Hotel Online Special Report

The Hospitality Research Group Projects the 
Typical Hotel in the U.S. Will Suffer Flat Revenues 
and Declining Profitability in 1999
New York, NY.  September 16, 1999 - The Hospitality Research Group (HRG), the research affiliate of PKF Consulting, finds that in 1999 the typical hotel in the United States will suffer flat revenues and declining profitability.  �The combination of declining occupancy and slow growth in room rates in 1999 reverses a seven-year trend of strong revenue increases and record-breaking levels of profitability,� said Robert Mandelbaum, Director of Information Services for The Hospitality Research Group, the research affiliate of PKF Consulting.  �While this news is distressing, it should be noted that the U.S. lodging industry remains quite diverse.  Certain markets and product types continue to prosper, albeit at modest levels compared to recent history.  In addition, we believe market conditions will improve somewhat in 2000, and unit level profits should rebound.�

Each year, The Hospitality Research Group of PKF Consulting (HRG/PKF) projects the performance of hotels located in major U.S. cities.  The 1999 � 2000 projections were released at a press briefing today at the Cornell Club of New York as part of The Hospitality Research Group/PKF Consulting�s annual �State of the Hotel Industry� report.

Occupancy Declines Bottom Out

Major U.S. city lodging markets will experience their second consecutive year of declining 
occupancy in 1999.  By year-end 1999, HRG/PKF estimates that the average occupancy for 
major U.S. cities will decline 1.7 percent, from 71.8 percent in 1998 to 70.6 in 1999. 

Through the first six months of 1999, two-thirds of the 44 cities in the HRG/PKF survey achieved a lower occupancy as compared to the same period in 1998.  This pattern is expected to continue through the end of the year.

�The main cause for the declines in national occupancy levels has been the tremendous increases in the supply of hotel rooms, as opposed to declines in the demand for lodging," said John Fox, Senior Vice President in the New York office of PKF Consulting. 

�Historically, the nation's major urban markets have been relatively insulated from new competition due to the greater costs and constraints of development in these areas.  Therefore, the aggregate average occupancy for our sample of major markets did not show a decline in occupancy until 1998, two years after the rest of the nation.  Conversely, it appears that these same urban markets will be the first to experience relief from the recent slowdown in hotel construction and rebound quicker than the secondary markets," Fox explained 

HRG/PKF is projecting that the average occupancy for its sample of 44 major markets will increase slightly from 70.6 percent in 1999 to 70.8 percent in 2000.

Rate Growth Still Stagnant

Of more concern for hotel owners and operators is the continued sluggish growth in room rates.  Through the first half of 1999, the average daily room rate for hotels in the HRG/PKF survey grew a mere 2.2 percent, equal to the estimated change in the Consumer Price Index for the year.  By year-end 1999, HRG/PKF estimates that the average room rate for hotels in its survey will be $114.21, up 2.1 percent from 1998.

"We believe the slowdown in rate growth is the result of a combination of influencing factors that the industry, historically, has successfully avoided," said Mandelbaum.  "In 1999, we have seen both a backlash from the demand side, as well as a weakening of pricing policies on the supply side." 

HRG/PKF found that leisure, corporate, and convention travelers, after years of paying anywhere from 5.0 to 8.0 percent more for hotel rooms, have all held their ground in negotiating room rates, or sought cheaper accommodations.  Concurrently, after a few years of declining occupancies, hotel managers have decided to sacrifice ADR growth in an effort to maintain market share.

Old Economics

Contrary to the "new economics" of the 1990s, hotels have benefited from the ability to increase their prices, but have not enjoyed the same degree of productivity improvements achieved by other industries.  According to PKF Consulting's Trends in the Hotel Industry database, total revenues for the average U.S. hotel has grown almost three times the pace of inflation.  However, during the same period, hotels have had to deal with operating expenses increasing at twice the pace of inflation.

"During the 1990s, hotels have followed a more traditional economic model to make money," said Mandelbaum.  "Relatively favorable supply/demand conditions allowed hotels to push their prices (room rates), which in turn drove the strong growth in revenues.  However, the industry dependence on human capital has pushed up the cost of doing business.  Labor-related expenses have consistently comprised 40 to 50 percent of a hotel's expense budget.  Therefore, any movement in the cost of labor has a significant effect on profitability,� he explained.

According to HRG/PKF, hotels� strong dependence on labor directly affects hotel profitability for two reasons.  First, personal service is a large component of the lodging product, especially in the front-of-the-house. Therefore, hotel labor is not as easily replaced by technology as in other industries.  In fact, several full-service and upper-end hotels have added staff to improve guest service and gain a competitive advantage.  Secondly, given the need to maintain staffing levels in an environment of low unemployment, the cost of salaries, wages, benefits, recruitment, and retention have all increased significantly.  Since 1993, labor costs in the hotel industry have grown 68 percent faster than the average for all private industries in the United States.

Profits Down, Despite Cost Controls

With revenue growth slowing down, how will hotel managers react?

"Historically, we have seen hotel managers spend money when they have it, but control expenses when revenues drop off," said Mandelbaum.  "However, with revenue projected to grow a mere 0.2 percent this year, and given the tight labor market, hotel managers will be hard pressed to cut costs that much."

