by Robert Rauch
The big news in 2016 was Marriott’s merger with Starwood and provides the new company with over 1,000,000 hotel rooms in 5,700 hotels, 30 brands and huge bargaining power with online travel agencies. The second was the Republican sweep—President Donald Trump will have an opportunity to change the economic landscape. President Trump has a majority in both the Senate and House of Representatives and if he focuses on tax reform, wages, regulations and the strength of our nation, he could keep this long but slow recovery going and dramatically enhance it.
Oil prices are back up around $50, consumer confidence is solid, interest rates remain low albeit forecast to inch up and the economy seems stronger than what we had initially forecasted last year. A soft landing is no longer imminent—in fact, gross domestic product may actually approach 3 percent in 2017, double what we forecasted a year ago for this coming year. Adding personal income growth, consumer confidence and low unemployment together with strong corporate earnings indicates that both the leisure and corporate traveler have the means to travel and pay for lodging.
There will always be naysayers, so what caveats could stall the economy? International markets are not as stable as the combination of a strong dollar and possible impact from travel bans could play a role in the way the global economy behaves. China’s economy is slowing, Japan’s economic lethargy continues and conflicts exist from North Korea to Iran and much more. The chances that a prolonged global funk would impact the U.S. economy today are much higher—we are not immune to any global crisis. Notwithstanding the aforementioned, if we continue the Visa Waiver Program, 2017 will be a solid year for international travel despite the strength of the dollar.
U.S. Lodging Industry
U.S. hotels grew revenue per available room (RevPar) at more than a 3 percent clip in 2016. This is down from over 6 percent in 2015 but that was somewhat expected, especially after a very slow Q1 2016. Occupancy growth slowed in Q3 and Q4 as demand from corporate clients experienced a decrease (some of it oil sector related) and an increase in new supply threatens some markets. At the same time, low gas prices fueled some growth in leisure travel. Occupancy levels are at a historic high and average daily rate (ADR) represents all of RevPAR growth. We see no reason that the economy cannot stay afloat and thrive in 2017 and keep ADR growth at that 3 percent level, albeit not enough to keep pace with costs.
New supply is not likely to stop the continuation of positive RevPAR growth for 2017. Banks will begin to put the brakes on lending in time to avoid approving deals that are just too late in the cycle for aggressive underwriting. That means those who are experienced, have solid equity, strong brands or unique ideas, are in great markets and are considered trustworthy and solid borrowers will be able to develop so long as their leverage requirements are not considered frothy. Increased developer cost of capital, new supply and Airbnb and others in the “sharing economy” are marginally reducing feasibility. Development economics in many markets will not support new construction.
While these factors might curb supply growth, the “sharing economy” is not going to have a material impact on demand in most markets and International travel will not go away if the American Hotel & Lodging Association holds strong in support of the Visa Waiver Program. Ergo, it will be something else that stops this growth—a Black Swan event or a global meltdown are not likely to occur but could certainly stop this positive growth. Only time will tell but 2017 looks rock solid.
CBRE Hotels’ Americas Research is projecting that the U.S. lodging industry will achieve an annual occupancy rate of 65.3 percent in 2017, just shy of the 65.4 percent all-time record occupancy level expected for 2016. Average rate growth should finish at 3.1 percent. The big challenge might be to reverse some of the trends that hoteliers have been battling relative to high costs of health care, wages and supplies. Further, CBRE has issued a report on reduced labor productivity. Hence, net income may have peaked unless we can successfully reverse these cost trends.
STR’s Jan Freitag is forecasting 2.5 percent RevPAR growth in 2017 and many feel he is being conservative. That comes after a year of RevPAR growth of just over 3 percent. It seems that this will be the year that supply exceeds demand so there is likely to be a slight decline in occupancy and average rate growth of 2.8 percent.
Trends to Watch: M&A, Foreign Capital, Values and Costs of Doing Business
With RevPar growth slowing across many markets, brands and management companies are looking to grow net income and synergies by adding hotels. Expect to see continued consolidation among hotel operators and franchise companies as there is a need to remain competitive and show Wall Street and investors some strong growth trends.
According to JLL, “the proportion of investments funded by off-shore capital reached an all-time record of 33 percent in hotel deals in 2016. In 2017, with more uncertainty regarding how capital from mainland China will shape up, this proportion is expected to decrease, but remain in line with the recent multi-year average.”
