Ten-X Research reveals hotel sector facing major challenges due to a large infusion of supply and steadily declining demand
IRVINE, Calif. and SILICON VALLEY, Calif., Dec. 7, 2016 — Ten-X, the nation's leading online real estate marketplace, today released its latest Quarterly Hotel Monitor report, including the top five 'Buy' and 'Sell' markets for hotel real estate assets. The long-term forecast reveals the sector continues to face significant challenges, including a slowdown in international travel and an expansion in supply coming to market as demand slows.
Ten-X's long-term forecast reveals Las Vegas, Jacksonville, Fla., Sacramento, Calif., Los Angeles and Indianapolis as markets in which investors should consider buying hotel assets. These markets are being fueled by strong economies fueling demand for rooms, coupled with well-timed lulls in hotel supply growth, which stands in stark contrast to the sector as a whole.
Houston, New York City, Pittsburgh, San Jose, Calif., and Northern New Jersey are the top markets where Ten-X Research estimates that market conditions might prompt hotel investors to consider selling their properties. While broader economic conditions in these cities vary widely, nearly all are being inundated with new supply – both traditional and non-traditional – which combined with slumping international travel and other factors, make for a weakened hospitality industry climate.
Total supply growth over the last year was measured at 1.7 percent, a new high for the cycle, while demand increased just 1.6 percent. This marked the second time in the last three quarters that supply outpaced demand, driving occupancies down 20 bps to a seasonally adjusted 65.3 percent. Despite those troubling signs, room rates rose 1.2 percent and are now 3.3 percent higher than a year ago, causing revenue per room to jump to take a corresponding jump. Room rates in the country's largest 25 metropolitan areas have now increased 2.5 percent over the last year, but continue to be dragged down by outliers such as Houston, which remains in the throes of an economic slump brought on by low oil prices. Rates in the country's smaller metro areas fared slightly better, increasing 3.6 percent year-over-year.
Thanks in large part to the U.S. economy's continued resilience amid widespread uncertainty both global and domestic, consumer spending on hotels and motels has now hovered around the $100 billion mark for several quarters. That should help fuel slow growth for the sector through 2018, according to Ten-X's forecast model, including annual room rate increases of roughly 3.5 percent and RevPAR increases of 4 percent this year and 3.7 percent during the two years to follow. As GDP continues to slowly expand, hotel revenues should follow suit, and occupancies are expected to hit a record peak of 73.5 percent by 2018 before declining to roughly 68.7 percent amid a expected modeled cyclical downturn.
The sector faces a number of troubling developments, including the strength of the dollar following Brexit that has tempered international travel to the U.S. High-profile markets such as New York City, Miami, Washington, D.C. and San Francisco – already struggling with a glut of shadow supply brought on by the rise of Airbnb – project to be hardest hit by the decline in visitors. Business travel has also declined modestly over the last year, and may face an uphill battle in the years to come as companies increasingly rely on videoconferencing and other tech-oriented solutions to communicate.
"While our research indicates the hotel sector will see modest growth over the next two years, a number of factors continue to erode demand, right as a surplus of supply prepares to hit the market," said Ten-X Chief Economist Peter Muoio. "While strong economic conditions in the West and other metro areas may still hold some allure, these dynamics are combining to make the market an increasingly risky bet for investors."
The average price per key declined modestly to just over $150,000 during Q3, though it remains nearly 7 percent higher than the same period in 2015. Cap rates, meanwhile, held steady at 8.5 percent, and have now risen 30 bps over the last year. Deal volume in the sector increased to roughly 7.6 billion during the third quarter – a 6.6 percent jump over the second quarter and 2 percent year-over-year – but continues to fall well short of the cyclical peak it reached in early 2015.
Buy Markets
Las Vegas
Las Vegas hotels are poised to flourish in the coming years, thanks largely to a contraction in room supply in recent quarters and quiet supply pipeline. Though demand saw only modest growth over the last year, occupancies jumped a full 110 bps to 73.4 percent in the third quarter alone, according to STR. Meanwhile, room rates spiked dramatically, most likely due to the closure of underperforming hotels that were weighing down the market statistics as a whole. The city's historically volatile economy is enjoying a fortunate period, having reached an all-time peak in employment thanks to three straight years of healthy growth, including a 2.3 percent gain over the last year. The massive leisure and hospitality sector has rebounded from a six-month slump, while the divergent directions of unemployment and population growth suggest an ideal economic backdrop for investors.
Jacksonville
A host of solid demographic shifts have made Jacksonville an ideal place for hotel investment, including an economy enjoying solid growth as evidenced by 4.7 percent job growth over the last year. The region's professional and business services sector, which accounts for more than 15 percent of its economy, has captured new momentum, while accelerating population growth and falling unemployment indicate it is in the midst of economic expansion. These dynamics have helped propel the area's hotel industry, raising both room rates and revenue per room to all-time peaks during Q3. A tepid supply pipeline poses little risk to the market's health, though Ten-X Research indicates it may take a step backward should the wider economy begin to slump in 2019.
