Hotels in Profitable Part of Business Cycle
Despite the slowdown in the pace of rooms revenue (RevPAR) growth in 2013, U.S. hotels were able to sustain strong gains in net operating income (NOI) during the year.
Looking forward, the combination of rising average daily rates (ADR) in a low inflation environment will allow for a continuation of profit growth in excess of 10 percent through 2015. This five year period (2011-2015) of continuous double-digit gains on the bottom-line will be the longest such streak for U.S. hotels since the high inflation days of the late 1970s.
Based on a sample of operating statements from approximately 7,000 properties in the U.S. that participated in PKF Hospitality Research, LLC's (PKF-HR) 2014 Trends in the Hotel Industry survey, unit-level hotel profits increased by 10.1 percent from 2012 to 2013. This was the result of a 5.4 percent gain in total revenue, along with a 3.7 percent increase in operating expenses. For the purpose of this analysis, profits are defined as NOI before deductions for capital reserve, rent, interest, income taxes, depreciation and amortization.
Other Revenues Bounce Back
The initial years of the U.S. lodging industry recovery for the 2008-2009 recession were led by strong gains in occupancy. However, once the growing number of guests checked in, hoteliers struggled to entice them to spend money on other hotel services and amenities. This general trend continued into 2013, but there were signs of improvement. During the year, RevPAR for the Trends sample increased by 5.9 percent, while the combined revenue from food and beverage, other operated departments, and rentals and other income grew by 4.2 percent. This growth rate for other revenue sources is up from the 2.3 percent increase posted in 2012.
Measured on a dollar-per-occupied room basis, the increase in other revenues grew from 0.5 percent in 2012 to 2.7 percent in 2013. This indicates that either hoteliers were able to raise the prices for the additional services, or more guests took advantage of the on-site restaurants and lounges, recreation venues, and other miscellaneous service outlets.
Despite a slowdown in RevPAR gains, the increase in revenues from sources other than the rooms department resulted in a rise in the pace of total hotel revenue growth. Total hotel revenues increased by 5.4 percent in 2013 compared to just 5.0 percent in 2012.
Variable vs Fixed Costs
Like other industries, hotel operators are tasked with controlling both fixed and variable expenses. In short, variable expenses increase or decrease as business volume expands or contracts. On the other hand, fixed expenses are impervious to fluctuations in business levels. Changes are influenced by external factors such as climate, inflation, and other economic conditions. In the hotel industry, operated department expenses tend to be highly variable, while the majority of undistributed expenses are mostly fixed in nature.
In 2013, operated department costs increased by 3.9 percent, while undistributed expenses rose by just 3.1 percent. Clearly the lodging industry is at a point in the business cycle when business volume is covering most of the fixed undistributed expenses, while continued growth in occupancy is driving the variable departmental costs.
Some lodging expenses are almost entirely out of the day-to-day control of management. These include expenses such as utilities, property taxes, and insurance. In 2012, utility costs at U.S. hotels declined from 2011 levels. Unfortunately, this downward trend ended in 2013 as the combined cost of electricity, gas, steam, water, and sewer increased by 2.0 percent. Property taxes and insurance grew by 3.9 percent in 2013, an increase from the 3.5 percent growth rate observed in 2012.
Profit Growth for All
All property types enjoyed growth in profits during 2013. For the year, NOI for the average hotel in our Trends sample grew by 10.1 percent in 2013. Resort hotels enjoyed the greatest gain in NOI (11.9%), followed by full-service (11.5%) properties. Lagging behind the overall average profit growth rate were limited-service hotels (6.8%), suite hotels with F&B (6.8%), and suite hotels without F&B (7.9%).
Convention hotels achieved a profit growth of 8.2 percent in 2013. While this was less than the overall sample average, it is greater than the profit growth these properties achieved in 2012. The increased profitability of convention hotels is consistent with the initial stages of the recovery of the group demand segment.
A Profitable Environment
An accumulation of factors results in a business environment that is currently very conducive to significant growth in hotel profits:
- PKF-HR Hotel Horizons forecasts limited gains in new competition through 2016.
- Future gains in RevPAR will be driven by growth in ADR.
- Revenue from sources other than guest room rental showed signs of growth in 2013.
- Moody's Analytics is forecasting the national unemployment rate to remain above 5.5 percent through 2017, thus tempering the growth of salaries and wage rates
- Moody's Analytics is also projecting inflation to grow less than 2.5 percent through 2018, which in turn will limit the growth of fixed expenses.
Based on the preceding factors, PKF-HR is forecasting unit-level NOI increases of 12.4 percent in 2014, and another 14.2 percent in 2015. By 2014, the average hotel in our Trends sample will finally achieve bottom-line profits greater than their pre-recession peak on a nominal basis. By 2015, real profit recovery will occur.
Written by Robert Mandelbaum, Director of Research Information Services, and Gary McDade, Research Analyst, both work in the Atlanta office of PKF-HR (www.pkfc.com). To purchase a copy the 2014 Trends® in the Hotel Industry report, please visit www.pkfc.com/buyannualtrends. This article was published in the June 2014 edition of Lodging.