By Mark D. Podgainy
The hospitality industry experienced a modest increase in RevPAR in 2023, and the industry seems to be optimistic about the future. What’s ahead for 2024? Uncertainty is the major theme.
What’s Ahead
• Interest rates will be higher for longer. Expectations of a number of rapid cuts to the Federal Funds rate early this year have been dashed with the latest inflation data. Most economists still expect reductions in the Federal Funds rate but have pushed back the time frame for the first reduction to late spring and have reduced their forecasts for the number of reductions. If inflation remains stubbornly high, the first rate reduction could be pushed back even further. The strength of the economy continues to be underestimated.
• The likelihood of a continued economic slowdown remains, but the risk is much lower than it was last year. The big question is: Will the U.S. consumer continue to spend? Despite clouds on the horizon (e.g., increases in auto loan and credit card default rates), the consumer has continued to spend so far. The consumer’s healthy spending is of critical importance to the hospitality industry since the recovery has been led by leisure travel and continues to be driven much more by ADR growth than occupancy. Fortunately, foreign travel has been coming back and will be a more important element of demand in 2024.
• Weakening consumer demand will pressure both ADR and occupancy. 2023 U.S. RevPAR exceeded 2022 levels by 4.9%, driven primarily by higher ADR (up 4.3% to 2022).[1] It is unlikely that hotels can continue to drive RevPAR through higher rates without consumer pushback, so expect more price resistance from leisure travelers this year. Further, a financially challenged consumer may reduce the number of trips made in 2024.
• Continued recovery in business travel will take the form of group, rather than transient business travel. The work from home trend has made it more difficult to see people in a one-on-one setting, and the gradual return to office has slowed to a trickle. Therefore, business travelers are relying on conventions and trade shows for in-person meetings.
• Inflation will hang around, but at lower levels than before. Inflation has been declining noticeably for the last year but is still stubbornly high, particularly due to wages, travel costs, and cost increases in the service sector. Further pressures exist, including transportation issues due to attacks on Red Sea shipping and the drought affecting the Panama Canal that are likely to increase shipping costs. These issues increase the uncertainty surrounding inflation.
• Margin pressure will grow. Hospitality wage inflation has been, and will continue to be high, and labor shortages will persist. According to a recent survey from the American Hotel & Lodging Association, two-thirds of respondents claim to be experiencing staffing shortages. The supply-demand imbalance, along with state and local wage mandates will keep labor costs high and impact margins. In addition, insurance rates have increased significantly, and there is no end in sight. The real question is how much higher will they climb.
• Properties that have held off on PIPs will need to address them. Since Covid-19, capex spend has been significantly below normal levels. Owners will need to increase spending to address brand requirements, due to increasing pressure, and to maintain favorable market positioning and competitiveness, but at significantly higher design, material and construction costs than pre-Covid-19. In addition, supply chain issues may return, delaying shipments of material and FF&E.
• Financing will continue to be more difficult to obtain, and expensive. Many regional and local banks pulled back from commercial real estate lending in 2023 and are seeking to return and redeploy capital to other sectors of the economy. Though private credit lenders have jumped in to provide needed capital, the interest rates are higher. Further, credit officers will continue to be careful about the deals they do until declining interest rates indicate the worst is over.
• The price gap between buyer and seller will likely shrink, enabling more deals to get done. Once the Federal Funds rate starts to decline there will likely be an increase in the number of transactions as buyers and sellers see light at the end of the tunnel. Higher transaction volume will provide more data points and therefore more confidence in values, which will further encourage transactions. Similar to 2023, sellers with the highest quality assets will be in the best position to get the pricing, terms, and structure they desire.
Key Implications
• Similar to 2023, there will be continued pressure on the P&L, both on the top line and on expenses. A challenged consumer, persistent (though lower) inflation, and high labor, insurance and services costs will challenge P&Ls in 2024. Owners and operators will need to be watchful and disciplined, including closing and reviewing monthly P&Ls timely so that cost issues can be identified and addressed quickly. Reducing labor through technology and creative use of vendors and suppliers will be beneficial.
• Owners facing debt maturities need to be proactive in the event of refinancing issues. Going to market early for refinancing is prudent due to longer due diligence lead times and increasing difficulty of obtaining affordable financing. Additional equity contributions may be required to make financing affordable and to facilitate transactions in a higher cap rate/lower LTV world. Banks are incentivized to extend mortgages for at least a short period of time to avoid potential write-downs, so arranging an extension may be the best option to buy time until the financing environment improves. Hiring professionals to assist with obtaining and negotiating financing is prudent as they have the pulse of the market and can save owners time and money in obtaining the best available deal.
• Pressure to initiate PIPs and renovations may result in transactions. Owners who don’t have the financial wherewithal to finance needed/required PIPs through their own equity or debt financing will need to find an equity partner or sell the property.
• Transacting your way out of trouble in the near term will be difficult. Until the markets open up, the ability to refinance or sell out of trouble will be limited. However, given the pressure on regional and local banks with large real estate loan books to contain losses, there may be opportunities to negotiate short term extensions to buy time.
[1] Source: CoStar and Tourism Economics
