Dec 17 2013
Going into 2014 the tourism industry has recovered ahead of the economy for the first time in history. This is unusual considering the lodging industry has run in sync with all major economic trends in the past. Normally, the economy improves and the lodging industry trails about six months later. In 2010, the economy continued to remain in a recession while demand for lodging began to improve. From 2011-2013 this trend was followed with additional growth in both occupancy as well as average daily rates. As many of us are aware, going into the 2012 elections the economy was just barely coming out of its recession yet many drivers have been laid out ensuring the lodging industry will be moving forward in 2014.
How are we able to keep track of what is really going on with the U.S. Economy when so many factors are constantly changing it? At The Lodging Conference this past September in Phoenix, I had the chance to meet the Chief Global Economist at the Economic Outlook Group, Bernard Baumohl. Through conversations with Bernard, I became aware of the impacts of geopolitical shocks, oil supplies, terrorism and global financial instability, and his insights have guided much of this section’s thoughts.
this past summer has restored more than 75 percent of all positions lost during the recession.
Due to the drama surrounding the shutdown, consumer confidence was impacted and the general consensus developed that the Fed will not tighten in any way until a series of solid, reliable economic reports are issued to show clear trends. The fact that China, the second largest economy behind the U.S., went from fighting growing pains to experiencing a sudden decrease in growth truly instills fear into the market.
Healthy domestic economic performance depends on the global markets. The export industry has been the best performing sector of the U.S. economy over the past decade, positively impacting tourism, an export industry. Most of us are aware that Europe has not fully recovered from its recession and geopolitical events can occur anytime. The growth of the global economy will largely be driven by emerging countries, not large, established countries. With the assumption that no major events will occur, we need to determine which key indicators to watch here in the U.S.
The jobs report is perhaps the most important indicator of economic performance and generally shares good news. Other key indicators include consumer confidence that had been doing well earlier this year, international trade and the consumer price index (CPI). The CPI is critical because inflation impacts everyone on a personal and professional level. U.S. employers are on track to add 2.5 million jobs this year, exceeding last year’s total of 2.2 million hires. Fueled by expanding payrolls, resilient consumer spending and the resurgent housing sector, the U.S. economy will grow 3-4 percent this year, according to the Economic Outlook Group. While I have a high regard for Bernard and his group, I believe we would be prudent to use 2.5 percent growth for 2014 as a result of two important factors: the Affordable Care Act might have a negative impact in the short run and the anticipation that interest rates may continue to rise.
Despite a weak government sector, private sector hiring year-to-date through this past summer has restored more than 75 percent of all positions lost during the recession. As we noted above, several segments of the economy are trending positive and contributing to economic growth. The housing market is recovering, posting upward trends in sales and construction of new dwellings, and household wealth is increasing while household debt is moving downward as desired.
In the energy sector, oil and gas production has driven strong hotel performance in several states over the past few years although this growth may be leveling off. The energy sector, notably oil and gas, has rocketed many North American cities that previously did not boast strong hotel markets. For example, in the Canadian province of Alberta, job growth fueled by this sector has created a huge demand for lodging. All things considered, aside from cyber wars causing global meltdowns, terrorism or other geopolitical events that may discredit these comments, our lodging forecast predicts strong growth.
Lodging Industry Forecast 2014
The pace of economic growth is not robust, however, it will drive improvement in hotel performance within the U.S. in 2014, just as it did in 2013. Development has been minimal and 2013 has shown growth of approximately 6 percent in revenue per available room (RevPAR). While development activity progresses, average rate growth should help keep us moving forward at that 6 percent RevPAR clip. This pace will allow net income (NOI) to rise at a double digit pace, fueled largely by average rate growth going forward. In 2012, NOI grew at 15.4 percent according to PKF Consulting. This has had an enormous impact on valuations because the two primary drivers of value are net income and capitalization rates (cap rates).
At the end of 2013, more than 75,000 rooms were under construction in the U.S., according to Lodging Econometrics, an increase of 23 percent from the previous year. However, projects underway represent 1.5 percent of supply, lower than the long term average of closer to 2 percent. Based on this newly limited supply, we see growth of demand at 2 percent increasing occupancy by half a percentage point and average rate growth of 4 percent. This 6 percent RevPAR growth should continue for the next two years.
We believe that valuations of hotel assets will improve by about 25 percent to hit a peak at the end of 2015. This will be made possible if two things occur: 1) NOI continues to grow by double digits, which we predict it will for the next two years, and 2) cap rates, driven largely by interest rates and economic conditions, stay where they are. For hotel owners who are looking to optimize cash flow and values without waiting too long to sell, this is crucial. As a buyer or developer, purchasing in 2015 allows you to ramp up earnings for a refinance at the end of 2016 with a new or purchased asset before the next economic downturn.
The bottom line, our forecast calls for an overall increase of 2 percent in demand and 4 percent in average rate with a 1 percent increase in supply.
