boykin Lodging Trust||8,275||20.00||165.5|
|Source: Securities Data Corporation; Coopers & Lybrand L.L.P.; Bear Stearns & Co.|
Lodging-related REITs returned after the economic recession in the early
nineties, and many had risen practically overnight and are already sizeable
companies. The excitement started in August 1993, when RFS Hotel Investors
became the first of the pack to go public at $10 a share. Within six months,
the stock price had jumped to $18.50 a share (Lodging, May 1996). In 1995,
Hospitality Properties Trust raised $315 million and Patriot American Hospitality
raised $350 million, the largest hotel REIT offering in the history according
to Lodging Magazine May
1996 issue. They all had rapidly expanding portfolios, and some came with very aggressive growth strategies. According to the National Association of Real Estate Investment Trusts (NAREIT), the overall REITs average return rate for 1995 was 18 percent, and the eleven hotel REITs generated returns of almost 3 1 percent.
The lodging industry has always relied heavily on public debts. Until recent years, the booming stock market has changed how lodging companies finance themselves. According to the Bear Stearns Lodging Almanac, the public debt markets served as an alternative to public equity financing between 1986 to 1992. After the post-1991 recovery, the amount of capital generated by equity offerings surpassed debt offerings .
STRATEGY FOR SUCCESS
It is crucial for lodging operations to take advantage of the current stable economy. According to the research conducted by Coopers & Lybrand in February 1997, the current U. S. lodging expansion has already lasted 71 months, well beyond the 55-month average duration of the past seven expansions. A lodging company needs to take precaution and focus on how much longer the current expansion can last. The research has also shown that in five of the previous seven business cycles, lodging industry output peaked prior to the general economy. That is, inflation-adjusted industry revenues began to drop even before real GDP declined.
A study conducted by the Bear Stearns in 1997 revealed that hotel companies
respond to the economic changes differently. The following are the result
|• High operating leverage companies have the greatest potential for
premium returns than any other types of lodging operations when there is
an increasing in room occupancy and room rates owing to increased demand
with real GDP growth.
• Management companies, REITs, and franchise companies benefit when industry fundamentals are strong and revenues increase. Incentive contracts, percentage leases, and royalty fees increase the hotel's profitability.
• Owners/operators face the increased risk because operating leverage applies on the downward side of a cycle.
• Increasing supply, rising capital costs, or higher interest rates, have a direct adverse effect on profits regardless of occupancy rate or ADR trends. Owners/operators are also unfavorably affected by accelerated construction, which increases the supply of new hotel rooms and places competitive pressures on occupancy and average daily room rate.
• Franchisers, management companies, and REITs offer less risk to the investors given their relatively low operating leverage.
• Contrary to the owners/operators' perspectives, franchising and management companies prefer new constructions. The increase in the supply of hotel rooms results in an increase in the number of franchise and management contracts written, thus benefiting these companies.
In 1996, the Arthur Andersen Company and New York University conducted a survey to identify major trends and strategic issues that will shape the industry of the future. The survey '"Hospitality 2000: A View to the Next Millennium" spanned five continents, covering key issues that will define success for lodging companies in the future. Most executives surveyed believe that strategic alliances is the number one growth strategy in hospitality operations following by mergers, joint ventures, franchising, management contracts, and new developments .
The main reason behind consolidation is when acquirers see an opportunity
to create valued-added economy in the acquired companies. Many major hotel
companies seek acquisitions that match strategies to build market share
nationally. For example, the Hilton Corporation bought out Bally Entertainment/Casino
in 1996 in order to gain more market share in the casino/gaming business
(CFO, May 1997). Many significant mergers and acquisitions have occurred
in the full-service hotel segment (Bear Sterns U.S. Lodging Almanac, 1997).
Acquisition costs in this segment remained below replacement costs with
more immediate accretion than new constructions (Lodging, May 1997). In
1994, there were five major consolidations in the U.S. market with a total
value of $111.2 million. And in 1996, the number jumped to seventeen major
consolidations with a total value of $1,070.9 million (see Table 10).
|Table 10: U.S. Lodging Consolidation Activities|
|Source: Securities Data Corporation; Coopers & Lybrand L.L.P.; Bear Stearns & Co.|
The strategic alliance is the top priority for most executives in the U.S. lodging industry (Arthur Andersen, 1996). The concept of the strategic alliance is to create a joint force with another company that shares the same market. It will allow both companies to cut their marketing costs in half and generate sales volumes that would be impossible to reach individually (HSMAI Marketing Review, Fall 1995).
The Hilton Hotels Corporation has recently established a closer working relationship with Ladbroke Group PLC (the parent company of Hilton International), the British company that own the rights to the Hilton name outside of the U.S. Under the terms of alliance, the Hilton Hotels Corporation and Hilton International have agreed to cooperate on sales and marketing, loyalty programs (the Hilton Honors and the Hilton Club), hotel development, and other matters to mutually benefit each company (Hilton Items, Winter 1996). The alliance provides Hilton Hotels an immediate and significantly larger presence in the global market, while giving Hilton International a major position in the U.S. lodging market.
There are many frequent stay programs in the lodging market to promote brand loyalty. However, the variety of brand options confused the public. Based on our calculations, there are at least sixty brands in the U.S. market that operate as chain operations. A smart hotel company must be able to define its position in the marketplace and focus on the target group or target area.
Although the U.S. economy is stable, the competition in the marketplace
is still very tense. In order to survive in the marketplace, a lodging
operator must be able to manage the following characteristics:
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