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The Global
Hospitality Advisor
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January 2002
Jim Butler: The
hospitality industry has been hit by recession, the events of September
11, and the aftermath of uncertainty. Where are we and where are we going?
Bjorn Hanson:
I agree, Randy. According to Smith Travel Research data, in the third quarter
of 2001, Revenue Per Available Room (�RevPAR�) declined by 11.1%. We predict
that there will be a further decline of 14.7% in the fourth quarter of
2001, with overall 2001 declining by 6.7%. We forecast a return to positive
annual growth in lodging demand, occupancy and RevPAR in the second half
of 2002, although 2002 RevPAR growth is expected to be only 0.2%. The market
is expected to recover in 2003, with RevPAR growth of 5.1%.
More specifically, the drive markets were not
affected as badly as the higher-end hotels in major urban centers and all
hotels in remote resort destinations. I expect a continued gradual recovery
over time, with the first quarter of 2002 being below the same period in
2001, the second and third quarters of 2002 to be essentially flat and
the fourth quarter to up fairly dramatically as compared with the fourth
quarter of this year. We expect to see more normalized growth from then
forward.
The worst of the bad news is that the lodging industry will have to create a new generation of �order makers� as opposed to order takers in order to generate positive operating results at their hotels. Many current hotel sales and marketing associates have never lived through a downturn and have no idea how to create or attract business in a down market. Those hotels that fail to do so will cease to exist. The best of the good news is that the industry is fundamentally stronger than it was in 1991 during the Gulf War, and will maintain much of its growth beyond 2003. Butler: What survival suggestions and warnings do you have for the industry? Baltin: Short-term survivors of this downturn will be those who cut costs quickly to match revenues and adjust marketing strategies to recognize changes in the various market segments. The most important thing to remember is that on the leisure side people are still traveling. They are just changing their destinations and modes of transportation to use the car more and stay closer to home. Short-haul business travel is recovering much faster than long-haul, which should begin to rise more strongly after the beginning of the new year. The biggest risk to the industry, however, is cutting costs too dramatically so that service levels go below basic needs. It�s critical to maintain basic concepts of hospitality at all levels of the industry from limited service to luxury properties and that�s going to be harder to do over the next year or so with overall staffing levels being reduced. Staff training and motivation are going to be more important than ever. Some wonder whether it makes sense to cut rates in order to maximize occupancy. While rates may or may not be reduced directly, many hotels will have to adjust the mix of demand by day of the week, month and season, with the end result being an overall reduction of Average Daily Room Rate while not lowering rates by segment. In other words, yield management and targeted marketing to fill valleys will be more important than ever. We believe that it does make sense to cut rates in order to even out occupancy peaks and valleys. Even if this means an overall reduction in average rate in the short-term, that�s better than a surplus of vacant rooms. Westergom: I agree with Bruce on the importance of quickly applying lessons learned during the last lodging real estate downturn to this current crisis and the negative impact on our industry. Those who survive and thrive will do the following:
Smith: Cost-cutting
may be critical to survival. That will raise some issues for franchisors
and operators, but in this environment, franchisors will be pragmatic for
the next 9 to 12 months. They won�t have a choice. Deep cuts in capital
budgets will raise problems in maintaining physical plant quality, and
this may affect the industry�s reputation. Hopefully this will be short-term
and can be repaired as we move into 2003. Strong operators will use this
atmosphere to cut rates and boost share and hopefully build guest loyalty
as the industry rebounds. Otherwise, it makes little sense to cut rates
at the level we have seen over the past two months. While rate cuts may
increase business from marginal travelers, it is primarily a share game
with little gain for the overall industry.
Other marketing ideas, such as packaging rooms, meals and entertainment / attractions, and pre-selling discount coupon booklets usable in rooms, restaurants and other hotel facilities, can also stimulate demand. There are also opportunities for increased activity in the small meetings segment, specifically from local businesses. Now, more than ever, attention to repeat/past guests will be most beneficial. In food and beverage departments, offering more buffets can reduce costs. Multi-tasking of employees (combining staff positions) will also help cut down on headcount and reduce labor costs, but in a way that reduces the total number of employees losing jobs. Another opportunity lies in the deferment of capital expenditures and major renovations/refurbishments. Discounting should be reviewed as only one small part of strategy. Butler: What
are the two or three biggest issues facing the hospitality industry?
