As the U.S. economy continues to flounder and the credit markets remain tight, the plight of many hotel owners and operators only worsens. PKF Hospitality Research forecasts a 37.8% average decline in net operating income this year on a same-store basis — the biggest drop on record since it began tracking hotel data in the 1930s.

Real Capital Analytics estimates that as of June 30 there were 1,025 distressed hotel assets nationally totaling some $17.4 billion. The recent filing by Extended Stay Hotels for Chapter 11 bankruptcy protection caused the level of distress to balloon by 216% year-to-date through June.

The hotel market is out of equilibrium, according to PKF Hospitality Research. An anticipated 5.6% drop in room demand this year combined with a 2.7% increase in supply is expected to result in a 17.5% decline in revenue per available room (RevPAR). The research firm projects that average U.S. hotel occupancy in 2009 will be 55.5%, the lowest in 20 years.

Recalibrating expectations

In 2010, RevPAR is forecast to drop an additional 3.5%. “We do not think that we will see a meaningful economic uptick until the housing market begins to recover, which will likely be in the back half of 2010,” says Mark Woodworth, president of Atlanta-based PKF Hospitality Research. “Come 2011, the economic recovery will hopefully begin to sustain itself and lodging demand will begin to expand at above average levels.”

The decline in hotel fundamentals is tied to U.S. real gross domestic product, which fell at an annualized rate of 5.5% in the first quarter. “I'll tell you what corporate demand is, if you tell me what GDP is going to be. It's as simple as that,” says Laurence Geller, CEO of Strategic Hotels & Resorts, whose portfolio of more than 8,300 rooms includes convention hotels, business hotels and resorts.

Hotel managers will cut costs by an average of 7.5% this year, predicts PKF Hospitality Research, but that's not nearly enough to offset revenue declines. Their ability to identify additional cost savings is becoming more challenging. “Given the fixed and variable cost structure of hotel operations, making further expense reductions at this low level of performance becomes very difficult,” says Woodworth.

Light at end of tunnel

The U.S. hotel industry is expected to turn a profit in 2009, but profit margins are forecast by PKF to be well below the long-term average of 25.7%. The good news is that the pace of decline is slowing. While demand fell 8% in the first quarter year-over-year, PKF projects quarterly declines for the rest of 2009 will average 4.7%. PKF is calling for average annual increases in demand of 3.2% over a four-year period beginning in 2010, well above the long-term average of 1.9%.

While the entire hospitality market has felt the sting of this recession, the luxury segment has been especially vulnerable with consumers becoming increasingly price conscious. Through the first four months of this year RevPAR at luxury hotels in the U.S. was down 27.5% compared with the same period a year earlier.

Strategic Hotels & Resorts reported first-quarter EBITDA (earnings before interest, taxes, depreciation and amortization) of $22.8 million compared with $55.7 million during the same period a year ago, a 59% drop. The REIT's stock, which had fallen to as low as 61 cents per share in March, closed at $1.06 on July 2, well below its 52-week high of $11.01.

Geller says that Strategic Hotels wants to “demonstrate to the world that we're not a bankruptcy candidate and that we're being unfairly priced as an option.” The company has no maturing debt until 2011, he emphasizes.

Strategic Hotels has cut corporate overhead and is marketing for sale underperforming assets such as the Fairmont Chicago. The company plans to enhance its liquidity through aggressive asset management practices. It's also limiting capital outlays and seeking opportunities to raise efficiently priced equity.

The longer-term outlook for the hotel sector is favorable, Geller says, in what he predicts will be a supply-constrained environment. “We will see an increase over the new few years in the meetings business, and the leisure business will be a tremendous boom. Then you will have the Indian subcontinent and Chinese subcontinent traveling extensively, adding to the overall global travel mix.”