Vacancy Signs Dot Lodging Landscape
Vacancy Signs Dot Lodging Landscape
The effects of the recession have finally caught up with the U.S. lodging industry. Leisure and business travel have fallen off as consumers and businesses tighten their purse strings. Hoteliers are trying to find creative ways to draw in customers and are waiting for a turn in the economic tide to bring travelers flooding back.
Without a doubt, the lodging industry has seen better days. The unfortunate mix of weak demand and strong supply growth has resulted in what Atlanta-based PKF Hospitality Research describes as one of the worst years on record for the industry. According to Smith Travel Research, a lodging industry research firm, three key industry performance measures declined sharply: from July 2008 through July 2009, occupancy rates fell 10.3 percent, average daily rates fell 8.8 percent (to $98.41), and average room revenue (referred to in the industry as revenue per available room, or RevPAR) fell 18.2 percent (from $67.40 to $55.12).
Troubling signs for the industry first appeared last summer, when occupancy rates sank to 68 percent, a 4 percent dip from 2007, according to Standard & Poor's. For much of 2008, an influx of international travelers, drawn by a weak dollar and the relative strength of other economies, helped offset the lull in domestic travel. According to the U.S. Commerce Department's Office of Travel and Tourism Industries, overseas arrivals to the United States (including those from Mexico and Canada) topped 25 million in 2008, up 6 percent from 2007. But the flood of international visitors to the United States slowed to a trickle after the financial crisis in the fall of 2008, and the number of foreign visitors is expected to drop 9 percent for 2009, according to the U.S. Travel Association.
Consumers curtail travel plans
But leisure demand may be starting to rebound, according to Peter Yesawich, CEO of Ypartnership. In a July 2009 survey by the market research firm, 63 percent of respondents planned to take an overnight trip in the next six months, up from 61 percent a year ago. But even though people are keeping their vacation plans, the hitch is that travelers are downgrading their accommodations and shortening their stays.
Business travel—the sweet spot goes sour
Corporate cost cutting for group business travel has been aggravated by what is being called the "AIG effect." Following the public backlash against some companies receiving taxpayer funds, many businesses are wary of attracting negative media attention for hosting corporate events that might be perceived as overly lavish. Group meetings, if not entirely forgone, are being scaled back. A recent survey of Association of Corporate Travel Executives members found that 60 percent were avoiding leisure or resort destinations, even if the less luxurious accommodations were more expensive. As a result, these resort properties have experienced sharp declines in revenue.
This increase in supply, combined with feeble demand, erodes hoteliers' pricing power. Smith Travel Research forecasts a 3 percent increase in supply this year and a 1.4 percent rise in 2010. Meanwhile, quarterly demand is expected to decline 5.5 percent in 2009.
Hoteliers are doing what they can to motivate consumers, including aggressively reducing room rates. Luxury chains are making the biggest cuts; Smith Travel Research's June report showed a 28.6 percent drop in these chains' average room revenue from a year earlier compared with a nearly 10 percent decline industrywide (see chart 1). In addition to cheaper rates, to help stimulate demand several hotel chains are offering incentives such as free additional nights and complimentary spa services.
Most industry experts agree, though, that rate cuts do more harm than good. Walter Banks, owner and president of Lago Mar Resort and Club and a director of the Atlanta Fed's Miami Branch, explains that lowering rates "creates a downward spiral, reducing dramatically the net profit for hotels." Jan Freitag, vice president at Smith Travel Research, agrees and considers rate cuts "a little bit suicidal." He reasons that certain groups of people will always travel regardless of the price. So hotel rate cuts are, in effect, "subsidizing inelastic demand."
Freitag says the double-digit declines in room rates are hurting hotels on two fronts. First, lower rates squeeze profit margins in the short term. And in the longer term, once the economy rebounds, it becomes difficult to raise rates. This difficulty stems in part from the fact that group meeting planners have a longer booking window. Thus, today's lower prices are being used as a starting point for negotiating future rates.
Problems paying the piper
Moreover, the fact that many commercial mortgages were securitized has complicated hoteliers' efforts to renegotiate the terms of their loans, and, until recently, laws governing commercial mortgage-backed securities prevented owners from restructuring their loan until they became delinquent. The IRS has since issued new rules giving servicers more flexibility to negotiate with borrowers on loans that are still current. But some hotel owners are using defaults as a tactic to force lenders to renegotiate their terms, according to CNNMoney.com.
One upside is that many distressed properties will be sold at prices low enough for the new owners to operate profitably. Kang of PKF Consulting observes that "investors who have the financial ability to take advantage of the market conditions can expect very attractive prices and realize spectacular returns when the market turns around."
Lodging's doldrums are a drag on local economies
Predictably, lodging's weakness has adversely affected the economy in the Southeast, where hotels and other accommodations have a strong presence. For example, Atlanta is the regional headquarters for Intercontinental Hotels Group, which includes brands such as Crowne Plaza and Holiday Inn. The lodging industry makes significant contributions to the local economy in terms of jobs, tax revenues, and sales for other businesses, such as transportation, entertainment, restaurants, and retailers. In 2008, hotels, resorts, and other lodging properties were projected to generate $13.8 billion in tax revenues for the Southeast's state and local governments, according to the American Hotel and Lodging Educational Foundation.
Ypartnership's Yesawich also points to the region's draw as a resort destination, especially Florida and the coastal areas of Georgia. Properties there are among the hardest hit. Chart 2 shows the impact of declining travel on the region's lodging industry. Florida, which relies heavily on tourism, has seen a 19 percent drop in average room revenues in the past three years compared to a 13 percent decline nationwide.
A light at the end of the tunnel?
As the economy begins to recover, the industry can expect to see a new balance that is more favorable toward hotel operators, Freitag observes. The Atlanta Fed's outlook for the U.S. economy is for a recovery to begin in the second half of 2009. PKF Hospitality Research forecasts that the lodging industry will resume sustained growth starting in 2011. But the pace and timing of the recovery will vary from market to market, so some locations could begin to improve as early as 2010.
Despite the down times being visited upon the lodging industry, analysts see some silver linings. IHG's Collazo asserts that, despite the current challenges, lodging is still a vibrant industry. For the remainder of 2009, the industry's decline should abate, and supply growth should slow down during the rest of 2009 and 2010. PKF Consulting's Kang stresses that although she does not envision the industry's performance turning positive until 2011, the industry appears to be on the road to recovery.
This article was written by Lela Pratte, a strategic information research analyst in the Atlanta Fed's Public Affairs Department.