No other corner of the commercial real estate industry has been victim to as many converging trends as the hotel sector: Corporations are cutting back on business trips, families are still avoiding airline travel and virtually everyone has less money to spend. The threat of war against Iraq only adds more uncertainty to the scenario, so it's not surprising that no one seems willing to venture a particularly sunny forecast as the industry heads into 2003.

“The conventional wisdom at the beginning of the year was that we would start seeing improvements in the second quarter, but that just didn't happen,” says Thomas Corcoran, CEO of FelCor Lodging Trust Inc., an Irving, Texas-based REIT that owns 183 hotels nationwide. “As the year has progressed, everybody keeps pushing the turnaround to later.”

There is ample reason to be pessimistic. As of September, all of the industry's benchmark statistics — occupancy rates, revenue per available room (RevPAR) and average room rate — trailed the 2001 figures, according to Smith Travel Research in Hendersonville, Tenn.

RevPAR, which takes into account room rates and occupancy levels, dropped 4.8% year-to-date, from $53.48 to $50.89. Through September, average daily room rents fell 2.8%, from $85.78 to $83.36, and occupancy rates dropped from 62.3% to 61.0%.

“We've seen a downward trend in RevPAR for two years now,” says Mark Woodworth, executive managing director at the Hospitality Research Group, a division of San Francisco-based PKF Consulting. “The economy, while slowly improving, is not improving as quickly as we had anticipated.”

The firm predicts RevPAR will increase by 5.6% next year, from $57.51 in 2002 to $60.73 in 2003 for all hotel types, but that still would fall far short of the $68.47 RevPAR posted in 2000.

Goodbye to Luxury

With both business and leisure travelers keeping a close eye on expenses, prospects are particularly gloomy for luxury hotels. Art Buser, managing director in the Los Angeles office of Jones Lang LaSalle Hotels, a New York-based brokerage and advisory firm, adds that corporate executives are under pressure to appear frugal in this down economy. Consequently, they don't want a luxury brand to appear on their expense accounts, even if they can get good deals on room rates.

“I think there's going to be continued pressure on travel budgets,” he says.

The belt-tightening trend is bad news for outfits such as Toronto-based Four Seasons, a favorite luxury brand among business travelers. In a November report, UBS Warburg notes that most travel managers plan to reduce bookings at Four Seasons hotels. As a result, UBS has lowered its 2003 stock price target for the company from $34 to $31.

However, the company predicts an increase in RevPAR and market share for several companies that own midscale brands: Six Continents Hotels, Hilton Hotels, Accor, Marriott International Inc. and Starwood Hotels & Resorts Worldwide Inc.

The Logjam Breaks

The decline in hotel revenues has contributed to a lackluster year for hotel sales. Through June of this year, the number of hotel sales plummeted from 181 to 62, reports the Hospitality Research Group. But experts predict transaction volumes will increase dramatically in 2003, largely because of pent-up demand.

Tom McConnell, senior managing director in the Chicago office of Insignia/ESG Hotel Partners, says even a modest increase in revenues will boost transaction volumes. “If you can point to a recovery, that will unlock a lot of sellers,” says McConnell. “The pent-up capital will have more opportunity next year than it had in 2002, which was really a desert.”

Still Profitable

Despite revenue problems, however, hotel operators have managed to cut costs enough to sustain profitability. The Hospitality Research Group reports that profits dropped 21% in the first six months of this year compared with the first half of 2001. However, the 26.2% profit margin is still higher than the average of 21% from 1960 to 2001.

When the industry enters an up cycle, hotel companies tend to pour money back into items they previously slashed. However, Woodworth believes some cost-cutting measures will continue. “As the market begins to recover — which we think is going to start in 2003 — operating costs will go up, but companies are going to be more efficient,” he explains. “So there were some good lessons learned.”

HOTELS: ANOTHER DISAPPOINTING YEAR

The economic downturn combined with the Sept. 11 terrorist attacks dealt a devastating one-two punch to the hotel sector. Profits declined by 29.4% in 2001 due to the economic slump and a decline in travel caused in part by a fear of airline travel. The industry's performance has remained sluggish this year. Profits are expected to increase by only 2.9% to $16.7 billion in 2002.

Hotel Profitability
1996 1997 1998 1999
Aggregate profit $12.5B $17.0B $20.9B $22.1B
Percentage change 47.1% 36.0% 22.9% 5.7%
Profit per available room $3,525 $4,608 $5,446 $5,566
Percentage change 42.7% 30.7% 18.2% 2.2%
2000 2001 2002E
Aggregate profit $22.5B $16.2B $16.7B
Percentage change 1.8% -28.0% 2.9%
Profit per available room $5,518 $3,898 $3,941
Percentage change -0.9% -29.4 1.1%
Source: PricewaterhouseCoopers LLP, Smith Travel Research