Hospitality Consulting Services
400 Spear Street, Suite 106
San Francisco, CA 94105
|by Rick Swig - January 2001
New hotel development and individual unit transaction trends in the first year of the millennium will be viewed as nearly stagnant. Even with continuing revenue growth in most markets, new construction and transactions are difficult to complete. Sellers’ market values and buyers’ pain thresholds are still in conflict, while lenders are hesitant to finance hotels of any kind.
The front pages of national business sections continue to make comments on the scarcity of hotel rooms and ballooning rates in major markets like San Francisco, New York, Boston, and New Orleans with REVPAR growth of 15% or more. In reality, however, national urban trends indicate an aggregate in the 6% - 7% REVPAR growth for the year 2000, which is mostly as a result of average daily rate growth.
The truth is that any generic national outlook is now inaccurate and misleading. Occupancy and rate trends are now even more so showing variance by neighborhood, much less city, state, and region. There is diversity of trends throughout regional areas. Where the Northeast in general is clearly booming in Boston and New York, Philadelphia with the addition of new supply slipped significantly in 2000, while in the Midwest Chicago is beginning to show signs of decline, while markets like Minneapolis and St. Louis are showing strength.
The commonality between markets in decline is new supply. This fuels the fire for lender conservatism, as fingers point to markets with new supply with justification for the tight purse strings. Just as simply, other pointing could be targeted at Houston and Dallas, where seemingly unbridled supply increases have not stopped growth in occupancy, which has been coupled, however, with negligible growth in average daily rate.
Clearly, new supply will be easily absorbed in markets like San Francisco, Boston, and New York, which have now become true “seven day” markets without major seasonal variances in demand. This contrasts most markets where there might be high demand for three or four days of the week with both occupancies and rates halved on the weekends.
It is also clear that in many (or some say most) markets that occupancy levels are at a peak, while revenue growth can only be expected through average daily rate growth. This cap on growth has severely impacted the transaction side, where the wisdom of buying at a premium in a market at near capacity occupancy is questionable, especially when the barriers to entry may be limited. As a result, single digit cap rates expected in the late 1990’s are a ratio of the past. Buyers of properties in mature markets are surely taking on more risk than the sellers due to full capacity levels, slowing average daily rate trends, and the inevitable vulnerability to new supply.
On the development side land values and costs for construction have put the brakes on financing new supply, even in full-capacity markets, which should merit new supply. There is a distinct imbalance between the investment expense and the ability to cover debt service plus provide an adequate return on investment.
Into the final quarter of 2000, construction starts were down by nearly 15% from the previous year. The residual trend of this ongoing slowdown is a slip in new supply from 4.2% in 1999 to an estimated 3.0% in 2000. The trend, as forecast through construction drop-offs, will slow even further to an estimated 2.8% in 2001. In consideration of at least a twelve-month lag between new construction and a hotel’s opening plus the current 1999/2000 trends for tighter lending standards the trend for 2002 may dip even further to 2.5%.
Coincidental with the declining trend of new supply, PriceWaterhouseCoopers for one believes that demand will also slow from 3.0% in 2000 to 2.9% in 2001, and then to 2.4% in 2002. Although further frustrating to developers, maybe the tightened lender purse strings are justified in the face of these trends of supply and demand.
There is another area of concern, which has no bearing on revenue potential, but clearly impacts the profit yield potential of hotel operations. This is the area of human resources, which may be an oxymoron in the context of availability of labor to populate hotels.
The hotel industry has continued to trail in compensation growth by comparison to other business sectors. As a result, the attraction of going to work on the front desk at a hotel for potentially the same wages as a fast food restaurant clerk has soured. Part of the contribution of operating profit growth in 2000 was a direct result of reduced staffing due to non-irreplaceable attrition.
The battle for human resources will heighten in 2001. With that increased battle will come the requirement to increase wages in both hourly and salaried positions. Revenue growth in 2001 will come primarily through rate growth. This has generally meant a high percentage of flow through to the bottom line. In 2001, however, there will be an expansion of a trend from the last half of 2000, where traditional flow through rates from increased average daily rates began to show downward shifts of 10% -15% from traditional 80% - 90% levels. In many of the aforementioned at-capacity hotel markets, where revenue increases have paralleled economic expansion and a resulting competition for human resources, flow through from average daily rate growth may be as little as 55% - 60%, as wages blast upwards.
There is no doubt that this shift and resulting contraction of profitability will catch both the eyes of lenders and buyers. The result will only be a further excuse to tighten lending parameters and negotiate even harder purchase prices. As a result, predict ongoing stagnation for both new construction and individual hotel asset transactions.
RSBA & Associates
400 Spear Street, Suite 106
San Francisco, CA 94105
Tel: (415) 541-7722
Fax: (415) 541-5333