Lodging Industry Rebounds
Investors check in for the next up cycle.
Operating metrics in the
lodging industry have rebounded smartly from the 2009 cycle bottom and have
already or are close to exceeding pre-recession peaks.
Revenue per available
room, or RevPAR, ran at a record high $68.69 in 2013 according to Smith Travel.
Also at a record high was the average daily rate at $110.35, up 13.2 percent
from the 2009 cyclical bottom.
Room occupancy has been
slower to recover, even with new supply additions of just 1 percent or less
during the last three years. Demand growth for 2013 was 2.2 percent while guest
room occupancy was 62.3 percent. The pre-recession occupancy peak was 63.3
percent set in 2006. Occupancy should inch ahead of that, probably in 2015.
Looking ahead, occupancy
growth is expected to follow economic growth. Both are expected to trend upward
over the next few years but only modestly so. Average daily room rate is
expected to increase at a faster pace, in the 3.5 percent to 4.0 percent range,
as new supply additions are forecast to remain at low levels.
These are the important
metrics for monitoring lodging’s earnings growth moving forward, as most of the
profitability gains from streamlined operations have already been taken. These
metrics are also the key to improved investor sentiment for increased
transaction activity and, a little bit later, for the developer sentiment
necessary to ignite a new construction cycle.
The Lodging Real Estate
The overall economic
recovery, although consistently trending up, has been slow and sluggish. The
fall from the previous peak was so steep and the financial crisis so pervasive
that the economic recovery could be running as much as two years behind the
pace of more normal recessions. Investors, lenders, and Wall Street still
appear a bit timid as capital accumulates on balance sheets.
Faster economic growth
would lead to increased guest room demand, which would lead to greater
transaction activity for single and portfolio assets. Higher interest rates
could also spark greater transaction activity.
The lodging construction
pipeline has been in a narrow bottoming channel since it reached bottom in
early 2012. The pipeline is now 50 percent below its peak reached in 2007. New
supply growth has been insignificant over the last four years. Yet as modest as
guest room demand growth has been, it has still outpaced supply growth.
Beyond a more complete
lending recovery, other important triggers to start a new construction cycle are
a further rise in transaction volume and selling price per room to reach a
crossover point where building new hotels becomes less expensive than buying
and repositioning existing hotels. It may take at least another two years
before the pipeline catapults forward.
In the meantime, the next
few years make for an attractive sweet spot for operators of existing open and
operating hotels: growing guest room demand, rising pricing power,
record-setting operating metrics, and little new supply coming online as the
economy moves forward. It’s an ideal investment environment.
Total transactions and
property transfers peaked at 3,218 hotels/441,613 rooms in 2007, then fell
precipitously to a bottom of 528 hotels/60,804 rooms in 2009, an 84 percent
decrease in hotels sold.
After rebounding a bit in
2010, transaction and property transfer volume have been locked in a narrow
bottoming formation, with little merger and acquisition activity. In 2013,
1,171 hotels were sold or transferred: 775 were individual, single-asset
transactions while another 395 were portfolio transactions.
Markets with the highest
number of transactions were Atlanta with 41; Dallas, 27; Houston, 22; Phoenix,
21; and Orlando, Fla., 19.
In 2013, 898 hotels had a
publicly reported selling price. Based on those figures, the average selling
price per room was $132,955, the highest ever recorded. Prices are accelerating
because of improved profitability, lower capitalization rates, and a larger
number of upscale hotels in the sales mix.
With a selling price of
$539,033 per room averaged over 12 transactions, New York City leads all
markets. Honolulu follows at $321,468 per room, then San Diego at $288,971, San
Francisco at $264,543, and Boston at $220,175. These major markets generally
have larger, more upscale center city or waterfront type hotels in their sales
Seller and Buyer Activity
The period 2013-14
represents the conclusion of the first leg of the new lodging real estate
cycle. The period is characterized by improved profitability, confidence about
future operating trends, and near-record low interest rates. It is an opportune
time for investors to dispose of their stabilized assets and take profits,
particularly for those acquired late last decade during the recessionary lows.
Total investment in the
lodging industry reached an estimated $21.8 billion in 2013, the highest level
recorded since 2009, and is expected to accelerate even higher in 2014.
For the 898 hotel
transactions that reported a selling price, investment totaled $16.8 billion,
up nearly 60 percent over 2012.
Privately held equity
funds and hotel companies accounted for 62 percent of the 2013 sales activity.
They were net sellers within their respective portfolios as they implemented
exit strategies for many assets acquired or developed earlier. Publicly traded
real estate investment trusts followed with 18 percent of the sales activity.
