Hotel Online  Special Report
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The Global Hospitality Advisor

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Outlook 2002:
A Roundtable Discussion


January 2002


Jim Butler Chairman of the Global Hospitality Group at Jeffer, Mangels, Butler & Marmaro, recently spoke with several other leaders in the hospitality industry, exploring their outlook for the industry in the upcoming year and asking them to share their predictions with our readers. Here, Jim speaks with Bruce Baltin, Vice President, PKF Consulting, Bjorn Hanson, National Industry Chairman - Hospitality, PricewaterhouseCoopers, Randy Smith, Chairman, Smith Travel and Research, and Jack Westergom, Chairman and Managing Director, Manhattan Hospitality Advisors.


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?
 

Randy Smith: By just about any measure, this is the sharpest downturn to ever affect the industry. We have never seen occupancies and room rates drop this far this fast. For the year, occupancy will be down three percentage points and rates will be down about 1% from 2000 levels. In addition, the industry seems to have stabilized at a level well below prior year levels to go way beyond the typical recessionary pattern. 

Clearly, travel trends have been interrupted and while the economy may rebound, the question remains as to travel rebounding. The good news


Randy Smith
Chairman
Smith Travel & Research
is that the pipeline of new properties is dropping dramatically so that any uptick in demand will result in a rapidly rising occupancy. This may not be until late 2002. The other good news is that next year’s comparisons will look terrific. We will be reporting huge increases in occupancy and demand levels, though rates may still be soft. 

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%.
 

Bruce Baltin: But you guys are talking about averages. Let’s look at the specific market segments. Coming off of a peak year in 2000, the business sector of demand was trending down throughout 2001. Consumer confidence sustained the leisure sector through August, but it too was beginning to trend down prior to September 11. The events of September 11 exacerbated the downward trend in both sectors causing short-term declines of astronomic proportions, especially in the sector of the industry that is most affected by airline travel. While a recovery is 

Bruce Baltin
Senior Vice President
PKF Consulting
now in process, the degree of recovery, as the degree of decline, is varying dramatically by location and market segment. 

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.
 

Jack Westergom: The U.S. lodging industry is currently facing a crisis of unparalleled proportions, albeit potentially a short-term one. Prior to September 11, the year was looking to be one of the weakest years in recent history as RevPAR for industry hotels was anticipated to decrease for the first time since 1991. The vibrant U.S. economy that had fueled the lodging industry’s profitability growth from a loss of $2.8 billion in 1991 to a record profit of $22.5 billion in 2000 was already in or near recession. To complicate matters, 2001 was hampered by high airline fuel prices, a weakened airline industry, cutbacks in corporate travel, the demise of the dot-com boom, a falling stock market and less discretionary income for leisure travel.

The short-term impact of the events of September was severe with most urban markets suffering dramatic decreases in September and October occupancy. We anticipate that the balance of 2001 will reveal decreases in RevPAR for November and December ranging from 20%-35%, severe rate discounting in all market segments and a renewed focus on 2-3 hour drive-in business to replace the lost fly-in business, vanishing new hotel construction financing, and major reductions in employee staffing at most lodging companies. 

Long-term turnaround can be anticipated by late third quarter 2002, depending on 

Rushmore on 
State of the Industry

Although he was not able to join our Roundtable Discussion, we caught up with Steve Rushmore, President of HVS International, and asked him for his views on the state of the hospitality industry and its prospects.  Here are Steve's comments:

Our research shows that hotel values declined between 10% and 40% on September 11.  This decline was the result of the terrorist activities AND ahe declining economy.  We believe that the decline attributed to the terrorist activity is recovering rapidly and should be fully recovered by the first quarter of 2002.  It will then take another 1 to 3 years for the economic decline to be fully recouped.  We think the recession will be
short-lived because of the massive amounts of government spending and stimulus being thrown at this issue.

The good news is that these events have stopped most hotel development so the growth in new supply should slow significantly.  Since hotel risk is largely a supply problem rather than a demand problem, we should be entering a period of very low investment risk in the hotel sector.  In fact, I would say that the next 3 to 5 years represents one of the best hotel investment climates we have seen in a long time.  We probably will not see the upsides that we experienced during the early 1990s-but rather moderate value gains and very little potential for value declines.

Markets that I would buy, sell or caution:  I would buy in any market now where I could get 20% - 30% off of 2000 values.  I would not sell in any market at this time.  There are no markets that I would show caution.  This is great opportunity to buy and hold hotels.

the results of the “War On Terrorism,” and the elimination of future domestic terrorist acts.