Baltin: I agree. The major issues facing the industry all revolve around the shortage of financing for deserving projects, getting lenders to really understand the fundamentals of the industry and matching supply with demand on a micro as well as a macro basis. I also think that another emerging critical issue is the need to find or develop executives who combine hospitality know-how with the financial, analytical and strategic thinking skills necessary to achieve success in a world where market segments, demand sources and channels of distribution change daily. Hanson: Financing tops our list too�particularly as to availability of capital for new construction. Lenders have become even more cautious in providing capital to new hotel projects, more conservative in their underwriting and imposing tougher requirements such as higher debt service coverage ratios, increasing spreads on the cost of capital reflecting perceived higher risk premiums and lowering LTV ratios. All lenders with which I am familiar are lowering allocations to lodging. Conversely, reduced availability of development capital is an effective barrier to development, which will translate to significant declines in new hotel supply. PricewaterhouseCoopers forecasts that annual hotel room starts will decline in 2001 by 65.2%, from 95,300 rooms in 2001 to 33,200 rooms in 2002. This is the largest decline and third lowest level of room starts for any of the 34 years for which room starts data are available. The silver lining in all this is that, if realized, the predicted decrease in new hotel construction could portend strong performance in 2004. Our analysis indicates that every low period of new construction is followed by a period of strong RevPAR growth. Smith: We see three main issues:
Butler: Opportunity Funds are already on the prowl. Will there be opportunities and how big will they be. Will they be like the early �90s with some properties going for $0.25 or even $0.10 on the replacement cost dollar? Hanson: While there will certainly be opportunities, they would tend to be less intuitive than in the last cycle. Unlike the early 1990s, most hotel owners today are not compelled to sell their properties and therefore would be less inclined to sell at low values. Specific opportunities for funds include originating high-yield mezzanine loans and purchasing hotel loans at discounted prices from lenders attempting to reduce lodging exposure. Currently, there is still such a large spread between �bid� and �asked� that there are few transactions. Smith: There will be tremendous opportunities primarily in the hardest hit segment of upscale, urban properties. By next summer, this group of properties in key markets such as San Francisco, Orlando and Miami should be ripe for this kind of activity. Baltin: There
definitely will be opportunities to make strategic purchases of hotels
as we move into the next cycle. I don�t expect the discounts to be as steep
as they were in the early 1990s but there will still be numerous opportunities
to buy hotels with strong upside. The challenge is going to be identifying
the opportunities because most will involve some level of repositioning
to achieve potential incomes and values. There could be numerous opportunities
to purchase hotels out of CMBS pools as people find it easier to sell than
try to restructure this debt. Of course there are some interesting issues
with that as Jim Butler has pointed out in his recent articles and workouts
program. To take advantage of these opportunities, buyers are going to
have to understand the dynamics of the various markets around the country
and the business side of the industry as well as the real estate side.
