2008 Hotel Profits To Worsen in '09

ATLANTA - A new report by a hotel research firm shows that hotel financial performance numbers were bad in 2008 and that those numbers are only getting worse. PKF Hospitality Research observes that while hotels were able to preserve profits by cutting costs, revenues are dropping now to a point where they are bumping against fixed costs.

When faced with lower levels of business in 2008, U.S. hotel managers cut operating costs by 0.3 percent. Unfortunately, total hotel revenues dropped 1.3 percent, resulting in a 3.8 percent decline in net operating income for the average U.S. hotel according to the 2009 edition of Trends in the Hotel Industry. Given the depth and breadth of the continuing economic downturn, further expense cuts will not be enough to offset the anticipated declines in revenue in 2009.

Forecasts of a double-digit decline in rooms revenue per available room (RevPAR) during 2009 are troubling enough. However, for the lenders, owners, and managers of U.S. hotels, the real concern is the impact on profitability. While the fall-off in lodging performance was not as great last year as it will be in 2009, an analysis of the 2008 data could prove instructive as a guide to how U.S. hotel managers will react this year as business levels continue to deteriorate.

Now in its 73rd year, PKF Hospitality Research (PKF-HR) collects financial statements from thousands of hotel owners and operators across the U.S. for its annual report. For the purpose of this analysis, net operating income (NOI) is defined as income before deductions for capital reserves, rent, interest, income taxes, depreciation, and amortization.

Revenues In 2008

Total revenue for the average property that participated in the 2009 survey declined 1.3 percent from 2007 to 2008. The main driver for the decline in revenues was the 1.8 percent drop off in occupancy. Not only did rooms revenue decline 1.0 percent, but food and beverage revenue fell off 3.0 percent as well.

Not all property types in the survey reported declines in revenue in 2008. Total sales at both limited-service and convention hotels increased slightly during the year. Resort hotels suffered the greatest decline in revenue (-4.6 percent) because of a 5.1 percent drop in occupancy, as well as declines in both food and beverage and other operated department revenues.

Expenses In 2008

As we have seen during past industry recessions, U.S. hotel managers responded to falling revenues by cutting costs 0.3 percent. When reviewing the changes in departmental costs from 2007 to 2008, it becomes clear that the nature of the expenses within each department determined the direction and magnitude of change.

Expenses within departments for which management has the greatest control either declined in 2008, or grew at less than the pace of inflation. Given the high degree of variable expenses found in the operated departments (rooms, food and beverage, other operated), the combined costs for these areas of a hotel decreased 1.5 percent from 2007 to 2008. Overhead departments were not immune to cost containment in 2008. Excluding utility costs, undistributed departmental expenses (administrative and general, sales and marketing, property operations and maintenance) increased a mere 0.3 percent during the year.

On the other hand, departmental expenses that are more fixed in nature grew greater than 3.0 percent. In 2008, growth in excess of inflation was observed in the utilities department (3.6 percent), property taxes (4.2 percent), and insurance (3.1 percent). Green practices, contract re-negotiation, and property tax appeals are available methods for management to reduce these costs. However, since they take longer to implement, the impact of these means may not be seen until 2009.

Profits in 2008

With total revenue off 1.3 percent and expenses cut just 0.3 percent, the typical hotel in the Trends survey suffered a 3.8 percent decline in net operating income. Except for convention hotels, all property types experienced a decrease in NOI.

Resort hotels reported the greatest decline in NOI (-11.3 percent) for 2008 followed by full-service properties (-5.1 percent) and suite hotels with food and beverage (-2.7 percent). Limited-service properties and suite hotels without food and beverage also suffered declines in NOI, but to a lesser degree.

The exception to the national trend was convention hotels. Properties in this category enjoyed a 3.2 percent growth in profits from 2007 to 2008, largely attributed to a relatively strong 3.0 percent gain in ADR. It appears that contracted group rates negotiated prior to 2008 helped to offset the discounting that occurred during the fourth quarter of the year.

Lessons From Past Contractions

While hotel managers faced challenging market conditions in 2008, the magnitude of the declines in revenue do not match the severity of the fall off in performance forecast for 2009. To simulate the potential impact of declining revenue on profits during the current industry recession, it is helpful to take a look back at lodging industry performance during the 2001 industry recession.

In PKF-HR’s 2001 Trends survey, properties with excessive RevPAR declines saw their profits fall off 24 to 31 percent from the prior year. As of August 2009, PKF-HR is forecasting a RevPAR decline 18.5 percent for the entire year.

This downside benchmarking exercise provides some interesting insights as to the direction of U.S. hotel profits in 2009. Given the inevitable decline in revenue for most properties, the focus once again will be on cost containment. Unfortunately, despite everyone’s best efforts, the magnitude of the declines in revenue will more than likely exceed the expense reductions, thus leading to further deterioration in profits in 2009.

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Robert Mandelbaum is Director of Research Information Services for PKF Hospitality Research. To purchase a copy of the 2009 Trends® in the Hotel Industry report and receive a complimentary copy of PKF-HR’s Downside Benchmarker tool, please visit www.pkfc.com/buyannualtrends. Portions of this article were published in the July 2009 edition of Lodging.

photo of Robert Mandelbaum