Hospitality

U.S. Hotel Market: An Overview

Demand is high and fundamentals are strong — for now.

There's an imbalance in the hotel segment right now, but it's benefiting investors and hotel owners. Demand is far outpacing supply. That simple dynamic has built a strong hotel segment across the United States, and it continues to gain steam in many of the largest U.S. markets. Thanks to that shortfall in supply, the hotel market should continue to improve over the next few years.

The data supports market observations; it's clear that demand for U.S. hotel rooms should remain high over the next several years, and investors and hotel operators should benefit from higher revenue per available room and higher average daily rates in markets from coast to coast.

Market Fundamentals

The U.S. hotel segment has experienced 78 consecutive months of positive growth, according to Marcus & Millichap’s National Hospitality Group. The market is buoyed by more than 60 months of steady employment gains, and 2.5 million new jobs are projected for 2016. The U.S. has already added a healthy 414,000 jobs in January and February this year, exceeding predictions from labor economists. Throughout the country, healthy job growth has translated into continued demand for business and leisure travel, which has yielded strong ADR and RevPar growth.

Supply. Approximately 132,000 rooms are under construction throughout the country, according to travel research firm STR. A majority of them are upscale and upper-midscale chains, represented by Hilton and Marriott’s familiar flags.

At this point in the cycle, the top-tier cities are approaching all-time supply highs, limiting the potential for continued occupancy gains. The San Francisco market is the perfect encapsulation of this, as occupancy dipped by 0.9 percent in third quarter 2015, but the occupancy level achieved was 90.3 percent.

Demand. U.S. hotel occupancy is expected to remain at record levels through 2017, based on data from PKF Hospitality Research/CBRE Hotels. In the December 2015 edition of Hotel Horizons, PKF estimated demand to exceed supply in each of the next two years. As a result, a national occupancy rate of 66.0 percent is projected in 2016 and 2017, which is nearly identical to Marcus & Millichap’s projection of 65.9 percent.

 

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Occupancy. Calendar year 2015 was the best year on record for occupancy rates. In 2015, occupancy rates averaged approximately 73 percent for full-service properties, and 70.5 percent for limited-services properties, according to Integra Realty Resources’ Viewpoints. These record occupancy rates top the previous peak, set in 1995, of 64.7 percent and stemmed from lagging supply that’s still trying to catch up to growing demand.

ADR Growth. Because of the forecasts of demand exceeding supply, IRR sees ADR growth ranging from 5.0 to 6.3 percent through 2018. Marcus & Millichap is predicting a $125.41 ADR in 2016, which represents an increase of 4.5 percent.

Transactions. CoStar reports a year-end total of 2,520 transactions in 2015 versus a year-end total of 2,517 transactions in calendar year 2014. Transaction values climbed in 2015 to $49.7 billion, according to Real Capital Analytics, a 45.2 percent year-over-year increase. Geographically, the largest YOY increase was realized in the Central region (106.6 percent), followed by the East (74.8 percent), the South (37.9 percent), and then the West (21.0 percent).

However, in January, the total transaction volume was down 60 percent across all hotel types from the year prior. The January volume was the lowest monthly volume in the past two years and the third lowest since January 2013. While transaction volume may dip throughout the remainder of 2016, IRR believes that the average price per room will continue to show steep gains, similar to the YOY gains between 2014 and 2015.

Hotel capitalization rates are gradually trending upward, according to RCA. Cap rates in January are 27 basis points higher than a year prior and are at their highest levels over a three-year period.

Threats. New supply is being artificially created by Airbnb; however, industry experts are uncertain how much collateral damage is being done to the industry. Because Airbnb is not forced to reveal its operating results, the industry has no way to gauge its true market.

“There is little evidence that Airbnb is leading to fewer compression nights or reducing pricing power of those nights,” STR recently reported, But, according to a recent Goldman Sachs survey, “once consumers switch, they don’t go back to hotels.” Until the playing field is leveled, and Airbnb is required to license and collect taxes, IRR believes that it remains a credible threat to the industry.

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Wage growth has increased by 5 to 6 percent in the past few years, according to Marcus & Millichap. Growth in 2015 was estimated at 2.1 percent and is expected to continue at 2.5 percent for 2016. RevPar growth of 8.0 to 10.0 percent has allowed operators to continue to pay increasing employee costs, but any leveling of ADR and occupancy would create an escalating expense, and a decrease in net operating income and resultant values.

Financing. Developers continue to utilize floating rates, taking advantage of the low Treasury rate. While there is some continued risk of increasing interest rates, it appears to be mitigated and offset by the current ADR and NOI growth. Increasing room rates and record occupancy levels allow developers to receive better financing terms. Because demand continues to outpace supply throughout most of the country, new construction is not yet a cause for alarm.

Strength Factor: Demand

Demand is driving the hotel segment in North America. That demand is causing upward pressure on both ADR and RevPar, across both large U.S. cities and resort towns on the water.

Continued demand will drive high occupancy rates over the next few years, and it will outpace supply even as more hotel rooms come online over the next 12 to 24 months. From coast to coast, investors see hotels as a safe bet because of these underlying fundamentals and favorable financing. Consistent job and wage growth should continue to bolster these trends.

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Jeff Greenwald, MAI, SRA, FRICS

Jeff Greenwald, MAI, SRA, FRICS, is senior managing director/principal, Integra Realty Resources in San Diego. Contact him at jgreenwald@irr.com.

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