Competitive conditions cause slowdown in hotel profits.

PKF Consulting, the international hospitality consulting and real estate firm, finds that hotels in U.S. urban lodging are no longer insulated from the impact of new supply.

"The recent strong performance of urban hotels has made it easier for developers to hurdle the high barriers to entry in these markets," said Patrick Quek, president and CEO of PKF Consulting. "Urban hotels are now encountering the slowdown in performance most rural and suburban properties have experienced in recent years."

Each year, PKF Consulting projects the performance of hotels located in major U.S. cities.

The Urban Streak Ends

For the first time since 1991, PkF Consulting's survey of major city lodging markets in the U.S. is estimating a decline in occupancy for 1998. For year-end 1997, the PKF Consulting sample of major cities revealed an average occupancy level of 73.9 percent. By year-end 1998, the sample is expected to achieve an aggregate occupancy level of 72.8 percent.

This trend of supply growth exceeding demand in major urban centers is projected to continue into 1999, with the average occupancy dropping to 72.8 percent. In fact, nearly half of the markets surveyed are expected to experience a decline in occupancy for both 1998 and 1999.

Despite the projected overall decline, some markets have yet to peak, or are still in a growth mode. "The diverse geographic pattern of development activity in the 1990's continues to impact the industry in a different fashion than did the building boom of the 1980's," said John Fox, senior vice president of PKF Consulting in New York. "While the overall levels of new supply additions have surpassed the number of new rooms built in the last decade, the development patterns have been more disparate in terms of property type and location. The uniformity of development in the Eighties has not been duplicated in the Nineties."

The result has been an avoidance of the sharp nationwide-decline experienced across the board in the late 1980's and early 199O's. Despite the recent surge in new competition, 11 markets of the 41 markets in the PKF Consulting survey will be in a growth mode by 1999. "In general, most markets are still achieving occupancy levels at or above their long-term average," said Fox,

Competition Slows Rate Growth

"Of more concern for hotel owners and operators than the decline in occupancy is the recent slowdown in the pace of growth in average daily room rates," said Fox. PKF Consulting is estimating that the average daily room rate (ADR) for its survey sample will be $112.96 by year-end 1998. This is up 6.8 percent from the $105.75 rate achieved in 1997. For 1999, the average daily room rate is expected to increase only 4.9 percent to $118.52. However, it should be noted that this $118.52 figure is nearly 50 percent greater than the ADR back in 1990.

"Up until 1998, most markets were able to mitigate their declines in occupancy with strong increases in ADR. However, starting in the first quarter of 1998, we began to track a slowdown in rate growth, that when combined with the declines in occupancy, results in revenue improvement that can best be called temperate," Fox added.

For 1998, 11 markets in the PKF Consulting survey are estimated to experience a decline in REVPAR (Revenue Per Available Room), while another 12 markets will average REVPAR increases less than inflation. "This trend is expected to slacken somewhat in 1999, driven by a slowdown in the pace of occupancy decline, not by an improvement in ADR growth," Fox said.

Tempered Rates Mean Tempered Profits

In the lodging industry, a direct correlation exists between the ability to raise room rates and the growth in hotel profits. In recent years, despite declining occupancies for most hotels, ADR growth in excess of inflation allowed for double-digit growth in profits. PKF Consulting's 1998 edition of U.S. Trends in the Hotel Industry surveyed over 2,800 hotel financial statements. Despite a 0.3 percent decline in occupancy, a 7.4 percent increase in ADR allowed for a 13.2 percent growth in operating profits. "The first signs of a slowdown in ADR growth should raise red flags for industry investors," said Fox.

He warned that this slowdown in rate growth does not necessarily mean bargains for meeting planners, travel agents and corporate travel executives. "Consumers shouldn't expect to see a broad-based decline in room rates. With the aid of automated yield management systems and revenue management practices, hotels will still continue to push room rates during peak weekdays and their in-seasons," said Fox. In order to find discounts, business people, tourists and meeting planners need to be flexible with their travel plans and allow the hotels to steer them towards dead spots on their calendars.

Economy is Key to the Future

With the industry approaching a period of slower growth or potential decline in some sectors, the magnitude of the recession is of most concern for hotel owners and operators. Two potential stimuli exist that could influence the extent of the next industry recession or downturn: over-development and the economy. "The implications of an industry recession induced by over-development, as opposed to an economic slowdown, are quite different," Fox said.

Most people in the industry have concentrated on observing and measuring new construction activity as the indicator or catalyst for the next downturn. As has been evident in previous surveys, the industry has been able to handle the current development surge more successfully than it did in the 1980's. "We know that overdevelopment will create a more competitive market, lower occupancies, and eventually a slowdown in rate growth," said Fox. "However, if the economy stays healthy, demand continues to grow, and consumer confidence remains high, there should be a continuation of the diverse performance levels among markets and product types that we have seen in the 1990's. An industry recession caused by oversupply will be a series of moderate cyclical fluctuations that allow for some to thrive while others fail."

Alternatively, an industry recession caused by a slowdown in the national economy could have much greater implications. If there is a sudden cutback in the volume of travel, the negative impact of all the new supply will be compounded. An economic recession will also cause a tightening of corporate, as well as personal, travel budgets. "The combination of greater room availability and intolerance for high prices would create an environment that could lead to a decline in room rates," said Fox.

Since a direct correlation exists between growth in ADR and profits, a decline in ADR can be expected to lead to a decline in profits. "Hotel managers typically fear new construction in their markets. They should look at the broader picture and check the economic indicators," said Fox. "Clearly, the ramifications of an industry recession caused by an economic downturn are greater than worries of over-supply."

New York City 

New York City projections for 1998 and 1999 indicate that the continued strong level of demand for hotel rooms will continue. Projected occupancies for New York are "flat at 84 percent for both years," said Fox. "This is not reflective of any downturn in demand, but of a capacity situation. For much of the year, the City is effectively sold out. Thus, the occupancies cannot rise by any sizeable margin."

Room rates are a different story. Fox indicated that the average cost of a room in New York City will be $212 for 1998 and $227 for 1999. "This is the first time on an annual basis a major city has broken the $200 barrier," Fox said. "What is most interesting is that it wasn't really all that long ago that we broke the $100 barrier. Room rates in New York City broke that barrier for a calendar year in 1987."

"All of the fundamental factors that have driven New York occupancies and rates to the record levels of these past few years are expected to continue," Fox said. "The strong local economy fueled by Wall Street, coupled with the better reputation the City now enjoys, have come together to create an unprecedented level of demand for rooms in New York."

There are indeed a number of new hotel projects in the planning stages for New York City, and in fact, net supply additions have occurred and will continue to occur for the next several years. "However, despite this fact, we believe the demand levels are such that the City can easily absorb this increase," Fox said.