The State of the Industry

 by: Jeffrey H. Walker, MAI, CHME (Contact Jeff)  

Last year at this time, the industry was still in a state of confusion from the events of 9/11. Entering the first quarter of 2002, the industry had experienced unprecedented declines in overall hotel RevPAR as our national economy stalled, and a previously non-existent factor, fear, became a prevalent force in our economy. Previous estimates of an economic recovery were repeatedly delayed, and the industry faced an uncertain future. Now, entering 2003, it is in many ways remarkable how little things have changed. Perhaps the major shift is psychological…owners, managers, and even the traveling public may simply be getting used to uncertainty. With inconsistency in industry trends among demand segments, property types, and positioning tiers, coupled with political and economic uncertainty, the picture is hardly becoming clearer.

A Year-End Recap

According to Smith Travel Research, the industry finished 2002 at a national average occupancy of 59.2%, continuing a slide since the mid-1990’s. Worse, the national ADR experienced its second annual decline to $83.15, a $1.70 slide. The increase in ADR through the mid-1990’s was largely responsible for escalating NOI and profits, as increases in ADR largely “flow through” to the NOI level. In the end, changes in ADR have significantly more impact on hotel profits than changes in occupancy. Conversely, the ADR slide continues to strain profits and, in some cases, asset values. Perhaps the major troubling news in 2002 was the industry’s implementation of discounting to rebuild occupancy and overall revenues, and history has shown the impact of that practice on profits.

There is some cause for optimism on the ADR front. Although 2002 ADR was down approximately 2.0% nationally in 2002, the major four-week period of January 2003 was flat to January 2002 ADR. Many managers and directors of sales we have spoken with over the past several months have indicated some progress toward bumping annual contract rates for 2003, albeit in a still very competitive environment. Movement in ADR, both on a macro trend and individual property level, will be a telling sign in the recovery of hotel profits in 2003.

Inconsistencies in Trends

While regional differences have historically been a primary focus of trends, the essentially similar regional trends mask the much greater other differences in market performances. In general, the weakest markets have been national destination cities, fly-in markets, the upper upscale segment, and corporate-and group-oriented markets. Leisure drive-in markets have fared relatively well compared to broader national averages.

For example, while the overall U.S. occupancy dropped 1.0% from 2001 to 2002, the weighted average occupancy in the Top 25 largest markets dropped 2.0%, while all remaining markets dropped a much more modest 0.5%. The steepest declines occurred in some of the very largest markets, including Houston (-8.7%), San Francisco (-4.9%), Atlanta (-4.1%), Denver (-4.0), and Dallas (-3.7%). These markets are heavily dependent on national conventions, one of the hardest hit segments, and have a heavy fly-in component to the demand base.

Similarly, the national average rate declined 1.5% in 2002, but the Top 25 markets saw a significant 3.1% decline, End column 2. PAGE 2 led by San Francisco with a large 13.4% drop. Individual segments’ ADR struggles were in direct relationship to their positioning, with luxury hotels dropping rates to keep demand. The Luxury segment saw ADRs decline by 3.8%, while the lowest tier, Budget, actually saw a 2.5% ADR gain.

Other Expense Issues

While the key to profit recovery largely lies with top-line growth, expense control remains important. Historically, cuts made to operations during demand declines have been difficult to maintain as competitive pressures lead management to add back staffing to assure competitiveness. Other “uncontrollable” expense will also be a factor in 2003. Insurance premiums for hotels have increased well above the rate of inflation, a trend which is expected to continue into 2003 for all commercial property types. Energy prices, which spiked in the winter of 2001 but moderated in 2002, could again become an issue if oil markets become unstable in the current political environment. Medical benefit costs continue to rise well above inflation.

What Lies Ahead

The future economic and political trends are clearly inter-related. The current slowdown in business travel will likely be exacerbated if and when military action in Iraq proceeds. The Gulf War of the last decade had a dramatically negative impact on commercial and group travel, which would likely repeat itself during any actual military operation.  If the political turmoil is resolved, one way or the other, an economic rebound, coupled with very low recent supply increases, could begin the create increased compression in many markets, restoring demand, reversing ADR slides, and indicating the early signs of a recovery.