AT THE TOP OF THE MARKET, HOTEL OWNERS LOOK TO REINVENT AND REINVEST
The hotel industry, especially in the U.S., but also in most parts of the world, is at the top of the mountain. All key performance indicators—occupancy, average rate, revenue per available room and more—are at record highs. And while it might be impossible to maintain this staggering growth trajectory forever, there is little reason to believe the industry will slow down anytime soon.
This kind of success creates opportunities for owners, developers and new investors in the business. With hotels generating a great deal of profit, many owners and investors are putting money back into their properties to ensure future profitability, and sustainability has become an important element in the upgrading process. Hotel owners, especially those who look at their properties as long-term investments, are putting capital into energy-saving elements engineered to save operating costs for years to come.
The lodging industry is really two businesses in one: a retail business that involves housing and feeding travelers on a daily basis; and a real estate business in which developers build hotels, hire operating companies to manage them and once the properties reach stabilization, sell them for a profit, which they often use to reinvest in new or existing properties.
According to JLL, more than $85 billion in worldwide hotel transactions took place last year, the second highest total on record. That volume of transactions included $46 billion in single-asset transactions.
This year, an estimated $70 billion in worldwide transactions will close, and, fueled by increased activity among private equity investors, single-asset sales will increase by 35%.
Most of the time, ownership change of those single properties, especially branded hotels, involves a brand change and a significant property improvement plan (PIP), which provides another opportunity to consider the addition of sustainable elements. In the Orlando, Florida, market, for example, 68 hotels of 500 surveyed changed ownership in 2015, up from 45 properties in 2014.
An increasing number of hotel owners and developers are pursuing certification from the U.S. Green Building Council® Leadership in Energy and Environmental Design green building program, also known as LEED®. According to the council, nearly 2,100 hotels around the globe participate in the LEED process, and more than 400 are LEED certified. An additional 1,600 properties are registered to clear certification.
LEED-certified hotels can be found in 40 U.S. states, 31 countries and four continents. In the U.S., California leads with 31 LEED hotels, followed by New York with 19 and Florida with 13. Outside the U.S., China has the most LEED properties with 32.
According to a recent study by McGraw Hill Construction, green construction in the hospitality sector has increased by 50% from 2011-2013 and now represents 25% of all new construction in the sector today.
While new construction can be an effective way for owners to adopt sustainability into their projects, other opportunities exist for owners of existing hotels to take advantage of cost-saving green principles. Some strategies involve big-ticket items such as HVAC systems and kitchen equipment. Other, easier-to-implement techniques include upgrades to operating systems, including change-outs of lighting fixtures and lamps to models that generate relatively quick paybacks with long-lasting green and money-saving benefits.
By any measure, 2015 was a record-breaking year for the U.S. hotel industry. Occupancy was 65.5%, a record. The upper segments of the industry recorded the highest occupancies, with the luxury segment topping them all at 75.3%, followed by upscale at 74.3% and upper upscale at 74.2%.
Average daily rate for the industry hit a record $120, up 4.4% from the year before. RevPAR rose 6.3%; excluding two distressed markets—New York City and Houston—the increase in RevPAR was 7%. The industry’s current prosperity has been long running: Through February, the industry has recorded 72 consecutive months of RevPAR increases.
Despite some opinions to the contrary, the hotel business should remain strong through 2016 and into 2017 and beyond. Most of the pessimism is coming from New York-based analysts who only see the problems that specific market is having, mostly due to overbuilding. Elsewhere in the U.S., and most of the world, forecasts call for continued improvements in performance measures.
STR forecasts a modest increase in occupancy in both 2016 (+0.6%) and 2017 (0.2%), but strong growth in RevPAR (5% this year and 4.5% in 2017). Most of the increase in RevPAR will be driven by 4%-plus gains in ADR during both years.
While rate and occupancy continue to climb, growth in operating expenses will be muted, up a projected 3.3% in 2016. That will result in an impressive 10.2% rise in net operating income for the industry, according to CBRE Hotels. As the industry approaches the top of the cycle, some markets have reached their natural peaks and might see some pullback in occupancy due to higher levels of supply addition. In 2015, seven of 59 markets studied by CBRE Hotels saw a decline in occupancy; this number is forecast to increase to 29 markets in 2016 and 38 in 2017.
