By Robert A. Rauch
The big news in 2017 was the stock market, consumer confidence and the economy in general. Tax reform, wage growth, reduced regulations and the strength of our nation could keep this robust economy going and dramatically enhance it. Supply growth has begun to moderate somewhat, in part due to high construction costs and also due to lender restraint.
Oil prices are back up, consumer confidence is solid, interest rates remain low albeit forecast to inch up and the U.S. and global economies seem stronger than last year. Gross domestic product may actually approach 3 percent in 2018, personal income growth is strong and low unemployment together with very strong corporate earnings indicates that both the leisure and corporate traveler have the means to travel and pay for lodging.
There will always be naysayers, so what caveats could stall the economy? We are not immune to any global crisis, politics and outside events. Notwithstanding the aforementioned, 2018 should be a very nice year in every area of hospitality.
U.S. Lodging Industry
U.S. hotels grew revenue per available room (RevPar) at more than a 2.6 percent clip in 2017. This is down from over 3 percent in 2016 but that was somewhat expected, especially considering political gridlock and the number of fires, hurricanes and active shooter events. Low gas prices fueled some growth in leisure travel. Occupancy levels are at a historic high and average daily rate (ADR) represents all of RevPAR growth. We see no reason that the economy cannot stay afloat and thrive in 2018 and keep ADR growth at a 3 percent level, albeit not enough to keep pace with the cost of labor.
New supply is not likely to stop the continuation of positive RevPAR growth for 2018. Banks will begin to put the brakes on lending in time to avoid approving deals that are just too late in the cycle for aggressive underwriting. That means those who are experienced, have solid equity, leading brands or unique ideas, are in great markets and are considered trustworthy and strong borrowers will be able to develop. Increased developer cost of capital, new supply and Airbnb and others in the “sharing economy” are marginally reducing feasibility. Development economics in many markets will not support new construction.
While these factors might curb supply growth, the “sharing economy” is not going to have a material impact on demand in most markets and International travel is likely to come back as the strength of the dollar drops modestly. Ergo, it will be something else that stops this growth—a Black Swan event or a global meltdown are not likely to occur but could certainly stop this positive growth. Only time will tell but 2018 looks rock solid.
The major forecasting firms, CBRE, PwC and STR are projecting that the U.S. lodging industry will achieve an annual occupancy rate of around 65 percent in 2018. It seems that this will be the year that supply meets demand so there is likely to be flat occupancy levels in 2018. Average rate growth should finish at between 2.5-3 percent, according to the pundits, in line with projected GDP growth. The big challenge might be to reverse some of the trends that hoteliers have been battling relative to high costs of health care, wages and supplies. Further, CBRE has issued a report on reduced labor productivity. Hence, net income may have peaked unless we can successfully reverse these cost trends.
Today’s labor costs represent nearly 45 percent of hotel costs when we factor in worker’s compensation, health care costs and other payroll related expenses so we must hire the best available talent, and they are getting more and more expensive. Distribution costs, due to reliance on OTAs as a direct substitute for poor performance of weak brands and the needs of independent hotels to be relevant, have been increasing, according to Kalibri Labs.
What do these cost increases mean to values? Assuming capitalization rates remain the same, a decrease in net income of $125,000 reduces a hotel’s value by about $1 million. An average limited-service hotel in the U.S. is approximately 90-100 rooms, with revenues of about $3 million and net income or EBITDA of about $900,000. That $125,000 can hit quickly between OTA commissions, labor, health care costs and related expenses. Enough bad news. On the good news side, new hotel lobbies, technology/robotics and improved food and beverage profits are three of the ten trends we identified for 2018. There are many opportunities to grow revenues.
Specific Markets We Follow
Phoenix Look for continued job growth as Arizona finished 2017 with over 3 million in the workforce and Metro Phoenix surpassed 2 million workers. With Governor Ducey in control, the pipeline for new businesses and expansions is stronger than I have witnessed since arriving in Arizona in 1978. A “stable and predictable business climate, workforce depth, quality of life and education pipeline are the most-cited reasons CEOs have said Arizona beat other states and markets,” according to the Phoenix Business Journal.
With minimal new supply growth, (Tempe is an exception but new corporate growth in that submarket has kept pace with new supply) the Metro Phoenix market will have a very strong 2018. While events like NCAA, Super Bowl, etc. are out of the picture in 2018, Spring Training and other events are still here to boost average rate growth by 3 percent with an additional 1 percent in occupancy growth. We expect occupancy, average rate and revenue per available room to finish at 69 percent, $131 and $90 respectively after a solid 68 percent at $127 and $86 in 2017.
San Diego San Diego should see continued strength from all market segments. Convention Center groups are down but leisure is up and corporate is stable. Supply is increasing in downtown but demand should absorb most of it. 2017 finished at over 77 percent occupancy and $160 average rate for a RevPar of almost $124. 78 percent is reachable in 2018, largely due to the tough finish San Diego had in December due to wildfires. La Jolla and coastal areas did well with over 5 percent ADR growth last year. We expect to see ADR at $165, up 3 percent from 2017.
Los Angeles LA finished 2017 at a very respectable 80 percent occupancy, down one point due to the extra occupancy levels picked up due to the Porter Ranch Gas Leak in 2016. Rates were up to over $175 in 2017 from $172 in 2016. Expect solid growth in 2018 with rates rising to the $180 level at stable occupancy. There is new supply coming in, especially downtown. This will begin to have some impact soon.
San Francisco RevPAR could start to benefit from the Moscone Convention Center gradually coming back on line in the second half of 2018. Group mix overall should also improve as the center completes renovations. Citywide room nights for San Francisco are up 20 percent for 2018. We expect occupancy levels to finish at 84 percent at $245, up over $15 or 7 percent from last year and up almost two occupancy points from 82 percent.
Despite the record occupancy levels, average daily rate (ADR) growth continues to challenge hoteliers. Factors such as increased supply, low inflation, the sharing economy and rate transparency make it more difficult to raise rates. Other challenges include the lack of buying opportunities available as sellers are not motivated to sell. But the bottom line is that there is great economic news that trumps any worries right now. To a great 2018!