Given the slow growth in total revenues, HRG/PKF estimates that the average hotel will respond and curb expense growth to a level of 1.0 percent.  Despite such slow growth in expenses, it is still greater than the 0.2 percent projected growth in revenues.  Therefore, the average profit margin for hotels in the U.S. should decline from 29.8 percent in 1998 to 29.3 percent in 2000.  The net result is a 1.6 decline in operating profits for the typical U.S. hotel in 1999.  This is distinctly contrary to the familiar mantra of "another year of record profitability," intoned for the industry at-large in 1999.

"It is true that the number of rooms occupied, income received, and profits derived for entire U.S. lodging industry is growing," said Mandelbaum.  "However, for the typical individual or institution owning a U. S. hotel, 1999 is a struggle and a little less profitable than 1998.  In this case, the sum does not reflect the actual experience of most of the parts."

"As we've stated on many occasions, the hotel industry is very much a street-corner business and each operation needs to be evaluated on its own merits," said Fox.  "While the overall average unit-level profit is projected to decline in 1999, there are segments of the industry that will still be able to increase their profits.  On the other hand, some may fair worse than the 1.6 percent average decline."

Through the first half of 1999, hotels have shown distinct performance differences based on their ADR or product segment.  In general, hotels with higher average room rates have seen less of a decline in occupancy, and greater gains in room rates.  When sorting by product type, limited-service and suite hotels have struggled much more than full-service, resort, or convention hotels.

Once again, higher-rated, full-service properties continue to benefit from fewer new competitors.  HRG/PKF believes this relative market success will also translate into success on the bottom line.

Industry Recession?

The rollback in unit-level profitability will be the first decline since 1991.  While this sounds distressing, distinct differences exist between the financial realities of a decade ago and today's economy.  Unlike the earlier time, HRG/PKF does not believe this decline in profitability will result in mass bankruptcies or workouts.

"An increase in number of owner-operators, plus more stringent lending requirements, means that owners today are in a better position to withstand the decline in profits," said 
Mandelbaum.  According to the HRG/PKF Trends in the Hotel Industry database, approximately 86 percent of U.S. hotels generated sufficient cash from their operations to 
pay their interest payments in 1998.  On average, these properties were able to cover their interest obligations by a ratio of 1.74 to one, therefore leaving enough leeway for the vast majority of properties to sustain the estimated 1.6 percent decline in profits.

Up Or Down In 2000?

The Hospitality Research Group of PKF Consulting projects a stabilizing of both market and financial performance for U.S. hotels in the year 2000.  Based on a decline in the pace of new supply additions, and an assumption of continued moderate economic growth, HRG/PKF projects that the average occupancy for hotels located in the nation's major cities will show a slight improvement of 0.2 percent in 2000.  This stops a two-year trend of declines in the national average of all major markets.

Unlike the change in direction for occupancies, HRG/PKF projects another year of slow growth in room rates.  The firm projects a 2.8 percent increase in the ADR from 1999 to 2000 for the hotels in its survey.  This is slightly greater than the estimated 2.3 percent inflation rate for 2000.

HRG/PKF says to look for a continuation of the travel patterns that have emerged in 1999 to suppress ADR growth again in 2000.  Professional travel planners (corporate travel executives and meeting planners), as well as individual consumers are smarter price shoppers.  Consequently, hotels will seek to make their gains via occupancy points, not aggressive rate growth.

With revenue growing due to an increase in both the number of occupied rooms and the rate paid, HRG/PKF projects total hotel revenues to grow 3.2 percent in 2000.  The increase in occupied rooms should contribute to a gain in revenues from sources other than the rental of guest rooms (i.e. food, beverage, recreation, gift shop, etc.).

With revenues growing more quickly than the pace of inflation, look for an improvement in the profit margin, which in turn should lead to a 3.9 percent growth in average operating profits.  While the 3.9 percent figure pales in comparison to the double-digit growth rates experienced since 1994, it does reflect the temporary nature of the negative performance exhibited in 1999, HRG/PKF concludes.

The Hospitality Research Group is the research affiliate of PKF Consulting, an international consulting and real estate firm specializing in the hospitality industry.  The HRG, along with PKF Consulting and hotel brokerage affiliate Hospitality Asset Advisors Incorporated are all wholly owned subsidiaries of Hospitality Asset Advisors International, a U.S. Corporation.  HAA International has offices in New York, Boston, Philadelphia, Washington DC, Atlanta, Houston, Dallas, Los Angeles, San Francisco, and Singapore.

John A. Fox 
Senior Vice President 
The Hospitality Research Group -PKF Consulting
420 Lexington Avenue Suite 2400
New York, NY 10170
(212) 867-8000
Robert Mandelbaum 
Director of Research Information Services
PKF Consulting
3340 Peachtree Road, Suite 580
Atlanta, GA  30326
(404) 842-1150
Also See: The Implications of Declining Occupancies / Patrick Quek / PKF / March 1999 
Newer, Bigger, and Better. But Are Full-Service Hotels Feasible? / Patrick Quek / PKF / April 1999 

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