The Current State of the Hospitality Industry
“Where are we in the cycle?”
This is the question frequently asked at nearly every hotel conference. The two primary schools of thought appear to be that we are either in a continuation of an extended economic cycle or that this has turned into a new game in the past couple of years. While there are some concerns going forward, investors still view the hotel sector as a good play.
Since the middle of 2016, the hotel industry has been on a streak of consolidation. In less than 21 months, we have witnessed well over 20 billion dollars in corporate acquisitions including management companies, REITs and most notably brands. Analysts and industry insiders expect this trend to continue for the foreseeable future.
Back in 1980, there were only 90 Hotel brands in the US and a mere 12 brands at that time were part of larger brands umbrellas. Today, there are over 259 hotel brands in the United States alone and almost two-thirds of them are now part of a large brand company. As a result, we are seeing an invasion of mega brand families. Today, nine companies house almost half of the hotel brands in the United States.
In addition to growth through consolidation, we see the creation of new brands. Many of these new brands are positioned in the mid-market lifestyle segment.
Stimulated by strong supply and demand dynamics, hotel development continues to climb with more than 30 billion dollars spent on hotel construction in 2017. This still below the volume of construction dollar spent on lodging back in 2007 and 2008.
Moreover, supply growth is only now returning to the long-term average of 1.8% annually — perhaps illustrating more disciplined approach to building hotels during this cycle.
With the industry continually reaching new performance records, some fear that is only a matter of time before demand weakens. However, there’s reason to believe that hotel demand will continue to grow when comparing the growth and key metrics for both the domestic lodging and airline industries in 2017.
Airlines outpaced lodging and supply growth, demand growth, and revenue growth — with air travel being a major driver of hotel demand. Valuation metrics for institutional quality hotel investments are slowly changing with the market while the Fed is raising rates. Hotel interest rates have been slowly climbing too — but remain near historic lows. Higher leverage has been one way to compensate for the higher cost of debt. The average loan to value ratio is at its highest level over the past seven years at just over 69% and cap rates on historic net operating income have been increasing as repositioning and turnaround opportunities are more limited.
The resulting impact has been a slow, yet steady transactions. Market median price per room declined in 2017 but that was more indicative of the types of assets being traded than a true indicator of declining values.
It is also important to note that the average cost to build an institutional quality asset reached 265 thousand dollars per key in 2017. With development costs in excess of acquisition prices, supply growth is anticipated to plateau and perhaps even taper over the next few years. Questions remain as to where the economy will go from here and how long it will run. Looking at macroeconomic indicators and expectations from the Federal Reserve’s survey of professional forecasters, we should anticipate continued growth.
The pace of growth in gross domestic product rose in 2017 and is expected to rise at an even faster pace in 2018. The pace is also expected to exhibit strong growth again in 2019. Unemployment dropped to 4.1 percent in 2017 and is forecast to slide further in 2018 and 2019. Consumer Price Index saw consistent growth in 2016 and 2017 and the next couple of years are expected to increase at a similar pace. Corporate profits experienced strong growth in 2017 after a slight decline in 2016, but 2018 is anticipated to be another banner year for corporate profits — partially driven by the corporate tax cut. This is all projected to lead to moderate increases to disposable income in 2018 and 2019 — which will benefit consumer spending.
For the public hotel companies system-wide Revenue per available room (RevPAR) growth ranged from 2.5 percent to 4.7 percent in 2017. Guidance from these companies for 2018 shows a fairly anemic outlook with most estimating only 1% to 3% increases in RevPAR. One of the key positives for top-line growth in the hotel industry is the improvement in group booking pace. Marriott, Hilton, and Hyatt along with several hotel REITs, acknowledged increases in group bookings for 2018 — with most than 2% to 4% range. This bodes well for further demand growth. Nevertheless, with only inflationary growth anticipated for revenue, minimal room for error is left on the expense side.
Although demand continues to grow and occupancy is remain strong, companies need to avoid the pitfalls of rising costs. The best opportunities for improving flow-through and increasing profitability will need to come from cost reductions that do not impact the operation. Direct booking initiatives along with recent moves to cut meeting planner commissions, illustrate efforts to rein in expenses.
The major hotel franchise companies continue to hype their rewards programs in efforts to encourage direct bookings through their own website. IHG and Marriott’s combined plans are nearly equal with roughly 100 million members each. Hilton, Wyndham, Choice, Hyatt and Best Western trail in size. Expedia and Hotels.com have also built programs of respectable size.
As much as the industry focuses on its direct booking strategy, in hopes of limiting the use of online travel sites, the two major Online Travel Agency (OTA) umbrella companies, Booking Holdings and Expedia Group, continue to see significant growth in room nights booked. In 2017, these two behemoths accounted for almost a billion room nights booked worldwide — a 19% increase from 2016.
On the expense side, employee compensation continues to increase with payroll typically accounting for roughly one third of a hotel’s expenses. This weighs heavily on an operation. 31 states currently have a minimum wage legislation that exceeds the federal minimum wage of $7.25 an hour. In 2018, 11 of those states will increase the minimum wage by 4% or more with several other states likely to make upward adjustments as well.
While concerns remain for the hotel industry as well as the greater economy, we have been able to evade most threats over the past few years with most of the current metrics having a positive spin. The outlook remains optimistic for the foreseeable future. However, the hotel industry should maintain its proactive efforts in order to survive any unexpected threats or disruptors in its space.
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