In 2000, investors remained bearish on hotel values because of the perceived risks associated with downward trends in the economy.  Studies indicate that the hotel industry reacts more severely than other sectors to both positive and negative economic movements.  With most economists projecting a slowdown in the U.S. economy, the 2000/2001 edition of PKF Consulting’s Hospitality Investment Survey confirms increased capitalization rates and declining values, when compared to the previous survey conducted in 1998.  Hospitality Investment Survey is produced by The Hospitality Research Group, the research affiliate of PKF Consulting.

Growth rate slows

Lodging performance during 2000 was characterized by a quick start and a slow finish ending with a 2.0 percent increase in occupancy, a 3.7 percent increase in average daily rate (ADR) and a 5.7 percent increase in revenues per available room. With inflation at 3.3 percent for the year, the increase in ADR above the CPI was the lowest posted since 1994.  Our projections of growth in occupancy and ADR for 2001 are also less than those posted in 2000.  For 2001, we estimate occupancy to grow slightly at a 0.6 percent pace and average room rates to grow 3.3 percent.  

But operating profits remain strong

Our survey of both equity and debt investors reflects the declining values of lodging properties.  However, dividend rates, or cash-on-cash returns, continue to provide relatively aggressive yields.  As operators continue to manage properties efficiently, operating profits remain strong.  As a result, many owners are electing to hold onto their assets.  As the market is at the top of its investment cycle, owners are selling only those assets that are not strategically desirable.  Equity investors continue to search for bargains, but most realize that upside potential is not what it used to be.  These investors are wary of the downside risk posed by what they perceive to be a looming recession.

Cap rates rise

The results of our investor survey tend to bear out these observations. The most frequently cited investment measures, capitalization rates and yield rates, or IRRs were higher in 2000 than in any previous year since 1992.  Having perhaps peaked in 1998, hotel investments have taken a dramatic downturn in 2000 as the effects of overbuilding and marginal increases in ADRs have taken their toll.  

Related statistics, such as the holding period, indicate that most investors are in a wait-and-see attitude, preferring to hold for cash flow and not take the discount on today’s values.  Loan-to-value and debt-coverage ratios have remained stable, suggesting that lenders feel the current terms afford adequate protection from any increase in delinquency and default risk.

Survey findings

Highlights of other findings of PKF Consulting’s 2000/2001 Hospitality Investment Survey include:
 

Summary

From an operational standpoint, the hotel industry is providing good cash-on-cash returns.  However, many investors appear to be discounting values as moderate growth rates in occupancy and ADR are forecasted to approximate inflation.  With marginal upside, investors are cautious, as the expectations for growth in the overall economy appear to be declining.   Risk premiums are currently overriding any forecast of decreasing interest rates, with the overall effect of increasing cap rates and decreasing values.   As the growth of new supply continues to slide, we do not foresee any serious decline in cash returns.  With increasing signs of a slowing economy, hotel investors, like all of us, are taking a wait-and-see perspective.  The complete Hospitality Investment Survey can be purchased from The Hospitality Research Group at (404) 842-1150.

Scott D. Smith, MAI, is a Vice President in the Atlanta office of PKF Consulting.  Contact him at ssmith@pkfc.com.