– The current slump in the U.S. lodging industry is going to last longer and cut deeper than the 1991 and 2002 recessions, predicts PKF Hospitality Research. At the root of the decline will be a double dip in demand, or a slowdown on top of weakness that began in April 2007.
“The weakening economy is forecast to lead to a second trough in November 2008 when PKF Hospitality Research forecasts a 0.3% loss in demand,” says Mark Eble, a PKF vice president who addressed the first Midwest Lodging Investors Summit this week in Chicago. NREI and sister publication Lodging Hospitality sponsored the gathering, which drew 500 hospitality executives and is planned to become an annual event.
Supply is projected to increase 2.3% in November, Eble says. As such, occupancies are forecast to decline to 61.6% in that month, well below the 63.1% occupancy level realized at the bottom of the April 2007 trough. In April 2007, demand dropped by 0.2% while room rates increased 7.2%. “The April 2007 dip, we believe, was initially driven by consumers as a result of rising room rates,” Eble says.
This time around, turmoil in the financial markets is slowing the economy and suppressing demand for lodging. “The contagion from the burst of the housing bubble has contributed toward not only the problems that have been well documented thus far on Wall Street, but now we’re seeing other financial institutions in trouble, including Fannie and Freddie,” Eble says. “All have contributed toward heightened levels of anxiety as it relates to the economic outlook ahead.”
Each trough in lodging demand translates into roughly two years to two and a half years of recovery from peak to trough. That’s the time it takes for developers to pull in their horns and allow demand to catch up with supply. “This double trough or double dip is going to extend the recovery to about four years,” Eble predicts.
Numbers in this unsettled climate have been revised downward over the past six months. “We rely on Moody’s Economy.com and their economic forecasts are what drive our lodging industry performance metrics,” says Eble. “Economy.com has continued to lower their outlook for 2008 primarily because of the overall weakening economic conditions -- and within that the persistent problems in the housing markets -- and the resulting difficulties that have evolved within the credit markets.”
In late 2007 and early 2008, for instance, PKF predicted 62.2% occupancy for 2008. That figure has since been revised downward to 61.6%. Average daily rates (ADR) have dropped from the original forecast of 4.7% to 4.1%. And revenue per available room (RevPAR) has been essentially cut in half, dropping from a forecast of 3% growth for 2008 to just 1.5%.
One positive differentiator in the current downturn is a slower decline in employment. “This year, we’re at about 30,000 [job losses] a month,” said Eble. That compares favorably with the 1991 and 2002 recessions when the monthly average of job loss was closer to 100,000 per month.
High oil prices and the credit crunch have taken a toll on the lodging sector. However, the most important and disturbing trend related to the growth -- or lack of growth -- in hotel demand is slowing employment growth, Eble notes. For the 2008 –2009 period, Moody’s Economy.com projects employment growth of just 0.6%. Slower job growth negatively impacts the lodging industry as business and leisure travelers cut back.
Capitalization rates are expected to increase as interest rates rise, cash flows decelerate, and there is higher volatility in the marketplace. While sellers may be lamenting the rise in cap rates from 7.6% in 2007 to 9.5% in 2010, Eble says sellers should take solace in the fact that the 25-year average for cap rates is 10.3%.
Another disturbing trend highlighted by PKF is inflation, historically a friend to the lodging industry. Since the fourth quarter of 2006, however, inflation has skyrocketed 116 basis points to 3.2% at the end of the first quarter 2008. “Hotels, unlike any other form of commercial real estate, are able to change their prices literally every single day,” says Eble. “Ultimately, however, too much inflation does erode the economy and all forms of commercial real estate, including hotels, are negatively impacted as a result.”