Hotel industry on brink of a downturn
admin | October 25, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The U.S. hotel industry has been experiencing anemic growth in 2019, with the latest Q3 performance numbers providing more evidence that the historically long growth cycle in lodging is beginning to turn. New supply has been outpacing growth in demand, resulting in flat to declining overall occupancy rates. Revenue growth, which has been decelerating since early 2018, ticked below 2.0% for the first time in nearly 10 years, and is projected to fall further in 2020 and 2021. The conventional wisdom for hotel investors is to be overweight the luxury and budget sectors during a downturn, since their performance tends to be less susceptible to economic drag. This remains good advice, but the overhang of new supply in many top markets means CMBS investors need to pick their exposures wisely.
Weakening industry performance
Unlike manufacturing or technology, the lodging industry does not typically stimulate or detract from economic growth. Lodging industry performance, broadly measured, tends to mirror that of the overall economy, driven primarily by growth in GDP, CPI, employment and personal income. However, there can be significant performance differences between markets, and between hotel sectors within markets, as changes in supply are absorbed and metropolitan areas are subject to local event risk.
Industry forecasters from STR and Tourism Economics originally projected overall revenue growth of 2.3% – 2.5% for 2019, but gradually revised those projections down after a weak first and third quarter, with growth now expected to be below 2.0% for the 2019 and to tick lower in 2020 (see articles here and here). Trends in the three primary metrics for hotel performance – occupancy, average daily rate (ADR), and revenue per available room (RevPAR) – have all been slowing for the past year, with occupancy growth turning negative in Q3, a year earlier than expected. Results for Q3 2019 from STR (the complete recap is available here):
- Occupancy declined by 0.1% year-over-year to 70.9%
- Average daily rate rose by 0.8% to $133.25
- Revenue per available room rose slightly by 0.7% to $94.42
This was the first quarter since Q1 2010 that RevPAR growth fell below 1%, during an expansion that has lasted over nine years. RevPAR is the product of occupancy times the average daily rate, so typically when occupancy declines RevPAR will trend down as well. The increase in ADR managed to offset the decline in occupancy during the quarter, but RevPAR has been decelerating for over a year, as supply has increased gradually since 2012 to equal and overtake growth in demand. An excellent time series of changes in supply, demand and RevPAR can be found in U.S. Lodging Industry Overview Mid-Year 2019, by Elaine Sahlins at Cushman & Wakefield (page 3).
Economy and luxury segments may outperform in downturn
The STR and Tourism Economics forecast for 2020, updated in June 2019, was for supply to increase +1.9%, for demand to increase +1.7%, with occupancy therefore projected to decline by -0.2%, further weakening revenue per available room to +1.9%. That forecast was made prior to the weaker than expected performance in Q3, and is likely to be revised lower. From the report (link above):
(forecast for 2019) … Among chain scales, the economy segment is likely to report the largest increase in occupancy (+0.5 percent). Luxury chains are expected to post the highest growth rate in ADR (+2.3 percent). Independents are expected to see the highest jump in RevPAR (+2.2 percent). While all segments should report RevPAR increases for 2019, the lowest rate of RevPAR growth is projected in the midscale segment (+1.2 percent).
(forecast for 2020) … All but four major markets are projected for RevPAR increases between 1 percent and 3 percent. Boston, Miami/Hialeah, Norfolk/Virginia Beach, and San Francisco/San Mateo are expected to see RevPAR increases between 3 percent and 7 percent.
The highest overall rate of RevPAR growth (+2.2 percent) is expected in the luxury segment, while the lowest (+1.4 percent) is projected among midscale chains.
Upper midscale and midscale segments could underperform
The majority of new hotel construction projects (72%) in the pipeline in May 2018 were in the upper-midscale and upscale segments, according to analysts at Lodging Econometrics. Those upper-midscale brands with the largest number of projects were IHG’s Holiday Inn Express, Home2 Suites by Hilton and Hampton Inn & Suites by Hilton. In the upscale segments Marriott and IHG had the largest number of projects and rooms in the pipeline.
Slowing economic growth and increased supply may already be taking a toll on the large, national midscale chains. Hilton reported weaker than expected Q3 earnings, and lowered full-year guidance. Hilton had previously projected RevPAR growth of 1% to 2% for 2019, but based on growth of only 0.40% in Q3, management lowered full-year RevPAR expectations to between 0% to 1%. Management attributed the underperformance to a difficult macroeconomic environment resulting in nearly flat growth in business and leisure travel.
Luxury and budget hotel segments are typically outperformers in a economic downturn, as luxury remains somewhat insulated from price pressure and midscale travelers trade down to budget hotels. Hotel property investors are still cautioned to monitor local markets for idiosyncratic risks – such as the post-hurricane hotel industry slump in Houston – and overhangs of supply driving down revenue growth in Seattle and New York. As they say in real estate, “all markets are local”, and hotel investors need to evaluate national economic and local market trends.