The scenario is all too familiar: For the third straight year the hotel industry is faced with lackluster demand and declining revenues. As the sector waits anxiously for business and leisure travel to bounce back, some of the most prominent hotel companies are focusing on maintaining their core properties instead of expanding their portfolios.

Hilton Hotels Corp. (NYSE:HLT), which placed No. 3 on NREI's ranking of the top hotel owners, finds itself adopting that strategy. The company owned 127 hotels as of Dec. 31, 2002 — including 58 wholly owned hotels and 69 joint-venture properties — down from 130 properties the previous year, and it has not made any major acquisitions in the past 12 months.

“We'd rather use our capital to improve the properties we have, to continue paying down our debt and perhaps to repurchase our stock,” says Matthew Hart, executive vice president and CFO at Hilton.

The company's last big acquisition was the $155 million purchase of the Hilton Waikoloa Village in Hawaii in the first quarter of 2002. The company, which previously owned a minority share of the property, purchased the remaining 87% from Japanese investors.

‘We Have Hit Bottom’

The numbers have been disappointing for both Hilton and the industry as a whole. Nationwide, revenue per available room (RevPAR) declined by 1.6% to $46.35 and the average daily room rate (ADR) decreased by 0.5% to $84.72 in the first quarter of 2003 compared with the same quarter last year, according to Hendersonville, Tenn.-based Smith Travel Research. Occupancy levels nationwide also fell to 54.7%, a 1.1% decrease from the first quarter of 2002. In the wake of revenue and occupancy declines in 2001 and 2002, hotel companies were hoping for better news to start off the year.

In the first quarter of 2003, RevPAR at Hilton's company-owned properties fell by 2.2% to $97.45, while ADR declined by 2.7% to $145.82. There was one bright spot in the first quarter — the occupancy rate rose to 66.8%, a 0.3% increase.

These disappointing numbers follow “a pretty poor year in 2002,” notes Hart. “We're doing okay, but we're nowhere near the profitability of the past and what we anticipate in the future.” Net income at the company dropped from $34 million in the first quarter of 2002 to $9 million in the same quarter this year.

The soft economy and continued concerns about terrorism are the main culprits, and Hilton isn't expecting a travel rebound this year. In its first quarter report, the company predicts RevPAR at its owned properties will decline by 1% to 2% this year.

The hospitality division of New York-based PricewaterhouseCoopers is a bit more optimistic. The firm predicts a slight RevPAR increase of 0.5% this year. “We have hit bottom, but it won't be until we're well into 2004 before the numbers will start to indicate that a recovery of some form is under way,” says Bjorn Hanson, a global hospitality partner at the firm.

Seizing the Opportunity

Although growth is at a standstill in Hilton's company-owned portfolio, the company plans to add 100 to 115 hotels through franchising agreements this year. The company's franchise roll now stands at 1,745 and includes the Hilton, Hilton Garden Inn, Doubletree, Embassy Suites, Hampton Inn and Homewood Suites brands.

Approximately two-thirds of the new properties will be Hampton Inn and Hilton Garden Inn hotels. Those hotels, which tend to be much smaller than the company's other properties, make more sense to build in today's tight financing climate, says Hart.

“They are the lowest-cost properties to build in our family of brands, so franchisees are able to come up with the financing to build them,” says Hart. It costs about $5 million to build a Hampton Inn and $10 million to construct a Hilton Garden Inn.

Although Hilton's company-owned construction pipeline is dry, its Orlando, Fla.-based Hilton Grand Vacations Co. timeshare division remains active. Hilton plans to spend $110 million this year to build timeshare units.

The company recently opened the first phase of its 384-unit timeshare property in Orlando near Walt Disney World and has begun offering timeshare units at its flagship New York Hilton property at 1355 Avenue of the Americas in Manhattan. One hundred units on the 35th and 36th floors of the hotel are being converted into 78 studio, and one- and two-bedroom suites, marking the first time the company has offered timeshares at one of its hotels.

Hilton considers the timeshare market a prime opportunity to grow revenues and eventually expects those properties to represent about 10% of its overall income.

Overall, Hart predicts that Hilton will benefit from an improved economy and a slow construction pipeline in 2004. “Investors feel that hotels have been through the worst of it,” Hart says. “And with little new supply on the horizon, that should translate into pricing power and operating leverage.”