Large States Dominate
The National Hospitality Group (NHG) put out a recent report that indicates an ongoing recovery in the hotel sector will be determined by the performance of the five largest states by room count. Collectively, California, Florida, Texas, New York and Nevada account for more than one third of all rooms in the U.S. Year to date each state has outperformed the U.S. in several primary performance measures according to STR (formerly called Smith Travel Research).
Increasing travel to popular leisure destinations and a recovering statewide economy are driving occupancy gains in California. In Anaheim, fueled by Disneyland, room nights have jumped by over 3 percent year to date with strong rate growth. The San Francisco Bay Area is flying high as is the Los Angeles metro area. Due largely to sequestration, cyclically low group demand at the San Diego Convention Center and especially due to a fight between former Mayor Bob Filner and the San Diego Tourism Marketing District, San Diego is up less than 5 percent this year. Full disclosure, I predicted very early on that then Mayor Filner would turn out to be the worst mayor in the history of the U.S. and he fulfilled that prediction. No funding in San Diego has shown how important promoting tourism is. Statewide, occupancy is up 2 percentage points year to date to 71.2 percent.
Texas and Oil and Gas
Oil and gas activities continue to fuel a strong economic recovery in Texas where occupancy year to date is up to 64.8 percent. Supply growth of 1.2 percent is well above the national rate of expansion and may pressure RevPAR growth in the months ahead according to NHG. This pattern might also be found in North Dakota, Alberta (Canada) and other markets where oil, gas or related energy booms are fueling rapid demand growth.
Revenue Management and Technology
We have all witnessed the shift in revenue management from art to science, but we have yet to see a shift in group room nights. As s sector group meetings have been invisible on the revenue lines since 2008. When it returns – and it will – it will have a material impact on revenue management trends considering many of today’s revenue managers are younger and were not in such positions when groups were abundant.
One thing that makes it difficult to manage revenues vis-a-vis group demand is that many guests desire to “book outside the block.” The key point is that as the economy expands, group travel will return but it will look different. Fewer attendees per company, fewer room nights per trip and smaller group size will be the new norm. While it may be years before big box hotels can host large conventions in abundance, smaller meetings and groups with limited needs are out there for all hotels with some space.
Whether it is revenue management systems or any other form of technology, the pace of change continues to be faster than most individual minds can handle. It is very prudent to use the RFP approach, just as we always have with major purchases. While the brands dictate the software you may use, most of our hotels are independent and require the use of new technology without any trusted individual to call upon for advice.
So what do we do? We subscribe to Hospitality Upgrade, a great publication that comes digitally or in a print edition. The fall 2013 edition has a feature story on analytics that is required reading for owners and managers. Proper analytics are capable of providing everything from your guest demographics to understanding the impact of the guest experience on your business.
Hot topics today are both flash sales and last minute bookings. Online Travel Agencies (OTAs) of various sorts have products that seem to fit perfectly with lodging industry needs. But of course the devil is always in the details. If you know how to use these products from the OTAs, they are very helpful in moving market share. If, however, you become reliant on this business and educate your customers that you always play in the last-minute discount sector, watch out for lower average rates!
Social Media and Millennials
To begin a discussion on social media, it is necessary to point out a few facts. Facebook has over 1 billion users. Twitter has over 400 million tweets per day. Google Plus, while way behind those numbers, serves as an entrée to Google searches and should not be ignored. Pinterest has more users than Google Plus, YouTube and LinkedIn combined and Instagram’s users average 257 minutes on the site per month.
While additional emerging social media might be encouraging and have great potential, the above should form your foundation. Baby Boomers might continue to be the strongest tourism market in the near future but it is time to play to the Millennials. All the chains are drastically changing their approach to these travelers with new open spaces in their lobbies and technologies to keep pace with this new generation of travelers.
Cornell’s Center for Hospitality Research found key links between social media and lodging performance. As an example, a hotel that improves its rating from 3.3 to 4.3 out of 5 could increase its price by 11.2 percent before impacting occupancy. This comprehensive study went way beyond my one example but the relationship between these two areas (social media and lodging performance) indicates the critical nature of user generated content.
Most hotels today are positioning themselves for future average rate growth with improved products. Brands demand it and independent hotels know that they must have a competitive edge. Interest rates are low and the return on equity of well-planned renovations will be strong.
Capital expenditure (Capex) needs and reserves are often out of sync due to weak cash flow during recessionary periods. Today, with three strong years of average rate growth ahead, hoteliers must have their properties in competitive condition. We have found a complete inability to drive rate when the product is inferior or tired. Those who do not have new or renovated products by early 2014 have missed the boat.
Interestingly, there is a direct correlation between the freshness and quality of an asset and the ability to execute on a business plan. An owner who looks at the competitive set of his/her hotel and believes that the hotel will achieve fair share is looking for trouble if the hotel is not up to par in physical condition vis-a-vis the comp set.
At the end of the day, those who have fresh products, strong marketing teams, experienced and hard-working operations executives and a clear understanding of the ever changing technology landscape are the winners. These winners will likely beat the competition on the revenue side by a fairly wide margin and due to the growth in average rates this year, they could very well see another 15 percent growth in profits as well. Let’s toast to another great year in 2014!