Riding the booming economy, hoteliers were able to increase revenues at a rate that exceeded the growth in expenses.  Measured on a per available room basis, total hotel revenue grew 5.5 percent, while operating expenses grew 3.7 percent.  While operating expenses grew anywhere from one-and-a-half to two times the pace of inflation, favorable market conditions still allowed hoteliers to improve their pricing nearly three times inflation, thus maintaining record profit margins.

Profit Rate Growth Still Going Down?

While double-digit growth in profits is an accomplishment to be appreciated, it should be noted that pace of profit growth has slowed from the 16-plus percent annual growth rates achieved in 1995 and 1996.  Based on the results of our first quarter survey of 42 major lodging markets, most U.S. hotels operators will be challenged to significantly increase their profits in 1998.  New construction activity during the past three years has already shown its effect on occupancy levels.  Once again, more than half the markets in our survey are on a pace to post occupancies lower than the prior year.

In the past two years, a troublesome trend is continuing to emerge for U.S. hotel owners and operators.  In the past, hotel management has been able to offset declines in occupancy by healthy increases in room rates.  However, in the first quarter of 1998, nearly one-third of the markets in our survey posted room rate increases of less than three percent.  Even more noteworthy is that ten cities in our survey actually experienced a decline in market-wide average REVPAR.  Improving profits with slow growing or declining REVPAR may be too big an obstacle for these unfortunate hoteliers to overcome.

In addition to the warning signs of slow room rate growth, we are beginning to see declines in regions of the country that have previously been impervious to the negative effects of new development.  For the first time in four years, occupancy levels in the Mountain/Pacific region are less than during the same quarter in the prior year.  Further investigation reveals that the markets in the Mountain States (i.e. Salt Lake City, Denver, Arizona,), as well as Hawaii, are the major contributors to the negative regional performance.  The larger coastal cities of Los Angeles, San Francisco, San Diego, and Seattle still posted gains in first quarter occupancy.  Comparing the relative performance of the Hawaiian hotels to the major cities on the west coast, it appears that the Asian economic flu has had a greater negative impact on leisure, as opposed to business travel.

Stormy weather, plus competition from new hotels, resulted in the poor performance of hotels in the South Atlantic region during the first quarter of 1998.  Lead by a 7.0 percent decline in occupancy for hotels in Orlando, the South Atlantic region suffered a 2.3 percent decline in occupancy from 1997.  It should be noted, that both the Miami and Orlando markets still achieved occupancies in excess of 80 percent.

Some Markets Getting Back Up

As has been true in the past, the performance of U.S. hotels is wide and diverse.  We still continue to see markets in various stages of their respective business cycles.  Contrary to the struggling Mountain markets are the hotels in South Central region, particularly Texas.  As one of the regions hit earliest and strongest by the recent surge in new hotel construction, most markets in this region have suffered declining occupancies during the past three to four years.  Except for El Paso, all major cities in the Lone Star State showed an increase in their 1998 first quarter occupancy.  Apparently, these markets are on the road to recovery as demand growth finally catches up to all the new supply additions.

Remaining strong are the nation’s major urban markets.  Not only did first quarter occupancy grow in New York, Boston, and Chicago, but each of these cities enjoyed double-digit growth in average room rates.  It is still apparent that high-end hotels in the urban markets show the greatest promise for strong performance and profit growth in the near- to mid-term.

A Crooked Path To Profitability

In spite of the decline, occupancy levels at U.S. hotels are at a high enough level that one would think the fixed costs of operation were sufficiently covered and the only expenses growing each year would be the variable ones.  However, looking up and down the income statement, we find that the more variable departmental expenses are growing more slowly than the undistributed expenses that are typically more fixed.  From 1996 to 1997, departmental expenses grew 3.6 percent, while the undistributed expenses grew 4.2 percent.

This phenomenon is indicative of the increasing cost for labor, cost of goods sold, and other services and products used by hotels.  While the consumption of goods and utilization of labor may be fixed or under control, the cost of paying for each unit of product or personnel is beginning to rise at a pace greater than inflation.  Unlike other industries, hotels have been able to buck the trend of low price growth by raising room rates three to four times the pace of inflation since 1994.  Now it appears that hotels are starting to feel the effects of inflation on their cost of doing business.  We have already seen wage growth in the lodging industry double the pace of growth of other industries.  With low unemployment rates expected to finally put pressure on wages all across the nation, the hotel industry could be particularly vulnerable, due to its strong dependence on personnel.  Payroll and related expenses already consume 30 percent of the typical hotel’s revenue.

Polarized Profit Performance

Just as we see hotel market performance vary by location across the country, we also we stratification among the different types of hotels when it comes to profitability.

Resort hotels enjoyed the greatest increase in profitability from 1996 to 1997.  At first glance, you would believe that the relative lack of new resort development would have led to a strong surge in occupancy and ADR, therefore resulting in the 15.6 percent increase in profits.  However, for the resort hotels in our preliminary sample, there was no gain in occupancy and an ADR increase of only 5.1 percent. 

The strong growth in resort profitability has come from both improved cost controls and revenue growth from the other operated departments.  Resort hotels were the only property type able to show an increase in total revenue greater than the growth in rooms revenue.

At the other end of the spectrum, limited-service hotels improved their operating profits by only 5.4 percent.  Despite this relatively slow pace of growth, the average dollar amount of the profits generated by limited-service hotels is still sufficient enough to cover the typical development costs associated with most properties in this category.  This statement is not as true for the other types of hotels.

Hard To Keep Down

It is tough to judge the U.S. hotel industry based on first quarter results alone.  For most markets, this is the slowest time of the year.  Therefore, any movement in statistics is magnified.

For the remainder of 1998, and the next few years, we can expect to see the continuance of recent trends:  diverse market performance by geographic location, increases in the costs of operations and labor, and a slowdown in the pace of growth for room rates and profits.  Does this mean an industry-wide collapse is imminent?  Probably not, especially if the economy continues to sustain itself.  But it is obvious that the industry is somewhere near the top, or slightly “to the right”, of the highest peak plotted on the curves of the traditional business cycle.

Fortunately, today’s business environment differs from the past.  If you are to believe the economists, future business cycles are expected to be much flatter.  In other words, the peaks and valleys will not be as prominent.  Unfortunately, history has shown that U.S. lodging industry tends to perform in a more exaggerated fashion.  Lodging industry peaks are higher, and the valleys lower.  If the resurgency of the 90s brought resiliency, as well, then the hotel industry should be able to recover quickly from the next downturn, whenever that might be.

Hopefully when the next downturn does come and the industry gets knocked down, it will get right back up again.  In the words of Chumbawamba, you’re never going to keep it down.