U.S. RevPAR has continued to rise since the beginning of 2019, and the economy continues to grow. Nonetheless, I fear we are at the beginning of a profit downturn for hotel owners.
Things are going pretty well in the U.S. hotel industry.
Owners are making a lot of money as industry trends have broken records for the last several years. Although the days of profit growth are likely coming to an end in the near term, there is no reason to despair. I expect a modest softening of profits, but not a sudden downdraft. Things are likely to be pretty healthy for hotel owners, just not quite as rewarding as they have been.
The U.S. economy appears to be slowing, with 2.2% GDP growth in the fourth quarter of 2018. The Federal Reserve is concerned enough about slowing growth that it has halted its move to raise short-term interest rates and is talking about the possibility of a rate cut later this year. And the yield curve has inverted, sending a signal that has historically forecast recessions with perfect accuracy. I believe a recession is coming, likely late this year or in 2020, but my expectation is that it will be a mild one.
What does this mean for U.S. hotel profits? Very likely a slow decline in same-store results. To date, occupancy continues to grow modestly, increasing 0.4% over the last 12 months according to STR, while ADR has grown 2.3%. (STR is the parent company of Hotel News Now).
I suspect that occupancy will be close to flat by the end of the year and likely decline slightly in 2020 on softening demand and steady supply growth. In some markets, this will probably set off a round of price competition that will lead to lower ADR, but I doubt that trend will lead to a significant deterioration in rates. Owners are not counting on a lot of top-line growth over the next two years.
Meanwhile cost pressures are showing no sign of abating. Labor costs are getting all the press these days, but labor is not the only area where costs are rising. Property insurance costs are up quite a bit as insurers wrestle with large claims from severe weather and begin to underwrite a more violent weather future. Property taxes continue to rise. But labor is clearly the biggest worry.
It is not just that labor is getting more expensive, but that labor availability is extremely tight. This is leading operators to reach out to contract labor—at a much higher cost—to fill critical gaps. Even with a recession, I expect labor costs pressures to continue, as wages rise to meet worker demands and as legislative initiatives continue to push up the minimum wage.
Overall, this could lead to same-property hotel results declining, but by how much? Market and chain-scale trends are likely to vary broadly, given that supply is concentrated in the top 25 markets and in the upper-midscale and upscale classes. My guess is that most owners will see profits decline by 3% to 8% over the next year or so.
One indication of this outlook can be found in earnings guidance from the publicly traded hotel real estate investment trusts. On average for the REITs that provide guidance, corporate level earnings before interest taxes depreciation and amortization is expected to decline by 0.8%, excluding Pebblebrook Hotel Trust and RLJ Lodging Trust, which are benefiting from acquiring other REITs. This is an imperfect measure, as many of these REITs acquired assets last year and a few were net sellers.
In addition, Chesapeake is expecting substantial growth from its San Francisco-heavy portfolio following the opening of the renovated and expanded Moscone Convention Center. Excluding some of the larger net purchasers and Chesapeake leads to an average decline in EBITDA forecast of 2.4%. Relative to the nation as a whole, the REITs are concentrated in major coastal markets and in larger hotels, many of which are benefiting from group trends that are outpacing growth in transient demand.
All of this suggests that 2019 and 2020 will still be quite strong years for hotel owners, just not as strong as 2018. I am not suggesting anyone rest on their laurels. Rather, aggressive revenue management, operational and asset management strategies will likely mitigate a portion of these macro headwinds, at least to a degree. And really, nearly as good as the record-breaking profits of the last few years is quite good.
Longer term, after these next couple of years, the economy and hotel demand will likely resume their upward growth. Then owners can look forward to new record profit levels.
After a 30-year career as a stock research analyst, David Loeb created Dirigo Consulting LLC, which advises on capital markets, strategy and communications issues. Clients have included REITs, brands, and private equity investors. He a member of the board of directors of CorePoint Lodging Inc., a publicly traded hotel REIT. He can be reached at firstname.lastname@example.org.
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