Hospitality Is Facing Near-Zero ADR Growth. But Here's Where It's Thriving.
Whether a recession comes in 2020 or not, hotels will continue facing industry-wide profitability challenges from a host of directions this year and next, experts said Thursday.
Most have already materialized to a degree, in spite of near-peak occupancy levels that have helped support a steady increase in hotel supply, and the effects of the coronavirus are only now starting to accelerate. In a short time, the virus, which causes the disease COVID-19, has ravaged many of the country’s top hospitality markets, leading to an overall revenue per available room, or RevPAR, year-over-year drop of 11.6% in the first week of March, according to new data from STR.
The impact of the coronavirus on hospitality, which STR Senior Vice President Jan Freitag said Wednesday will likely “get worse before it gets better,” is layered on top of some already big changes happening within the sector, according to Evan Weiss, LW Hospitality Advisors principal and chief operating officer.
“The industry already was entering a point where supply was outpacing or certainly meeting demand,” Weiss said. “The industry generally has shifted.”
By the end of 2019, the nationwide construction pipeline consisted of 5,748 hotel projects (708,898 rooms), marking the eighth consecutive year of pipeline growth and 135 projects shy of the all-time peak (seen in Q2 2008), according to Lodging Econometrics. In New York City, for instance, so many hotels are coming online that Mayor Bill de Blasio has pushed the city to require a special permit for hotel development.
The national hotel pipeline's size, and its makeup of more limited-service hotels, have been factors in slowing revenue growth, as have short-term rentals to a degree, Weiss said.
Even as occupancy rates have held strong, the traditional hotel industry hasn’t seen any inflation-adjusted ADR growth since 2016, according to CBRE. In the brokerage's report from earlier this year on short-term rentals, it cites several studies showing a significant negative impact of new traditional and STR supply on RevPAR. Both the growth of STRs and their fluidity have presented problems for traditional hotel owners and operators, CBRE Senior Managing Economist Jamie Lane said.
STR market penetration, or the percentage of total lodging inventory made up by STRs, reached 10.4% and is expected to hit 12.2% this year, CBRE projects in its report. But a portion of that only becomes available during high-demand times of the year, when hotels have traditionally been able to charge higher rates, Lane said.
“[STRs] are coming in during high-demand periods and leaving during low-demand periods,” he said.
On top of slowing revenue growth, hotels are also being squeezed by increasing costs, Weiss and others point out. A reaction to that has been to build more limited-service hotels, but that in turn has tended to undercut industry-wide ADR growth through a smaller product that commands lesser rates.
“If you look at what type of supply has been added, for the most part, it’s a lot of limited-service, select-service hotels, which are more cost-efficient to operate,” Weiss said.
In many markets, especially those seeing thousands of rooms under development like NYC and the San Francisco Bay Area, continually soaring construction costs make building higher-end hotels difficult, he said. In 2018, the average per-room development cost for a full-service hotel came out to about $397K, more than double the $149K average for a limited-service hotel room, according to hospitality consulting firm HVS.
That limited-service hotels are also less labor-intensive has resulted in their rise as well. Like other industries, hospitality has seen profits pressured by minimum-wage legislation and a tight labor market.
To Weiss, the most pronounced result of cost pressures for hotel owners and operators is the introduction of micro-hotels and even just smaller rooms in general. Thousands of sub-200 SF rooms added — first by upstarts like Yotel and then by big operators like Marriott International — have also cut into ADR, while also giving developers better return on investment through density and more rooms.
An intensifying emphasis on modular construction has also enabled more limited-service hotel production. Marriot International and citizenM have embraced the technology for limited-service hotels and select-service hotels, respectively.
Some innovation exists that bodes well for more traditional four- and five-star hotel owners and operators. Though getting rising labor, insurance and property tax costs to budge is unlikely, cost savings through energy efficiency is a budding opportunity for hotel owners, according to Carbon Lighthouse Executive Vice President JJ Steeley.
With about $70M in venture capital raised, Carbon Lighthouse operates in a growing energy-as-a-service market, using proprietary artificial intelligence software to identify mechanical inefficiencies in systems like HVAC or lighting.
Though it works on multiple property types, the San Francisco-based startup has found higher-end hotels like Montage Beverly Hills and Claremont Club & Spa in Berkeley, California, which it says it has saved a projected $300K in energy costs, as especially in need of its services, Steeley said.
Because of a hotel building boom in several major markets, “it’s just harder for hotels to capture top-line revenue they were hoping for, and at a time when labor costs have escalated,” Steeley, a veteran of the hospitality industry, told Bisnow. “It leaves energy open as a more interesting area to affect net operating income.”
Also working in favor of nicer urban hotels is that ADR might not be quite as stagnant as it seems. The growing use of urban resort fees of often around $40 make it “tough to say ADR is truly flat,” Weiss said.
Moreover, for all its rising costs and slowing ADR growth, high occupancy seems to have so far kept many of the hotel industry's challenges at bay. In 2019, it still enjoyed near-peak growth operating margins of 37.9%, down only slightly from the recent high of 38.6% in 2017, according to CBRE’s Lane.
But oversupply from an ever-growing development pipeline still might loom, as does a potential recession. Economist Alan Blinder, a former Federal Reserve vice chairman, told CNBC on Wednesday that he thinks the latter is already underway thanks to a slowdown from coronavirus uncertainty.
If so, hotel owners should hope to have access to credit and good relationships, both Weiss and LW Hospitality Advisors President and CEO Dan Lesser said.
“It’s bound to happen,” Lesser said. “Everybody’s been waiting for the black swan event.”