Last year, the Chinese government announced significantly tighter measures on outbound capital but mainland Chinese investors continue to be players for trophy assets in key global markets and more recently, investment in secondary markets. From 2010-2015, Chinese investors spent over $17 billion in the U.S. and that continued well into 2016. As currency devaluation continues, the Chinese still believe that transactions in the U.S. can result in a double digit return and are hence, attractive.
Speaking of China, notwithstanding the economic slowdown, “the Chinese outbound travel market is number one in the world,” according to HotelREZ Hotels & Resorts. Some researchers have indicated that the number of outbound travelers from China will reach 200 million by 2020. If we get our fair share here in the U.S. that will mean tens of millions of Chinese travelers will travel here in 2020.
According to Kalibri Labs, just 10 years ago OTAs had just a 5-6 percent share of the market; now it is more than double that. While brand.com still leads the way, Cindy Estes-Green and Mark Lomanno of Kalibri Labs indicated that $147 billion in room revenue was consumed in the U.S. last year and only $123 billion went to the hotel (84 percent). The direct channels seem to be taking quite a beating. According to Kalibri Labs, following is the way the pie slices added up in 2016:
- Direct to property – 34.3%
- Brand.com or hotel property website – 20.0%
- Groups, Meetings or Events – 14.2%
- OTAs (online travel agencies) – 12.4%
- GDS (travel agents) – 9.5%
- Voice (telephone) – 8.1%
- Other – 1.4%
Today’s labor costs represent nearly 45 percent of hotel costs when we factor in worker’s compensation, health care costs and other payroll related expenses so we must hire the best available talent. Distribution costs, due to reliance on OTAs as a direct substitute for poor performance of weak brands and the needs of independent hotels to be relevant, have been increasing as indicated above.
What do these cost increases mean to values? Assuming capitalization rates remain the same, a decrease in net income of $125,000 reduces a hotel’s value by about $1 million. An average limited-service hotel in the U.S. is approximately 90-100 rooms, with revenues of about $3 million and net income or EBITDA of about $900,000. That $125,000 can hit quickly between OTA commissions, labor, health care costs and related expenses. Enough bad news.
On the good news side, artificial intelligence, text and chat and mobile check-in are three of the ten trends we identified for 2017. See our related article here.
Specific Markets
We would be remiss if we did not offer any hints about our two home markets of San Diego, CA (detailed sub-market analysis featured below) and Phoenix, AZ. While our growth is largely into Arizona, California and Colorado markets at the present time, we have 15 hotels in San Diego County and 5 in Maricopa County in Arizona (Metro Phoenix). Overall, in California, the major markets in both the San Francisco Bay Area and the Los Angeles Metropolitan Area experienced very strong average rate growth and marginal occupancy growth (one exception was the relocation of guests in NW Los Angeles area). Silicon Valley will benefit from construction at the Moscone Center in San Francisco.
Phoenix
Look for continued job growth as Arizona finished 2016 with over 3 million in the workforce and Metro Phoenix surpassed 2 million workers. With Governor Ducey in control, the pipeline for new businesses and expansions is stronger than I have witnessed since arriving in Arizona in 1978. Incentives play a big role, but a “stable and predictable business climate, workforce depth, quality of life and education pipeline are the most cited reasons CEOs have said Arizona beat other states and markets,” according to the Phoenix Business Journal.
With minimal new supply growth, (Tempe is an exception but new corporate growth in that submarket has kept pace with new supply) the Metro Phoenix market will have a very strong 2017. Comparisons to the record year of 2015 made the first half of 2016 look weak but it picked up dramatically in Q3 and Q4.
In 2017, with a very nice boost next week from the NCAA Basketball Tournament and the last games of Spring Training baseball games, average rate growth should be 4 percent with an additional 2 percent in occupancy growth. We expect occupancy, average rate and revenue per available room to finish close to 69 percent, $125 and $86 respectively.
A Soft Landing? Not Likely in 2017
2017 looks to be another solid year for the lodging industry with three percent growth in gross domestic product, nearly double what we originally forecasted early in 2016. We are no longer calling for a soft landing in 2017 (it still could occur in 2018) but that can change due to a multitude of unpredictable factors. Look for technology to play a huge role in how this year shapes up as trends of doing business can directly impact demand on individual hotels. This idea carries into the industry as a whole as we continue to catch up with the technology of today.
Check out our detailed 2017 San Diego Forecast here.
To a successful 2017 and beyond!
