The highlight of the recovery from the 2008/2009 industry recession has been the strong return of lodging demand. According to Smith Travel Research (STR), occupancy levels at U.S. hotels increased from a low of 54.5 percent in 2009 to 61.4 percent in 2012. With occupancy levels approaching the long-run average, hotel managers have become more aggressive with their pricing policies. Average Daily room Rates (ADR) rose 4.2 percent in 2012, and are forecast to nominally eclipse the pre-recession peak ADR in 2013. Gains in both ADR and occupancy resulted in a 6.8 percent growth in RevPAR for all U.S. hotels in the STR sample during 2012.

While hoteliers have enjoyed strong growth in rooms revenue, what gains have they experienced from other revenue generating sources within their hotels?

Other Revenue - Slow

Based on a sample of operating statements collected from approximately 6,500 hotels in the U.S. for PKF Hospitality Research, LLC's (PKF-HR) 2013 edition of Trends® in the Hotel Industry, rooms revenue increased by a healthy 6.3 percent from 2011 to 2012; however, total hotel revenue grew by just 5.0 percent. This means that the combined revenue earned from food and beverage, other operated departments, and rentals and other income increased only 2.3 percent per available room (PAR), or a mere 0.5 percent when measured on a dollar per occupied room basis (POR).

This finding is consistent with other research conducted by PKF-HR. According to our annual survey of meeting planners for ConventionSouth magazine, as well as discussions with corporate travel planners, these professionals have reconciled that rising occupancy levels have led to limited availability, thus requiring higher room rates. However, to keep control of their meeting and travel budgets, limitations have been placed on the amount their constituents can spend on ancillary services and amenities. We have already seen hotel owners and operators react to this trend by reducing the levels of food and beverage service at their properties, along with an enhanced focus on building select-service hotels.

Variable Costs Contained

Facing the challenge of boosting their revenue, hotel managers responded once again by controlling costs. Total hotel operating expenses[1] for the properties in the Trends® sample increased by 3.3 percent in 2012, compared to the 4.3 percent rise observed in 2011. Because of the high degree of variable costs at hotels, part of the decline in the pace of expense growth can be attributed to the reduced pace of occupancy increases. Nonetheless, when measured on a POR basis, operators were able to limit expense growth to just 1.5 percent in 2012.

In 2012, labor related expenses accounted for 45.3 percent of total operating expenses. Total labor costs increased by 3.6 percent in 2012, down from the 4.1 percent growth rate posted in 2011. This implies that managers monitored employee compensation closely during the year. In 2012, salaries and wages (the more controllable component of labor costs) increased by 2.9 percent, while payroll-related expenses (benefits) rose by 5.4 percent. Many U.S. hoteliers are concerned that this could be a foreshadowing of future escalation in government mandated taxes and benefits.

With labor costs being the most significant component, operated department expenses increased by just 3.5 percent in 2012. With revenues growing faster than expenses, operated department profits grew by a healthy 6.0 percent.

Fixed Expense Growth Explained

In general, undistributed expenses are considered to be more fixed in nature compared to the operated departmental costs. Therefore, at first glance, the 5.3 percent rise in sales and marketing expenses, along with the 5.0 percent increase in management fees, appear to be a cause for concern. However, it should be noted that changes in revenue and profits influence these two expense categories. Franchise fees (considered a sales and marketing expense), as well as sales personnel bonuses, rose in large part because of the increases in rooms revenue. Management fees are almost exclusively driven by changes in revenues and profits, thus explaining the relatively strong growth in this expense item.

The greatest percentage change in an individual expense category was observed in insurance. The amount paid by hotels for property and liability insurance grew by 6.0 percent in 2012. According to the firm Swiss Re, 2011 saw the second greatest dollar volume of worldwide insured losses ever. It appears that the insurance companies needed to recoup their 2011 outlays by raising premiums in 2012.

On a positive note, utility costs declined by 3.4 percent from 2011 to 2012. We attribute this reduction to the continued implementation of green and sustainable operating practices, the purchase of energy efficient equipment, and, according to the Bureau of Labor Statistics, a 0.9 percent increase in energy costs during the year.

Profits

Net Operating Income (NOI) [1] for the average hotel in our Trends® sample grew by 10.2 percent in 2012. Resort hotels enjoyed the greatest gain in NOI (10.6%), followed by limited-service (10.6%) and full-service (9.8%) properties. Lagging in profit growth were convention hotels (5.7%), suite hotels with F&B (7.7%), and suite hotels without F&B (8.1%). Resort hotels benefited from the greatest increase in ADR, while convention hotels were impacted by the lag in the recovery of the group market segment.

Bright Future

Based on the June 2013 edition of Hotel Horizons®, PKF-HR is forecasting double-digit growth in NOI for U.S. hotels through 2015. Strong growth in ADR will be the main catalyst of bottom-line improvement, along with limited growth in expenses. Our outlook for restrained increases in expense growth is driven by Moody's Analytics' forecasts for modest increases in inflation, as well as subdued growth in variable operating costs attributable to the slowdown in the pace of occupancy gains.

Managers will continue to be challenged to grow other revenues sources, especially since travelers will be offered an increasing inventory of select-service properties. Alternatively, owners will benefit from increases in the value of their properties resulting from improving profits.

[1] Before deductions for capital reserve, rent, interest, income taxes, depreciation, and amortizationBefore deductions for capital reserve, rent, interest, income taxes, depreciation, and amortization

About Robert Mandelbaum

Robert Mandelbaum is Director of Research Information Services for PKF Hospitality Research, LLC. He is located in the firm's Atlanta office (www.pkfc.com). To purchase a copy the 2013 Trends® in the Hotel Industry report, please visit www.pkfc.com/buyannualtrends. This article was published in the June 2013 issue of Lodging.

Contact: Robert Mandelbaum

robert.mandelbaum@pkfc.com / 404 842 1150, ext 223

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