On the buy side, REITs
were net purchasers of lodging real estate for their portfolios and accounted
for 30 percent of buying activity. Privately held equity funds and hotel
companies were also heavy buyers, accounting for 27 percent and 15 percent of
all buying activity respectively.
In great demand are
upscale branded and independent hotels in center city, suburban, and resort
locations in the largest markets.
Investors see considerable
opportunity ahead in the second leg of the new cycle. Since the construction
pipeline is unlikely to produce new supply additions of any magnitude until
late in the decade, and even if overall economic growth were to remain
sluggish, slow and steady growth should still produce attractive returns over a
typical holding period for assets purchased today.
The New Construction
At the end 2013, the total
construction pipeline stood at 3,020 projects/382,958 rooms.
The pre-recession pipeline
peak occurred in 2007 at a whopping 5,438 projects/718,387 rooms, the highest
year-end peak ever recorded. It later bottomed at 2,753 projects/334,712 rooms
at year-end 2011.
New hotel openings (new
supply) peaked in 2008 at 1,341 hotels/154,257 rooms, tailed a bit in 2009,
then fell precipitously and bottomed in 2011 registering 346 hotels/37,193
Ninety percent of today’s
pipeline is made up of select-service properties, practically all are branded,
most are under 200 rooms and are located in urban center and suburban locations
in the largest markets. Most are prototypical branded projects, generally enter
the pipeline a year out, and get into the ground quickly.
Conversely, there are
historically few luxury and “big box” convention hotels with long development
timelines in the pipeline. It’s a reason why the early planning stage continues
to fall and has yet to bottom. Large urban center or resort projects can take
up to 48 months in the pipeline while the typical mid-market project averages
about 22 months from entering the pipeline until it opens and comes on line as
Franchise companies with a
portfolio of brands across the upscale and midscale chain scales dominate the
pipeline: Marriott with its Residence Inn, Courtyard, Fairfield Inn, and
TownPlace Suites; InterContinental Hotel Group’s Holiday Inn, Holiday Inn
Express, and Staybridge Suites; and Hilton with its Garden Inn, Homewood
Suites, Hampton Inns, and Home2 Suites are among developer favorites.
By far, New York City has
the largest construction pipeline of any market in the country at 160
projects/27,464 rooms. When built out, New York’s stock of open and operating
hotels will expand a remarkable 30 percent by hotels and 26 percent by rooms.
Other markets follow: Houston with 89 projects; Washington, D.C., 86; Los
Angeles, 59; and Dallas, 50. Miami; Austin, Texas; and Boston all have 48 each.
Investment in property
redesign and furniture, fixture, and equipment replacement again ran at record
levels in 2013.
Because of the recession,
hotel profitability decreased sharply and bank lending dried up as well. As a
result, renovation activity plummeted from previous peaks and bottomed out in
mid-2010. When the economy finally reached its bottom, property owners moved
quickly to upgrade their hotels for the expected recovery in guest room demand,
pricing power and the anticipation of the lag in new supply additions coming
In hindsight, this
reinvestment surge will prove to be quite favorable as product life cycles were
extended and property valuations increased.
For the lodging industry,
there’s a terrific sweet spot ahead that could last late into the decade, the
depth of which depends on the overall growth and speed of improvement in the
The key is boosting the
GDP growth rate up more than 3 percent for the next few years. That could
happen now that many of last year’s economic and political issues have been
resolved or at least mitigated.
Main Street lending for
smaller projects is increasingly more available but delays in the
implementation of the Dodd Frank rules remain a big restraint to economic
growth. It hinders the re-emergence of Wall Street’s traditional investment
banking role, serves as a drag on real estate financing, and has an adverse
impact on investor and developer sentiment.
The second leg of the
lodging recovery cycle shows great promise. Against a backdrop of benign new
supply, economic improvement should bring increases in guest room demand and
greater pricing opportunity, causing profitability to accelerate forward.
Look for transaction
volume to increase as Wall Street becomes reenergized and the industry begins
to consolidate. It will be an opportune time to be an investor as there should
be a strong five-year holding period ahead.
Later, as occupancy rates
increase and transaction prices plus the cost of renovations rise above the
cost of replacement, a surge in new project announcements into the construction
pipeline will be triggered. But any pipeline increase will not convert into new
supply additions for at least two years thereafter.
When new supply, currently
at less than 1 percent of existing inventory, rises above 3.5 percent that will
signal that we have entered into the maturity leg of the lodging cycle.
All indications are that
that won’t happen until late in the decade. Barring any reversal in the overall
economy, the interim period from now until then defines that highly desired
sweet spot for investors.
Patrick H. Ford is
chairman and founder of Lodging Econometrics, National Hotel Realty, and New
England Hotel Realty of Portsmouth, N.H. Contact him at