Butler: What is happening with development? Westergom: At least for the moment, new development is at a standstill for all segments, due primarily to a lack of available financing. Additionally, most branded management companies have stopped placing equity or mezzanine debt into hotel development. This increases the equity requirements well beyond the means of most developers. Other management companies are re-trading deals and seeking to eliminate previously agreed upon equity, credit enhancement or negative loans. We anticipate development to begin again in 2003 with limited-service, budget and economy hotels first due to the minimal cost of construction and lower lending requirements. Smith: Nothing new is coming on line. The only projects we see are those already in the pipeline. Nothing new is being started. When it does begin again, it will be on limited basis and I think outside some of the traditional development areas. Mid-price, full-service properties could see a rebound while the excess in the upscale, full-service is absorbed. Baltin: There will continue to be development opportunities. We are currently working on projects that are in the pipeline and make sense. As we get into 2003 and beyond, there will be a need for new supply in many markets around the country. I would expect supply growth to be moderate over the next several years, hopefully less than 2.5% on a macro basis, but that still leaves numerous opportunities for spot projects. There is a need for new supply in some major urban centers where demand far exceeded supply by the end of 2000 and even where the current downturn is only providing a respite for several years. San Diego is an example of this type of market. Other opportunities for development include infill resort properties close to the major urban centers and limited-service properties in commercial centers. Hanson: Room starts are forecast by PwC to include a 6% incremental pipeline decline for 2001, compared with what would have occurred before September, and then for a year-over-year decline of 65.2% in 2002, representing only 33,200 rooms. A recovery to 79,655 room starts is forecast for 2003, but this is still approximately 17% below the 25-year average. Those segments most affected will continue to be deluxe, upper upscale, convention, destination resort and boutique, and the least affected will be mid-scale without food and beverage, and economy. Butler: What will be the single biggest effect of this downturn? Smith: We are concerned that some travel patterns may have shifted permanently. A significant portion of air travel may be gone for good. There will definitely be more driving. Overseas travel is in serious trouble�both outbound and inbound. This could greatly affect the major coastal markets in states such as New York, Florida, California and Hawaii. Baltin: I am concerned about shifts in travel patterns as well, but I am optimistic they will rebound to near previous levels. In the final analysis, I don�t expect to see any major changes in the industry from the consumer side several years down the road. However, I would not be surprised to see more dramatic changes in the makeup of the supply side of the industry. The trick is going to be having the financial strength and operating expertise to ride out the downturn. Those same skills are going to be required to identify and capitalize on the real opportunities that are and will be out there. Westergom: We anticipate that lenders will again become the �reluctant owners� of hotel assets due to the downturn. Many assets, although poorly managed, scraped by the past few years with a robust economy, and not through enlightened management. We believe that a number of these assets will not meet debt service and will be taken back by their lenders. Likely candidates for lender foreclosure are those older assets re-branded (downward) in the late 1990s with minimal capital upgrades since. Many of these assets are in severely distressed markets with an over-supply of new product and franchises, or their management is not capable of generating the business necessary for survival. Butler: Who are the winners and the losers? Hanson: The weaker performers include large urban luxury hotels, large urban convention hotels, destination resorts (requiring air transportation for access), �wannabe� expensive boutique hotels and new hotels which are typically riskier because of their high development costs, high debt service and operations that have not stabilized. Westergom: The biggest losers will be those owners who should have sold their lodging assets in 1997 at the peak of the real estate cycle or those owners that bought high profile assets in the late 1990s and traded discounted fees for long-term, 30-year, no-cut management agreements. These owners have no flexibility in their agreements and could lose up to 25% of their asset�s value if forced to sell at this time. Asset managers will be the winners as lenders seek assistance in sorting out the good hotels from the bad. The veteran consultants and asset managers of the last downturn will become invaluable in maximizing asset value and navigating the path from foreclosure to workout or asset sale. Other big winners will be extended-stay hotel companies. Strong business fundamentals and the desire of consumers to seek value will allow the better companies to increase market share as they offer a suite or apartment-like product for the same price as a typical guest room. Lastly, the remaining big winners will be those owners that negotiated flexible management and franchise agreements, enabling those owners or future owners (lenders) to make unencumbered decisions that can increase the value of their assets by millions of dollars. Smith: We also believe there could be a rebound for the traditional roadside property. Those properties located along the interstates could see demand gradually move higher as travel patterns shift. Butler: Thank
you, gentlemen, for taking the time to speak with me today.
For more information, please Jim Butler at 310.201.3526 or [email protected]. The Global Hospitality Group(r) is a registered servicemark of Jeffer, Mangels, Butler & Marmaro LLP |
Jeffer, Mangels, Butler & Marmaro LLP web site: http://www.jmbm.com Email Jim Butler at [email protected] Or contact Jim Butler at the Firm Jeffer, Mangels, Butler & Marmaro LLP 2121 Avenue of the Stars Los Angeles, CA 90067 Phone: 310-201-3526 The premier hospitality practice in a full-service law firm |