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:

  • Utilize professional asset managers to assist in analyzing their hotel assets and developing a plan to improve performance.
  • Do not accept everything your management company tells you as reality.
  • Identify and go after the real current markets for your hotel. There are viable markets for every hotel. They may not be the ones you want to target, but they will help your hotel survive.
  • Communicate regularly and openly with your lender on a consistent basis. Make your lender a part of the solution when difficult times arrive.
  • Slashing your marketing budget is not the answer for a hotel operating in a distressed market. Creative sales and marketing will drive revenue. Franchise contributions to occupancy and revenue will by themselves not make a hotel successful.
  • Adaptive re-use of a lodging asset is a viable alternative for maximizing asset value.
  • Focus on efficiency. You cannot save your way to success, but you cannot ignore costs and cost-benefit analysis.
Cutting rates will not make people travel if they are afraid to do so. However, offering special rates or value-enhanced packages may increase market share from those potential guests who are traveling. Value-added offers like free breakfasts, free nights, free or discounted venue tickets, free rental cars or other marketing partner co-ops are cost effective tools to “buy” business.

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. 
 

Hanson: Hotel owners, operators and franchisors can prioritize local marketing, offering special promotions such as discounts and packages to “locals” or potential customers living in close proximity. “Value for money” deals, which go beyond offering mere room and restaurant discounts, will be most attractive to potential customers. Offering extra services and amenities, such as complimentary breakfast, pressing/laundry, local calls, Internet access and transportation to/from airport, train/bus station or downtown area (where normally not provided) could mean savings for guests and entice them to choose one hotel over another. 

Bjorn Hanson
National Industry Chairman -
Hospitality
PricewaterhouseCoopers

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? 
Westergom: The three most important issues are financing, financing and financing.
Financing for new development and acquisitions is difficult, if not impossible, to find at the moment. We anticipate that financing for acquisitions will become more available late in the first quarter of 2002. Financing for new hotel construction will remain poor throughout 2002 and improve slightly in 2003. Terms for new construction loans are difficult with Loan To Value (“LTV”) at 50%. That number should increase to 60%-65% by 2003.

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:

  1. How to get Americans traveling again. When will they trust the airlines? Travel has become difficult and time-consuming. Everyone accepts the need for this inconvenience as they continue to cut back on travel plans. Has there been a permanent shift in the transportation habits of travelers? 
  2. How to get money flowing into the industry again. While funding for new construction has vanished, there is still a need to fund rehabs and ongoing capital expenditures. Where will this money come from? 
  3. Can the room rate wars be stopped without a rebound in occupancy? If occupancy remains at current levels for an extended period, is it going to be possible to increase rates back to Spring 2001 levels. What is the impact of lower rates on the bottom line? 
Money is cheap but not available to the lodging industry. There will have to be solid signs of a rebound before lenders move back in. For now, this is OK. We do not need money for new construction at a time of falling demand. The problem will come just prior to the rebound when the industry is desperate for new funds and investors are still looking at the past. I have no idea where the industry goes from here for new financing.

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.
 

Westergom: Opportunities always surface in any troubled economic situation and this one will not disappoint. Like Bruce and Bjorn, we anticipate that the discounting on asset sales experienced during the economic downturn of the early 1990s will not be as severe this time around. We expect opportunities to present themselves, especially in mid-market hotels in all geographic areas, as well as full-service, independent and boutique properties in urban areas and older, full-service properties with exterior corridors.

Jack Westergom
Chairman & Managing Director
Manhattan Hospitality Advisors

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

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For more information:
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
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Also See: New Rules for Hotel Workouts: REMICs for Dummies / The Global Hospitality Advisor / JMBM / December 2001 
Living in the Wake: Predictions & Practical Implications / The Global Hospitality Advisor / JMBM / December 2001 
Avoiding Liability for Lay-Offs / The Global Hospitality Advisor / December 2001
The Worker Adustment and Retraining Notification Act: Impact on the Hotel Industry / JMBM 
When is an Apartment a Hotel ... and Who Cares? / The Global Hospitality Advisor / JMBM / September 2001 
The 'Perfect Storm' / The Global Hospitality Advisor / JMBM / September 2001 
Richard Kessler's Grand Theme Hotels - Interview with GHG Chairman  Jim Butler / March 2001
Stephen Rushmore's  Industry Trends / Top Markets, Predictions & Opportunities  / Jan 2001
Outlook 2001: A Roundtable Discussion The Global Hospitality Advisor / Jan 2001
Perspectives on Hotel Financing in 2001; Jim Butler, JMBM's Global Hospitality Group Chairman, Interviews Two Active Players in Hotel Finance / Jan 2001 
Robert J. Morse: Millennium’s New President / Interview with GHG Chairman Jim Butler / Nov 2000 
Special Reports / Jeffer, Mangels, Butler & Marmaro LLP

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