Sacramento
While occupancy rates in California's capital are currently sitting just below 70 percent, and room rates and revenue per room have been climbing for 13 straight quarters, and demand is projected to outpace the limited additions to supply through at least 2018. A consistently growing regional economy makes the area a strong bet for investors, buoyed by a burgeoning education and healthcare services sector.
Los Angeles
Demand for rooms in Los Angeles rebounded after a weak second quarter, helping rates continue to grow at a breakneck pace of about 9 percent year-over-year. Nearly flat supply has helped drive occupancies to 80.9 percent and will help the market weather any cyclical downturn. Currently, the local economy is healthy highlighted by thriving leisure and education/healthcare sector. According to Ten-X Research, occupancies should not fall to lower than 78 percent during 2019 and 2020, while revenue per room should decline by only around 9.6 percent total – well below the national average under a stress test scenario.
Indianapolis
Demand for hotels in Indianapolis is currently in a slump, as evidenced by occupancies falling 60 bps during Q3 to just 64.7 percent, per STR, dragging rates and revenues down along with it. The market is poised to rebound, however, with Ten-X Research indicating RevPAR will see gains of about 6.5 percent through 2018. A diverse economy, buoyed by healthy gains in the financial activities and transportation/utilities, also helps minimize the market's risk in the near-term. Revenue per room in the metro are expected to remain healthy – declining just 4.3 percent – during the expected cyclical downturn in 2019 and 2020.
Sell Markets
Houston
The prolonged oil price slump continues to take its toll on Texas' largest city, highlighted by a 6.8 percent decline in energy and manufacturing jobs to this point in 2016. Area hotels are seeing a corresponding dip in demand right as a flood of supply comes to market, plunging occupancies down to 64 percent and revenue per room taking a massive 15.6 percent hit year-over-year. Additional supply looms on the immediate horizon as oil prices show no sign of regaining significant momentum, making the city especially vulnerable to a cyclical downturn in 2019 and beyond.
New York City
New York's economy continues to soar to nearly unprecedented heights, though its hotel sector is not sharing in the spoils. The industry's fundamentals continue to weaken amid a steady stream of supply additions that have boosted the city's total rooms more than 5 percent over the last year. While that pipeline is poised to continue at its torrid pace, competitors such as Airbnb continue to create shadow supply, contributing to year-over-year declines in both room rates and revenue per room. The city, along with other high-profile markets, also finds itself at particular risk for any slowdown in international travel thanks to the strong dollar. Ten-X Research projects the occupancy to fall to 83 percent by 2018, followed by another dip of approximately 5 percent over the next two years, making for a bleak overall outlook for the market.
Pittsburgh
Pittsburgh's overall economy remains in a firm decline, with total metro employment now 0.2 percent lower than it was during the third quarter of 2015. Limited growth in its education/healthcare services and professional/business services sectors – the city's two largest – have been offset by outright contract in a number of other industries, and population has now dipped for three consecutive years. Those troubling trends have made their way into the hotel market, where an infusion of supply and falling demand has driven occupancies down 660 bps year-over-year and revenue per room has declined by roughly 11 percent. A turnaround appears unlikely in the near term, as Ten-X data shows demand struggling to absorb unrelenting supply additions. By 2020, occupancy rates are likely to fall as low as 54.6 percent, making it an unattractive setting for prospective buyers.
San Jose
The poor state of San Jose's hotel market comes in spite of an economy that continues to grow at a torrid pace, including soaring wages and total employment numbers. Occupancies in the area's hotels dropped a full 100 bps to 75.8 percent during Q3, and has now faced three consecutive quarters of decelerating demand growth. Room rate growth has also slowed, jumping just 4.7 percent over the last year. Ten-X Research forecasts occupancy rates to level off until 2018, when a wider economic slump will send them plummeting to as low as 62.7 percent owing to the local economy's high volatility. While the boom surrounding San Jose's tech and service industries continues to push employment and population to all-time highs, investors should be wary of strong domestic outflow and poor housing affordability, which could eventually spell trouble for the city's labor market.
Northern NJ
Hotel occupancies in the Garden State's northern reaches increased during Q3, though that represented a blip on an otherwise discouraging radar. Its downward trend, which includes a 2.9 percent dip in revenue per room, can be attributed largely to a glut of supply being added to the market, according to Ten-X Research. Though that pipeline is set to soften in 2017, the region is projected to continue to suffer from weak demand that will keep occupancies trending downward. This will be exacerbated by rising supply and falling room rates in neighboring NYC, as the market typically draws some of its demand as a cheaper option for travelers to the city. The area's economy continues to see only tepid employment and population growth, making significant growth in its hotel sector unlikely for the near future.
