Squeezing Juice From The Pineapple

Stability, however, carries with it a great burden for hotel operators. Historically, hotel managers have made money differently than other businesses. Lodging is an industry that has benefited from its ability to increase prices to offset sharp gains in operating expenses. This contrasts the typical U.S. business model of increases in productivity and modest price increases.

Already in 2006, as the pace of occupancy and ADR growth slowed as the year progressed, our forecasts for unit-level profit growth decelerated commensurately. Looking towards the future, if revenues are going to grow at a more modest pace, operators must begin to pay attention to the cost side of the equation to generate profits. Managers no longer will have the luxury of covering rising operating costs with extraordinary increases in revenue.

Future profits will come from squeezing more juice out of the hospitality pineapple.

Sour Fourth Quarter

U.S. lodging industry performance fell off during the fourth quarter of 2006. Through the first nine months of the year, RevPAR was up 10.1 percent from the same period of the prior year. However during the fourth quarter of 2006, RevPAR growth had decelerated to 8.8 percent.

Limited-service property performance was impacted the most. In the fourth quarter of 2006, the RevPAR for this segment grew 6.4 percent over the fourth quarter of 2005. This compares to a 10.9 percent gain in RevPAR during the first three quarters of the year. Concurrently, fourth quarter full-service RevPAR growth was a relatively strong 9.6 percent, down just slightly from the 9.8 percent pace achieved through September of 2006.

Much of the slowdown can be attributed to the abnormally strong performance experienced during the fourth quarter of 2005. It would be unrealistic to repeat the lofty occupancy and ADR levels achieved by markets that benefited from displaced Katrina related demand during the later months of 2005.

Also influencing the reduction in RevPAR growth were the first signs of new development. Although the room inventory in major U.S. markets grew just 1.1 percent in the fourth quarter of 2006, this is the greatest quarterly supply increase observed since the third quarter of 2003. The increase in supply, combined with a slight decline in demand (0.3 percent), combined to lower fourth quarter occupancy rates by 1.4 percent. Fortunately, for hotel owners and operators, average daily room rate growth remained strong at 9.2 percent.

2006 Still Sweet

Despite the slowdown in fourth quarter performance, 2006 was a strong year for U.S. hotels. By year end 2006, the RevPAR for hotels in the nation’s largest cities grew 9.5 percent over the RevPAR achieved in 2005. While this RevPAR growth is less than that achieved during the initial stages of the industry recovery (2004 and 2005), the revenue improvement was driven primarily by gains in ADR (9.2 %), as opposed to growth in occupancy (0.3 %). Given that the industry is at the peak of the recovery cycle, this relative movement of occupancy and ADR is to be expected.

Although both segments performed extremely well, limited-service hotels fared slightly better than full-service properties in 2006. Limited-service RevPAR grew 10.0 percent for the year, while full-service properties enjoyed a 9.2 percent growth in rooms revenue.

The cliché says that, “a rising tide lifts all boats.” However, as we always caution our clients, the hotel industry is a “street corner” business. Industry performance varies significantly from market to market. Despite the strong national industry performance measurements, we did observe some markets that had sub-par growth in RevPAR, while others achieved exceptional gains.

Not including markets in the South Central region that were directly impacted (both positively and negatively) by displaced Katrina demand, there were four markets in the U.S. that achieved RevPAR growth in excess of 15 percent. On the other hand, hotels in three cities saw their RevPAR grow less than 2.0 percent for the year.

With most markets enjoying moderate to strong gains in ADR, occupancy growth appeared to be the determining factor in the success of RevPAR gains. Occupancy declined in each of the cities with low RevPAR growth. Conversely, occupancy grew in excess of 3.5 percent in the markets with extremely strong RevPAR growth rates.

2007 – The Core Is Solid

For 2007, PKF Hospitality Research and Torto Wheaton Research are projecting continuing growth in revenues, but at a much more modest pace. By year-end 2007, we are forecasting occupancy to increase by 0.4 percent, while room rates should grow 4.5 percent. The net result will be a 5.0 percent gain in RevPAR.

The year looks brighter for limited-service revenue growth. Hotels in this segment are forecast to enjoy gains in both occupancy (3.2 %) and ADR (4.3 %), for an annual RevPAR increase of 7.6 percent. Full-service properties are expected to be able to push their room rates to a greater degree (5.3 %) than their limited-service counterparts, but suffer a 1.3 percent decline in occupancy. Therefore, this segment will see RevPAR growth of just 3.9 percent for the year.

As we have seen the past few years, hotel performance is expected to be strongest in the coastal regions of the country. Hotels in the New England / Middle Atlantic, and Mountain / Pacific regions are forecast to achieve RevPAR growth in excess of 6.0 percent in 2007. Market conditions will be softer in the central part of the country. North Central cities are projected to see a RevPAR increase of 3.4 percent, while RevPAR in the South Central region is forecast to grow just 0.3 percent.

Drink Up

U.S. lodging industry fundamentals are solid. Supply is growing at reasonable levels, and the forecasted performance of the nation’s economy should continue to have a positive impact on lodging demand. The pace of revenue and profit gains may diminish, but we are forecasting an abnormally long period of industry growth.

For hotel owners and operators, our recommendation is to stick an umbrella and straw in your pineapple and drink up. Happy hour should last a while.

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