|by Patrick Quek, March 1999
Each year since 1996, more than half the U.S. hotel markets surveyed by PKF Consulting have experienced a decline in occupancy from the prior year. In fact, approximately 58 percent of the individual properties surveyed by our firm achieved a lower occupancy in 1998 than they did in 1997.
Given all the new hotels that have recently entered the market, the fear of over development is a major concern for U.S. hotel owners and operators. Stung by the consequences of overbuilding in the 1980s, hoteliers fear a repeat performance of the industry recession that extended into the early 1990s.
After recovering from the recession, several U.S. hotel markets enjoyed
occupancies in excess of 65 or 70 percent throughout the mid- to late-
1990s. However, if market occupancies should drop into the high 50s
or low 60s, would the current crop of hotel developers and owners have
positioned themselves to withstand a repeat recession and its resultant
bankruptcies this time around?
The majority of hotels that have been developed in recent years have been in the limited-service category. Despite lofty market-wide occupancies, over one-quarter (27.9%) of these limited-service hotels in our 1998 edition of Trends in the Hotel Industry achieved an annual occupancy of less than 60 percent. In comparison, only 16.5 percent of all full-service hotels in our survey achieved less than 60 percent occupancy.
Given the fact that limited-service hotels will continue to dominate the number of properties being developed, an analysis of the performance of these properties is needed to understand the real meaning and implications of lower market-wide average occupancies in the future.
ADRs By Performance
As might be expected, the lower the occupancy of a property, the lower the average daily room rate. This phenomenon applies to both limited-service and full-service hotels. However, the degree of difference from the average ADR for the overall segment varies more drastically for full-service hotels than limited-service hotels. Regardless of occupancy, ADRs for the limited-service hotels do not vary more than 19 percent from their overall group average. Conversely, the ADR for full-service hotels with an occupancy less than 50 percent is 34 percent less than the average ADR for all full-service hotels.
The main reason for this disparity is that most limited-service hotels are in the economy sector where the ADR range is more confined. Full-service hotels, on the other hand, can reside anywhere from the mid-market to the luxury segment. Thus, price elasticity at limited-service hotels appears to be less than at full-service properties.
Limited-Service, Limited Obligations
Another factor influencing the financial viability of limited-service properties at lower occupancies is the fact that recent ownership and development trends have altered the economics and lowered the hurdles needed to achieve a desirable return.
First of all, a large percentage, if not the majority, of new limited-service hotels are now owned by individuals who also manage the properties themselves. With this business structure, all funds (in addition to any profits from the operation) that would be steered towards management fees and management salaries under other scenarios go directly into the pocket of the owners. In addition, these owner/operators usually put a substantial percentage of their own equity into the funding of the property. It would seem that ownership control over a greater percentage of the revenue ensures that sufficient funds are available to cover the limited amount of debt owed to others. The end result is generally an ability to survive at lower occupancy levels.
Secondly, the prototype designs of most new limited-service brands require a minimal amount of staffing. In fact, these new limited-service lodging products are so programmed that the majority of operating costs are fixed in nature. Therefore, the key to generating profits is to take in as much revenue as possible, be it through increasing occupancy and/or ADR. This gives the owner/operators of limited-service hotels the flexibility to run their hotels at a low occupancy, as long as they maintain a relatively high room rate.
Chicken Little Limited
It appears that the inventory of U.S. hotels in the future will be significantly
influenced by thousands of limited-service hotels operating at lower break-even
occupancy requirements. With so many hotels operating
viably at 50 percent occupancies, the net result will be a lowering of
the overall national and individual market-wide average occupancies.
However, the historical assumption that market-wide occupancies in the
high 50s or low 60s automatically leads to widespread business failures
can now be challenged.
Don’t necessarily write off the entire lodging industry if future occupancies
in fact drop below what have historically been deemed to be “good” levels.
A closer look at the composition of the industry will find several limited-service
hotels operating at the bottom of the market, yet thriving.
Patrick Quek is president and CEO of PKF Consulting, an international hospitality consulting firm headquartered in San Francisco.