However, because of high levels of actual occupancy, hoteliers will be able to drive rates in the next couple of years. Of the 59 markets in the CBRE Hotels universe, 24 are expected to record ADR growth in excess of 5% this year and next. That compares favorably to the Consumer Price Index, which is expected to rise 3% this year.
ISSUES AND CHALLENGES
Like the U.S. and world economies, the hotel industry faces a number of issues in the coming years. The chief long-term challenge is one of its own making: oversupply of hotel rooms.
Additions to room supply have been muted since before the last recession, but levels of new construction have begun to creep up in the past 18 months. In 2015, supply of hotel rooms increased by 1.2%, the first time the figure was above 1% since the mid-2000s, but still well below the 20-year supply growth average of 1.9%.
However, at the end of January 2016, 141,000 hotel rooms were under construction, up 17% from the same time the previous year, and rooms in final planning—the last development step before construction begins—were up 47%.
The impact of increased supply varies by market and type of property. Nearly 70% of new construction in the past two years has been in limited-service segments of the industry, and urban markets are seeing more construction than other geographic locations, with supply up 2% in 2015.
The tumultuous nature of world oil markets has had a profound effect on the hotel industry in recent months. Within the past year, the price of oil has yo-yoed from more than $100 per barrel to less than $30, with a corresponding drop in per-gallon gasoline prices. While rising gas prices usually stunt hotel demand, falling prices don’t always have the opposite effect.
In fact, the precipitous drop in oil prices sent world stock markets into a dive (although they have stabilized in recent weeks, along with the price of oil). The drop in stock prices has made some investors and consumers skittish about the future of the economy and the travel industry.
And hotels in some oil-producing markets in the U.S. have felt the effects of curtailed drilling. Ten oil-related markets experienced declines in RevPAR in 2015, with west Texas down 19.2% and North Dakota off 20.9%.
Hotel industry executives have been concerned about what effect so-called disruptors will have on the long-term health of the industry. Of specific concern has been the rise of Airbnb and other sharing economy sites, which have siphoned some business away from traditional hotels, especially among millennial-aged travelers.
New York City is one market with a lot of Airbnb inventory, which is partially responsible for generally disappointing results for the city’s hotel industry. In 2015, while New York registered occupancy of 84.7%, RevPAR fell by nearly 2%. Most analysts believe the drop was due to the growing popularity of Airbnb combined with high levels of hotel construction.
Cost creep is a constant issue for hotel owners and operators. As the general economy improves, the availability of labor becomes tighter and operators need to raise wages. Increased occupancies mean more guests, resulting in higher labor, operating and energy costs. As costs climb, owners and operators look for ways to improve efficiencies, such as through the adoption of energy-saving equipment and systems.
Despite known and unknown challenges ahead for the hotel industry, investors, owners and brand companies remain very bullish about the future. In a pre-event survey of Hunter Hotel Conference attendees, more than 60% said they plan to develop a new hotel this year, and 85% of attendees said they plan to finance or refinance hotels this year.
It’s hard to believe the hotel industry can improve in demand, occupancy rate and profits beyond where it stands today; however, a stabilized economy, an absence of global unrest and advancements in technologies and operating techniques should ensure a continued bright future for the business.
Many believe the hotel industry is at a performance plateau with fewer opportunities for significant increases in demand and occupancy. And while increasing rate is a good strategy, it also has limitations. Therefore, smart owners and operators view sensible cost-saving measures as a more reliable route to increase profitability.
It’s wise for owners and operators to regularly audit their operations to find techniques that combine sustainability measures along with ongoing cost savings. A smart operating strategy can help owners continue an upward profitability path, even in an environment where more guests aren’t coming through the door.
Ed Watkins has been covering the hotel industry for more than 40 years. From 1980 to 2012 he was editor of Lodging Hospitality, a Penton Media publication. After that, he joined Hotel News Now as editor-at-large until retiring in 2014.