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Contain Your Costs to Maintain Your Margins

Feb 27, 2020

Continued disruptions to the lodging industry by alternative accommodation providers, labor shortages, tariffs, uncertainty surrounding an upcoming presidential election, and the fallout from the COVID-19 virus are the many factors poised to affect the hospitality industry this year. Hoteliers will want to focus their efforts on aggressive cost containment in order to maintain profitability.

Revenue per available room (RevPAR) is projected to grow between 0.0% and 1.1% in 2020 due to increases in supply in both traditional lodging assets and alternative accommodations such as Airbnb, short-term leases offered by residential properties, and other disruptors to the industry including recently announced pop-up hotels. According to economists at The Americas Lodging Investment Summit (ALIS), the largest hotel investment industry conference in the world, top line growth in 2020 will decline when adjusted for inflation.  Supply and demand will continue to grow in tandem.  Average daily rate (ADR) will be the sole driver of RevPAR gain. In EisnerAmper’s opinion, these forecasts will prove aggressive, as the impact from the coronavirus was not fully understood at the time these forecasts were made. Without topline growth, hoteliers must focus on the expense side of the business.

Impact of Coronavirus:

The outbreak that has sickened nearly 75,000 and killed more than 2,000, mainly in China, has had severe ramifications for the industry globally and even for U.S. hotels located in suburban markets. Hotels have been shut down and flights have been canceled. The recent surge in cases reported outside of China has would-be travelers canceling vacation and business trips, which will lead to a sharp falloff in earnings for the leisure industry overall and for single hotel assets. While not officially labeled a pandemic, the decline in the financial markets continues to indicate that the world economy predicts that it will soon reach this level.

Alternative Accommodations Are Here to Stay:

The short-term rental market is maturing and is estimated to reach 12.2% of total hotel room supply in 2020 according to CBRE Group, a commercial real estate services and investment firm. While some hotel segments such as the luxury sector are relatively unaffected by short-term rentals, this shadow supply which includes Airbnb, Sonder, Churchill Living, Stay Alfred, Domio, Selina and AutoCamp, has crippled the industry’s ability to push rates, particularly in the top 25 markets.

Slowing Macro Economic Growth:

Gross domestic product (GDP) increased at an annual rate of 2.1% in the fourth quarter of 2019, according the Bureau of Economic Analysis. GDP projections for the U.S. for the next five years average 2.0 %. The slowing growth combined with interruptions in travel related to climate change, coronavirus, and terrorism will lead to a difficult environment for the industry.

Consumer spending is going well; however, business investment spending has slowed. The consumer remains the growth driver. A solid labor market continues to support rising disposable income and strong balance sheets, which equal elevated consumer confidence. The trade war has dampened business investment and, in turn, is slowing economic growth. With uncertainty comes a lack of commitment by businesses to invest in large capital projects. Moreover, political uncertainty is adding to the challenge as decision makers wait to see the outcome of the 2020 election.

Robust Cheap Capital:

By cutting interest rates by 0.75 percentage points over three meetings, the Federal Reserve has helped mitigate fears of a downturn and has allowed both the private and public sectors to borrow cheaply. Lower interest rates will revitalize the nation’s struggling housing sector along with supporting rate-sensitive purchases of goods. The missing ingredient in this outlook is inflation. The low-interest-rate environment will provide would-be sellers with alternative options to recapitalize as lack of short-term tailwinds in hotel fundamentals may keep transaction volume low.

Labor Market Remains Tight:

U.S. unemployment continued falling for the fourth quarter and ended 2019 at 3.7% compared with 3.9% for 2018. Wage growth has remained subdued. Employment cost in general increased by 0.7% in the fourth quarter of 2020. Notable is that employment cost in the leisure and hospitality sector demonstrated an increase of 1.2% for the same time period, supporting the thesis that increases in labor cost will represent a threat to continued growth in profitability for the lodging industry. Employee retention is key and the industry should take successful tactics from other industries regarding creative ways to keep valuable employees satisfied.

Construction Project Delays Flatten Supply Growth:

 Hotel construction projects, ranging from renovations to new properties, are taking longer, and this trend is expected to escalate with factory closures and production decreases. While new supply growth has been on the radar for some time, this slackening of the pace has kept the rate of increased rooms stable. STR and Tourism Economics, which provides data benchmarking and analytics for global hospitality sectors, reveal that in the luxury hotel segment, room construction has taken an additional nine months to complete, for a total of two-and-a-half years to complete one room. Meanwhile, in the mid-scale to upscale hotels, it takes hotels an additional three-to-five months from construction inception until completion. Hence, supply forecast for 2020 and 2021 will stay at 1.9%.

Hotel owners and operators will have their work cut out to ensure profitability and, in many cases, meet debt service.

This year, the hotel industry is expected to ramp up the technology and continue their efforts in sustainability, due to customer demand.

Technology: Gaining traction with guests, increased use of technology will be prevalent in the industry with “smart rooms.” From access to streaming services to a room key on a smartphone and more, the essential amenities are becoming increasingly digital. While upfront costs of installation will negatively impact profitability, technological advances in the industry will lower the reliance on labor and enhance the guests’ individual experience through personalization. Watch for increased M&A activity as the industry leaders look to new ways to integrate technology into their model and realize the cost of being slow to react to change.

Going Green: While the focus on sustainability has been prevalent over the last few years, hotel brands have been slow to offer more than simply giving guests the options to reuse their towels. The industry is awakening to consumers’ insistence to fight climate change. The industry is “going green” by incorporating solar power, LEED Certification (Leadership in Energy and Environmental Design), ‘no plastic’ policies and vegan options for dining. Consumers are demanding action against climate change and the industry is listening.

Hospitality Intelligence - Q1 2020

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Deborah S. Friedland

Deborah Friedland specializes in in operational strategy analysis, asset management, valuation, internal control review and assessments, market studies, and transactional due diligence for investors and lenders.

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