How To Recover In 2010

The March 2010 edition of PKF Hospitality Research’s (PKF-HR) Hotel Horizons® report predicts hotels in the U.S. will suffer a 1.1 percent decline in RevPAR for 2010, which will translate into an estimated 5.3 percent drop in net operating income (NOI) for the year. This will represent the third consecutive year of decreases in these two important performance measures. While the annual forecasts are disappointing, a closer look at the quarterly movements of these indicators throughout 2010 reveals that U.S. lodging industry demand, occupancy, average daily rate (ADR), and rooms revenue per available room (RevPAR) will all start to show year-over-year quarterly gains sometime during the year.

Given the turn towards favorable market conditions that is expected to occur during 2010, an opportunity will exist for some U.S. hotels to improve their performance and achieve growth in NOI. To identify potential tactics managers can implement to take advantage of the improving operating environment, PKF-HR has examined the financial performance of hotels that achieved a gain in profits (NOI) during 2003. The year 2003 was chosen because, like 2010, this historical period represented that last of year of a three year (2001 – 2003) industry recession. The data that was analyzed comes from PKF-HR’s proprietary Trends® in the Hotel Industry database of revenues, expenses, and profits from 6,000 hotel operating statements.

Who Increased Their Profits In 2003?

In 2003, 34.5 percent of the hotels that participated in the Trends® survey achieved a gain in NOI. This compares to an all time low of 25.1 percent in 2001, and an increase to 32.9 percent in 2002. In aggregate, the properties that achieved growth in NOI in 2003 enjoyed a 14.9 percent increase in profits. This compares to the overall Trends® sample that suffered a 12.4 percent decline in NOI from 2002 to 2003.

Among property type categories, four of ten limited-service hotels achieved an increase on the bottom-line in 2003. This is not a surprise since 40.3 percent of limited-service hotels were able to achieve profit growth during the depth of the recession in 2001.

Conversely, resort hotels had the greatest reversal of fortune during the last major industry downturn. In 2001, only one in four resort properties were able to achieve an increase in NOI. However, by the third year of the recession, 41.4 percent of the resort managers in our Trends® sample were able to turn things around on the bottom line. Many resort hotels fall into the upper-upscale and luxury chain-scale segments. Historically, these two segments have seen some of the greatest declines in performance during the early stages of industry recessions, but tend to recover relatively quickly.

Convention hotels (23.6 percent), followed by full-service properties (26.1 percent) had the lowest share of properties that experienced an increase in NOI from 2002 to 2003.

How Did They Benefit?

An increase in top-line revenues, as opposed to controlling costs, was the main reason for growth on the bottom-line at those properties that achieved a gain in NOI from 2002 to 2003. In 2003, total revenues for the properties in this group grew 6.9 percent, while expenses rose only 4.0 percent. For the overall Trends® sample that year, total revenues declined 1.8 percent, while expenses grew 2.1 percent.

Prior research conducted by PKF-HR has found that changes in ADR have a significant impact on the profitability of hotels. In 2003, those hotels that were able to take advantage of the improving market conditions by raising their room rates were most likely to achieve an increase in profits. Of the hotels that posted a gain in NOI, 50.8 percent achieved an increase in ADR. This compares to just 32.5 percent for the overall Trends® sample. In aggregate, the hotels that posted an increase in profits averaged an ADR increase of 0.4 percent in 2003, compared to a decline of 2.6 percent for the entire survey sample.

Part of the reason for the relatively strong 4.0 percent rise in expenses at the hotels that improved their profits was the increased business volume. On average, these hotels sold 6.5 percent more room nights in 2003 than they did in 2002. Accordingly, the predominately variable department expenses at these properties rose 5.2 percent. In addition to the rise in occupied rooms, the growth in total revenue allowed management at these hotels to reinstate services, amenities, and employee positions that may have been cut or reduced during the recession.

Fixed expenses typically get overlooked by owners because they tend to be less influenced by management and business volume. However, in 2003, property taxes and insurance expenses moved along divergent paths and impacted the bottom-line in different ways.

The hotels that were able to achieve an increase in NOI in 2003 had to overcome a significant 18.7 percent rise in the cost of insurance. In the wake of the terrorist attacks of 2001, insurance premiums soared for three consecutive years.

The other “fixed” cost, property taxes, took a different turn in 2003. For the entire Trends® sample, property taxes increased 2.2 percent. However, for those properties that enjoyed profit growth during the year, property taxes decreased an average of 9.7 percent. After suffering low levels of revenues and profits in 2001 and 2002, it appears that the owners of these hotels were successful in proving the decline in value of their properties and thus lowering their property tax assessments.

Who May Benefit in 2010?

The ability to raise room rates was the most common factor driving profit growth during the final year of the last industry recession. According to the March 2010 edition of Hotel Horizons®, hotels operating in the mid-scale without F&B segments are forecast to experience a 0.4 percent decline in ADR in 2010. This is the lowest decline among all chain scale categories and implies that several properties in the segment will actually enjoy an increase in ADR during the year. This segment is dominated by limited-service hotels, which is also the property type that displayed the greatest propensity to post an increase in NOI during the final year of the last recession.

Hotels in the upper-upscale segment are forecast to experience a decline in ADR of 2.3 percent. For these hotels, expense control will be the key to improving profitability in 2010. Also lagging in ADR growth, and the potential for profit gains, are the properties in the midscale with F&B and economy segments.

¹ Before deductions for capital reserve, rent, interest, income taxes, depreciation, and amortization.

Robert Mandelbaum is the Director of Research Information Services for PKF Hospitality Research. He is located in the firm’s Atlanta office (). Portions of this article was published in the March 2010 edition of Lodging."

Robert Mandelbaum
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CBRE Hotels